Growth and Development Economics Summary PDF

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Chapter 5 – Poverty, inequality, and development5 – Measuring inequality and povertyLorenz curve: graphs variance of income distribution from perfect equality Gini coefficient: aggregate numerical measure of income inequality ranging from 0 (perfect equality) to 1 (perfect inequality) - Principles: ...

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Chapter 5 – Poverty, inequality, and development 5.1 – Measuring inequality and poverty Lorenz curve: graphs variance of income distribution from perfect equality Gini coefficient: aggregate numerical measure of income inequality ranging from 0 (perfect equality) to 1 (perfect inequality) - Principles:  Anonymity principle: should not depend on who has the higher income  Scale independence principle: measure should not depend on the size of the economy or the way we measure its income (i.e. dispersion not magnitude)  Population independence principle: measure should not be based on number of income recipients  Transfer (Pigou-Dalton) principle: new income distribution becomes more equal when, holding all other incomes constant, income from a richer person is transferred to a poorer person - Limitation: equal coefficient despite different income inequality distribution Functional (factor share) distribution: income distribution to production factors without regard to the ownership of these factors  See figure 5.5 on page 211 - Limitation: fails to take importance and influence of non-market forces (i.e. power in determining factor prices) into account (e.g. bargaining power, monopolies, etc.) Headcount index: proportion of the population living below the poverty line (i.e. H/N) - Limitations: relative income not considered below poverty line and, hence, magnitude poverty problem lacks (i.e. how much is the population below the line?) Total poverty gap (TPG): extent to which the incomes of the poor lie below the poverty line, which reveals the total amount of income necessary to raise everyone below the poverty line up to the line H

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TPG=∑ ( y p− y i )  sum of the difference between the poverty line and actual i=1

income levels of all people living below the line Foster-Greer-Thorbecke (FGT) index: class of measures of the level of absolute poverty α H y p − yi 1 Pα = ∑ yp N i=1

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Monotonicity principle: adding income to someone below the poverty line, poverty has to improve Distributional sensitivity principle: income from poor person transferred to a richer person results in a poorer economy

Multidimensional poverty index (MPI) takes into account that there are negative interaction effects when people have worse poverty than averages reveal (i.e. multiplied/interactive harm done when multiple deprivations are experienced by the same individual or family). The measure identifies the very poor by measuring a range of important household deprivations (health, education, and standard of living) directly, rather than only indirectly through income, which implies that one’s capabilities are substitutes and a lack in one area can, to a degree, be made up by other capabilities. The dimensional monotonicity implies that when a person deemed poor becomes deprived in another indicator, he or she is deemed even poorer. The limitations of the measure are: (i) data are from households rather than individuals; (ii) does not distinguish between past and present conditions; (iii) does not distinguish between differences within households; (iv) and proxies are imperfect.

5.2 – Poverty, inequality, and social welfare Reasons why relative poverty matters (i.e. extreme inequality): - Economic inefficiency: the poor cannot borrow to invest and lack primary education, while the rich do not save and are not efficient enough and, hence, there is a low average income and low rate of economic growth - Social stability and solidarity undermined: the focus of politics tends to be on resisting redistribution of inequality, as the bargaining power of the rich (i.e. rent seeking) leads to unproductive activities and poor, difficult to improve institutions - Perceived as unfair/unethical: nobody wants to be poor Kuznet’s inverted-U hypothesis: suggestion that the distribution of income will first worsen and only at later stages it will improve (evidence contradicts!) - Kuznets curve: relationship between a country’s income per capita and its equality of income distribution

5.3 – Absolute poverty: extent and magnitude Reasons for poverty-reducing policies: - Credit constraints: widespread poverty creates conditions in which the poor have no access to credit and, hence, cannot invest - Savings and investments: the rich in developing countries lack tendency to save and invest substantial amounts of their income - Productivity: poor health, nutrition, and education lowers productivity - Demand: raising income of the poor stimulates demand - Public participation: reducing mass poverty stimulates incentives to work

5.4 – Economic characteristics of high-poverty groups The poor are disproportionately located in rural areas, are primarily engaged in agricultural and associated activities, are more likely to be women and children than adult males, and are often concentrated among minority ethnic groups and indigenous peoples.

