Economic Development, 11E Michael P Todaro Stephen C Smith Instructor Manuals

Online Instructor’s Manual to accompany

Economic Development Eleventh Edition

Michael P. Todaro New York University

Stephen C. Smith The George Washington University

Authored by

Pareena G. Lawrence University of Minnesota, Morris

Copyright © 2012, Pearson Addison-Wesley. All rights reserved.

Contents Introduction

........................................................................................................................................

iv

Part One

Principles and Concepts ...............................................................................................

1

Chapter 1

Introducing Economic Development: A Global Perspective ..........................................

2

Chapter 2

Comparative Economic Development ............................................................................

8

Chapter 3

Classic Theories of Economic Growth and Development ..............................................

17

Chapter 4

Contemporary Models of Development and Underdevelopment ...................................

26

Part Two

Problems and Policies: Domestic .................................................................................

31

Chapter 5

Poverty, Inequality, and Development ...........................................................................

32

Chapter 6

Population Growth and Economic Development: Causes, Consequences, and Controversies ..................................................................................

43

Chapter 7

Urbanization and Rural–Urban Migration: Theory and Policy ......................................

51

Chapter 8

Human Capital: Education and Health in Economic Development ...............................

58

Chapter 9

Agricultural Transformation and Rural Development ....................................................

66

Chapter 10

The Environment and Development ...............................................................................

74

Chapter 11

Development Policymaking and the Roles of Market, State, and Civil Society ............................................................................................................

82

Part Three

Problems and Policies: International and Macro ......................................................

89

Chapter 12

International Trade Theory and Development Strategy .................................................

90

Chapter 13

Balance of Payments, Debt, Financial Crises, and Stabilization Policies ...................................................................................................... 104

Chapter 14

Foreign Finance, Investment, and Aid: Controversies and Opportunities ...................... 112

Chapter 15

Finance and Fiscal Policy for Development ................................................................... 120

Appendix

Additional Exam Questions ......................................................................................... 129

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Introduction This introduction offers a description of the main features of this manual and provides some general suggestions for teaching undergraduate development economics, which may be particularly useful for instructors who have not previously taught a development economics course.

Each chapter of the manual corresponds to a chapter in the text and contains the following sections: • Key Concepts: This section highlights the major topics covered in the chapter and offers a brief interpretation of the chapter’s general perspective and overall conclusions for easy reference.

This is not to be considered an inclusive summary of all the points covered in the text.

• Lecture Suggestions: Suggestions for developing and organizing lectures are offered, based on the experiences of several instructors who have previously used this text. Many chapters contain suggestions on where to find additional material that can be useful for expanding on some of the topics covered in the text. This section of the manual is not to be considered a complete lecture guide, but it can be useful for organizing lectures, filling in gaps, and suggesting new ideas for lecture topics. There are also suggestions for discussion topics included in each chapter.

• Sample Questions: These questions can be used for homework or exams. The questions for review found at the end of each chapter in the text can also suggest potential essay questions for the exam. In many cases, where a question is not directly derived from material in the text, a very brief answer is suggested.

In most cases, what you expect for an answer will depend on what you cover in lecture, as far as the level of detail. Most chapters also have one or two questions related to the case study at the end of each chapter. It is suggested that you use these questions only if you plan to lecture and expand on the case study.

The case study summaries can be found at the end of the chapter. As in previous editions, case studies have been updated and revised to reflect the content of the relevant chapters. The appendix to this manual contains more exam questions for each section of the text.

◼ Lecture Ideas for First-Time Instructors Development economics, with the breadth of material and ideas it covers, is one of the most difficult undergraduate courses to teach. The material in the text touches on every branch of economics, whereas most instructors tend to specialize in only a few branches of economics. In this respect, teaching the class for the first time can be overwhelming. Here are a few ideas which may make it easier: • Pick the topics and chapters that you would like to cover in your course and follow the text fairly closely the first time. The students tend to like this anyway because then they know what to expect on the test.

• Emphasize economic theory and the applicability of the theory to developing countries. This works especially well in cases where the economics background of the students is only at the introductory level.

• Emphasize development problems and the associated pros and cons of solutions. This provides a nice structure to many lectures.

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Introduction

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• Research selected countries to use as examples. Talk about these countries throughout the whole course. Remind student that there are many developing countries, and it is not realistic to expect one person to be an expert on all countries.

• Look up examples from current events and apply them to the theories discussed. Student interest is maintained by illustrating important problems and policy issues with recent events in the developing world, growth in microcredit organizations, climate change and its impact on developing nations, controversies over structural adjustment packages, export success of East Asia, reforms in China, Aids crisis in Africa, work of the Gates Foundation and the economic aftermath and recovery after the Asian tsunami. In the United States, the Newspaper Periodicals Index will help you locate the right article as well as identify topics you may have missed.

• Use the group presentation approach described below. This has the advantage of taking up some lecture time, but is also a valuable learning experience for all concerned.

• Emphasize the areas that you know best.

Teaching development economics can be fun and exciting, yet challenging at the same time. The extent of the challenge is a function of class size and each student’s background in economics, as well as the breadth of the material and ideas it covers.

◼

Writing Exams

Many instructors will find that essay-type questions (and to a lesser extent numerical problems) are most appropriate for this subject, in order to see if students have really grasped the ideas. Suggestions for multiple choice questions are also offered, though frequently the material does not lend itself to multiple choice questions, but may be useful if class size is large.

◼ Ideas for Assignments There are many different types of assignments that can be used.

• Traditional homework assignments. This works well if you plan to use graphical analysis, numerical analysis, or econometric analysis in your lectures. It also works well if the students have had intermediate level micro and macro as a prerequisite. In this case, they will already have been exposed to a lot of the analytical tools that you will use.

• Short papers. This works well if you do not want to use traditional homework assignments. One option is to assign two short papers of about five pages in length. Have the first one due a few weeks after the start of the course, and the second one at the end of the course. For the first paper, have the students research the general growth and development experience of a country of their, or your, choice. The purpose of the assignment is to get them to do some background reading on the country. You can assign specific items that they must report on or leave it more open. Possibilities include data on growth and other key indicators. Political and social factors can also be included. For the second paper, have the student keep the same country and research a more specific hypothesis or problem that they have learned in the class. Popular topics are growth and the environment, trade strategy, population growth, and income inequality. You may restrict the list of topics or have them submit the topic for approval.

• Group projects. This works well if you have a small class. You should choose a list of countries and have the students decide which group to be in. You might then choose three or four hypotheses or problems for the group to research, and have each person in the group present one topic. To encourage interest and participation in the presentation process, tell the students that they will be tested on the other group presentations. This will encourage questions and discussion.

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Introduction

• Current events/News journal. Have the students collect articles throughout the course related to development issues (two or three per week) and have them write up a short summary of each article discussing the relationship between the article and what they learned in class. You can even have one or two students present their article in class at the start of each class. You may want to devote ten minutes of class time to a brief discussion about the articles and how they relate to what students have covered in the course or will shortly cover; perhaps they may never explicitly study the topic but you can explain to them why the issue is still important to the dialogue on economic development.

◼ The Internet The Internet has opened up great possibilities as far as sources of information are concerned. It is worth remembering that, when assigning papers, many of your students will not go to the library at all, but will use the Internet instead. Therefore, instructors should point out both the potentials and pitfalls of information collected from the Internet. The World Bank web site (www.worldbank.org), for example, has a wealth of information, and it is relatively easy to locate country summaries on the Internet that help with assignments.

As a result, it is not too unrealistic to assign students the task of looking up information about particular countries in order to be prepared for class discussion. Other useful web sites include: Countries and Regions (www.worldbank.org/html/extdr/regions.htm) World Bank Development Data and Statistics (www.worldbank.org/data/) International Monetary Fund (www.imf.org) IMF World Economic Outlook (http://www.imf.org/external/pubs/ft/weo/2010/02/index.htm) United Nations Economic and Social Development (www.un.org/ecosocdev/) United Nations Statistics Division (unstats.un.org/unsd/) United Nations Development Program (www.undp.org) Human Development Report (http://hdr.undp.org/en/) For more online resources, visit the text’s Companion Website at www.pearsonhighered.com/todaro_smith. Updates to the Companion Website were provided by Abbas Grammy of California State University, Bakersfield. There you’ll find an online syllabus builder to create a calendar of assignments for each class. For the student, this site offers multiple-choice quizzes, readings, graphing and quantitative exercises, and maps and Internet exercises based upon the country case studies, with numerous web links to economic development and country data sites. The Instructor’s Resource Center (http://www.pearsonhighered.com/educator/product/EconomicDevelopment/9780138013882.page) carries PowerPoint lecture slides to aid you in classroom discussion.

These were authored by Meenakshi Rishi of Seattle University.

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Part One Principles and Concepts

Chapter 1 Introducing Economic Development: A Global Perspective ◼ Key Concepts It is easy to forget that students (especially in rich countries) may have a limited understanding of how life in the developing world differs from life in the developed world. The first main point of Chapter 1 is to drive this idea home, while also introducing through examples of debt crises and oil shocks, the idea that the world is becoming increasingly interdependent and that actions taken in the developed world can have a profound impact, for better or worse, on the developing world.

The second point is to provide an overview of the nature of development economics as a field. A defense of development economics as a distinct field, rather than an agglomeration of other economics subfields, is offered. A major theme of the book, that development economics must encompass the study of institutional and social, as well as economic, mechanisms for modernizing an economy while eliminating absolute poverty, is introduced.

The plan of the book is introduced through a series of 27 basic questions of development economics.

Depending on the amount of material covered by the instructor, students should be able to intelligently address most of these questions by the end of the course.

Section 1.3 looks deeper into the meaning of development and offers both the traditional economic measures and the new economic view of development that is multidimensional. This alternative approach is closely tied to the discussion of Sen’s “Capabilities” approach, first introduced in the 7th edition. Further, this section talks specifically about happiness in the context of economic development, relating the level of happiness not only to level of income but to other factors such as democratic freedoms and the quality of social relationships. The role of normative values in development economics—a subject dealing with human misery and human potential, with equity as well as efficiency, with cultural change that causes losses as well as gains, and with transfer as well as creation of wealth—is also stressed.

The conclusion is that development is both a physical reality and a state of mind. The meaning and objectives of development include the provision of basic needs, reducing inequality, raising living standards through appropriate economic growth, improving self-esteem in relation to the developed countries, and expanding freedom of choice in the market and beyond.

Section 1.4 presents an in depth examination of the UN’s Millennium Development Goals (MDGs). This includes a more comprehensive list of the goals themselves (appearing in Table 1.1) and a discussion of the shortcomings of the MDGs. Finally, the case study on Brazil at the end of the chapter has been revised and updated.

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Introducing Economic Development: A Global Perspective

3

◼ Lecture Suggestions The diversity of the developing world is worth stressing not only for the benefit of American students, notorious for being a bit shaky on geography, but students in developing countries as well, who may be unfamiliar with developing regions other than their own. Students should know that the developing world is economically and culturally far more diverse than the developed world. You might make some summary observations, such as within the developing world, per capita incomes range by a factor of well over 100 (from Mozambique to Singapore), while South Korea has a per capita income about equal to that of Greece and about half that of Spain. Incomes in industrial economies range by a factor of only three. Interesting statistics can be found from sources such as the World Bank World Development Reports and the United Nations Human Development Reports.

Presenting a few maps and tables, or even a slide show if you take the time to develop one, can be a valuable way to refresh the student’s memory on geography, highlight important differences between nations and regions, and provide an overview of development issues and problems. For the slide show you could select color graphics drawn from sources such as the United Nations Human Development Reports and World Bank World Development Reports, both of which are published annually. The art history department at many colleges and universities will have special equipment for making slides from prints. These graphics can be combined with a few representative photos of economic activities that you yourself, or a colleague, have taken in developing countries. The result is a presentation that maintains student interest and sets the stage for the issues covered in the course.

Some students have limited knowledge of historical events in the post World War II era, especially the events of the 1970s and 1980s. Some have little notion of oil price shocks, the external debt crises of the 1980s and the more recent Asian financial crises such as: what caused them, what effects they had around the globe, and how they underline economic interdependence. Touching briefly on these issues can make for a good introductory lecture theme.

In many universities, the economic development course will be filled with students who are not majoring in economics. These students may come from different colleges with majors such as social sciences (anthropology, sociology, or political science) or the business college (management, finance, etc.) and may have had as little as one semester of introductory economics. Given that you are teaching an economics class, you may wish to remind the students of this fact. Economics provides an important framework for analyzing many of the important development problems and hence the class will draw on the students’ knowledge of economics. You may also remind the students that traditional economics is in large the study of decision making under conditions of scarcity. You might use the first lecture to set the stage for the approach you will take, whether it will be more interdisciplinary, more economic, more mathematical and quantitative, more historical, or some combination. The first week or two of class will likely involve discussions of social, political, and institutional factors as well as economic factors.

Emphasize that development economics is a difficult subject to study and teach because it does not focus just on one country, but on all less-developed countries. Further emphasize that you will try to teach key concepts and ideas which can be applied to the experiences of many developing countries. These concepts and ideas are important for understanding where the developing countries are today, as well as what their options are for the future.

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Todaro/Smith • Economic Development, Eleventh Edition

The 27 basic questions can be used to motivate student interest in the subject as well as present an overview of what the class is all about. It can be emphasized that there is no one answer to the general question of why some countries are more developed than others. There are as many different opinions on what a less developed-country should do to become more developed. A good approach is to present differing viewpoints throughout the course and let the students make up their minds on their own.

If you have developing-country experience, mentioning some of your own experiences with, “How the Other Half Live,” is a way of introducing the first chapter and really getting students’ attention.

◼ Discussion Topics Encouraging class participation is a good way to motivate the students and make them feel involved in the learning process. The first few weeks of class in particular are conducive to this sort of exercise. Two ideas for discussions at this stage are: • What is the meaning of economic development? In what way(s) is economic growth different from economic development?

• Is it possible for the whole world to be developed? This can be an interesting question to ask at the beginning of the course and then again at the end of the course.

◼

Sample Questions

Short Answer 1. Provide a definition of development economics. Justify your choice carefully.

Answer: See the section in Chapter 1 entitled, “The Nature of Development Economics,” on pages 7–8 for some ideas about how the students might answer this question. They should in some way say that development economics is more than just growth in GDP. 2. In defining development to include more than just the growth of per capita income, there is an implicit assumption that the growth of per capita income alone is not sufficient to guarantee the reduction of poverty and the growth of self-esteem. Is it possible that there could be growth of per capita income without the achievement of these other objectives?

Answer: Per capita income can show growth even when that growth does not touch vast portions of the population. The growth may be centered in one area or sector of the economy for example. Also, most developed countries have, at some time in their histories, introduced policies emphasizing equality.

3. In what way is development economics greater in scope than traditional economics?

Answer: Development economics must encompass the study of institutional, political, and social as well as economic mechanisms for modernizing an economy while eliminating absolute poverty and transforming states of mind as well as physical conditions. More details found in the chapter.

4. Make a case that development economics might be merely a combination of all the other subfields of economics, only applied to low-income countries.

Answer: See Question 3 above.

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5

5. What do you think are the most serious obstacles to further progress in the developing world?

Answer: The main point here is to ensure that students are thinking carefully about the issues raised in the text. You may also wish to draw from the critical questions on Pages 9–11.

6. In reviewing discussions of life in developing countries, what is it about lifestyles in the low-income countries compared with lifestyles in the high-income countries that most strikes you? Why? Answer: This is an open-ended question to stimulate reflection.

7. It has been said that “underdevelopment is a state of mind.” Comment.

Answer: You may look for a discussion of the role of modern values in the development process, as on Pages 12–14 of the text.

8. Do you think it is in the material interests of high-income countries to help low-income countries improve their economic performance? Why or why not?

Answer: Answers might touch on increasing the market for products in which high-income countries have a comparative advantage, reducing the dangers of regional war and terrorism, reducing international transmission of disease, and curbing international migration.

9. How is happiness related to development?

Answer: Answers should make reference to the correlation between happiness and income level as well as touch on the connection between happiness and social relationships, personal and democratic freedoms, religious beliefs, and health, among other factors listed on Page 20.

Further, answers should include a discussion on happiness as being a part of Amartya Sen’s concept of functionings.

10. What are the Millennium Development Goals (MDGs) and how did they come about? What do you consider to be the most important of these and why?

Answer: The answer should stress that the goals cover a broad range of objectives both economic and social. These were put forward so that developing countries would have numerical targets against which their progress could be judged and, where warranted, appropriate assistance offered. An interim assessment of the MDGs can be found at: www.unmilleniumproject.org.

11. Why are women often referred to as playing a central role in economic development?

Answer: An answer should include how women can influence whether or not the next generation will be impoverished through their role of childrearing based on the resources they bring to this task and the values they pass to their children. Another key point that should be mentioned is that empirically, women tend to allocate a higher percentage of the income under their own control to the family and children than men.

12. What are the most important characteristics that have shaped Brazil’s economic and social progress during the last three decades?

Answer: Discussion should include the large degree of income inequality, the need for land reform as a result of the dualistic nature of the land tenure system and the environmental challenge faced by what is one of the world’s most environmentally diverse countries.

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Todaro/Smith • Economic Development, Eleventh Edition

◼ Multiple Choice 1. Countries tend to be classified as more or less developed based on a. the literacy rate. b. the poverty rate. c. the level of income per capita. d. the types of goods they produce.

Answer: C 2. Which of the following demonstrates international interdependence? a. the oil shocks b. the debt crisis c. global warming d. all of the above.

Answer: D 3. A subsistence economy is a. a very low income economy. b. an economy in which people make what they consume. c. an economy in which people receive food for pay. d. all of the above.

Answer: B 4. Development economics is the study of the a. alleviation of absolute poverty. b. transformation of institutions. c. allocation of resources in developing countries. d. all of the above.

Answer: D 5. Development economics must have a scope wider than traditional economics because a. values and attitudes play little role in the pace of development. b. people in developing societies do less utility-maximizing. c. transformation of social institutions is necessary for development. d. all of the above.

Answer: C 6. A good definition of the meaning of development is the a. elimination of absolute poverty. b. improvement in the quality of life. c. fulfillment of the potential of individuals. d. all of the above.

Answer: D

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Chapter 1

Introducing Economic Development: A Global Perspective

7. Which of the following is not an important objective of development? a. increases in per capita income b. the expansion of available choices c. increases in individual and national self-esteem d. all of the above are important objectives of development Answer: D 8. The Millennium Development Goals include a. eliminating the proportion of people living on less than $1 per day. b. universal primary education. c. increasing exports by one half. d. all of the above.

Answer: B 9. The core values of development include a. increasing income per person. b. reducing the inequality of income. c. the ability to meet basic needs. d. all of the above.

Answer: C

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Chapter 2 Comparative Economic Development ◼ Key Concepts In the new edition, Chapter 2 serves to further examine the extreme contrasts not only between developed and developing countries, but also between different developing countries.

As in the last edition, Chapter 2 introduces quantitative comparison methods. After classifying countries as low–income, lower–middle income, upper–middle income, high income OECD, and other high-income countries (in accordance with the World Bank’s income classification structure), Purchasing Power Parity (PPP) is explained as a tool to make more accurate comparisons between countries based on income level. As an alternative to the World Bank’s classification based on income, Chapter 2 looks at other key development factors such as education and gender inequality, mainly through an introduction to the Human Development Index and how it is calculated. This edition also introduces students to the new Human Development Index and how it differs from the original HDI. It emphasizes the calculations of these two indexes and how a nation’s income level is often not consistent with its HDI or NHDI. Numerous new country comparison tables were added to better illustrate this point.

The new edition emphasizes the similarities among developing countries. The chapter stresses ten key similarities of developing countries: • • • • • • • • • •

Low levels of living and productivity Low levels of human capital High levels of income inequality and absolute poverty High rates of population growth Social fraternization Large rural population with rapid rural–urban migration Low levels of industrialization Adverse geography Underdeveloped financial systems and markets Lingering colonial impact and external dependence

The subsection on the relative importance of private and public sector and civil society has been eliminated from this chapter. Within the discussion of these similarities are highlights of the diversity among developing nations despite their commonalities.

The chapter goes into greater detail when discussing that developing countries began modern economic growth with initial conditions much different from those of the developed countries. In comparison to the position of the developed countries on the eve of their development, many of today’s LDCs have: • more limited natural resource endowments.

• lower per capita incomes.

• a less temperate climate and possibly unfavorable geographic conditions. .

Chapter 2

Comparative Economic Development

9

• larger population sizes and growth rates.

• fewer migration possibilities, but a larger “braindrain” problem among those who do migrate (the new edition specifically addresses the problems associated with remittances).

• fewer growth benefits from international trade.

• limited scientific and technological research capacity.

• ineffective domestic institutions.

This section is followed up by a discussion as to whether the living standards in developing and developed nations are starting to converge.

A section on the long-run causes of comparative development provides a framework linking these causes, designed purposely to give students a foundation for the following chapters which discuss different theories of economic development. Included is a diagram that is helpful for students when trying to visualize the linkages.

The chapter ends with a case study on Pakistan and Bangladesh.

◼ Lecture Suggestions To avoid presenting list after list of similarities and differences between countries, students find it more interesting if you ask them to come up with the list and then fill in any items they have missed, as noted in the discussion topic section below.

If you did not already discuss interesting statistics (or covered those very briefly) you could do this here as part of the discussion of common characteristics. Interesting statistics include data on the distribution of income, the percentage of people by region or country who are absolutely poor, life expectancy, infant mortality, literacy, and health indicators. The discussion of common characteristics can be viewed as a preview of topics to be discussed in more detail later in the course. Interesting questions can be raised that will be answered throughout the course. The questions that students ask at this stage can indicate which topics they are interested in, their knowledge of some of these topics, and any misconceptions they may have about various development issues.

Note that the text discusses GNP as opposed to GDP, though both terms are defined in the chapter. Given that many principles of macroeconomics textbooks focus on GDP rather than GNP, it may be helpful to remind students of the difference. You can also discuss which may be the better measure for less developed countries and/or whether there is likely to be a significant difference between the two. Look up some examples for different countries. Stressing this issue depends, of course, on the background of the students.

When discussing the classification of developing countries as either low income, lower-middle income, or upper-middle income you can also discuss: • Classifying countries using GNP per capita, or the human development index and comparing the two classifications. Show the students what factors are represented in the HDI and how it is computed (note the new coefficients in the newer version). This can further focus student attention on the broader meaning of development and the importance of looking beyond average income levels. The table on page 52 can help students contrast GDP per capita with HDI levels to show that a certain level of GDP does not guarantee an equivalent HDI. Starting on page 54, eight new changes are outlined as of 2010.

• The GNP conversion problem. In order to classify countries according to GNP per capita each country’s GNP must be converted to dollars. This discussion can first review the definition of GNP and what counts and does not count in GNP. In particular, non-market transactions may be more prevalent in less developed countries. Nominal versus real GNP can also be reviewed. The concept of an exchange rate can be introduced here, as can fixed versus flexible exchange rates, in terms of highlighting problems

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with exchange rate conversions. A distinction can be made between market and central-bank determined exchange rates and mention that, in the past two decades, many LDCs have adopted market rates.

To explain purchasing power parity you can look up the latest Big Mac index from The Economist magazine.

• Characteristics such as education, literacy, and share of industry in GNP tend to change predictably with the level of GNP. The diversity that exists between developing nations can be discussed partly by highlighting the differences between countries in Africa, Asia, and Latin America in terms of colonial experience, income level, political regime, wars, culture, trade strategy, and level of education. To further highlight specific country differences, such as size and resource endowments, it is useful to focus on one or two countries and point out the differences between them, as well as the special challenges each country faces.

Introduce the concepts of modern economic growth and structural change. Traditional society and modern economic growth can be placed in historical perspective and a short discussion on the different conditions faced by developing countries and currently developed countries can follow. The legacy of colonialism and dependence in representative countries from various developing regions can be contrasted.

Discuss the various theories of Comparative Development.

◼ Discussion Topics • Ask the students what they think the common features of developing countries are and make a list of their suggestions on the board. At the end, add anything that they have missed. Along the way you can elaborate on their suggestions.

• Ask the students whether they think becoming more economically developed is equivalent to becoming more industrialized. You can present data on the share of industry in GDP, discuss the difference between necessary and sufficient conditions, and introduce the concept of modern economic growth and the structural changes that go along with development (this is discussed further in Chapter 3 as part of the structural change theory).

Students will find it instructive to review the many differences between Europe on the eve of its postwar “miracle” and developing countries at their time of independence. These differences include infrastructure (at least engineering plans for destroyed sections), human capital (such as industrial skills even if industry was destroyed), magnitude and type of capital inflow, values of modernity, developing countries lower political autonomy and the legacy of colonialism, and the fact European countries not only were not colonies themselves but owned colonies. This topic can also be discussed in Chapter 3 as part of the discussion of the Harrod-Domar model. The Harrod-Domar model worked well for the European countries after WWII because they had the right complementary inputs in place.

◼

Sample Questions

Short Answer 1. Explain how low levels of living can turn into a vicious cycle in developing countries.

Answer: See the section on low levels of living in the chapter.

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2. Carefully explain some of the similar problems faced by otherwise diverse countries in Africa, Asia, and Latin America.

Answer: This calls for students to summarize some of the main points discussed in the chapter.

3. What are some of the main ways in which the economies of developing countries differ from one another?

Answer: See the Key Concepts above for a summary.

4. Explain why purchasing power parity measures of income levels tend to show a smaller difference between poor and rich countries.

Answer: PPP measures show the number of units of developing country currency required to purchase a basket of goods and services in the developing country market that costs one dollar in the U.S. Prices for most services tend to be much cheaper in developing countries than in the U.S. 5. In what way does nationalism tend to be a hindering force in attaining modern economic growth and development, and in what way a facilitating force?

Answer: This is a question that would depend on what you have covered in lecture.

6. What are the three main indicators that make up the Human Development Index?

Answer: Life expectancy, educational attainment, GDP per capita measured in PPP terms.

7. If countries are first ranked by level of real GDP per capita, and then by the value of the Human Development Index, would you expect the ranking of countries to be similar or different? Explain.

Answer: The final column of Table 1 in the Human Development Report (hdr.undp.org) shows the difference in ranking between the two classification methods and students can be directed to that.

8. Comment on the following statement: The level and growth rate of real GDP per capita can be a misleading indicator of development. At the same time, countries that experience sustained increases in real GDP per capita over time will tend to be more developed.

Answer: Open-ended essay.

9. What are the three major components of economic growth?

Answer: Capital accumulation, labor force growth, and technological progress.

10. Explain the lingering effects of colonialism and how it is still playing a role in hindering economic development in the developing world.

Answer: Answers should be based on the points covered in the section on the colonial impact as well as in lecture.

11. Why might the use of more advanced technology not be a sufficient condition for sustained economic growth?

Answer: It may require an inefficiently high capital labor ratio and complementary factors, especially education, may be lacking. Additional points depend on lecture coverage.

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Todaro/Smith • Economic Development, Eleventh Edition

12. The 2006 Human Development Report reported that the HDI of South Africa was 0.653 (and its rank was 121) and that of the Peru was 0.767 (and its rank was 82). South Africa’s per capita income (in PPP dollars) was 11,192 and that of Peru was 5,678. Comment and explain.

Answer: Instructors can use figures similar to those in the question from the most recent issue of the HDR (at hdr.undp.org) in updating this question. Students should discuss the difference between economic growth (per capita income) and economic development by discussing the components of the HDI. 13. What are remittances and what role do they in developing countries? How could this potentially benefit an economy?

Answer: An answer should pose a definition, mention how remittances reduce poverty for many migrants and their families, and speak to the possible net increase in labor force skills driven by the desire to emigrate.

14. Are living standards in developed and developing countries converging? Give evidence to support your answer.

Answer: Answers should refer to Figures 2.8–2.10 and the supporting text.

How do differences in culture lead to comparative development?

Answer: Cultural factors effect the development and amount of emphasis put on education, institutions, and how effective civil society is. An important part of the answer should be how the role of culture has not been clearly established due to its complexity.

15. In what way(s) do the development paths chosen by Pakistan and Bangladesh differ? What are the main factors that have contributed to these differing paths?

Answer: The key differences are the aspects of economic development discussed in the chapter. The case study at the end of the chapter provides comparative figures for the two countries and the main factors contributing to the divergent paths.

16. How is poverty measured? What is the extent of poverty in the developing world?

Answer: The concept of absolute poverty is discussed in the text and the progression of absolute poverty in the developing world is shown in Figure 2.7. If the concept of relative poverty was discussed in the lectures, instructors may look for that distinction in the answer.

17. What are the major differences between the new HDI and the original HDI? Answer: Open ended essay. Refer to pages 54–56 of text for the discussion.

◼ Multiple Choice 1. An example of an upper-middle income country is a. India. b. Brazil. c. Indonesia. d. Nigeria.

Answer: B

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2. A newly industrialized country is a. the same as a high income country. b. any country that has experienced sustained growth in industry. c. a special classification given to some upper-middle income countries that have achieved relatively advanced manufacturing sectors. d. any country that has moved out of lower income status.

Answer: C 3. Which of the following is not an upper middle-income country? a. Brazil b. South Africa c. Pakistan d. Argentina Answer: C 4. Which of the following is a low-income country? a. Mexico b. Thailand c. Turkey d. Bangladesh Answer: D 5. One of the components of the human development index is a. the percentage of the population who are high school graduates. b. the average daily intake of protein. c. life expectancy at birth. d. the number of doctors per hundred people in the population.

