Economic Development, 12 th Ed. M. P. Todaro and S. C. Smith Slides for Chapter Four. Updated and Expanded Stephen C. Smith Fall 2017

Transcription

1 Economic Development, 12 th Ed. M. P. Todaro and S. C. Smith Slides for Chapter Four Updated and Expanded Stephen C. Smith Fall 2017

2 4.1 Underdevelopment as a CoordinaDon Failure A newer school of thought on problems of economic development CoordinaDon failures occur when agents inability to coordinate their acdons leads to an outcome that makes all agents worse off. This can occur when acdons are complementary, i.e., AcDons taken by one agent reinforces incendves for others to take similar acdons This circumstance can, under some circumstances, lead to muldple equilibria

3 4.2 MulDple Equilibria: A DiagrammaDc Approach OPen, these models can be diagrammed by graphing an S-shaped funcdon and the 45º line Equilibria are Stable: funcdon crosses the 45º line from above Unstable: funcdon crosses the 45º line from below

4 Figure 4.1 MulDple Equilibria

5 4.3 StarDng Economic Development: The Big Push SomeDmes market failures lead to a need for public policy intervendon The Big Push: A Graphical Model, 6 assumpdons One factor of producdon Two sectors Same producdon funcdon for each sector Consumers spend an equal amount on each good Closed economy Perfect compeddon with tradidonal firms operadng, limit pricing monopolist with a modern firm operadng CondiDons for MulDple Equilibria A big push may also be necessary when there are: Intertemporal effects UrbanizaDon effects Infrastructure effects Training effects

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7 Figure 4.2 The Big Push

8 Why the Problem Cannot be Solved by a Super-Entrepreneur Super Entrepreneur? Capital market failures Cost of monitoring managers- Asymmetric InformaDon CommunicaDon failures Limits to knowledge Lack of any empirical evidence that would suggest this is possible

9 In a Nutshell: Big Push Mechanisms Raising total demand Reducing fixed costs of later entrants RedistribuDng demand to later periods when other industrializing firms sell ShiPing demand toward manufacturing goods (usually produced in urban areas) Help defray costs of essendal infrastructure (a similar mechanism can hold when there are costs of training, and other shared intermediate inputs)

10 4.4 Further Problems of MulDple Equilibria Inefficient Advantages of Incumbency Behavior and Norms Linkages Inequality, MulDple Equilibria, and Growth

11 4.5 Michael Kremer s O-Ring Theory of Economic Development The O-Ring Model ProducDon is modeled with strong complementarides among inputs PosiDve assortadve matching in producdon ImplicaDons of strong complementarides for economic development and the distribudon of income across countries

12 Kremer s O-Ring Theory: A Numerical IllustraDon The O-Ring Model ProducDon modeled with strong complementarides among inputs PosiDve assortadve matching in producdon Simple IllustraDon of the basic idea Suppose a Human Resources (HR) Department has four workers - two H-types and two L-types; Strong complementarides are present when output Q is determined by the product of the qualides, i.e. Q = q i* q j How to allocate for efficiency: {HL, LH} or {HH, LL}? That is: Mix or Match? We know that H 2 + L 2 > 2HL because: (H L) 2 > 0 This illustrates that with strong complementarity it is more efficient to match, i.e. produce using posidve assortadve matching

13 O-ring production analysis setup: details Kremer s concept of q is quite flexible. Interpretations may include a quality index for characteristics of the good: For example, suppose q=.95. Among other interpretations this can mean: a) There is a 95% chance that the task is completed perfectly so the product keeps maximum value, and a 5% chance that it is completed so poorly that it has no value; b) The task is always completed well enough that it keeps 95% of its maximum value; or c) The product has a 50% chance of having full value and a 50% chance of error reducing product value to 90%. d) NOTE: the higher the skill, the higher the probability that the task will be successfully completed (for example, the part created in this task will not fail).

14 O-Ring Model: Bottleneck Effects Following Kremer, consider a simple illustration of bottleneck effects Suppose that n tasks are required to produce a good. Let q be a standard skill level of these n tasks. But now, let the actual skill level of two workers be cut in half in all firms. Then production would fall by 75% (the result of cutting output in half once, then again). But then the marginal product of quality also falls by 75% for all the other n-2 tasks, and thus so does the incentive to invest in increasing skill. As workers reduce their skill investments, they further reduce level of skill in the economy, and thereby lower further the incentive to invest in skill.

15 Kremer s O-Ring theory : Implications Firms tend to employ workers of similar skills for tasks. Workers performing the same task at a high skill firm earn higher wages than in a low skill firm. The model explains why a worker of given skill moving from a developing to developed country immediately receives a higher wage for using the same skills. Wages increase with q at an increasing rate, so wages will be more than proportionally higher in developed countries than predicted from some objective measures of skill. When co-workers or others doing complementary work have higher skills, greater incentive to acquire more skills. This type of income externality is by now a familiar condition in which multiple equilibria can emerge.