5.5 – Policy options on income inequality and poverty: some basic considerations Determinants of developing economy’s distribution of income: - Altering the functional distribution: correct factor price distortions to ensure accurate signals and incentives to both producers and resource suppliers - Structural changes in distribution of assets, power, and access to education and associated employment opportunities: knowledge of how ownership and control over productive assets and labour skills are concentrated and distributed throughout the population to reveal distribution personal income - Moderating(reducing) the size distribution at the upper levels: progressive taxation to increase government revenues to invest in human capital and rural and other lagging infrastructure needs (i.e. “safety net” for people bypassed development) - Moderating (increasing) the size distribution at the lower levels: raise incomes of the poor by public expenditures of tax revenues and offer of programs that build capabilities and human and social capital

Chapter 6 (Nestor) – Economic inequality Reasons to be interested in income inequality: - Philosophical and ethical grounds - Functional level (i.e. important impact economic features related to growth) Caveats: - Mobility: short- or long-term, flows-, stocks-, or lifetime income distribution, etc. - Distinction functional and personal income distributions: knowledge on how production factors are paid and how they are owned vital in understanding relationship between income inequality and economic growth Criteria inequality measurement: - Anonymity principle: should not depend on who has the higher income - Population principle: measure should not depend on the size of the economy or the way we measure its income (i.e. dispersion not magnitude) - Relative income principle: relative income more important than absolute levels - Dalton principle: more quality when transfer income from rich to poor Lorenz criterion: if one Lorenz curve lies to the right of another Lorenz curve at every single point, the former should be judged more unequal than the latter - Inequality measure is consistent with this criterion if and only if it is simultaneously consistent with the above mentioned principles

Complete measures of income inequality: - Range: difference incomes richest and poorest divided by the mean - Kuznets ratio: shares of income of the richest x% to the poorest y% - Mean absolute deviation: inequality is proportional to distance from mean income, however is incentive to Dalton principle  Do not use! n j∨ y j −μ∨¿  1 M= ∑ ¿ μn j 1 - Coefficient of variation: C= ∑ n j ( y i−μ )2 μ√ n j m m 1 - Gini coefficient: G= 2 ∑ ∑ n j n k|y i − y k | 2 n μ j=1 k=1

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Different concepts of inequality: 1. Between nations: comparison GDPs or mean incomes 2. Per capita: populations are weighted 3. Individual based: each person, regardless of nationality, enters into the calculation with their actual income Purchasing power parity (PPP): number of units of a foreign currency required to purchase the identical quantity of goods and services in the local developing country market as $1 would buy in the US  Adjustments for differing relative prices to measure standard of living more accurately, as prices of non-traded services are lower due to lower wages Harrod-Domar growth model: functional economic relationship in which the growth rate of gross domestic product depends directly on the national net savings rate and inversely on the national capital-output ratio ∆Y s = −δ−n  The rate of growth of GDP is determined by the - Growth GDP: Y c net national savings ratio (s), the national capital-output ratio (c), the capital depreciation ( δ ), and the population growth (n) Solow neoclassical growth model: allows for substitution between labour and capital and argues there are diminishing returns to production factors, constant returns to scale, and exogenous technological change generates long-term economic growth - Growth model: Y =K α ( AL ) 1−α Malthusian population trap: anticipated threshold population level at which the population increase was bound to stop, as life-sustaining resources would become insufficient to support human population - Limitations:  Underestimated impact technological progress  Empirical results prove the model wrong  Per capita income wrong variable to focus on, microeconomics of family size decision making is better  Individual focus better than aggregate

