Where we have been?

1. Where we have been? First stop: The economics of growth. Solow.

2. Unmodified Solow • Given DMR, the long-run (“steady state”) rate of growth is governed by rate of technological progress. • For LDCs, this rate IS largely exogenous. • Changes in depreciation rates, rates of population growth and investment ratios affect the transitional rate of economic growth. • They do not however affect the “steady state” rate of growth.

3. Level effects(transitional rates of growth in the unmodified Solow model) • The unmodified Solow model is a very simple model of economic growth. It is very much in the same vein as the model of the economic growth David Ricardo developed. Ricardo was a very famous English economist from the early 19th century. His contemporary Thomas Malthus questioned the very long-run perspective of Ricardo’s model when he noted that “it is in the transition that we have our being”. In short, the transitional stuff is what really matters! We could say the same to Solow (and Solow unlike Ricardo would agree!) • Regardless, the factors just mentioned DO have level or transitional effects. The level of per capita income may be SIGNIFICANTLY different thanks to an increase in the investment ratio or a decline in the rate of population growth or depreciation rates. • So, despite the fact that changes in these factors have no impact on growth in the “long-run” steady state this does NOT mean that they are unimportant.

4. Modified Solow (New Growth Theory or NGT) • NGT starts by focusing on what the original unmodified Solow model ignores: • Investment in human capital. • Endogeneity of technological progress. • Complementarities.

5. Delays the onset of DMR. Means that the level of real per capita income the economy eventually reaches will be higher than if investment directed exclusively toward physical capital CAN also help endogenize the rate of technological progress. A skilled labor force means one that R&D can possibly be carried out in one’s own country. The significance of human capital

6. The degree to which technological progress is a function investment means that increases in the investment ratio CAN have growth effects (long-run) as well as level (transitional) effects. TO THE DEGREE THAT investment in human capital CAN encourage R&D (or at the very least make it easier) increased investment in human capital CAN have growth effects as well. The significance of endogenous technological progress

7. An interlude: The idea of conditional convergence • If growth rates differ over time it is due to rates of technological progress. • If levels of real per capita income differ it is due to differences in investment ratios, population growth rates and depreciation. • Note what happens if these things are taken as given and therefore are treated as root causal factors . • Low growth and low real per capita income can be blamed on (1) lack of inquisitiveness and corruption (so low investment ratios and low rates of technological progress).

8. Idea of conditional convergence (cont’d) • (2) Lack of foresight and irrationality (high population growth rates and low investment in physical and human capital) • (3) Lack of care in maintaining structures and capital or geography (high depreciation rates) • The solution then becomes simply that “they” need to be more like “us” if “they” want the same rates of growth and the same standard of living that “we” have.

9. This unfortunately is the central thesis of the best selling Wealth and Poverty of Nations by historian David Landes • Early on this book Landes states that “If we learn anything from the history of economic development, it is that culture makes all the difference”. • This is pure unmodified Solow and conditional convergence which takes key economic factors as exogenous: In terms of policy this implies that the culture of a poor country must change first if its economy is to change. Fatalism, attachment to large families, lack of foresight and inquisitiveness, acceptance of corruption must all change so that investment ratios and technological progress may rise and population growth rates and depreciation may fall.

10. Debraj Ray, New Growth Theory and the Macro Perspective on Development. • The modifications of Solow discussed above encourage us ask what if the factors held responsible for low growth and low real per capita income are not culturally determined but rather are themselves driven by economic considerations? • What if they are the result of poverty and underdevelopment rather than the root causes? • Then policy advice that asks the poor nations of the world to change first as a precondition to growth are akin to the oncologist asking her cancer patient to eat more. Weight loss is a symptom of cancer not its cause. She would be attacking one symptom of the cancer and not doing anything about the disease itself. And her patient would die.

11. Once we understand this … • We ask the question what fundamentally keeps countries back? • Answer is complementarities (positive feedback effects).

12. The significance of complementarities: If you build them, they won’t necessarily come: • The very poverty we are trying to conquer creates all sorts of obstacles to dotting the i’s and crossing the t’s in the preceding! • The very poverty, both relative and absolute, in an economically developing country can keep population growth rates high, make agriculture inefficient, crowd cities and act as disincentives to investment overall and investment in education and training.

13. Example 1: It is not enough to build schools and train teachers. • Families living in poverty face a tremendous amount of cost upfront and the potential benefits of sending a child to school • (1) Are just that … potential, off in the distant future. • (2) uncertain unless a sufficient number of students enroll.

14. Example 2: Limited access to credit • Also, because of poverty, the money needed to fund an education is hard to come by. • The poor (who would benefit most from education) lack the assets/wealth that could be used as collateral for loans to fund this education or for other investments. • And significant default risk and general uncertainty makes the need for collateral especially important.

15. Why do the poor lack assets/wealth? • At one level, this is a very stupid question. • If they had assets they would not be poor! • As a vestige of the past however land (the principle form of wealth in a largely rural society) tends to be very unevenly distributed. • On the one hand you have the rich who hold a great deal of land …

16. Why do the poor lack assets/wealth(continued)? • They tend to underutilize the land they hold. • The yields per acre tend to be higher for the smaller farms operated by the poor (see chapter 12 of Ray for evidence) • If collateral not an issue then it should be possible for land sales to take place between rich and poor. • This would shift land resources from lower yield activities (less productive ones of the rich) to higher yield activities of the poor

17. “Catch 22” • Lack of land means poverty. • Poverty means high default risks in credit markets. • High default risks means need for collateral to access what credit is there. • The circle is complete and the poor are shut out.

18. Hopeless? • Not in the least! • (1) We can argue that once a transfer of resources occurs the gap between rich and poor will narrow • (with the poor gaining more than the rich, at least the rich in the short-term, will lose!) • (2) As the previously poor gain assets and the risk of default falls, the need for collateral to access credit declines.

19. And … • Microcredit can be used to minimize default risk and so get around the problem of poor collateral. • Support programs designed to break the lock-in effects of low education and large family sizes can be encouraged. • Infrastructural investment that is complementary to private investment (and therefore “crowds in” rather than “crowds out” this private economic investment) must be carried out.

20. Just like someone trying to move a very heavy piece of furniture • They may push once and find that it was not enough. • They push again and see that it was still too little. • They finally push hard enough to make it move. • Similarly, the effort in terms of policy must be on a sufficiently large enough scale and sustained long enough to budge the economy from its spot. • It makes no sense to tell the heavy piece of furniture that it needs to move itself. • Nor does it make any sense to give up after only one push.