Answer: C 6. What percent of the world’s nations have at least five significant ethnic populations? a. 0–10 b. 10–20 c. 20–30 d. 30–40 e. over 40 Answer: E 7. What fraction of developing countries have recently experienced some form of significant interethnic conflict? a. less than one-tenth b. a tenth to one-quarter c. one quarter to one half d. over one half Answer: D .

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8. Which of the following African countries has experienced widespread death and destruction due to ethnic or clan based conflict in the previous decade? a. Rwanda b. Sudan c. Somalia d. all of the above Answer: D 9. Which measure uses a common set of international prices for all goods and services produced? a. purchasing power parity income levels b. GNP price deflators c. foreign exchange rate conversions to U.S. dollars d. the exchange rate Answer: A 10. The number of units of developing country currency required to purchase a basket of goods and services in a developing country that costs one dollar in the U.S. is given by a. GNP price deflator. b. Human Development Index ranking. c. purchasing power parity. d. the exchange rate.

Answer: C 11. About how many people lack access to basic sanitation? a. 20 million b. 200 million c. 500 million d. 1 billion e. 2 billion Answer: E 12. About how many people lack access to safe water? a. 20 million b. 200 million c. 500 million d. 1 billion e. 2 billion Answer: D 13. About how many malnourished children under age five are there in the developing world? a. 20 million b. 150 million c. 500 million d. 1 billion e. 2 billion Answer: B

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14. Neutral technological progress occurs when a. higher output levels are achieved with the same quantity and combinations of factor inputs. b. higher output levels are achieved by more capital intensive methods. d. higher output levels are achieved by more labor intensive methods. e. higher output levels are achieved.

Answer: A 15. Conditions of today’s developed countries at the start of their industrialization differ from conditions in the developing world in that a. population growth rates were higher. b. more advanced technology was available. c. there were more opportunities for development assistance. d. none of the above.

Answer: D 16. Most successful examples of modern economic growth have occurred in a country with a. a temperate-zone climate. b. a market economy. c. exports of manufactured goods. d. all of the above.

Answer: D 17. Which of the following is not an indicator that is used by the World Bank in measuring the level of economic development? a. life expectancy at birth. b. adult literacy rate. c. infant mortality rate. d. all of the above are not used by the World Bank.

Answer: D 18. The dependency burden is a. a measure of the degree to which the less developed countries are dependent on the rich industrial countries. b. the average number of children that a woman gives birth to during her lifetime. c. the number of babies born per 1000 persons. d. the percent of the population that is below 15 and above 65 years of age.

Answer: D 19. How many people still live on less than the equivalent of $1.25 per day (new definition of “extreme poverty”)? a. 100 million. b. 500 million. c. 1.4 billion. d. 2.2 billion.

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Answer: C 20. Which of the following is not an indicator that is used to compute the Human Development Index? a. life expectancy at birth. b. real GDP per capita. c. infant mortality rate. d. adult literacy rate.

Answer: C 21. The combined GDP of developing countries constitutes approximately a. 5 percent of global GDP. b. 20 percent of global GDP. c. 30 percent of global GDP. d. 40 percent of global GDP. Answer: D 22. Developing countries are starting to converge with developed countries in the long run in what respect? a. Growth rate b. Income inequality c. Population d. Per capita income Answer: D 23. Which region in the world has the lowest GNI per capita based on the World Bank Atlas method? a. Sub-Saharan Africa b. East Asia/Pacific c. South Asia d. Latin America/The Caribbean Answer: C

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Chapter 3 Classic Theories of Economic Growth and Development

◼ Key Concepts The overall aim of the chapter is to provide a historical overview of the major development theories put forth during the past half century. The theories are presented in historical sequence. The key features of each theory are presented, along with a discussion of its major contributions and limitations. It is emphasized that, while the theories are often competing in nature, each offers valuable insights into the development process. The comparative case study of South Korea and Argentina at the end of this chapter emphasizes the theories. The chapter also retains the three appendices from the previous edition on Components of Economic Growth, the Solow neoclassical growth model and Endogenous growth theory.

The theories discussed in this chapter include: • • • • • •

Rostow’s theory.

The Harrod-Domar model. (k variable has been changed to c in the capital-output ratio) The Lewis model.

Chenery’s patterns of development.

Dependency theory.

Neoclassical theory.

The chapter also emphasizes the basic concepts of economic growth theory, using the production possibilities frontier (Appendix 3.1). The basics of economic growth are covered with a discussion of the role played by capital accumulation, labor force growth, and technological progress. The discussion uses the production possibilities frontier for illustration purposes. Neutral, capital saving and labor saving technological progress are also compared.

The linear stages of growth models share the central role of savings and capital formation as their basic theme. The two examples given are W.W. Rostow’s theory and the Harrod-Domar model. The text finds this approach limited since the structural and institutional conditions necessary to effectively utilize savings are often lacking, and the possibilities of development are often conditioned on international factors beyond a developing country’s influence. It also draws a distinction between necessary and sufficient condition for economic growth to occur.

Structural change models stress the transformation from a traditional, agricultural economy to a modern, industrial economy. The Lewis model is carefully developed and analyzed as the key theoretical illustration of this approach. Though important for its emphasis on labor transfer between traditional agriculture and modern industry, it is criticized for assuming that real urban wages are constant and that migration and modern sector employment grow proportionately (with urban full employment). Chenery’s findings of the patterns of development are presented as an illustration of an empirical approach, and include the shift .

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in production from agriculture to industry and services, the accumulation of physical and human capital, the shift to nonfood consumption and investment, urbanization, and the growth of trade as a share of GNP. The text cautions that country variations are large. Three variants of the international dependence models of the 1970’s are explained.

•

The neocolonial dependence model emphasizes the unequal power relationships between the developed and less developed countries and blames underdevelopment on conscious or unconscious developed country exploitation, perpetuated by power inequality within each developing country, whereby a small ruling elite controls the means of production.

•

Arguments that underdevelopment is fostered by well-meaning but inappropriate advice from aid agencies and other Western trained economists is termed the false-paradigm model.

•

(“The Dualistic-Development Thesis”) Singer’s superior-inferior sectors model is cited as representative of the dualistic development thesis. Despite doubts that developed countries are intentionally keeping the developing countries in a dependent state, the fact that many key international economic decisions are made in the developed countries is acknowledged.

The chapter emphasizes the more recent theories, termed the neoclassical counterrevolution, that focus on the working of markets, inefficiency, and a lack of economic incentives within developing countries as being responsible for the lack of development. The text makes a distinction between three approaches: •

The free market approach argues that markets are efficient and any government intervention is counterproductive.

•

The public choice, or new political economy, approach emphasizes inherent government failure and the self-interested behavior of public officials.

•

The market-friendly approach recognizes market imperfections, and hence a limited but important role for government through nonselective interventions such as infrastructure, education, and providing a climate for private enterprise.

The Solow growth model is mentioned in the context of traditional neoclassical growth theory, and its implications for the determinants of economic growth are explored further in Appendix 3.2 to the chapter.

This section concludes by identifying three important contributions: •

Market price allocation is usually more efficient than intervention.

•

State-owned enterprises have not fulfilled their promise and have been inefficient.

•

Incentives must be stressed.

The neoclassical approach is criticized on the grounds that markets in developing countries, when they exist, are far from perfect and cannot be made perfect by any simple formula. Chapter 11 provides more details on market liberalization.

Endogenous growth theory and the Romer model are discussed in Appendix 3.3. Contemporary models of development are discussed in Chapter 4.

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◼ Lecture Suggestions As a general observation, there are many ways to combine material from the first three chapters. While all the later chapters are constrained in subject matter and lectures, there is no obviously optimal way of introducing the developing world and development economics. It is possible to jump between the first three chapters and choose the order which makes the most sense for the class being taught. The most important concepts to convey in the first three chapters include: •

An understanding of similarities and differences between developing and developed countries (Chapter 2).

•

An understanding of the complexity of the development process and its multidisciplinary approach (Chapters 1 and 2).

•

An understanding of the basics of economic growth theory (Chapter 3).

•

An understanding of the advantages and disadvantages of drawing from the experience and knowledge base of developed countries.

•

A basic understanding of the different schools of thought concerning the development process and the question of why some countries are less developed (Chapter 3).

There is value in spending a few lectures on the theories presented in Chapter 3 for several reasons. Learning about the different theories gives students a feeling for how the approach to economic development has evolved over time. This process illustrates how theories tend to evolve over time as more information is accumulated. There is also value in studying the history of development thought because it gives the students a better perspective on where the thinking is today, as well as helping to explain what has worked and what has not worked. Finally, and, perhaps, most importantly the intellectual basis of the theories of development is closely tied to the political climate, hence the recent neoclassical revival.

Instructors who wish to expand on the coverage of the theories provided in the text may look up the original articles for supplemental lecture material. Another possibility is to incorporate some of the important ideas from classical political economists in more detail, such as Smith (commodity exports and development), Ricardo (infinitely elastic labor supplies), Mill (development benefits of lowered inequality, cooperatives, or connections between economic and political development), and Marx (radical dualism and dependency).

The linear stages of growth theories can be identified by three key characteristics: an emphasis on capital scarcity, on the importance of the historical experience of the developed countries, and on economic growth, specialization, and industrial development.

•

Rostow’s stages of growth theory can provide important insights into the development process, such as the important role played by savings, investment, and capital accumulation. His identification of which stages countries were in at the time his theory was developed are interesting in comparison to where some of those countries are today. This can help emphasize that there is no recipe for economic development. Also, the possibility of economic regression (ignored by Rostow) can be introduced here.

•

A discussion of the Harrod-Domar model helps stress the idea that the inputs that complement capital are equally as important as the capital itself. A discussion of the incremental capital output ratio, constant returns to scale, and isoquants can be useful for introducing the concepts of labor and capital intensive technologies.

The description of economic growth from Appendix 3.1 can be incorporated into the discussion of the different growth theories in order to emphasize the importance of labor, capital and technology, as well as the unique situation of the developing countries.

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The structural change theories are important for identifying common structural changes that occur within countries as they develop, and brings up the important issue of cause and effect. Will encouraging these structural changes cause development or do these changes have to be an effect of the development process?

What can be learned by studying the historical experience of developing countries? The Lewis model is interesting, in part, because it highlights many of the important topics to come including migration, the use of capital intensive technologies, the existence of minimum wages, the lack of rural development, and rapid population growth. The Lewis model also provides a good review of the relationship between marginal productivity and wages, the concept of diminishing returns, the importance of capital and technology, and the concept of elasticity. The model can be illustrated by reference to the massive exodus from countryside to industry taking place in China during the past two decades.

Along with the change in emphasis in development thinking, more recent editions of the text have reduced the amount of material devoted to dependence theories. Nonetheless, most students may be unfamiliar with the heavy emphasis on planning and government intervention that was predominant in development thinking in the 1970s. While care must be exercised not to overemphasize these theories, there are a number of benefits from drawing attention to them. The general message of these theories, namely that developing countries are not entirely responsible for their economic destiny, has appeal among many students. In addition, it is worth noting that the theories emphasize the economic links between rich and poor nations, even though the theories argue that these links work to the detriment of poor nations. Finally, the existence of large wealth and power discrepancies within each developing nation is a theme central to the study of economic development, and worth emphasizing at many points throughout the semester.

There are many important ideas that can be emphasized with respect to the neoclassical counterrevolution theories. The historical evolution of the different schools of thought is interesting in that the dependence theories blame the developed countries for underdevelopment while the neoclassical theories blame the less developed countries for underdevelopment. Key concepts to stress include: •

Market failure and efficiency. Important market failures that you may mention but will discuss later in the course may include externalities, infant industry, a lack of property rights, a lack of complementary inputs such as credit, a lack of financial institutions, and a lack of information.

•

The appeal of adopting different policies to try to speed up the development process.

•

Macroeconomic stability and the IMF.

•

Privatization.

•

Competition.

•

Free trade.

These ideas can be mentioned in terms of their theoretical importance and discussed in more or less detail depending on what you plan to cover later.

Emphasize that each theory has some important idea to add to the questions of how a country can become more economically developed and why some countries remain less developed. The comparative case study of South Korea and Argentina illustrates the four groups of theories for these two countries.

◼ Discussion Topics •

What type of technology is most appropriate for developing countries, capital intensive or labor intensive? What are the advantages and disadvantages to the developing country of borrowing technologies from developed countries as opposed to developing their own technologies?

•

Why are complementary inputs to capital so important and often lacking?

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Chapter 3

◼

Classic Theories of Economic Growth and Development

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Sample Questions

Short Answer 1. What are the main differences between the linear stages and international dependency models of development?

Answer: Lack of development is generated internally with the linear stages model, and is attributed to a lack of savings and investment. It is generated externally in the dependency model, and is the result of actions taken by the developed countries.

2. Why is the debate between the international dependence and the neoclassical counter-revolution schools referred to as “finger pointing?”

Answer: The text stresses that most members of the former school tend to be developing country economists, while most members of the latter school are developed country economists.

The former blames underdevelopment on policies adopted by the developed countries, while the latter blames policies adopted by the developing countries.

3. Describe some of the advantages and disadvantages of each of the following schools: linear stages, structural change, dependence and neoclassical.

Answer: Discussed in detail in the chapter and in the comparative case study at the end of the chapter.

4. Describe one important criticism of Rostow’s stages of economic growth theory.

Answer: The stages are only necessary and not sufficient conditions, savings is too aggregate a measure, the theory does not take into account the constraints of the international economic order, and there are counter-examples such as Argentina.

5. Dependency theory characterizes countries as being either in the center or on the periphery. Explain these two concepts. If this theory is correct, what are the implications for development strategy?

Answer: Grading would depend on what is covered in lecture, but an answer might include inward looking trade policies, regional economic integration, collective action to increase bargaining power in relation to multinational corporations, as well as creation of state-owned enterprises.

6. Apply what you have learned about development and development theories so speculate on the following thought experiment: What if anything might be different about today’s international economic order if the Spanish had colonized North America and the English had colonized South America?

Answer: You may wish to note for students that there may be more than one correct answer.

Careful reasoning and application of the material is necessary.

7. Does it follow from the false-paradigm model that World Bank economists are intentionally trying to keep developing countries from realizing genuine development? Why or why not?

Answer: It does not exclude this possibility, but suggests that this may be done unwittingly as a result of having to work within narrow policy parameters defined by the international economic system.

8. Patterns of development or structural change analysis stress internal change in a developing country’s economic, industrial, and institutional structure. What are some of the most important changes?

Answer: Discussed in the text.

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9. Explain the concept of the “idea gap” in development economics.

Answer: Developing countries lack knowledge, information, and skills for production and productivity in comparison to more developed countries.

10. Assume a closed economy, perfectly elastic labor supply, and linear technology. Suppose the incremental capital-output ratio (ICOR) is 3, the depreciation rate is 3%, and the gross savings rate is 10%. Use the Harrod-Domar growth equation to determine the rate of growth. What would the gross savings rate have to be to achieve 5% growth? Assuming a perfectly elastic labor supply, state one criticism of this model from an exogenous growth theory viewpoint and another criticism of this model from an endogenous growth theory viewpoint.

Answer: This question may be asked later in the course or may be broken up into several questions.

Whether to use it at this stage will depend on how much coverage you gave this topic in lecture, especially for the last part of the question and also whether the Harrod-Domar model was covered assuming a zero depreciation rate (as in the text) or a positive depreciation rate. Answer: growth rate of 0.003, that is 0.3%, and 0.24, or 24% savings rate. Exogenous: does not allow factor substitution; endogenous: does not address sources of productivity growth, or the savings decision.

11. What are the key assumptions of the Lewis model that give rise to its conclusions? How would the theory’s conclusions differ if these assumptions do not hold?

Answer: There may be a variety of answers depending on what was emphasized in the lecture. The answer should include the existence of surplus labor in the rural sector that guarantees an infinitely elastic labor supply in industry until the surplus is exhausted and a propensity to save by industrialists equal to one. The lack of rural surplus labor (and infinite labor supply) would imply that when industrialists reinvest their profits there is no guarantee that their surplus increases. A low marginal propensity to save by industrialists puts a break on the labor transfer process.

12. During the past decade, India has invested about 22% of its GDP while China’s investment rate has been double that of India’s. India’s annual growth rate has been about 6% while that of China has been about 9%. What conclusions can you draw?

Answer: Students are asked to relate investment rates to the rate of economic growth through the Harrod-Domar model. The students should calculate the ICOR for the two countries and note that India’s ICOR (about 3.67) is lower than China’s (about 5).

◼ Multiple Choice 1. Which of the following is not a policy proposal of the neoclassical counter-revolution school? (a) promoting free trade (b) privatizing state-owned enterprises (c) welcoming multinational corporations (d) promoting trade unions Answer: D 2. Which of the following is an assumption of the Lewis two-sector model? (a) surplus labor in the rural sector (b) high unemployment in the urban modern sector (c) rising real urban wages (d) rising marginal product of labor in the rural sector Answer: A .

Chapter 3

Classic Theories of Economic Growth and Development

3. The false paradigm model attributes lack of development to (a) inadequate attention to price incentives. (b) inappropriate advice from rich country economists. (c) low levels of savings and investment. (d) a lack of government regulation.

Answer: B 4. Which of the following is a criticism of the neoclassical counter-revolution school’s approach? (a) markets are not competitive in developing countries. (b) externalities are common in developing countries. (c) inequality may worsen when interventions are removed in developing countries. (d) all of the above.

Answer: D 5. Which of the following approaches does not offer an international dependence explanation of underdevelopment? (a) the false paradigm model (b) the neoclassical counter-revolution (c) the dualistic development model (d) the neocolonial dependence model Answer: B 6. The neoclassical counter-revolution school supports (a) trade restrictions. (b) state-owned enterprises. (c) eliminating government regulations. (d) limitations on foreign investors.

Answer: C 7. Implicit assumptions from which theories evolve are known as (a) a paradigm. (b) biases. (c) stylized facts. (d) normative economics.

Answer: A 8. On which of the following does the neoclassical counter-revolution school most blame underdevelopment? (a) misguided government policies (b) relatively rigid cultural traditions (c) the legacy of colonialism (d) unfair trade practices on the part of developed countries Answer: A

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9. According to the theory of structural patterns of development, which of the following tends to occur as a country develops? (a) a shift from agriculture to industry and services (b) an increase in the percentage of income spent on food (c) growth of the rural sector (d) a decline in trade as a share of GNP Answer: A 10. In the public choice (or new political economy) approach to development the emphasis is on (a) growth in the rural sector. (b) the self-interested behavior of public officials. (c) the dependence of LDCs on former colonial powers. (d) the inherent efficiency of developing country markets.

Answer: B 11. A situation in which government intervention in the economy worsens the economic outcome is termed (a) neoclassical failure. (b) socialism. (c) government failure. (d) dependency revolution.

Answer: C 12. According to the dependence theory, the developing world is known as the (a) backward areas. (b) periphery. (c) first world. (d) center.

Answer: B 13. The underlying assumption of the Harrod-Domar growth model is that (a) the incremental capital-output ratio is given by k = Y/K. (b) growth is mainly determined by capital accumulation. (c) growth can be sustained only if agricultural productivity rises. (d) developing countries save too much and invest too little.

Answer: B 14. The supply curve of labor to industry in the Lewis model is horizontal if there is surplus labor in agriculture. This condition persists as long as (a) the marginal product of labor is less than the average product of labor in agriculture. (b) the marginal product of labor in agriculture is less than the marginal product of labor in industry. (c) there are diminishing returns to labor in agriculture. (d) the marginal product of labor in agriculture is zero.

Answer: D .

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25

15. International dependence theories distinguish between two groups of countries known as (a) rich-poor. (b) developed-developing. (c) center-periphery. (d) independent-dependent.

Answer: C 16. Which of the following is an assumption of the Lewis two-sector model? (a) surplus labor in industry. (b) positive marginal product of labor in agriculture. (c) an upward sloping labor supply curve in industry. (d) none of the above.

Answer: D 17. The market-friendly approach to development emphasizes (a) self-interested behavior of public officials in LDCs. (b) the dependence of LDCs on former colonial powers. (c) the inherent efficiency of markets in developing countries. (d) that markets in LDCs fail sometimes and selective interventions can promote economic development.

Answer: D 18. The linear stages theory of economic growth fails to recognize that increased investment is (a) both a necessary and a sufficient condition. (b) a necessary but not a sufficient condition. (c) a sufficient but not a necessary condition. (d) neither a necessary nor a sufficient condition.

Answer: B 19. Which of the following are components of economic growth (a) growth in labor force. (b) technological progress. (c) investment. (d) all of the above.

Answer: D

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Chapter 4 Contemporary Models of Development and Underdevelopment

◼ Key Concepts The chapter retains the models of economic development that are more sophisticated versions of the older models from the previous edition including the Hausmann-Rodrick-Velasco growth diagnostic framework.

These new models relax many assumptions such as diminishing returns, constant returns to scale, and perfect competition. Major topics in the chapter include: •

The new growth theories, or endogenous growth theories

• • • •

Coordination failure as an explanation for underdevelopment The existence and implication of multiple equilibria Kremer’s O-Ring Theory Hausmann-Rodrick-Velsco growth diagnostic framework

The new growth theories attempt to explain the factors that determine the size of the Solow residual, the part of growth which is unexplained or exogenously determined. There are various versions that emphasize the role of complementary investments in human capital, infrastructure, and research and development.

These models suggest an active role for public policy in promoting economic development.

Section 4.1 discusses underdevelopment as a coordination failure and introduces the concepts of coordination failure and multiple equilibria. Some interesting non-technical examples are presented.

The existence of multiple equilibria is illustrated graphically using an S-shaped curve to reflect the benefits of some action. Stable and unstable equilibria are discussed. It is noted that markets cannot be expected to arrive at the best equilibrium point, and furthermore, that some help from the government may be necessary.

Section 4.3 reviews the original “Big Push” model and describes an updated version of this model. The six key assumptions are explained, followed by a graphical explanation of how multiple equilibria are possible, depending on the wage level in the modern sector. A big push might be required to achieve the desired equilibrium point. Other cases in which a big push might be required are mentioned, and include the existence of intertemporal effects, urbanization effects, infrastructure effects, and training effects.

Section 4.5 introduces the Kremer’s O-ring theory to explain the existence of poverty traps. The model is presented in some detail and its implications are discussed. This model assumes strong complementarities between the inputs.

Section 4.6 discusses the concept of economic development as a process of self-discovery regarding the discovery of one’s comparative advantage and the associated market failures in this self-discovery process.

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Chapter 4

Contemporary Models of Development and Underdevelopment

27

Section 4.7 presents the Hausmann-Rodrick-Velsco growth diagnostic framework and focuses on identifying a country’s binding constraints on economic growth and alleviating the most pressing constraints. The HRV framework highlights that there is no “one size fits all” in development policy. Particular economic development strategies are most effective depending on the social and private rates of return on economic activities and the constraints facing the economy.

Box 4.1 discusses efforts in Ecuador to change the culture of arriving late for public events, business meetings etc. This is by way of illustrating the idea of multiple equilibria and Ecuador is seen as attempting to move from an inferior to a superior one. Box 4.2 presents a case study of Brazil, El Salvador and the Dominican Republic and identifies the binding constraints faced by each of these nations and suggests the best economic policy in light of these constraints. The end of the chapter includes a revised and updated case study on the sources of economic growth in China during the last two decades. Several explanations for the exceptional Chinese economic performance are offered as a means to illustrating the different approaches to economic development discussed in this chapter. The authors conclude that while the record of Chinese economic performance has much to teach us, it would be almost impossible for other countries to emulate the Chinese example. In addition challenges faced by China are also revisited including the growing environmental crisis and product safety standards.

◼ Lecture Suggestions This is the most technical of all chapters and is also the hardest, for students not majoring in economics, to understand. A footnote in the previous edition (eliminated in the current edition) suggested that this was an optional chapter that could be skipped without loss of continuity. Unless the students attending this course are well versed in microeconomics, this may be a chapter that instructors find not necessary to cover or, if covered, only certain sections of it. Illustration of the material in this chapter with data or examples from the experience of developing countries is challenging.

If the basic Solow model in the appendix to chapter 3 was not covered, then the endogenous growth model should not be covered because the student needs to understand the Solow model to appreciate the endogenous growth model.

The least technical sections of the chapter include: •

The four page section on underdevelopment as a coordination failure. These pages can be covered even in you do not cover the Solow model or the rest of Chapter 4. The section introduces the basic idea of complementarities and coordination failures, and includes several interesting examples.

•

The first two pages of the section on the big push, introducing the original idea without any technical detail.

•

Linkages, backward and forward, are also explained. This idea comes up in many instances (import substitution, export diversification, leading sectors etc) and is one concept that lends itself to illustration with examples from several developing economics.

•

The Hausmann-Rodrick-Velsco growth diagnostic framework makes a fairly compelling argument that development economist need to focus on specific country circumstances while formulating development policy for the nation.

The S-curve which is used to illustrate the existence of multiple equilibria will not be too challenging for many students, as long as you are willing to spend a little bit of time on it.

The most difficult and abstract sections are the endogenous growth models and the O-ring model.

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Todaro/Smith • Economic Development, Eleventh Edition

◼ Discussion Topics •

Have students think of as many examples of coordination failures or complementarities as they can and make a list on the board. Discuss how some of them could be solved.

◼

Sample Questions

Short Answer 1. What three factors distinguish models of endogenous growth from their neoclassical counterparts?

Answer: There are increasing returns to capital investment (as opposed to decreasing), there are increasing returns to scale (as opposed to constant), and externality effects are included.

2. What is meant by the term technological spillover?

Answer: Technological spillovers are present when investment generates external economies. The knowledge component of the firm’s capital stock is like a public good that spills over to other firms in the economy.

3. Explain what is meant by the term coordination failure and provide an example.

Answer: This is a state of affairs in which agents are unable to coordinate their efforts, and hence end up in an equilibrium that leaves them worse off than they would be if they were able to coordinate. There are several examples offered in the text, or the students may come up with their own.

4. Suppose that a developing country devotes extensive resources towards improving the education and skill level of the labor force. How might this help the country avoid a coordination failure? Is this strategy likely to be successful? Why or why not?

Answer: See page 157 for an answer to the first part. The answer to the second part is more open ended and will depend on lecture coverage.

5. Show in a diagram an S-curve and a 45-degree line. Are all three points of intersection stable equilibrium points? Explain.

Answer: Explained in the text.

6. Explain how the S-curve reflects the typical nature of complementarities?

Answer: See pages 160-161 for a good explanation.

7. Explain how the government can help the economy avoid a coordination failure.

Answer: Discussed in the chapter.

8. Is a coordination failure a type of market failure? Explain.

Answer: Yes, because an equilibrium can be reached that is not the true social equilibrium.

9. Explain the basic idea behind the Big Push model?

Answer: What you expect for an answer depends on what you cover in lecture.

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Chapter 4

Contemporary Models of Development and Underdevelopment

29

10. Explain how relatively high wages in the modern sector, as compared to the traditional sector, can lead to a coordination failure.

Answer: See the section on the Big Push.

11. Is it possible for a super-entrepreneur to solve all of the coordination failure problems within a developing economy? Discuss.

Answer: Open ended essay.

12. How can the O-ring theory help explain the existence of a low-level equilibrium that an economy may find itself in?

Answer: Explained on page 179.

13. According to the HRV growth diagnostic framework why is there no “one size fits all” development policy?

Answer: Explained on page 184.

14. Based on the HRV growth diagnostic framework and the case study in Box 4.2, what are the binding constraints faced by Brazil, El Salvador and the Dominican Republic and how can these constraints be overcome?

Answer: Explained on page 186.

◼ Multiple Choice 1.

The Solow residual helps explain growth that derives from (a) increasing the size of the labor force. (b) increasing the size of the capital stock. (c) increasing the capital-labor ratio. (d) anything except increases in the size of the labor force or the capital stock.

Answer: D

2.

In endogenous growth models, it is assumed that (a) there are external economies from public or private investments. (b) there are diminishing marginal returns to capital. (c) growth is explained by forces outside the model. (d) the capital-labor ratio is constant.

Answer: A

3.

In contrast to the earlier neoclassical models of economic growth, in endogenous growth models, there is more emphasis on (a) human capital. (b) externalities. (c) increasing returns to scale. (d) all of the above.

Answer: D

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4.

The new growth theory attempts to explain (a) the rate of population growth within a country. (b) the rate of capital accumulation within a country. (c) the factors that determine the size of the Solow residual. (d) why there are diminishing returns to capital.

Answer: C

5.

The S-curve is used to illustrate (a) the typical path taken by the current account over time. (b) economic fluctuations in the economy. (c) the typical growth path of a developing economy. (d) the existence of multiple equilibria.

Answer: D

6.

The big-push theory argues that coordination failures may arise because of (a) pecuniary externalities. (b) technological externalities. (c) lack of human capital. (d) all of the above.

Answer: A

7.

The O-ring theory places emphasis on (a) education of the labor force. (b) skill complementarities. (c) purchases of machinery and equipment by firms. (d) none of the above.

Answer: B

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Part Two Problems and Policies: Domestic

Chapter 5 Poverty, Inequality, and Development

◼ Key Concepts This chapter takes up the question of growth versus income distribution and poverty. The chapter examines seven questions: • • • • • • •

What is the extent of relative inequality and poverty in developing countries?

