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Economic development

IDEC 8022 –Economic Development
Pareto efficiency
•Coined by Vilfredo Pareto (1848-1923), Italian economist/engineer/sociologist.
•Resource allocation is Pareto-efficient if there does not exist another allocation in which at least
one person is better off and nobody is worse-off.
•Recall the growth-development nexus where growth is necessary but not sufficient for
development. Growth is necessary to enable redistribution policy without worsening-off a part of
a society.
•Pareto efficiency does not require a totally equitable distribution of wealth. An economy in
which a wealthy few hold the vast majority of resources can be Pareto efficient.
•A simple example is the distribution of a pie among three people. The most equitable
distribution would assign one third to each person.
•However the assignment of, say, a half section to each of two individuals and none to the third
is also Pareto optimal despite not being equitable, because none of the recipients could be made
better off without decreasing someone else's share; and there are many other such distribution
•An example of a Pareto inefficient distribution of the pie would be allocation of a quarter of the
pie to each of the three, with the remainder discarded.
The big push model
•Advocated by Paul Rosenstein-Rodanin 1945
•The model postulates that underdeveloped countries need significant amounts of investments to
commence on the track of economic development from their current state of backwardness
•"There is a minimum level of resources that must be devoted to... a development programmeif it
is to have any chance of success. Launching a country into self-sustaining growth is a little like
getting an airplane off the ground. There is a critical ground speed which must be passed before
the craft can become airborne....“Notes on the theory of the Big Push", in Howard S. Ellis (ed.)
for Latin America, Macmillan & Co., 1961
•The role of government / state in this theory is important by investing in social capital (such as
power, transport, communication, security, health & education) that is lumpy and has long
gestation periods, and not attractive for the private sector.
•Criticisms: inconsistency with facts (growth experiences), shortage of resources of in
underdeveloping countries, difficulties in execution and implementation.
Forward and backward linkage
•Sectors in the economy are interlinked to one another and their direct and indirect interaction
are depicted in an input-output table where changes in one sector affect or affected by other
•Two forms of intersectoral linkages:
•Backward linkages: a given industry/sector uses products and intermediate inputs of some other
•Forward linkages : a given industry/sector supply intermediate inputs to some other
Terms of tradeNet barter terms of trade
Income terms of trade
•An index of the price ratio between exports and imports of a country
•NBTT = (Pexport/Pimport) x 100
•Usually represented using index number (base year = 100)
•An index of the value of ex
measure import-purchasing p
•Also called the capacity of
•ITT = NBTT * QX= (PX* Q
•A rise in the ITT implies th
its exports
•A country’s ITT may impro
constant, a fall in export pric
of exports
Growth convergence
•When low-income countries catch-up with high-income countries.
•Unconditional convergence: growth rate is entirely determined by the initial level of
•Test: simple bivariate analysis, cross section comparison
•A negative sign of the regression coefficient indicates convergence
•Conditional convergence: the initial level of development is a significant determinant of growth
only when controlling for the other relevant determinants of growth
•Test: regression of average growth rate on initial level of income, controlling for other variables
affecting growth/steady state
•Club of convergence: OECD countries, the US states, the Swedish counties, the Japanese
prefectures, Canadian provinces, Australian states
Middle-Income Trap
•A situation of a country that remains stuck in middle-income levels, failing to move up to a
high-income economy.
•Many countries have managed to move up from low-income to middle-income economies, but
only few continues their transitions toward high-income economies (eg: Asian Tigers: Japan,
Singapore, Taiwan, South Korea, China)
•Problem and challenges facing developing countries in their effort to accelerate/maintain their
growth rate become harder as the level of income increases .
•Whether a country is stuck in the middle-income level because of factors beyond its control (‘a
natural phenomenon) or due to domestic policy failures is a subject of debate.
•Countries’ failure to adopt growth strategies to suit their resource endowment and initial
•Try to leapfrog to “knowledge economies” without necessary supports: institutions, human
capital, and financial capital.
•Try to sustain labour-intensive manufacturing export-led growth while wages increasing
•Empirical: many countries are within middle-income cluster, depends on the measure being
•Absolute measures (a certain level of income threshold)
•Relative measures (compared with the level of income of a certain country)
•The absence of convergence to a benchmark advanced country (US)
•Plot pc GDP relative to US in 1960 against the same relative income in 2008 .
Source: Gill, I.S. and H. Kharas, 2015. “The middle-income trap turns ten”. Policy Research
Working Paper 7403, World Bank Group, August 2015.
Washington Consensus
•A term first used by John Williamson (1989) to label the standard reform package generally
accepted by the Washington based institutions –the World Bank, IMF, and the US Treasury –to
foster economic growth in developing countries (Latin America).
•3 broad areas of reform: macro stability, liberalization, privatization
•10 components of policy recommendation:
•(1) fiscal discipline,
•(2) reordering public expenditure / cutting subsidies,
•(3) tax reform,
•(4) liberalization of interest rates,
•(5) competitive exchange rates,
•(6) trade liberalization,
•(7) liberalization of FDI,
•(8) privatization,
•(9) deregulation,
•(10) secure property rights.
Growth Diagnostic (GD)
•GD is an alternative approach to reform aiming at accelerating economic growth, focusing on
short run and targeted reform (as opposed to broad based reform).
•Using a decision tree method to trace a country’s current most binding constraint to growth.
•A constraint that if tackled will result in significant direct effects
•Identifying price signals as well as non-price signals
•Advantage: provide a tool to recognize countries’ specific problem.
Criticisms to GD
•It is more art than science, heavily relying on analysts’ knowledge on the country of interest
•Relevant for igniting growth in stagnant/slow-growing economies
•Only focus on short-run constraints
•Assuming each branch operates independently