Economic Development <Lecture Note 2 > 13.03.15

1. Economic Development <Lecture Note 2> 13.03.15 ED: Traditional and New Theories of Development * Some parts of this note are summaries of references for teaching purpose only. Semester: Spring 2013 Time: Monday 9:00~12:00 am Class Room: No. 322 Professor: Yoo Soo Hong Office Hour: By appointment Mobile: 010-4001-8060 E-mail: yshong123@gmail.com Home P.://yoosoohong.weebly.com

2. BasicConcepts

4. Economic Dualism

5. Searching for Food in Landfill

6. Ratio of People Living in Absolute Poverty by Country

7. World Poverty by Region People living on less than $1 a day Source: UN MDG REPORT, 2008 - In terms of absolute number, Asia shows higher numbers than Africa, however sub-Saharan Africa shows the highest ratio. 71%(1 billion) of them are infants

8. The Poor in Africa How can we help more than 400 million people in Africa who barely survive on less than $1 a day? To start to eradicate abject poverty is to start to bring healing to a nation…….

9. Poverty and Hunger • Africa is the poorest continent on earth. • Only 1 in 3 children completes elementary school. • 1 in 3 residents of sub-Saharan Africa is chronically undernourished. • Average life expectancy in sub-Saharan Africa has dropped from roughly 62 years to 47 years, mainly due to AIDS.

10. Refugees from famine and war

11. Poverty in Africa 34 of the world’s 42 poorest countries are in Africa.

12. Poverty in Africa Half of Africa’s 850 million people live on less than $1 a day.

13. Facts on World Poverty • World in 2005 • Every fifth second, one child under 10 died of hunger • Every third minute, one lost eyesight due to a lack of Vitamin A • 850 million (1/7 of world population) was suffering from malnutrition (an increase of 120 million from 2000) • 36% of Africans were experiencing hunger • The urban poor searched landfill to find food wasted by the rich • 3 out of 10 children had a defective physical development. • 1 out of 10 children was underweight.

14. East Asia and SSA

15. Income Inequality by Country

16. Why people hunger • If all foods available in the world are evenly distributed, can feed more than 13 billion people. • Although the population in the Philippines grew 2.3% every year for the past 10 years, but 35% more than 10 years ago people in the Philippines cannot buy rice because of price increase. • Disparity between the developed countries and developing countries • Income level: 30:1 1960 → 114:1 2002 • Why “the rich become richer, the poor become poorer”, despite of capital investment and technological development? <-Due to structural and institutional problems from  “greedy and no sympathy”, “poverty trap”, and  “ignorance”.

17. What is the Cycle of Poverty? • The cycle of poverty has been described as a phenomenon where poor families become trapped in poverty for generations. Because they have no or limited access to critical resources, such as education and financial services, subsequent generations are also impoverished. • Due to the many root causes of poverty and the complexity with how poverty is measured and defined, there are multiple cycles of poverty—based on, among other things, economic, social, spiritual and geographical factors. Many cycles overlap or perpetuate new cycles and therefore any attempt to depict the cycle of poverty will be far more simplistic than realistic. • A key goal of development aid, working together with recipients, is to fund new and existing poverty-reduction initiatives that inject positive change into a poverty cycle with the intent of breaking the cycle for the individual, family or community benefiting from that initiative.

18. A cycle of poverty related to hunger keeps a person or household poor in a developing country.

19. In most cases, the cycle of poverty is systemic in nature, meaning action needs to be taken to combat the root causes of poverty. For instance, the reduction or cancellation of the national debt for the world's poorest countries will have a potentially dramatic effect on those nations' economies. They can, in turn, spend money on government-funded education for instance, rather than interest payments on a debt they will ultimately never repay. • One cycle of poverty can expand or develop into another. A country's slow economy, and consequently a family's low income, not only means a lack of access to food and safe water, but also means limited or no funds for sending their children to school.

