Development Economics

By Bahrum Lamehdasht

This book contains essays for Development Economics at the undergraduate level. This book includes the following topics:
- Defining and Measuring Development;
- Harrod-Domar Model;
- Lewis Model;
- Balanced Growth vs. Unbalanced Growth;
- Structuralism;
- Industrialization;
- Agriculture;
- Kuznets Curve;
- Poverty and Economic Growth;
- Kalecki's Development Finance Model; - Migration;
- Amartya Sen’s Entitlement Approach to Famine;
- Race to the Bottom: International Labour Standards;
- Democracy or Dictatorship?;
- Military Spending and Economic Growth;
- Multinational Companies;
- Globalization;
- Bretton Woods Institutions: The IMF and World Bank
- Aid.

• Language: English
• Publisher: Lulu.com
• Release date: Jun 6, 2014
• ISBN: 9781291909012

Book preview

Development Economics

Development Economics

Undergraduate Essays and Revision Notes

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Bahrum Lamehdasht

© Bahrum Lamehdasht 2012

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without prior permission of the publisher.

Introduction

Development Economics: Undergraduate Essays contains a collection of development essays that answer the key questions in all the major development economics topics studied at the undergraduate level. This book contains essays that thoroughly explain the assumptions, theories, empirical evidence and critiques of the major development growth theories such as the Harrod-Domar model and the Lewis model. Moreover, this book possesses a wide array of essays focusing on the industry vs. agriculture debate in development economics as well as the problems of rapid population growth in developing countries. Lastly, this book looks at the main external influences on LDCs such as MNCs, globalization, and the IMF, and discusses whether these external influences are a positive or negative force for developing countries.

As for the intended audience, this book is aimed at undergraduate economics students all over the world. This book is mainly written for second and third year undergraduate students. Whether you are starting an essay and want some guidance or you have written an essay and want confirmation that you are on the right track, this book is here to help you. Additionally, Masters and PhD students could also use this book to study or revize a particular topic.

Economic theory can, at the best of times, be difficult to understand. Thus, this book explains theory in a step-by-step approach to help you build your understanding. Moreover, all the relevant diagrams and equations for each topic are presented and explained thoroughly throughout this book.

This book treats each essay in an unbiased manner and comes to a fair conclusion for each topic based on a careful consideration of theory and empirical evidence. Each essay has been researched meticulously and all the references are provided to allow you to follow up this research and explore further readings.

Finally, please note that this book is not intended for you to plagiarise from. This book intends to help you better understand economic theories, show you how to lay out an essay and gives you relevant empirical examples to illustrate economic theory in action.

Measuring Development

Question: What is economic development? How can we measure development?

Introduction

Adam Smith (1776 cited in Todaro and Smith 2006, p.8) arguably became the first development economist when he began to consider the processes and problems of economic growth and development in his famous book ‘The Wealth of Nations’. However, it was Arthur Lewis (1955 cited in Todaro and Smith 2006, p.8) who established development economics as a separate field. Development economics deals with LDCs and, in particular, how their economic, social, political and institutional mechanisms work to allocate resources, grow over time and increase living standards (Todaro and Smith 2006, p.9). Although, defining and measuring economic development has proved to be a difficult task, mostly because of the normative nature surrounding the term ‘economic development’.

This essay begins by attempting to define economic development. Next, this essay explains how development could be measured using real GDP per capita at Purchasing Power Parity (PPP), and also how this is a flawed measure of development. Afterwards, this essay describes how the Human Development Index (HDI) may be used to measure development as well as the drawbacks in using the HDI to measure development. Finally, this essay concludes.

What is Development?

Across the planet there are developed and developing countries. Developed countries are typically characterized by high GDP per capita, high living standards, families of four, electrical goods, suburban houses, cars, people eating three meals a day, access to clean water, electricity and social and political freedoms (Todaro and Smith 2006, pp.3-4). LDCs are typically characterized by low GDP per capita, low living standards, families of eight, a subsistence economy, shanty towns, carts, people eating only one meal a day, limited access to clean water, electrical black-outs and civil unrest (Todaro and Smith 2006, pp.4-5).