Chapter 7 (Nestor) – Inequality and development: interconnections Hirschman’s tunnel effect hypothesis: spirits go up for a while when things improve to others around one, however eventually one needs to improve himself otherwise spirits go down again  degree of tolerance for income inequality should be considered when making policies of economic growth and income distribution Kuznet’s inverted-U hypothesis: inequality rises at low levels of per capita income and then falls (evidence contradicts!) - Problems:  Small: high variation, artefact statistical methodology  Lack of data forces studies to pool all countries and assume they all have the same inequality-income relationship (i.e. qualitative and quantitative patterns)  Not true, although middle ground can be found by assuming they have some connection and are parallel to each other  Latin effect: most high-inequality middle-income countries are Latin American  biases results and U-shape disappears when adding dummies Arguments in favour of hypothetical possibility inverted-U hypothesis: agriculture and industry – unskilled and skilled labour - Dual economy: economically backward and progressive sectors coexist and development proceeds by the advanced sector feeding on the backward sector for resources to propel its own growth (i.e. productive manufacturing sector and nonproductive labour intensive agricultural sector) - Technological progress: only fraction of economy benefits (i.e. industrial sector) and is biased against unskilled labour and drives down wages - Owners of production factors profit: owners of capital will benefit from industrialization, while the many unskilled workers don’t see their wages rise due to the abundancy of such workers and lacking policies to benefit workers The relationship of savings and income in figure 3 reflects the situations where redistributive policies have different effects because of differing marginal savings (i.e. the relatively poor who can’t afford to save and the rich who don’t need or want to save): - Beginning: savings in very poor developing countries will not increase, as the small fraction that desires and is able to accumulate wealth disappears and no person saves anything of any significance - Ending: savings in developed countries will increase, as the fraction of people that spend extraordinary amounts of their very high income decreases and more highincome individuals with international inspirations who want to save appear Figure 4 shows how savings behaviour is determined by income and aspirations as well, where the latter depends on existing inequalities of income and wealth Taxes on the margin (i.e. on the increments to the stock of wealth) reduce the incentive to accumulate wealth and, therefore, the rate of economic growth

3.3 – Structural-change models Lewis two-sector model: surplus labour from the traditional agricultural sector is transferred to the modern industrial sector, the growth of which absorbs the surplus labour, promotes industrialization and stimulates sustained development - Surplus labour: overpopulated sector with zero marginal labour productivity that can be withdrawn without any loss of output - Lewis turning point: the point the surplus of labour is used up and adding an additional worker from the agriculture sector can only be done at a higher cost of lost food production because the declining labour-to-land ratio means the marginal product of labour is no longer zero (i.e. point where the surplus is gone and the marginal product is labour is no longer zero) - Wrong assumptions: (i) labour saving bias of most modern technological transfer; (ii) existence of substantial capital flight; (iii) widespread nonexistence of rural surplus labor; (iv) growing prevalence of urban surplus labour; (v) tendency for modernsector wages to rise rapidly even where substantial open unemployment exists  Rate of labour transfer and employment creation in the modern sector is proportional to the rate of modern sector capital accumulation: profits being reinvested in more sophisticated, labour-saving capital more realistic  Surplus labour exists in rural areas while there is full employment in the urban areas: empirical evidence of little surplus in labour in rural areas  Constant real urban wages: more realistic that wages rise substantially in both relative and absolute terms compared to average rural incomes  Diminishing returns in the modern industrial sector: evidence that increasing returns prevail (poses significant problems for development policymakers) Chapter 7 Todaro migration model: explains rural-urban migration as an economically rational process, despite high urban unemployment, where migrants calculate (present value of) urban expected income (or its equivalent) and move if this exceeds average rural income Harris-Todaro model: equilibrium version of the Todaro migration model that predicts that expected incomes will be equated across rural and urban sectors when taking into account informal-sector activities and outright unemployment - Probability of urban job success necessary (i.e. point of indifference): L ´ W A= M ( W with LM = employment in manufacturing, LUS = total urban M) LUS LM ´ labour pool, W A is agricultural income, and ( W ) is expected urban LUS M income - Characteristics:  Migration is stimulated primarily by rational economic considerations of relative benefits and costs (mostly financial but also psychological)  The decision to migrate depends on expected rather than actual urban-rural real-wage differentials (determined by interaction actual urban-rural wage differential and probability successfully obtain employment)

