Economic Development(525)

Prepared by

Dr. Ahmad Mouneer NAJJAR

www.cba.edu.kw/mouneer

• mouneer@cba.edu.kw

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Subject : 1

Economics, Institutions, and Development: A Global Perspective

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living condition around the world

a brief comparison:

in rich countries: a small “nuclear” family will enjoy many comfortable features:

big house, cars, separate bedrooms, many consumer goods usually manufactures outside, schools, healthcare, choose their careers, high annual income, and live longer.

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in poor countries: an “extended” family will almost “fight” to live:

small house, 1-2 crowded rooms, separate bedrooms, low annual income ($200-$300), children attend school irregularly, the elderly cannot write or read, no sufficient 1-2 meals a day, sickness......

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yet in other countries.... the story in different!

sharp contrasts in living conditions from one section to another within the same country.

examples...( Egypt – USA- Indonesia France….)-

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the development process

why does poverty exist in different countries and within the same country and same city?

international and national differences in standards of living...

can we overcome such problem?

what process that can be applied to solve the problem?

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the development process: an overview

started with Adam Smith’s “Wealth of Nations”

A systematic study of the problem and process of development started in the past 50 years

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the nature of development economics:

traditional economics:

concerned with efficient,

least cost allocation of scarce productive resources,

optimal growth of these resources,

economic rationality.

political economy: study social and institutional processes through which certain groups of economic and political elites influence the allocation of scarce productive resources

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development economics: efficient allocation of scarce productive resources and their sustained growth, it deals also with economic, social, political, and institutional mechanisms

more developed countries (MDCs)

less developed countries (LDCs)

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Subject ( 2)

What do we mean by development

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Development may mean different things!

Traditional economic measurements:

to generate and sustain an annual increase in gross national income (GNI) 5%-7% or more.

growth rate of income per capita:

to expand its output at a rate > population growth rate

real measures vs. nominal

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to measure the economic well-being of population: how much of real goods and services is available to the average citizen for consumption and investment.

Alteration( change in deepness) of the structure of production and employment: agriculture’s share declines while manufacturing and service industries increases.

yet, problems of poverty, discrimination, unemployment, and income distribution were of secondary important.

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the new economic view of development

during 1950s and 1960s many developing economies did reach their economic growth target

yet, for many people, nothing changed!(Like which countries ???)

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redistribution from growth and improving living standards

therefore, development must be viewed as a multidimensional process that involves among other factors:- changes in social structure- popular attitudes- institutions- in addition to classical economic measurements

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Sen’s “capabilities” Approach

income and wealth are not ends in themselves but instruments for other purposes

Amartya Sen: “... development has to be more concerned with enhancing or improve the lives we lead and the freedoms we enjoy.”

what a person is, or can be, and does, or can do.

different than utility approach.

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it is beyond the availability of a commodity and its use: functionings: - what a person does with the commodities of given characteristics that they come to posses or control.

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• thus looking at real income levels or levels of consumption of specific commodities cannot sufficiently measure the well-being

• one may have a lot of commodities, but are not what consumer desire( ex union soviet )

• one may have income, but some essential commodities for well-being may be unavailable. ( secure life in USA )

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• capabilities according to Sen:“the freedom that a person has in terms of the choice of functioning, given his personal features( capabilities ) and his command over commodities.

• this explains why development economists concentrate on health and education.

• growth without development.( could be or not ??)

• for Sen, human “well-being” means being well” issue to discuss.being healthy, well nourished, highly literate, having freedom of choice in what one can become and can do.

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Subject (3)-A

Core Values of Development

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• development is both: physical reality and a state of mind.

• in general, development means to have a “better” and “more humane” life.( quantity & quality )

• such statement must be reevaluated from time to time to determine what “better” and more means.

• such answer for developing nations today is not necessarily the same as it would have been in previous decades.( Kuwait situation after 70s & before )

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• three basic components or core values serve as a conceptual basis and guideline for understanding the inner meaning of development.

• these are common goals sought by all individuals and societies

• they relate to fundamental human needs

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(1)Sustenance( nessities ): The Ability to Meet Basic Needs

• sustaining basic human needs: food, health, and protection.( yes protection )

• أطعمهم من جوع وآمنهم من خوف

• if any is absent or in short supply: a condition of “absolute underdevelopment” exists.

• a basic function of all economic activity: to provide as many people as possible with the means of overcoming the helplessness and misery arising fro such shortness.

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• without sustained and contiguous(proportional ) economic progress at the individual and societal level, the realization of the human potential would not be possible.

• rising per capita real incomes, the elimination of absolute poverty, grater employment opportunities, and lessening income inequalities are “necessary” but not “sufficient” conditions for development.

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(2)Self-Esteem: To Be a Person

• a sense of worth and self-respect

• society’s values: differs across countries

• worthiness and esteem in developed vs. undeveloped

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(3)Freedom from Servitude( not in thecexact meaning ): To Be Able to Choose

• “the advantage of economic growth is not that wealth increases happiness, but it increases the range of human choices”

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the 3 objectives of development

• development is both: physical reality and a state of mind in which society has (through some combination of social, economic, and institutional process), secured the means for obtaining better life.