20. Human Welfare (W) WA Relatively lower level of welfare WB Relatively higher level of welfare (Direction of Economic Development) C11 Cij CMN Society A Society B A fillter named ‘Ideal Typus’ (ideal type of cultural values of different countries or areas) Various Types of path for transition, which depend on various causal relation -ships and likelihood of their realization Economic Development Process Source: Lee, Jong Won. 2004. Revised.

21. Traditional Theories

22. Study of Economic Development • Theories start with observations of facts. On the basis of theories and observations, policies are formulated and applied to the real world, which will change facts. There is a circular flow. Facts Policies Theories • Several different schools (theorists) of economic development • emerged.

23. Development Economics • Development economics is a branch of economics which deals with economic aspects of the development process in low-income countries. • Its focus is not only on methods of promoting economic growth and structural change but also on improving the potential for the mass of the population. • DE involves the creation of the theories and methods that aid in the determination of policies and practices and can be implemented at either the domestic or international level. • Unlike in many other fields of economics, approaches in development economics may incorporate social and political factors to devise particular policies.

24. Causes of Underdevelopment □ Characterization • Very easy to focus on characteristics • Underdevelopment is usually characterized by: low per capita incomes, low literacy and educational attainment, lack of basic services such as water and power • But how can we explain (under)development? □ Environmental and internal instability • Old view that absence of development caused by certain physical environments, particular cultural traditions and value systems • Lack of natural resources certainly impediment to development but not impossible - example of Japan, Korea, Singapore, etc. • Instability and other adverse internal situations such as political factors, e.g. central African nations with tribal rivalries and ethnic cleansing • Poor physical environment: lack of rainfall, poor soils also may pose barriers to development.

25. ‘Colonialism as Scapegoat’ Explanation • Need to view development in historical perspective as sequence of dynamic events and explore roots • Colonialism viewed as the cause of disintegration and decline • Indigenous population exploited • Traditional way of life and self sufficient mode of production have been destroyed. • Forced to pay taxes and conscripted labor practices • Social differentiation increased: disintegrating force • Fatal effects on secondary (manufacturing) and tertiary (service) sectors: import of cheap goods forced indigenous artisans out of work • Discouraged modern industrialization • Colonial powers extracted wealth for home country such as Netherlands, France, Great Britain, etc. • International division of labor and western dominated trading structure was created to take advantage of colonial authority.

26. Marxist View of Development • Emphasizes Mode of Production - elements and activities necessary to produce and reproduce real, material life • Capitalist (market economy) mode depends on wage labor whose labor power produces a surplus which is accumulated and appropriated by the employer, resulting often class conflict in capitalist societies. • Development’s ingredient is: Capital accumulation + labor exploitation to generate surplus value and profits. • 1848: “The Communist Manifesto” (co-written with Friedrich Engels. • History is a series of class struggles between the owners of capital and the workers. • An inevitable consequence of the capitalist system is an ever-increasing concentration of wealth in the hands of a few of the owners of capital, which at some critical point will lead to a revolution and from this, there will exist a classless society.

27. Traditional Theories of Economic Development □ Earlier literature on economic development is dominated by the following strands of thought: • Keynesian growth and neo-classical growth theory: 1940-50s • Modernization and stages-of-growth model: 1950s and 1960s • Theories and patterns of structural change: 1970s • International dependence theory: 1970s • Endogenous growth (New neo-classical, free-market) theories: 1980s and 1990s • Other theories such as Institutional, Evolutionary, Sustainable development,

28. Theories of Development • 1940-50s: Keynesian growth theory - Process of capital of formation is determined by savings and investment. • Domestic savings are channelled to productive investments such as manufacturing which usually result in high productivity. • Growth is market driven as income levels rise, savings rises and frees capital for alternative investment.

