University of Wisconsin-Madison
Department of Agricultural and Applied Economics
Development Economics Preliminary Examination
January 25-29, 2010
Answer any two of the following four questions. All questions have equal weight. Submit your answers to Ian Coxhead, 413 Taylor Hall (or coxhead@wisc.edu
) by 5pm on Friday, Jan. 29.
1.
The Gates Foundation asks you to propose a project to reduce the total number of households in Paraguay with income per household-member below one dollar a day. You (amazingly!) have panel data on demographic characteristics of the people and the households’ income and expenditures. You are given a budget to work with and are told that you can make targeted (non-negative) transfers to households. a.
What is your (most simple) proposal? Specify a rule indicating how much money should be given to each household based on data regarding household size and income. b.
You have heard that the Gates Foundation is going to show your proposal to a board of expert reviewers including Anthony Atkinson, Michael Carter, Garance Genicot,
Dean Karlan, Shelly Lundberg, James Robinson, and Robert Townsend. Summarize what you expect at least four of these reviewers’ objections to be. c.
Suggest modifications to your proposal that would address the four (or more) objections you described in part (b). d.
Of course, you may not be able (or want) to implement each of these modifications.
Design a modified proposal that you find the most satisfying and discuss why you have chosen that design as your final proposal. e.
At the same time that you would like to help both the Gates Foundation, and the people of Paraguay, you would also like to help your own academic career. The Gates
Foundation does not want to carry out a randomized experiment. Still, you are sure that there will be some ‘natural experiment’ to emerge when your proposal is implemented. You would like to take advantage of that to write a nifty empirical paper on poverty alleviation. Discuss a natural experiment that might arise, the question you could use it to answer, and the empirical identification strategy you would use to test your hypothesis. Try to think of the objections that other economists might come up with to your identification strategy and give rebuttals to them.

2.
Some recent empirical growth models suggest that geography is a major determinant of economic growth. This question invites you to explore microfoundations for this empirical finding, and to consider their policy implications.
To begin, assume that expected income for individual i in period t is given by: f ( k it
)




( k
( k it it
)
)

L

H if agent chooses low technology

E otherwise
, where k it
is the individual’s accumulated capital stock,

H
 
L
and E>0 are the fixed costs
 the following relation: k it

1
  it
( k it
( 1
 
)

I it
) , where

is the depreciation rate and I it
is new investment. The random asset shock variable
 it can be decomposed as follows:
 it
  t
  it
, where
 t
is a common community (covariant) shock and
 it is a purely idiosyncratic shock.
For purposes of this question, assume that different geographies are characterized by different variances of
 t
: In an Asian irrigated rice economy, Var (
 t
)

0 ; whereas in an
African rainfed economy Var (
 t
)

Var (
 it
)

0 . a) Assume first that agents operate in autarkic isolation. Drawing on the literature, what do we know about the course of micro level growth and development? Will agents reach the higher level of income afforded by the high technology? How will growth and development differ between the Asian irrigated economy and the African rainfed economy? In answering this question, you should write down an explicit model, but you should (probably) not try to solve it. Do draw on the literature to help justify your conclusions. b) Suppose now that individuals within a locale can contract with each other to share risk. What happens now to the patterns of growth and development in the two prototypical economies (irrigated and rainfed)? Please be explicit about the nature and the form of the risk sharing that you have in mind. c) Is geography fate? In other words, are there market or other instruments that can be used to foster convergence between the two regions?
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3.
From mid-2008 to mid-2009 the global financial crisis (GFC) induced a recession in which the value of world trade fell by over 20%. For the typical developing economy, with a trade:GDP ratio of about 75%, this represented a substantial drop in net exports and income
(of course, China, India and some other large developing economies have had atypical experiences, with continued high growth rates despite the global downturn). a.
Making (and stating) appropriate simplifying assumptions, construct a model to illustrate the main impacts of the global crisis on a typical developing economy. Describe the likely real effects of the global economic crisis: on the structure of production, domestic prices, and employment. b.
Use the model to identify the set of economic channels through which the GFC is expected to impact on household-level incomes and poverty in this economy. Briefly describe each one, using the model to illustrate its operation. c.
Now focus on just one of these channels, the factor market. Use the Stolper-Samuelson theorem plus additional theory as needed to analyze distributional effects of the shock.
For an external shock of given size, what are the main parameters governing its factor market impact on household welfare? What do the values of these parameters reflect about the structure and operation of factor markets? Briefly discuss the interactions between external shocks and imperfect operation of such markets. d.
In normal times, many developing countries pursue some form of exchange rate peg (or fixed exchange rate) as a means to promote trade and inward investment by reducing uncertainty about rates of return on international transactions. After a negative trade shock, however, there is a trade deficit, and defending the fixed exchange rate requires a policy intervention. In practice, this often takes the form of a rise in the domestic real interest rate. But enacting a domestic stimulus package in response to recession requires lowering the real interest rate.
If the goal of the developing country government is to minimize the impact of the GFC on poverty, what should it do: focus on domestic stabilization with low interest rates, or target exchange rate stability, possibly with higher rates? Retaining the focus on the real economy, use the model to work through the poverty implications of each alternative.
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