Economic Growth in Developing and Transitional Economies

2. 36 Economic Growthin Developingand Transitional Economies Chapter Outline Life in the Developing Nations: Population and PovertyEconomic Development: Sources and StrategiesThe Sources of Economic DevelopmentStrategies for Economic DevelopmentGrowth versus Development: The Policy CycleIssues in Economic DevelopmentPopulation GrowthDeveloping-Country Debt BurdensEconomies in TransitionPolitical Systems and Economic Systems: Socialism, Capitalism, and CommunismCentral Planning versus the MarketThe End of the Soviet UnionThe Transition to a Market EconomySix Basic Requirements for Successful Transition

3. ECONOMIC GROWTH IN DEVELOPINGAND TRANSITIONAL ECONOMIES The same economic principles that have been studied through the text apply to less-developed countries. Scarcity is universal The economic problems facing the developing countries are often quite different from those confronting industrialized nations. The policy options available to governments may also differ. Nonetheless, the tools of economic analysis are as useful in understanding the economies of less developed countries as in understanding the U.S. economy.

4. Chapter 28 Figure 28-1 Life Expectancy and Incomes, 2000

5. LIFE IN THE DEVELOPING NATIONS:POPULATION AND POVERTY While the developed nations account for only about one-quarter of the world’s population, they are estimated to consume three-quarters of the world’s output. This leaves the developing countries with about three-fourths of the world’s people, but only one-fourth of the world’s income. The simple result is that most of our planet’s population is poor.

6. A. Economic Growth in Poor Countries 1. Human resources, natural resources, capital formation, and technological advance are the four driving forces of development. Less developed countries typically have difficulty in exploiting all four. 2. Investments in the labor force (i.e., human capital) are critical to economic development. While the other factors of production can be imported if need be, labor is homegrown. Education, training, health, and Nutrition are vital to the development of this resource and the economy.

7. The United Nations has developed a Human Development Index (HDI) which combines four different demographic, social, and economic statistics: life expectancy at birth, school enrollment, adult literacy, and real GDP per capita. The relationship between HDI and per capita output is strong and positive for most countries.

8. Chapter 28 Table 28-1

9. Economic Development: Sources and Strategies • 1. Economists have been trying to understand economic growth and development since the beginnings of the subject (Adam Smith and David Ricardo). • 2. The actual study of economic growth as it applies to developing countries began after World War II. • 3. Economic development as a field of economics asks one simple question: Why are some countries poor while others are rich?

10. ECONOMIC DEVELOPMENT: SOURCESAND STRATEGIES THE SOURCES OF ECONOMIC DEVELOPMENT Capital Formation vicious-circle-of-poverty hypothesisحلقة الفقر المفرغةSuggests that poverty is self-perpetuating because poor nations are unable to save and invest enough to accumulate the capital stock that would help them grow. capital flight The tendency for both human capital and financial capital to leave developing countries in search of higher rates of return elsewhere. If the vicious circle hypothesis were universally true no nation would ever develop. Poverty alone cannot explain capital shortages. Poverty is not necessarily self-perpetuating.

11. Chapter 28 Figure 28-3 The Vicious Cycle of Poverty

12. ECONOMIC DEVELOPMENT: SOURCESAND STRATEGIES Human Resources and Entrepreneurial Ability The brain drain is the tendency for talented people from developing countries to become educated in a developed country and remain there after graduation. The brain drain siphons off many of the most talented minds from developing countries. Entrepreneurial activity also seems to be lacking. Entrepreneurial activity is often discouraged by political and economic systems that do not enforce property rights. There is little incentive to be an entrepreneur if the state will take the results of your success by force. Development cannot proceed without human resources capable of initiating and managing economic activity.

13. ECONOMIC DEVELOPMENT: SOURCESAND STRATEGIES Social Overhead Capital social overhead capital Also called infrastructure projects, includes building roads, power generation systems, and irrigation systems…... Social overhead capital needs to be produced by the government because the projects are too large for the private sector. The governments of developing countries can do important and useful things to encourage development, but many of their efforts must be concentrated in areas that the private sector would never touch. If government action in these realms is not forthcoming, economic development may be curtailed by a lack of social overhead capital.

14. Economic Development: Sources and Strategies The Sources of Economic Development Corruption Social Overhead Capital The following chart shows the World Bank’s rating of corruption levels in a number of countries around the world. The countries are ranked from those with the strongest controls on corruption—Germany and France—to those with the lowest controls—Pakistan and Nigeria. Indonesia, as you can see, is near the bottom of the list.

