EC3771 Development Economics

Second Term, AY2016-17

Lecture 1
Introduction

January, 2017

Outlines

Course information

The relation between economic growth and development

Measuring economic growth and development

An overview of economic growth around the world

Development thinking after World War II

Instructors

Dr Liu Zhengning (first half)

Email: ecslz@nus.edu.sg

Office: AS2-04-38

Office hours: By appointment

Dr Li Bingjing (second half)

Email ecslib@nus.edu.sg

Office: AS2-04-41

Office hours: By appointment

Tentative Syllabus

Introduction

Economic growth model

Geography, institution and development

Agriculture, structural change and development

Midterm exam

International trade and development

Environment and development

Foreign aid and development

Assessment and Reference

Participation: 5%

Group project: 25%

Midterm exam: 30%

Final exam: 40%

Main reference book: Economics of Development (7e),

written by Perkins, Radelet, Lindauer and Block

Knowledge required: basic microeconomics (EC2101) and

econometrics (EC3303)

Economic Growth and Economic Development

Economic growth 6= Economic development

Economic growth: a rise in national or per capita income

Economic development: improvements in income, health,

education, environment and overall living standards

Economic development is to expand the capacities of people

to live the lives they choose to lead (Amartya Sen).
I

For example, an individual deprived of education opportunity

will not be capable of leading the life s/he would like to lead

Economic growth may not lead to economic development.

Equatorial Guinea is a small nation of fewer than 700,000

people on the west coast of Africa.

The discovery of vast oil deposits raised its per capita income
from US$330 in 1990 to US$12,420 in 2009. The average
growth rate was 25 percent per year.

By 2009, it had a per capita income comparable to Hungarys.

However, its life expectancy was 50 years (in Hungary, it was

74 years); its primary school enrollment rate was 50 percent
(in Hungary, it was 90 percent).

China did a remarkable job in economic growth in the past

four decades, but its environment is now under red alert.
The health and living of people are being seriously affected.

Possible reasons that economic growth may not guarantee

improvements in mass living standards:
I

Governments promote growth to augment the power and glory

of the state and its rulers.

Resources may be heavily invested in further growth, with

significant consumption gains deferred to a later date.

New income is concentrated in the hands of a few people. The

rich get richer, and the poor get poorer.

Negative externalities such as pollution is not properly handled.

Economic development cannot be sustained without economic

growth. If there is no growth, Pareto improvement is not
possible.

After Peoples Republic of China was established in 1949, the

government focused on liberalizing the people from being
pressed by capitalist.

Land was taken away from landlords and was redistributed to

landless farmers. Private production factors were nationalized
and were owned by all the people.

The poor were better off at the cost of suppressing the rich.
Such development is not Pareto improvement.

If there is no growth, individuals can become better off only

through transfers of income and assets from others. Pareto
improvement of welfare is impossible without growth.

Economic growth, by contrast, has the potential for all people

to become better off without anyone being worse off.

Making the cake bigger instead of redistributing the cake

(efficiency vs. equity)

Economic growth is a necessary but not sufficient condition of

economic development.

In reverse, economic development such as improvements in

health and education can bring about economic growth.

Readings: Hard Times in Venezuela Breed Malaria as Desperate

Flock to Mines (NYTimes)
I

Malaria has killed people since the dawn of man. In 1900 it

was endemic in almost every country on Earth and throughout
the first half of the 20th century it killed 2m people a year.

Since 2000, malaria deaths around the world have fallen by

nearly half. Today, more than 100 countries have eliminated
malaria within their borders.

Malaria incidence rate is one of the metrics of economic

development. Controlling the incidence of malaria is one of
the targets of the UN Millennium Development Goals.

Source: The Economist

Venezuela rose only after malaria declined.

I

Due to large-scale efforts to eradicate malaria, by 1949,

Venezuelas malaria deaths had fallen drastically to only 0.1
per 1,000 people from 3.

Economic growth followed. From the 1950s and early 1980s,

the country enjoyed the highest standard of living in Latin
America.

During 2014 to 2016, oil prices collapsed. As a country relying

heavily on oil export, Venezuela is suffering its worst economic
crisis. According to the IMF, it has the worlds worst negative
growth rate (-8%) and the worst inflation rate (482%)

Unemployed workers flock to illegal gold mines to make a

living. The watery pits of the mines, perfect mosquito
breeding grounds, are spreading malaria to miners.

There is severe shortage of insecticides to eradicate mosquito

and medicines to treat malaria, as the country has limited
capacities to product those products and is unable to fund the
imports.

In the first six months of 2016, malaria cases rose 72 percent,

to a total of 125,000.

Where incidence rate malaria is low, people lose immunity

over time. So a recurrence of the disease can lead to an
outbreak that affects everyone.

Measuring Economic Growth

I

Gross Domestic Product (GDP): the sum of the value of final

goods and services produced within a nations territory during
a given year.

Gross National Product (GNP): the sum of the value of final

goods and services produced by a nations citizens during a
given year. GNP is also referred as GNI by the World Bank.

GDP or GNP divided by total population provides a measure

of per capita income.

Real GDP is adjusted for domestic price inflation, measured

by the consumer price index (CPI) or the GDP deflator.

Problems in measuring and comparing GDP:

I

Not account for family production activities that are not sold
in the market. In Cambodia, for example, about one-third of
labor force is classified as unpaid family workers.

Not account for the bads a nation produces, such as crime,

congestion, pollution, etc.

