Economic Development -Todaro All Chapters Summary ~ Universal Magzine

Chapter 1

Advancement in communications technology has brought people closer together. Yet, the global community is divided between affluent developed nations and struggling developing countries. Many of us have a limited understanding of how greatly life in Africa, Asia, and Latin America differs from life in Western Europe and North America. The first main point of Chapter 1 is to drive this idea home, and consider that policy decisions made in the developed nations exert profound impacts, for better or worse, on the people of developing countries.

The second major point of Chapter 1 is that development economics must encompass the study of social, political, and economic factors affecting the well-being of all people. With improved distribution of income and application of appropriate modern technology, developing countries, assisted by developed nations, must aim at eliminating absolute poverty.

A major theme of Chapter 1 is the sustained increases in the level of per capita income must enhance human capabilities in achieving equality, freedom, and interdependence. The chapter stresses the role of normative values in development economics, which is a subject dealing with human misery and human potential, equity and efficiency, cultural change, and transfer and creation of wealth.

The chapter concludes that economic development is both a physical reality and a state of mind. The meaning and objectives of development include the provision of basic human needs, reduction of inequality, raising living standards through appropriate economic growth, improving self-esteem in relation to the developed countries, and expanding opportunities and freedom of choice.

Chapter 2

Chapter 2 presents several important topics in development economics. They are

· A classification of countries according to economic and social indicators

· A method of measuring the level economic development across countries The Human Development Index: measurement and ranking of countries

· An overview of the common development problems faced by many developing countries

· A discussion on the relevance of the historical experience of the developed countries for the less developed countries

· A discussion of the question of income convergence across countries

· A discussion of long-run causes of comparative development

Per capita income (using exchange rate conversion and/or in purchasing power parity equivalence) is used to classify countries. Data on several social indicators (e.g., life expectancy and adult literacy) complement per capita income to measure economic development as a broad based improvement in human life. Moreover, the Human Development Index is employed to measure development and to classify countries.

Developing countries are not homogeneous but are enormously diverse in their structure. Nevertheless, they have several common features and problems including the following:

· Lower levels of living and productivity

· Lower levels of human capital investment

· Higher levels of inequality and absolute poverty

· Higher rates of population growth

· Greater social fractionalization

· Larger rural population and rapid rural-urban migration

· Lower levels of industrialization and manufactured exports

· Adverse geography

· Underdeveloped markets

· Lingering colonial heritage, external dependence, and governance challenges

· Relative importance of private and public sectors and civil society

The chapter concludes with a discussion on the relevance of the historical experience of the developed countries to today's LDCs with respect to:

Physical and human resources endowments
Per capita income and GDP relative to the rest of the world
Population size, distribution, and growth
Historical role of international migration
International trade benefits
Scientific and technological research capabilities
Efficacy of domestic institutions

Due to variable income growth rates, it is expected that the per capita incomes within MDCs would converge. However, the MDCs-LDCs income disparity has a tendency to widen over time

Chapter 3

The overall aim of the chapter is to provide a historical overview of the classic development theories put forth in the past 50 or so years that there has been a development economics field of study. The key features of each theory are presented, along with a discussion of the major contributions and limitations of each theory. It is emphasized that while the theories are often competing in nature, each offers valuable insight into the development process. The comparative case study at the end of this section of the text also emphasizes this idea. The theories discussed are the:

· Rostow's Theory

· Harrod-Domar Model

· Lewis Model

· Structural Change and Patterns of Development

· Neoclassical Dependence Model

· False Paradigm Model

· Dualistic Development Thesis

· Neoclassical Market Orientation Model

· Neoclassical Growth Theory

The linear stages of growth models share the central role of savings and capital formation as their basic theme. The two examples given are W.W. Rostow's theory and the Harrod-Domar model. The text finds this approach limited since the structural and institutional conditions necessary to effectively utilize savings are often lacking, and the possibilities of development are often conditioned on international factors beyond an LDC's influence.

The structural change models stress the transformation from a traditional, agricultural economy to a modern, industrial economy. The Lewis model is carefully developed and analyzed as the key theoretical illustration of this approach. Though important for attracting attention to linkages between traditional agriculture and modern industry, it is criticized for assuming that real urban wages will not rise and that migration and modern sector employment grow proportionately (with urban full employment). Chenery's findings of the patterns of development are presented as an illustration of an empirical approach, and include the shift in production from agriculture to industry and services, the accumulation of physical and human capital, the shift to nonfood consumption and investment, urbanization, and the growth of trade as a share of GNP. The text cautions that country variations are large.