But how exactly do we know if a country is developed? This is not an easy question to answer because ‘economic development’ means different things to different people (Todaro and Smith 2006, p.15). Additionally, the debate over what constitutes as development or the ‘good life’ is as old as philosophy itself (Todaro and Smith 2006, p.20). As economics is a social science it looks at human beings satisfying basic material needs (food, shelter and clothing) and non-material wants (education, knowledge and spiritual fulfilment) (Todaro and Smith 2006, p.13). Resultantly, value judgments must be made about what is or is not considered as helping economic development (Todaro and Smith 2006, p.13). For example, subjective value judgements must be made regarding equity, national independence, democracy and personal fulfilment and whether these contribute towards development (Todaro and Smith 2006, p.13). Consequently, there can be no fixed definition of economic development.

Development, traditionally, has been linked to the economic capacity of a country (Todaro and Smith 2006, p.15). Until the 1980s, the World Bank championed economic growth as the major goal of economic development (Todaro and Smith 2006, p.17). An increase in economic growth means GDP per capita rises, income increases and consumers can buy more basic foods so their diet improves. Moreover, as incomes keep rising, consumers can buy electrical goods like televisions and enjoy life so living standards rise further. However, an increase in economic growth does not necessarily mean there is economic development. Economic growth is necessary but not sufficient for development (Nazfiger 2006, p.15). Economic development is multidimensional and includes incomes, health, nutrition, education, happiness, social and political freedoms (Todaro and Smith 2006, p.17). Better education and literacy means people can read books. Social freedoms give people the right to meet friends and engage in activities they enjoy. Political freedoms mean people can vote and speak freely.

Real GDP Per Capita at Purchasing Power Parity (PPP)

A possible measure of economic development is real GDP per capita at Purchasing Power Parity (PPP). The idea behind GDP measuring development is the neoclassical trickle-down effect (Todaro and Smith 2006, p.16). Basically, a rise in GDP means that there is more money flowing around the economy, more incomes are being spent, AD increases, firms produce more goods and, since labour is a derived demand, more jobs are created and particularly jobs for the poor. Resultantly, the benefits of economic growth ‘tickle-down’ to the poor. The poor can then use their new jobs and incomes to buy basic necessities such as food and clothing that increases their living standards. Besley and Burgess’ (2003, pp.3-22) research reveals that LDCs’ GDP per capita elasticity of poverty is -0.73 meaning that a doubling of GDP per capita will decrease poverty rates by 73%.

Nominal GDP cannot measure development though as we must take into account inflation. A rise in nominal GDP could be due to a rise in the output of the economy or a rise in prices. A rise in prices means consumers’ buying power shrinks and, consequently, their living standards fall. Thus, we must use real GDP to take into account inflation. A rise in real GDP means consumers have more money to spend and can increase their living standards by buying more goods and services.

Also, real GDP alone cannot measure development as we must consider the size of the economy. An economy with a large population will likely have a higher GDP than an economy with a smaller population because the larger one can produce more so it is unfair to compare their GDPs. Instead, real GDP per capita must be used to compare economies and living standards. Real GDP per capita is real GDP divided by population, it measures the average real GDP per person. An economy could have a high real GDP but a low real GDP per capita in contrast to another economy with a low real GDP but high real GDP per capita, the average person is better off in the second economy.

How do we compare the real GDP per capita of two countries? We could convert their GDPs into a common currency say, for example, US dollars using market exchange rates but this will not help us measure living standards because market exchange rates fluctuate wildly and the price of many non-tradable goods like houses and domestic transportation are not included in market exchange rates (Ray 1998, pp.12-13). GDP must be compared using Purchasing Power Parity (PPP) instead. With PPP, two countries’ real GDP per capita is compared adjusting for the prices of the same bundle of goods and services within those countries.

Critique of Using Real GDP Per Capita at PPP to Measure Development

As good as it may seem to use real GDP per capita at PPP as a measure of development, there are some serious flaws in this measure as it does not accurately measure the welfare or living standards of an economy because many other factors affect welfare, as described below.

1) Health. Better health means better living standards, but GDP does not take into account the health of the population. GDP may be correlated with health because a higher GDP means people have more money and better access to healthcare. But there is no guarantee that a higher GDP will be distributed to the poor or that an adequate healthcare facility will be available in LDCs.

2) Social Indicators. Better education and less crime means better living standards, but again this is not included in GDP. Again it may be the case that a higher GDP means people’s living standards rise and there is less incentive to commit crime but this will not be true if income distribution is becoming more uneven, the poor may actually then be incentivized to commit crime as they cannot obtain what they need/want through legal means (i.e. working).