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1.to increase the availability and widen the distribution of basic life-sustaining goods (food, shelter, and protection)

2.to rise levels of living (higher income, more jobs, better education, greater attention to culture and human values...)

3.to expand the range of economic and social choices

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Subject 3(B)Growth and Development

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What is growth?

• Economic growth is the increase of a nation’s real output (GDP).

• Results from:• Greater quantities of natural resources, human resources,

and capital,

• Improvements in the quality of resources, and

• Technological advances that boost productivity.

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Development

• Economic development is the process by which a nation enhances its standard of living over time.

• The economic standard of living is often defined as GDP per capita.

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Growth and Development Models

• Harrod and Doman—Keynesian Growth

• Solow—Neoclassical growth

• Schumpeter—economic development and institutional change

• Nurkse, Lewis, Schultz—theories of economic development

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Sir Roy Harrod and Evsey Domar

• Sir Roy F. Harrod (1900-1978), University of London

• Evsey Domar (1914- ), Johns Hopkins and MIT

• Harrod viewed himself as more of a specialist on the int’l monetary system.

• “An Essay in Dynamic Theory” (1939), Economic Journal.

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Harrod’s Ideas• Based on two hypotheses:

• Capital and labor have to combine in a fixed proportion dictated by current technology to produce product.

• The saving rate is fixed.

• The rate of growth of the capital stock (“the warranted rate of growth”) is defined as the ratio of two constants:• Saving and investment per unit of desired output

• Stock of capital per unit of output dictated by technology.

• The rate of growth of labor is called the “natural rate of growth”

• Society is fully utilizing the capital and labor only if the “warranted” and the “natural” rates of growth happen to be equal.

• This is the “knife edge” problem. If investment is above the warranted rate, recession follows. If investment is below, inflation follows.

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Domar’s Ideas

• “Essay’s in the Theory of Economic Growth” (1957).

• Assumes:

• Fixed saving rate. Change in AD is proportional to the change in investment.

• The productivity of investment is constant.

• Net investment adds to the capital stock, increasing potential GDP.

• Investment spending also adds to aggregate demand, but investment spending must increase from period to period if the potential income arising from increased capital is to be realized.

• “Balanced growth” is a rate of income growth which maintains full employment of all resources. To achieve balanced growth, investment must increase at a rate equal to the product of the potential average productivity of investment and the propensity to save.

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Robert M. Solow (1924- )

• PhD, Harvard. Career at MIT.

• Contributions across the breadth of economics.

• Nobel prize in 1987.

• Solow’s theory on growth supports the neoclassical view that the economy naturally adjusts to achieve stable equilibrium growth.

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Joseph Schumpeter (1883-1950)

• Background

• 1908, The Nature and Essence of Theoretical Economics

• 1911, The Theory of Economic Development

• 1914, Economic Doctrine and Method

• 1939, Business Cycles

• 1942, Capitalism, Socialism, and Democracy

• 1954, History of Economic Analysis (published posthumously)

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Schumpeter (2)

• Starts with neoclassical model.

• Introduces entrepreneurship and innovation—change. The balanced, circular flow is disrupted.

• Innovations drive business cycles and development. Innovations occur in clusters.

• Innovation is followed by recession and depression, then recovery.

• Breaks down economic development three cycles:• Kitchin Cycles (40 months)

• Kuznet’s Cycles (10 years)

• Kondratieff Waves (35-55 years)

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Schumpeter (3)• Argues that capitalism will not survive.

• Rejects Ricardian and Socialist arguments for the decline of capitalism.

• Obsolescence of entrepreneurial function

• Collapse of Political Strata

• Institutions crumble• The cold, rational mindset of capitalism is destructive of moral

authority• Economic issues move to political sphere• Welfare state expands and takes over—guided capitalism to state

capitalism, etc.

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Theodore Schultz (1902-1998)

• Background and accomplishments.

• Nobel Prize, 1979. Cited his work in growth and development, as well as agricultural economics.

• Initiated the “human capital” revolution in economic thought. • Knowledge and skill are the result of investment, and

help to explain the productivity advantages of developed nations.

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Schultz (2)

• Human capital helps to explain three things:• We thought that K/L ratios should rise with growth, but in fact

they fall. The problem is that we are not including the entire stock of capital.

• Income has risen faster than the combined amount of factors. That is, there appears to be increasing returns to scale. How? Ans: better quality of factors.

• To develop economies, we should not focus solely on physical capital formation, but rather include human capital formation.

