Chapter 35: Development Economics

11© 2014 by McGraw-Hill Education Chapter 35 Development Economics 2© 2014 by McGraw-Hill Education • What the capabilities approach is to development economics. • What relationship exists between economic growth and economic development. • How education and health improvements promote human capital development. • Why institutions, good governance, industrial policy, and clusters in development are important. • How migration and remittances promote development. • What the arguments are for and against foreign aid. • What role impact evaluation and randomized controlled trials play in measuring program impact. What will you learn in this chapter? 3© 2014 by McGraw-Hill Education • The capabilities approach provides a framework for thinking about poverty, inequality, and human development. – A capability is something a person is able to be or do. – The approach looks to improve what individuals can be and can do. – Institutional and market failures restrict what people can do. – In contrast, economic growth primarily focuses on expanding the economy. The capabilities approach 24© 2014 by McGraw-Hill Education • GDP growth does not necessarily improve the standard of living for everyone in a country. • Policy mechanisms are crucial to translating higher average incomes into improved capabilities for the poorest citizens. • There are many reasons to believe that economic development leads to economic growth. The capabilities approach 5© 2014 by McGraw-Hill Education • There are basic aspects to economic development: • Policies can be categorized in two ways: 1. Some policies put in place the conditions for economic growth. 2. Some policies translate economic growth into greater capabilities for people in a society. The basics of development economics Human Capital Migration Investment Trade 6© 2014 by McGraw-Hill Education • Health care facilities don’t exist in many parts of the world. • Even where clinics exist, many people don’t use them. • National health care programs are not as effective as they could be. The basics of development economics Health Education • Educated workers are generally more productive. • Families living on a few dollars per day often cannot afford school fees. • There is a tradeoff between the quantity and quality of education provided. Improvements to health and education can develop human capital. 37© 2014 by McGraw-Hill Education People who live in countries with higher average incomes generally live longer lives. The basics of development economics Life expectancy (years) GDP per capita (logarithmic scale) 40 45 50 55 60 65 70 75 80 85 90 $100 $1,000 $10,000 $100,000 Mexico South Africa Brazil United States Japan Nigeria Vietnam Liberia 8© 2014 by McGraw-Hill Education Using the figure below, is higher GDP per capita necessary for longer life expectancy? Active Learning: Correlation and causation Life expectancy (years) GDP per capita (logarithmic scale) 40 45 50 55 60 65 70 75 80 85 90 $100 $1,000 $10,000 $100,000 Mexico South Africa Brazil United States Japan Nigeria Vietnam Liberia 9© 2014 by McGraw-Hill Education • Good governance is also crucially important in economic development. • Many basic capabilities rely on having a competent, well-intentioned government and good institutions. – Institutions are humanly-devised constraints that shape human interactions. • Most development economists agree that the most basic and important task of any government is to create a stable political system. – This includes maintaining enforceable property rights and the rule of law. The basics of development economics 410© 2014 by McGraw-Hill Education • Investment is a key concern in promoting growth. • Development economists debate what the best way is for developing countries’ governments to handle flows of capital. • Industrial policy manages these flows and has two traditional tactics: • As governments consider how to develop their industrial sectors, they often choose to focus on promoting not just one industry but clusters. – Clusters are networks of independent firms, universities, and businesses that focus on the production of a specific type of good. The basics of development economics Import substitution Export-led growth 11© 2014 by McGraw-Hill Education • By opening up to foreign markets, countries can gain access to new, cheaper goods and find new customers for their products. – Countries benefit when they produce the good for which they have the comparative advantage. • The World Trade Organization (WTO) monitors and enforces trade agreements and promotes international free trade. The basics of development economics 12© 2014 by McGraw-Hill Education • The prospect of a better life drives people to move away from home in search of opportunities. • It is difficult to legally move into a high-income country. – The influx of immigrants can be a highly controversial issue. – From the perspective of countries of origin, it provides opportunities to promote development. The basics of development economics 513© 2014 by McGraw-Hill Education Remittances have grown substantially. The basics of development economics 0 In di a C hi na M ex ic o Ph ili pp in es Fr an ce G er m an y B an gl ad es h B el gu im Sp ai n N ig er ia 10 20 30 40 50 60 Billions of 