3) Political Freedoms. Additionally, GDP does not measure democracy or dictatorship (Ray 1998, p.8). An LDC could have an extremely high GDP but if the economy is under a dictatorship then the population may feel like they have no autonomy and this can have a major negative effect on self-esteem and living standards (Todaro and Smith 2006, p.21).

4) Income Distribution. Moreover, as eluded to by the previous critiques, GDP does not consider income distribution. As GDP per capita is an average of national income it tells us nothing of how that income is distributed within an economy (Quah 2001, p.4094). Are the rich getting richer and the poor getting poorer? If an LDC has a high GDP per capita this does not necessarily mean income is distributed evenly because an economy could have a high GDP per capita if there is one extremely rich person and the rest are poor. As Seers (1969, pp.3-4) puts it, it would be ‘strange’ to call development a situation where GDP per capita rises rapidly but so too does inequality, poverty and/or unemployment.

5) Black Economy and the Subsistence Sector. Furthermore, GDP only measures official transactions, it does not measure illegal transactions in the black economy or unrecorded transactions in the subsistence sector. In LDCs there is likely to be many unrecorded transactions in the black economy and the majority of people may work on their own farm with their family and consume the food they produce (Ray 1998, p.10). These will have a major effect on development but GDP cannot capture them.

6) External Costs. Lastly, GDP may be a poor measure of development because it does not include the effects of externalities (Ray 1998, p.16). A high GDP means a lot is being produced, but it is also likely to mean that pollution is high and pollution could damage health and thus lower living standards. Also, too much production could mean resources deplete and future generations suffer lower living standards.

Human Development Index (HDI)

An alternative measure of economic development is the United Nation’s Human Development Index (HDI). The HDI is an index combining: 1) Income - Measured by GDP per capita at Purchasing Power Parity (PPP), 2) Health - Measured by life expectancy at birth and 3) Education - Measured by the adult literacy rate and primary/secondary/tertiary educational enrolment rates.

The HDI is therefore a multi-dimensional measure of development as it measures a mix of income, health and education. These three measures are given equal weighting. The HDI lies between 0 and 1. A country is more developed the higher its HDI score is. A HDI score between 0-0.499 means the country is in a ‘low stage of development’, a HDI score between 0.5-0.799 means the country is in a ‘medium stage of development’ and a HDI score of 0.8-1 means the country is in a ‘high stage of development’. The data used to compile the HDI is easy to obtain as almost every country has GDP, life expectancy and literacy rate figures (Todaro and Smith 2006, p.61). Also, international agencies value the simplicity of the HDI as they seek a universal measure of development (Maxwell 1999, p.1).

As the UNDP (2013) reveals, the 2012 HDI scores of DR Congo, Saudi Arabia and the USA were the following:

1)                              The HDI of DR Congo was 0.273, meaning DR Congo was in the ‘low development’ bracket.

2)                              The HDI of Saudi Arabia was 0.782, putting Saudi Arabia into the ‘medium development’ bracket.

3)                              The HDI of the USA was 0.937, placing the USA in the ‘high development’ bracket.

Additionally, the HDI shows that, although a contributing factor, an economy does not need to have high growth rates of GDP per capita to increase their economic development as health and education are equally important. Kerala for instance, an Indian state with almost the lowest GDP per capita in India, emphasized female education and property ownership, communal medical care and old-age pensions and resultantly increased their HDI score to 0.68 compared to India’s average of 0.59 (Nazfiger 2006, p.38). This is in stark contrast to the oil economies of the Middle East who experienced economic growth without economic development (Todaro and Smith 2006, p.61).

Critique of Using the HDI to Measure Development

The HDI may be an improvement on real GDP per capita at PPP as a measure of development but it too suffers from some drawbacks, as explained below.

1) Income Distribution. The HDI includes GDP per capita but it does not reveal the distribution of income. A high GDP per capita tells us nothing of the majority of the population because it is only an average measure. An LDC could have a high GDP per capita even though the majority of the population are in poverty. Maybe the Human Poverty Index could be added to the HDI to include a deprivation measure.

2) Quality of Life or Education. Although the HDI incorporates life expectancy and educational figures it does not reveal the quality of life or education. An LDC is not developed if life expectancy is high but quality of life is low due to, for example, disease and war. Moreover, kids could be in school but not learning. Also, maybe kids are taught academic knowledge when they need practical knowledge (cooking, cleaning and building) to raise their living standards.