What are the economic characteristics of the poor?

Who benefits from economic growth?

Are increased economic growth and more equitable income distributions compatible objectives?

Do the poor benefit from growth?

What is so bad about extreme inequality?

What policies will reduce absolute poverty?

5.1 deals with measurement issues relating to poverty and inequality. The concepts of size and functional distribution of income are defined. Within this section, the following topics are covered: •

A review of Lorenz curves and the Gini coefficient.

•

Measuring absolute poverty using the poverty gap (total and average poverty gap), the Foster-GreerThorbecke index, and the newly introduced Multidimensional Poverty Index.

An important conclusion is that there is no clear relationship between the level of income per capita and inequality.

5.2 seeks to explain: • • • •

Why inequality is a problem.

Three cases of dualistic development using Lorenz curves.

The relationship between inequality and per capita income or the Kuznets inverted-U hypothesis.

The relationship between growth and inequality.

The new edition includes updated data tables for various countries. Evidence suggests it is the character of economic growth that determines how much living standards improve as growth increases.

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Chapter 5 Poverty, Inequality, and Development

33

5.3 takes up the topic of absolute poverty. The new edition adds and explains the concept of extreme poverty and chronic poverty. New and more extensive data are presented on the degree of absolute poverty in the world today, and the question of growth versus equity is debated in terms of which to pursue first.

Arguments are made for each case and include the following points: •

Economic growth is not sufficient to eradicate poverty because it may benefit only the modern sector with little or no trickle-down. The rich may not use their wealth to make productive local investments.

Investing in health and education improves worker productivity. Increasing the income of the poor may be translated into demand-led growth.

•

Pro-growth arguments emphasize more savings by the higher income groups and the trickle-down theory.

In 5.4, the economic characteristics of the poor are described. It is argued that poverty is disproportionately present among the rural population, women and minority/indigenous groups.

5.5 considers policy options for addressing poverty and inequality while still maintaining growth: • • • •

Remove factor price distortions. This topic is discussed further in Appendix 5.1.

Redistribution of asset ownership, such as land reform. This topic is discussed further in Chapter 9.

Progressive income and wealth taxes to reduce income inequality.

Direct transfer payments and public provision of goods and services to reduce the extent of poverty.

The price-incentive model, discussed in Appendix 5.1, suggests firms are profit maximizers who choose the combination of inputs that will minimize cost. The many factor price distortions present in developing countries send the wrong signal to firms in terms of choice over labor and capital. Graphical analysis using isoquants and isocost lines is included. The appropriate technology concept is introduced and suggests that developing countries who are relatively well endowed with labor should try to employ labor-intensive technologies. The employment effect of removing factor price distortions depends on the elasticity of substitution.

The Ahluwalia-Chenery Welfare Index is explained in detail in Appendix 5.2. GNP is shown to be a biased indicator of development and welfare, and equal-weighted and poverty-weighted measures are demonstrated to be better indicators of who is benefiting from the growth of production.

The chapter ends with a case study that demonstrates how the frameworks and multi-country statistical studies of Chapters 2 and 5 can be applied to understand development and experiences in an comparative perspective.

◼ Lecture Suggestions This is the beginning of Part 2 of the text that focuses on quality of life and equity issues. It can be stressed again that growth can occur without a corresponding improvement in the living standards of the entire population.

Income distribution data can be used to evaluate the effect of growth on welfare. The level of GDP per capita is not a good indicator of the benefits of growth in terms of economic welfare. Topics to discuss in this section include: •

Size and functional distribution of income.

•

Lorenz curve and Gini coefficient.

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•

Equal and poverty weighted measures of growth.

Reference to the Gini coefficient for different countries will show that there is no clear relationship between income per capita level and inequality and that the type of growth pursued in terms of capital or labor intensity can have a large impact on inequality. You might compare Brazil, Mexico, Taiwan, and South Korea.

Stress that Lorenz curves and Gini coefficients measure relative income as opposed to absolute income.

Neither says anything about the extent of absolute poverty. When making policy decisions, it is important to look at what is happening to both relative and absolute income.

Examining the different cases of dualistic development can be an excellent teaching tool. Following the Fields model, it is useful to set up numerical examples of stylized dual economies. One example of a dual economy is to assume there are 10 people, five of whom are rich (each with $2) and five of whom are poor (each with $1). The students can draw the Lorenz curve, and then illustrate how the curve shifts when there is modern sector enrichment (those with $2 incomes get $3), traditional sector enrichment (those with $1 get $1.25), and modern sector enlargement (one person with $1 now gets $2). The Fields’ book (cited in footnote 15) and his more recent book (cited in Further Reading) are excellent sources of additional lecture material.

Tables in the text which illustrate poverty, growth and income distribution data for different countries, combined with data on poverty from the 2010 World Development Indicators Report, can be used to summarize some important propositions about growth, poverty, and income distribution, such as: •

The Kuznets inverted-U hypothesis is a relatively weak relationship in that there are many countries whose growth experience does not follow this pattern.

•

High inequality is neither necessary nor sufficient for high growth.

•

High growth is neither necessary nor sufficient for reductions in absolute poverty.

This helps emphasize that it is not just the growth process but the character of growth that largely determines the incidence of poverty and the extent of inequality. The character of growth can be identified by the policy choices made by each country. These policy choices will be identified in later chapters.

If you intend to cover the Ahluwalia-Chenery Welfare Index, it is advisable to allocate adequate lecture time because students always need a lot of help with this topic. Numerical examples can prove useful.

The economy can be divided into terciles, for example, with five people earning $1, five $2, and five $3.

Compare the three measures when the source of growth is a 50% increase in the incomes of the poor versus a 50% increase in the incomes of the rich, and various combinations (see below for an example).

Table A 5.2 illustrating the application of the index can be discussed as a handout. The income growth portion of the table can be discussed to illustrate what has happened to income distribution in different countries as growth has occurred even if you choose not to discuss the equal and poverty weight indices.

Initial income and poverty level data help illustrate the impact on absolute poverty.

The growth versus economic welfare debate is related to the dilemma of how to provide basic human needs without sacrificing growth. Policies to reduce income inequality can be discussed (increase employment, improve education, redistribute assets, tax the wealthy, subsidize the poor) as can rural development programs such as food for work programs.

For instructors who wish to emphasize the measurement of poverty, its global distribution and policies aimed at alleviating its burden, the World Bank devotes the whole of its World Development Report to this issue on occasions. The most recent Report devoted to this theme is the 2010 issue and contains a

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Chapter 5 Poverty, Inequality, and Development

lot of valuable information on this topic. Some of the material from this Report is presented on pages 218–225 of the text.

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The price incentive model can be taught with or without graphs and equations. Basic supply and demand arguments can convey the main idea of the model. Common factor price distortions can be discussed (minimum wage, unions, multinational corporation hiring practices, low interest rates). Factor prices have been distorted with good intentions, but poor results. The adoption of inappropriate technology can be reviewed. The material in Appendix 5.1 is more technical and can be omitted without any loss of continuity.

This chapter lends itself well to numerical problems that clarify the main points. Some of these can be done in class or for homework. Similar questions can be asked on exams. Here are three examples to draw from.

1.

The following income distribution data are for Brazil.

Quintile Lowest 20% Second quintile Third quintile Fourth quintile Highest 20% Highest 10%

Percent Share 3.0% 6.9% 11.8% 19.6% 58.7% 43.0%

(a) Carefully graph the Lorenz curve, labeling the axes.

Answer: The cumulative distribution by quintiles is 3.0, 9.9, 21.7, 41.3, and 100. (b) Explain how to find the Gini coefficient, graphically. (c) Brazil’s national income is about $300 billion. What is the approximate dollar income of the bottom 20%? Bottom 40%?

Answer: $ 9 billion and $ 29.7 billion. (d) Brazil’s population is approximately 150 million. Suppose that each household makes the average income for its quintile. What is the level of poverty if the poverty line is $400 per capita?

Answer: 1st quintile: $300, below poverty line; 2nd quintile: $ 590 above poverty line; headcount = 30 million; income shortfall = 30 Million  $100 = $3.0B. (e) Suppose one percent of national income were transferred from the richest 20% of households to the poorest 20% of households. Show the effect on relative inequality.

Answer: Decreases by Lorenz criterion. (f) Under the same transfer, what is the effect on poverty?

Answer: Poorest quintile receives $12B. H = 30 but income shortfall drops to $ 0B. You may choose to have students calculate Gini, which is easily done with the trapezoid formula.

Analogous questions can easily be constructed for other countries using the World Development Report, 2004, Table 2.

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Chapter 5 Poverty, Inequality, and Development

37

2.

Consider the following distribution of income in a 12-person economy, with the modern urban wage = 3, the traditional rural income = 1, and the informal urban wage = 2: (1,1,1,1,2,2,2,2,3,3,3,3).

The poverty line = 1.25. Suppose rural incomes are raised to 1.5 through expanded agricultural exports.

What happens to relative inequality? Absolute poverty? Calculate the Ahluwalia-Chenery welfare index for terciles (3 fractiles) under GNP weights and equal weights. Why is the equal-weighted index higher?

Answer: Inequality decreases. Poverty is eliminated. ACWI = 0.083 with GNP weights. ACWI = 0.167 with equal weights.

3.

Consider the following distribution of income in a 12-person economy, with the modern urban wage = 10, the traditional rural income = 2, and the informal urban wage = 4: (2,2,2,2,4,4,4,4,10,10,10,10). (a) Suppose rural incomes are raised to 3, other things equal. Show the change using the Lorenz curve. How would this type of growth be characterized? (It is suggested that you use the Fields growth decomposition in answering. This shows traditional sector enrichment growth.) (b) Calculate the Ahluwalia-Chenery welfare index for terciles (3 fractiles) under GNP weights and equal weights. Which index is higher and why?

Answer: (GNP is 64, so the index with GNP weights is: (1/2) (1/8) = (1/16). The index with equal weights is: (1/2) (1/3) = (1/6). The latter is higher because growth is concentrated in a fractile with a smaller than average income share.)

◼ Discussion Topics •

Discuss the relative importance of income inequality and absolute poverty as problems that need to be solved. Present data from the developed countries for comparison. Discuss policy options and the opportunity cost of devoting resources to such policies.

◼

Sample Questions

Short Answer 1. About how many people are living in extreme poverty in the world? Which regions have the greatest percentages of people living in extreme poverty?

Answer: There are various estimates, including the World Bank estimate of 1.4 billion people living in extreme poverty in 2005. Percentage wise, 40.3% of those who reside in South Asia, 51% of sub Saharan Africans live under $1.25 per day. Specific examples and data cited in the text should also be expected in an answer.

2. Explain the difference between size and functional measures of income distribution.

Answer: Size refers to family or personal income and function refers to factor shares.

3. What is a Lorenz curve? Draw one, labeling the axes.

Answer: Examined in the text.

4. Explain why a Lorenz curve can never lie to the left or above the 45 degree line.

Answer: It is constructed by ordering income recipients from poorest to richest. Note: if ordered from richest to poorest, the curve would never fall below the 45 degree line.

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5. Using a Lorenz curve diagram, explain how to calculate the Gini coefficient.

Answer: Examined in the text.

6. Distinguish between economic growth by modern sector enlargement, modern sector enrichment and traditional sector enrichment. For each of the three cases, show what happens to absolute poverty and to relative inequality, using a precise measure of each.

Answer: Students may use either the headcount or the income shortfall measure for absolute poverty, and the Lorenz criterion or fractile shares for an inequality measure.

7. Generally speaking, higher income countries tend to have less income inequality than low income countries, however this does not always hold true. What could cause a low income country to have low income inequality?

Answer: Low inequality can result due to very little income to be distributed in the first place.

8. Discuss the benefits of using a “poverty weighted” index of GNP growth as a measure of social welfare as opposed to using the growth in GNP to measure change in social welfare.

Answer: Students should refer specifically to the Ahluwalia Chenery welfare index. Poverty weights will place more emphasis on what happens to the income of the poor.

9. Increasing GNP is a necessary but not a sufficient condition for improving living standards in less developed countries. True or false, explain.

Answer: True. Growth in income is necessary but it does not guarantee that all will benefit.

See the discussion in the text.

10. “The 1980s were a lost decade for the absolutely poor.” Evaluate this statement.

Answer: Answers will vary. You might expect some presentation of data.

11. What are the characteristics of the poor (be specific)?

Answer: A person is more likely to be absolutely poor if rural, agricultural, female or from a female-headed family, landless, from a large family, from a family with a high ratio of dependents, or from among ethnic minorities or indigenous peoples. Clearly, those who are poor are also more likely to come from a low-income country.

12. Why are about 100 million girls and women said to be “missing” in developing countries?

Answer: This is the number of females that would be proportional to the number of living males if females had equal access to resources such as food, medical care, and education, and were not subject to differential abortion and infanticide.

13. What are factor price distortions, and what are their major causes in developing countries?

Answer: Factors of production are paid prices that do not reflect the prices that would prevail under a true competitive market, that is, their scarcity prices. Prices for capital and intermediate goods are often artificially low because of tax rebates, investment subsidies, high capital depreciation allowances, ceilings on interest rates etc. Wages are often above opportunity costs due to trade union, political, and other pressures.

14. Just what is it that makes a technology “appropriate” for a developing country?

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Chapter 5 Poverty, Inequality, and Development

39

Answer: A technology is appropriate if it fits with existing factor endowments.

15. Discuss the reasons why developing countries so often use a technology with an excessively high capital labor ratio.

Answer: Factor price distortions and the unavailability of appropriate technology.

16. Discuss some policies or strategies that would give firms an incentive to substitute labor for capital within modern production techniques.

Answer: Depends on lecture development.

17. The 2002 World Development Report provides the following information for Colombia and Thailand:

Colombia Thailand

Per Capita GDP ($) 2080 2010

Per Capita GDP (PPP $) 5890 6330

Population below National Poverty Line (%) 17.7 13.1

Population below $1 Day PPP (%) 11.0 <2

Poverty Gap at $1 Day PPP (%) 3.2 <0.5

Gini Index 57.1 41.4

(a) Explain carefully what each of the entries in the final four columns of this table measures. What concepts are being presented and what is their importance to economic development?

Answer: The student is asked to define and comment on the various ways of measuring poverty (headcount index, poverty gap) and income inequality (Gini coefficient) (b) The table above shows that Colombia and Thailand are roughly at the same level of economic development as measured by the level per capita national income. Their performance in terms of poverty indicators is quite different. What factors may contribute to their differing performance?

Answer: The student is asked to comment on the distinction between per capita income growth and poverty reduction.

18. Compare and contrast the similarities and the differences in the development experience of Ghana and Cote d’Ivoire. How did the economic development policies followed by the two countries differ?

Answer: The case study on Ghana and Cote D’Ivoire discusses these issues in detail.

19. What is the Multidimensional Poverty Index and how is it a more improved measure of poverty?

Answer: The MPI identifies the poor at the household level and uses the dual cutoff method. First, the cutoff levels within each of the dimensions and second, the cutoff of the number of dimensions in which a person must be deprived to be deemed multidimensionally poor.

This is a better indicator of poverty and it goes beyond income and looks at other weighted indicators (health, education, and standard of living) for which poor households are deprived.

◼ Multiple Choice 1. The absolute poverty line (a) decreases as real income grows. (b) shows the average income of the lowest income group.

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(c) can be measured with the Lorenz curve. (d) none of the above.

Answer: D 2. The Gini coefficient provides a measure of (a) the level of poverty. (b) the level of relative inequality. (c) disguised unemployment. (d) the rate of growth.

Answer: B 3. Kuznets’ inverted-U hypothesis (a) implies that things must get worse before they get better. (b) suggests that inequality will worsen and then improve as a country grows. (c) suggests that inequality will improve and then worsen as a country grows. (d) points out six characteristics of modern economic growth.

Answer: B 4. According to Kuznets, in the process of development inequality in an economy will normally (a) first rise and then fall. (b) first fall and then rise. (c) remain about the same. (d) show no definite pattern.

Answer: A 5. Poverty is better studied with size distribution measures than those based on factor distribution because (a) labor income may be highly concentrated in well-paid modern sector workers. (b) some poor farmers may receive a sizable share of income in rent. (c) income from nonmarket activities such as foraging may be important. (d) all of the above.

Answer: D 6. The number of people in the world who are absolutely poor is closest to (a) a quarter-billion. (b) a half-billion. (c) one and a half billion. (d) two billion. (e) four billion.

Answer: C 7. With modern sector enrichment growth, inequality will (a) first rise and then fall. (b) first fall and then rise.

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Chapter 5 Poverty, Inequality, and Development

(c) remain about the same. (d) none of the above.

Answer: D

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8. With modern sector enlargement growth, inequality will (a) first rise and then fall. (b) first fall and then rise. (c) remain about the same. (d) all of the above.

Answer: A 9. Higher income countries tend to have lower levels of absolute poverty because (a) more employment opportunities (b) more public assistance (c) greater entrepreneurship opportunities. (d) all of the above.

Answer: D 10. One of the characteristics of the poor is that they are (a) more likely to be employed in the modern industrial sector. (b) more likely to come from small families. (c) more likely to be well educated. (d) more likely to live in a rural area.

Answer: D 11. Which of the following policies might increase labor intensity in industry? (a) a decline in the cost of credit (b) a decline in the minimum wage rate (c) a decline in the elasticity of substitution (d) all of the above.

Answer: B 12. Which of the following policies may decrease the level of capital intensity in industry? (a) an increase in the cost of capital (b) a decrease in the minimum wage (c) an increase in the elasticity of substitution (d) all of the above.

Answer: D 13. The Ahluwalia-Chenery welfare index (a) is a method used to measure changes in absolute poverty. (b) shows the value judgement implications of using the change in income per capita as a measure of the change in development. (c) is a method used to measure changes in inequality. (d) is a method used to measure the growth rate of GDP. Answer: B

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Chapter 5 Poverty, Inequality, and Development

14. About what percent of the world’s poorest people are female? (a) 30 (b) 50 (c) 70 (d) 90 Answer: C 15. About how many girls and women are said to be “missing” in LDCs? (a) 2 million (b) 20 million (c) 100 million (d) 2 billion Answer: C 16. Which of the following groups is(are) more likely to be poor? (a) minorities (b) indigenous people (c) women (d) all of the above.

Answer: D 17. Distribution of income according to percentiles, such as the highest 40% or lowest 20% is known as the _______________ distribution of income. (a) size (b) functional (c) GNP-weighted (d) equal-weighted Answer: A 18. What conclusion can be reached from the following data on income shares?

Bangladesh Indonesia

Percentage of Income Received by Lowest 40% Highest 20% 17.3 45.3 14.4 49.4

(a) absolute poverty is more widespread in Bangladesh (b) the size distribution of income is more unequal in Indonesia (c) Bangladesh had adopted a strategy of redistribution with growth (d) growth in Bangladesh is calculated using poverty weights rather than income weights Answer: B

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19. Developing countries who have adopted capital intensive technologies tend to have (a) relatively higher Gini coefficients. (b) relatively lower Gini coefficients. (c) Gini coefficients equal to one. (d) Gini coefficients equal to zero.

Answer: A 20. Assuming that the Gini coefficient for Egypt is 0.403 and the Gini coefficient for Australia is 0.404, it is possible to conclude that both Egypt and Australia have (a) virtually the same number of households in absolute poverty. (b) virtually the same percentage of households in absolute poverty. (c) virtually the same level of the Human Development Index. (d) none of the above.

Answer: D 21. Brazil’s growth rate during the 1960’s was 6.0% when poverty weights were used to evaluate growth, compared with 8.2% when GNP weights were used to evaluate growth. One can conclude from these numbers that (a) average income growth was greater for poor households than for rich households. (b) average income growth was greater for rich households than for poor households. (c) more and more households were falling below the poverty line. (d) the size distribution of income was getting worse.

Answer: B 22. The poverty gap is the (a) absolute number of people below the international poverty line. (b) percentage of the population below the international poverty line. (c) consumption (measured in dollars) necessary to bring everyone below the poverty line up to the line. (d) percentage of a country’s total consumption necessary to bring everyone in the country below the poverty line up to the line.

Answer: D 23. The functional distribution of income refers to the distribution of income between (a) individuals or households. (b) rural individuals or households. (c) urban individuals or households. (d) the factors of production (land, labor and capital).

Answer: D

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Chapter 6 Population Growth and Economic Development: Causes, Consequences, and Controversies

◼ Key Concepts This chapter examines how population growth in many developing countries affects their chances of becoming more economically developed, and conversely, how economic development affects population growth.

Section 6.2 and 6.3 explore historical and recent population trends and the changing geographic distribution of the world’s people. Interesting statistics include world population data, distribution by region, and fertility and mortality rates. Key concepts include: • • •

The dependency burden.

The hidden momentum of population growth.

The demographic transition.

The new edition goes into more depth about the hidden momentum of population growth based on the age structures of a country’s population. To illustrate the difference between the age composition of developed and developing countries, new charts are included that break down the population structure of Ethiopia versus the United States.

Section 6.4 examines the causes of high fertility in developing countries are explained using the Malthusian and Household models.

•

•

The Malthusian Population Trap model suggests the population will be forced to live at the subsistence level of income as population growth outstrips growth in the supply of food. In the absence of measures to control population growth (e.g. birth control), starvation, wars, epidemics will provide a check on population growth. Criticisms are offered and include the failure to take technological progress into account and to account for the microeconomics of family-size decision making.

The Microeconomic Theory of Fertility attempts to explain the falling birthrates associated with stage III of the demographic transition. It is suggested that people choose how many children to “consume” as part of their utility maximization problem. Budget constraint and indifference curve analysis is presented. Children in developing countries can be thought of as investment goods.

Reasons are offered why families in developing countries have more children, such as the lower opportunity cost of time and a lack of job and education opportunities for women.

Section 6.5 addresses the debate of whether rapid population growth is a genuine problem or constraint in achieving economic development is discussed.

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Todaro/Smith • Economic Development, Eleventh Edition

•

Arguments why population growth is not a problem include identifying population growth as merely a symptom of widespread poverty and a lack of alternatives for women, identifying the global distribution of population as the dominant question, and identifying benefits that come with having a larger population such as a larger domestic market for consumer goods.

•

Arguments why population growth is a problem include reduced family savings rates, difficulties in providing basic services to a growing population, and the need for more rapid growth in GDP to keep up with rising demands for jobs and living standards. Population growth as a cause and consequence of underdevelopment is discussed. Empirical evidence suggests seven negative consequences of population growth.

•

The possibility of consensus is discussed in insofar as population growth is not the primary cause of low levels of living, rapid population growth makes development more difficult to achieve and sustain, and many problems can be attributed to population density.

Section 6.6 describes the policy approaches which include eliminating absolute poverty, reducing income inequality, expanding education opportunities for women, providing more job opportunities, and improving access to health care and clean water. Family planning programs in some developing countries are presented The chapter ends with a case study on China’s one child law.

◼ Lecture Suggestions The analysis of population and development is of great interest to students. A first lecture should introduce students to the history of population growth, the geographic dispersion of population, the hidden momentum of population growth, and the demographic transition. The demographic transition is particularly useful in stressing the following: •

In the developed countries there was a strong link between prosperity and population growth, in that population growth remained fairly stable until incomes started to increase.

•

In the developing countries there is a strong link between access to modern technology and population growth. This has enabled death rates to decline dramatically without a corresponding increase in income and move towards modern economic growth.

Other interesting points are related to the natural rate of increase in different regions. In Europe for example the natural rate of increase rarely exceeded 1%, whereas it is 2–2.5% for many LDCs. Some countries are actively fighting low fertility including Italy, France, Sweden, S. Korea, Malaysia, and Singapore. More and more developed countries (with the exception of the US) are experiencing fertility rates below replacement level which has implications for their role as producers and consumers of developing country goods.

The Malthusian model can be related to a time period before the era of modern economic growth when labor was the only factor and technological progress was virtually nonexistent.

A fairly detailed discussion of the new home economics theory of fertility is a good lecture topic. The goal is to explain: •

Why birthrates fall in stage III of the demographic transition.

•

Why women in developing countries have more children than women in developed countries when they can least afford them.

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Chapter 6

Population Growth and Economic Development: Causes, Consequences, and Controversies

45

The discussion of utility maximization and the budget constraint/indifference curve diagram can be covered in greater or less detail depending on the economics background of the students. Numerical examples may be appropriate at some levels. The discussion of why it is rational for poor women to have more kids is always interesting. It is also interesting to discuss whether children can truly be considered an “inferior” good, in terms of a good that is “consumed” less as income increases.

The UN population conferences are an important source of material. Details as well as useful data can be found from the UN Population Division at www.un.org/esa/population.

Examples of economic and social incentives for fertility control in China and India and elsewhere seem to go over well in lecture and reinforce the mechanisms of the microeconomic theory of fertility choice in student’s minds.

Externalities and the common property problem can be introduced here. This can also be a good time to review the concepts of marginal benefit and marginal cost in terms of deciding how many children to have. The number of children a person has can be viewed as a common property problem because if a person has 5 kids the effect on the total population is negligible but when everyone has 5 kids there is an “overproduction” of children from society’s point of view. Each individual has no incentive to consider the extra social cost imposed by their children. Policy can attempt to increase the perceived cost, as some of the examples in the text illustrate.

◼ Discussion Topics These will be some of the most animated discussions of the entire course.

•

Is population growth a problem? You can add information from the book on the position of each side.

•

How can you encourage people in developing countries to have fewer children?

•

Should the government try to limit population growth and if so, how?

◼

Sample Questions

Short Answer 1. Provide a concise statement about the relationship between population growth and absolute poverty, female wages, rural-urban migration, availability of pensions, availability of healthcare, availability of education, and rate of investment.

Answer: The question can be posed as one long essay or subdivided into separate questions.

Answers are discussed in the text.

2. Explain what is meant by “investment in children,” describing the goals and methods of the parents.

Answer: See the chapter. Parents’ goals include higher farm or non-farm income in the medium run and retirement security in the longer run.

3. Explain carefully the opportunity costs of a mother’s time, what may lead these to change over time, and what effects these changes have on family decisions.

Answer: An increase in earning opportunities outside the home may lead the family to substitute child quality and consumption of other goods and services for quantity of children.

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4. The government of China has explicitly stated that the goal of its strict population control measures is to raise income per capita. What are the mechanisms at work in such a claimed relationship? Are there any counterarguments?

Answer: See the case study.

5. Are developing countries experiencing a demographic transition much like the one developed countries did at their earlier stages of economic development or are there important differences?

Answer: The demographic transition is broadly similar for middle income countries although death rates have fallen more quickly. In some low income countries birth rates remain stubbornly high, while death rates have declined.

6. Is there evidence that an increase in per capita income stimulates population growth?

Answer: No. This is an assumption of the Malthus trap but one not borne out by the evidence.

7. Why might improvements in children’s public health care services lower fertility?

Answer: If parents have a target number of children lowering the expected mortality rate would lower planned fertility.

8. Explain the reasons for the hidden momentum of population growth and state its implication for population levels.

Answer: Even after a decline in birthrates to replacement levels, population growth continues because of a large young population that widens the potential parent base. Implication: population will not stabilize until after a couple of generations.

9. China has adopted a unique approach to the population growth problem. Please explain. Have they been successful? Please explain.

Answer: See the case study.

10. Has population growth been a burden for China? Please answer true or false and explain.

Answer: Apply the burden of population growth debate to China’s development experience.

11. What is meant by the demographic transition? What are the differences in the demographic transition between the current developed economies and developing countries?

Answer: The answer is discussed in the text on pages 278–281.

12. What are some of the differences between the population policies of China and India? What factors may have contributed to their success or failure?

Answer: The case study provides some clues to the answer. This may be a nice question for students to reflect on the interplay between politics and economics. Efforts in India, a functioning democracy (despite the authoritarian tendencies of Mrs Ghandi), has meant that population control have come up against resistance. On the other hand, China’s ability, inherent in its political system, to enforce birth control policies has meant it has been more successful.

13. India is expected to surpass the population of China in the next decade or so? What differences between these two nations could have contributed to this outcome?

Answer: See answer to 12.

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Chapter 6

Population Growth and Economic Development: Causes, Consequences, and Controversies

◼ Multiple Choice 1. Projections place world population by 2050 at (a) between 4 and 6 billion. (b) between 6 and 8 billion. (c) between 8 and 10 billion. (d) between 10 and 12 billion.

Answer: C 2. Children under the age of 15 represent about __________ percent of the population of developing countries. (a) 25 (b) 29 (c) 30 (d) 61 (e) 75 Answer: C 3. Evidence presented in the text suggests that birthrates among developing countries are lower with (a) higher growth. (b) higher inequality. (c) higher GNP per capita. (d) all of the above.

Answer: A 4. The hidden momentum of population growth is caused by (a) the demographic transition. (b) population age structure. (c) the opportunity cost of a woman’s time. (d) children’s contribution to income.

Answer: B 5. The world rate of population growth is closest to (a) 1%. (b) 2%. (c) 3%. (d) 4%.

Answer: A 6. In stage III of the demographic transition, (a) the birth rate and the death rate are relatively low. (b) the birth rate and the death rate are relatively high. (c) the birth rate is relatively high and the death rate is relatively low. (d) the birth rate is relatively low and the death rate is relatively high.

Answer: A .

