EC 454

Lecture 3

Prof. Dr. Durmuş Özdemir Department of Economics

Yaşar University

Development Economics and its

counterrevolution

• The specialized field of ‘development

economics’ was critical of certain aspects

of classical doctrine, found conventional

economics too abstract, often believed

with Keynes, in state intervention in the

growth process.

• A primary area of conflict: Trade and

Inflation

A critique to N-O Classical

economics: Structuralist approach

• Neoclassical economics had assumed that

smoothly working market systems and

effective price mechanisms organized all

economies efficiently (one type of

economy) contested by ‘structuralist

approach’

• Structuralists explained ‘specificity of third

world’.

Paul Prebish (1972) (Structuralist)

• World is not in monoeconomics terms; two

distinct areas;

– Periphery (Weak countries such as latin America,

Africa, Asia)

– Center (Economic power is in Europe and in USA.)

• Conventional economic theory argued

(comparative advantage). The exchange of the

central area’s industrial goods for the pripheral

area’s primary goods was to the periphery’s

advantage.

Periphery and the Center

• Technical progress in the center would lead to lower prices for industrial exports so that a unit of primary exports would buy more units of industrial imports.

• Over the long term progress would accrue to the periphery, without it becoming industrialized.

• Instead Prebish argued that Latin America’s peripheral position and primary exports were the cause of its lack of progress, specifically because of a long term decline in the peripher’s terms of trade (the ratio between the value of exports and the value of imports)

Terms of trade for Center

• Prebisch showed that the terms of trade for

center countries had improved with

industrialization, from which he concluded that

those of the periphery must have deteriorated.

• Technical advantage benefitted the center

countries rather than the entire world.

• This was not a temporary situation but a

structural characteristics of the global system.

Why conventional economic theory

failed to work?

• 1) Markets in the Center were characterized by imperfect competition and price reductions could be avoided while competition among primary producers reduced the prices for their goods.

• 2) The income elasticity of demand (the degree to which demand changes with a given change in income) is higher for industrial than for primary goods, so that the periphery’s terms of trade tended to decline from the demand side.

• PREBİSH concluded... Periphery should be industrialized

PREBİSH ... Periphery should be

industrialized

• Use import substitution strategy (i.e. Replacing industrial imports with domestic production under the cover of tariff protection), using income from primary exports to pay for imports of capital goods, state supervision of industrialization and , paradoxically, the enlishment of foreign companies to help start local businesses.

• This strategy (import substitution)adopted in peripheries and rapid industrialization is achieved.

Import substitution and its problems

• Over time, import substitution created:

– High cost

– Low quality industrial output.

– Economical damage in agriculture

– Entrenched positions (engelleme)for foreign

capital

Inflation conflict in periphery vs.

center• Monetarists: High inflation in periphery explained

by high money supply by monetarists. They argued price stability can be achieved by decreasing money supply.

• Structuralist: argued conversely. Supply and demand operated differently in peripheries (i.e. İn Latin America) with supply inelastic (i.e. Requiring a large price change to bring about small change in quantities of goods) because of structural characteristics like the domination of agriculture by latifundia(large estates) that did not operate on market principles.

Inflation conflict in periphery vs.

Center... Structuralists ..cont.

• The inflation problem could be resolved

only by structural changes such as land

reform, import substitution (to make

countries less dependent on foreign

manufactures) increased educational

opportunities, and improved fiscal system.

Structuralist Development

Economists (In general)• 1) Attempts to identify specific rigidities, lays,

and other characteristics of the structure of

developing economies that affect economic

adjustments and the choice of development.

• 2) Developing countries had features that set

them apart from the economies theorized by

orthodox economics. These features include;

– Hıgh level of rural underdevelopment

– Low levels of industrialization

– Disadvantages in international trade

The Position of Development

Economics• The development economics that emerged in

the 1950’s was different from neoclassical and Keynesian economics because of their specific focus on developing countries and their greater practicality in term of a more immediate policy orientation.

• The position of development economics eventually became not neoclassical or Keynesian. The result was hybrid development economics, a melange of ideas.

