Development Economics VII

1. Development EconomicsVII Prof. Dr. Hans H. Bass Jacobs University, Spring 2010

2. Agenda March 18 Development Economics III. Production and Sector Issues • Saving and Investment* 1.1 Saving 1.1.1 Taxonomy 1.1.2 Stylized facts of saving in a cross-country comparison 1.1.3 Theoretical approaches to explain saving behavior 1.2 Investment 2. Primary Production: Agriculture (and Minerals) *) Source: Perkins/ Radelet / Lindauer 2006, pp. 365-428

3. Taxonomy 1.1 Saving Sacrifice consumption from current income to provide resources necessary for investment for future gain = SAVING: • Domestic saving(averages.: 20 % of GDP in LICs, 27 % in LMICs, 20 % in UMICs + HICs) 1.1 Private domestic saving (from individuals / households): formal savings institutions or by purchasing investment goods (jewelry, livestock, building materials ...) 1.2 From corporations (<3 % of GDP in HICs, very small in LICs/MICs) 1.3 From government (<2% of GDP in LICs – 10 % in HICs) 2. Foreign saving (< 2 % of GDP in LICs/MICs) 2.1 Official development assistance (ODA) 2.2 Private (external commercial borrowing and equity finance)

4. Taxonomy 1.1 Saving 1. Domestic saving 1.1 Private domestic saving (until recently neglected in development policy) 1.2 From corporations 1.3 From government (until recently focused in development policy) Government revenues from taxes and tariffs = Government consumption (all current expenditures such as salaries, subsidies, maintenance costs, interest payments plus outlays for military hardware) + Government saving (to finance public investment)

5. Stylized facts of household saving 1.1 Saving 1.Within a particular country, higher-income households tend to save larger fractions of their income than lower-income households; 2. Within a particular country, household saving ratios tend to be roughly constant, more so in HICs than in LICs; 3. Across countries, household saving ratios vary with no clear relationship to income.

6. Household saving 1.1 Saving Reasons for household saving: 1. to generate higher future income by saving and investing 2. to protect themselves from the risk of unexpected falls in income in the future (drought, livestock diseases ...)

7. Explanations of household saving 1.1 Saving 1. Absolute-income hypothesis (Keynes) 2. Relative-income hypothesis (Duesenberry) 3. Permanent-income hypothesis (Friedman) 4. Life-cycle hypothesis (Modigliani)

8. Absolute-income hypothesis (Keynes) 1.1 Saving • Autonomous consumption Ca • constant marginal saving rate s • S = – Ca + s Yd • Increasing disposal income results in an increasing average saving rate S/Yd • Only very weak empirical support (only for very short term)

9. Relative-income hypothesis (Duesenberry) 1.1 Saving Two time lines: 1. Short term: consumers adjust their savings up or down with little change in consumption 2. Medium term: consumers adjust their consumption but maintain a basic share of previous high level of consumption regardless of their current level of income (“ratchet effect”). In DCs a “demonstration effect” (Nurkse) operates to cause consumption to ratchet upward as incomes grow

10. Permanent-income hypothesis (Friedman) 1.1 Saving Two components of income: 1. permanent income (i.e. stable over time) 2. transitory income (i.e. non-recurring income) S = - Ca + sp Yp+ st Yt extreme version: sp = 0, st = 1  no empirical support less extreme version: 0 < sp < st < 1  some empirical support  in DCs: Saving is a method of smoothing consumption in the face of volatile income! (Saving reason # 2)

11. Life-cycle hypothesis (Modigliani) 1.1 Saving • Household income-expenditure life-cycle: young age: low income, high expenditures  de-saving or low saving ratio middle age: high income, decreasing expenditures  high saving old age: lower income, rising expenditures  de-saving

12. Life-cycle hypothesis (Modigliani) 1.1 Saving • Demographic life cycle: LICs: pre-transition stage = high young-age dependency per worker  low saving rates MICs: demographic transition stage = low young-age dependency per worker  higher saving rates HICs: post-transition stage = high old-age dependency per worker  low saving rates

