ITC-ILO Master in Management of Development 2011/12 Module of Economics

THE RISE OF DEVELOPMENT ECONOMICS Notes by Donatella Saccone

AIM: Understand how the international cooperation and its modalities have been influenced by: - the historical economic and political context - the economic theories

The Official Development Aid system as well as that part of economics dealing with the concept of development originated at the end of 40s for two historical reasons: - reconstruction of the post-II war Europe (Marshall plan: large scale USA plan to help the European reconstruction, consisting of US$ 13 billion in economic and technical assistance) successful possible replication in other countries, namely in developing countries - new independent States after the process of decolonization new economic problems dichotomy between growth and development

We can individuate 4 different phases.

1) 1950s-1960s: EMERGENCE OF DEVELOPMENT ECONOMICS AND INSTITUTIONALIZATION OF THE INTERNATIONAL COOPERATION SYSTEM
Until now, economists just dealt with the concept of growth. Starting from the end of 40s, dichotomy between growth (developed countries) and development (developing countries). In 1952, a French journalist, Alfred Sauvy, ideated the expression Third World, in analogy with the French Revolution. During the French Revolution, three states or classes: clergy, nobility and the third state or

class, that was represented by the 98% of poor population without rights and economic power. Now (in 1952), the most part of world population lives in the Third World without rights and income. According to Sauvy, they should joint and work together to claim for their rights. In 1955, Conference in Bandung (Indonesia), in which for the first time 29 developing countries met to discuss their economic and social problems and declare their neutrality with regard to the Cold War (First World: developed, capitalistic and democratic countries; Second World: socialist and communist countries). The main (and weak!) logic of the economic theories was the following: 1. Stages of development (based on Rostows theory, 1960). In order to develop, developing countries should follow the same path of growth followed by developed countries. 2. Industrialization (all the theories). This path consists in the transition from an agricultural society to an industrialized economic system. All the investment should be concentrated in the industrial sector that needs a big-push of investment to take off. Which industrial sectors? According to Rosenstein- Rodan (1943, Problems of Capital Formation in Underdeveloped Countries) in all the industrial sectors, with a State planning, in order to create new employment, new wages, new purchasing power and then new demand for industrial goods. According to Hirschman (1958, The Strategy of Economic Development) without a State planning (that pushes down the individual entrepreneurship) and just in those sectors that present more backward and forward linkages (for example sectors that buy of supply inputs and intermediate goods from/to other sectors; for example heavy industry has more linkages to other sectors than manufacturing industry). 3. Agriculture is just seen as functional to industrialization (Lewiss model, 1954, Economic Development with Unlimited Supplies of Labor). In agriculture there is a surplus of labor, with zero-productivity (too many people are employed in agriculture), that should be incentivized to move and be employed in the industrial sector, where the productivity is high. Because the surplus of labor, wages in the industrial sector can remain constant (at a subsistence level + a little premium for moving) and this allows firms to get profits and re-invest them. In this way, the industrial sector grows, the production in agriculture will not decrease (because labor moving to industry has zero-productivity in agriculture) and there is a more efficient allocation of labor. (Actually, the precious role of agriculture in development will be explained by Prof. Romano). 4. No attention on social problems (based on Kuznetss theory, 1955). Once a process of growth is started, its benefits will spread across the population and the income distribution will improve (this point will be developed by Prof. Tasgian lecture). 5.Role of international cooperation (based on the Harrod- Domar model, 1939 and 1946). In order to follow a path of industrialization, countries need to save and invest. Since developing countries have a gap of saving, this gap should be filled by international financial aids.

To sum up: international financial aid investment and industrialization growth social equity.

To go in details. The Harrod-Domar model was formulated in 1939 and 1946 by two economists, Harrod (UK) and Domar (USA) to study developed countries. However, its main logic was applied to developing

countries by other economists. The rational is to find an economic expression to find what determines the rate of growth of an economy. Lets call: Y = GDP (output, income) S = saving s = marginal propensity to save (ranging from 0 to 1) = 1-c c = marginal propensity to consume (ranging from 0 to 1) = 1-s I = investment K = capital k = capital/output ratio (greater than 1: for each unit of capital, I obtain less than 1 unit of output) = K/Y if k = 3 it means that I need 3 unit of capital to produce 1 unit of output

We know that the saving is equal to a portion of income: St = sYt and that, in equilibrium, It = St, i.e. that saving should be equal to investment.

We know also that the change in capital is equal to the investment (K = I). If the value of capital in my design firm is equal to 10 computers, each of them having a value of 1000$, (capital = 1000*10 = 10000) and I invest by buying a new computer (I = 1000$), the new value of my capital is now equal to 10000 + 1000 = 11000. Obviously, K = 11000 10000 = 1000 = I. We have already defined S. We need now to find a definition for I. Since k = K/Y, we can also say that k = K/Y (every time I changed my capital by K, my output changes by Y), or that k = I/Y. In this way, we can define I: It = k * (Y) = k * (Yt+1 -Yt) This is a mathematical derivation. However, this definition for I can also be understood by reasoning. If I want to produce more because I think that tomorrow the demand will increase, I have to invest more. How much? Since for having one unit of additional output I have to buy 3 more unit of capital, my investment should be equal to the desired increase in output times the capital I need for producing one more unit of output ( = K/Y = k). If k = 3 and I want to increase the production by 10 unit, I need to increase my capital (K = I) by 3*10 = 30 = I (for each unit of new output I need 3 unit of new capital). Knowing k, this means that the firms take their decision on investment on the basis of the expected increase in income and, then, in the demand. The important point is: do firms know how much is great the increase in income and, then, in the demand???