Three variants of the international dependence and false-paradigm models are explained.

· The neocolonial dependence school emphasizes the unequal power relationships between the developed and less developed countries and blames underdevelopment on conscious or unconscious developed country exploitation, which is perpetuated by a small elite ruling class within the less developed countries.

· The false-paradigm model argues that underdevelopment is fostered by well-meant but inappropriate advice from aid agencies and other Western trained economists.

· Singer's superior-inferior sectors model is cited as representative of the dualistic development thesis. Despite doubts that developed countries are intentionally keeping the developing countries in a dependent state, the fact that many key international economic decisions are made in the developed countries is acknowledged.

The theory of the 1980s is termed the neoclassical counterrevolution, and this theory emphasizes corruption, inefficiency, and a lack of economic incentives within developing countries as being responsible for the lack of development. The text makes a distinction between three approaches:

· The free market approach argues that markets are efficient and any government intervention is counterproductive.

· The public choice or new political economy approach emphasizes inherent government failure and the self-interested behavior of public officials.

· The market friendly approach, currently advocated by the World Bank, recognizes market imperfections, and hence a limited but important role for government through nonselective interventions such as infrastructure, education, and providing a climate for private enterprise.

The Solow growth model is mentioned in the context of traditional neoclassical growth theory. This section concludes by identifying three important contributions:

· Market price allocation is usually more efficient than intervention.

· State-owned enterprises have not fulfilled their promise and have been inefficient.

· Incentives must be stressed.

This approach is criticized on the grounds that the markets in developing countries, when they exist, are far from perfect in many respects and cannot be made perfect by any simple formula.

Appendix 3.1 employs the Production Possibility Frontier to offer theoretical discussion and graphical illustration about three major components of economic growth:

· Physical and human capital formation

· Labor force growth

· Technological advancement

Chapter 4

This chapter presents the most influential newer models of economic development. The classic models are insufficient, and so have been refined or replaced by new ideas. The general goal of the chapter is to demonstrate that development may be more difficult to accomplish than has been previously understood.

Contemporary models of development attempt to incorporate one or more of the following ideas:

· Problems of coordination among agents

· Increasing returns to scale

· Finer divisions of labor

· New economic ideas of information

· Learning by doing

· Imperfect competition, such as monopolistic competition

Several particular types of models are discussed. These include endogenous growth models such as Roemer's model, and coordination failure models such as the "Big Push" model and Kremer's O-Ring theory.

After a general introduction, the chapter begins with a discussion of "new" growth theory (or endogenous growth models). The text motivates this discussion by considering the shortcomings of Solow's growth model, in which technological progress is exogenously determined. In the Roemer model, technological change is endogenously determined: economy wide capital stock affects industry-wide output (that is, increasing returns to scale may exist). This model, unlike the Solow model, can explain persistent economic growth. Several criticisms of Romer's model are presented.

The chapter continues on to describe and discuss models that posit that underdevelopment is the result of economic agents' failures to coordinate with each other. In such models, multiple equilibria are possible, and economies can be stuck in a "bad" equilibrium. In such cases, government intervention may be required to move the economy to a preferable equilibrium. For example, in an underdeveloped area industrialization may fail to occur because firms are reluctant to locate in places where workers do not possess the requisite skills. Workers in that have no incentive to acquire such skills, since no employment opportunities exist. The text presents a diagram explaining the concepts of multiple equilibria and coordination failure. Rosenstein-Rodan's "big push" model is described and presented diagrammatically as an example.

Several other multiple equilibria problems are then discussed. These include inefficiencies associated with incumbency, and behavior and societal norms. Linkages between industries are also discussed, as are the relationships between multiple equilibria, economic growth and income inequality.

Kremer's O-ring model is presented as a final example of coordination failure. In these models, workers of similar skill levels tend to work together (that is, high-skill workers tend to match up, and low-skill workers also work with other low-skill workers). This creates the possibility that an economy can be caught in a low production quality 'trap.' Production bottlenecks are also possible outcomes.

Hausmann-Rodrik-Velasco's "growth diagnostic framework" proposes a decision tree to illustrate that one development model would not fit all economies. It argues that the development strategy must identify a economy’s most binding constraints and the development policy must target the removal of such constraints.

Chapter 5

This chapter takes up the question of growth versus income distribution. The chapter examines five questions:

· What is the extent of relative inequality and poverty in LDCs?

· What are the economic characteristics of the poor?

· Who benefits from economic growth?

· Are economic growth and more equitable income distributions compatible objectives?

