EC336 Economic Development in a Global Perspective

EC336Economic Development in a Global Perspective Abhishek chakravarty 2013-14 Revision Lecture

Lecture 1 – Poverty and Economic Development • Amartya Sen’s “capabilities” approach: • Encapsulates the human goals of development to which income is a means, rather than the end in itself. • Sen argues that poverty should be measured in terms of what a person can do with the commodities that are available to him. What a person does with the commodities available to him are defined by Sen as “functionings”. The set of valued functionings for individuals can be elementary, such as being well nourished, or more complex, such as gaining respect in society. • Sen then defines capabilities as “the freedom that a person has in terms of his choice of functionings, given his personal features and his command over commodities.” • Five sources of disparity between income and its actual advantages: Personal heterogeneities (age, gender etc.), Environmental diversities (clothing requirements in heat or cold etc.), Variation in Social Climate (crime rate, social capital), Within-family income distribution, Differences in relational perspectives (conventions may mean people cannot achieve basic functionings despite high incomes. E.g. Wearing the right clothing to avoid shame in public.)

Lecture 1 – Poverty and Economic Development • Millennium Development Goals: • 1. Eradicate extreme poverty and hunger, 2. Achieve universal primary education, 3. Promote gender equality and empower women, 4. Reduce child mortality, 5. Improve maternal health, 6. Combat HIV/AIDS, Malaria, and other diseases, 7. Ensure environmental sustainability, 8. Develop a global partnership for development. • Each MDG is assigned specific targets that are deemed achievable by 2015 based on past achievements. There is also a lot regional disparity in success, with East Asia doing far better than Sub-Saharan Africa for example. Things have been made worse by a food price spike in 2008 and the global recession. • According to current trends, the reduction in under-5 child mortality rate will be a quarter rather than the targeted two thirds. Universal primary school enrolment is also unlikely to be achieved, largely due to lack of progress in Sub-Saharan Africa. In terms of halving poverty, the UNDP estimates that the gap between the current trend and the target represents approximately 380 million people still living on less than $1 per day in 2015.

Lecture 1 – Poverty and Economic Development • Indicators of development: • Real per capita GNI is difficult to compare between countries, because official exchange rates used to convert different currencies into dollars do not account for relative domestic purchasing power of these currencies. This is important because non-tradeable goods are generally cheaper in developing countries due to lower wages, and exchange rates are calculated from traded goods. • Purchasing Power Parity (PPP) is used instead of exchange rates. It is defined as the amount of local currency required to buy the quantity of goods and services in a country’s local market that $1would buy in the United States.This closes the gap somewhat between developed and developing country per capita GNI. • The Human Development Index (HDI) is the widely used measure of comparative socioeconomic development between countries. The HDI ranks countries from a scale of 0 to 1 based on three development goals: 1. Longevity, 2. Knowledge, 3. Standard of Living. The New Human Development Index (NHDI) was introduced by the UNDP in 2010, making 8 changes to the original HDI calculation. The most important change was using the harmonic mean instead of the arithmetic mean of the three development indicators.

Lecture 2 – Poverty and Economic Development • Globalisation and Growth: • Early phase of rapid globalisation between 1820 and 1914 created high levels of global integration driven by the advent of steam shipping and an Anglo-French trade agreement. The start of WW I until the end of WW II saw protectionism and restricted migration. But economies re-integrated in the post-war period up to 1980 with increased trade liberalisation under GATT. The current wave of globalisation began in 1978 with Chinese economic reforms. Several other developing countries also shifted to outward-oriented regimes. • There have been large increases in trade-GDP ratios for several major developing economies since 1978. The nature of exports from developing countries has also shifted overwhelmingly towards manufactures, away from primary products and natural resources. Since the late 1980s, growth in developing countries has also accelerated rapidly beyond that of developed countries. • Is it globalisation that increased growth rates? India and China clearly benefited. Amongst developing countries, the globalisers grew much faster than the non-globalisers. Firm-level studies also show that with more trade-openness, high cost producers exit the market more due to higher competition, increasing productivity in the economy. Hence the evidence in favour is strong.