29. The Harrod-Domar (Keynesian) Growth Model • The principal strategy for development is mobilization of saving and generation of investment to accelerate economic growth • Importance of H-D growth model : It explains the mechanism by which investment leads to growth. Harrod-Domar’s Growth Model gc=s (g=growth rate in GDP, c=marginal capital coefficient (change in capital growth/change in output growth), s=savings rate) (Ex: If the final goal, g=7% and c=5, s should be 35%.) • Investment comes from savings • Rate of economic growth (GNP growth rate) is determined jointly by the ability of the economy to save (savings ratio) and the capital-output ratio.

30. Obstacles and Constraints - Discussion • Is it really true that GDP growth is proportional to the share of investment expenditure (savings) in GDP? • In reality, low rate of savings in developing countries gives rise to savings gap and capital constraint • (Savings and) investment is a necessary condition for accelerated economic growth but not a sufficient condition.

31. Solow's Neoclassical Model or Exogenous Growth Model • Solow’s model of economic growth implies that economies will conditionally converge to the same level of income, given that they have the same rates of savings, depreciation, labor force growth, and productivity growth • Solow’s model differs from H-D model in the following respects: • Allows for substitution between labor and capital • Assumes that there exist diminishing returns to these inputs • Introduces technology in the growth equation, but technology is exogenous. • Usually the H-D Model and Solow’s Growth Model areregarded as the neoclassical growth model, although Solow’s Model is theoretically more flexible. • An implication of Solow’s Model is convergence of all economies in the long run.

32. Implications of Solow's Neoclassical Model or Exogenous Growth Model • Impact of increase in productivity: • Raises steady state per capita output through increase in per capita capital. • In the long-run increase in per capita income takes place at the same rate as productivity/ technical progress Do Economies Converge? • Unconditional convergence occurs when poor countries will eventually catch up with the rich countries resulting in similar living standards. • Conditional convergence occurs when countries with similar characteristics will converge (savings rate, investment rate, population growth). • No convergence occurs when poor countries do not catch up over time and living standards may diverge.

33. Trade in the Neoclassical Growth/Development Theory - These economists argue that international trade can provide a substitute for low domestic aggregate demand. • The only things governments need to do is to position an economy on an autonomous, sustained-growth path is to remove barriers to international trade in commodities. - In this view, domestic and international liberalization programs suffice to bring about sustained economic growth and structural change.

34. Modernization Theory of Development • Modernization Theory - This theory suggests that economic dimension alone is insufficient and adds theories on institutional and social change. • Incorporates non-economic elements such as social practices, beliefs, values and customs • Diffusion and speed of change is critical as is removal of various cultural and social barriers • Backward internal structures-rather than external factors-cause underdevelopment • Modernization is understood implicitly as following the advanced countries’ path.

35. Modernization Theory and Stages of Economic Development/Growth • Modernization is a change process for less developed countries to the development process of the Western countries in the 17-19 century. Economic development is a part of the modernization process. • Modernization theory distinguishes a society to a traditional one and a modern one. • Rostow’s five-stage economic development/growth hypothesis is a response to Marxian view. • Formulated in the 1950s by W. W. Rostow in The Stages of Growth: A Non-Communist Manifesto, following works of K. Marx and F. List. • Rostow’s Stages of Economic Growth: ① Traditional society, ② Preconditions for take-off, ③ Take-off, ④ Drive to maturity, ⑤ High mass consumption

36. Linear-stages theory • Viewed the process of development as a series of successive stages of economic growth • Mixture of saving, investment, and foreign aid was necessary for economic development • Emphasized the role of accelerated capital accumulation in economic development • Rostow identified five stages of growth: - The traditional society - The pre-conditions for take-off - The take-off - The drive to maturity - The age of high mass consumption

37. Rostow’s Five-stage Model of Development

38. Modernization Theory • Increase investment – increase industrialization • Improve productivity and raise GDP • Incomes increase, and thus consumption increases