Exchange-rate conversion problems: market exchange rate vs.

purchasing power parity (PPP) exchange rate

In Jan. 2013, A Big-mac burger was sold at US$4.37 in the

U.S. and S$4.5 in Singapore.

Ignoring transportation cost and trade barrier, the price should

be the same US$1 = S$1.03 (this is an exchange rate
based on real purchasing power.)

However, the actual market rate was US$1 = S$1.23.

If you use the market exchange rate to do the comparison,

Singapores GDP (reported in SGD) will be under-estimated.

That is, if you look at the real purchasing power, Singaporean

are richer than what the market rate would suggest.

Comparing GDP under market and PPP exchange rate

Measuring Economic Development

The United Nation Development Program (UNDP) develops

the Human Development Index (HDI) to gauge economic
development.

The HDI considers three aspects:

I

Living a long and healthy life, proxied by life expectancy

Acquiring knowledge, proxied by years of schooling

Having access to resources needed for a decent standard of

living, proxied by GNI per capital (PPP in US$)

Infant Mortality Rate, per 1,000 live births

0
50
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12

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8
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Urban population, % of total

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Economic Growth around the World

80

Employment in Agriculture, % of total

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8
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12

Growth was flat before 1820: no growth between 1 B.C. and

1000; just 0.05 percent per year between 1000 and 1820.

Growth accelerated and sustained since 1820, led by the rich

western countries (and their offshoots).

During 1960-2000, growth patterns diverged: economic catch

ups happened in Asia, but not in Latin America and Africa.

Economic development is accompanied by structural change:

I

Share of agriculture = share of manufacturing

Share of manufacturing = share of service

People move from rural areas to cities = urbanization

Some Questions about Growth

I

What sustains countries growth for centuries?

Why do countries grow so differently with each other?

What drives the structural change and how does it relate to

growth?

What are the lessons for policy makers?

In the next few lectures, we will discuss the answers for these
questions, starting from theoretical model, then, moving onto
empirical evidence.

Development Thinking After World War II

The heart of debate: should development be guided by state

or market?

The Soviet Union model in communist countries

The Asian miracles (the Four Tigers)

The Washington Consensus for transitional economies

The rise of China and India

Soviet Union model in 1950s and 1960s:

I

Emphasize the role of capital and high rate of investment by

limiting consumption

Give priority to the development of heavy industry that would

produce physical capital goods

Reject the use of market forces; almost everything is centrally

planned

The model was welcomed by many developing countries who

perceived: market = capitalism = colonialism

After 1949, China adopted the model in its entirety.

I

surpassing the U.K and catching up the U.S. in 15 years

The Asian Four Tigers in 1970s and 1980s:

I

South Korea, Taiwan, Hong Kong, and Singapore

Rapid economic growth driven by export of labor intensive

manufactures

The role of governments was quite different:

I

South Korea and Taiwan: actively promote and subsidize

exports, devalue currency, support education and research

Singapore: support selective industries and corporations;

Create a favorable climate for FDI

Hong Kong: laissez faire market with little intervention

The Washington Consensus in 1980s and 1990s:

I

Growing agreement among the IMF, the World Bank, the U.S.
government, and other key international organizations

Emphasize on financial and trade liberalization, privatization,

deregulation, fiscal discipline and public expenditure towards
education, health, and key infrastructure, property rights

Not working well in some transitional economies which were

lack of institutions needed for market to function

The Consensus was recommended to transitional economies

(particularly in eastern Europe and in Russia) to guide their
reforms, but the results were catastrophic.
I

The old economic agents such as firms could not adapt to the
new environment within a short period of time (big bang).

The rise of China and India:

I

China achieved remarkable growth since 1979, mainly driven

by manufacturing sector and the gain from globalization.

Indian did a good job since 1991. The growth was supported
by service sector, while industry was still heavily regulated.

Vietnam followed Chinas approach and did well after 1991.

New thinking on economic transition and growth:

I

Gradual reform, small-scale experimentation

Appropriate role of state, political and economic stability

Open economy industrialization, access to global market

Debate on Market and State

Market force is the invisible hand: Individuals work through

the market to specialize in the production of one particular
product and exchange that product on the market for what
they need.

Market failure:
I

Marginal social cost 6= marginal social benefit

Monopolies, externalities, public goods (e.g. free rider),

information asymmetries (e.g. AS and MH)

The overproduction of greenhouse gasses has been called the

biggest market failure the world has ever seen.

Market failure calls for government policies: breaking and

regulating monopolies, taxing polluters, directly providing
public goods, etc.

Interventions should be carefully targeted towards areas in

which market guidance is clearly insufficient:
I

the financial sector, environmental controls, amelioration of

extreme poverty

Government failure: public intervention makes the situation

even worse than it would have been without the intervention.
I

Government can be corrupt, short-sighted, tied to election

cycles, or subject to dictatorship.

To summarize,
I

An economy should make great use of market forces to guide

production and distribution.

For economies under transition, market-oriented reforms are

required. But one should not expect everything to be done at
once and as quickly as possible.

Government interventions are needed to deal with clear market

failure.

The interventions, however, should be carefully managed by a

government not so much affected by politics, rent seeking, or
corruption.

Putting aside the debate, the most rapidly growing developing

countries tend to share six broad characteristics:
I

Macroeconomic and political stability

Investment in health and education

Effective governance and institutions

Favorable environment for private enterprise

Trade, openness, and growth

Favorable geography