13. Other determinants 1.1 Saving • Population distribution: rural households have a higher savings ratio than urban households (precautionary saving: farmers’ incomes more variable than those of urban wage earners) • (lack of) access to formal credit and insurance markets: over-saving on the household level, such as necessity to accumulate a large share of saving in advance of opening a business or purchasing a house • culture-specific attitudes to thrift and consumption

14. Agenda March 18 Development Economics III. Production and Sector Issues • Saving and Investment* 1.1 Saving 1.2 Investment 1.2.1 Public Investment 1.2.2 Private Investment 2. Primary Production: Agriculture (and Minerals) *) Source: Perkins/ Radelet / Lindauer 2006, pp. 365-428

15. Public and private investment 1.2 Investment • Public investment - if too large for individual private investors - if positive externalities (public goods: no exclusion from consumption possible and marginal costs near zero (non-rivalry); example lighthouse) - if generation of economic resources > costs - if greater return than all of the other available options - financed by taxes, fees, or new (PPP) finance methods 2. Private investment

16. Public and private investment 1.2 Investment 2. Private investment especially catching-up processes need both high levels of private investment and more-productive investment

17. Public and private investment 1.2 Investment Governments can encourage private investment by: • reducing risks of high rates of inflation, volatile exchange rates, recurring financial crises ... (“macroeconomic stability”) • providing reliable transport and communication infrastructure • making imported inputs readily available (opening up the economy) (danger: import competition!) • providing internal security • lowering institutional costs of doing business

18. Costs to start a business 1.2 Investment

19. Reducing costs of doing business 1.2 Investment

20. „The Mystery of Capital“ 1.2 Investment H. de Soto: the poor in DCs have substantial assets that they are unable to use to leverage investment because of weak institutions and inadequate rules and procedures(example: no land titles  no collateral)

21. Agenda March 18 Development Economics III. Production and Sector Issues • Saving and Investment • Primary Production: Agriculture (and Minerals)

22. The historical experience of agricultural transformation in Europe: Stylized facts 2. Primary Production • Increases in labor productivity in agriculture (agricultural revolution often preceding an industrial revolution) • Transformation from subsistence production to market production increases urban domestic consumption or exports (lower urban wages, more forex) • Rural laborers becoming redundant, farmers accumulate capital  both transferred to industry (“factor effect”) • Rural population absorbs industrial products (“market effect”)

23. Declining share of agriculture in labor force and GDP in today‘s DCs, but exceptions 2. Primary Production

24. Cereal Yields 1960-2005 2. Primary Production

26. Reasons for the neglect of agriculture in early development strategies 2. Primary Production • Early development economists (e.g. Lewis): agricultural innovations retarding capital accumulation in the modern sector by rising the supply price of labor – agriculture as the “handmaiden of an industrial push”  at best: passive, supporting role • technology pessimism: science-based, input-intensive agriculture (HYV) scale-neutral; allegedly slow dissemination of innovations

27. Reasons for the neglect of agriculture in early development strategies 2. Primary Production • domestic demand pessimism: low income elasticity of demand for food (Engel’s Law) in addition to low price elasticity of demand • trade pessimism (Prebish-Singer Hypothesis) • linkage pessimism: agriculture an unlikely growth pole • institutional pessimism: too powerful landowners

28. Towards a new sector strategy 2. Primary Production • a shrinking agricultural sector supplying a growing industrial sector needs innovations in agriculture! • scale-neutrality of agricultural innovations is a strength  egalitarian growth! • income elasticity of demand for grain rises (low income levels: more varieties, middle income levels: meat) • linkage pessimism factually unjustified (Irma Adelman) • institutional reforms needed towards owner-operated, medium size farming

29. ”Integrated rural development” or... 2. Primary Production • accelerated output growth through technological, institutional, and price incentive changes designed to raise the productivity of family farms • rising domestic demand for agricultural output derived from an employment-oriented urban development strategy • diversified, non-agricultural, labor-intensive rural development activities

30. ... Agricultural-demand led industrialization strategy (ADLI) 2. Primary Production • Improve productivity of food-agriculture on small/medium farms, • invest in agricultural infrastructure, • disseminate appropriate technology, and • generate induced demand for industrial output through increased demand for industrial inputs and consumption of manufactures by farmers