History, Expectations, and Development, part 1

Transcription

1 History, Expectations, and Development, part 1 Econ Outline Two approaches to economic development Complementarity A model of demand complementarity A model of Pitfall of partial reforms 2 1

2 Approaches to development Big bang versus gradualism (or balanced growth versus unbalanced growth) Post-World-War II agenda: helping underdeveloped countries develop Problem: underdevelopment Late 1980s: Reforms in Soviet Union, Central and Eastern Europe, China, etc. Problem: planned economy 3 complementarity I use facebook because my friends use facebook I don t use Wechat because my friends don t use Wechat (they use WhatsApp!) My son s friends are thinking about switching to Wechat upon rumors that WhatsApp will start charging a small annual fee.what should he do? 4 2

3 complementarities When more people taking an action leads to a bigger tendency for any one person to take that same action Fax machine Telephone Typing system 5 Which typing system should be used? Return from using Dvorak Return from using QWERTY 0 0 Using Dvorak Using QWERTY 6 3

4 Not every strategic problem has complementarities Return from using western tunnel Return from using crossharbour tunnel 0 0 Using cross-harbour tunnel Using western tunne 7 Other examples Technology: iphone versus android smart phones Infrastructure: public sector covers fixed and various cost Finance: thicker financial market=>high diversification => easier for individual to invest => thicker market Countries are underdeveloped because of being trapped in a vicious cycle 8 4

5 Rosenstein-Rodan (1943) Complementarity suggests we should adopt a big bang approach for reform. Problems of Industrialization of Eastern and Southeastern Europe, Econ Journal a shoe factory that hires 20,000 workers cannot have its shoe sold to these 20,000 workers These 20,000 workers will buy other goods, and the shoe factory should find workers of other factories to buy from it. The planned creation of such a complementary system reduces the risk of not being able to sell, and, since risk can be considered as cost, it reduces costs. It is in this sense a special case of external economies. 9 Demand complementarities (Rosenstein-Rodan 1943) Industrial expansion raises income, generates demand for other industries These models lay a (limited) foundation for policy debates Balanced versus unbalanced growth Rosenstein-Rodan (1943, 1961), Nurkse (1952, 1953), Hirschman (1958), Streeten (1956, 1963) 10 5

6 Implications Complementarities may result in multiple equilibria When they do, the equilibria are typically Pareto-ranked. Two fundamentally identical societies can behave differently. Formal models of Rosenstain-Rodan s (1943) ideas are provided in Murphy, Shleifer, Vishny (1989), Industrialization and the Big Push, Journal of Political Economy, A model of big push, contd Resources: labor only, homogenous, can work in traditional sector: wage rate = 1 in modern sector: wage rate = w >1 (to justify moving to urban area) Technology: N goods, N is large, each can be produced in the traditional or modern sector Traditional: one to one technology Modern: produced by a single enterpriser with technology Li=F+cQi 12 6

7 A model of big push, contd Technology: Modern sector: Li=F + cqi (1) where Li is labor requirement F: fixed cost (in terms of labor amount) c: marginal labor requirement Qi is the production of good i 13 A model of big push, contd (this model is from Paul Krugman s paper) Demand: consumers spend equal amount of spending on each good & don t care in which sector the good is produced Static model: no growth, no asset accumulation Market structure: traditional sector: perfect competition, charging price = 1 Modern sector: each produced by one single entrepreneur, also charging price =

8 A model of big push, contd Will production take place in the traditional or the modern sector? If no modern sector at all, Qi=L/N If all modern sector, Qi=(L/N-F)/c Interesting case: (L/N-F)/c>L/N (2) Suppose (2) is satisfied. Can entrepreneurs profit from starting the modern sector? 15 externality When deciding whether to start the business, the entrepreneur considers his own profit. But the workers hired will have a higher wage (w>1), hence bringing extra demand for goods from other firms. A positive externality not taken into account by the entrepreneur. 16 8