· What policies will reduce absolute poverty?

The concepts of size and functional income distribution are defined as common measures of income distribution. Within this section, the following topics are covered:

· A review of Lorenz curves and measures of inequality.

· A discussion of functional income distributions and the role of labor supply and demand in determining wages.

The issue of measuring poverty is tackled next. Headcount indices and poverty gap measures are discussed first, and then the Foster-Greer-Thorbecke poverty measure and the Human Poverty Index are described.

The text goes on to discuss the relationships between poverty, inequality, and social welfare, beginning with a general discussion of why inequality is such a bad thing. Three stylized typologies, modern-sector enlargement, modern-sector enrichment, and traditional-sector enrichment, are described in terms of their effects on inequality. Empirical evidence on the relationships between inequality and income level and between inequality and economic growth is presented. This evidence suggests a weak or absent relationship in both cases.

Empirical evidence on inequality and absolute poverty is presented. Country and regional data includes size distribution of income, Gini coefficients, and numbers living in poverty.

The economic characteristics of the poor are described. This helps explain who benefits from growth, and can provide guidance to policymakers who want to reduce poverty. In particular, rural dwellers, women, and ethnic minorities are disproportionately affected.

Policy options for addressing poverty and inequality while maintaining growth are considered:

Remove factor price distortions.
Redistribution of asset ownership, such as land reform. This topic is discussed further in Chapter 9.
Progressive income and wealth taxes to reduce income inequality.
Direct transfer payments and public provision of goods and services to reduce the extent of poverty.

Appendix 5.1 takes up the issue of appropriate technology and how factor price distortions may lead to inappropriate choices regarding production technique.

Appendix 5.2 explains the Ahluwalia-Chenery Welfare Index in detail. GNP is shown to be a biased indicator of development and welfare, and equal-weighted and poverty-weighted measures are demonstrated to be better indicators of who is benefiting from the growth of production. Data is presented for 12 countries.

Chapter 6

This chapter examines how the population situation in many developing countries affects their chances of becoming more economically developed, and conversely, how economic development affects population growth.

The first part of the chapter explores historical and recent population trends and the changing geographic distribution of the world's people. Interesting statistics include world population data, distribution by region, and fertility and mortality rates. Key concepts include:

The dependency burden.
The hidden momentum of population growth.
The demographic transition.

The causes of high fertility in LDCs are explained using the Malthusian and Household models.

The Malthusian Population Trap model suggests the population will be forced to live at the subsistence level of income as population growth outstrips growth in the supply of food. The solution is to implement birth control measures. Criticisms are offered and include the failure to take technological progress into account and the failure to account for the microeconomics of family-size decision making.
The Microeconomic Theory of Fertility attempts to explain the falling birthrates associated with stage III of the demographic transition. It is suggested that people choose how many children to "consume" as part of their utility maximization problem. Budget constraint indifference curve analysis is presented. Children in LDCs can be thought of as investment goods. Reasons are offered for why families in LDCs are having more children, such as the lower opportunity cost of time and a lack of job and education opportunities for women.

The debate over whether rapid population growth is a genuine problem or constraint in achieving economic development is discussed.

Arguments for why population growth is not a problem include identifying population growth as merely a symptom of widespread poverty and a lack of alternatives for women, identifying population distribution as the real issue, and identifying benefits that come with having a larger population such as a larger domestic market for consumer goods.
Arguments for why population growth is a problem include reduced family savings rates, government difficulties in providing basic services to a growing population, and the need for more rapid growth in GDP to keep up with population growth and maintain living standards. Population growth as a cause and consequence of underdevelopment is discussed. Empirical evidence suggests seven negative consequences of population growth.
Recent consensus between the two sides is discussed in terms of agreement that population growth is not the primary cause of low levels of living, agreement that rapid population growth makes development more difficult to achieve and sustain, and agreement that many problems can be attributed to population density.

Policy approaches include eliminating absolute poverty, reducing income inequality, expanding education opportunities for women, providing more job opportunities, and improving access to health care and clean water. Family planning programs for some developing countries are presented. It is suggested that the developed countries try to simplify lifestyles and consumption habits to conserve world resources.

Chapter 7

The chapter discusses the related problems of urbanization and migration. Key topics include:

Urbanization trends and projections
The role of cities and of the informal sector of the economy
Urban unemployment
Todaro’s migration model
Policy options for limiting rural-urban migration

The urbanization problem is described using data on urban population growth over the past 50 years. Urban population growth is generally far more rapid than total population growth, with about half the urban growth accounted for by migrants from the rural areas. Developing country cities are growing far more rapidly than those in the developed countries. Shantytowns and similar makeshift settlements represent over one-third of developing country urban residents.