2010 U.S. dollars 14© 2014 by McGraw-Hill Education • Foreign aid has long been seen as part of economic development. • Taxes and private donations in many countries provide aid to the poor around the world. • These donations can be very important, from providing necessities to funding investments. • The problem is how to make sure these funds are put to the best use. What can aid do? 15© 2014 by McGraw-Hill Education • Foreign aid started in the wake of WWII, when the U.S. distributed $12 billion to help European countries rebuild. • The 1947 Truman Doctrine pledged $650 million to spread development. • In 2002, at the Monterrey Conference on Financing for Development, the leaders of the world’s most industrialized countries reaffirmed to pledge 0.7 percent of their gross national income. • Foreign aid continues and is largely dedicated towards building public goods. – The financing gap is the difference between the savings rate and the amount of investment needed for sustainable growth in a country. What can aid do? 616© 2014 by McGraw-Hill Education Over the past 50 years, the amount given in aid has increased in dollar terms, but has fallen in terms of aid as a share of GDP. What can aid do? 0 0.1 0.2 0.3 0.4 0.5 0.6 0 20,000 40,000 60,000 80,000 100,000 120,000 140,000 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Constant 2009 dollars % of GNI Billions of constant 2009 U.S. dollars % of total GNI Official development assistance 17© 2014 by McGraw-Hill Education • Proponents of foreign aid argue that it can help countries break out of the poverty trap. – A poverty trap is a self-reinforcing mechanism that causes the poor to stay poor. • Foreign aid can be used to break the negative self-reinforcing mechanisms. – Can help create positive economic growth and development cycles. What can aid do? 18© 2014 by McGraw-Hill Education • Many governments channel foreign aid through national development agencies. • The World Bank is a multinational organization that provides financial and technical assistance to developing countries. • The United Nations Development Program (UNDP) is a global UN network that provides knowledge and resources to developing countries. What can aid do? 719© 2014 by McGraw-Hill Education • Not everyone supports sending billions of dollars into poor countries. • Historically, some aid has been inefficient and even counterproductive. • Not all aid results in growth and/or development in the receiving country. – Some argue that aid can hurt countries that receive it. What can aid do? 20© 2014 by McGraw-Hill Education • A group of private investors and institutions is supporting this new breed of socially-minded businesses through impact investing. – Impact investing is when firms invest money to generate both financial and social returns. – These firms are called social businesses. • Impact investors want their money to be a part of creating social change. • They are willing to be patient, take greater risks, and accept lower financial returns. What can aid do? 21© 2014 by McGraw-Hill Education • Impact evaluations assess how a program or policy changes lives relative to how they would have changed without it. • Randomized controlled trials (RCT) randomly assign subjects into control and treatment groups to assess the causal effect of intervention on an outcome. – This makes it so any factor other than the intervention should affect both groups equally. What can aid do? 822© 2014 by McGraw-Hill Education RTCs allow policy-makers and program managers to more confidently channel resources to their best use. What can aid do? 20.70 13.90 0.71 0.27 0.03 0 5 10 15 20 25 Information on returns Deworming School uniforms Scholarships Progresa Years in extra schooling per $100 spent Impact of programs intended to increase years of education 23© 2014 by McGraw-Hill Education • Development is a field of economics that studies international poverty. • The capabilities approach is one way to think about development. • The ideas of economic growth and development are similar but not identical. • There is general agreement that economic growth will spark economic development. Summary 24© 2014 by McGraw-Hill Education • Access to more and better schools and health care can develop human capital. • Efforts to improve education and health in countries must be of high quality to be effective. • Human capital is important for economic development because it allows more productive workers and greater economic growth. Summary 925© 2014 by McGraw-Hill Education • Development is most likely in places where there are strong institutions. • Institutions are human-devised constraints that shape human interactions. – Strong property rights, rule of law, and a government capable of implementing good policy are important for development. • Governments implement industrial policy in an attempt to favor certain industries. Summary 26© 2014 by McGraw-Hill Education • The main industrial policies are import substitution, export-led industrialization, and clustering. • Every year, millions of people leave their own country to migrate for better-paying jobs. • Foreign aid does not always promote growth and development. • Impact evaluations and randomized controlled trials can measure how policies change lives. Summary