Lecture 2 – Poverty and Economic Development • Globalisation and Poverty: • From 1981 to 2001, the number of people in the world living on less than $1 a day declined by about 375 million individuals, from 1.5 billion to 1.1 billion. Such a decline has never happened in human history. However it is unclear whether globalisation is responsible, or if other factors are at work. Also relative poverty as defined under the capabilities approach may have increased over this period. • Globalisation and Inequality: • International inequality in per capita income between countries has risen when each country is treated as a single observation. However when country per capita income is weighted by population to account for numbers of individuals, income inequality actually declines. Vertical income inequality is the usual focus when analysing globalisation impacts on inequality. However globalisation can differentially affect people with the same mean income, thus creating horizontal inequality. Relative inequality has been more or less unaffected by growth in the latest phase of globalisation, but absolute inequality has grown considerably. • Basu (2006) – Theory suggests we should have globally coordinated policy to prevent higher inequality with more economic integration.

Lecture 3 – International Trade • Neoclassical Theories of Trade: • The most basic neoclassical model of international trade is Ricardo’s theory of comparative advantage, which states that countries should specialise in the production of goods in which they have a relative cost advantage. • Ricardo’s model was developed further into the Hecksher-Ohlin factor endowments trade model to account for differences in stocks of labour and capital across countries. The gains from trade in the Hecksher-Ohlin theory arise from differing factor prices due to different stocks of labour and capital across countries. • Neoclassical trade theory does not fit well with the real world experience of developing countries, because the following main assumptions of the theory are untrue for these countries: 1. Productive resources are fixed in quantity and quality, and fully employed. 2. The technology of production is fixed and freely available globally; the spread of technology benefits all. Consumer tastes are also fixed independent of producer influence. 3. Within countries, factors of production can be transferred between productive activities without a high cost, and perfect competition prevails. 4. The national government plays no role in international economic relations. 5. Trade is balanced for each country at any time, and countries can adjust to changes in international prices with minimum dislocation. 6. The gains from trade that accrue to any country benefit the nationals of that country.

Lecture 4 – International Trade • Export Promotion vs Import Substitution: • First-stage IS involves substituting domestic production for imported simple consumer goods using the protection of tariff barriers and import quotas to develop infant industries. Second-stage IS involves diversifying domestic production into more complex manufacturing goods using the same tariff and quota protection. • However in practice protected industries get inefficient and costly due to lack of competition. Foreign firms often benefit more by locating behind tariff barriers. Subsidization of imports of capital goods shifts industrialization towards capital-intensive production and contributes to BOP problems. Overvalued exchange rates hurt exports. Self-reliant integrated industrialization is not stimulated due to reliance on imported capital goods rather than backward linkages in domestic industry. The East Asian countries are exceptions, having used IS effectively to build up local industries and later orient outward. • Arguments for export orientation include market failures in transfer of innovations, because individual firms import less than the social optimum of superior technologies if their competitors also benefit. Also there are gains from coordinated sector-wide policy for industrialisation, learning by doing spillovers, concrete and manageable export targets, and potential growth increases from producing a mix of high-income goods.

Lecture 4 – International Trade • WTO Doha Round: • Rich-nation economic and commercial policies matter for developing countries. But despite 8 liberalization rounds over 50 years under GATT and then the WTO, trade barriers remain in place in agriculture; and, through various mechanisms, to a degree in other sectors. Doha Development Round of WTO talks begun in 2001 tilted the nominal focus to needs of developing world; but talks remained stalled through the end of 2010. • Tariffs on agricultural products were addressed directly, as these products are seen as the main exports of developing countries. The formula proposed in July 2004 proposed tiered cuts in tariffs to account for high peak in developed countries. Subsidies were classified into three different types in the 1995 Uruguay Round: Clearly trade-distorting - Amber box, Potentially distorting, but intended to limit production – Blue box, Little or not distorting – Green box. The proposal advocates that all Amber and Blue box subsidies be reduced by 20% and calls for an end to all export subsidies, except those by least developed countries. Domestic subsidies to agriculture are to be reduced to a maximum capped level. • Panagariya’s six fallacies make the case that developed country policies are not the most important factor in preventing gains from trade to developing countries.