15. ECONOMIC DEVELOPMENT: SOURCESAND STRATEGIES STRATEGIES FOR ECONOMIC DEVELOPMENT Agriculture or Industry?

16. ECONOMIC DEVELOPMENT: SOURCESAND STRATEGIES Exports or Import Substitution? import substitution An industrial trade strategy that favors developing local industries that can manufacture goods to replace imports. Most economists believe that import substitution strategies have failed almost everywhere they have been tried. Such policies have created major economic inefficiencies, which limits jobs.

17. export promotion strategy • encourages development of local industries that produce goods and services for export. Export promotion has seemed to result in higher rates of growth. Japan, Hong Kong, Singapore, Korea, and Taiwan have all pursued such strategies fairly successfully. Such strategies often include keeping the exchange rate low so export prices remain low.

18. ECONOMIC DEVELOPMENT: SOURCESAND STRATEGIES • Central Planning or the Market? • a. The economic appeal of planning lies theoretically in its ability to channel savings into productive investment and to coordinate economic activities that private actors in the economy might not otherwise undertake. • b. The reality is that central planners rarely know which sectors of the economy offer the highest rates of return on investment. • c. The failure of many central planning efforts has brought increasing calls for less government intervention and more market orientation in developing countries. These are frequently recommended by the International Monetary Fund and the World Bank

19. ECONOMIC DEVELOPMENT: SOURCESAND STRATEGIES Central Planning or the Market? International Monetary Fund (IMF) An international agency whose primary goals are to stabilize international exchange rates and to lend money to countries that have problems financing their international transactions. World Bank An international agency that lends money to individual countries for projects that promote economic development.

20. Economic Development: Sources and Strategies Strategies for Economic Development Microfinance: A New Idea In the mid 1970s, Muhammad Yunus, a young Bangladeshi economist created the Grameen Bank in Bangladesh. Microfinance is the practice of lending very small amounts of money, with no collateral, and accepting very small savings deposits. It is aimed at introducing entrepreneurs in the poorest parts of the developing world to the capital market. Relative to traditional bank loans, microfinance loans are much smaller, repayment begins very quickly, and the vast majority of the loans are made to women (who, in many cases, have been underserved by mainstream banks).

21. ECONOMIC DEVELOPMENT: SOURCESAND STRATEGIES GROWTH VERSUS DEVELOPMENT: THE POLICY CYCLE structural adjustment A series of programs in developing nations designed to (1) reduce the size of their public sectors through privatization and/or expenditure reductions, (2) decrease their budget deficits, (3) control inflation, and (4) encourage private saving and investment through tax reform.

22. Economic Development: Sources and Strategies Growth versus Development: The Policy Cycle Cell Phones Increase Profits for Fishermen in India Kerala is a poor state in a regionof India. Beginning in 1997 and continuingfor the next several years, mobilephone service was introduced to this region of India. Once the phones were introduced, waste, which had averaged 5 to 8 percent of the total catch, was virtually eliminated. In fact, cell phones are improving the way markets in less developed countries work by providing price and quantity information so that both producers and consumers can make better economic decisions.

23. Economic Development: Sources and Strategies Two Examples of Development: China and India China and India provide two interesting examples of rapidly developing economies. While low per- capita incomes still mean that both countries are typically labeled developing as opposed to developed countries, many expect that to change in the near future. Many commentators expect India and China to dominate the world economy in the twenty-first century.

24. ISSUES IN ECONOMIC DEVELOPMENT POPULATION GROWTH The Consequences of Rapid Population Growth Rapid population growth is characteristic of many developing countries. Large families can be economically rational for parents who need support in their old age, or because children offer an important source of labor. However, having many children does not mean a net benefit to society as a whole. Rapid population growth can put a strain on already overburdened public services such as education and health.

25. Population Growth • Population growth is a major problem for developing countries. • a. In developing countries population growth is 1.7 percent per year versus 0.5 percent per year in the industrial market economies. • b. At a growth rate of 1.7 percent per year population will double from its 1990 level by the year 2031. It will take the industrialized countries 139 years to double their population.

26. ISSUES IN ECONOMIC DEVELOPMENT Causes of Rapid Population Growth fertility rate The birth rate. Equal to (the number of births per year divided by the population) x 100. mortality rate The death rate. Equal to (the number of deaths per year divided by the population) x 100. natural rate of population increase The difference between the birth rate and the death rate. It does not take migration into account. Any nation that wants to slow its rate of population growth will probably find it necessary to have in place economic incentives for fewer children as well as family planning programs.