Let me show this point. We know that It = k * (Y) = k * (Yt+1 -Yt) and that in equilibrium It = St = s * Yt . Then: sYt = k (Yt+1 -Yt) = k (Y) (Yt+1 -Yt)/ Yt= s/k In other words: (Y)/Y = s/k = g

g is called warranted rate of growth. This means that the rate of growth of a country is positively related to its capacity of saving. Since developing countries, given their low income, have a low rate of saving, the gap of saving necessary to grow should be provided by international aids. Example. Target: growth rate of 7% If we know that k=3, we can calculate the necessary saving rate: s/3=7 s=7*3=21% Let s suppose that a developing country just saves the 15% of its income, so it is able to grow just at 5% (=15/3). In order to reach a rate of growth of 7%, the saving gap (21%-15%=6%) should be provided in form of financial foreign aids.

Result: the role of cooperation in 50 and 60 was just limited to massive transfer of capital from developed to developing countries. Did it work? This point will be developed by Dr Bertolis lecture).

(Actually, in 50s and 60s some alternative theories of development were formulated, in particular in Latin America. In particular, two economists have been representatives of this approach, Prebisch (Argentina) and Singer (Germany). According to their theory (structuralism), the economic structure of developing countries was just a consequence of the international economic dynamics, in which they were seen by developed countries just as a source of raw materials and a market to which export manufacturing and capital goods. Through this mechanism, developing countries exported raw materials (low value) and imported manufacturing and capital goods (high value) and this determined a negative trade balance. The proposed solution was a policy of import-substitution, in order to substitute imported goods with domestically-produced goods. At a first stage, domestic firms should be protected by international competition by trade barriers (tariffs). This paradigm was applied to various Latina American countries in 50 and 60 (ex. Brazil, Chile, Argentina). Moreover, in 1964 there was the first UN Conference on Trade and

Development, to promote the trade right of development countries, that will become a permanent organization in Geneva with the name of UNCTAD. Prebisch was the first secretary of UNCTAD.)

2) 1970S: ATTENTION ON SOCIAL ISSUES BUT...

In 70, the failure of the previous theories of development was clear: even if on average developing countries had registered a growth rate of 3%, poverty and inequality did not change. The role of international organizations was reviewed and the focus was shifted to peoples basic needs (nourishment, health, housing, water, education etc.). The aim of international organizations as well as of development economics was not only growth but also redistribution (1974, , Hollis Chenery, WB Chief Economist, Redistribution with Growth. As a consequence, international aid should provide not only financial resources, but also concrete assets (access to water, sanitation projects, houses etc.) Cycle project management and the active role of NGOs. However, from an historical point of view, the 70s created the basis for what happened in 80. In particular, 1973 and 1979: oil crisis, that caused an increasing inflation and hurt both developed and developing countries importing oil. As a consequence, USA Federal Reserve increased interest rates to fight the rise of prices. The foreign debt of developing countries, already high, further increased. In 1982 Mexico was the first country to declare the impossibility to pay back its debt. The debt crisis started.

3) 1980s: DEBT CRISIS, WASHINGTON CONSENSUS AND STRUCTURAL ADJUSTMENT.

Political context: conservative government in developed countries (Reagan in USA and Thatcher in UK) and conservative economists in international organizations (Anne Krueger and Stanley Fischer at the WB, hes now Governor of the Bank of Israel). In order to have a rescheduling of their debt, developing countries had to implement a series of rigorous policies (public expenditure cuts, free markets and free trade, privatizations, deregulations etc.) called by the economist John Wlliamson in 1989 Washington Consensus (US Treasury Department, FMI and WB in Washington). The focus was on public accounts, while social issues were put aside. Result: the 80 were called the lost decade in fighting poverty, since the poor were seriously hurt by the policies of structural adjustment. In 1987 Giovanni Andrea Cornia wrote the essay Adjustment with a Human Face and in the 1990 World Development Report (WB) fighting poverty was put again at the center of the role of international organizations.

4) 1990s AND 2000s: FIGHTING POVERTY AND MDGs

In the two following decades, new concepts have enriched the theories of economic development and the approach of international organizations in fighting poverty: - governance and institutions (development cannot occur without good institutions!) (this point will be developed by the module of Economics of Institutions) - international law, human rights and intellectual property rights (this point will be developed by the module of Law)

- environmental sustainability (this point will be developed by Prof. Dalmazzones lecture) - childrens rights (this point will be developed by Dr Bertolis lecture) - migration (this point will be developed by Prof. Venturinis lecture) - international financial stability (this point will be developed by Prof. Deaglios lecture) - globalization, inequality and poverty (this point will be developed by Prof. Tasgians and Prof. Badhuris lectures) - globalization and the role of FDI (this point will be developed by Prof. Balcets lecture) - the role of agriculture for economic development (this point will be developed by Prof. Romanos lecture) - education and human capital (this point will be developed by Prof. Vallis lecture) - ownership and bottom-up development strategies - womens empowerment - importance of technological progress (second part of my lecture)