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7. The Malthusian population trap assumes that (a) contraception is unavailable. (b) technological progress may be rapid. (c) fertility increases with per capita income. (d) all of the above.

Answer: C 8. Which of the following would most likely reduce the birthrate? (a) public health improvements (b) an increase in child mortality (c) a decline in the availability of secondary education (d) a reduction in the opportunity cost of a woman’s time (e) all of the above.

Answer: A 9. The number of live births per 1000 people in the population per year is the (a) hidden momentum of population growth. (b) population growth rate. (c) demographic transition. (d) crude birth rate.

Answer: D 10. Which of the following will cause the largest reduction in the birthrate? (a) the population becomes less religious (b) public healthcare improves (c) education becomes more available (d) an increase in the opportunity cost of a woman’s time Answer: D 11. In recent years, the fertility rate in developing countries has been (a) declining. (b) holding steady. (c) increasing. (d) showing no particular pattern.

Answer: A 12. Evidence suggests that population growth has negative effects on (a) economic growth. (b) poverty reduction. (c) environment. (d) education. (e) all of the above.

Answer: E

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13. The proportion of the total population aged 0–15 and over 65, is known as the (a) dependency burden. (b) unproductive population. (c) surplus labor. (d) population momentum.

Answer: A 14. The rate of natural increase in the population of developing countries is most correlated with (a) advances in developed country technology (b) increases in developing country income (c) an increase in the fertility rate (d) all of the above.

Answer: A 15. Which of the following is a direct implication of the view that childbearing is an economic decision? (a) People will not have additional children unless they can earn a profit from doing so. (b) Social factors have no effect on childbearing decisions. (c) Compulsory education will increase fertility because educated children have the potential to earn higher salaries. (d) Fertility should fall with improved opportunities for women to work in jobs outside the home.

Answer: D 16. Which of the following geographic regions is expected to experience the largest percentage increase in its population between 2003 and 2050? (a) Asia and Oceania. (b) Latin America. (c) North America. (d) Africa.

Answer: D 17. At present, approximately how many years would it take for the world’s population to double? (a) 35. (b) 58. (c) 96. (d) 211.

Answer: B 18. The Malthusian population trap model has been criticized on the grounds that it (a) ignores the role of technological progress. (b) assumes that population growth is primarily determined by individual choice over the number of children to have. (c) both (a) and (b) are correct. (d) neither (a) nor (b) is correct.

Answer: A

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19. Approximately how many women were estimated to be “missing” in China? (a) 20-30 million (b) 35-48 million (c) 44-50 million (d) 52-58 million Answer: C

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Chapter 7 Urbanization and Rural-Urban Migration: Theory and Policy

◼ Key Concepts The chapter discusses the related problems of urbanization and migration. Key topics include: •

Urbanization trends and projections.

• • • •

The role of cities.

The role of the informal sector of the economy.

The Todaro migration model.

Policy options for limiting rural-urban migration.

In section 7.1, Urbanization is described using data on urban population growth over the past 50 years.

Urban population growth is generally far more rapid than aggregate population growth, with about half the urban growth accounted by migrants from the rural areas.

Section 7.2 focuses on the role of cities. Developing-country cities are growing far more rapidly than those in the developed countries. Shantytowns and similar makeshift settlements represent over one-third of developing country urban residents.

Section 7.3 explains the problems this growth causes. The chapter provides a case study on industrial clusters in China.

Section 7.4 focuses on the urban informal sector. Many developing-country urban areas have experienced dualistic development where a modern formal sector exists alongside a large urban informal sector. Between 30% and 70% of the urban labor force works in the informal sector. Characteristics of urban informal sector jobs include: •

low skill

• • • • •

low productivity self-employment lack of complementary inputs jobs in petty sales and services recent migrants.

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Given constraints on modern sector growth, the text argues that the informal sector should be promoted as a major source of employment and income for the urban labor force. This sector already generates up to a third of urban income and demand for unskilled labor, and adopts appropriate technology. An improvement in infrastructure and credit available to this sector could generate large benefits in terms of increases in income and jobs for the poor. But promoting this sector runs the risk of encouraging more migration, unless more resources are devoted to the rural sector at the same time.

In section 7.5 The pros and cons of rural-urban migration are reviewed. Migration is viewed as both a symptom and contributor to underdevelopment, much as population growth is. The Todaro migration model helps explain why it is rational for people to continue to move to crowded cities where unemployment is high and rising in section 7.6. The model is based on differences in expected income between the urban and rural sector. High urban unemployment is inevitable given the large expected income differentials between the rural and urban sectors that exist in many developing countries. Both a verbal and a diagrammatic presentation of the model are included.

Important conclusions from the Todaro model include: •

The need to reduce the urban bias of development strategies and encourage integrated rural development. This will reduce the wage differential between the urban and rural area.

•

Creating urban jobs is an insufficient solution to the urban unemployment problem because more migration is induced.

Expanding education opportunities often results in more migration.

Urban wage subsidies are counterproductive as they encourage more migration by increasing the probability of finding a job.

• •

Section 7.7 describes policy options for reducing migration and increasing employment that follow from the Todaro model and include creating an appropriate rural-urban economic balance, expanding small scale labor intensive industries, eliminating factor price distortions, choosing appropriate labor-intensive technologies, modifying the link between education and employment, reducing population growth, and decentralizing authority.

A mathematical formulation of the Todaro migration model is included in an appendix to the chapter.

Data in chapter seven of the new edition have been updated and many charts have been replaced with more effective ones.

The chapter ends with a description of migration and urbanization in India and Botswana, with most emphasis placed on the former.

◼ Lecture Suggestions Students find the statistics on urbanization and the growth of the informal sector interesting. A debate on the pros and cons of promoting the informal sector is more interesting if it comes after the discussion of the price incentive model in Appendix 5.1 and the Todaro migration model. Some students think of urban areas in New York or other fast-world cities (rather than a makeshift shantytown) when the term “slum” is used. A vivid description of a shantytown will maintain student interest and make sure they understand the very different condition of living in one of the urban areas in, say, Latin America (Rio or Sao Paulo) and North America (New York or Washington DC).

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Simple numerical examples can help illustrate why it is rational to migrate given high rates of urban unemployment. The Todaro model looks at the difference between the expected urban wage, (the urban wage times the probability of finding a job) and the rural wage. Suppose the rural wage is 30 and the urban wage is 70. If unemployment is 50% then it is still rational for some people to migrate, depending on their level of risk aversion and other opportunities. A main point to stress is that migration will be influenced by any policy that directly or indirectly affects rural and/or urban absolute incomes. This is important because migration, in turn, will affect every aspect of development. It is worth stressing that migration may reinforce urban bias.

A point worth mentioning in class, and one which relates to chapter 9, is that excessive migration imposes external costs on the rural areas emptied of better-educated, more venturesome young people, as well as on urban infrastructure and lost output. On average migrants seem to have slightly better prospects in the urban areas than those who do not migrate.

A discussion of the role of remittances can be of interest to the students, particularly in relation to Mexico, California, and Texas. Migration possibilities have a positive impact on Mexico in terms of relieving pressure to create jobs. Migration also relieves population pressure within Mexico. At the same time, surveys suggest Mexicans would prefer to stay in Mexico if they could find a job. Surveys also suggest that the most educated people migrate internally rather than internationally.

◼ Discussion Topics •

Debate the pros and cons of promoting the informal sector. Introduce the basic facts of the informal sector and see what ideas the students come up with for the pros and cons. You can lead them with questions about how to improve productivity and what is the most appropriate technology.

•

Given the joint nature of poverty, population growth, and lack of employment faced by many developing countries, see what kinds of solutions students can come up with to address simultaneously all three problems. Possibilities include wage subsidies, investment credits, public works projects, credit for small scale producers, and expanding or reforming the education system. Ask them to propose a policy and discuss how it affects each of the 3 problems. If you are going to cover chapter 8 on education you may wish to defer this discussion. You may also defer this discussion until after the discussion of agriculture and the rural sector in chapter 9.

•

Debate the pros and cons of multinational corporation hiring practices, in relation to urban bias. In other words should MNCs pay higher than equilibrium wages? This discussion draws on labor demand and supply analysis as well as the price incentive model. The discussion also draws on the media attention given to such hiring practices within the developed countries, in terms of fairness and equity. This question can be postponed until chapter 15 when MNCs are discussed in greater detail.

◼

Sample Questions

Short Answer 1. Suppose the rural wage is $1 per day. Urban modern sector employment can be obtained with 5 probability and pays $2 per day. Will there be any rural-urban migration? Explain your reasoning, stating explicitly any simplifying assumptions, and show all work.

Answer: In this case the expected urban wage is equal to the rural wage. Only an individual who is risk loving will migrate.

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2. How could the removal of labor market distortions increase employment even if the elasticity of factor substitution is very low?

Answer: Reduce speculative rural-urban migration based on expected wages as in the Todaro model.

3. What are the characteristics of those who migrate to urban areas? What positive and negative effects does their leaving have on those who remain?

Answer: Younger, better educated, and probably less risk averse, given their willingness to migrate.

These factors suggest they could be more entrepreneurial than average had they not migrated, which would benefit the rural area and help alleviate the urbanization problem.

4. Explain why policies designed to reduce urban unemployment may not greatly reduce poverty in developing countries.

Answer: They may lead to more migration, and may draw capital away from labor intensive rural development projects benefiting the rural poor.

5. Suppose that, for example in India, a minimum wage is instituted in the modern sector above the market clearing wage, while the rural traditional wage is market determined at a lower level than in the modern sector. (a) Describe the impact of this policy on the rural labor force, urban unemployment, and the rural wage. (b) Will the modern sector wage be equal to the traditional sector wage after markets equilibrate through migration? Explain. (c) What effect might moving costs have on the equilibrium you described in part (b)? (d) What effect might the introduction of factories to rural areas have no the equilibrium you described in part (b)?

Answer: (a) Use of the Todaro model is called for here. The rural wage will not necessarily change despite a reduction in the rural labor force as a result of migration. The minimum wage in the urban sector will encourage migration until the expected urban wage is equal to the rural wage. Urban unemployment will rise, both from migration and the minimum wage. (b) Expected, not actual, urban wages will equal rural wages after equilibration. (c) With moving costs, there would be less migration. (d) With rural development, there would be less migration if this increased the rural wage.

6. Discuss the importance of rural-urban migration as a source of urban population growth in various parts of the developing world, being as specific as you can.

Answer: Discussed in the chapter.

7. Point out the main differences in job conditions and worker characteristics between the urban formal and informal sectors.

Answer: Discussed in the chapter.

8. Explain some important policy measures that you would expect to reduce excessive rural-urban migration. Explain.

Answer: Students may mention various types of traditional sector enrichment strategies.

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9. Are developing country cities too large, too small, or about right in size? Justify your answer with evidence from developing economies.

Answer: Too large. Cities are capital intensive, the largest cities are increasingly found in the developing countries, and there are many urban biases causing the distortion.

10. Explain what is meant by urban bias. What are the major effects of urban bias?

Answer: Developing country policies that favor the urban sector with a disproportionate share of investments in infrastructure, factories, buildings, and education. This creates a widening gap in incomes and amenities between urban and rural economies and induces rural-urban migration.

11. Describe some of the benefits and costs associated with the emergence of large cities in developing countries.

Answer: Benefits include the ability to learn from others that are located in close proximity, a reduction in transportation costs, and a large availability of skilled labor. Costs include congestion and pollution.

12. Describe some of the causes of urban giantism in developing countries.

Answer: The hub and spoke transportation system, avoiding transportation costs, location of industry in the political center, and the import substitution strategy that led firms to want to locate close to the local market.

13. What are the main features of the Harris-Todaro model of rural-urban migration?

Answer: Rational economic decision based on costs/benefits. The reward to migration is expected rather than actual urban income. The probability of obtaining an urban job depends on urban employment rates. High rates of urban unemployment are inevitable.

14. Why is urban giantism less prevalent in mature democracies?

Answer: The student is asked to draw on the political economy explanation whereby autocratic regimes must satisfy the demands of the urban masses to avoid political unrest (the Ades and Glaeser argument).

15. Even though women may often constitute the majority of the rural-urban migrants in a country, they usually still remain employed in the informal sector. Why? What are the consequences of this?

Answer: Men tend to dominate the formal sector therefore limiting employment opportunities for women. This leaves women with employment in the informal sector which is usually comprised of low wage and unstable employment with little or no employee or social security benefits.

◼ Multiple Choice 1. An argument supporting promotion of the urban informal sector is (a) the formal sector is incapable of providing enough employment. (b) informal sector workers are poorly educated. (c) it uses a relatively high capital intensity. (d) it would reduce urban bias.

Answer: A .

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2. Rural-urban migrants differ from the rest of the rural population in that they are more likely to be (a) well educated (b) poor (c) female (d) all of the above Answer: A 3. Other things constant, the elimination of factor price distortions in developing countries would most likely (a) decrease rural-urban migration. (b) have little effect on rural-urban migration. (c) increase rural-urban migration. (d) increase urbanization.

Answer: A 4. The informal sector exhibits (a) free entry (b) labor intensive methods (c) small, competitive firms (d) all of the above Answer: D 5. If the rural wage is 4 and the formal urban wage rate is 10, there will be rural to urban migration if the formal urban unemployment rate is (a) 50% (b) 60% (c) 70% (d) all of the above Answer: A 6. According to the United Nations, Millennium Development Goals Report, the annual growth in % of slum population from 1990-2001 has been the largest in: (a) Latin America and the Caribbean (b) South-East Asia (c) Sub-Saharan Africa (d) Southern Asia Answer: C

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Chapter 7

Urbanization and Rural-Urban Migration: Theory and Policy

7. For what percentage of urban population growth is rural-urban migration responsible? (a) between 35% and 60%. (b) between 40% and 80%. (c) between 50% and 70% (d) between 50% and 90%.

Answer: A 8. According to UN projections, what proportion of the world’s urban population will reside in the urban areas of developing countries by 2025? (a) two fifths. (b) one half. (c) two thirds. (d) four fifths.

Answer: D

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Chapter 8 Human Capital: Education and Health in Economic Development

◼ Key Concepts Education and health are discussed as part of the development of human capital. Key topics addressed in the chapter include: • • • • • •

The central role of education and health in the development process.

The complementary relationship between education and health.

Child labor and the gender gap.

Educational systems and development.

Health systems and development.

Policy options for improving education and health.

Section 8.2 describes the key complementary relationship between education and health. Section 8.3 discusses child labor and section 8.4 discusses the gender gap in health and education and present data and several approaches to dealing with these two issues.

Section 8.5 focuses on educational systems and development which includes the determinants of the demand and supply of education places, and the distinction between the private and social benefits and costs of investment in education.

•

The demand for education is determined by the expected income benefits and direct and indirect costs of schooling, while the supply of school places (at all levels) is determined by the political process, and is often unrelated to economic criteria. In most developing countries expected income gains from additional years of education are high, in that modern sector employers, including the government, select by educational attainment irrespective of actual work requirements.

•

The concepts of social and private costs and returns to education are explained. Two graphs illustrate how the private and social costs and benefits change as years of schooling increase. The expected private return increases at an increasing rate while the private cost increases much more slowly, indicating that from an individual’s viewpoint it is optimal to secure as much schooling as possible. In contrast, the social returns increase sharply at first and then taper off while the social costs increase at an increasing rate, indicating that there is an optimal quantity of schooling, at the point where the marginal social costs and benefits are equal. The text suggests that public resources are being misallocated by providing too much schooling. It is also suggested that it might be better for the government to invest in higher quality, rather than higher quantity, education.

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Several conclusions are drawn with respect to the relationship between education, society, and development.

•

Distribution of Education: Not only the quantity of education is important. More important is its quality and how it is distributed amongst the population.

•

Education, inequality, and poverty: The education system can increase inequality if the poor lack access to education and/or the rich are disproportionately represented in secondary and university schooling. A poor person’s rate of return to investment in education may be lower than a rich person’s. This is demonstrated with an added section on tutor and computer-assisted learning programs.

•

Education, internal migration, and the brain drain: The more educated tend to migrate out of the rural areas, and sometimes out of the country.

•

Education of women, fertility, and child health: education of women and family size.

There is an inverse relationship between the

Section 8.6 focuses on health systems and development. Section 8.7 provides information on the burden of various diseases (specifically malaria and HIV/AIDS) in developing countries, as well as how the prevalence of certain diseases affects labor productivity. A new section on Parasitic Worms and other neglected tropical diseases has been added. The new edition provides a small case study on Uganda and how its efforts allowed it to become the first to see a significant reduction in the prevalence of HIV/AIDS, before moving onto productivity and health policy in section 8.8.

The chapter includes a case study on Progresa/Oportunidades program in Mexico which directly benefits over 21 million Mexicans. The case study illustrates how successful development programs increases human capital and can be an effective tool in combating poverty.

◼ Lecture Suggestions Though there is a great deal of material covered in this chapter, it is written in such a way that you can choose to omit certain sections. For example, you may choose to cover the first few sections which discuss the complementarity between investment in education and health, and how increasing human capital is a crucial part of the whole development process. From there you can choose between the next three topics of child labor and the gender gap, education systems, and the disease burden. Instructors will find, however, that there is sufficient student interest and relatively high rewards from covering all these topics.

The concepts of the social and private costs and returns to education can provide some interesting lecture material. The idea that the optimal choice occurs where marginal cost is equal to marginal benefit can be reinforced, as can the concept of opportunity cost as it relates to the allocation of scarce public resources.

•

It can be useful to spend some time discussing the difference between private and social costs and benefits, as well as how they can be measured. Some of these concepts are discussed in the section on the demand for schooling.

•

It can be useful to discuss policy options for increasing the private costs of education and/or reducing the expected private returns to education. Discuss how the graphs change in each case and reasons why governments may want to change these.

•

Several references provide interesting supplemental material on empirical studies of rates of return to investment and the idea of the quality of education versus the quantity of education.

An updated version of Table 8.1 showing the rates of return to education by level and type is available from G. Psacharopouls and A. Patrinos, “Returns to Investment in Education: A Further Update,” World Bank Working Paper #2881, 2002.

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Reference to this chapter, can stress one of the basic issues of development i.e. to distinguish between cause and effect. The belief that an emphasis on higher education will spur development stems, in part, from an observed correlation between world education levels and per capita income. However, income and higher education attainment are mutually reinforcing in the developed countries where the demand for higher education follows from development, which is itself caused more by expanded basic education. The same confused cause and effect story line holds for agriculture versus industry development, urbanization, etc.

The subject matter of this chapter, education and health, is one of the most fundamental in development and one most closely tied to current events. It lends itself very easily to illustration with examples from nonacademic publications. Of course, the tremendous interest in the media on HIV/AIDS goes without saying and, in the course of the semester, instructors can find many stories to illustrate policies to combat this pandemic. Combating malaria has also been widely discussed recently, with the Gates Foundation taking an active role, to provide just one example. The role of education, especially higher, is also a subject frequently covered by the press, especially when, as a recent story from Chile shows, efforts to introduce fees at universities are met with strong, sometimes violent, protest from students. Instructors will find that referring to such current interest stories is rewarding not only by illustrating the lectures but also by raising student awareness of different approaches to health and education around the world.

◼ Discussion Topics •

Discuss the short run and long run equity issues related to increasing the quality of education as opposed to the quantity. Students should be able to comment on the short run and long run effects on population growth, employment, growth, and welfare.

•

Have students discuss their decision to attend college with respect to private costs and expected private returns.

•

Discuss the difficulties associated with allocating scarce public resources. Make up a budget and two or three projects in addition to education, and have students discuss the costs and benefits of each.

Alternative projects could include rural public works projects, urban infrastructure improvements for the informal sector, investment subsidies for the modern industrial sector, or credit programs for the rural or informal sector. Students should have enough knowledge at this point to be fairly specific about costs and benefits as they relate to welfare, growth in output, growth in labor productivity, and growth in employment. If your class is small you could also break up into groups and then have each group make a short, informal presentation.

◼

Sample Questions

Short Answer 1. Write an essay on the economic relationship of greatest concern for development between education and (a) the level of growth, (b) the character of growth, (c) inequality, (d) fertility, (e) absolute poverty, (f) international migration.

Answer: This question may be given as one long essay, or limited to one or more of the parts as a short essay. Discussed in the chapter.

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2. What is human capital and why is it crucial to expand human capital as part of the development process?

Answer: Human capital is defined as human capacities that raise productivity. In particular, human capital is focused on the level of education and health within the population. As more human capital is accumulated, labor productivity rises, which is essential for sustained growth in the economy.

3. What factors cause private and social rates of return for primary and secondary education to diverge in developing countries?

Answer: Subsidies. Credential inflation as a way to select from among qualified applicants in the high wage modern sector.

4. Why have poor nations invested so much money in education and health? Evaluate the soundness of these reasons.

Answer: Discussed in the chapter. Education and health improvements will increase labor productivity.

Both are essential for sustained growth.

5. Why is eradicating child labor seen as an economic investment?

Answer: Answers should include reference to the estimated $5 trillion in economic gains and a high rate of return on the investment needed to eliminate child labor and provide more education up to age 14.

6.

Compare the relative effectiveness of the balsakhi program to the Computer-Assisted Learning (CAL) program in India.

Answer: Discussed in Box 8.4. Both programs are effective in helping primary school students learn. The balsakhi program is relatively more cost effective than the CAL program, though both are fairly inexpensive ($5–$16 per child per year).

7. Explain some of the reasons why developing countries have not realized a greater positive development impact from their higher education programs.

Answer: Lack of program focus on the needs of the country and lack of mechanisms to ensure college graduates have the incentives to apply their abilities to pressing development needs. See the chapter.

8. Why should the development of a solid elementary education system take precedence over an expansion of the university system in developing countries?

Answer: One reasonable answer would apply the law of diminishing returns. Another would stress that university trained graduates have limited benefit without complementary inputs of moderately trained personnel. Also the higher rate of return (both private and social) from investing in primary education.

9. Evaluate critically the following statement: The developed countries have all shown a significant increase in the numbers of university-trained workers as incomes have risen; thus the development of a solid university system should be among the major priorities of developing countries.

Answer: Students might be expected to distinguish between cause and effect. A better educated labor force does not in itself cause development. It is necessary but not sufficient.

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10. Explain why the education of girls is probably the most cost-effective development investment. Be sure to include in your answer some discussion of at least two of the following: absolute poverty, health and development, fertility, and agriculture.

Answer: Female education leads not just to better employment opportunities but to a better distribution of benefits within a family. It leads to improved child health, reduced fertility, and it improves agricultural productivity as women do most of the work in this sector.

11. In developing countries higher educational facilities have tended to expand to the point where social benefits exceed private benefits. What is the economic explanation for this?

Answer: Supply and demand are not equated by a price adjusting market mechanism, but rather institutionally, through the state. Those with political influence seek to create subsidized education for their children.

12. Is child labor a problem in developing countries? Explain.

Answer: Discussed in the chapter. Students might comment on the magnitude of the problem as well as the fact that working children cannot attend school.

13. Explain how a better educated population will also tend to be healthier, and vice versa, that a healthier population will tend to be better educated.

Answer: Education and health care complementary.

14. How can an increase in human capital lead to an increase in GDP? Why might it not lead to an increase in GDP? Answer: will vary. Labor is more productive as human capital increases. Population growth can be expected to eventually fall as human capital increases. It might not lead to an increase in GDP if there is not sufficient job growth, or increased education is not directed at productive activities.

15. Investment in human capital is very similar to investing in physical capital. True or false? Explain your answer.

Answer: They are similar in the sense that rates of return can be calculated for each form of capital so one can compare these and make a choice as to which type of investment to undertake.

Rates of return to education are provided in Table 8.1. Of course, there is a market for physical capital where it can be bought/sold but no market for human capital.

16. What is educational inequality and how is it measured? Why is it important to measure the degree of educational inequality in a country? Explain your answer.

Answer: Measures how the quantity of education is distributed amongst the population ages 15 and above. It can be measured by the Lorenz curve and the Gini coefficient, much like the distribution of income.

17. What are the critical health challenges facing developing countries today and what measure(s) are being taken to confront these challenges? Explain your answer.

Answer: Combating the burden of diseases (malaria and HIV/AIDS prominent among these) and breaking the vicious circle between lack of health and low productivity.

18. Why do you think Uganda has been so successful at decreasing the prevalence of HIV/AIDS?

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Answer: An answer should make reference Box 8.6, especially noting the role of education, awareness, and an analysis of the economic forces behind the disease.

19. Although Progresa/Oportunidades has been successful in Mexico, why might a similar program not work elsewhere?

Answer: This problem is designed to get students to think about how development solutions in one country cannot necessarily be duplicated and be successful in another country. Answers should discuss the financial cost of implementing a similar program as well as the other necessary actions that would have to go hand in hand with such a program, such as the building of infrastructure and national level investments in health care among other things.

◼ Multiple Choice 1. Developing countries have not benefited as much as expected from their higher education programs because of (a) lack of program focus on the needs of the country. (b) increasing returns to scale in each individual’s education. (c) graduates get jobs in the private sector. (d) all of the above.

Answer: A 2. Education of girls is a crucial development investment because (a) it leads to improved child health. (b) it leads to reduced fertility. (c) women do most of the work in agriculture. (d) all of the above.

Answer: D 3. It is important to place particular stress on the role of primary education in the development strategy because of (a) LDC’s comparative advantage from basic skills education. (b) the law of diminishing returns. (c) development emphasis on poverty alleviation. (d) all of the above.

Answer: D 4. Credential inflation results from (a) a combination of cost-push inflation and demand-pull inflation. (b) rigidities in the industrial sector. (c) the need to select from among qualified applicants in the modern sector. (d) all of the above.

Answer: C 5. The fact that developed countries have strong, widely attended university systems indicates that (a) university expansion should be a development priority. (b) universities teach skills used on the job. .

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(c) developing countries place too much stress on agriculture. (d) none of the above.

Answer: D 6. An individual’s demand for education is most affected by (a) direct and indirect costs of schooling. (b) development priorities of the country. (c) the desire to escape agricultural work. (d) all of the above.

Answer: A 7. Concentration of resources on higher rather than basic education in developing countries tends to lead to (a) greater inequality. (b) lower fertility. (c) less international migration. (d) more job creation.

Answer: A 8. The supply of public school places is determined by (a) individuals’ demand for education. (b) direct and indirect costs of schooling. (c) political processes, often unrelated to economic criteria. (d) all of the above.

Answer: C 9. Studies show that improved education of women in developing countries leads to (a) lower infant mortality. (b) better designed, market based development policies. (c) lower international dependence. (d) all of the above.

Answer: A 10. Human capital is best defined as (a) the amount of wealth people have. (b) the amount of money people have to spend on schooling. (c) human capacities that raise productivity. (d) the average education level of the population.

Answer: C 11. Child labor is a widespread problem that applies primarily to children (a) between the ages of 5 and 14. (b) between the ages of 10 and 14. (c) between the ages of 12 and 14. (d) between the ages of 12 and 16. .

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Answer: A

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12. The World Bank approach to combating child labor stresses (a) making child labor legal under certain conditions. (b) tackling the sources of poverty. (c) encouraging families to migrate to richer countries. (d) providing each child with a computer so that children have an alternative to working.

Answer: B 13. The ILO approach to combating child labor stresses (a) encouraging parents to migrate to the cities in search of work. (b) banning child labor. (c) tackling the sources of poverty. (d) all of the above.

Answer: B 14. As the number of years of schooling completed increases, the expected private return and private cost of education (a) increase at roughly the same rate. (b) increase at different rates with expected private return increasing at a slower rate than private cost. (c) increase at different rates with expected private return increasing at a faster rate than private cost. (d) do not increase.

Answer: C 15. According to the 2005 UNDP Human Development Report child mortality (under age 5) has declined in all regions of the world except: (a) South Asia (b) Sub-Saharan Africa (c) Middle East and North Africa (d) None of the above Answer: B 16. According to the Regional HIV and AIDS Statistics data from WHO, which region of the world has the largest number of adults and children living with HIV? (a) South and South-East Asia (b) Sub-Saharan Africa (c) Latin America (d) North America Answer: B

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Chapter 9 Agricultural Transformation and Rural Development ◼ Key Concepts This chapter emphasizes that a country’s development strategy must include plans for achieving agricultural progress and rural development, as explained in section 9.1. The major topics addressed in the chapter include: • • • • • • •

How to increase per capita agricultural output and productivity in order to benefit the average rural dweller and provide a sufficient supply of food for the country.

Role of Government with respect to agriculture and poverty alleviation.

How to transform traditional low productivity agriculture into high productivity commercial agriculture.

Explaining why the decisions of peasant farmers are rational.

The role of risk faced by subsistence farmers and strategies to cope with this risk.

Explaining the role of economic and price incentives in increasing output.

Explaining the exact meaning of rural development.

In section 9.2, progress in the agricultural (cereal yields) sector since 1960 is reviewed and Sub-Saharan Africa’s continued stagnation features prominently. In many developing countries the agricultural sector often accounts for a majority of total employment; yet low productivity causes agriculture to represent a much smaller share of output.

There is a fairly detailed explanation on the structure of Developing World agrarian systems in section 9.3.