• Part structuralist, part neoclassical, part Keynesian, part pragmatic.

Some of the leading positions of

Development Economics

• 1) Dualistic Development

• 2) Mobilizing domestic resources

• 3) Mobilizing foreign resources

• 4) Industrial strategy

• 5) Agricultural strategy

• 6) Trade strategy

• 7) Human resource development

• 8) Project appraisal

• 9) Development planning and policymaking

1) Dualistic Development

• Poor countries have dual economy;

– A) A modern commercial sector; (Higher wage, Investment capital comes from high profit, Expanded until the excess labour was absorbed, whereupon wages rose to a point that might halt the capital accumulation.)

– B) A traditional sector; ( Low labour productivity (MPL =0 ), Large number of workers eager to transfer to the modern sector).

Dualistic Development.. (Cont.)

• Moreover, the terms of trade for products exchanged between the two sectors might eventually turn against the modern sector unless traditional agriculture was transformed along with the industrialization of the modern sector.

• Other aspects of this model included technological dualism, rural-urban migration even when urban unemployment rates rose, and the existence of a substantial informal sector providing basic goods and services to low income people.

• The main policy conclusion of the dual model was that attention had to be given to the utilization of labour outside the modern sector.

2) Mobilizing domestic resources

• Typically poor countries S = I = 5% of GNP.

• Development depended on increasing this ratio to 12-15%.

• The goal was to find ways to increase the saving rate and mobilize domestic saving (through banks and other financial institutions) to make domestic funds available for productive investment.

3) Mobilizing foreign resources

• However, both a ‘saving gap’ and a

‘foreign exchange gap’ could still remain.

• These could be filled from external

sources in the forms of public financial aid,

loans, private foreign investment, and

nonmonetary transfers of managerial and

technological knowledge.

4) Industrial strategy• Industrialization should produce, often in labour-

intensive, capital saving ways, the simple producer and consumer goods required particularly by rural people.

• In terms of strategy, some theorists advocated a ‘big push’ in the form of initially large industrial investments to enable external economies to be earned. (i.e. Lower costs through the growth of several industries at the same time)

• Harvey Liebenstein (1957) explained ‘economic backwardness’ in terms of a ‘low-level equilibrium trap’ whereby increased incomes tended to be pushed back down by population growth and consumption in the style of development economics.

Industrial strategy... (Cont.)

• Small efforts aimed at gradual change would be counter acted by population growth.

• For Liebenstein, the solution lay in a critical minimum effort mainly using the existing savings potential, especially funds used unproductively for luxury consumption or land purchases.

• With such an effort the scale of investment would enable a growth rate greater than population increases, typically as high as 4% a year.

Industrial strategy... (Cont.)

• Albert Hirschman (1958) advocated deliberately

promoting ‘unbalanced’ growth to stimulate

investment decisions and economize on scarce

entrepreneurial resources.

• Still others emphasized industrial exporting

• Increasingly this school paid attention to the

mutually supportive interactions between

industry and agriculture.

5) Agricultural strategy• Progress in agriculture was thought to be essential

for providing food and raw materials, yielding savings and tax revenue for development elsewhere in an economy, earning foreign exchange, and forming a market for industrial goods.

• Intersectoral relations between agriculture and industry would determine the course of structural transformation ina developing economy.

• Special help should be given to the rural poor to enable them to take advantage of new technologies (e.g. The ‘green revolution’ in new crop types and fertilizers).

• More radically a land reform lead better access for poor farmers to productive resources.

6) Trade strategy• Development economists were originally divided

on whether free trade increased international

inequalities or whether it could contribute to the

development of primary exporting countries.

• They disagreed also on whether development

strategies should be inward or outward-oriented.

Increasingly they favoured export promotion of

semi manufactured and manufactured goods

and the liberalization of trade regimes.

7) Human resource development

• The accumulation of material capital was to be paralleled by investment in ‘human capital’ by changing their abilities and skills, even by modifying motivations and values.