The chapter explores the consequences of public policies favoring large cities at the expense of small towns and villages. In addition, it explores the dualistic pattern of urban development, where a modern formal sector exists alongside a large urban informal sector. About half of the urban labor force works in the informal sector, often with low wages and no fringe benefits. Characteristics of urban informal sector jobs include:

low skill
low productivity
self-employment
lack of complementary inputs
jobs in petty sales and services
recent migrants facing social and economic adjustments

Given constraints on modern sector growth, the text argues that this sector should be promoted as a major source of employment and income for the urban labor force. This sector already generates up to a third of urban income, generates demand for unskilled labor, and adopts appropriate technology. An improvement in the infrastructure and credit available to this sector could generate large benefits in terms of increases in income and jobs for the poor. On the downside, promoting this sector runs the risk of encouraging more migration unless more resources are devoted to the rural sector at the same time.

The pros and cons of rural-urban migration are reviewed. Migration is viewed as both a symptom and contributor to underdevelopment, much as population growth is. Todaro’s migration model helps explain why it is rational for rural residents moving to crowded cities, where unemployment is high and the probability of finding jobs is low. The model is based on differences in expected income between the urban and rural sectors. High urban unemployment is inevitable given the large expected income differentials between the rural and urban sectors which exist in many LDCs. A diagrammatic presentation of the model is included.

Highlights of Todaro’s migration model include:

The need to reduce the urban bias of development strategies and encourage integrated rural development. This will reduce the wage differential between the urban and rural area.
Creating urban jobs is an insufficient solution to the urban unemployment problem because more migration is induced
Expanding education opportunities often results in more urban migration
Urban wage subsidies are counterproductive as they encourage more migration by increasing the probability of finding a job

Policy options for reducing migration and increasing employment follow from Todaro’s migration model conclusions. They include creating an appropriate rural-urban economic balance, expanding small scale labor intensive industries, eliminating factor price distortions, and reducing population growth.

Chapter 8

The chapter begins with some general comments on the critical role of education and health in the development process. These are seen as determinants of growth and development as well as objectives of the development process. The introduction also argues that investments in these two areas are so closely intertwined that they must be considered together.

Next, the chapter presents and discusses trends in education and in health since 1970. Evidence is presented on enrollment rates, teacher-pupil ratios, average schooling years, life expectancy, and survival rates.

Contrary to what some have believed, increasing incomes may be insufficient for increasing health status and educational attainment. Several reasons for this are given, including a presentation of evidence of income inelasticity of demand for calories, and that additional incomes may be spent on "convenience" foods with lesser nutritional value.

The chapter next presents the human capital approach, which is a useful way to analyze investments in health and education. The approach is described, and calculations of private and social rates of return are presented for different developing regions and for developed countries.

The pervasive issue of child labor is taken up next. The text uses a coordination failure approach (see chapter 5) to demonstrate that government intervention may be necessary to break away from a "bad" equilibrium. Various policy options relating to child labor are discussed.

A discussion of the important issue of women and education is the next topic in this chapter. Evidence of the 'gender gap' from 10 developing countries is presented, followed by a description of the consequences of such a gap.

The relationship between the education system and development is considered next.

The demand for education is determined by the expected income benefits and direct and indirect costs of schooling, while the supply of school places at all levels is determined by the political process, and is often unrelated to economic criteria. In most developing countries expected income gains to education are high, in that modern sector employers, including the government, select by educational attainment irrespective of actual work requirements. The demand for more schooling tends to spiral upward over time.
The concepts of social and private costs and returns to education are explained. Two graphs in the text illustrate how the private and social costs and benefits change as years of schooling increase. The expected private returns increase at an increasing rate while the private costs increase much more slowly, indicating that it is optimal to secure as much schooling as possible. In contrast, the social returns increase sharply at first and then taper off while the social costs increase at an increasing rate, indicating that there is an optimal quantity of schooling to provide at the point where the marginal social costs and benefits are equal. The text suggests that public resources are being misallocated in that too much schooling is being provided. It is also suggested that it might be better for the government to invest in higher quality education, rather than higher quantity.

Lorenz curves for education show that there are significant differences between developing countries regarding the distribution of education. In addition, there seems to be an inverse relationship between a country's average years of schooling and the degree of inequality in the distribution of education. The next part of this section discusses the counterintuitive finding that in many developing countries the education system may lead to higher degrees of income inequality. A final part discusses the so-called brain-drain: the observation that highly educated citizens of developing countries often emigrate to developed countries.