39. Five-stages of Economic Development

40. OECD outside Korea and Mexico Stages of Economic Development and Countries Taiwan South Korea Chile Take-off Stage Maturity Stage Latin America Asia Eastern Europe Economic Growth India Pakistan China Africa Stages 1-2 3 4 5

41. This theory modifies Marx’s stages theory of development and focuses on the accelerated accumulation of capital, through the utilization of both as a means of spurring investment, as the primary means of promoting economic growth and development. • The take-off stage is the distinctive stage in which investment rate increases usually from less than 5% to more than 10%; development of manufacturing sectors; existence of a political, social and institutional framework which supports the expansion of the modern sector. • - It is questionable whether all countries follow the same stages as • claimed by Rostow. • Such theories have been criticized for not recognizing that capital accumulation is not a sufficient condition for development. Early and simplistic theory failed to account for political, social and institutional obstacles to development.

42. Structural-Change Models • Structural-change theory focuses on the mechanism by which underdeveloped economies transform their domestic economic structures from traditional to an industrial economy A. The Two-Sector Model of Lewis (=Model of Unlimited Supply of Labor) B. Chenery’s patterns of development Model? (Approach) • Kuznets and Chenery - Focused on changes and patterns of industrial structure

43.  Structural-change Theory • This theory deals with policies focused on changing the economic structures of developing countries from being composed primarily of subsistence agricultural practices to being a “more modern, more urbanized, and more industrially diverse manufacturing and service economy.” • Lewis’ two-sector surplus (or “unlimited supply of labor” ) model, which views agrarian societies as consisting of large amounts of surplus labor which can be utilized to spur the development of an urbanized industrial sector. • Chenery’s patterns of development approach, which is the empirical analysis of the “sequential process through which the economic, industrial and institutional structure of an underdeveloped economy is transformed over time to permit new industries to replace traditional agriculture as the engine of economic growth.”

44. Lewis Theory of Development • Also known as the two-sector surplus labor model • Features of the basic model: • Economy consists of two sectors- traditional and modern • Traditional sector has surplus of labor (MPL=0) • Model focuses on the process of transfer of surplus labor and the growth of output in the modern sector • The process of self-sustaining growth and employment expansion continues in the modern sector until all of the surplus labor is absorbed • Structural transformation of the economy has taken place with the growth of the modern industry

45. Essence of the Lewis’ Model • The Structure of the Lewis’ Model: Dual economy

46. Model of Unlimited Supply of Labor by Lewis MPL C B II3 II2 A II1 WC E F G Ws (MPL)3 = (DL)3 (MPL)2 = (DL)2 (MPL)1 = (DL)1 0 L1 L2 L3 L

48. Shortcomins of Lewis Theory of Development • Some of the key assumptions do not fit the realities of contemporary developing countries. • Reality is that: • Capitalist profits are invested in labor saving technology • Existence of capital flight • Little surplus labor in rural areas • Growing prevalence of urban surplus labor • Tendency for industrial sector wages to rise even in the face of open unemployment • However, the model is a very powerful explanation for the earlier • industrialization process.The concept of the “turning point” is very useful.

49. Structural Changes • The Process of Structural Changes and Economic Development • There is continuous and successive structural transformation in the process of development from a less developed country to a developed country. This structural transformation continues even after being a developed country. • S. Kuznets • Empirically analyzed the development process of developed countries in the last 200 years. • H. B. Chenery • Identified structural patterns in the process of development through empirical analyses of the relationship between structural change and economic development in both developed and developing countries in about 20 years period.

50. Characteristics of Structural Transformation in an Economy • Realized with plural and close interrelationships • Not a temporary phenomenon but a continuous process • Speeds and types of structural changes are not necessarily • the same among countries • Usually follow an S-shape logistic curve • 10 basic Process of Structural Transformation • Related to physical and human capital accumulation:investment, • government revenue, education, • Related to resource allocation: domestic demand, production, trade • Related to population and income distribution: employment, • urbanization, population changes, income distribution.