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Subject (4 )

Theories of Economic Growth: H.D-SOLOW & other

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Lucas (1985): “The diversity across countries in measured per-capita income levels, is literally too great to be believed”

Recall: growth depends on:

1.Accumulation of assets (K, L, land)

2. Increasing productivity of these assets

3.S( Saving) and I( Investment )

other factors influencing growth:

Government policy,

institutions,

political and economic stability

geography,

natural resource endowment,

health and education services quality

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This chapter: models of economic growth

In general: relating quantity of L and K,

their productivity, and the resulting aggregate

output

The Basic Growth ModelAggregate Production function

Is based on five equations

1. Aggregate production function Y=f (K,L)

2. Saving(S)= sY (s=.20 and Y=10bill, S=2B)

3. S= I (Saving=Investment)

4. ΔK=(I- dK) where d=depreciation and K= capital

5. Δ L= nxL n=population growth and L=Labor force, (If L=1mill. & n=.02)

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Combining 2,3,4, leads to

ΔK =sY-dK

5 equations and 5 variables can be solved

ΔK can be substituted into Production function Y=f(K,L)

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The Harrod-Domar Growth Model

HD Growth model is a particular model with basic feature of fixed coefficient production function.

It assumes no substitution between labor and capital Q= min F(L,K): the production Isoquant is L shaped

It also shows constant returns to scale (CRS) i.e. doubling inputs will double output

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Production function

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Harrod-Domar Prod. function

The production function Y= (1/v).K or Y=K/v, where v= constant or v=K/Y

v= capital output ratio or measure of the productivity of capital or investment. (indication of K intensity)

For example if v=4, then how 20 million investment will be needed produce 5 million output or 20/4 =5 based on Y=K/v

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ΔY=ΔK/v and g= ΔY/Y=ΔK/Yv ... growth rate of output

since ΔK =sY-dK:

g= (s/v)-d ... thus:

1.K created by I is the main determinant of growth in output

2.S makes I possible

The Basic HD Model Point: S more and make productive I and the economy will grow. This makes sense!

Example: if s=.24, v=3, and d=.05, then the economy will grow at 3% (why?)

[(s/v)-d] =(0.24/3)-0.05= 0.03=3%)

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Case Study: Economic Growth in Thailand

Thailand in 1960 was an agrarian economy with 75% of population in agriculture, GDP was about $1000, Life expectancy was 53, infant mortality was 103 per 1000

Beginning 1970 Thailand began to save averaging 20% and reaching 35% in 1990

This combined with good governance and prudent policies led to rapid economic growth

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Average income is more than 6 times it was in 1960,Life expectancy is 69, infant mortality 24 per 1000, adult literacy is 93%, Labor intensive manufacturing is 80% of exports and ICOR* rose from 2.6 to 4.1 by 1990.

Incremental Capital Output Ratio

The Solow Model

The Solow model is an improvement over Harrod-Domar Model

It drops fixed coefficient or no substitution and allows for substitution between factors

Y= f(K,L) Labor and capital are substitutable

The production function or Isoquant is u-shaped showing substitution as in figure 4.2

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if the production function facing a country i a neoclassical, then capital output ratio becomes a variable that influenced by relative prices, policies,...

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Evaluating the Solow Model: Strengths and Weaknesses

It is an improvement over H-D Fixed coefficient model

With neoclassical production function it allows for substitution between inputs

Provides good insights about the relationship between role of technology and innovation on growth

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Limitations: One sector approach, factors that drive steady state, and assumes saving rate, population growth , and technical change as given. It does not explain how these parameters change over time

Read: What Explains Differences in Growth Rates among countries

Key factors from a recent study: initial level of income, openness to trade, healthy population, effective governance, high saving rate and geography

The above policy variables explain the differences between 3 groups of countries from 1965-90

10 East Asian countries (4.6%)

17 African Countries (0.6%)

21 Latin American countries (0.7%)

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Summary of Theories of Economic Growth

I. Building blocks common to modern theories of growth: the production function (technology), saving and investment behavior, the relationship between existing stock of capital and new investment, and labor force growth.

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II. Three models of growth have informed much of the empirical work and policy analysis on developing economies. They are the HD growth model, which is short term in orientation and Keynesian in spirit; the Solow growth model, which is long term in orientation and neoclassical in spirit; and the Lewis two-sector model, which is also long term but is classical in spirit.

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The basic HD growth model suggests that the steady-state rate of growth is determined by the saving rate, the fixed incremental capital-output ratio (ICOR), and the rate of depreciation of fixed capital. Full employment is assured if this growth rate is equal to the rate of growth of the labor force. In terms of the realism of its (highly restrictive) assumptions and its widespread use by development institutions in formulating policy advice.

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III. The basic Solow model suggests that the steady-state rate of growth is determined by the saving rate, the flexible ICOR, and the rate of depreciation of fixed capital. Furthermore, factor substitution ensures that steady-state output, net capital, and the labor force grow at the same rate. This implies that all per capita variables remain unchanged in the long run following any changes in such parameters as the saving rate or the population growth rate. The basic model is extended to accommodate exogenously given, labor-augmenting technological change, which ensures that total output will grow at the rate of labor force growth plus technological progress.

