Institutions Theory & Other Development Theories Flashcards
Lecture 5
What functions of institutions matter?
- Restrain powerful actors
-Facilitate exchange
-Example: security property rights, unbiased system of law, provision of public services that level the playing field, permit new entry of businesses, allow people to choose their careers
Structural Change
- Industrial revolution
- 19th century Britain: millions of people left the countryside to go to textile
factories/steel mills, invent of the steam engine - Followed by Germany, USA (late 19th century)
- Extraction of oil, manufacturing products, car industry
- China, since 1978, has followed a similar path
-How did they change form agriculture to manufacturing?–> lewis model–> development strategy
Lewis Model
Won the nobel prize in 1979, was the most important/used model in the 60s and 70s
- 2 sectors: Traditional and modern
- Main idea = economic growth occurs as the labour force shifts away from the less (albeit
increasingly) productive traditional/agricultural sector and towards the more productive
and expanding modern/manufacturing sector
- Policy implications: Assuming that this structural change is desirable, we must
accelerate this change, which can be done by favouring certain industries
Traditional Sector (Lewis Model)
- No new technologies, productivity very low
- Marginal product of labour = 0
- Adding 1 extra unit of labour produces 0 extra units of output
- Therefore, there is a surplus of labour
- Zero marginal product of labour means that it is possible to withdraw people from
traditional sector without any fall in output
Modern Sector (Lewis Model)
- Wage is necessary to attract people from the traditional sector; however, this wage is very low
- Low wages and high initial marginal productivity of labour results in huge profits: these profits are reinvested in firm, resulting in more capital (K) → solow-type growth
- At higher levels of K, firms are more productive, and can afford to pay higher wages, even though they don’t need to (given the surplus of labour in the traditional sector)
- Until… the surplus of labour is absorbed
- Traditional sector: MPL becomes >0, incomes increase as agricultural output
increases (relative to when MPL was 0) - Modern sector: higher wage suddenly necessary to attract labour, but firms can
afford it
Natal vs Transkei
- Towns in South Africa of Natal (considered to be modern economy) vs Transkei (considered to be traditional economy) that are essentially right next to each other
- Research question: Is it an inevitable process that Transkei will become like Natal in the future? Or are there other things happening?
- Illustrates well the dual economy: the traditional and the modern sectors
- Natal: private property rights, functioning legal systems, markets, commercial
agriculture, and industry - Transkei: communal property in land and all-powerful traditional chiefs until
recently - Implication of the Lewis Model: We can change Transkei’s economy to resemble Natal’s
economy with structural change - However, it is important to note that the discrepancies between Natal and Transkei were
man-made, not naturally occurring
Dual economy
the traditional and the modern sectors
Criticisms of Lewis Model
- Dual economy may not be a passing stage
- Structural change is not inevitable
- Extractive political institutions may block the fear of creative destruction
- 1960s, 70s: foreign aid directed at building the modern sector, was a total failure
- Not as simple as simply “favouring firms”, as the Lewis model would suggest
How to actually accelerate structural change
Protect domestic industries: ISI, export promotion; foreign aid
Import Substitution Strategies
-Developing countries tend to specialize in the export of primary commodities (raw + agricultural)
-Protect infant industries (in import substitution sectors or export sectors)
- With inclusive political and economic institutions, probably a good idea: Entrepreneurs are protected, get credit, start businesses, compete on a global level, growth
- With extractive political and economic institutions, probably a bad idea: Elite has political power, pressures government to extend protection, no
incentives to increase productivity, remain inefficient, no growth
-Import substitution worked in Germany but failed in brazil and india
-Export promotion worked in japan, south korea, taiwan, singapore, hong-kong, is working still in china
Declining terms of Trade
- Ratio of export prices to import prices increases as demand for manufactured
goods increases as the world economy develops
Prebisch-Singer Hypothesis
argues that the price of primary commodities
declines relative to the price of manufactured goods over the long term, which
causes the terms of trade of primary-product-based economies to deteriorate
- Basically, developing countries kept in poverty by industrialized countries
Foreign aid
Initial idea of foreign aid in the 50s/60s was related to structural change
- Idea was to encourage/support local industries in developing countries
- However, yielded mixed results
- 1980s: structural adjustment policies, Washington consensus
The Washington Consensus (1990s)
- Called for privatization, trade liberalization, and fiscal discipline
- Also called for structural adjustment policies
- Implemented as conditions for loans to country in crisis by World Bank and IMF
The Washington Consensus (With inclusive political and economic institutions)
- Privatization: probably good: state-owned firms go in the hands of new dynamic entrepreneurs
- Trade liberalization: probably good: entrepreneurs specialize in their comparative advantage
- Fiscal discipline: probably good: less repayment on debt