16 O-Ring Effects Across Firms (Supplemental Notes) Economy-wide low level quality of production traps may occur when there are O-ring effects across firms as well as within firms In this case, there is an externality at work, so there could be a case for industrial policy to encourage quality upgrading, as some East Asian countries have undertaken. This magnifies the effect of local production bottlenecks (because they have a multiplicative effect on other firms' production) Bottlenecks also reduce incentives for workers to invest in skills, by lowering its expected return To some extent such bottlenecks could be ameliorated by international trade and investment, because they provide an alternative source of inputs from outside the bottlenecked economy This offers one explanation why economies that cut themselves off from the international economy have generally performed less well those more integrated This also helps explain why rich countries tend to have larger firms and specialize in more complex products, and firm size and wages are positively correlated within and across countries.

17 4.6 Economic Development as Self-Discovery No person is born knowing their comparadve advantage The specific comparadve advantage of an economy is not obvious; there may be no alternadve to trial and error Hausmann and Rodrik: A Problem of InformaDon Not enough to say developing countries should produce labor intensive products, because there are thousands of them Industrial policy may help to idendfy true direct and indirect domesdc costs of potendal products to specialize in, by: Encouraging exploradon in first stage Encouraging movement out of inefficient sectors and into more efficient sectors in the second stage

18 Economic Development as Self-Discovery, condnued Three building blocks of the theory; and authors case examples of the reasonableness of these assumpdons in pracdce: 1: Uncertainty about products can be produced efficiently. Authors examples: India s widely unexpected success in informadon technology Reasons for Bangladesh s efficiency in hats vs Pakistan s in bed sheets is unclear 2: Need for local adaptadon of foreign technology Authors example: seen in cases such as shipbuilding in South Korea 3: ImitaDon can be rapid Authors example: The spread of cut flower expordng in Colombia

19 4.7 The Hausmann-Rodrik-Velasco Growth DiagnosDcs Framework Focus on a country s most binding constraints on economic growth No one size fits all in development policy Requires careful research to determine the most likely binding constraint

20 Figure 4.3 Hausmann-Rodrik-Velasco Growth DiagnosDcs Decision Tree

21 Growth DiagnosDcs: Categories of most binding constraints in the decision tree Constraint categories are the boxes from which no further arrows emanate 10 are included These 10 are fairly comprehensive; many specific constraints fit well within these categories Example: natural disasters pose immediate constraints, but if extended problems for the growth follow, government failure is likely the root problem - not the inidal shock of the disaster But potendal addidonal independent boxes for constraint types that have been raised for consideradon but are debatable could include: Environment: if ecological collapse and climate change threaten food security, or domesdc degradadon leads to near un-livability of the major cides (lowering producdvity, stopping investment ) Inability to resolve conflict Social capital (or cultural ) dimensions such as lack of trust (e.g. in forming business reladonships, etc) IdenDfying other possible boxes is a good discussion exercise Note: Diagnosis requires painstaking evaluadon

22 Haussman: Doing Growth Diagnostics in Practice Careful research required to determine most likely binding constraint: In practice, growth diagnostics usually involves some economic detective work. To evaluate whether a proposed constraint is binding, a growth diagnostician looks for evidence on its implications. If the constraint is excessive taxation, we can expect high movement into the informal sector or underground economy. If the constraint is infrastructure, we can expect significant congestion. If the constraint is education, we can expect high rates of return to education. In general, the analyst will look for economic behavior consistent with agents trying to get around a constraint.

23 Hausmann: Further Notes on Doing Growth DiagnosDcs Principles of a DifferenDal Diagnosis : Four features to look for in drawing conclusions on which is the binding constraint 1) The (Shadow) Price of the Constraint is High 2) Movements in the Constraint Should Produce Significant Movements in the ObjecDve 3) Agents in the Economy Should be AuempDng to Overcome or Bypass the Constraint 4) Agents Less Intensive in a Binding Constraint Should be More Likely to Survive and Thrive, and Vice Versa

24 Findings Box 4.2: Village CoordinaDon and Monitoring for Beuer Health Outcomes The problem: poor health outcomes and low public health care provision in rural Uganda Villagers have access to public dispensaries but use levels and sadsfacdon are low; government oversight has been ineffecdve A program intervendon provided villagers with the knowledge and resources to enable them to monitor health workers, both individually and through their community organizadon 50 villages were selected for the experiment; 25 for treatment and 25 for the control group Surveys were conducted of all households on health outcomes and sadsfacdon with the health care providers; Data also collected from health care providers Authors use a randomized control trial (RCT) to idendfy causal impacts of the intervendon Purpose of an RCT: It is impossible to observe the same person with and without treatment Next best: Find the average effect on a group of people randomly selected for treatment, from a broader, randomly selected pool. Those not selected become the control group Treatment: Using household survey data, a report card for each health care provider was developed and presented at community meedngs, with health care providers present Goal: giving informadon to users about overall and reladve outcomes enables them to more effecdvely monitor their health care providers Effects: significant improvements in health outcomes Source: M. Bjorkman and J. Svensson, Village Coordina5on and Monitoring for Be9er Health Outcomes, Quarterly Journal of Economics, 124 (2), pp , May 2009

25 Concepts for Review Agency costs Asymmetric informadon Big push Complementarity CongesDon CoordinaDon failure Deep intervendon Economic agent Growth diagnosdcs InformaDon externality Linkage Middle-income trap MulDple equilibria O-ring model O-ring producdon funcdon Pareto improvement Pecuniary externalides Poverty trap Prisoners dilemma

26 Concepts for Review (condnued) Social returns Technological externality Underdevelopment trap Where-to-meet dilemma