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IV. A brief discussion of recent research that attempts to explain technological progress within the model (endogenize it) rather than taking it as determined outside the model. Endogenous growth models seek to understand how the interplay between technological knowledge (produced by such efforts as investment in human capital, R&D, and the diffusion of ideas to latecomers) and a country’s institutions affect the prospects for sustained economic growth.

Economic Growth and Development

Subject 4 : Continue

A Few Warm Up Questions

• What is “Development?”

• What is the difference between economic growth and development?

• What does it mean for a country to be “developing?”

• What factors (economic, political, cultural, social) are necessary for development to occur?

• Is promoting the growth and development of LDCs in the best interest of more developed countries?

The Wealth (and Welfare) Gap

• The 80/20 rule does apply …

• The richest 20% of the world’s population receives more than 80% of the world’s income

• At the other end of the spectrum …

• The poorest 60% receives less than 6% of the world’s income

A Few Other Comparisons

• The GDP of the U.S. is about 70% greater than the combined GDPs of all the developing countries in the world.

• The U.S.(with only 5% of the world’s population) accounts for more than 30% of the world’s output.

Defining the Challenge

• So, just how big is the global development challenge?

• Let’s take a look …

Obstacles to (and Sources of) Economic Development

• Natural resources

• Human resources

• Capital formation

• Technology

• Sociocultural and institutional factors

Natural Resources

• Availability of natural resources varies widely among LDCs

• If available, LDC natural resources are sometimes owned or controlled by foreign MNCs.

• Commodity prices subject to price volatility

• Without a strong resource base – a tougher road to development

Human Resources

• Overpopulation• Extremely low per capita income

• Relatively high population growth rates

• Any increase in income tends to increase population growth rates

• Un/underemployment

• Low labor productivity (literacy, health care, technology, investment)

Capital Formation

• Capital investment drives increases in labor productivity and per capita output.

• If output rises faster than population growth, savings may enable additional capital formation.

• But, generating savings is extremely difficult when income levels are so low.

Capital Formation

• Relatively high level of investment risk in LDCs acts as a disincentive for investment• Political risk

• Currency devaluation

• Poor public infrastructure

Technology

• Linked to capital investment

• Helps drive increases in productivity

• Ability to borrow technology from more advanced countries

• Lack of skilled labor and existing capital base can limit application of new technology

Sociocultural Obstacles

• Culture, tradition and custom

• Tribal allegiances and animosity

• Views regarding work and individual achievement

Institutional Obstacles

• Corruption and bribery

• Education systems

• Land ownership (too concentrated or too fractured)

The Vicious Circle

• Low per capita income …

• Creates a low level of demand and low (or negative) savings rate …

• Which limits new investment …

• Which maintains low productivity …

• And perpetuates low income, which is further reduced by population growth

• And the cycle begins again …

How Can More Developed Nations Help?

• Expanding trade

• Foreign aid (worth a separate discussion)

• Flows of private capital• Direct foreign investment

• Technology often moves with capital

• Selective regional focus

Subject 4: ContinueEconomic growth, economic

development, well-beingShould we increase it at all cost? – a question of national planning

Basic Concepts

What is Economic Growth?

• An increase in Gross National Product (GNP) or GDP

GNP: Measures the dollar value of all goods and services that an economy produces during a specified timeperiod - the throughput of stuff flowing through an economy

Economic Growth

• Is a quantity based concept - not quality based

• A direct measure of changes in the size of the economy• Is it a measure of welfare?

• Development?

• Sustainable development?

Importance of Economic Growth (via GNP)

• Political Importance• Domestic (4 year planning)• International (Must be better to have higher GNP/Cap., than lower);

IMF Policies

• Humanitarian Importance• As an indicator of welfare?• As an indicator of development?• As an indicator of sustainable development?• Remember:( invisible Hand- Absolute Poverty- Income

Inequality- Population Transformation )

What can we really use it for?

Basic Concepts

• GDP vs GNP

• Nominal or current GNP• Not accounting for inflation

• Constant or real GNP• Accounting for inflation

Standard National Accounts

• How to measure GNP?

• 3 methods:• Expenditures

• Value added of production

• Income

Standard National Accounts

Expenditures

• GNP = C + I + G + (X - M)

• Where:• C: Personal consumption expenditures

• I: Gross private investment

• G: Government expenditures

• X: Exports

• M: imports

Standard National Accounts

• Production side

• The sum of value added: the difference between revenue and cost.

• Accounted for all sectors of the economy e.g.• Agriculture, construction, manufacturing, trade, finance, services,

government

Standard National Accounts

• Income side:• Income earned by all factors of production

• Employee compensation

• Rents (return to housing)

• Interest payments (return to lenders of capital)

• Payment to owners (return to capital)

• Indirect business taxes (return to government)

Standard National Accounts

Net National Product

• NNP = GNP - Depreciation

Depreciation: reduction in capital stock due to use causing wear and tear.