• Population growth strained public services, producing advarse effects, particularly on child nutrition.

• The idea was to relate health policies to the ecological, cultural, and nutritional situations that permitted disease to thrive in poverty areas.

• As with technology transfers, there was a need too for an appropriate transfer of medical knowledge and technology.

• Education had to be seen in relation to employment as an investment good-as ‘human capital’ or ‘embedied savings’.

8) Project appraisal

• Because investment resources were scarce in developing countries, there was a particular need for the rational allocation of capital and thus for development project appraisels by Governments and international agencies like World Bank.

• National or social profitability might differ from commercial profitability.

• So appraisel involved using applied welfare economics in a world of the second best.

• A ‘first best’ economy would ‘fulfil the marginal conditions of perfectly competitive equilibrium in all product and factor markets, with no uncertainty, no externalities and a given income distribution’ but conditions in adeveloping economy diverged particularly because of price distortions, hence the need for calculate efficient ‘shadow prices’ for project evaluations.

9) Development planning and

policymaking

• Some development economists voiced criticism of the market mechanism as;– Ineffective

– Unreliable

– Irrelevant to the problems faced by developing countries and a need to supersede markets by using state planning.

• Others; Found the deficiencies of market systems in developing countries relatively unimportant compared with the benefits deriving from the essential functions of markets. They argued that best way to strengthen an economy was to strengthen the market system..

Others:...strengthen the market

system.. (Cont.)

• As this last point illustrates, development economics increasingly divided on crucial issues like the efficiency of the market or state planning.

• At the same time, development economics was subject to a number of critical studies, from the perspective of conventional, established, economic principles, which undercut its scientific validity.

COUNTERREVOLUTION IN

DEVELOPMENT ECONOMICS

• A more general neoliberal or even

conservative reaction.

• Opposes:

– Keynesianism

– Structuralism

– Radical theories like dependency.

Opposers....

• Harry Johnson (1923-1977) criticised Keynesian economics in the early 1970’s;

• Intellectual movements in economics responded to perceived social needs rather than arising from an autonomous scientific dynamic. Keynesianism argued to end mass unemployment.

• Johnson said, Keynes’s conclusion that capitalism tended systematically to produce massive economic problems (stagnation, unemployment) was unjustifiable critical of entire system.

Johnson... (Cont..)

• Keynesian economic policies-ideas

displayed similar lack of confidence in

capitalism.

• Development economists erred (hata) in

adopting industrialization and national self

sufficiency as prime policy objectives with

economic planning as their instruments.

Johnson’s critiques.. Further..

• Unproductive industrial investments in developing counries, especially those of post independence Africa.

• Encouraged corruption.

• Favoured import substitution which in turn led to balance of payments problems.

• Misguided interventions into economic life in futile attempts at achieving social justice.

• Problems in the developing countries came not from the legacy of colonial history, nor from global inequalities, but from misguided Keynesian development policies (i.e. Great Depression-1930).

Johnson’s critiques.....

• Johnson also criticised the Keynesian Harrod-Domar model; Concentration on fixed capital investment as the prime economic mover.

• A neglect by Keynesian policymakers of the possibilities of technical progress and their mesmerization by problems of disguised under employment, especially in rural areas led to development policies that merely transferred productive resources into industrial production with no economic gain; poor farmers even efficient profit maximizers..

P.T. Bauer

• Bauer further criticised that mainstream

development economics not merely wrong, it

was intellectually corrupt.

• Many of the views taken by orthodox

development economics conflict with obvious;.....

Empirical evidence.

• So ınfact reducing powerty in the third world did

not require large scale capital formation, nor

even investment in human capital.

Bauer and his critiques...

• Foreign capital aid and technical assistance

might also do great harm.

• Bauer insisted that nontotalitarian societies

should refrain (çekinmek) from governmental

participation in the economy.

• These 1970’s theoretical critiques supported

politically by 10 years later by W.Germany, USA

and Britain in 1980’s.

• The period of ‘NEOLIBERALISM’ started..

Conclusion

• Questions

• Discussions