1 development economics lecture 5 development policy & strategy options

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Development EconomicsDevelopment Economics

Lecture 5 Lecture 5

Development Policy & Development Policy &

Strategy OptionsStrategy Options

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Trade Policies - EP or IS?Trade Policies - EP or IS?

Export Promotion (EP) - Outward orientedExport Promotion (EP) - Outward oriented PoliciesPolicies

encourage free trade in goodsencourage free trade in goods free movement of capital and laborfree movement of capital and labor encourage multinationals, their tech. and productsencourage multinationals, their tech. and products encourage manufactures in practiceencourage manufactures in practice

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Justifications - theoreticalJustifications - theoretical increased output and growth arising from comparative advantageincreased output and growth arising from comparative advantage economies of scaleeconomies of scale increased competition and efficiencyincreased competition and efficiency modern technologymodern technology Protectionist policies result in higher prices and lower outputProtectionist policies result in higher prices and lower output

Justifications - practical successJustifications - practical success Asian tigersAsian tigers Other NICs, like Brazil, MalaysiaOther NICs, like Brazil, Malaysia Other LDCs, like China, VietnamOther LDCs, like China, Vietnam

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ProblemsProblems Limited growth of world demand for primary exportsLimited growth of world demand for primary exports Worsening terms of trade for primary producing nationsWorsening terms of trade for primary producing nations Protectionism of DCsProtectionism of DCs

• Labor-intensive industries suffer the most from LDC Labor-intensive industries suffer the most from LDC competition and hurt the relatively poor in DCscompetition and hurt the relatively poor in DCs

• The more LDCs there are to adopt EP, the more likely there The more LDCs there are to adopt EP, the more likely there will be protectionism in DCswill be protectionism in DCs

• But, counter-argumentsBut, counter-arguments LDC growth offers market potential to DC exportsLDC growth offers market potential to DC exports Intra-LDC trade can also grow as incomes riseIntra-LDC trade can also grow as incomes rise

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Import substitution (IS) - Inward OrientedImport substitution (IS) - Inward Oriented PoliciesPolicies

Encourage self-reliance in the manufacturesEncourage self-reliance in the manufactures Erect tariff barriers against importsErect tariff barriers against imports Restrict movement of labor and capitalRestrict movement of labor and capital Restrict MNCs with inappropriate tech. and productsRestrict MNCs with inappropriate tech. and products

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Theoretical justificationsTheoretical justifications Problems with trade theory (see Lecture 4)Problems with trade theory (see Lecture 4) Problems with EP policies (above)Problems with EP policies (above) Infant Industry argumentInfant Industry argument

Practical experience - not very successfulPractical experience - not very successful Low growthLow growth ““Infants” never grow upInfants” never grow up Benefits went to the richBenefits went to the rich Inappropriate technologyInappropriate technology Examples:Examples:

• Argentina, India, Peru, GhanaArgentina, India, Peru, Ghana

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Exchange rate policiesExchange rate policies High fixed ratesHigh fixed rates

Tax on exporters Tax on exporters • Exporters receive less local currency than true market valueExporters receive less local currency than true market value• Primary producers are the ones often penalizedPrimary producers are the ones often penalized

Subsidy on importersSubsidy on importers• Importers get more foreign currency to buy importsImporters get more foreign currency to buy imports

Excess demand for foreign exchangeExcess demand for foreign exchange• Exchange controlsExchange controls• Corruption, evasion, black marketCorruption, evasion, black market

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Overall Policy - Plan or Market?Overall Policy - Plan or Market?

Rationale for PlanningRationale for Planning Markets in LDCs often imperfect or non-existentMarkets in LDCs often imperfect or non-existent

Poor information and uncertaintyPoor information and uncertainty Lack of effective competitionLack of effective competition

• Economies of scale and small national marketsEconomies of scale and small national markets• Market power and high pricesMarket power and high prices

Substantial externalitiesSubstantial externalities• Social vs private costsSocial vs private costs• Short-term vs long-term: especially important to growthShort-term vs long-term: especially important to growth

Result: Relative prices do not reflect scarcity and Result: Relative prices do not reflect scarcity and relative social opportunity costrelative social opportunity cost

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Capital formationCapital formation LDCs have low saving ratesLDCs have low saving rates LDCs have poor financial systemLDCs have poor financial system Human capitalHuman capital

• gov’t should provide educationgov’t should provide education

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Resource allocationResource allocation LDCs cannot afford to waste their limited financial and LDCs cannot afford to waste their limited financial and

skilled manpower resourcesskilled manpower resources Investment decisions must be made in the context of an Investment decisions must be made in the context of an

overall development program, includingoverall development program, including• external economiesexternal economies• indirect repercussionsindirect repercussions• long-term objectiveslong-term objectives

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Income distributionIncome distribution Market system will not improve income inequality, may Market system will not improve income inequality, may

actually exacerbate the problemactually exacerbate the problem

Attitudinal or psychological impactAttitudinal or psychological impact Statement of national economic objective has rallying Statement of national economic objective has rallying

effect on an often fragmented populationeffect on an often fragmented population

Foreign aidForeign aid formulation of detailed plan is a necessity for receipt of formulation of detailed plan is a necessity for receipt of

foreign aid foreign aid • provides a “shopping list” of projects to persuade DC gov’tsprovides a “shopping list” of projects to persuade DC gov’ts• criticism: Plan becomes a charadecriticism: Plan becomes a charade

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Plan FailuresPlan Failures Deficiencies in plans and their implementationDeficiencies in plans and their implementation

over-ambitious, not specific enough, difficult to over-ambitious, not specific enough, difficult to implementimplement

Insufficient or unreliable dataInsufficient or unreliable data especially in LDCsespecially in LDCs

Unanticipated economic disturbances - external or Unanticipated economic disturbances - external or internalinternal Most LDCs vulnerable to changes in int’l marketsMost LDCs vulnerable to changes in int’l markets

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Institutional weaknessesInstitutional weaknesses separation of planning agency from day-to-day separation of planning agency from day-to-day

decision-makers in gov’tdecision-makers in gov’t incompetent civil servants, bureaucratic procedures, incompetent civil servants, bureaucratic procedures,

self-interests of politiciansself-interests of politicians

Lack of political willLack of political will political instabilitypolitical instability resistance to reforms - entrenched interestsresistance to reforms - entrenched interests

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Problems of gov’t intervention in general Problems of gov’t intervention in general Use previous learning from MicroeconomicsUse previous learning from Microeconomics

Gov’t and private sector COOPERATIONGov’t and private sector COOPERATION Korea, TaiwanKorea, Taiwan

1 development economics lecture 5 development policy & strategy options

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