Two types of world agriculture are defined: low and high productivity. Agricultural productivity (value added/worker) and land productivity (average grain yield) is compared for some developed and developing countries as an illustration of the difference. There is also a new discussion on the categorization of world agriculture in developing countries into three dynamic categories: agriculture-based countries, transforming countries and urbanized countries where movement from one category to another is expected. Agricultural practices in Asia, Africa, and Latin America are compared and contrasted in terms of the structure of their agricultural sectors and the advantages/disadvantages of each, while acknowledging regional disparities within regions and countries: •

Latin American agriculture is characterized by the dualistic latifundio-minifundio system, in which a small fraction of landowners own the great majority of cultivated land in the region. Land concentration as discussed by way of Lorenz curves and the Gini coefficient. Total factor productivity is twice as high on family farms as on latifundios. Latifundios under-utilize labor, while minifundios over-utilize labor, relative to land. The latifundio system persists partly because land ownership provides such positive externalities as social status and political power.

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•

Asian agriculture is characterized by too many people crowded onto too little land (land fragmentation).

Farms tend to be small, and production is often characterized by sharecropping and tenant farming.

There is a good discussion of the impact of colonial rule, money lending, and recent population growth.

•

African agriculture is characterized by low productivity subsistence farming, traditional techniques, a lack of investment, shifting cultivation, and labor scarcity during the peak agricultural season. Though traditionally land has been less scarce in Africa, population growth has caused land to become more scarce, and production has been shifting towards small owner-occupied plots, as opposed to communal shifting cultivation.

Section 9.4, the section on the role of women, points out that, although women perform a majority of the work inside and outside of the home in the rural regions, development programs have often targeted men.

In addition, recent research indicates that the contribution of men and women to family income leads to different expenditure outcomes. Women spend more on children’s health and education compared to men, which yields larger social returns. Also, reallocating inputs, including training and credit access to women and their plots has a major impact on the productivity and the incomes of women.

Section 9.5 on the economics of agricultural development, includes an extensive discussion of the transition from subsistence farming to diversified and partially commercial farming, and to specialized commercial farming. Key topics include: •

Identifying characteristics of subsistence farming. For example, risk aversion may lead poor peasants to resist new techniques that offer higher average yields because the variance of the yield may be larger. The relationship between risk aversion and sharecropping is discussed. Interlocking factor markets and monopoly and monopsony power are mentioned.

• •

Identifying characteristics of the transition to mixed farming.

Identifying characteristics of modern commercial farming. Technology plays a major role at this stage.

An example of the importance of shared learning and technology is given, focusing on pineapple farms in Ghana.

The chapter concludes with a section on strategies for a comprehensive program of agricultural and rural development in 9.6. The discussion covers the role of technology, pricing policy and other economic incentives, land reform possibilities, and supportive policies.

In the new edition, the case study on women farmers in Kenya has been revised to reflect current developments.

◼ Lecture Suggestions A good place to start lecturing on this topic is with a review of the performance of the agricultural sector in less developed countries over the past 40–50 years. The urban bias of many development policies can also be reviewed. This is closely connected with an emphasis on why rural sector development is as important as urban sector development: •

The majority of the population often lives in the rural sector, especially the poor.

• • •

Industrial jobs are in limited supply.

Demand creation in the rural sector is important.

The rural sector is a source of many development problems discussed in other chapters including poverty, migration, unemployment, income inequality, and population growth.

The rural sector can be an important source of labor, food, and foreign exchange.

•

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It is important to discuss the structure of production in the agricultural sector of different geographic regions. This is important in terms of thinking about the most appropriate polices to use for encouraging development of the rural sector. Pros and cons of alternative agrarian systems can be explored with a table showing the different structures of production and what the implications are for some of the important issues: • •

Production Structure: plantation/latifundio, sharecropping, minifundio, family farms, and cooperatives.

Issues: technical efficiency, allocative efficiency, financial incentives, economics of uncertainty, incentives to produce for local needs, distribution, values of modernity, contributions to the modern sector, and delivery of social services.

Some evidence suggests that successful agrarian systems as diverse as those in South Korea and China have been converging toward a hybrid, with family farming and cooperative features.

Farming in South Korea is among the most efficient in the developing world, and its Saemaul Undong (“new village movement”) rural development program makes for an excellent discussion. The program aims to create a “development climate” through a philosophy of “diligence, self-help, and cooperation,” by maintaining individual family private ownership of land while at the same time emphasizing the role of collective action of villagers in developing infrastructure and raising income and welfare. The efforts to privatize and deregulate the ejidos (commons) sector in Mexico is also a good and lively discussion topic.

The development of the agricultural sector in the current less developed countries can be compared to the now developed countries in their earlier stages when productivity in agriculture kept pace with the industrial revolution, and land reform often occurred. This can be a good lead for a land reform discussion. The external benefits of being a big landowner often explain why land reform is politically hard to implement. At the same time, the experience of Brazil shows that the lack of land reform is leading poor farmers to attempt to occupy land owned by latifundios.

The discussion on low versus high productivity agriculture can be made more technical depending on the background of the students.

•

•

Students with intermediate micro may find interesting a Tobin-Markowitz indifference map diagram to illustrate the choice of a low-yield variety “Indica rice” over a new high-yield variety “super-rice,” and an illustration of under-utilization of intermediate inputs and capital on a factor productivity diagram from an expected utility maximization perspective.

The importance and impact of an increase in the quantity of capital and/or technology can be reviewed. You may start with the Malthusian model where labor is the only factor and discuss the subsistence level of living concept. Appropriate technology can also be discussed.

Policy options are numerous and include the provision of public capital infrastructure, research and development, extension services, input access, transportation, marketing, and storage, and price and exchange rate policies. Some of these are discussed in the case study of women farmers in Kenya at the end of the chapter. For example, an overvalued exchange rate can hurt agricultural exports. With respect to price controls, note that price plays three important roles: crop choice, urban cost of living, and farm income. Access to information may also be discussed. There may be many opportunities that poor peasant farmers are not aware of, such as growing high-end organic products for the developed countries.

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Additional sources of lecture material are: •

Pranab Bardhan. Land Labor and Rural Poverty. Oxford 1984 (for example his chapter on interlocking factor markets).

Ghatak and Ingersent. Agriculture and Economic Development. Johns Hopkins 1984.

Idriss Jazairy, Mohiuddin Alamgir, and Theresa Panuccio. The State of World Rural Poverty: an Inquiry into its Causes and Consequences. Published for the International Fund for Agricultural Development. NYU Press 1992.

Michael Lipton. Why Poor People Stay Poor: A Study of Urban Bias in World Development. London: Maurice Temple Smith 1977.

Gerald M. Meier. Leading Issues in Economic Development. Oxford University Press 1995.

• • • •

This chapter also lends itself to illustration from current events. Land reform is a very emotive issue, especially in Latin America where it is closely tied to political power and social status. The MST movement (at http://www.mst.org.br, with links to pages in various languages) is a good example to illustrate the struggle for land in Brazil. There is almost constant reporting of conflict over land in Latin America, with the murder of a US-born nun, a supporter of indigenous rights in Brazil, the most recent event making the news. Several documentaries are available on this issue; screening one of them may be a good source of class discussion or class report. The role of women is another issue that can be illustrated by reference to current events drawing attention to the unequal work burden in rural areas of many developing countries.

Discussion Topics: The students should now know enough from earlier chapters to allow for some interesting discussions. This is a good time to get them to try to integrate the different development problems into policy options.

•

Land reform: Present some background information, or have students do independent reading and research on selected countries before class. Discuss the pros and cons of land reform.

• •

Urban bias and the role of government policy with respect to the agriculture sector.

Policy options: After identifying structural constraints and other data on the agricultural sector’s performance in many developing countries, see what sort of policy options the students can come up with.

◼

Sample Questions

Short Answer 1. Explain the concept, goals, and methods of integrated rural development.

Answer: A solid answer will usually be based on the section, “Toward a Strategy of Agricultural and Rural Development,” in the text.

2. What are the primary determinants of agricultural labor productivity?

Answer: See the section on the economics of agricultural development.

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3. Explain the case for land reform in Latin America. Are there any potential negative effects? What steps could be taken to address these effects?

Answer: The goal would be to increase productivity, and reduce poverty and inequality. Peasants must be prepared with technical and business skills. Incentives must be offered to keep competent large farmers in business. Possibility (very real) of conflict and resistance from large land owners.

4. What are the implications for a successful agricultural development strategy of the finding that women perform 60 to 90% of all work in the traditional rural areas?

Answer: Agricultural extension programs and access to small scale credit must be focused on women.

5. In Bangladesh, the government guarantees rice farmers that it will buy rice at a specific price. Explain the costs and benefits to farmers in good and bad harvest years.

Answer: Supply and demand analysis with reference to elasticities plus a discussion of risk aversion is called for.

6. Describe briefly five major characteristics or problems of developing countries’ agricultural sector.

Make reference to specific countries or regions where you can.

Answer: Answers may be expected to vary according to lecture topics, and might include a discussion of land ownership, available inputs, credit access, training program, etc.

7. Explain the role of risk and uncertainty in an analysis of the economic behavior of peasant farmers.

What kinds of questions does this analysis enable us to answer?

Answer: Answers may be expected to vary according to lecture topics, with some discussion of why peasant production decisions are rational. See the section in the text that discusses sharecropping.

8. Critically evaluate the following statement: Government policies to keep the price at which staple foods are bought and sold low helps to reduce poverty and inequality.

Answer: Students must consider negative effects on rural areas.

9. Is sharecropping economically efficient or inefficient? Explain Answer: See the section in the text.

10. What are the key characteristics of the agrarian system in Asia that distinguish it from that of Latin America? Explain your answer.

Answer: Land fragmentation, greater population density and absentee landlords.

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11. Women bear a disproportionate burden in the agrarian system of Sub-Saharan Africa, Asia and Latin America. In addition their productivity is low. Explain these statements with specific examples from individual developing economies. What measures/policies have been implemented to deal with these two issues? Once again discuss with specific examples from individual developing economies.

Answer: Discussed in the section on the role of women in agriculture. Specific policies aimed at raising female agricultural productivity include facilitating access to credit, training programs, providing titles to land as a way of securing property rights (and thus the possibility of borrowing), cash subsidies in exchange for sending children (especially girls) to school etc.

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12. What is (are) the key characteristic(s) of the agrarian system in Sub-Saharan Africa?

Answer: Lack of complementary inputs (mechanical power, irrigation, tools, seeds, fertilizer), shifting cultivation, labor scarcity during the harvesting season while surplus labor during the rest of the year, rights of the extended family to land and water.

13. What are some of the specific policies aimed at improving the productivity of women farmers in Kenya?

Answer: Discussed in the case study to the chapter.

14. What is the Alliance for a Green Revolution in Africa and who are its primary supporters?

Answer: Discussed on Page 421–422 15. What role should the government play with respect to the agricultural sector in developing countries in their attempt to alleviate poverty?

Answer: Discussed on Page 422–423

◼ Multiple Choice 1. Crops produced entirely for the market are known as (a) basic crops. (b) mixed crops. (c) hybrid crops. (d) cash crops.

Answer: D 2. An agrarian system refers to (a) the pattern of land ownership. (b) the type of crops grown. (c) the processing of agricultural commodities. (d) an economy that has no industry.

Answer: A 3. The primary goal of an agricultural extension service is to (a) bring new areas under cultivation. (b) increase the yield per hectare. (c) introduce land reform. (d) assist rural-urban migration.

Answer: B 4. Which of the following is an important factor in the success of agrarian land reform policies? (a) the introduction of sharecropping. (b) the introduction of tenant farming. (c) farmer training programs. (d) the introduction of more capital intensive methods.

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5. It is important to place particular stress on the role of women in rural development programs because (a) women have received less training in the past. (b) women perform a large majority of the work in the rural sector. (c) women tend to allocate more resources to their children’s health and education. (d) all of the above.

Answer: D 6. Sharecropping can be best understood as (a) a type of agreement preferred by peasants. (b) a type of agreement preferred by landlords. (c) a compromise between peasant and landlord preferences. (d) a type of agreement preferred by neither but given by tradition.

Answer: C 7. A program through which new ideas, methods, and advice are offered to farmers to increase farm yields is known as (a) agricultural extension. (b) agricultural mechanization. (c) an agrarian system. (d) land reform.

Answer: A 8. In South Asia and Sub-Saharan Africa, about what share of the labor force works in agriculture? (a) One tenth. (b) One third. (c) One half. (d) Two thirds.

Answer: D 9. In South Asia and Sub-Saharan Africa, about what share of output is contributed by agriculture? (a) One tenth. (b) One fifth. (c) Two fifths. (d) One half.

Answer: B 10. In which of these developing regions has food production per capita steadily fallen over the last quarter century? (a) Africa. (b) East Asia. (c) South Asia. (d) Latin America.

Answer: A

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11. In a world of perfect certainty, sharecropping would be less efficient than a farm owner working his own farm because (a) sharecroppers receive only half of their marginal product. (b) paying a worker a wage gives him or her an incentive to shirk. (c) sharecroppers are exploited by landlords. (d) renting farmland concentrates risk on the renters. (e) all of the above.

Answer: A 12. During the 1990s, food production increased faster than population in all regions of the developing world except (a) Latin America. (b) East Asia. (c) Sub-Saharan Africa. (d) none of the above.

Answer: C 13. The African agrarian system is characterized by (a) absentee landlords. (b) a dual agrarian system known as latifundio-minifundio. (c) land fragmentation. (d) shifting cultivation.

Answer: D 14. The system of land tenure in which tenant farmers pay a fixed share of their crop to landowners is called (a) communal farming. (b) collective farming. (c) latifundio-minifundio system. (d) sharecropping.

Answer: D 15. Absentee landowners characterize the agrarian system of (a) Asia. (b) Latin America. (c) Sub-Saharan Africa. (d) all of the above.

Answer: A

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Chapter 10 The Environment and Development

◼ Key Concepts Section 10.1 discusses seven basic issues related to the environment and economic development.

Environmental issues are closely connected with many of the topics discussed in previous chapters.

• •

• • • • • • •

Economics and the environment: The issues inherent in considering the environment while analyzing development are introduced. It is important to recognize that environmental costs affect development even if they are excluded from traditional indicators of economic development.

Sustainable development and environmental accounting: The concept of sustainable development is introduced, and defined broadly as when the needs of the present generation are met without compromising the needs of future generations. Environmental accounting is a method of incorporating environmental decay into national income accounts.

Population, resources, and the environment: The consequences for the environment of rapidly growing populations are mentioned, some of which were discussed in Chapter 6.

Poverty and the environment: Environmental destruction is frequently a symptom of poverty.

Growth versus the environment: It is possible that there may be a tradeoff between the two and the Environmental Kuznets Curve is introduced.

Rural development and the environment: Sustainable methods of farming are mentioned.

Urban development and the environment: Urban pollution problems are discussed.

The global environment and economy: Many environmental problems are global in nature, and hence present special challenges.

Nature and Pace of Greenhouse gas induced climate change: Both developed and developing countries will need to play an important role in limiting global warming particularly as it’s pace hastens.

The next section highlights the promises and the limitations of natural resource based livelihoods such as agriculture, fishing and forestry.

Persistent rural poverty is shown to be the root cause of many of the environmental problems in less developed countries, which include deforestation, soil erosion, and ground water contamination. The principal health and productivity consequences of environmental damage are summarized.

In section 10.2, two hypothetical examples of two villages, one in Africa and one in South America, are presented to clarify the relationship between rural poverty and environmental degradation.

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Section 10.3 on Global warming and Climate change examines the scope of the problem of climate change on developing nations, particularly the poor, and identifies the most vulnerable zones across the world: Sub-Saharan Africa (drought), Asian megadeltas (flooding), small islands and the arctic. In addition, weather related problems in South Asia and Latin America are also discussed. The cost of these direct and indirect environmental catastrophes will be primarily borne by the poor as they directly depend on environmental resources for their livelihood and are impacted by adverse health conditions and poor/inadequate housing and sanitation that can be affected by climate change. Strategies to mitigate the progress of global warming and policy adaptations to help the “poor” are also discussed. Finding box 10.1 presents ways that African farmers have adapted to climate change in order to continue their way of living. Section 10.4 on economic models of the environment includes a definition of the optimal allocation of resources, and discusses different types of market failure that can lead to inefficient resource allocation. Topics include the characteristics of perfect property rights markets, externality and common property resource problems, and public good and free rider problems. Some limitations of each of these frameworks of analysis, particularly for specific developing country situations, are mentioned.

Section 10.5 on urban development and the environment contains some interesting descriptions of the severity of urban pollution in developing countries and its very severe health impacts. An analysis of some of the different types of pollution control policies is presented. The negative impact of severe environmental degradation on economic growth is described and it is suggested that in many cases pollution control can have a positive effect on growth and development.

Section 10.6 looks at the costs of rainforest destruction. Land cleared is relatively infertile and soon abandoned. It also presents concerns in that rainforests absorb carbon dioxide from the atmosphere.

Section 10.7 discusses options for policy reform. These are divided into what developing and developed countries can do. The developing countries can practice more efficient resource pricing, encourage community involvement, clarifying property rights and resource ownership, improving conditions for the poor, raising the economic status of women, and adopting policies that both lower current industrial pollution and adapt to future climate change. The developed countries can alter their trade practices, offer debt relief including debt-for-nature swaps, increase aid levels, assist with research and development on clean technologies appropriate for developing countries, curtail their own emissions, and reduce demand for environmentally harmful products.

A new case study on Haiti and the Dominican Republic has been added and examines their economic development efforts and indicators and their treatment of the environment.

◼ Lecture Suggestions The role of the environment in economic development has received a tremendous amount of attention recently. An overview of the issues can be given in one or two lectures, while a more detailed discussion and analysis might require an additional one or two lectures. Coverage can be expected to vary depending on the background of the students. Those who have had intermediate microeconomics will be able to handle a more rigorous discussion of the economic models of the environment.

It is worthwhile spending time on the eight basic issues presented at the beginning of the chapter to give students a sense for the environmental consequences associated with many economic decisions and development problems. Sustainability is a word that is frequently encountered but difficult to pinpoint accurately. A discussion of the meaning of sustainable development can include: • •

Tradeoffs between current and future consumption.

Using an appropriate social discount rate.

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How to correctly value the environment as a resource whose depletion represents a cost to future generations.

How to internalize negative externalities and correct for these market failures.

A review of the circular flow diagram, including the link between nature and the economy. Resources come from nature, and waste is returned to nature. Both resource use and pollution are linked to the choices made by each individual.

A good lecture theme is the (theoretical and empirical) finding of the close connection between poverty and environmental degradation. Key themes include the following: • • • • • • •

The high fertility of the absolutely poor. Larger populations have the potential to cause greater environmental damage.

The short time horizon of the poor. When starvation is a possibility there is no finite discount rate.

Farmers sometimes resort to eating next year’s seed corn to avoid starvation now, a metaphor for the general problem.

Land tenure insecurity of the poor. Even if survival is not at stake when one has insecure land tenure rights, as the relatively poor often do, there is an incentive to treat land as short-term resource. Lack of access to credit can have the same effect.

The land distribution. Particularly in Latin America, unequal land distribution produces political incentives to encourage poor farmers to establish inefficient rainforest settlements.

The low status of women among the poor. Poverty is closely linked with women who often have roles as guardians of natural resources, are responsible for (especially marginal) agriculture, and have an ultimate responsibility for fertility.

Poorly defined or nonexistent property nights.

Dependence of the poor on natural resource based activities for their livelihoods.

It is important to spend some time discussing why environmental problems exist. This ties in nicely with the meaning of development, which includes providing people with an expanded set of options. Key topics include the incentives people face, the property rights system, and the difference between private and social costs and benefits. The tragedy of the commons may be discussed in terms of possibilities for a cooperative game solution among participants, where common holdings can improve efficiency given the existence of returns to scale.

The relationship between growth and environmental quality can be discussed in more detail, both theoretically and empirically. Growth and environmental quality can be both complements and substitutes. Production possibility curves can be useful, and short run and long run tradeoffs can be highlighted.

The topic of Global warming and Climate change and its impact on developing nations, particularly the poor, can be discussed along with the strategies that need to be pursued to impede the pace of global warming and climate change.

The close connection between the need to service the country’s external debt and environmental degradation can be stressed either now or in connection with Chapter 13. Among the many implications of the debt crisis is inability to afford to import cleaner technologies, the discount rate is likely to be very high, and a shift from emphasizing the diversification of manufacturing to intensive natural resource extraction may be encouraged. Natural resource extraction is often worse in terms of total environmental impact than industry, especially when it degrades rainforests.

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The deforestation of the Brazilian Amazon rainforest illustrates many of the points in the text. Some important issues to note: • • • •

Conflicts between short and long term development goals.

Nonrenewable resource extraction with little thought of the resulting negative externalities and resource extraction which often benefits from ill-conceived subsidies for grandiose showcase development projects and often lacks economic justification, but supported by development agencies.

The encouragement of low-income farmers to move to the edge of the Amazonian rain forest as a politically inexpensive alternative to land reform.

The problem of perverse government incentives, such as awarding land titles to settlers on the basis of forest area cleared, which provided incentives for rainforest burning even when no economic use was planned; also tax breaks given for using Amazon land for ranches, which led the wealthy to develop the region to save taxes rather than on the basis of economic merits (cattle ranching activities for which there was a negative real rate of return, before the value of ecological damage was even considered, became viable to investors on tax-saving grounds alone).

A discussion of environmental accounting, an extension of social accounting, can be interest. Two good references are: 1.

Robert Repetto et al. Wasting Assets, Natural Resources in the National Income Accounts. World Resources Institute.

2.

Wouter Van Dieren, editor. Taking Nature Into Account: A Report to the Club of Rome. Copernicus, Springer-Verlag New York 1995.

Two additional reports that include both a discussion and some very interesting statistics are: World Resource Institute, World Resources 2002–2004: Decision for the Earth: Balance, Voice and Power, available at: governance.wri.org. Chapter 1 of the report is a useful summary of the importance of governance.

World Bank, World Development Report 2003, Sustainable Development in a Dynamic World, available at: econ.worldbank.org/wdr/. Chapter 2 defines and operationalizes the concept of sustainability and chapter 3 discusses the crucial role of institutions.

◼ Discussion Topics •

Select some specific environmental problems in one or two developing countries and discuss the pros and cons of possible solutions in class. You may choose to have students do some background reading and/or research first.

Discuss possible alternative measures of the quality of life. What indicators are important?

• Discuss the role and responsibilities of Developing and Developed countries with respect to climate change and its impact on the economy and the lives of people.

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◼

Sample Questions

Short Answer 1. Discuss the relationship between poverty, growth and the environment.

Answer: Discussed in the chapter.

2. Recurrent flooding in Bangladesh is causing the land area of the country to shrink. In what ways might environmental mismanagement play a role in explaining this phenomenon?

Answer: Depends on lecture coverage.

3. Why might it be in the direct economic interest of the United States to finance rain forest conservation programs in the Amazon?

Answer: Answers may include global warming effects, which may lower the productivity of the American Midwest, and loss of biodiversity for future medicines.

4. What is the relationship between debt, falling commodity prices and rainforest degradation?

Answer: Discussed in the chapter.

5. Provide a short definition of sustainable development.

Answer: Meeting the needs of the present generation without compromising the needs of future generations.

6. Describe the basic issues involved in setting up a system of national accounts that includes the value of environmental capital and its loss.

Answer: Detailed in the text.

7. In what way is better protection of the environment a possible result of successful development?

Answer: Successful development brings the poor above the poverty line; the poorest 1 billion people do a great deal of environmental damage, for example, cutting and clearing trees, using biomass fuels, etc., as detailed in the chapter.

8. Describe the effect of the loss of biodiversity on productivity and health.

Answer: Reduced adaptability of ecosystem; loss of new drugs.

9. Explain what developed countries can do to respond constructively to the environmental damage being done in developing countries.

Answer: Discussed at the end of the chapter; this may also depend on lecture coverage.

10. Describe the costs of deforestation.

Answer: Flooding, leading to disease and death; loss of sustainable logging potential, erosion potential, watershed stability, and carbon sequestration.

11. Describe the costs of water pollution.

Answer: Disease and death, poor household hygiene, declining fisheries, time and costs of providing safe water, aquifer depletion and compaction, water shortage, and increased costs of water for industrial use.

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12. Compare and contrast the path of economic development for Haiti and the Dominican Republic?

How did differences in in earlier institutions and the policies pursued by the two nations play a role in determining the development related outcomes?

Answer: Detailed in the case study at the end of chapter.

13. How will global warming and climate change adversely impact the “poor,” particularly in developing nations?

Answer: The poor are heavily dependent on natural resources, particularly rain fed agriculture.

The infrastructure they live in is also poorly constructed causing the impact of global warming and climate change on their lives and livelihoods to be severer. Additional details in Section 10.3, page 476–478.

14. What are some of the strategies that have been proposed to mitigate global warming at a macro level?

Answer: These include, capping emissions, development of carbon markets, taxes on carbon, and subsidies for green technologies. Additional details in Section 10.3, page 478–479.

◼ Multiple Choice 1. A major cause of environmental degradation in developing countries is (a) population growth. (b) rural poverty. (c) rapid urbanization. (d) all of the above.

Answer: D 2. Sustainable development means (a) emphasizing the role of the market. (b) emphasizing the role of government. (c) meeting the present generation’s needs without compromising the needs of future generations. (d) maintaining output growth at a constant rate.

Answer: C 3. Which of the following environmental problems are largely caused by persistent poverty? (a) Deforestation. (b) Soil erosion. (c) Ground water contamination. (d) All of the above.

Answer: D 4. Which of the following conditions is violated if there is a free rider problem? (a) universality (b) exclusivity (c) transferability (d) enforceability

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Answer: B 5. A major cause of environmental degradation in developing countries is (a) debt for nature swaps. (b) poverty. (c) a lack of public transportation. (d) land reform.

Answer: B 6. The “cost of rainforest preservation” can be lowered for developing countries by (a) the development of alternative rainforest products. (b) research on agriculture in rainforest soils. (c) encouraging rainforest settlement of the poor. (d) subsidies for activities like cattle raising.

Answer: A 7. Debt-for-nature swaps are most generally (a) beneficial only to the developing country. (b) beneficial only to the developed country. (c) beneficial only to the bank which can write off the debt. (d) beneficial to all countries.

Answer: D 8. A resource that is publicly owned and allocated under a system of unrestricted access is known as (a) a socialist resource. (b) a collective resource. (c) a common property resource. (d) a transferable resource.

Answer: C 9. The portion of a country’s overall assets that is directly related to the environment, such as forests and soil quality, is known as (a) environmental capital. (b) debt for nature swaps. (c) protected areas. (d) common property assets.

Answer: A 10. The free rider problem is a situation in which (a) effluents such as CFCs combine with ozone and decrease concentrations of that protective chemical. (b) one agent secures benefits that others pay for. (c) there are excessive subsidies given to polluting buses or other forms of mass transit. (d) perfect property rights exist.

Answer: B .

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11. International resources shared by all countries such as oceans and air are known as (a) global commons. (b) free rider problems. (c) nonrenewable resources. (d) cooperative resources.

Answer: A 12. The annual income that can be consumed without diminishing the total capital assets of a nation is (a) purchasing power parity income. (b) sustainable national income. (c) environmental capital stock. (d) per capita income.

Answer: B 13. An example of a biomass fuel is (a) coal. (b) nuclear fuel. (c) manure. (d) oil.

Answer: C 14. Which of the following conditions does not characterize perfect property rights markets? (a) universality (b) exclusivity (c) sustainability. (d) enforceability.

Answer: C 15. In what way do developing countries make the largest contribution to the global concentrations of greenhouse gases? (a) vehicle emissions. (b) deforestation. (c) mining. (d) irrigation.

Answer: B

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Chapter 11 Development Policymaking and the Roles of Market, State, and Civil Society

◼ Key Concepts This chapter looks at the effects of large, locally owned domestic firms in emerging economies as part of the private sector in developing countries. In this edition, some of the discussion on the roles and limitations of markets have been removed.

This chapter discusses development planning and the role played by the state versus the market. Major topics include: • • • • • •

The role and limitations of planning as practiced by less developed countries, including a discussion of different types of planning models.

The problems of economic transition to competitive free market economies.

A discussion of what government can do best in terms of correcting market failures.

The “Washington Consensus” both the old and the new (“Santiago”) version.

The impact of the political process on the quality of policy decisions.

Tackling corruption, implementing decentralization, and encouraging broad based development participation.

Economic planning is defined as an attempt by the government to coordinate economic decision making and influence economic outcomes. An economic plan is defined as a set of quantitative economic targets to be reached by a certain date. In the past, most developing countries adopted some degree of economic planning. The justification for developing planning includes the following: • • •

The need to correct market failures.

The need to ensure the most productive use of scarce financial and skilled manpower resources.

An increase in the ability to qualify for foreign aid.

Planning is introduced at various levels including aggregate, sectoral, and project (the components of the entire economic plan). The three types of planning models described are: • • •

applied macroeconomic growth models based on variants of the Harrod-Domar model, with reference to the two-gap model to be introduced in Chapter 15. input-output models. project appraisal, including a discussion of relevant objectives, shadow prices, social discount rates, and decision criteria.

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The crisis in planning is discussed in the inability of plans to meet their objectives. Problems include: plan designs that are often over-ambitious while vague on specific policies, data often insufficient or unreliable, unanticipated shocks that can wreak havoc, a planning agency often weak and ineffective, and countries that lack the political will to carry out otherwise sound plans.

