History , Expectations and Development

1. History, ExpectationsandDevelopment

2. TheQuestion: • Theory and evidence reviewed so far indicate that the level and growth of GDP depends on savings (investment) rates and that, conditional on (s, n) countries converge to the same growth rate • But then what determines the saving (investment) rate? What if it depends on the past history of a country? What is the role of expectations about the future?

3. HistoryandExpectationsworkthroughtwoChannels: • Complementarities • Increasing Returns

4. Complementarities • Complementarities are a special kind of externalities. They happen when the cost of an action is lower (or the benefit is higher) if many agents are undertaking the same action. • Examples: Qwerty vs. Dvorak; XBox vs. PSII

5. Complementaritieshave 3 importantConsequences: • There can be multiple equilibria • History matters • Short-lived policy interventions can have long lasting effects

6. MultipleEquilibria -1- • AssumeNintendocomeupwith a newconsole, clearlybetterthanthe PSII, • Withcomplementarities, thecost of usingeitherconsoledepends on howmanyotherpeopleareusing it. • We can have 2 equilibria: everybodybuys N, everybodybuys PSII. • Notethat “everybodybuys PSII” is a “worse” equilibrium. However, duetocomplementarities it is rationalforeachconsumerto buy PSII wheneverybody else is doingso.

7. MultipleEquilibria -2-

8. HisotyMatters • The equilibrium reached by the economy depends on its initial conditions, in the example above, the fact that many consumers are purchasing PSII before the introduction of N, makes it more likely that the economy ends up in the equilibrium where everybody sticks with PSII even if N is better

9. Short-livedPolicies can Have a LongLastingEffect • Assume Nintendo sells games cheap enough to overcome the complementarity effect (in the graph AC curve for N shifts down “enough”). This will make each consumer want to shift regardless of what everybody else is doing. Once enough people have shifted to N, the equilibrium is self-sustaining – i.e. Nintendo can stop the sale • The fact that externalities take the form of complementarities plays a key role

10. Complementarities & EconomicDevelopment: MicroIssues • Complementaritiesarise in manycircumstances – theyareparticularlyimportantfortheadoption of newtechnologies, • Rethink of theexampleabove in terms of cropsvarietiesinstead of gameconsoless, • Namelyfarmers can choosebetweentraditionalstaplecropand a newcashcrop, • Complementaritiesariseforseveralreasons: informationsharing, marketing costs.. • Theexampleillustratesthatthenewcashcropwill not necessarily be adopted, evenif it is moreprofitablethanthetraditionalstaplecrops

11. Complementarities & EconomicDevelopment: MacroIssues -1- • Idea: Coordination Failure (Rosenstein – Rodan) • Assume all production must be sold within a country. Compare two industrialisation paths: • Huge shoe factory, employing all workers => not sustainable: all income needed to be spent on shoes. • Divide resources into shoe, cloth and food factories => is sustainable • Profitablity of each industry depends on the other existing (and paying wages) => jointly viable

12. Complementarities & EconomicDevelopment: MacroIssues -2- • Need for Coordination: Every entrepreneur invests if he thinks others will • Multiple equilibria • History matters • Complementarities in investment can lead similar economies to very different equilibria. • Endogenous growth model with externalities in capital accumulation

13. A RelatedConcept: Linkages • Industriesareconnected not onlythroughthedemandfor final products, but alsothroughinputmarkets • Example

14. A PolicyAlternative • Activate Links – Less costly and lower information requirement • Which Sectors? • Sectors with many strong links, preferable backward • Sectors that are least profitable for private investors (eg. Railways)