27. ISSUES IN ECONOMIC DEVELOPMENT DEVELOPING-COUNTRY DEBT BURDENS debt rescheduling An agreement between banks and borrowers through which a new schedule of repayments of the debt is negotiated; often some of the debt is written off and the repayment period is extended. stabilization program An agreement between a borrower country and the International Monetary Fund in which the country agrees to revamp its economic policies to provide incentives for higher export earnings and lower imports.

28. ECONOMIES IN TRANSITION For 40 years, between the end of World War II and the mid-1980s, a powerful rivalry existed between the Soviet Union and the United States. • We reflect on historical political rivalries in an economics text for two reasons. • First, the 40-year struggle between the United States and the Soviet Union was fundamentally a struggle between two economic systems: market-based capitalism (the U.S. system) and centrally planned socialism (the Soviet system). • Second, the Cold War ended so abruptly in the late 1980s because the Soviet and Eastern European economies virtually collapsed during that period.

29. ECONOMIES IN TRANSITION POLITICAL SYSTEMS AND ECONOMIC SYSTEMS: SOCIALISM, CAPITALISM, AND COMMUNISM socialist economy An economy in which most capital is owned by the government instead of private citizens. Also called social ownership. capitalist economy An economy in which most capital is privately owned. communism An economic system in which the people control the means of production (capital and land) directly, without the intervention of a government or state. Comparing economies today, the real distinction is between centrally planned socialism and capitalism, not between capitalism and communism.

30. ECONOMIES IN TRANSITION CENTRAL PLANNING VERSUS THE MARKET Just as there are no pure capitalist and no pure socialist economies, there are no pure market economies and no pure planned economies. Generally, socialist economies favor central planning over market allocation, while capitalist economies rely to a much greater extent on the market. Nonetheless, some variety exists. market–socialist economy An economy that combines government ownership with market allocation.

31. THE END OF THE SOVIET UNION The Soviet Union grew rapidly through the mid-1970s. During the late 1950s, the Soviet Union’s economy was growing much faster than that of the United States. The key to early Soviet success was rapid planned capital accumulation. In the late 1970s, things began to deteriorate. Dramatic reforms were finally introduced by Mikhail Gorbachev after his rise to power in 1985. Nonetheless, the Soviet economy collapsed in 1991. The Soviet Union was dissolved, and the new president of the Russian Republic, Boris Yeltsin, was left to start the difficult task of transition to a market system.

32. THE TRANSITION TO A MARKET ECONOMY SIX BASIC REQUIREMENTS FOR SUCCESSFUL TRANSITION • Economists generally agree on six basic requirements for a successful transition from socialism to a market-based system: • macroeconomic stabilization; • deregulation of prices and liberalization of trade; • privatization of state-owned enterprises and development of new private industry; • establishment of market-supporting institutions such as property and contract laws, accounting systems, and so forth; • a social safety net to deal with unemployment and poverty; and • external assistance.

33. THE TRANSITION TO A MARKET ECONOMY Macroeconomic Stabilization To achieve a properly functioning market system, prices must be stabilized. Deregulation of Prices and Liberalization of Trade An unregulated price mechanism ensures an efficient allocation of resources across industries.

34. THE TRANSITION TO A MARKET ECONOMY Privatization Private ownership provides a strong incentive for efficient operation, innovation, and hard work that is lacking when ownership is centralized and profits are distributed to the people. tragedy of commons The idea that collective ownership may not provide the proper private incentives for efficiency because individuals do not bear the full costs of their own decisions but do enjoy the full benefits.

35. THE TRANSITION TO A MARKET ECONOMY Market-Supporting Institutions The capital market, which channels private saving into productive capital investment in developed capitalist economies, is made up of hundreds of different institutions. Social Safety Net This social safety net might include unemployment insurance, aid for the poor, and food and housing assistance.

36. THE TRANSITION TO A MARKET ECONOMY External Assistance Very few believe the transition to a market system can be achieved without outside support and some outside financing. Shock Therapy or Gradualism? shock therapy The approach to transition from socialism to market capitalism that advocates rapid deregulation of prices, liberalization of trade, and privatization.

37. REVIEW TERMS AND CONCEPTS • brain drain • capital flight • capitalist economy • communism • debt rescheduling • export promotion • fertility rate • import substitution • International Monetary Fund (IMF) • market–socialist economy mortality rate natural rate of population increase shock therapy social overhead capital socialist economy stabilization program structural adjustment tragedy of commons vicious-circle-of-poverty hypothesis World Bank