The role of markets has been gaining ground at the expense of planning since the early 1980s. Many developing countries have attempted to reduce the role of the public sector, eliminate distortions in interest rates, wages, and prices, and encourage growth in the private sector. Development problems have been increasingly viewed (especially by aid agencies) as exacerbated by planning policies. The importance of government failure as well as market failure is stressed, and Box 11.1 presents a list of drawbacks of government intervention in developing countries.

In converting to a more market based economy, the text presents a broad range of institutional and cultural requirements for the operation of effective private markets (14 requirements) and for market-facilitating legal and economic practices (11 requirements).

The 10 points of the Washington Consensus are described. These 10 points defined the approach to development policy in the 1980’s and 1990’s. In Table 11.1, the ten points are evaluated with respect to two South East Asian economies. The Santiago Consensus is then described. A section explores the political economy of successful policy reform and implementation. Whether democracy or autocracy facilitates faster growth is also discussed in this section. A final section, “Trends in governance and reform,” takes up the topics of corruption, decentralization, and development participation.

In sum, the text emphasizes the need for both a public and private sector and the need for these sectors to cooperate in areas where government can best play a role, and in areas the private market should be left unencumbered. South Korea and Taiwan are cited as examples of successful proactive government industrial policy.

◼ Lecture Suggestions There is great leeway on material to be covered, emphasis on market vs. state, description of success/failure in planning, to accommodate the instructor’s preferences. You may, for example, provide an introduction to input-output and social accounting analysis, describe computable general equilibrium models, review the uses of such models in development studies, and describe the Little-Mirrlees method of shadow pricing.

Government failure and resurgence of the market, for example, is an open-ended topic that can spark student discussion and debate.

Though somewhat dated, the 2002 World Development Report, Building Institutions for Markets, makes the point that markets are unlikely to yield improvements in well being in developing countries unless appropriate institutions are encouraged that will ensure the successful operation of markets. Institution building is one of the fundamental themes of successful development policy and one that lecturers can gain a lot of mileage by emphasizing. Comparisons can be made between the difficulties of registering a business in poor countries (in terms of the number of necessary permits and time spent obtaining these) with the relative ease in the developed world.

The vital role of NGOs in the development process is another important topic of discussion. Does the existence of NGOs absolve the government of its role in making progress towards social development.

The case study on BRAC can also help facilitate this discussion.

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◼

Sample Questions

Short Answer 1. Explain what is meant by market failure.

Answer: Discussed in the chapter, pages 514–516.

2. In the Harrod-Domar model, if the savings rate is 20% and the incremental capital output ratio is five, abstracting from depreciation, what is the implied growth rate?

Answer: 4%.

3. In the Harrod-Domar growth model, if 12.5% of income is saved, the incremental capital output ratio is 2.5 and the rate of depreciation is 4%, what is the implied rate of growth?

Answer: 1%.

4. Assume a closed economy. Suppose the incremental capital-output ratio is 3, and the depreciation rate is 4%. Using the Harrod-Domar growth equation, if the savings rate is 9%, what will be the rate of growth? What would the savings rate have to be to achieve 5% growth?

Answer: –1%; 27%.

5. Why must projects be appraised? What do we learn from project appraisals?

Answer: Discussed in the chapter, pages 520–524.

6. What is the role of input-output analysis in development planning? What are the strengths and weaknesses of this technique?

Answer: Discussed in the chapter, pages 519–524.

7. In what ways may social evaluations of costs and benefits differ from those implied by market prices?

Explain carefully.

Answer: Discussed in the chapter.

8. What are accounting, or “shadow” prices for project appraisal? In what way do they differ from market prices, and why do we need them? Additional question or part of question: How can reference to world prices help countries gauge the real opportunity costs of development projects?

Answer: The additional question would depend on supplemental coverage of the ideas of the LittleMirrlees method project evaluation method.

9. Name <<some number>> of the ten points of the Washington Consensus. What is missing from this list? Did the Santiago Consensus address what was missing?

Answer: Covered in detail in the chapter.

10. How does the Washington Consensus differ from the Santiago Consensus?

Answer: The Santiago Consensus stresses poverty alleviation and the government taking responsibility for poverty alleviation. The Washington Consensus was much more free market based. See the chapter for more details.

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11. What economic benefits might a developing country gain by reducing corruption? Discuss only economic benefits and provide examples from specific developing countries.

Answer: The student is asked to describe the economic benefits of reducing corruption. These include the growth enhancing effects described in the text and illustrated in Figure 11.3 for Ecuador.

The text notes that the burden of corruption falls disproportionately on the poor so combating corruption could couple as a poverty reduction strategy.

12. As an agent of economic development, in what areas do NGOs have a comparative advantage, compared to governments or markets?

Answer: The new section on NGOs describes seven such areas of comparative advantage.

13. What is the primary composition/ownership pattern of the private sector in most developing countries?

Answer: Page 513–514 in the textbook.

14. Discuss the BRAC model and evaluate its performance in achieving the goals of economic development? Can this model be replicated in other countries?

Answer: Detailed in the case study at the end of the chapter.

◼ Multiple Choice 1. Development plans have often failed because (a) they have been insufficiently specific about projects. (b) they have overlooked noneconomic considerations. (c) they have been overambitious. (d) all of the above. (e) none of the above.

Answer: D 2. Sectors where the development process leads to a more rapid expansion of demand than supply in goods or factor markets are known as (a) the crisis in planning. (b) input-output analysis. (c) bottlenecks. (d) infant industries.

Answer: C 3. The price reflecting the true social opportunity costs of a resource is known as (a) a shadow price. (b) an equilibrium price. (c) a world price. (d) a price index.

Answer: A

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4. Which of the following factors has led to poor plan performance? (a) unanticipated changes, such as in terms of trade. (b) corruption of government officials. (c) foreign firms are less subject to the constraints of the plan than domestic ones. (d) all of the above. (e) none of the above.

Answer: D 5. An example of an institutional requirement for the operation of effective private markets is (a) enforcement of contracts. (b) the ability of government to correctly project trends. (c) the ability of advertisers to influence consumers. (d) all of the above.

Answer: A 6. An example of a market-facilitating legal practice is (a) clearly established property rights. (b) corruption of government officials. (c) extensive licensing requirements for starting firms. (d) all of the above. (e) none of the above.

Answer: A 7. A plan that sets targets to cover all major aspects of the national economy is known as a/an _____ plan: (a) interindustry (b) complete (c) comprehensive (d) economic Answer: C 8. Which of the following is a rationale for development planning? (a) government failure. (b) market failure. (c) failure of consumers to understand their preferences. (d) all of the above are rationales for development planning. (e) none of the above are rationales for development planning.

Answer: B 9. A shadow price is: (a) the price in the previous period. (b) the price in the next period. (c) the social value of a good or service. (d) the market value of a good or service. (e) none of the above.

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Answer: C

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10. Which of the following is a reason for the failure of development plans? (a) unreliable data. (b) unanticipated economic disturbances. (c) lack of political will. (d) all of the above. (e) none of the above.

Answer: D 11. Which of the following is not a rationale for development planning? (a) capital market failures. (b) rent seeking behavior. (c) attitudinal or psychological impact. (d) all are rationales for development planning in developing countries.

Answer: B 12. If the incremental capital output ratio is 3 and the ratio of saving to national income is 9%, according to the Harrod-Domar model the growth rate of income is (a) zero. (b) 3%. (c) 6%. (d) 12%.

Answer: B 13. If the population growth rate is 2%, the incremental capital output ratio is 3, the saving ratio is 24% and the depreciation rate is 5%, the rate of growth of income per person is (a) 1%. (b) 2%. (c) 3%. (d) 5%. (e) 8%.

Answer: A 14. If the population growth rate is 2%, the incremental capital output ratio is 3, the saving ratio is 24%, and the depreciation rate is 5%, the rate of growth of income is (a) 1%. (b) 2%. (c) 3%. (d) 5%. (e) 8%.

Answer: C 15. In Ecuador, as a share of a firm’s revenue, the cost of bribes is highest for (a) micro enterprises. (b) small enterprises. (c) medium enterprises. (d) large enterprises.

Answer: A .

Part Three Problems and Policies: International and Macro

Chapter 12 International Trade Theory and Development Strategy

◼ Key Concepts This chapter focuses on alternative theories of international trade and trade policy in order to answer the following questions: • • •

How does trade affect economic growth and income distribution?

Does trade promote the achievement of development objectives?

Should less developed countries pursue outward or inward oriented trade policies, or some combination of the two?

It is emphasized that the answers will not be the same for all countries given the great diversity that exists among developing countries; no unique solution can be recommended as regards the role of international trade in promoting economic development.

Section 12.1 serves as an introduction, with section 12.2 following with the central importance of international trade in economic development is explained in detail with both theoretical arguments and statistical evidence.

The weak export performance of many developing countries is explained by low income and price elasticities of demand for their products, and declining terms of trade (the Prebisch-Singer Thesis described in box 12.1).

In section 12.3, the traditional neoclassical model of international trade is reviewed, including: • • •

Complete specialization based on the theory of comparative advantage.

The factor endowment theory that emphasizes production of those goods which intensively use a country’s abundant factor. Graphical analysis and detailed conclusions are presented.

The traditional arguments for the impact of trade upon development are summarized.

Criticisms of traditional free trade theory are presented in section 12.4 by scrutinizing some of the assumptions the theory makes that are typically violated in less developed countries. The text analyzes the implications of such violations.

•

• • •

North-South Models of Unequal Trade: These models suggest that trade tends to reinforce the unequal distribution of resource endowments between countries, particularly with respect to skilled and unskilled labor. For many developing countries trade is unlikely to stimulate a shift to more capital-intensive forms of production, and the associated benefits.

The Vent-for-Surplus theory of trade: This provides a good description of the actual experience of many less developed countries.

The impact of the international movement of capital and skilled labor is mentioned.

The existence of monopoly and oligopoly power, product differentiation, increasing returns, and the existence of risk and uncertainty are also discussed. .

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The impact of international trade is examined in terms of the effects on growth, income distribution, poverty, and employment. To summarize, trade can be an important stimulus to rapid economic growth by promoting greater utilization of idle human and capital resources, increasing foreign exchange earnings, and expanding access to technological knowledge. At the same time, for a majority of developing countries, the principal benefits of world trade have accrued disproportionately to foreign residents and wealthy nationals (as well as to the developed countries).

Clearly, some developing countries such as Taiwan, South Korea and other Asian economies have benefited from trade. The issue is not whether to trade but which export products to try to promote. Whether expanding trade is economically beneficial depends on the nature of the export sector and its medium to long term potential (for example, terms of trade), the distribution of benefits, its linkages with the rest of the economy, and the country’s ability to respond smoothly to changing international price signals. In general balanced success will require access to developed countries’ markets for labor-intensive manufactures, extensive linkages between the export sector and other sectors of the economy, and the ability to influence activities of foreign enterprises to the benefit of the local economy.

Section 12.5, combines discussion on trade policy, previously in chapter 13 into chapter 12. Two broad trade and development policy strategies are defined: outward-looking and inward-looking development policies. Outward-looking policies encourage free trade and the free movement of the factors of production, while inward-oriented policies encourage production for the domestic market and restricted trade and movement of factors of production.

The major topics addressed include: • • • • •

Encouraging the export of primary products.

Encouraging industrialization via the important substitution strategy.

Encouraging industrialization via the export promotion strategy.

The trade optimist/pessimist debate.

Encouraging South-South trade and economic integration.

The pros and cons of emphasizing primary product exports as a growth strategy are discussed. Five important factors tend to work against the success of this strategy: low income and price elasticity of demand for primary products, slow population growth in developed countries, the development of synthetic substitutes, and agricultural protection in developed countries. Supply side factors emphasize rigidities in the structure of production and low productivity (covered in Chapter 9).

The export of manufactured goods as a growth strategy is mentioned, particularly with respect to the spectacular performance of the four Asian Tigers. The text cites rising protectionism by the developed countries as a barrier against the success of this strategy. The text also points to the need for more SouthSouth trade.

The import substitution strategy involves identifying consumer goods with large domestic market and simple technology to produce that are currently being imported, and replacing the imports with domestic production.

A second stage would involve expanding domestic production to more sophisticated manufactured items, including those with linkages to the consumer goods sectors established in the first stage. Key points mentioned include: • • •

A built in demand for the product already exists.

The infant industry argument.

The use of tariffs and quotas.

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The effective rate of protection.

The appropriate exchange rate policy.

Reasons for the failure of the strategy.

A section on foreign exchange rates reviews the concept of a foreign exchange market and discusses the options available for maintaining an official exchange rate. Overvalued exchange rates, dual exchange rate systems, and currency devaluation are discussed.

The trade optimist and trade pessimist arguments are listed. This is a good summary of the major issues relating to inward versus outward oriented trade strategies. Trade pessimists focus on the limited growth of world demand for primary exports, the deterioration in the terms of trade for many developing countries specializing in the production of primary products for export, and the rise of protectionism within the developed countries. The trade optimists focus on economic efficiency: the promotion of competition, getting prices right, improving resource allocation, and achieving economies of scale.

Section 12.6 on “The Industrialization Strategy Approach to Export Policy,” argues that, during the last two decades, several countries have pursued a strategy that emphasizes following an industrialization path through expanding presence in global markets. This strategy is broadly sympathetic to the arguments of trade optimists but also places heavy emphasis on government efforts to promote industrial export growth rather than leaving industrialization entirely to the market mechanism. This section discusses the experience of several countries, especially the South East Asian economies, with this strategy.

Section 12.7, on South-South trade outlines arguments why developing countries should move in the direction of economic integration. Economic integration among developing countries at relatively equal stages of development with similar market sizes and an interest in coordinating their efforts stand to gain the most. Mercosur, the Andean Bloc, and the Southern African Development Community are mentioned.

The final section of the chapter, 12.8, discusses how developed countries can reform their trade policies to promote the expansion of world trade by lowering tariff barriers, lowering export subsidies such as those used by Japan, expanding domestic adjustment assistance, and considering macroeconomic policies in the context of the developed as well as the developing world’s needs.

A chapter concludes with a case study on Taiwan.

◼ Lecture Suggestions It is essential to develop the assumptions and conclusions of neoclassical trade theory, as well as the nature of the criticisms offered in the text, in some detail. It is useful to emphasize that this is one of the most controversial issues in development economics. A distinction between the logic of the arguments and their empirical relevance should be made. This may take several lectures, depending on the background of the students.

A first lecture should include a statistical overview of trade patterns and experiences, followed by a discussion of the theory of comparative advantage. You might discuss: • • • •

the classic comparative advantage model the case of specialized factors of production and increasing opportunity costs of production the budget line and gains from trade the fact that small countries may gain more from trade.

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A discussion of how comparative advantage changes over time can be interesting in terms of the shift from labor to capital-intensive production. This is a good introduction to the North-South model. Many students may have seen this type of theory in a political science class. A role for government can be introduced here in terms of encouraging saving and investment, promoting stability, providing appropriate education, providing infrastructure, and encouraging research and development.

A simple illustration of declining net barter terms of trade may be helpful for some students, especially non-majors (for example, an increasing tonnage of copper exports required per car imported). It is worthwhile to explain that quality changes must be taken into account to arrive at a balanced assessment.

Note also that the terms of trade effect can be expected to vary across countries and commodities. Some studies suggest that there has not been a decline in the terms of trade, though there have been great fluctuations. See for example: Davis Sapsford and VN Balasubramanyam. “The Long-run Behavior of the Relative Price of Primary Commodities: Statistical Evidence and Policy Implications.” World Development 22(11):1737–45 November 1994.

You might also mention the income terms of trade as an alternative measure. Some evidence suggests that the income terms of trade have increased. Volume increases, which cause a decline in price, have a positive effect on revenue if the absolute value of the demand elasticity is greater than one. The long run behavior of the terms of trade is controversial and an issue not settled by empirical research. The concensus is that the Prebisch Singer thesis is not valid.

One way to summarize and develop the chapter in class is to provide a number of arguments, first for liberalization and then for international trade industrial policies. Liberalization arguments include (1) increased technical efficiency (returns to scale); (2) economic or allocative efficiency; (3) accelerated technical progress (due to increased contacts with the world market, subcontracts that provide technical training, etc.); (4) decreased shortages of foreign exchange and restricted commodities; (5) decreased losses from rent-seeking activities; and (6) increased investment due to cheaper capital goods. Arguments against liberalization include: (1) adjustment and dislocation, (2) dynamic comparative advantage including infant industries, (3) declining terms of trade, (4) fluctuating export earnings with dependence on exports of a handful of primary exports (due to weather uncertainties on the supply side and developed country business cycles on the demand side), (5) strategic trade policy arguments, (6) product discrimination, (7) growing protectionism, and (8) unequal bargaining power.

The tables at the end of the World Development Report are good sources of current statistics to update textbook material on which countries are experiencing a rapid expansion of exports and which stagnant or negative growth. The WDR tables include statistics on the nature of exports. For example, the importance of high tech exports (as percent of a country’s manufactured exports) is a good indication of how countries exploit world markets to diversity away from primary products.

The discussion of three trade strategies (primary product exports, import substitution, and export promotion for manufactured goods) and the discussion of South-South trade possibilities provides a good introduction of alternative trade policies. For each of the models, it is useful to discuss the pros and cons. The North-South model of unequal trade illustrates the dangers of specializing in the production of primary products for export. If you do not want to spend much time on this topic, then shorten the technical discussion, including the graphs, and present a general description of each strategy. Comment on how well each strategy has worked for select countries. Introduce primary product exports as an engine of growth after the theoretical material in the beginning of this chapter has been covered. The following points can be included in class discussion.

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Developing countries may tend to have a comparative advantage in primary products because of their stage of development.

Arguments in favor of this strategy include the ability to earn foreign exchange to finance growth, primary exports can help growth (referring to the experience of the now developed countries), and how exporting primary products can be a key part of an overall growth strategy.

Arguments against include the North-South model, demand factors, terms of trade effects, and ineffective linkage effects.

Introduce linkage effects: forward, backward, consumption, and fiscal. Positive linkages create value added in the economy and contribute to a positive job, spending, and income cycle.

Summary: the need to diversify across products and sectors, the need to increase demand at a low income level, the need to create advanced factors and/or the role government can play in this area, the possibilities for South-South trade as an answer to developed country protection.

The following points can be elaborated on with respect to import substitution: • • • •

•

A market for the good already exists, the country thinks it can gain comparative advantage in production of that good, industrial growth is key to development, and a current account deficit can be reduced.

The infant industry argument.

Three policies: tariffs, quotas, and an overvalued exchange rate. Spend time on the mechanics of each, and how they all fit together. Use supply and demand graphs, talk about monopoly power resulting from the use of a quota, and talk about differentiated goods resulting in a need for a quota on top of a tariff.

Discuss the supply and demand for foreign exchange and the exchange rate as the “price” of the foreign currency. Make sure students understand that the aim of an overvalued exchange rate is to reduce the cost of imported intermediate and capital goods for IS industries. Also emphasize that overvalued exchange rates reduce the competitiveness of goods in the export market. Stress that some developing countries have fixed exchange rate systems. Exchange rate policy can hurt export industries, help finance a payments deficit, encourage capital intensive production, and reduce backward linkages.

Conclusions: limited domestic market, scale economies may result in monopoly power, infants never grow up (and maybe cannot because of a lack of complementary factors such as skilled labor, inadequate input supplies, and poor infrastructure), the tendency for temporary tariffs to become permanent, input industries receive less protection, choice of technology and employment creation, migration and neglect of the rural sector, and a failure to improve productivity.

Export promotion (EP) of manufactured goods is in part a response to the failure of import substitution.

Export promotion involves targeting sectors with a (potential) comparative advantage in world trade to realize economies of scale and productivity growth. Trade liberalization is often considered as EP policy because it reduces incentives to produce for home over foreign markets. Some successful countries such as South Korea have effectively combined IS and EP strategies across time and industries, as detailed in the new case study at the end of this chapter.

EP is more market based, in that countries are forced to compete on the world market. Pro trade arguments apply here. Policies include government subsidies for export, removing factor price distortions, and other specific policies used by South Korea or Taiwan. Discuss its success in absorbing the growth of the labor force and the general advantages of increasing exports in terms of earning foreign exchange, attracting foreign investment, and preventing bottlenecks related to the agricultural sector.

It is helpful to offer a simple numerical example of the divergence between nominal and effective rates of protection: Suppose a country has an economy-wide tariff of 10%. It decides to protect stereos, raising its tariff rate—but no other rates—to 40%. It uses 50 cents of material inputs per dollar of output. What is the nominal rate of protection (before and after)? What is the effective rate of protection (before and after)? .

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Most students know about the success of Taiwan’s export oriented growth strategy. This case study looks at the various factors that have led to Taiwan’s success including initial import substitution policies.

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◼ Discussion Topics Discussion topics may be of more interest after the next chapter is covered.

•

Does trade reinforce existing inequalities? This fits in nicely with the North-South model. Discuss supply and demand basics and vicious circles.

Creating a demand for wage goods, and increasing value-added are two important goals for growth.

How does trade impact either of these goals?

Can all countries pursue export led growth and be successful? What are the limitations if any?

Can import substitution and export promotion of manufactured goods be pursued at the same time?

What are the difficulties in terms of selecting appropriate policies?

Compare and contrast a successful strategy of import substitution (Korea, Taiwan) with a disastrous one (e.g. Argentina).

• • • •

◼

Sample Questions

Short Answer 1. What are the terms of trade? What factors lead them to change over time?

Answer: The ratio of the price of a country’s exports to that of its imports both in index form.

Changes in the pattern of relative demand as income or tastes change in various parts of the world, and changes in supply, such as those brought about by technological progress.

Discussed in detail in the chapter.

2. Briefly explain the major argument of the factor endowment trade theory.

Answer: Countries will tend to specialize in the production of commodities making intensive use of their relatively abundant factors of production; for example, unskilled labor, or natural resources.

3. You are a lobbyist hired by a less developed country to try to prevent a developed country from increasing trade barriers against labor-intensive manufactured imports such as textiles. Make your case, arguing from both developed and developing country perspectives, in terms of who gains and who loses.

Answer: Requires synthesis of the neoclassical theory of international trade as applied to developed countries and benefits of outward looking trade policies from the developing country point of view. Students should note benefits to developed country consumers and developing country incomes.

4. Explain why a country’s gains from trade may not accrue to nationals. Indicate the differential effects on GNP and GDP. Answer: Discussed in the chapter; students should note that some of the value of output is repatriated by multinational corporations.

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5. Provide a concise statement about the relationship between a developing country’s emphasis on the export of traditional commodities and: (a) export earnings stability; (b) comparative advantage; (c) terms of trade.

Answer: (a) Traditional commodities may tend to experience greater price fluctuations; (b) less developed countries tend to have a comparative advantage in traditional commodities; (c) terms of trade for traditional commodities may tend to fall over time according to the Prebisch-Singer thesis.

6. Evaluate critically the following statement: In light of the experience of the last two decades, free trade is the best trade policy for most developing countries.

Answer: Discussed at length in the chapter.

7. When and under what circumstances is intervention in international trade justified on market correction grounds? What preconditions would have to be met from the government side for there to be a reasonable likelihood of success?

Answer: This will depend on what you cover in lecture.

8. In the North-South model, how are “basic factors” distinguished from “advanced factors,” and what are the implications for growth and development possibilities?

Answer: Basic factors include relatively unskilled labor, physical resources, location, and general infrastructure. Advanced factors include education and firm specific human capital, knowledge resources including universities, research facilities, and specialized infrastructure. Trade based on a comparative advantage in primary products may result in limited growth possibilities for a country.

9. Briefly, what are the major causes of export earnings instability for developing countries?

Answer: Low price and income elasticities of demand leading to erratic movements in export prices.

10. What are the key ingredients of Taiwan’s successful entry into world markets? What lessons can other developing countries draw from Taiwan’s experience with global markets?

Answer: The new case study discusses some of the key factors of Taiwan’s success in global markets.

The case study focuses mostly on economic variables but social variables (such as the work ethic, somewhat relegated under “other factors” in the case study) should be mentioned in lectures.

11. Explain briefly the vent-for-surplus theory of international trade. What is the relevance of this theory to the current development experience of low income economies?

Answer: Discussed in the text.

12. A country simultaneously raises tariffs on manufactured goods and overvalues the exchange rate.

Why might these seemingly contradictory policies be pursued together?

Answer: Students should show they understand why a general import substitution strategy could include making some imports cheaper while effectively prohibiting others. You may wish to combine this question with the following question.

13. What are the drawbacks of overvaluing the exchange rate as an import substitution policy?

Answer: Discourages exports and leads to trade deficit or to use of exchange controls.

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14. After a policy of import substitution has begun, a developing country finds that employment has not risen significantly and that urban unemployment seems to be rising. Explain how these developments might be connected.

Answer: Modern sector enrichment with wage increases/migration/capital intensive industries.

15. Many developing countries have a static comparative advantage in the production of one or two primary products. In what ways might specialization in these products contribute to growth and development? In what ways might this fail to contribute?

Answer: Calls for a discussion of short and long run effects as in the text.

16. Taiwan and Jamaica are both islands that have pursued export-oriented development strategies, but Jamaica has experienced increases in unemployment and poverty, while Taiwan has experienced decreases. How might you explain this?

Answer: The type of exports, commodity or manufactured, may matter. You may wish to use other countries as illustrations, depending on the examples you use in lecture.

17. Discuss some of the factors that lead infant manufactured goods industries to become more efficient over time, and some of the factors that might lead them to fail to do so.

Answer: Industries with significant learning by doing; firms threatened by a specific deadline for tariff reductions.

18. (a) Under what circumstances is the effective rate of protection of a tariff greater than the nominal rate? (b) Why is this a concern for developing countries?

Answer: (a) When tariffs on final goods exceed those on intermediate and capital good inputs. (b) The magnitude of protection may be greater than intended, which comes with opportunity costs.

19. State three country characteristics that encourage and three that discourage economic integration among developing countries.

Answer: Among those encouraging: similar economic systems, locations, development levels, and goals. Discouraging: nationalism, desire for high tech prestige projects regardless of efficiency, similar resources, and similar comparative advantage.

20. Explain the dynamic rationale for economic integration among developing countries.

Answer: Similar to the infant industry argument—see the chapter.

21. State and explain three [or some other number chosen by the instructor] reasons why the scope for further expansion of developing country commodity exports is likely to be limited.

Answer: (a) development of further synthetic substitutes, (b) continued agricultural protection in developed countries, (c) the developing country’s desire for agricultural self-sufficiency, (d) low income elasticities for these products. (e) instability of export earnings.

22. Suppose that a good that was formerly an import becomes an export, perhaps after an import substitution and export promotion strategy. How is this change reflected in the production possibility frontier?

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Answer: The good that was on the import axis, now is found on the export axis. Leaving the goods on the same axes as before, with the import on the y-axis, the ppf becomes more bowed out toward and further up this axis.

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23. Explain the difference between nominal and effective tariffs.

Answer: Spelled out in the text.

24. What is the difference between a devaluation and a depreciation?

Answer: A currency is devaluated when the rate at which the central bank will exchange the local currency for foreign convertible currency, such as dollars, is abruptly increased. A depreciation is the gradual decrease in the purchasing power of a domestic currency in foreign markets relative to domestic markets.

25. Explain how international trade and trade policy helped Taiwan transform itself from an underdeveloped country to a high income country in a relatively short span of time. You might begin by discussing Taiwan’s trade strategy. Why do you think international trade is of such vital importance to Taiwan?

Answer: Discussed in the case study.

26. Economists frequently urge governments of developing countries to replace import quotas with import tariffs as a first step in a strategy that aims to reduce import protection. What is the reasoning offered by economists to support this recommendation to developing countries?

Answer: Quotas yield rents that result in domestic groups wasting real resources fighting over these rents and at the same time quotas generate no public revenues.

27. What is an overvalued exchange rate? What factors may cause a country’s currency to become overvalued?

Answer: The value of the domestic currency is greater than its value at the equilibrium point in the foreign exchange market. One likely reason why currencies become overvalued is the insistence of the central bank in maintaining fixed exchange rates in the face of substantial domestic inflation.

28. How did active government industrialization strategy and industrial policies, including the collaboration between private and public sectors contribute to the East Asian development success?

Answer: Page 615 in the textbook. The policies included encouraging indigenous skills, technologies, and firms. Upgrading technologies over time from labor intensive to relatively more capital intensive. The government also played a coordinating role with good communication with the private sector.

◼ Multiple Choice 1. The ratio of a country’s average export price to its average import price is (a) its absolute advantage. (b) its comparative advantage. (c) its terms of trade. (d) its exchange rate.

Answer: C

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2. According to the Prebisch-Singer thesis (a) demand for primary products has steadily fallen. (b) profits of primary producers have steadily fallen. (c) primary producers’ terms of trade have steadily fallen. (d) prices of primary products have risen over time.

Answer: C 3. The purpose of commodity buffer stocks is (a) to moderate price fluctuations. (b) to raise commodity prices. (c) to encourage commodity substitution. (d) to guarantee national security.

Answer: A 4. Developing countries might be unable to respond smoothly to changing international price signals because of (a) a lack of government regulation. (b) an abundance of skilled labor. (c) inelastic supply curves. (d) limited foreign exchange.

Answer: C 5. Autarchy as used in the text refers to (a) an economy that does not trade. (b) an economy that trades primary products in exchange for manufactures. (c) developing country dictatorships. (d) the caste system and related social structures.