National Income

• NI = NNP - indirect taxes

Available for spending

Standard National Accounts

• Personal Income:

PI = NI - Corporate profits - contribution to social insurance + transfer payments + interest income + dividend income

• Disposable personal income:

DPI = PI - personal tax payments

What does GNP measure?

• Total value of goods and services produced within an economy in a given year

• Measure of welfare, development, sustainable anything?

Definitions

• Welfare: measures quality of life

• Development: Quality based concept

• Economic income:Value of goods and services

• Sustainable income:How much we can spend without running down capital stocks - can maintain same level of spending in perpetuity

Definitions

• Economic Welfare: GNP corrected for expenditures on various regrettable necessities

• Human Welfare: Separation of means from ends - a direct measure of well-being

But can GDP be an indicator of human development or human welfare?

Do changes in GDP correlate to changes in environmental quality?

The Environmetnal Kuznets Curve

• Kuznets curve (KC) is the graphical representation of Kuznet’s theory from the 1940’s that economic inequality increases over time, then at a critical point begins to decrease.

• Environmental KC (EKC) shows a hypothesized relationship between various indicators of environmental degradation and income per capita.

ECK

• In the early stages of economic growth degradation and pollution increase,

• Beyond some level of income per capita (which varies for different indicators) the trend reverses, so that at high-income levels economic growth leads to environmental improvement.

• This implies that the environmental impact indicator is an inverted U-shaped function of income per capita.

ECK

• Various functional form found: EKC does not always apply

• Logistic Increase – e.g. carbon dioxide emissions

• Constant Decrease – e.g. bacteria in drinking water

• Inverted U – sulfur dioxide concentration

ECK

• Scale effect: Economic growth increases environmental pollution if there is no change in other factors

• Other factors explain the shape e.g.:• Change in output mix

• Change in input mix

• State of technology

• Production efficiency

• Demand for “improved environment”

Increase GDP at all cost?

Should we always aim to increase GDP?

What is the ultimate gain?

Happiness?

What is the cost?

Environmental degradation?• Remember Kuznets curve and IPAT

Stress?

Depends on what GDP really measures – is it an indicator of wealth?

What is (not) included in GNP?

1. Ignores income distribution• Can be fixed using Gini coefficient

2. Rough measure of employment

3. Must use real or constant values• Always use deflators

4. Does not capture well quality of products

What is (not) included in GNP?

5. Excludes some non-market and non-productive transactions - but not all• Excluded

• Things produced at home• If women only counted

• Childcare

• Subsistence production

• Things that are resold or reused• Increased durability reduces growth

What is (not) included in GNP?

5. Excludes some non-market and non-productive transactions - but not all• Included

• Consumption/production at farms of food and fuel

• Rental income of all houses

What is (not) included in GNP?

6. Depreciation of the capital stock• Neither man-made (Included in NNP) - increased depreciation increases

growth

• Nor natural capital

What is (not) included in GNP?

7. Treats some expenditures as final use - even if some are intermediate factors of production:

a) defensive expenditures• Households (included)

• Firms (excluded)

• Government (included)

b) Army expenditures (included)

What is (not) included in GNP?

8. No measure for leasure;

• Increased work increases GNP

9. Urbanization increases GNP

10. Includes various expenditures such as:1. Commuting

2. National defense

3. Police

4. Sanitation etc.

What does GNP measure?

• Wealth?

• Sustainable income?

• Hicksian income?

• Economic development?

• Sustainable development?

• Economic welfare?

• Human welfare?

Subject ( 5 )

Education & Development

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Introduction

• Education is a form of Human Capital

• Schooling vs Education?

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Trends and Patterns

• Stocks and Flows: Stock is amount of schooling embodied in a population

• Flows: Net change in those flows as a result of enrollment

• Gross enrollment rates have risen many parts of the world at various levels

• Net enrollment rates are enrollments of those relevant age

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Gross enrollment ratio: (GER) or Gross Enrollment Index (GEI) to determine the number of students enrolled in school at several different grade levels (like elementary, middle school and high school),

and examine it to analyze the ratio of the number of students who live in that country to those who qualify for the particular grade level.

'Gross Enrollment Ratio' the total enrollment within a country "in a specific level of education, regardless of age, expressed as a percentage of the population in the official age group corresponding to this level of education.

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The Net Enrollment Ratio (NER) is enrollment of the official age-group for a given level of education expressed as a percentage of the corresponding population.

For example, in 2005, Djibouti had the worst measured NER in primary education in the world at 34.4%.

http://data.worldbank.org/indicator/SE.PRM.NENR

Thus, out of every 100 children within the official age-group for primary education, only 34 were enrolled in school.

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Schooling versus Education

• There is a gap between rich and poor nations in educational quality

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The Benefits of Education

• Education is an Investment

• Education is a human capital investment

• Internal Rates of Return to Schooling

• Estimated Rates of Return

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Benefits of Education

• Present Value (PV) of all costs and benefits

• PVb= Sum of the present value of all future private benefits

• PVc= Present value of all anticipated private costs

• Internal Rate of Return is the rate or (r ) that which equates $PVb=$ PVc ( see formula 8.3)

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Education is a “public good”

• Education is a public good with a positive externalities

• The Private sector or markets will under-produce education if left to themselves.