Lecture 5 – International Debt, Financial Crisis, and Foreign Aid • 1980s Debt Crisis: • In 1974-79 there was a large increase in international lending to developing countries, fueled by high oil prices that increased OPEC oil export earnings. The OPEC countries deposited these earnings in developed country commercial banks, who loaned the money to Latin American and other fast-growing developing countries. The level of debt to developing countries more than doubled, and the proportion of debt on shorter and riskier terms also increased sharply. • A second oil price shock in 1979 drove up oil import bills and made industrial good imports more expensive. There was also a decline in export earnings due to slowed growth in developed countries and a decline in the terms of trade for primary product exports. Interest rates increased due to restrictive monetary policy in developed countries and the interest rate hikes were passed on by developed country banks to developing countries in their debt servicing charges. There was also large-scale capital flight from debtor countries. • 1980 onwards saw widespread adoption of IMF stabilisation policies, and loan restructuring agreements such as the Paris club deal, Brady plan, debt for equity swaps etc.

Lecture 5 – International Debt, Financial Crisis, and Foreign Aid • 2008 Debt Crisis: • Main causes are deregulation of rules in the US that separated commercial and investment banking, no regulation of new financial instruments, public policy encouraging home ownership through subprime lending, support of subprime lending via implicit government guarantees on enterprises such as Freddie Mac and Fannie Mae, repackaging and reselling of subprime debt internationally as securities whose risk was purposely and systematically undervalued. China and the East Asian countries deposited their export earnings in developed country banks, providing cheap capital to fuel the housing bubble. • The outsize share of the US in world imports means the global recovery depends heavily on US growth and correction of US trade imbalances. Developing countries faced a drop in export values of 31% in 2009, compared to a 23% average drop worldwide. A declining US dollar could also mean lower export growth in the future. Foreign investment inflows declined by 27% in developing countries in 2009 after six years of uninterrupted growth, but this was still less than the 44% decline in developed countries. Developing countries such as China and India have an important role to play in the recovery, as developed countries are facing tight credit constraints, high sovereign debt, and various factors that limit their demand for imports.

Lecture 6 – International Debt, Financial Crisis, and Foreign Aid • Foreign Aid: • Foreign aid was institutionalised in the 1940s after the World War II with the Marshall and the creation of IMF, WB, UN etc. to provide multilateral assistance. After the reconstruction of Europe, attention turned to developing nations. During the 1960s aid was seen as necessary for supplementing domestic savings to increase investment and capital accumulation. However the evidence shows that although aid may raise savings and contribute to investment, not all of the aid money materialises into investment and growth. • Alesina and Dollar (2000) find that the allocation of foreign aid follows political and strategic considerations much more than economic needs and policy performance of the recipient. In particular, they find that colonial past and political alliances are main determinants of foreign aid allocation. Nordic countries give aid much more on the basis of income levels and good policies, whereas many countries with former colonies give aid to maintain political alliances. • Burnside and Dollar (2000) find that foreign aid can accelerate growth but institutional and policy distortions can lower the return to capital. Therefore, the impact of aid is greater in low distortion environment. A good policy environment is defined as having trade openness, a budget surplus, and low inflation.

Lecture 7 – Institutions • Institutions: • Differences in geography and differences in institutions are two competing explanations for why there are such large cross-country differences in income and development. The poorest countries in the world are largely located near the equator, suggesting that tropical climate (hot weather, torrential rain, and disease) is bad for productivity and growth. History however provides a natural experiment via the colonisation of many developing countries by European powers that changed the institutions prevailing in these countries, but did not change the geography. • At on extreme were very extractive institutions such as the slave trade in the Belgian Congo and forced labour in the Caribbean. At the other extreme, colonies such as New Zealand, Australia, and the US where Europeans settled benefited from institutions modeled on those Europe that protected private property. Evidence shows that instead of persistence in economic prosperity as predicted by the geography hypothesis, there is a remarkable reversal of fortunes among countries that were colonised. This evidence strongly favours the importance of institutions over that of geography.