Answer: A 6. Which of the following is an argument in favor of the liberalization? (a) Increased technical efficiency. (b) Accelerated technical progress. (c) Decreased shortages of foreign exchange. (d) All of the above. (e) both (a) and (b) are correct.

Answer: D 7. Which of the following is an argument in favor of trade liberalization? (a) Increased investment. (b) Infant industry. (c) Fluctuating export earnings. (d) Increased government revenue.

Answer: A

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8. Which of the following is an argument in favor of interventionist trade policies? (a) Cheaper capital goods. (b) Declining terms of trade. (c) Decreased losses from rent-seeking activities. (d) All of the above. (e) None of the above.

Answer: B 9. Guiding the market through strategic coordination of business investments to increase export market shares is known as (a) development planning. (b) industrial policy. (c) shifting terms of trade. (d) all of the above. (e) none of the above.

Answer: B 10. The opening of export markets for primary products can provide employment for previously underutilized land and labor. The term for this is (a) vent for surplus. (b) comparative advantage. (c) Prebisch-Singer thesis. (d) barter trade.

Answer: A 11. Which of the following statements is true? (a) larger countries (in terms of size) tend to be more open (in terms of larger share of exports in GDP) than smaller countries and developing countries tend to be less open than developed economies. (b) larger countries (in terms of size) tend to be less open (in terms of lower share of exports in GDP) than smaller countries and developing countries tend to be less open than developed economies. (c) larger countries (in terms of size) tend to be more open (in terms of larger share of exports in GDP) than smaller countries and developing countries tend to be more open than developed economies. (d) larger countries (in terms of size) tend to be less open (in terms of lower share of exports in GDP) than smaller countries and developing countries tend to be more open than developed economies.

Answer: D 12. The dependence on the export of one or two primary products for a majority of the revenue from exports is most severe in countries in (a) South Asia. (b) East Asia. (c) Sub Saharan Africa. (d) Latin America.

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Answer: C 13. The real price trendline for non fuel primary commodities from 1960-2005 has been (a) Unchanged (b) Steadily increasing (c) Steadily decreasing (d) First decreased and then increased.

Answer: C 14. The nominal rate of protection shows the extent to which the domestic price of imported goods exceeds (a) what the price would be without tariffs. (b) the cost of intermediate inputs. (c) the social opportunity costs of the good. (d) the no-trade equilibrium price.

Answer: A 15. The effective rate of protection is (a) value added with protection divided by value added without protection. (b) value added with protection. (c) value added without protection. (d) (value added with protection minus value added without protection) divided by value added without protection.

Answer: D 16. The average level of effective protection has exceeded 300% for which of the following countries? (a) Pakistan and Uruguay. (b) Argentina and Brazil. (c) Phillipines and Mexico. (d) India and China.

Answer: A 17. An economic community (a) attempts to raise prices by restricting quantity. (b) seeks to stabilize commodity prices. (c) seeks concesssional loans. (d) imposes a common external tariff. (e) none of the above.

Answer: D 18. The long-run social benefits of infant industry protection are more likely to be realized if (a) investors believe that tariff barriers are permanent. (b) investors believe that tariff barriers are transitory. (c) tariff barriers increase over time. (d) tariff barriers are replaced with quotas over time. .

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Answer: B

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19. Which of the following factors makes the success of economic integration more likely? (a) Nationalism. (b) Desire for prestige projects. (c) Diverse economic systems. (d) All of the above. (e) None of the above.

Answer: E 20. Why is it impossible that all industries in a developing country qualify as infant industries? (a) You cannot have a comparative advantage in everything. (b) You cannot have an absolute advantage in everything. (c) This would violate international law. (d) This would reduce the terms of trade.

Answer: A 21. Which of the following is not a reason why the prospects for the further expansion of developing country commodity exports is likely to be limited? (a) Low income elasticities for these products. (b) Low likelihood of development of further synthetic substitutes. (c) Continued agricultural protection despite trade agreements. (d) Declining terms of trade.

Answer: B 22. Which of the following is a major argument of trade pessimists? (a) Increased productivity of developed country agriculture. (b) Increased efficiency in industrial use of raw materials. (c) Protectionism against labor-intensive manufactures. (d) All of the above.

Answer: D 23. Which of the following is a major argument of trade optimists? (a) Industrial policy can increase productivity of developing country manufacturing efficiency. (b) New synthetic substitutes are constantly being discovered and improved. (c) Developing country efficiency would improve with trade liberalization. (d) All of the above.

Answer: C 24. Which of the following countries provides the best example of a successful import substitution development strategy? (a) Chile. (b) Taiwan. (c) Argentina. (d) Botswana.

Answer: B .

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25. Which of the following is a nontariff barrier policy tool? (a) Sanitary regulations. (b) Average duties. (c) Phased liberalization. (d) Ad valorem tax.

Answer: A 26. Nontariff barriers (a) decrease foreign exchange earnings. (b) reduce the quantity of goods exported. (c) lower the effective price received for exports. (d) all of the above.

Answer: D 27. The most important role of the World Trade Organization is (a) to promote market oriented economic policies. (b) to settle trade disputes. (c) to provide development assistance. (d) to help countries choose the appropriate level of a tariff or quota.

Answer: B 28. If the equilibrium exchange rate is 15 pesos per dollar and the central bank fixes the exchange rate at 17 pesos per dollar then we can conclude that the peso is (a) appreciated. (b) depreciated. (c) overvalued. (d) undervalued.

Answer: D 29. In most less developed countries, the initial target of import substitution is to promote domestic production of (a) consumer goods. (b) food and other agricultural goods. (c) capital goods. (d) manufactured intermediate goods.

Answer: A 30. Which of the following is not an argument in favor of export promotion over import substitution? (a) international competition compels domestic producers to become more efficient. (b) exposure to world markets provides greater opportunities to learn new technologies. (c) producing for export permits greater specialization and economies of scale. (d) outward-looking development promotes larger firms.

Answer: D

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Chapter 13 Balance of Payments, Debt, Financial Crises, and Stabilization Policies

◼ Key Concepts This chapter maintains its focus on international monetary and macroeconomic issues with a discussion of odious debt and its prevention and adds a section on the effects of the global financial crisis as related to developing countries.

The major topics are: • • • • •

Understanding the balance of payments accounts.

Identifying recent trends in developing country balance of payments accounts.

Understanding the causes and effects of debt crises through the example of the 1980’s debt crisis.

Attempts to alleviate macroeconomic instability in the economy including debt relief.

The impacts of the global financial crisis on developing countries.

Basic balance of payments accounting is introduced in section 13.2 of the chapter. Key definitions include the current account, the capital account and the cash account or net change in international reserves. A detailed numerical example is used to illustrate how the accounts work, as well as the impact of capital flight. Options for financing and reducing payments deficits are discussed including increasing net exports, changing the official exchange rate, borrowing, adopting IMF stabilization policies, and acquiring SDR’s.

Recent trends in the balance of payments of LDCs are presented and explanations are offered, for instance, why current and capital account balances declined in the 1980’s and 1990’s. LDC current account balance declined as a result of a fall in commodity prices and the contraction of world trade (associated with the 1981–1982 world recession and protectionism). The capital account balance declined as a result of rising debt obligations, capital flight, and reductions in the amount of new lending.

Sections 13.4 and 13.5 are devoted to the debt crisis and methods of alleviation. The basic transfer is defined as the difference between net capital inflow and interest payments on accumulated debt. The basic transfer represents the amount of foreign exchange that a developing country gains or loses each year from international capital flows. A very significant issue in development economics is a negative basic transfer for many developing countries during the 1980s.

The dimensions of the 1980’s debt crisis are reviewed. Total external debt of developing countries more than doubled from 180 billion in 1975 to $406 billion in 1979, a mere 5 year period. In the same time frame the debt service payment tripled from 25 billion to 75 million. The text summarizes the history of the debt crisis noting that the first oil shock triggered international lending through a combination of

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increased loan demand and recycling petrodollars that expanded the supply of loanable funds. The second oil shock triggered a reversal of this process, as interest rates rose. Stagnation reduced the demand for developing country exports, and already high debt levels made further borrowing to accommodate high oil prices all the more difficult.

Typical elements of an IMF stabilization package are outlined: liberalization of foreign exchange and import controls, devaluation, interest rate increases, deficit reduction, wage restrictions, reduced price controls, and a general opening up of the economy. The text finds that these elements have not worked well in response to the debt crisis, leading to adjustment without growth and negative consequences for living standards.

A case study on Mexico is included in the chapter as Box 13.1. This case study highlights Mexico’s battle with the international financial community over its foreign debt.

Recent initiatives for managing the debt crisis include debt forgiveness, debt restructuring, new SDR allocations, repayments linked to export earnings, debt-for-equity swaps, and debt-for-nature swaps. A new section on odious debt and its prevention has been added. The text reexamines the current situation of the debt crisis. Until 1997, LDC debt was considered to be one of the top international crises. However, a majority of loans were then restructured and if the debt crisis is defined as a threat to large commercial banks it might be considered over after the restructuring. But if one defines the debt crisis as a threat to development prospects, the text argues that then the crisis is not over. Infact, debt relief, though promised to certain countries, has been very slow to come.

The text also highlights new concerns of instability that have risen with the 1997–98 financial crisis across Asia, Latin America and Russia. In addition, the enormous U.S. trade imbalance and its eventual impact on the debt performance of developing nations is still a large unanswered question.

The final section of the chapter deals with the global financial crisis and how it affects the developing countries through trade and the interconnected financial markets of today. While it is uncertain why the crisis occurred, financial deregulation in the United States and large trade imbalances between East Asian countries and developed countries (U.S.) are largely cited as reasons. The section then goes on to discuss the effects the crisis had on developing nations in the areas of economic growth, exports, foreign investment inflows, developing country stock markets, aid, distribution of influence among developing countries, worker remittances, poverty, health and education, and general policy framework.

The text also looks at how the crisis affected different regions of the global economy – China, India, and other East Asian countries in particular. China experienced an economic slowdown between 2008 and 2009, before resuming its historically fast economic growth by the end of 2009 and into 2010. The final part in the chapter looks towards the future and examines the prospects for recovery and stability following the recession. The chapter outlines five reasons for caution—the United States large trade deficits, large fiscal deficits in most OECD countries, market perceptions that risk of sovereign debt default is high, the risk of deflation, and the benefits of exporting manufactures to high-income countries.

South Korea and its successful development strategy of export promotion among others is highlighted in this case study. It also examines the current account and debt problem experienced in the 80’s and the recovery from the East Asian financial crisis.

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◼ Lecture Suggestions It is important to define and discuss the balance of payments accounts. Depending on their background, many students may not be familiar with these concepts beyond some basic understanding of a trade deficit.

You might discuss: • •

•

The relationship between the capital account and the current account in that they sum to zero by construction because of the way the cash account is defined. With a fixed exchange rate, there will be a payments deficit or surplus.

The impact of a current account deficit on the exchange rate or the supply of international reserves. If you have not already done so, this is a good time to discuss basic exchange rate systems and exchange rate policies in developed and developing countries. The section in the text on financing payment deficits is a good place to start.

Discuss the opportunity cost of borrowing, the marginal productivity of investment in developing vs. developed countries, long-run vs. short-run capital flows, and risk and the political environment.

It may be helpful to explain that countries borrow for reasons analogous to those of individuals, that is to smooth consumption over time and to make an investment which will result in higher income in the future (as students do with education). In this sense debt may be “appropriate” or “inappropriate.” Inappropriate borrowing includes spending funds on consumption or investing in projects lacking positive benefits for development, as well as projects associated with corruption or outright theft.

Other good topics for lecture or discussion are distinctions between capital flight and portfolio diversification, developing country proposals for reform of the IMF, and distinctions between a debt crisis and a short-term balance of payments problem.

One interesting application of the material on the debt crisis is the confrontation between Argentina and its foreign bond holders. There has been extensive coverage of this issue in the financial press and by all accounts Argentina has forced its creditors to accept substantial losses on their bond holdings.

Major lessons of the debt crisis include: • • • • •

It was not a one-time crisis, in that there are still countries with major debt problems. The “Highly Indebted Poor Country” (HIPC) initiative is an attempt to deal with these.

Treating a genuine debt (solvency) crisis as a liquidity problem only delays a solution.

There is some public role to deal with lenders’ free rider problems.

It is important to ensure that borrowing is matched by productive investments.

The private sector cannot be expected to finance investment in the poorest developing countries.

The global financial crisis and its causes and implications for development is important to be highlighted and discussed. Focus on the economic impact of the recession on developing economies and include the impact on growth, exports, FDI, markets and aid.

◼ Discussion Topics • •

Discuss the pros and cons of running a trade deficit. Some initial balance of payments concepts can be reviewed and then opened up for discussion. Discuss the alternative options and opportunity costs.

Have students locate data on remittances and capital flight for select countries and discuss the impacts on growth, income distribution, etc.

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Proposals for debt forgiveness or debt cancellation and now odious debt are much in fashion, especially with rock stars heavily involved (Live 8, Bono etc). Students will find it interesting researching their arguments and using development economics to evaluate them.

Discuss the current global financial crisis and its impact by studying countries like China, India, and South Korea.

Reasons for caution in recovery from the global crisis could be discussed as students come up with potential solutions in the future.

Compare and contrast the successful strategy of debt management of South Korea with the failure of Brazil.

• • •

◼

Sample Questions

Short Answer 1. Provide a concise statement on the relationship between the debt crisis and: (a) foreign direct investment, (b) trade liberalization, (c) absolute poverty, and (d) investment levels.

Answer: May be asked as a long essay or subdivided into short essays. Answers will depend on what you cover in lecture.

2. Consider the following hypothetical data for a developing country: Year

Total Debt ($ bn)

Debt/Export (%)

GDP Growth

Inv. Growth

1

6

134

0.6%

–1.0%

2

6.5

147

2.9%

1.1%

3

7

159

5.1%

1.6%

4

7.5

174

6.4%

2.4%

5

8

198

1.1%

–0.6%

Does this country have a debt crisis? What additional pieces of quantitative or qualitative evidence (if any) would help you to decide?

Answer: Various answers are plausible and this will depend on lecture coverage. Close attention to investment growth should be found in students’ answers.

3. An IMF official was quoted as acknowledging that the Fund’s stabilization packages have often led to adjustment without growth. However, he said, “the Fund is a firefighter not a carpenter, and you cannot expect the firefighter to rebuild the house as well as put out the fire.” Provide a balanced evaluation of this statement.

Answer: Suggestion: Nothing should be left smoldering either.

4. Explain what is meant by capital flight. How would you distinguish capital flight from the normal desire of investors to diversify their portfolios by investing abroad?

Answer: Students should show that they understand capital flight as discussed in the chapter.

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5. What economic variables would you need to consider in order to distinguish between a developing country with a short-term balance of payments problem and one in a debt crisis? Explain what data you would need to look at and why.

Answer: Look for an understanding that investment in exportable goods must increase above trend during borrowing to provide foreign exchange earnings sufficient to repay the debt without a drop in the standard of living.

6. Explain how the devaluation of a developing country’s currency is supposed to reduce its external debt. Give two reasons why a devaluation may be less effective than expected.

Answer: Discussed in the chapter.

7. Outline the principal sources of the debt crisis.

Answer: Discussed in the chapter.

8. Outline the elements of an IMF stabilization package. Explain the mechanism by which it is expected to help a balance of payments deficit. How successful have these packages been? Explain your answer.

Answer: Discussed in the chapter.

9. What kinds of domestic policies, short of significant debt reduction, can be followed to alleviate a debt crisis? How effective have these policies been?

Answer: Expectations here will depend on lecture coverage.

10. Consider debt-equity swaps as an approach to debt reduction. Briefly describe how this works.

State two arguments in favor of significant reliance on this strategy and two arguments against.

Answer: In favor: may help restore a healthy balance between debt and equity, which in turn provides greater flexibility in repayment of debt, and may help facilitate a privatization program.

Against: leads to issue of high-powered currency (so may be inflationary) and in some indebted countries there is limited availability of companies in which foreign investors have an interest in purchasing. If the question is asked after Chapter 15 has been covered, pros and cons of MNCs in development may figure into the answers.

11. Why may the debt crisis be only “sleeping” rather than “dead?”

Answer: Debt restructuring has postponed but not eliminated the need for eventual repayment, and a small share of debt has actually been written off. It remains to be seen whether indebted economies have reformed sufficiently and will operate in an economic climate that enables the debts to be repaid. See section 13.7.

12. Provide a definition of the current account, the capital account, and the cash account. What is the relationship between the three accounts?

Answer: Discussed in the chapter.

13. Discuss the options for financing a balance of payments deficit.

Answer: Discussed in the chapter.

14. Discuss some of the reasons why economists are concerned about the current recovery from the global financial crisis.

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Answer: Large trade deficit. Large fiscal deficits in most OECD countries, market perception that risk of sovereign debt default is high, risk of deflation all contribute to a cautious outlook for the future.

15. How did the Mexican debt crisis of the early 1980s come about? How has the Mexican economy coped during the past 20 years, in the aftermath of the debt crisis? What has been the legacy of the debt crisis for the Mexican economy?

Answer: Discussed in box 13.3.

16. What is meant by petrodollar recycling? Explain the mechanism by which this phenomenon occurred.

What were the consequences of this phenomenon for developing countries?

Answer: Explained in the section 13.4 “Origins of the 1980s Debt Crisis.”

17. What is meant by the term Odious Debt”?

Answer: Explained in the section 13.6 “Odious Debt and Prevention.”

18. Explain how international trade and trade policy helped South Korea transform itself from an underdeveloped country to a high income country in the space of a single generation. You might begin by discussing South Korea’s trade strategy. Why do you think international trade is of such vital importance to South Korea?

Answer: Discussed in the case study.

◼ Multiple Choice 1. The flow of private foreign investment and grants and loans is included in a country’s (a) current account. (b) capital account. (c) cash account. (d) none of the above.

Answer: B 2. Debt service payments appear in (a) the current account. (b) the capital account. (c) the cash account. (d) errors and omissions.

Answer: A 3. A typical IMF stabilization package involves (a) erecting barriers against foreign investment. (b) overvaluing the exchange rate. (c) liberalization of exchange controls. (d) a reduction in interest rates. (e) all of the above.

Answer: C

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4. The need for exchange controls may arise from (a) overvalued exchange rates. (b) export promotion policies. (c) a current account surplus. (d) all of the above.

Answer: A 5. Which of the following was not a factor contributing to the debt crisis in Latin America? (a) The oil shocks. (b) Trade liberalization in many developing countries. (c) An increase in global interest rates. (d) A lack of investment opportunities in the developed countries. (e) All of the above.

Answer: B 6. Special Drawing Rights are financial assets created by (a) the World Bank. (b) the United National Development Program. (c) multinational corporations. (d) the International Monetary Fund.

Answer: D 7. Debt equity swaps may lead to (a) increased foreign ownership. (b) greater domestic inflation. (c) lower debt servicing requirements. (d) all of the above. (e) none of the above.

Answer: D 8. A significant problem of a dual exchange rate system is that it (a) is difficult to administer. (b) leads companies to pursue rent-seeking behavior. (c) promotes black markets. (d) all of the above. (e) none of the above.

Answer: D 9. A country with high inflation, rising budget and trade deficits, and a rapidly expanding money supply (a) is in transition. (b) has macroeconomic instability. (c) is practicing import substitution. (d) is practicing export promotion.

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Answer: B

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10. Exchange of developing country debt (at a discount) for private ownership of state-owned assets is called (a) debt-equity swaps. (b) debt restructuring. (c) the Brady Plan. (d) debt-nature swaps.

Answer: A 11. The debt service ratio is the ratio of (a) external debt to the size of the service sector. (b) external debt to total GNP. (c) internal debt to the size of the service sector. (d) internal debt to total GNP. (e) none of the above.

Answer: E 12. The debt service ratio is defined as (a) the ratio of total debt to export earnings. (b) the ratio of total debt to GDP. (c) the ratio of payments on foreign debt to export earnings. (d) the ratio of payments on foreign debt to GDP. Answer: C 13. If the current account is a deficit of 25 then (a) the capital account is a surplus of 25. (b) the cash account is a surplus of 25. (c) the capital account is a surplus of 25 if the cash account is zero. (d) the cash account is a deficit of 25.

Answer: C 14. The basic transfer is defined as (a) net capital inflow. (b) interest payments on foreign debt. (c) net capital inflow divided by interest payments on foreign debt. (d) net capital inflow minus interest payments on foreign debt.

Answer: D 15. The concept of odious debt implies (a) an excessive debt. (b) a debt that is not the responsibility of the nation’s people. (c) a large debt burden. (d) the total external debt of a nation’s people.

Answer: B

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Chapter 14 Foreign Finance, Investment, and Aid: Controversies and Opportunities

◼ Key Concepts This chapter examines the international flow of financial resources to LDCs and weights the pros and cons of the different forms.

• •

Private foreign direct investment (FDI) and portfolio investment: Direct investment by multinational corporations and the purchase of stocks and bonds in emerging credit and equity markets by foreign investors are discussed.

Foreign aid: Both government and non-government aid is discussed.

After an introduction in section 14.1, section 14.2 deals with foreign direct investment (FDI) and the role of multinational corporations (MNCs) in economic development. Conflicts between the objectives of MNCs (profit maximization) and host countries are discussed. Figure 14.1 has been added that shows FDI inflows both global and by groups from 1980 to 2005. Figure 14.2 presents an updated time-series breakdown of resource flows to LDCs by type: official flows, FDI, portfolio flows and commercial bank loans (the last three make up private flows to LDCs).

14.3 discusses growth and remittance of developing economies. This section presents two figures, 14.3 and table 14.1 that highlight resource flow to developing countries from 1990–2008 and the top 20 remittance receipt countries in dollars and as a percentage of GDP for 2008. The importance and benefits associated with increasing remittances to recipient nations are also discussed.

Multinational corporations are firms that own or manage resources in more than one country. Potential benefits include filling gaps in savings, foreign exchange, government revenue, management skills, technology, and entrepreneurship, all of which may ultimately increase economic growth, this is discussed in 14.4. The text shows that these contributions may be small because: (1) MNC capital is often raised locally, perhaps from the government at subsidized rates, (2) little of the profits may be reinvested in the local economy, (3) MNCs may import many of the intermediate and capital goods they use in production, (4) liberal tax concessions and transfer pricing (that avoids taxation), and (5) there may be negative effects on indigenous entrepreneurship. Moreover, MNCs may encourage dualism and inappropriate consumption of luxury goods, use excessively capital intensive techniques, and displace indigenous production. The net benefits of MNCs should be empirically determined on a case by case basis.

Private portfolio investment represents one-third of the net financial resource flow to developing countries.

The pros and cons of investing in emerging country stock markets are mentioned, with reference to several crises (Mexico, Russia, Asia).

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Foreign aid is defined as a flow of official capital to developing countries that has a noncommercial, nonmilitary purpose (from the point of view of the donor) and features favorable interest rates and/or repayment periods. Some measurement issues are mentioned and data are presented on the volume and source of foreign aid. It is noted that there is a fine line between commercial and noncommercial objectives, and tied aid is stressed. The chapter discusses donor country motives and cites political as well as economic objectives. The two-gap model is introduced to describe the role of aid in relieving the foreign exchange gap. Developing countries tend to accept aid to supplement scarce domestic resources and to help speed up the development process. The growing role of non-governmental organizations is mentioned as a source of aid.

A new section has been added, 14.5, focusing on conflict and development. The scope of conflict is discussed, as well as the consequences for armed conflict, including destruction of wealth, worsening poverty, loss of education and changes in social fabric. Figure 14.4 explains global trends in armed conflict from 1946 to 2008. Next, the section explains what the risk factors for armed conflict include, finishing with how such conflicts can best be prevented.

The case study on Botswana highlights one of Africa’s few success stories and discusses the reasons for it. It also identifies some of the challenges facing Botswana that puts this successful case at risk such as high-income inequality and the impact of the HIV/AIDS epidemic.

◼ Lecture Suggestions It is important to take some time developing the arguments for and against MNC investment. Students often have formed opinions about this topic that may or may not be based on sound economic analysis.

Go through hypothetical examples to identify the goals of the MNC and the developing country as well as the likely impact on various aspects of the economy. Box 14.1 is a useful summary of the arguments.

Other comments may include how developing countries have altered their views of MNC investment.

This is a topic that is highly politically charged and, though politics and economics are closely connected, instructors should try to distinguish the two.

American students may have an exaggerated view of the share of the U.S. federal budget devoted to foreign aid. In fact, the U.S. contributes just 0.1 percent of GNP to aid, placing it last in percentage terms among major industrialized countries. A handout ranking countries based on recent information (the World Development Report contains such information) can be an eye-opener for some students; especially when the U.S. is contrasted with the relative generosity of the Scandinavians. (Maybe a note that the U.S. is the most charitable country when private giving is factored in) Numerical examples can be used to show how MNC investment may not necessarily increase domestic employment (and may decrease it), assuming a substantially higher capital labor ratio and significant MNC local borrowing that causes some crowding out of local entrepreneurs.

The political motives behind foreign aid are controversial. It may be pointed out that advancement of U.S. interests is an explicit objective of the U.S. State Department’s Agency for International Development, and U.S. AID spokespersons readily volunteer that this has a major influence on aid decisions.

Having groups of students scan news articles from the last decade on armed conflict and its impediment to development in Somalia, Sudan and other nations and present them to their peers is an excellent way to introduce students to this topic.

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◼ Discussion Topics •

Have students brainstorm on how MNC and LDC goals can be reconciled in the short run and the long run. What policies might address some of the arguments against MNC investment?

Weigh the costs and benefits of MNC investment against other alternative options, such as import substitution. What are the proposed short and long run differences for the economy? You might have students research Argentina and India.

Discuss the feasibility of achieving the U.N. target for provision of foreign aid of 0.70% of GNI. An interesting angle is the current move by the entertainment industry towards putting pressure on governments to meet this target.

Have students discuss news articles, essays and commentaries from the last decade on armed conflict and its impediment to development in Somalia, Sudan and other nations.

• • •

◼

Sample Questions

Short Answer 1. Suppose an MNC subsidiary buys 100 input units from its parent at a price of $2 each. It has $300 in additional production costs, and sells its 100 units of output for $6 to the MNC. It pays a 25% local profit tax. The MNC sells the output at home for $8, and its cost of producing inputs is $1. It pays a profit tax of 20% at home on repatriated profits. What is the subsidiary net profit? Assume no selling costs at home. What is the MNC’s total profit from the operation?

Answer: $75; $360.

2. It has been argued that tied aid leads to inefficiencies in the recipient country’s economy. Explain how this could occur.

Answer: Discussed in the chapter.

3. State three major potential advantages of foreign direct investment for a developing country. State three major potential disadvantages.

Answer: See Key Concepts.

4. Provide a concise statement on the relationship between multinational corporation investment and economic activity in developing countries with respect to: (a) the three gaps, (b) comparative advantage, (c) the debt crisis, (d) scale economies, and (e) pattern of consumption.

Answer: The question may be asked as one long essay or selected parts for short essays. Discussed in the chapter.

5. Explain the motives of developed countries in providing foreign aid.

Answer: Creation of markets, geopolitical influence, etc., discussed in the chapter.

6. Why does investment by multinational corporations not necessarily help to close the foreign exchange gap.

Answer: Investment funds may be raised locally, and the subsidiary may not export its output.

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7. Provide a concise statement about the relationship between multinational corporations and: (a) domestic employment, (b) foreign exchange, (c) taxes, (d) investment, (e) consumption, (f) industrialization, (g) inequality, and (h) technology.

Answer: Depends on lecture coverage.

8. Explain what is meant by investment by MNCs encouraging inappropriate consumption.

Answer: Discussed in the chapter.

9. Why does multinational corporation investment not necessarily offer the advantage of domestic employment expansion?

Answer: Capital-intensive production coupled with crowding out of local borrowers when capital is raised locally.

10. Critically evaluate the following statement: “If no other assistance is available, tied aid should be accepted anyway, on the grounds that developing countries should accept any help they can get.”

Answer: Calls for a discussion of the costs and benefits of tied aid, which can lead to net positive or negative benefits.

11. State at least two major benefits of promoting non-governmental organizations in developing countries as sources and conduits of foreign assistance.

Answer: Benefits: less constrained by political motivations, and able to avoid cynicism and suspicion by working directly with and for local people.

12. Discuss the pattern of allocation of foreign aid by members of the Development Assistance Committee (DAC) to developing countries in recent years. What are the priorities of the DAC members in allocating foreign aid among recipients?

Answer: Amounts contributed by major donors are in Table 15.2. In terms of where the funds end up, priorities amongst geographic regions are in Table 15.3 and major country recipients are in Table 15.4.

13. What are the main forms through which foreign capital flows into LDCs? Discuss the evolution of the various forms across the last decade.

Answer: Official and private flows. Private flows are made up of FDI, portfolio investment and commercial bank loans. Official flows are now much less important than they were at the beginning of the 1990s (see Figure 15.2). In recent years, bank loans represent net outflows for LDCs. 14. What are the main factors that have contributed to Botswana’s relative economic success compared to other Sub-Saharan African countries? Why were these factors not emulated by other SSA countries?

Answer: Discussed, in part, in the case study.

