Economic Growth in Developing and Transitional Economies: Fernando & Yvonn Quijano

Chapter
36
Economic Growth
in Developing
and Transitional Economies
Prepared by:
Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
Economic Growth
in Developing 36
Chapter Outline
and Transitional Economies Life in the Developing Nations:
Population and Poverty
Economic Development: Sources and

Strategies
The Sources of Economic Development
Strategies for Economic Development
Growth versus Development: The Policy
Cycle
mo noc El a noi ti s nar T dna
Issues in Economic Development

Population Growth
Developing-Country Debt Burdens
Economies in Transition
Political Systems and Economic Systems:
Socialism, Capitalism, and Communism
Central Planning versus the Market
The End of the Soviet Union

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The Transition to a Market Economy

Six Basic Requirements for Successful
Transition
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 25
ECONOMIC GROWTH IN DEVELOPING
AND TRANSITIONAL ECONOMIES
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.
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LIFE IN THE DEVELOPING NATIONS:
POPULATION AND POVERTY
TABLE 20.1 Indicators of Economic Development

COUNTRY GROUP POPULATION, GROSS ANNUAL HEALTH INFANT URBAN
2004 NATIONAL EXPENDITURES MORTALITY, POPULATION
INCOME PER CAPITA 2003 (PERCENTAGE
PER CAPITA, 2004 (DEATHS OF TOTAL),
2004 (DOLLARS) BEFORE 2002
(DOLLARS) AGE 5 PER
1,000 BIRTHS)
Low-income 2.3 billion 510 29 122.0 30
Lower middle-income 2.4 billion 1,580 75 42.0 47

Upper middle-income 575.9 million 4,770 243 29.7 72
High-income 1.0 billion 32,040 2,977 7.0 76

Source: World Bank, www.worldbank.org
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
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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.
ECONOMIC DEVELOPMENT: SOURCES
AND STRATEGIES
THE SOURCES OF ECONOMIC DEVELOPMENT

Capital Formation
vicious-circle-of-poverty hypothesis
Suggests 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.
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Poverty alone cannot explain capital shortages, and poverty is not necessarily self-
perpetuating.
AND STRATEGIES
Human Resources and Entrepreneurial Ability
brain drain The tendency for talented

people from developing countries to
become educated in a developed country
and remain there after graduation.
P A HC
Development cannot proceed without human resources capable of initiating and managing
economic activity.
AND STRATEGIES
Social Overhead Capital
social overhead capital Basic

infrastructure projects such as roads, power
generation, and irrigation systems.
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
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would never touch. If government action in these realms is not forthcoming, economic
development may be curtailed by a lack of social overhead capital.
AND STRATEGIES
STRATEGIES FOR ECONOMIC DEVELOPMENT
Agriculture or Industry?
TABLE 20.2 The Structure of Production in Selected Developed and Developing Economies
2003
COUNTRY PER-CAPITA
GROSS NATIONAL INCOME PERCENTAGE OF GROSS DOMESTIC PRODUCT
(GNI)
AGRICULTURE INDUSTRY SERVICES
Tanzania $ 330 45 16 39
Bangladesh 440 21 27 53
China 1,290 15 51 35
Colombia 2,000 13 0 87
Thailand 2,540 10 44 46
Brazil 3,090 5 17 78
Korea (Rep.) 13,980 3 35 62
United States 41,400 2
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Japan 37,180 1 30 68
Source: World Bank, www.worldbank.org, 2005.
AND STRATEGIES
Exports or Import Substitution?
import substitution An industrial trade

strategy that favors developing local
industries that can manufacture goods to
replace imports.
export promotion A trade policy designed

to encourage exports.
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AND 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.
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AND 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.
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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.
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FIGURE 20.1 The Growth of World Population, Projected to 2020 A.D.

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.
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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.
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.
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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.
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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.
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Comparing economies today, the real distinction is between centrally planned socialism and
capitalism, not between capitalism and communism.
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.
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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.
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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:
(1) macroeconomic stabilization;

(2) deregulation of prices and liberalization of trade;
(3) privatization of state-owned enterprises and

development of new private industry;
(4) establishment of market-supporting institutions
such as property and contract laws, accounting
systems, and so forth;
(5) a social safety net to deal with unemployment and
poverty; and
(6) external assistance.
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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.
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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.
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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.
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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.
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REVIEW TERMS AND CONCEPTS
brain drain mortality rate

capital flight natural rate of population
capitalist economy increase
communism shock therapy
debt rescheduling social overhead capital
export promotion socialist economy
fertility rate stabilization program
import substitution structural adjustment

International Monetary Fund tragedy of commons
(IMF) vicious-circle-of-poverty
market–socialist economy hypothesis
World Bank
P A HC

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Chapter

Fernando & Yvonn Quijano

Economic Development: Sources and

Issues in Economic Development

The End of the Soviet Union

The Transition to a Market Economy

The economic problems facing the developing

TABLE 20.1 Indicators of Economic Development

Low-income 2.3 billion 510 29 122.0 30

Lower middle-income 2.4 billion 1,580 75 42.0 47

Upper middle-income 575.9 million 4,770 243 29.7 72

High-income 1.0 billion 32,040 2,977 7.0 76

THE SOURCES OF ECONOMIC DEVELOPMENT

capital flight The tendency for both human

Human Resources and Entrepreneurial Ability

brain drain The tendency for talented

Social Overhead Capital

social overhead capital Basic

Exports or Import Substitution?

import substitution An industrial trade

export promotion A trade policy designed

Central Planning or the Market?

International Monetary Fund (IMF) An

World Bank An international agency that

structural adjustment A series of

deficits, (3) control inflation, and (4)

The Consequences of Rapid Population Growth

Rapid population growth is characteristic of many

source of labor. However, having many children

FIGURE 20.1 The Growth of World Population, Projected to 2020 A.D.

fertility rate The birth rate. Equal to (the

natural rate of population increase The

DEVELOPING-COUNTRY DEBT BURDENS

debt rescheduling An agreement between

stabilization program An agreement

For 40 years, between the end of World War II and

We reflect on historical political rivalries in an

• First, the 40-year struggle between the United

a struggle between two economic systems:

socialist economy An economy in which most

communism An economic system in which the

CENTRAL PLANNING VERSUS THE MARKET

Just as there are no pure capitalist and no pure

Generally, socialist economies favor central planning

rely to a much greater extent on the market.

market–socialist economy An economy

The Soviet Union grew rapidly through the mid-

During the late 1950s, the Soviet Union’s economy

In the late 1970s, things began to deteriorate.

Dramatic reforms were finally introduced by Mikhail

SIX BASIC REQUIREMENTS FOR SUCCESSFUL

Economists generally agree on six basic requirements

(1) macroeconomic stabilization;

(3) privatization of state-owned enterprises and

Deregulation of Prices and Liberalization of

An unregulated price mechanism ensures an

tragedy of commons The idea that collective

ownership may not provide the proper private

Social Safety Net

This social safety net might include unemployment

Shock Therapy or Gradualism?

shock therapy The approach to transition from