3) Ad Hoc Weights. The HDI weights each of its three measures equally (1/3rd each) but this is ad hoc as there is no reason why they should be weighted equally (Ray 1998, p.28). Maybe health should be weighted more than income as you can only enjoy your income if you are healthy. As Todaro and Smith (2006, p.61) sum up, the value judgements behind the HDI’s weights are difficult to understand.

4) Political Aspects. The HDI does not include political indicators like democracy and dictatorship or other social indicators such as crime rates. An economy cannot be considered developed if incomes are high but there is a dictatorship and the population are given no choice over their social lives, education or careers.

5) Gender Inequality. An LDC cannot be regarded as developed if the male population have freedoms and an education but the female population are restricted any similar rights. As Saith and Harris-White (2000, pp.57-88) suggests there are high gender gaps in education in Sub-Saharan Africa and South Asia which the HDI does not include.

Conclusion

As this essay has argued, there can be no fixed definition of economic development because it has many meanings and can be interpreted in many ways. For example, one development expert may see development as merely increasing income whereas another development expert may see it as increasing income, health and education. Two ‘development studies’ experts who want to promote development in the same country may then actually be talking about very different things. Even if a definition of development can be agreed on, there is the problem of measurement. This essay has discussed the use of real GDP per capita at PPP and the HDI as measures of development and shown that, although they help us measure development to some extent, they cannot capture all the necessary ingredients of economic development. Maxwell (1999, p.1) neatly sums up the problem at hand by stating that the challenge is to achieve a trade-off between measurability, which requires standardisation, and local complexity. A useful starting point to measure economic development is real GDP per capita at PPP and the HDI, and these can then be used in conjunction with other measures such as income inequality, gender inequality and political indicators to give a clearer picture of the economic development of an economy.

Bibliography

1) Besley, T. and Burgess, R., (2003), Halving Global Poverty, Journal of Economic Perspectives, 17(3).

2) Maxwell, S., (1999), The Meanings and Measurement of Poverty, ODI Briefing Paper, vol.3, February, online, available from:

http://www.odi.org.uk/sites/odi.org.uk/files/odi-assets/publications-opinion-files/3095.pdf

Accessed 20th August 2013

3) Nazfiger, E., (2006), Economic Development, Cambridge: Cambridge University Press.

4) Quah, D., (2001), Economic Growth: Measurement, in Ashenfelter, O., (eds), International Encyclopaedia of Social and Behavioural Sciences, Amsterdam: Elsevier.

5) Ray, D., (1998), Development Economics, Princeton: Princeton University Press.

6) Saith, R., and Harris-White, B., (2000), The Gender Sensitivity of Well-being Indicators, in Razavi, S., Gendered Poverty and Well-being, United Kingdom: Blackwell Publishers.

7) Seers, D., The Meaning of Development, International Development Review, 11(4).

8) Todaro, M. and Smith, S., (2006), Economic Development, London: Pearson Addison Wesley.

9) United Nations Development Programme (UNDP), (2013), online, available from:

http://hdr.undp.org/en/humandev/

Accessed 20th August 2013

The Harrod-Domar Model

Question: Assess the adequacy of the Harrod-Domar model in the context of poor countries.

Introduction

The Harrod-Domar model is a dynamic extension of Keynes’ static equilibrium model (Thirlwall 2003, p.137). The Harrod-Domar model was built independently by Roy Harrod (1939, pp.14-33) and Evsy Domar (1946, pp.137-147). The Harrod-Domar model was developed in the context of advanced capitalist economies and posits that an economy is balanced on a knife-edge of equilibrium growth, but it is also used to address the growth process of LDCs (Solow 1956, p.65).

Adam Smith (1776) sparked off economists’ interest in economic growth in his book ‘The Wealth of Nations’. Alfred Marshall (1920, p.4) claimed that the quest for economic growth is economics’ holy grail. Robert Lucas Jr. (1988, p.5) stated that once one starts thinking about economic growth, it is hard to think about anything else. With the Harrod-Domar growth model presented between the late 1930s and mid-1940s, advanced capitalist economies were interested in economic growth. After World War 2, policy mavens, having ignored LDCs for centuries, called for attention to the ‘urgent problems’ of LDCs and inevitably turned to the growth process of LDCs (Easterly 1997, p.4).

This essay begins by building