EDPSE-C4: Contemporary Economic Development §
Underdevelopment as coordination failure §
- Theories specifying what must work for development to occur and maintain
- Complementaries: when it is present, an action taken by one agent will incentivize other agents to take similar actions
- investments must be made by many agents for any individual agent to profit
- Coordination Failure: is a state of affair where agents fail to act together → all agents worse off (equilibrium) instead of the complementaries equilibrium
- Everyone has different expectation
- Everyone’s waiting for someone to take the first move
- Ex: The big push that reinforce the O-ring model
- People use MS Office because everyone use it, → circular causation of positive feedback loop
- Ex: Middle Income Trap: sunk cost fallacy
- They develop, but lack innovative capacity to reach high-income
- Ex: Small agricultural industry aren’t trust worthy in their quality, they need middlemen to sell to big buyers, to be qualified for middleman qualifications farmers need to specialize in a certain crop, but farmers have no incentive to do that since there is no buyers yet.
- Underdevelopment Trap: region remaining subsistent agriculture forever
- “Chicken or Egg” “Skill or Investment” Comes first:
- Solution: coordination of skill and investment coming at the same time. Government can take first step to make both happen at once
- Governments can be the initiator in complementaries, but it can also halt development
- Authoritarian Government thinks it might lose power if economy develops too far
- Solution: governments should make the economy more self-sustaining, where there is no incentive to go back to the bad equilibrium?
- What can the government do to solve coordination failures?
- Complementaries doesn’t exist in most places: especially where demand > supply in a competitive market
- Where to meet problem: farmers doesn’t know what to specialize in
Multiple Equilibria Diagram §
- The benefits for an agent for taking an action positively correlates to how many other agents are expected to take the same action and the extent of those actions
- The equilibrium is when the agent sees what it expects to see
- Agents chase their expected changes in the market → settling on the equilibrium either from up or down
- Both traditional and modern sector workers are important to holistic economic growth.
- There are 3 possible equilibrium
- Why is D1 and D3 are more stable
- In D2, if investment were a little bit over expectations it move to D3, if a little below it would move to D1
- Change starts slow as few agents invest in unexpected, then snowball effect to rapid change, then slow down again (S)
- Pareto-ranked Equilibrium: higher utility of it is beneficial to everyone (higher equilibrium is always better)
- Ex: Investment market: more investors benefits all investors, but its usually hard to get to the equilibrium
- Country’s middle income trap: industry not growing, no investment
- Requires government policy to move from a bad equilibria to a better one.
- The Invisible Hand of markets might change equilibrium, but can’t control direction: to bad/good
The Big Push §
- by Paul Rosenstein-Rodan
- Coordination failures make states fail to industrialize
- The first firms to spend on training which benefits later firms ⇒ no one wants to be the first firm ⇒ no industrialization
- The first firms can’t sell to its citizens or workers without the existence of other firms of different products
- To reach industrialization an economy needs a market failure to
- cause economywide and probably public-policy-led effort to hugely reform and push for an economic development
- Assumptions of the Big Push
- Factors: Labor (L): the only factor of production. It is a fixed total supply.
- 2 sectors with same production function (same input, same tech)
- Workers in traditional sector’s Wage = 1
- Workers in modern sector’s Wage > 1
- Technology: (N) types of products, where N is a large number
- Traditional Sector: 1 worker produces 1 unit of output (if it means 3 pairs of shoes a day)
- What is constant return to scale production?
- Modern Sector:
- What is increasing return to scale production?
- no product can be produced unless a minimum of (F) workers are employed
- labor requirements for producing any product in the modern sector take the form of L=F+cQ
- where (c) < 1 is the marginal labor required for an extra unit of output
- modern workers are more productive, but only if a significant cost is paid up front
- Increasing return to scale: makes every unit cheaper the more they are mass produced (economy of scale, production of scale)
- Domestic Demands: Each good receives a constant and equal share of consumption out of national income (Y)
- There is no savings
- National Income (Y) = Consumption
- International Supply and Demand:
- Domestic consumerism: service, quality, economy of scale, price… must be ensured before it can sell on the international markets
- Export-led economies have benefited from active industrial policy aimed at overcoming coordination failures
- Market Structure: Don’t understand!!!
- The role of the government to correct market failure is acknowledge
- They have to attract the first factories to set up (but very difficult because:)
- Intertemporal effects: no immediate result, takes lot of time to get result
- because no existing infrastructure
- have to train workers
- Which benefits later investors who have already trained workers
- Urbanization only happens when factories are already set up. But firms won’t set up factories in rural areas in the first place
- The government or public sector must be the one to bare the cost of the first step for firms to move in
- Government only have to pay for the initial stage of development, further development will be paid by incoming firms
- Why problem can’t be solved by Super-Entrepreneur investing instead of government?
- Super-Entrepreneur can’t bring in all the money into economy
- Too many things to be responsible for
- Electricity generation
- Pipe, electricity laying
- Road and bridge building and maintaining
- Communication failure
- Lack of access to information on time
- Limit to knowledge
- Locals don’t know how to manage building bridges, roads, telecommunication…
- They only know how to do simple things like garment
- Not enough empirical data to show its possible
O Ring Model §
- the O-ring model of economic development, this refers to the theory that even the smallest components of a complex production process must be performed properly if the end product of the process is to have any useful value.
- O Ring Model: firms must properly coordinate to all benefit
- Production is modeled with strong complementarities among inputs
- Positive assortative matching in production
- Implications of strong complementarities for economic development and the distribution of income across countries
- Positive associative matching
- Group high skill with high skill
- Group low skill with low skill
- To develop economy you have to develop the successful sector
- Challenges
- Uncertainty about which products can produce efficiently
- Ex: India’s success in information technology was unexpected;
- Ex: reasons for Bangladesh’s efficiency in hats vs Pakistan’s in bedsheets is not clear
- Need for local adaptation (evidence: seen in cases such as shipbuilding in South Korea): can’t transfer directly what works in one country to another without modifications
- Imitation can be rapid (e.g. the spread of cut flower exporting in Colombia): late comers grow much easier from your earlier success
Self Discovery §
- States don’t know their comparative advantage and what they should specialize in naturally
- They must discover that themselves
- Problem: During the process of discovery, they could face market failure
Questions and Answers §
- What are the models in the chapter:
- Multiple Equilibria
- Michael Kremer’s O-Ring model
- Economic Development as Self-Discovery
- The Hausmann-Rodrik-Velasco Growth Diagnostics Framework
- One of the characteristics of some developing economies is the relatively low level of trust of people outside one’s extended family.
- How might the models explored in this chapter shed light on this problem?
- What kinds of market failures are present in the economic self-discovery framework?
- how may they be overcome?
References §