• The fact that Education has a positive externalities justified public provision or subsidy of education.

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Social and Private Rate Returns to Education

• There is a difference between private and social rate of return to education for countries which depends on the level of income

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HDI Country 1980 1990 2000 2010-2011

1 Norway 5.8 6.4 6.6 7.3

3 USA .. 5 4.7 5.1

10 Japan 5.2 .. 3.7 3.8

45 Kuwait 2.8 4.7 (2005) 3.8 (2006) ..

167 Rwanda 2.7 .. 4.1 4.7

186 Niger .. 2.9 3.2 3.8

186 Congo 2.3 .. .. 2..5

http://hdrstats.undp.org/en/indicators/38006.html

Public expenditure on education

(% of GDP) (%)

Subject (6)

Foreign Aid &Development

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1. Some on foreign aid: definition, decomposition, the major donors and major recipients.

2.The controversies surrounding foreign aid including its motivations.

• 3. Three views on aid’s impact on growth and development.

4.The issue of conditionality & the future of foreign aid.

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1.Foreign Aid: Introduction

“I have long opposed foreign aid programs that have lined the pockets of corrupt dictators, while funding the salaries of a growing, bloated bureaucracy” ... US Senator Jesse Helms, 2002.

Diverse views on Aid: James Wolfenson –World Bank: There is need for more aid Senator Jesse Helms; no US aid should be given to any country.

Massive Historic Aid: Marshall Plan during WW led by USA- made a huge difference in European post-ww2 reconstruction

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Economist Views on Foreign Aid

Strong supporter: Jeffery Sachs and Joseph Stigltz

Others such as Chicago school conservative economists: do not care for more aid

Case massive Foreign Aid Failure in Africa

Congo/Zaire, Haiti, Zambia, etc

Case success: Botswana, Korea, Taiwan, Mozambique, Uganda, Tanzania.

There is mixed record of Aid effectiveness

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2.Donors & Recipient

• Foreign Aid comprises of financial flows, technical assistance, commodities given by one country to another.

• Two criteria: .

1.promote development and welfare- excluding military aid

2.Provided as a grant or a subsidized loan

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Who Gives Aid

Mostly Industrial Countries (OECD)

Government Agencies such as: USAID, SIDA. etc

World Bank, IMF, UNDP, Regional Banks

Marshall Plan: The US committed 1.5% of GDP about 10 times as much US aid today.

US official development assistance now is 0.16% of GDP.

Marshall plan was successful because of presence of skilled workforce, financial & legal institutions

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The Commitment to Development Index: Ranking of quality of their Aid policies

Ranking of 21 richest countries by CDI criteria

1.Foreign aid quantity

2.Trade policies

3.Foreign Investment Policies

4.Environmental Policy

5.Security including peace keeping operations

6.Migration-ease of migration

7.Technology-support of Research & Development

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The Motivations for Aid: Why do nations give aid?

Foreign policy objectives & political alliances

Poverty reduction

Country size; Smaller states more aid

Look for commercial or trade ties

Enhancing Democracy??

Fighting Global Terrorism? Strategic aid.

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The Effect of Aid on Growth and Development

Generally, there are 4 Broad of Objectives of Aid

1. Stimulate economic growth through building infrastructure, supporting sectors such as agriculture, technology, new ideas

2. Strengthening education, health, political systems, environment

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3. Food aid and other commodities in case of emergencies and disaster

4. Economic Stabilization following natural or man-made shocks…

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Types of Aid

Emergency and humanitarian negatively associated with growth

• Aid that has effect over a long period of time- on health, education, democracy

Aid that directly affects growth inlcudes; roads, electricity, agricultural support, etc

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Aid, Growth, and Development

1.Stimulate economic growth: building infrastructure, supporting productive sectors: agriculture, new ideas, new tech

2.Other development objectives: education, health, environmental and political systems

3.Helping in natural disasters ad humanitarian crises

4.Help stabilizing economies after economic shocks

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Three Views of Aid- The AID debate

• View 1; On average Aid has a positive impact on economic development, but not always- especially on health, education,

• View 2: Has little or not effect may actually undermine growth and development. For example the effect of Food Aid may lower domestic food prices and displace local production,,Create Aid dependency

• View 3. The Effect is conditional depending on Good policies, institutions and Good Governance- Example Aid to Botswana and Korea has been effective.

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Toward Aid Effectiveness

• Country Selectivity – Give aid to more democratic with good governance &least corruption

• Harmonize and coordinate better- several hundred aid missions are in Tanzania and Ethiopia

• Result based management- allocate to projects that show results, modify existing programs, Learn from experience , better information

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Motivations & Objectives of Aid

to support foreign policy and political alliances,

to raise income levels and reduce poverty,,

to strengthen commercial ties,

to reward newly democratic countries.