The relationships between development and health systems are considered in greater detail. Measurement issues are discussed first, followed by a presentation of evidence regarding the 'disease burden.' Specific health issues, especially malaria and the HIV-AIDS epidemic, are considered in particular detail before the possible effects of poor health on productivity are considered. A comparison of health systems and the implications for policy makers conclude the section.

Policy options for how to make the educational and health systems more relevant for development needs is discussed. The text emphasizes the complementary nature of investments in health and investments in education. Mexico's PROGRESA program and microcredit programs in general are cited as examples of innovative strategies.

Chapter 9

This chapter discusses the economic stagnation that has occurred in the rural sector of many less developed countries, and emphasizes that a country's development strategy must include plans for achieving agricultural progress and rural development. The major topics addressed in the chapter include:

How to increase per capita agricultural output and productivity in order to benefit the average rural dweller and provide a sufficient supply of food for the country?
How to transform traditional low productivity agriculture into high productivity commercial agriculture?
An explanation of why the decisions of peasant farmers are rational
An explanation of the role of economic and price incentives in increasing output.
An explanation of the economic role of women in Third World agriculture
An explanation of the exact meaning of rural development.

The growth experience of the agricultural sector over the last 50 years is reviewed for different regions of the world. Findings include stagnant growth in agricultural output despite respectable growth rates of GNP, an index of per capita food production which has declined for Africa since 1970, and a situation in many LDCs where the agricultural sector often accounts for a majority of total employment, and yet low productivity causes agriculture to represent a much smaller share of output.

There is a fairly detailed section on the structure of Third World agrarian systems. Two types of world agriculture are defined, low productivity and high productivity, and land productivity is compared for some developed and developing countries as an illustration of the difference. Asia, Africa, and Latin America are compared and contrasted in terms of the structure of their agricultural sectors.

Latin American agriculture is characterized by the dualistic latifundio-minifundio system, in which a small fraction of landowners own the great majority of cultivated land in the region. Total factor productivity is twice as high on family farms as on latifundios. Latifundios under-utilize labor, while minifundios over-utilize labor, relative to land. The latifundio system persists partly because land ownership provides positive externalities, such as social status and political power.
Asian agriculture is characterized by too many people crowded onto too little land. Farms tend to be inefficiently small, and production is often characterized by sharecropping and tenant farming. There is a good discussion of the impacts of colonial rule, money lending, and recent population growth.
African agriculture is characterized by low productivity subsistence farming, primitive techniques, shifting cultivation, and labor scarcity during the peak agricultural season. Though traditionally land has been less scarce in Africa, population growth has caused land to become scarcer, and production has been shifting towards small owner-occupied plots, as opposed to communal shifting cultivation.

The section on the role of women points out that although women perform a majority of the work inside and outside of the home in the rural regions of the developing world, development programs have often targeted men. Training and credit access must be targeted at women to have a major impact on productivity.

The section on the economics of agricultural development includes an extensive discussion of the transition from subsistence farming to diversified and partially commercial farming to farming primarily for the market. Key topics include:

Identifying characteristics of subsistence farming. For example, risk aversion may lead poor peasants to resist new techniques that offer higher average yields because the variance of the yield may be larger. The relationship between risk aversion and sharecropping is discussed. Interlocking factor markets and monopoly and monopsony power are mentioned.
Identifying characteristics of the transition to mixed farming.
Identifying characteristics of modern commercial farming. Technology plays a major role at this stage.

The chapter concludes with a section on strategies for agricultural and rural development. The discussion covers the role of technology, pricing policy and other economic incentives, land reform possibilities, and a permanent reduction in urban-rural opportunity imbalances.

Chapter 10

The first section discusses seven basic issues related to the environment and economic development. This section shows that there are environmental issues associated with many of the topics discussed in previous chapters.

Sustainable development and environmental accounting: The concept of sustainable development is introduced, and can loosely be said to occur when the needs of the present generation are met without compromising the needs of future generations. The concept of environmental accounting defines a method of incorporating environmental decay into the national income accounts.
Population, resources, and the environment: The consequences for the environment of rapidly growing populations are mentioned, some of which were discussed in Chapter 6.
Poverty and the environment: Increasing income and expanding options can lead to more environmentally sound decisions.
Growth versus the environment: The idea that there may be a tradeoff between the two is introduced.
Rural development and the environment: Sustainable methods of farming are mentioned.
Urban development and the environment: Urban pollution problems are discussed.
The global environment: Many environmental problems are global in nature, and hence present special challenges. There is a section at the end of the chapter that goes into more detail on this topic.