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The probability of obtaining an urban job is directly related to the urban employment rate and thus inversely related to the urban unemployment rate  Migration rates in excess of urban job opportunity growth rates are not only possible, but also rational and even likely in the face of wide urban-rural expected income differentials (i.e. high rates of urban unemployment inevitable outcome of significant imbalance economic opportunities) Policy implications:  Imbalances urban-rural employment opportunities (caused by urban and firstcity biases) of development strategies need to be reduced  Urban job creation is insufficient solution (only increases incentives to migrate  Induced migration) and lowers agricultural output  Indiscriminate educational expansion leads to further migration and unemployment (i.e. education determines job opportunity)  Wage subsidies and traditional scarcity factor pricing can be counterproductive  Programs of integrated rural development should be encouraged

Key elements regarding migration: - Creating an appropriate rural-urban economic balance to reduce unemployment and slow down rural-urban migration - Expansion of small-scale, labour-intensive industries - Eliminating factor price distortions - Choosing appropriate labour-intensive technologies of production - Modifying the linkages between education and employment - Reducing population growth - Decentralizing authority to cities and neighbourhoods Disguised employment, because the marginal product of labour in agriculture is less than the wage for labour inputs in the segment. Agricultural surplus is the vertical gap between the production function and the wage bill line, dividing this by the number of transferred workers we obtain the average agricultural surplus that reflects the per capita surplus amount relative to the transferred workers (equals the wage). The average surplus first follows a horizontal line equalling the wages. Commercialization of agriculture means the wage bill falls more slowly than it did before along the diagonal line of the lowest panel, because wages rise as the agricultural labour force decreases. Lewis-Ranis-Fei story: development occurs via the joint transfer of labour and agricultural surplus from the “traditional” agricultural sector to the “modern” industrial sector. The ability to expand the industrial sector depends on the production conditions in agriculture, as it is difficult create growth without the labour surplus of the agricultural sector  Capital accumulation increases demand for labour, which induces rural-urban migration. The terms of trade gradually turn against the industry and industrial wages increase, as they need to compensate for the increased food prices due to fewer farmers having to support more nonagricultural workers (i.e. the pace of development is driven by the accumulation of capital, but is limited by the ability of the economy to produce a surplus of food).

Chapter 4 – Contemporary models of development and underdevelopment

Multiple equilibria: coordination problems result in several possible equilibria, where the privately rational decision function follows a S-shape according to the agents’ expectations - Equilibrium is (un)stable when the decision function intersects the diagonal line from (below) above, where with an unstable equilibrium small changes in expectations results in different equilibria Big push: concerted, economy-wide, and typically public policy-led effort to initiate or accelerate economic development across a broad spectrum of new industries and skills required because of pecuniary externalities - Pecuniary externality: positive or negative spill-over effect on agent’s cost or revenues (e.g. training costs that competitors avoid by offering higher wages and stealing workers) - Assumptions:  Factors: only labour exists (fixed total supply)  Factor payments: traditional wages are 1 and modern wages are larger than 1  Technology: constant (increasing) returns to scale in the traditional (modern) sector  Domestic demand: each product receives constant and equal share of consumption of national income (i.e. Y/N)  International supply and demand: closed economy  Market structure: perfect competition - Alternative conditions for a big push to be necessary:  Intertemporal effects: investments in period 1 required to become profitable in period 2  redistributing demand toward the (later) periods in which other industrializing firms sell  Urbanization effects: industrialization only capable if urbanization is achieved  shifts demand towards manufactured goods  Infrastructure effects: defrays fixed costs of an essential infrastructure  Training effects: reduces fixed costs of later entrants (i.e. training workers has coordination failures and opportunity costs) Information externality: spill-over of information from one agent to another, without intermediation of a market transaction, which reflects the public good characteristic (i.e. neither fully excludable from other uses nor non-rival) Linkages approach: coordination failure can ...