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Subject ( 7 )

Foreign Debt & Development

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Prudent borrowing has been an important part of the development strategy for some developing countries

Most countries in Western Europe (And USA in 19th century) relied on foreign borrowing to finance its development strategy.

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ADVANTAGES AND DISADVANTAGES OF FOREIGN

BORROWING

Borrowing permits a country to invest more than it can save and import more than it can export

If the additional funds finance productive investment sufficient returns

recall that low-income countries have the potential to realize higher rate of return!

Therefore, foreign borrowing can help support growth and development and yield attractive returns to lenders

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Some countries prefer foreign borrowing over

FDI..... can you explain?

Think: Tax holiday, ownership, fast and ease....

Yet debts must be paid

Borrowing to finance consumption or bad

investment!

Debt sustainability

How much aggregate debt can a country take before it begins to get into trouble?

As long as the country’s loan can be serviced, the loan is sustainable

Different factors determine country’s ability to repay debt:

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Debt size, trade and budget deficit,

interest rate on debt, loan mix, GDP growth

rate, economic factors, exports, government

revenues

Debt service: the amount due for principle

and interest payments in a given year

Country’s Capacity to Pay

• 3 measures:

• GDP, exports, and government tax revenues

• The larger a country’s productive capacity and corresponding income, the greater its ability to repay debt

• For foreign debt, the country’s ability to earn the dollars (or other currencies) needed to repay the debt dominated to foreign currency is important

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Escape from the crises, for some countries

• Refinancing: making new loans to repay the old

• Rescheduling: to allow longer repayment and possibly low interest

• Reduction

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• Buyback: the debtor buys the loan from

the creditor

• Debt-equity swaps: creditors are given

equity in a company in return for

eliminating the debt outstanding

Conclusion

• Advantages and disadvantages of foreign debt

• “loans solve liquidity problems not economic crises”!

• Utilization of foreign loans?

• Absence of economic vision

• Foreign loans and macroeconomic policy

• Independence and freedom?

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Subject ( 8 )

Primary Exports & Development

Primary Exports

• international trade is one of the most powerful forces affecting the process of and economic development

• influences economic growth, income distribution, use of natural resources, economic and political relations with the world

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• provides access to new markets, new opportunities, wider choices, competitive priceso allows low-income countries to

import machines and technology and facilitates flow of knowledge and information

• Export-led growth

• WTO

• Bilateral trade agreements

Export characteristics of developing countries

• exports of developing countries: oil and petroleum products, minerals, food and agriculture,,,,

• countries tend to export products based on their own particular endowments of the basic factors of production (L,L,K)

• i.e labor intensive

• import products that rely on factors of production relatively scarce in their countries

• almost all developing countries import machines and capital equipments and technology products

• many developing countries are highly dependent on one or few primary commodities in their export earnings

• the importance of diversified economic base

Comparative Advantage

• A country has a comparative advantage in producing (X) if it can produce (X) at lower cost than anyone else.

• Having a comparative advantage is not the same as being the best at something. In fact, someone can be completely unskilled at doing something, yet still have a comparative advantage at doing it! How can that happen?

• comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another.

• Even if one country is more efficient in the production of all goods (absolute advantage in all goods) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies

• comparative advantage has important implications:

1.any country can increase its welfare by trading

2.the smaller the country the greater it gains from trade

3.export goods that are most intensively and import the scarce

• before trade: produce and consume at (A)

• with trade: produce at (B) and increase consumption of both to (C)

• C is on higher IC

• Different relative prices means an opportunity to improve welfare through trade

• with trade: produce more at higher world prices

• import more at lower world prices

L-intensive

K-intensive

well endowed with L and L

Different relative prices

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Primary Exports as an Engine of Growth

1.Improved Factor Utilization

• primary-export-led growth can drive an economy to :

• a. use more of the available factors of production

• b. use those factors more efficiently

2. Expanded Factor Endowments

• lead to accumulation of additional factors of production (K, L) through FDI, S, skills,

• i.e. international oil companies in developing countries

3. Linkage Effect

• Stimulating other sectors of the economy

Barriers to primary Export Led Growth

1.Sluggish demand growth

2.Declining terms of trade: the value of a country's exports to that of its imports. If a country's (TOT) is less than 100%, there is more capital going out (to buy imports) than there is coming in. If greater than 100%: the country is accumulating capital (more money is coming in from exports).

Barriers -continue

3. Fluctuating export earnings

4. Ineffective linkages

5. Rent seeking and corruption

Subject ( 9 )

Sustainable Development

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China: an example of economic growth

It is the third largest in the world after the EU and US with a nominal GDP of US$8.22 trillion (2012) when measured in exchange-rate terms.

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China has been the fastest-growing major nation for the past quarter of a century with an average annual GDP growth rate about 9.3 (2008-2011).

China's per capita income has grown at an average annual rate of more than 8% over the last three decades drastically reducing poverty.

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This is a great economic growth model

But what are the costs?