9 (L/N-F)/c L/N Qi A If only one entrepreneur innovates, he will sell a quantity of L/N and employ L A. His profit is L/N-w L A Li F L A L/N 17 CASE 1: w-1>0 is sufficiently small Qi (L/N-F)/c L/N A Total cost wli Li The business is viable There is a unique equilibrium, so all entrepreneurs will start their business, and only the modern sector exists F L A L/N 18 9

10 CASE 2: w -1>0 is of intermediate range Qi (L/N-F)/c L/N Total cost wli A The business is not viable Two equilibria Only traditional sector Only modern sector Li F L A L/N 19 CASE 3: w-1>0 is sufficiently large Qi (L/N-F)/c L/N Total cost wli A The business is not viable Unique equilibrium: only traditional sector Li F L A L/N 20 10

11 Pitfalls of Partial Reforms Murphy, Shleifer, and Vishny (QJE, 1992) in response to reform experiences in Soviet Union in late 80s Partial reform started in 1988 The GNP fell 2% in 1990; fell 8% in the 1 st quarter of 1991 Did partial reforms cause output fall? 21 An analogue Suppose the state of Washington produces apples which are sold throughout the US. Let the market clearing price be 15. Suppose all states impose a price ceiling at 10. Then supply falls and apples are rationed. There may be lines and speculation as well

12 An analogue Suppose, now, only 30 states have the price ceiling and other states don t have it. What happens? Consumers in the unconstrained 20 states get all the apples they want at the price of 10 (because they can bid epsilon above 10, defeating the other 30 states). Consumers in the constrained 30 states get the remainder. Downstream firms (e.g., apple juice makers) in these 30 states have to cut down their production. Hence, liberalizing some states actually makes things worse! 23 A model of supply diversion Three goods: a) timber, and b) boxcars and c) houses 1. The official price of timber, P, is below the market clearing price 2. The price P is what the buyers actually pay 3. Producers of timber are on their supply curves 4. Initially, timber is rationed efficiently 5. After reform, the timber industry can choose to whom to sell its output 6. After reform, the boxcar industry cannot bid more than P for timber, but the industry sector can

13 A model of supply diversion Before reform All sectors are state owned Db, Dh are marginal value product curves p*: market clearing price Timber rationed efficiently, hence Qb and Qh 25 A model of supply diversion 26 13

14 A model of supply diversion Welfare loss in the boxcars sector: A + B Welfare gain in the house sector: C Total welfare change: C - A B < 0 27 A model of supply diversion The welfare loss is higher when the demand for timber by the housing sector is more elastic and the demand for timber by the boxcar sector is less elastic For several reasons, the case of elastic demand for timber the free sector and inelastic demand in the state sector is realistic

15 Sell to housing only when meeting boxcars demand We now assume that the state uses quantity controls to force the delivery of timber to the boxcar industry a the price P. Take the case where the boxcar sector got all the timber in wanted under rationing, and assume even after the liberalization of the housing sector the state can still enforce the delivery of that same amount of timber to the boxcar sector. In timber sector delivers its lowest production cost units to the boxcar sector, and then sells what it produces afterwards to the housing at an equilibrium price. 29 Sell to housing only when meeting boxcars demand Suppose the timber industry is required to supply Qb at p to boxcar industry. Then partial reform is welfare improving! 30 15

16 China versus Russia reforms This sheds light on an important difference between partial reforms in the former Soviet Union and in China. China has pursued partial reforms but the central government maintained extremely strict enforcement of state quotas and allowed firms to sell only the units above the state quotas to private buyers. Hence containing the supply diversion problem. 31 Conclusion Big bang versus gradualism A model of big push (concerned about development) A model of partial reform (concerned about transition from planned to market economy) The outcome of partial reform is very detail specific

17 Readings Krugman: The rise & fall of development economics, found in The Transition to a Market Economy: pitfalls of Partial Reform, Murphy, Shleifer, and Vishny (Quarterly Journal of Economics,1992) 33 17