Lecture 7 – Institutions • Jensen and Oster (2009): • Jensen and Oster (2009) studies the impact of the introduction of cable television in rural areas in India on measures of female autonomy and fertility behaviour. The basis for the study is that television greatly increases the availability of information about life in the outside world, especially in remote rural villages. Villages adding cable is associated with a 12 percentage-point decrease in the reported preference for the next child to be a boy, and a 0.16 decrease in the number of situations in which it is considered acceptable for a man to beat his wife. • Kudamatsu (2011) • Kudamatsu investigates whether the political institution of democracy promotes development in 28 African countries, where the chosen indicator of development in infant mortality. He finds that democratisation reduces both infant and neo-natal mortality by about 12 percentage points and 6 percentage points respectively. The declines are potentially due to better health service delivery after countries become democratic.

Lecture 8 – Human Capital • Health, Education, and Income: • The causality between human capital and income runs in both directions. Higher income leads to more spending on education and health, and better health and education increases income earned. However simply increasing income does not increase nutrition. The income elasticity of demand for calories has been estimated to be as low as 0-0.5 in developing countries, due mainly to substitution towards greater variety of foods that have similar caloric content, but are less nutritious. • Education of mothers has an important role to play in improving child health and reducing gender bias in human capital investments against girl children according to a growing body of evidence. Health status also affects educational performance directly. E.g. Undernourished children lag by 20% in test scores in northeast Brazil. • As of 2008, the ILO reported that a total of 306 million children between the ages of 5 and 17 were doing some kind of work, only about one-third of which was permissible. However a ban on child labour is not always unambiguously good, as without employment the child and his family might become malnourished. Basu presents a simple model with multiple equilibria in labour supply.

Lecture 9 – Human Capital • Bleakley (2007): • Bleakley exploits anti-malaria measures implemented by governments in the Americas in the twentieth century to estimate the impacts of reduced exposure to malaria in early childhood on adult earnings. The results show a sharp decline in malaria incidence in previously malarious regions at the time of the eradication campaigns, and a large increase in earnings for individuals born after the campaigns in previously malarious regions, compared to those born in the same areas who were already adults at the time of the campaigns. Given that the decline in malaria incidence was much greater in areas that had relatively higher pre-treatment malaria prevalence rates, the rise in adult earnings for individuals born after campaigns in these previously malarious regions is unlikely to have been driven by other factors. • Jensen (2010): • The paper examines the impact of increased opportunities for female employment in India on the health and employment of girl children. This is done by offering recruitment services for BPO jobs to girls randomly across villages, and comparing enrolments and BMI of girls in “treated” to “untreated” villages. The results show that increased economic opportunities for female employment increase female child enrolment and BMI, without increasing the same indices for male children.

Lecture 10 – Migration • Migration: • Most researchers agree that, in general, it is explained by income differentials, prospects of finding a job and improvement in living standards. The evidence is mixed for both source on destination country on whether migration is beneficial. The only somewhat conclusive finding is that migrants benefit after arriving in the destination country. • Panagariya’s one-good migration model - Emigration from South raises the real wage of the remaining workers there. It increases the quantity of labour and decreases the real wage in the North. The effect of this migration on national welfare depends on whether the welfare of migrant is included in the source or the destination country. If migration is temporary, then it makes sense to incorporate welfare of the migrants in the source country. If migration is permanent, the effects on welfare are less clear cut because of migrant ties to source country. • Faini (2003) argues that the size of the brain drain is large. Migration rates are large among educated people. He also argues that any benefits from this, or brain gain, are unproven and there are valid concerns about the negative effect of skilled migration from the poor countries. Remittances are sent mostly by unskilled migrants, and there is no visible increase in skilled return migration or tertiary education as a result of the brain drain.

EC336 Economic Development in a Global Perspective