This rapid growth has been accompanied by rising income inequalities.

The country's per capita income is classified in the lower middle category by world standards, at about $3,180 (nominal, 104th of 178 countries/economies), and $5,943 (PPP, 97th of 178 countries/economies) in 2008, according to the IMF.

What is more important? a Long-run view!

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China's dazzling economic growth, but when the negative effects of China's pollution are factored in, the growth rate is less impressive.

The Chinese government has calculated that the effects of pollution wiped out $67 billion, or 3 percent of the nation's GDP, in 2004.

The World Bank calculates that pollution costs China about 5.8 percent of GDP every year.

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In China, packaging and containers has been associated with a problem called "White Pollution”. The lack of environmental awareness amongst the citizenry contribute to the adverse impact caused by plastic materials; they throw away used foam boxes everywhere, unaware of the effect on their city’s image and environment.

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In some situations there is a trade-off between economic growth and environmental quality, with expansion of some economic activities coming at the cost of depleted resources or increased pollution

In other situations, the 2 are complements: with prudent resource management a critical component of sustained growth

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What is the relationship between economic development, natural resource management, and environmental quality?

Is there a trade-off in which economic growth can proceed only at the cost of continued environmental degradation?

Are environmental quality and growth sometimes complementary?

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A country’s environment is a valuable natural resource.

These resources can be critical inputs to economic activity, job creation, and growth.

Prudent management of fisheries can help provide sustainable source of food for fisheries and their families or support large scale commercial fishing

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To some extent, all economic activity uses the environment as a dump for waste products.

Environment damage can have substantial detrimental effects on health and welfare.

Contaminated water (water pollution) and resulting diseases kill about 2 million children and causes about 300,000 to 700,000 premature deaths a year.

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Many people suppose that rapid growth only comes with environmental degradation, and an improved environment can come only at the cost of reduced growth and development.

In some cases, this is true!

Rapid economic growth today may create pollution that reduces welfare and incurs cleanup costs in the future

If rapid growth today is possible only through depleting resource (forest: timber industry), growth may not be sustainable and may come at a very high cost.

Efforts to reduce pollution or better manage the environment can be costly, and hard choices need to be made weighing the costs and benefits.

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In other cases, there in no trade-off!

development and environmental goals are complementary, and reducing environmental degradation can help lower production costs and directly improve economic output and welfare.

Ex. Reduced air and water pollution should support tourism, fisheries development, and agricultural production.

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These issues take on greater meaning when going beyond national borders to consider the entire planet.

Running out of minerals (fuels) before we can develop technologies for renewable sources of energy

Heating earth atmosphere, emissions, changing world climate...

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These issues take on greater meaning when going beyond national borders to consider the entire planet.

Running out of minerals (fuels) before we can develop technologies for renewable sources of energy

Heating earth atmosphere, emissions, changing world climate...

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Market Failures

Environmental degradation is often a result of market failures: in which markets prices deviate from scarcity values and individuals and firms make decisions that maximize their own profits but cause losses for others and society as a whole

Within a single country, correcting those failures and establishing properly working, efficient markets can be among the most powerful and effective mechanisms to promote efficient resource use, reduce environment degradation, and generate sustainable development.

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Environmental degradation often occurs because market participants do not take into account the full costs of their actions on the environment.

Ex: prices of goods produced in a factory may not include the costs to society of the air pollution generated by that factory.

Government policies and interventions aimed at incorporating these costs into market marketdecisions help improve environmental outcomes, make markets work better, and bring broader benefits to society.

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Market failures affecting resources are externalities: costs borne by the population at large but not by individual producers and benefits that occur to society but cannot be captured by producers.

The most important externalities are those caused by the deletion or degrading of natural resources, including the environment

If resources are depleted at rates faster than they can be replenished or substituted by human made capital, development will be unsustainable

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Why Markets Fail to Allocate Natural Resources Efficiently?

THE COMMONS:

A dilemma in which multiple individuals acting independently in their own self-interest can ultimately destroy a shared limited resource even when it is clear that it is not in anyone's long term interest for this to happen

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The commons dilemma stands as a model for a great variety of resource problems in society today, such as water, land, fish, and non-renewable energy sources like oil and coal.

When fish consumption exceeds its reproductive capacity, or oil supplies are exhausted, then we face a tragedy of the commons.

When we include the environment as a common resource, then much private activity generates external costs and market failure becomes a very general phenomenon

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EXTERNALITIES

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P2

P1

q1q2

SMC

S=PMC

Quantity

Price

Polluters impose costs on

others. If these external costs

were reflected in firms costs,

SMC would prevail.

EXTERNALITIES

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P2

P1

q1q2

SMC

S=PMC

Quantity

PriceThe market price would be

P2 and output Q2

EXTERNALITIES

187

P2

P1

q1q2

SMC

S=PMC

Quantity

Price

Because the firms do not

bear those costs, their PMC

is Lower, So more Q1 of the

polluting product is

produced and consumed