Persistent rural poverty is shown to be the root cause of many of the environmental problems in less developed countries. Common environmental problems include deforestation, soil erosion, and ground water contamination. The principle health and productivity consequences of environmental damage are summarized. Two hypothetical examples, one in Africa and one in South America, are presented to clarify the relationship between rural poverty and environmental degradation.

The section on traditional economic models of the environment includes a definition of the optimal allocation of resources, and discusses different types of market failure which can lead to inefficient resource allocation. Topics include characteristics of perfect property rights, externality and common property resource problems, and public good and free rider problems. Some limitations of each of these frameworks of analysis, particularly for specific developing country situations, are mentioned. The section on urban development and the environment contains some interesting descriptions of the severity of urban pollution in developing countries and the associated health impacts. An analysis of some of the different types of pollution control policies that can be used is presented. The negative impact of environmental degradation on economic growth is described, which suggests that in many cases pollution control can have a positive effect on growth and development.

A section on the 'greenhouse' phenomenon is presented. This section highlights the fact that pollution and environmental degradation are global issues.

Policy discussion is divided into what developing and developed countries can do. The developing countries can practice more efficient resource pricing, work closely with villages to address their economic and environmental concerns together, clarify property rights, introduce urban pollution control policies, and most important, intensify programs to alleviate absolute poverty and improve conditions of rural women. The developed countries can reduce protectionism, offer debt relief including debt-for-nature swaps, increase aid levels, assist with research and development on clean technologies appropriate for LDCs, curtail their own emissions, and reduce demand for environmentally harmful products.

Chapter 11

This chapter presents a great deal of information about development planning and the role played by the state versus the market. Major topics include:

The role and limitations of planning as practiced by less developed countries, including a discussion of different types of planning models.
The problems of economic transition to competitive free market economies.
A discussion of what the government can do best, in terms of correcting market failures, and what the market can do best.

Economic planning is defined as a governmental attempt to coordinate economic decision making and influence economic outcomes. An economic plan is defined as a set of quantitative economic targets to be reached by a certain date using a stated strategy. Most developing countries have adopted some degree of economic planning with the aim of spurring development. The justification for developing a market plan includes the following points:

The need to correct for market failures.
The need to ensure the most productive use of scarce financial and skilled manpower resources.
The value of a plan in overcoming sectional and traditional attitudes.
An increase in the ability to qualify for foreign aid.

Planning in stages is emphasized in terms of employing aggregate, sectoral, and project planning as components of the entire economic plan. The three types of planning models described are:

Applied macroeconomic growth models based on variants of the Harrod-Domar model, with reference to the two-gap model introduced in Chapter 15.
Input-output models.
Project appraisal, with reference to including relevant objectives, shadow prices, social discount rates, and decision criteria.

The text aims to provide a feel for the planning process and demonstrate how the three different types of models can be interrelated.

The crisis in planning is discussed, whereby development planning in practice has often not realized its objectives. The fact that plan designs are often overambitious while vague on specific policies, that data are often insufficient or unreliable, that unanticipated shocks can wreak havoc on a development plan, that the planning agency is often weak and ineffective, and that countries lack the political will to carry out otherwise sound plans are all implicated in this crisis. Four examples are used to demonstrate how government policy often increases the divergence between private and social valuation:

Factor prices, choice of technique, and employment creation.
Rural-urban imbalance and migration.
Demand for education and the employment problem.
Structure of the economy.

Market liberalization has gained in importance relative to administrative planning since the early 1980s. Many LDCs have attempted to reduce the role of the public sector, eliminate distortions in interest rates, wages, and prices, and encourage growth in the private sector. Development problems have been increasingly viewed (especially by aid agencies) as being exacerbated by LDC planning policies, rather than helped by them. The importance of government failure as well as market failure is stressed, and Table 16.1 presents a list of problems with government intervention in LDCs. At the same time, the text points out that it is hard to make across the board judgements about the relative merit of public versus private economic activity because, for example, some public companies are highly efficient and some are not.

In the context of converting to a more market based economy, the text presents a broad range of institutional and cultural requirements for the operation of effective private markets (14 requirements) and for market-facilitating legal and economic practices (11 requirements). Evidence presented suggests that liberalization has helped but has run into limitations in many LDCs because of market failures, or areas where the market is lacking:

There tends to be a lack of information and/or considerable uncertainty, both of which hamper effective decision making.
Effective competition is lacking.
Externalities exist.
Capital formation is a problem, as well as a great need.
Income distribution is often not helped by the market.
Structural change is required and the government may need to intervene in key sectors.

