Why is Economic Development
so Difficult?
[2 – June 12 2003]
Review
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Many conceptions of human development
– Roosevelt: four freedoms
– Sen: sustenance, self-esteem, freedom
– Stiglitz: transformation of society
– HDI: life expectancy, literacy,
enrollment, GDP per capita (PPP$)
Economic Growth correlates with human
development, and in particular
Growth helps the poor
– 1% in overall GDP per capita =
1% in GDP per capita for poorest 20%
Great Structural Diversity
among
Developing Economies
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Size and income level
Historical background
Physical and human
resources
Ethnic and religious
composition
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Relative importance of
public and private
sectors
Industrial structure
External dependence
Political structure,
power, and interest
groups
But, they face Common
Challenges:
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Extremely Low per capita GDP
Low or negative GDP growth over time
Growing disparity between richest and
poorest countries
Sructural Challenges:
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High dependence on agriculture and primary
product exports
Rapid rural-urban migration
Low levels of productivity
High rates of population growth and
dependency burdens
Basic Structure of Economies:
Africa vs. Asia vs. U.S.:
100%
80%
60%
40%
20%
0%
Africa
agriculture
Asia
industry
U.S.
services / other
Deeper Economic Challenges
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Macroeconomic:
– High inflation
– Black markets for foreign
exchange
– Trade barriers imposed by rich
countries
– External debt (?)
Deeper Economic Challenges
Microeconomic: imperfect or missing
markets
– Markets for borrowing, saving,
and investing (credit and
financial markets)
– Markets for spreading risk
(insurance markets)
Deeper Economic Challenges:
Imperfect Information
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Markets work well when buyers and sellers
have good information
Markets fail or don’t exist when buyers or
sellers (or both) have poor information
Poor information is not the same as “little
information” (recall our auction)
Markets can work poorly when buyers have
information but sellers do not, or vice
versa – asymmetric information
Imperfect Information: Example
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Lenders do not know if farmer is good
credit risk……
Farmers have no collateral (the developed
countries solution to this problem)
Hence, farmer cannot get loan to buy land,
Hence, farmer must somehow rent the
land….perhaps by sharecropping
Which does not give farmer full marginal
benefit of his labor – “inefficient”
Without Credit and Insurance:
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People live “on the economic edge”
A small shock can mean ruin:
– Illness  can’t work, no income
– [no unemployment, no insurance]
– Sell assets for medicine, food
– [What assets???]
– Future productivity drops
Social Challenges: Missing
Institutions
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A market economy needs:
– Security, peace
– Justice system to enforce contracts
– Financial system:
• To collect funds from savers
• Allocate credit to borrowers
• Stable currency
– Transaction information (what am I
buying?)
– Effective, fair, government
What about Science and
Technology?
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We will see that technological progress is
the only real source of long-run growth
Technology is already here…..
Why can’t LDCs take advantage of past
(and current) discoveries?
Sachs’ “Quadruple Bind”
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1) Innovation responds to demand.
Demand comes from rich countries
2) Innovation requires critical mass
of science. Poor countries have no
critical mass
3) Existing knowledge applies to
temperate zones
4) climate change limits world growth (shakier argument)
Looking Ahead: The Quest for Growth
(in per capita GDP)
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Does Aid for Investment for Machines
cause growth?
Does Education for Skills cause growth?
(Does controlling population cause growth?)
Does reducing debt cause growth?
What is a poverty trap?
How can people escape from poverty traps?
How can policy and institutions be improved
to help people escape from poverty traps?