15. Discuss how remittances can help reduce poverty and meet other development objectives in recipient nations?

Answer: Discussed in the section on “Role and Growth of Remittances.”

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16. What are the primary causes of armed conflict in developing countries and what increases the risk factor for these conflicts?

Answer: inequalities in access to resources by culturally defined groups, political differences, inability to meet basic needs. And presence of mineral wealth all increase the risk factor for conflicts.

17. Is it possible to proactively prevent armed conflict in developing countries?

Answer: Adequate investment in well-functioning institutions, both legal and economic; and, global and regional actors who can play an important role of facilitator of conflicts and can reduce the incentive to engage in conflict. Detailed discussion on page 713–717 of the text.

◼ Multiple Choice 1. An argument in favor of foreign direct investment is that it tends to (a) reduce inequality. (b) promote rural development. (c) increase access to modern technology. (d) decrease local ownership. (e) none of the above.

Answer: C 2. Which of the following is an argument against MNCs? (a) A reduction in inequality. (b) An increase in the use of labor intensive technology. (c) A deterioration of the balance of payments accounts. (d) An increase in government tax revenue. (e) None of the above.

Answer: C 3. One of the significant criticisms of MNCs is (a) the relatively low wages they pay. (b) on balance they bring in more capital than officially registered. (c) increased monetary policy effectiveness. (d) all of the above. (e) none of the above.

Answer: E 4. The amount of foreign aid in proportion to developed countries’ GNP has (a) increased over time. (b) remained fairly stable over time. (c) decreased over time. (d) fluctuated widely but has shown no clear trend.

Answer: C

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5. MNCs can often decrease their tax liability through (a) use of more capital-intensive techniques. (b) use of transfer pricing. (c) use of more foreign input sources. (d) bargaining with the host country. (e) none of the above.

Answer: B 6. A motivation of developed countries in providing development assistance is (a) the creation of markets. (b) geopolitical influence. (c) genuine humanitarian concern. (d) all of the above. (e) none of the above.

Answer: D 7. With tied aid (a) MNC investment depends on tax concessions. (b) aid recipients must use the aid to purchase goods and services from the donor. (c) aid recipients must follow World Bank/IMF conditionality. (d) all of the above.

Answer: B 8. The developing area receiving the largest share of direct foreign investment is (a) Africa. (b) Asia. (c) Latin America. (d) Transition economies.

Answer: B 9. Which of the following is not a type of portfolio investment? (a) Investment in stocks. (b) Multinational corporation investment. (c) Investment in commercial paper. (d) All are types of portfolio investment. (e) None are types of portfolio investment.

Answer: B 10. The best explanation for the late 1994/early 1995 collapse of the Mexican peso and stock market is (a) free movement of capital internationally is destabilizing for a developing country. (b) portfolio investments were camouflaging overvalued exchange rates. (c) debt for equity swaps had created imbalances in the ownership structure of the economy. (d) the potential benefits of NAFTA had been oversold.

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Answer: B

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11. In the two-gap model, which of the following gaps, when binding, leads to foreign aid having the largest impact on GNP? (a) Fiscal gap. (b) Savings gap. (c) Foreign exchange gap. (d) None of the above.

Answer: C 12. Voluntary organizations that work with and on behalf of mostly local grassroots organizations in developing countries are termed (a) international organizations. (b) nongovernmental organizations. (c) multilateral institutions. (d) equity organizations. (e) none of the above.

Answer: B 13. A model comparing savings and foreign exchange constraints to see which is binding for economic growth is known as a (a) project appraisal. (b) two gap model. (c) computable general equilibrium. (d) trickle down model. (e) none of the above.

Answer: B 14. Which of the following countries meets regularly the UN target for the provision of foreign aid (as a percent of GNI)? (a) Japan. (b) United States. (c) Denmark. (d) France.

Answer: C 15. During 1990–2003, as a percentage of total resource flows to developing countries, the share of official flows has (a) remained relatively constant. (b) increased by a relatively small percentage. (c) increased by a relatively large percentage. (d) decreased by a relatively small percentage. (e) decreased by a relatively large percentage.

Answer: E

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16. As a percentage of GNI, which of the following countries provides the greatest amount of foreign aid? (a) United Kingdom. (b) United States. (c) Italy. (d) Sweden.

Answer: D 17. As an absolute amount (billions of dollars), which of the following countries provides the greatest amount of foreign aid? (a) United Kingdom. (b) United States. (c) Italy. (d) Sweden.

Answer: B 18. The direct benefits of out-migration to a developing nation include: (a) Loss of skilled workers. (b) Increased remittances. (c) Job growth. (d) Larger capital formation.

Answer: B 19. The largest recipient of remittances in dollars in the year 2008 was: (a) India. (b) Mexico. (c) Pakistan. (d) Philippines.

Answer: A

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Chapter 15 Finance and Fiscal Policy for Development

◼ Key Concepts Macroeconomic stabilization is stressed as a central concern of development policy since the 1980s.

This means an effort is made to moderate inflation, reduce government budget deficits, and reduce trade deficits. Major topics of the chapter include: • • • •

The structure of developing country financial and fiscal systems: monetary and fiscal policy challenges.

Public administration.

Privatization of state owned enterprises.

The economic impact of military expenditures.

The role of financial systems in developing countries is described in section 15.1. These systems are compared to those in developed countries. While developed countries are able to use their financial systems to mobilize private saving and allocate efficiently saving, this is frequently not the case in developing countries. The following describe the conditions of many developing-country financial markets: • •

• • •

In developing countries, financial systems tend to be unorganized, externally dependent, and spatially fragmented.

The ability of the monetary authorities to regulate the money supply is constrained by several factors: pegging of the currency to another currency (or basket of currencies), the quantity of accumulated foreign exchange earnings is a significant but variable source of domestic financial resources, and currency substitution.

A lack of transparency restricts the ability to borrow.

A dual monetary system often exists where a small, often externally controlled money market caters to a small segment of the economy and a large, unorganized, unregulated money market serves the rest of the economy.

Interest rates are often kept artificially low.

It is not uncommon to find a weak link between low interest rates (promoted to stimulate growth) and the resulting increase in investment and output. Structural supply constraints may prevent output from increasing and demand increases merely serve to increase price. In addition, budget deficits and expansionary monetary policy also contribute to rising prices.

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In section 15.2 the role of the central bank in developed countries is compared to its role in developing countries. The central bank generally lacks the flexibility and independence to conduct traditional monetary policy and regulatory functions. Four alternatives to traditional central banks, (transitional, supranational central bank, currency enclave and open-economy central bank), are discussed. A list of four broad patterns in changes of central banking over the past two decades is given. The text notes that the organizational structure does not matter as much as the ability to finance and promote domestic economic development. Commercial banks need to take a more active role in this respect.

Section 15.3 describes how development banks and informal credit markets have emerged to fill the gap left by the formal financial systems. Development banks are specialized private and public institutions that supply medium and long run funds for industrial growth. Existing commercial banks tend to focus on short-run safe borrowers. Despite substantial growth in the number of development banks, they have been criticized for concentrating on large loans and projects. To fill in this gap, informal credit markets have emerged to address the finances of small scale enterprises, such as rotating savings and credit associations and group lending schemes and microfinance institutions. Details on the size of the small scale producer sector and its unique credit needs are presented, as is an expanded discussion of NGOs and microfinance institutions as well as three current MFI policy debates. Box 15.1 is added to describe the financial lives of the poor, as is 15.2, describing training in relation to microfinance. At the end of 15.3, the limits of microfinance in development are discussed.

In section 15.4, the effects of interest rate ceilings are discussed and it is suggested that the removal of artificially low ceilings on nominal interest rates should generate more domestic savings, while higher real interest rates should improve the allocation of loanable funds to the most productive projects. Direct initiatives to channel credit to small entrepreneurs are also essential, and may require new types of financial intermediaries oriented towards the traditional or informal sector. Seven market failures are enumerated and it is suggested that the state can still play an active role, even as the financial sector is liberalized.

Finally, the role of the stock market in channeling domestic funds towards investment is mentioned.

The role of the stock market is controversial and the text discusses the debate.

Section 15.5 focuses on fiscal policy aimed at development. The mobilization of resources to finance public expenditures is the most important purpose of taxation. Tax sources for developing countries and the limitations developing country governments face in collecting taxes are reviewed, comparative data on levels of tax revenue are presented.

State-owned enterprises (SOEs), described in section 15.6, contribute an average of 7–15% to GDP in the developing world. The rationale behind SOEs includes the existence of monopoly power in markets, the need for capital formation, and the desirability of national control over strategic sectors of the economy.

However, SOEs have frequently made losses, in part because they are expected to pursue both commercial and social goals. Benefits of privatization of SOEs are: lower production costs, an increase in output, an improvement in overall efficiency, a reduction in government expenditure, an increase in individual initiative (while rewarding entrepreneurship), and broadened ownership and the sense of a stake in the system. At the same time, questions of feasibility, appropriate financing, property rights structure, indigenous ownership, distribution, and dualism must be adequately considered. An example of the questions posed by the need for privatization is given in box 15.3, focusing on Chile and Poland.

Section 15.7 describes how the quality of public administration is among the scarcest resources in a developing country. This is an important problem that is often glossed over. The example of the Tazara railroad through Tanzania and Zambia is mentioned to emphasize this point.

The chapter concludes with a case study on the Grameen Bank of Bangladesh.

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◼ Lecture Suggestions Four distinct lecture themes emerge from this chapter: • • •

Monetary policy and the banking/credit system.

Fiscal policy and taxation.

State owned enterprises.

It might be useful to review the operation of monetary policy in developed countries in order to get at the question of why it often does not work in the same way in less developed countries. This may also be helpful if you plan to introduce additional information on inflation and cases of hyperinflation, and the practice of monetizing the budget deficit.

You can find the outline of a lecture on the characteristics and the implications of financial repression in a short article by Michael Dooley and Donald Mathieson, “Financial Liberalization in Developing Countries,” Finance and Development, September 1987.

The characteristics include: • • • • • • •

interest rate ceilings and negative real interest rates pervasive credit rationing portfolio selection restrictions for financial institutions that prevent capital from flowing to the highest rate of return central bank rediscounting of credits to key sectors, often at subsidized rates licensing to restrict entry into the financial services market, with associated losses due to rent seeking behavior, high liquidity and required reserve ratio (to create a ready demand for high powered money to finance deficits) disintermediation from the banking system lack of demand for credit rating services.

The implications include: • • • • • •

reduced incentive to save reduced possibility of diversification encouraging capital flight reduced incentive to lend to the most profitable projects reduced ability to transform illiquid assets into liquid ones, hence to match financial supply and demand and pool risks reduced money services, in the extreme currency substitution.

Fry’s book (endnote 5) and Diaz-Alejandro’s “Goodbye Financial Repression, Hello Financial Crash,” (endnote 1), offer additional valuable sources of lecture notes. Lance Taylor offers a good theoretical and empirical critique of financial repression theory and liberalization arguments in his Varieties of Stabilization Experience. It is a good source for lectures in presenting the structuralist viewpoint, but may be too difficult for most undergraduate students.

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You may wish to discuss the sequence of financial sector liberalization in more detail. A good source is Ronald I. McKinnon, The Order of Economic Liberalization: Financial Control in the Transition to a Market Economy, Johns Hopkins, 1993, or Sebastian Edwards, The Sequencing of Structural Adjustment and Stabilization, ICS Press, 1992, or the Stiglitz article (endnote 22). Issues for discussion include: • • • • • • • •

avoiding disruption of the real sector avoiding damage to the information capital of the financial sector a consideration of the country’s level of development noting that very rapid liberalization may lead to financial crashes considering the extent to which the inflation tax is needed in the short to medium run to finance unavoidable deficits getting macroeconomic stability in place first, including cutting the fiscal budget, reforming the tax system, and achieving internal balance before external balance conducting current account liberalization before capital market liberalization liberalizing, though not entirely deregulating, the domestic capital market before opening the capital account.

The role of stock markets in economic development is especially contentious but also of interest to students, especially when it comes to foreign investment in stock markets of emerging economies. A survey of issues relating to the liberalization of stock markets is G. Bekaert, C. Harvey and C. Lundblad, “Equity Market Liberalization in Emerging Markets” Journal of Financial Research, 2003. This paper has a table showing the initial date of liberalization of stock markets of various emerging economies (defined as the date at which foreigners were first allowed to invest in local stock markets). This table can be presented in class and students should find it interesting. A couple of papers showing that stock market liberalization can have positive effects on economic growth are: R. Levine, and S. Zervos, “Stock Market Development and Economic Growth,” World Bank Economic Review, 1996 and R. Levine and S. Zervos, “Stock Markets, Banks, and Economic Growth,” American Economic Review, 1998; these two papers tend to be more academically oriented. The best source of information and data on investing in emerging economies is the Emerging Markets Data Base of Standard and Poors. Morgan Stanley Capital International has some basic data on stock market performance in emerging economies available (free of charge but registration is required) on the net at: http://www.msci.com/equity/index2.html.

Regarding taxes, it can be useful to illustrate the political economy difficulties of implementing tax reform with specific examples. The 1986 Bolivian tax reform can be a good topic for lecture material.

The Bolivian tax system, though nominally progressive, was in reality flat or even regressive, once tax evasion was accounted for. Bolivia illustrates one case in which the neoclassical prescriptions for tax reform were followed quite closely. This tax reform did help balance the budget and formed an integral part of a stabilization reform program. At the same time, it was accomplished under (politically) very unusual circumstances, and has left a legacy of some bitterness over its apparently regressive structure (though again perhaps not really more regressive in practice than before) that cast doubt on its long term sustainability.

◼ Discussion Topics •

The arguments in favor of privatizing SOEs are frequently discussed in the financial press. Students can make a list of these and discuss them in class. If possible students should research the experience of a specific country with reference to the political and economic climate behind privatization.

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•

A number of countries (e.g. Ecuador) have replaced the local currency with the U.S. dollar (dollarization). Students can research the reasons for adopting the dollar and the aftermath of dollarization for domestic inflation, tax revenue and evasion, and, generally, living standards.

◼

Sample Questions

Short Answer 1. Compare and contrast the workings of the organized and unorganized money markets in developing countries.

Answer: Discussed in the chapter, section 15.1.

2. What are some of the major characteristics of financial repression? To what degree may financial liberalization be expected to address the issue of inadequate saving?

Answer: Discussed in the chapter, section 15.4.

3. In what ways do the actual and potential roles of central banks differ between developed and developing countries?

Answer: Discussed in the chapter, section 15.2.

4. What is a development bank? What are some of the reasons they have not had greater success?

Answer: Discussed in the chapter, section 15.2.

5. Describe the costs and benefits of privatization of state-owned enterprises. In which cases would privatization seem most advisable?

Answer: Discussed in the chapter and in the included case study of Chile and Poland.

6. Does it matter how much a developing country saves? Explain why or why not. Discuss theories and evidence on whether developing countries can increase the net savings rate in the economy through public policy. In particular, consider whether this can be accomplished through increased or decreased taxation of one or more types, and increased or decreased government spending of one or more types.

Answer: Requirements for student answers will depend on what you have introduced in lecture.

7. What are the major market failures that imply a potential role for state intervention in financial markets?

Answer: Described in the section “Financial Policy and the Role of the State” in section 15.4.

8. What are the key elements that need to be considered in developing an optimal sequence of financial sector liberalization? Will the order differ across countries? Why or why not?

Answer: Depends on lecture coverage. See the lecture suggestions above.

9. Explain how group lending works.

Answer: Discussed in the chapter, 15.3.

10. How can joint liability lower the interest rate for micro borrowers.

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Answer: Discussed in the chapter in the section on Microfinance Institutions, section 15.3.

11. What is meant by the term dynamic incentives in the context of making loans to micro borrowers.

Answer: Discussed in the chapter in the section on Microfinance Institutions, section 15.3.

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12. Why are women considered to be more credit worthy for micro loans?

Answer: Discussed in the chapter in the section on Microfinance Institutions, section 15.3.

13. Why do NGOs target women borrowers while making micro loans?

Answer: Discussed in the chapter in the section on Microfinance Institutions, section 15.3.

14. Discuss the pros and cons of the recent introduction and expansion of stock markets in the developing countries.

Answer: Discussed in the chapter, section 15.4.

15. Compare and contrast the experience of Poland and Chile in their efforts at privatizing SOEs. Make sure you include a discussion of the background to the privatization, methods adopted and the outcomes of privatization in the two countries.

Answer: Discussed in box 15.3.

16. Explain how the Grameen bank has helped address the problem of poverty while minimizing the risk of default?

Answer: The case study on microfinance discusses the Grameen bank in detail.

◼ Multiple Choice 1. A development bank (a) accepts deposits from the poor. (b) makes loans for industry expansion. (c) is an agency such as the World Bank. (d) all of the above. (e) none of the above.

Answer: B 2. Among the rationales for state owned enterprises is (a) existence of monopoly. (b) the need for capital formation. (c) desirability of national control over strategic sectors of the economy. (d) all of the above. (e) none of the above.

Answer: D 3. Among the rationales for state owned enterprises is (a) that the private sector is inefficient. (b) that there is unemployment of capable managers. (c) desirability of national control over strategic sectors of the economy. (d) all of the above. (e) none of the above.

Answer: C .

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4. Among the benefits of privatization of state owned enterprises is (a) increased employment. (b) improved efficiency. (c) reduced pollution. (d) all of the above. (e) none of the above.

Answer: B 5. One of the characteristics of financial repression is (a) negative real interest rates. (b) lack of credit rationing. (c) capital flowing to the highest rate of return. (d) all of the above. (e) none of the above.

Answer: A 6. Currency substitution means (a) use of money instead of barter. (b) use of countertrade instead of money. (c) use of foreign exchange instead of domestic currency. (d) all of the above. (e) none of the above.

Answer: C 7. Macroeconomic stabilization involves (a) reduction of inflation. (b) reduction of government budget deficits. (c) reduction of trade deficits. (d) all of the above. (e) none of the above.

Answer: D 8. Which of the following is an objective of macroeconomic stabilization? (a) eliminating current account deficits. (b) controlling inflation. (c) restoring fiscal balance. (d) all of the above.

Answer: D

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9. When it comes to the composition of tax revenues from different sources, (a) developing countries derive the largest portion of their revenue from income taxes and developed countries from consumption taxes. (b) developing countries derive the largest portion of their revenue from consumption taxes and developed countries from income taxes. (c) both developing countries and developed countries derive the largest portion of their revenue from income taxes. (d) both developing countries and developed countries derive the largest portion of their revenue from consumption taxes.

Answer: B 10. In 1995–7, tax revenue as a percent of GDP (a) was roughly equal between developing and developed countries. (b) was a few percentage points higher for developed than for developing countries. (c) was a few percentage points lower for developed than for developing countries. (d) was much higher (approximately double) for developed countries than for developing countries. (e) was much higher (approximately double) for developing countries than for developed countries.

Answer: D

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Appendix Additional Exam Questions ◼

Exam Questions Part I

1. The change in GDP over time is the most common measure of growth and development. Discuss the pros and cons of this method. Is there an alternative way to decide which of two countries is more developed? Explain briefly.

2. You are given the assignment of comparing GDP between Country A and Country B. Suppose each country produces two goods. The following table lists the quantities produced and the prices in each country. The current exchange rate is ten pesos per dollar. Determine which country has a higher level of GDP in dollars, explaining clearly how you arrived at this conclusion. Discuss the validity of the method you chose.

Country A Food Housing

Country B

Price($)

Quantity

Price(pesos)

Quantity

4 8

20 40

40 50

10 25

3. List and explain four common barriers to growth among less developed countries. Do you think today’s developed countries had to overcome these same barriers in their earlier stage of economic development? Comment to the best of your knowledge.

4. What is the primary difference between economic growth and development? Is it possible to achieve one without the other? In your answer, use the examples of the two countries from the discussion in class to illustrate your point.

5. Explain the calculation of the indicator Human Development Index in detail? Give one pro and one con of this indicator.

6. What are the major differences between the new Human Development Indicator (HDI) and the original HDI? 7. In this question, you will compare the Lewis model and dependency theory. a. Discuss the main idea behind each theory, including an explanation of how growth occurs (or does not occur) in each case. b. Compare the validity of each theory; in other words, does each theory have important insights to offer into the development process?

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8. Prices of Big Macs in various countries have been used to illustrate purchasing power parity exchange rates between countries. a. Suppose the price of a Big Mac in Moscow is 11,000 rubles, and in the U.S., the price is $2.50.

What would be the purchasing-power-parity exchange rate according to Big Mac prices? b. Define purchasing-power-parity exchange rates and explain why Big Mac prices can provide an estimate. c. Your friend comes back from Moscow and says he received 5,800 rubles per dollar on the street near Red Square. How does this exchange rate compare to your answer in Part a? d. Suppose Russian GDP is 1,130 billion rubles in 1997, the price of a Big Mac is 11,000 rubles, the market exchange rate is 5,800 rubles per dollar, and the price of a Big Mac in the U.S. is $2.50.

Compare Russian GDP in dollars, using purchasing-power-parity and market exchange rates.

Why are the two estimates different? Which is more reliable? Explain.

9. For all their diversity, developing countries are linked by a range of common economic conditions/ problems. Mention and briefly explain four of these common problems. Use the example of one of the countries discussed in class to highlight these economic problems.

10. This is a four-part question: a. The Harrod-Domar model is part of the linear stages of growth theories. What are the three common features of these models as far as explaining how growth occurs? b. What is the source of growth according to the Harrod-Domar model? c. Is the Harrod-Domar model likely to be useful as an explanation of growth in developing countries? Why or why not? d. Explain why modern growth theory is preferable to the Harrod-Domar model as an explanation of economic growth.

11. Explain briefly why following the Lewis model may fail to lead to successful long-term development.

12. Explain what is meant by the term surplus labor. What is the significance of surplus labor in explaining growth in an economy described by the Lewis model?

13. The less developed countries today have an advantage over the developed countries because they have all of the past experiences of the developed countries to draw from. In other words, less developed countries can draw on the experiences of the developed countries and their technologies, and they too will reach a more developed state. Carefully discuss the validity of this statement.

14. The dominant characteristic of the Harrod-Domar model is also its ultimate flaw in terms of it being a useful model for planning or explaining economic growth in developing countries. Please explain.

15. True or False: economic development is equivalent to economic growth? Explain.

16. True or False: economic development is equivalent to industrialization? Explain.

17. True or False: it is more accurate to use the purchasing power parity method than it is to use the exchange rate method to compare GDP between different countries? Explain.

18. What is the main idea behind the international dependence model? Discuss whether you think this theory has any merit.

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Appendix

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Additional Exam Questions

131

Exam Questions Part II

1. True or False: LDCs that pursue capital-intensive growth can be expected to have lower values of income inequality as measured by the Gini coefficient? Explain.

2. Explain the apparent paradox that people having the most children can least afford them and those who can afford them most have the fewest number of children.

3. This is a four-part question relating to factor markets and unemployment in LDCs: a. If wages are perfectly flexible, then there will be no involuntary unemployment. True, False, Explain. b. Give three reasons why wages may not be perfectly flexible. c. In addition to wages, the price of capital may be distorted and not reflect its scarcity value.

List and explain two policies that can distort the price of capital. d. Why should factor prices reflect the scarcity value of labor and capital?

4. Certain growth strategies or patterns of growth may result in greater income inequality within the country. You are asked to advise on policies to increase economic growth while at the same time improve income inequality. What would you do to further both goals at the same time?

Discuss 2 to 3 options. You may pick a combination of policies that will address both goals.

5. In many countries, despite growth in GDP, surplus labor did not disappear, as predicted by the Lewis model, and was merely relocated. Please explain this statement. Hint: Think about the causes of unemployment.

6. Empirically, population growth slows as per capita income increases. Please explain why this is true.

7. Should developing countries attempt to limit population growth? Why or why not?

8. This is a three-part question: a. Subsidizing wages in the urban area, so that a firm receives a certain payment per worker hired, is a good policy if the goal is to decrease urban unemployment. Explain. b. Suppose the rural wage is 4, the urban wage is 10, and the probability of finding a job in the urban area is 50%. Will we observe positive levels of migration from the rural to the urban area?

Explain. c. Illustrate graphically what happens to the number of workers hired, the number of people unemployed, and the cost to the government of a wage subsidy, using a labor supply and demand graph. Please label your graph carefully. Assume the wage is initially above the equilibrium level.

9. How does a shift from emphasizing economic growth to economic development alter the choice of growth strategy? What sort of strategy may be pursued in each case? Hint: What does development include as an objective that growth does not? Comment on the pros and cons of each strategy.

10. Explain the relationship between the opportunity cost of time and population growth.

11. List three reasons why rural development is as important as industrial development in less developed countries. Include a brief explanation where appropriate.

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12. Name three often-pursued policies that distort factor prices. Though often adopted with well intentioned goals, these policies often have less favorable results in LDCs. Please explain.

13. Explain how population growth or migration can be viewed as a common property or open access resource problem. Is there a market failure in this case?

14. Why do the poorest countries tend to cause significant environmental damage?

15. What are the three major causes of environmental degradation in LDCs? How can DCs help LDCs prevent further environmental damage (think very carefully here with respect to offender)?

16. Subsidizing food prices for urban consumers is beneficial because firms can then pay lower wages.

Critically evaluate this statement.

17. Explain how population growth can be both a cause and an effect of underdevelopment.

18. What is meant by sustainable development? How could NNP measures reflect sustained development?

19. Why have poor nations invested so much money in higher education? Evaluate the soundness of this policy, sighting examples of countries from case studies covered in the course.

20. What are the primary objectives of Microfinance institutions such as the Grameen Bank, and how do they operate in contrast to traditional banks?

21. What is the Multidimensional Poverty Index and how is it a more improved measure of poverty?

22. What is the BRAC model? Evaluate its performance with respect to achieving the goals of economic development? How successfully can this model be replicated in other countries?

23. How can differences in earlier institutions and the policies pursued by nations play an important role in determining the development related outcomes for the nations? Use the examples of Haiti and Dominican Republic to illustrate your answer.

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Exam Questions Part III

1. Illustrate graphically and explain how a subsidy can be used to encourage the production of manufactured goods for export.

2. True or False: historically, a country pursuing an import substitution strategy will tend to maintain a relatively undervalued exchange rate because this will tend to encourage exports and discourage imports? Explain.

3. A less developed country’s success in emphasizing exports of primary products as a growth strategy depends on several demand factors and linkage effects. Please explain how these demand factors and linkage effects can contribute or fail to contribute to economic growth.

4. This is a three-part question: a. Briefly describe the import substitution strategy as a means towards economic growth. b. Briefly explain three limitations or reasons for failure of import substitution. c. With hindsight, could some action have been taken to reverse those limitations? Explain. .

Appendix

Additional Exam Questions

133

5. Suppose you are given the following information about the production of bananas and shoes in Country X and Country Y.

Labor days per ton of bananas Labor days per shoe

Country X

Country Y

2 8

3 9

a. What is the opportunity cost of producing bananas in each country, numerically and in words? b. Will trade take place, and if so, who exports what? c. Suppose Country Y has 270 days of labor available. Draw the production possibilities frontier.

Label your graph carefully. d. Compare a possible consumption point, pre-trade and post-trade, to illustrate the gains from trade. Include an explanation as to why, in general, countries gain from trade.

6. It is in the material interest of the DCs to help the LDCs improve their economic performance. Justify or oppose this statement and explain.

7. True or False: Country A can produce all products using less labor hours than Country B, so there is no advantage to Country A from engaging in trade with Country B? Explain.

8. Some of the most successful less developed countries have pursued both import substitution and export promotion at the same time. Explain why growth in the economy may tend to be highest when both strategies are followed at the same time. Does this present any challenges in terms of the policies adopted for each strategy? Explain. Mention briefly which policies may be adopted to promote each strategy.

9. Explain four reasons why the import substitution strategy may not lead to successful long-term economic growth in the economy. Note that you are not asked to explain the strategy itself except where it helps you to explain the limitations of the strategy.

10. Why are linkages emphasized as part of a successful industrialization strategy? Discuss briefly in terms of the primary product export strategy, the import substitution strategy, and the export promotion strategy. Hint: What role do linkages play in the success of these three strategies?

11. Many less developed countries have, in the past, simultaneously imposed tariffs on manufactured goods and maintained an overvalued exchange rate. Explain the logic and apparent contradiction in enacting both policies together.

12. True or False: producers and consumers are indifferent between a tariff and subsidy protection to producers? Explain.

13. Why is it optimal for a country to specialize in the production of those goods that use its most abundant factor?

14. Explain “export promotion policies” and “import substitution policies” with examples of countries that successfully or unsuccessfully pursued these policies. Why was one policy successful but not the other? In your opinion, could all LDCs possibly thrive had they followed the successful strategy between the two? Why or why not?

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15. The global financial crisis has impacted almost all nations of the world, some more adversely than others. Why are many economists concerned about the recovery from the global financial crisis?

16. In the past several decades the world had witnessed several armed conflicts. What are the primary reasons for armed conflict in developing countries and what factors increases the risks of such conflicts?

17. East Asia is often cited as a shining example of development done right. How did active government industrialization strategy and industrial policies, including the collaboration can between private and public sectors contribute to its success?

18. In your opinion, what are the three most serious obstacles to development faced by most LDCs in the 21st century? Explain.

19. In your opinion, what are the three most serious socioeconomic problems faced by a majority of developing nations in the 21st century? Explain.

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