The "Washington Consensus" was in vogue for the 1980s and much of the 1990s. This view of development policy is very much a free-market one. Since that time the "Santiago Consensus" has become more influential. This view has a larger role for the government, but retains many of the Washington Consensus' market-based approach.

The next section presents a discussion of the emerging field of development political economy. These theories generally begin with the assumption that people are ultimately self-interested, and so it may be instructive to consider who gains and who loses when a given reform is undertaken. This literature also includes the concept of path dependency, whereby past actions and conditions affect future situations. Examples of path dependency were encountered in earlier chapters of the text: poverty traps (chapter 5) and child labor traps (chapter 9). Mixed empirical evidence is presented regarding whether democracy or autocracy leads to faster economic growth.

More recent trends in governance are addressed, including decentralization, democratization, and participation in the development process. Also covered in this chapter are the development roles of non-government organizations (NGOs) and the problem of corruption and reforms designed to tackle it.

Chapter 12

The impact of international trade on development is examined in terms of the effects on growth, income distribution, poverty, and employment. To summarize the detailed analysis of the text, trade can be an important stimulus to rapid economic growth by promoting greater utilization of idle human and capital resources, increasing foreign exchange earnings, and expanding access to technological knowledge. At the same time, for a majority of developing countries, the principal benefits of world trade have accrued disproportionately to foreign residents and wealthy nationals (as well as to the developed countries). This is the result not of trade as such, but of the imbalanced structure of the world economy in which trade takes place, with bargaining power concentrated in the hands of developed country private and public institutions. Trade, because of its biased distributional effects, may often tend to reinforce existing inequalities rather than serve development objectives.

Two broad strategies are defined, outward-looking development policies and inward-looking development policies. Outward-looking development policies encourage free trade and the free movement of the factors of production, while inward-oriented development policies encourage greater self-reliance and restricted trade and movement of factors of production. Within these two broad approaches lie the debate between free traders and protectionists and the debate between import substitution and export promotion as the best strategy for industrialization. The major topics addressed include:

Encouraging the export of primary products.
Encouraging industrialization via the import substitution strategy.
Encouraging industrialization via the export promotion strategy.
The trade optimist-trade pessimist debate.
Encouraging South-South trade and economic integration.

The pros and cons of emphasizing primary product exports as a growth strategy are discussed. Five important demand factors tend to work against the success of this strategy (low income and price elasticity of demand for the primary products, slow population growth in developed countries, the development of synthetic substitutes, and the growth of agricultural protection in the developed countries). Supply side factors emphasize what was learned in Chapter 9, with respect to the structure of production and low productivity.

The export of manufactured goods as a growth strategy is mentioned, particularly with respect to the spectacular performance of the four Asian Tigers. The text cites rising protection by the developed countries as a barrier against the success of this strategy. The text also points to the need for more South-South trade, as is discussed later in the chapter.

The import substitution strategy involves identifying relatively simple consumer goods which are currently being imported, and replacing these imports with domestic production. A second stage would involve expanding domestic production to more sophisticated manufactured items, including those with linkages to the consumer goods sectors established in the first stage. Key points mentioned include:

A built in demand for the product already exists.
The infant industry argument.
The use of tariffs and quotas.
The effective rate of protection.
The appropriate exchange rate policy.
The role of backward and forward linkages.
Reasons for the failure of the strategy.

A section on foreign exchange rates, exchange controls, and the devaluation decision reviews the concept of an exchange rate market, and discusses the options available for maintaining the official exchange rate. Overvalued exchange rates, dual exchange rate systems, and currency devaluation are discussed.

Chapter 13

This chapter moves away from examining international commodity trade and instead focuses on international monetary and macroeconomic issues. The major topics are:

Understanding the balance of payments accounts
Identifying recent trends in LDC balance of payments accounts
Understanding the causes and effects of the debt crisis
Evaluating the controversy about the IMF policy of macroeconomic stabilization

Basic balance of payments accounting is introduced in the first section of the chapter. Key definitions include the current account, the capital account, the cash account or international reserve account, and capital flight. A detailed numerical example is used to illustrate how the accounts work, as well as the impact of capital flight. Options for financing and reducing payments deficits are discussed and include increasing net exports, changing the official exchange rate, borrowing, adopting IMF stabilization policies, and acquiring SDRs.

