Economics 216: The Macroeconomics of Development

1. Economics 216:The Macroeconomics of Development Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.) Kwoh-Ting Li Professor of Economic Development Department of Economics Stanford University Stanford, CA 94305-6072, U.S.A. Spring 2000-2001 Email: ljlau@stanford.edu; WebPages: http://www.stanford.edu/~ljlau

2. Lecture 11Development Policies and Strategies Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.) Kwoh-Ting Li Professor of Economic Development Department of Economics Stanford University Stanford, CA 94305-6072, U.S.A. Spring 2000-2001 Email: ljlau@stanford.edu; WebPages: http://www.stanford.edu/~ljlau

3. Plan versus Market:Achieving an Efficient Allocation of Resources • The objective is to achieve the highest and best use of resources through the market system • The efficiency of the market system depends on achieving the following conditions: • Price = Marginal Revenue for every good (and factor) in every sector and every period • Price = Marginal Cost for every good (and factor) in every sector and every period • The real rate of return on every investment is equal to the rate of discount (rate of time preference) in every sector and every period • These conditions are not always automatically satisfied by a market system Lawrence J. Lau, Stanford University

4. Plan versus Market:Achieving an Efficient Allocation of Resources • Centrally planned command economy • Pre-determined quantities and prices • Pre-determined producers (sellers) and users (buyers) • Feasibility • Material balance • Indicative planning (France, Japan, South Korea, Taiwan) • Public investment • The role of expectations Lawrence J. Lau, Stanford University

5. Market Failures • Infrastructural investment • Human resources • Monopolistic industries • Public ownership • Regulation • Spillover Effects (R&D) • Coordination externalities • Market failure Lawrence J. Lau, Stanford University

6. Failure of Central Planning • Inadequate self-correction--too little, too slow • The disjunction between information and authority--local and central • The incentive for local information collection • The incentive for local information transmission • The incentive for local corrective action • The problem of identification at the center Lawrence J. Lau, Stanford University

7. State versus Non-State Ownership:Soft versus Hard Budget Constraints • Incentive compatibility • Responsiveness to unfavorable outcomes Lawrence J. Lau, Stanford University

8. Balanced versus Unbalanced Growth • Arguments for the Big Push • Economies of Scale • Limitational Factors • Capital • Human Capital • Entrepreneurship • Comparative Advantage • Arguments for Balanced Growth • Complementarity in production • Complementarity in final demand • Limited domestic market Lawrence J. Lau, Stanford University

9. Industrial Policy • Agriculture versus industry • Infrastructure • Human resources • R&D • Pioneering industries (steel mills, automobile manufacturing plants, semiconductor fabrication) • Protection of domestic market • Direct and indirect subsidies • Below market exchange rate • Below market rate of interest • Below market price of land • Tax incentives Lawrence J. Lau, Stanford University

10. Export Promotion versus Import Substitution • Export promotion has been more successful than import substitution • The advantages of specialization (comparative advantage) • Competitive world market versus protected home market Lawrence J. Lau, Stanford University

11. The Infant Industry Argument • Temporary tariff and/or quota protection can be justified for a newly established firm (or firms) in a newly established industry • It takes time for such a firm to attain the scale of the lowest long-term average cost: • Domestic market expansion (supply can, under some circumstances, create its own demand) • ”Learning by doing”--the productive efficiency increases with experience in production, e.g., with cumulative output or investment • Thus, even if the firm or industry is not competitive with imports today, given sufficient time, it will in fact become competitive • The importance of a pre-commitment for the phasing out of protection--a “sunset” clause Lawrence J. Lau, Stanford University

12. The Benefits of Openness • Capital • Technology transfer • Managerial know-how • Efficiency-enhancing competition Lawrence J. Lau, Stanford University

13. The Transition from Plan to Market • “Big Bang” • “The Dual-Track Approach” (“Big Bang Chinese Style”)--reform without losers • Gradualism Lawrence J. Lau, Stanford University

14. How is Efficiency Achievedin the East Asian NIEs? • Maintenance of a stable macroeconomic environment • Market-directed allocation of new investment, aided by export orientation, promotes efficiency • Private enterprises have the incentives for prompt self-correction Lawrence J. Lau, Stanford University