The dimensions of the debt crisis have been expanded by the rising oil prices over the previous four decades. The text summarizes the history of the debt crisis by noting that oil shocks triggered international lending through a combination of increased loan demand and the recycling of petrodollars that expanded the supply of loanable funds. The accumulation of external debt, which requires greater debt service payments, has made it more difficult to borrow more funds to finance developmental projects and programs.

Typical elements of IMF stabilization policies are outlined, including liberalization of foreign exchange and import controls, devaluation, interest rate increases, deficit reduction, wage restrictions, reduced price controls, and the general opening up of the economy. These policies have not worked well in response to the debt crisis, leading to adjustment without growth and negative development consequences.

Newer initiatives and suggestions for managing the debt crisis include debt forgiveness, debt restructuring, new SDR allocations, repayments linked to export earnings, debt-for-equity swaps, debt-for-nature swaps, and the Brady Plan. Finally, the text considers whether the debt crisis is really over. If the crisis is defined as a threat to the large commercial banks it may be over. If defined as a threat to development prospects, the text argues that it is not over.

Chapter 14

This chapter examines the international flow of financial resources, and weighs the pros and cons of the different forms of those financial resources:

Private foreign direct investment and portfolio investment: Direct investment by multinational corporations, and stocks and bonds in LDC emerging credit and equity markets are discussed.
The role and growth of remittances are presented.
Foreign aid: Both government and non-government aid is discussed.

The first section of the chapter presents data on foreign direct investment, and multinational corporations in particular. Characteristics of MNCs are presented, including the fact that the goal of the MNC, profit maximization, may differ from a country's development goals. The size of the largest MNCs in dollar terms is compared to the size of some developing countries entire economies.

Multinational corporations are firms that by engaging in direct foreign investment own or manage resources in more than one country. Their argued benefits include filling gaps in savings, foreign exchange, government revenue, management skills, technology, and entrepreneurship, all of which may ultimately increase economic growth throughout the country. The text shows that these contributions may be small because 1) capital is often raised locally, perhaps from the government at subsidized rates, 2) little of the profits may be reinvested, 3) MNCs may import many of the intermediate and capital goods they use in production, 4) liberal tax concessions and tax-avoiding transfer pricing may be present, and 5) there may be negative effects on indigenous entrepreneurship. Additional drawbacks may include reinforcement of dualism and inappropriate consumption of luxury goods, use of excessively capital intensive techniques, displacement of indigenous production, and development of allied local groups. The text in effect argues that the net benefits of MNCs are an empirical question to be evaluated on a case by case basis.

Remittances have grown due to improved accounting, greater number of migrant workers, and the ease of funds transfer from host to home countries. Following a very rapid growth after 200, India has emerged as the largest recipient country. Remittances provide a significant pathway out of families for many LDC families.

Foreign aid is defined as a flow of official capital to LDCs that has a noncommercial, nonmilitary, and pro-development objective from the point of view of the donor and features concessional interest rates and/or repayment periods. Some measurement issues are mentioned and some data is presented on the volume and source of foreign aid. It is noted that there is a fine line between commercial and noncommercial objectives, and the tied aid phenomenon is stressed. The discussion of why donor countries give aid cites political as well as economic objectives. The two-gap model is introduced to describe the role of aid in relieving the foreign exchange gap. LDCs tend to accept aid to supplement scarce domestic resources and speed up the development process. The growing role of non-governmental organizations is mentioned, as a source of aid. The role of foreign aid into the next century is discussed at the end of the chapter, and summarizes past concerns as well as some possible new directions.

A new section presents the effects, consequences, and prevention methods of armed conflict, ethnic violence, and interstate wars on economic development. The high cost of conflict deprives the LDCs of much needed funds for developmental programs and projects.

Chapter 15

This chapter examines the international flow of financial resources, and weighs the pros and cons of the different forms of those financial resources:

Private foreign direct investment and portfolio investment: Direct investment by multinational corporations, and stocks and bonds in LDC emerging credit and equity markets are discussed.
Foreign aid: Both government and non-government aid is discussed.

Private portfolio investment represents one-third of the net financial resource flow to LDCs. The pros and cons of emerging country stock markets are mentioned, with reference to Mexico, Russia, Asia, and Brazil.

Two new features are added to this chapter. The case study of Box 15.1 states that even the poor save some of their income because they avoid living hand to mouth. The cash flow, of the poor in India and South Africa, is often a multiple of household income. In Box 15.2, we learn that female micro-enterprises supported by local financing and training help develop entrepreneurial skills of the poor and create a sources of steady income.

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