Lecture notes: Economics of Development
What is Development Economics ?
For people all around the world living in poverty it is important that countries in South East Asia such as
South Korea, Taiwan and China, as well as Brazil in South America recently have been able to get out of the
poverty trap. They are not so many, but there is a group of countries that have essentially completed the
transformation to become developed. I think, for countries in Africa such as the Gambia, it is relevant to
raise questions about the extent to which they can learn from experience of the newly industrialized
countries and if they are potential models for other countries to follow.
Another question arising is if economics can help us to better understand the process of development,
which is extremely complex, and if economics also can become an efficient tool for shaping adequate
development policies. Sometimes economists are criticized for being too narrow primarily focusing on the
task to increase economic growth, even if it is empirical evidence that economic growth often increase
inequality and, therefore, does not provide a sustainable solution for the poor. Furthermore, traditional
neoclassical economics have been developed to deal with developed economies emphasizing market
efficiency, while developing countries usually are lacking market institutions. Neoclassical economics
concerns the determination of equilibrium, while transformation from a developing to a developed
economy is characterized by disequilibrium processes and transactions out of (traditional) equilibrium.
In addition, with regard to understanding poverty and economic growth in Africa, it is extremely important
to understand the influence of geography; the intersection of climate, ecology and economic activity is
crucial. For example, since long, and in the Gambia, there has been a negative development of productivity
in agriculture which has depreciated the situation of the poor both in the rural and urban areas. A policy
breaking this trend must be based on analyses that can explain relations between poverty and
environmental destruction, for instance, deforestation destructing the quality of the soil. It links up with
the green revolution by including measures to increase the rate of technology diffusion that relies on
scientific discoveries of hybrid seed varieties.
In order to take account of the fact that poor countries differ from developed countries, development
economics also draws on other sciences than economics. When looking at the contribution by economic
science, we should admit that before the neoclassical school became mainstream, the classical economists
used the notion political economy instead of economics. This distinction is important when it comes to
development economics, which stresses the role of institutions. Accordingly, contemporary theory in the
field of development economics has sometimes pointed at poor governance as main cause of stagnation in
developing countries. It should be an important task to examine this explanation of why poverty persists
which cannot be done unless economic activity is viewed in its political context taking account of political
Moreover, recently emphasis has been put on the importance of women for bringing about economic
change in Africa, which suggests that economic development should be seen in view of another important
institution: the extended family.
All in all, economists should recognize that mainstream, neoclassical economics is too narrow to address
issues on economic development. But also T/S view of political economy as concerned with the
relationships between politics and economics does not fully admit the importance of social and cultural
institutions, which were included in the classical economists’ understanding of political economy. For
example female genital cutting, which has a tremendous influence on the life of the women and their
ability to contribute to the development of the rural economy. A more complete understanding of
development economics recognizes that this field of study is rapidly evolving its own distinctive analytical
and methodological identity.
T/S are arguing that the ultimate purpose of development economics is to help us understand developing
economies in order to help improve the material lives of the majority of the global population. More
specifically, it is the study of how economies are transformed from stagnation to growth and from low-
income status to high-income status and to overcome problems of absolute poverty.
What do we mean by development
Not long ago, it was referred to poor countries, not as developing countries or economies, but as
underdeveloped. This was the ethnocentric perspective of the colonizers, who used the European culture,
which was considered as enlightened and as based on true knowledge, as a model for a developed Africa.
The colonizing states believed that they had a responsibility to transfer this culture, which was seen as
favorable to economic development. Inherent in this view was an idea that Africa had to pass the same
type of industrialization as Europe had done before. This kind of intellectual orientation is very interestingly
described by the Palestinian author Edward Said in a book called “Orientalism”.
Even if the way of referring to poor countries was changed, and they were now called developing countries,
the view of the development process was only slightly changed in the field of development economics.
Thus, proposed development policies have often focused on rapid industrialization, where manufacturing
and service industries increase at the expense of agriculture and rural development. Accordingly,
development has been synonymous to sustained growth in per capita income, i.e. output is growing
faster than the population. This measure brings increases in gross domestic product (GDI) into the fore,
but for the most part the well-being of the population has been in focus, which should be associated with
monetary growth of real per capita gross national income (GNI) (monetary growth of GNI per capita
minus the growth of inflation).
During the 1970s it became more and more obvious to those working in the field that even if the
economies were growing, a majority of the populations continued to be poor in combination with growing
inequality. Development was redefined instead emphasizing reduction or elimination of poverty,
inequality and unemployment within the context of a growing economy.
Furthermore, poverty is not just an assessment of income, but it is a fact of life that influence your self-
understanding as a person living a life that is not human as you are unable to control your hunger, diseases
and you know that you are unable to change this situation. This raises two questions about a how to
formulate a more inclusive definition of development. Firstly, if it is possible to link up with the notion of
utility in economics and define a measure that takes account of how people think about their lives as
more or less satisfactory. Secondly, if we can define a measure that is concerned with /and here we use
the wording of Amartya Sen/ “enhancing the lives we lead and the freedoms we enjoy”.
Sen refers to the capability to function as a status of a person that matters for whether he or she is poor or
non-poor. Functionings, then, is what a person does or can do with commodities of given characteristics
that he or she comes to possess or control. At the same time, individuals value functionings, for instance,
to be nourished, being free from diseases or being able to read.
Individuals also value a high per capita income but there are important disparities between these two
measures of development. For example, a person can have a high income and, thus, being able to buy food
or books. However, when looking at his or her functionings, we may find that he or she has low or no
capability to function, i.e. has a parasitic disease implying that he or she cannot extract nourishment from
food or is illiterate, and therefore has a low or no well-being in spite of high income.
With regard to finding a method for measuring development, some economists have linked up with the
notion of utility in the sense of happiness and defined national happiness which they have identified with
family relationships, financial situation, work community, health etc.. It has been found that the average
level of happiness increases with a country’s average income, but evidence also shows that people are
happier when they are not unemployed, not divorced, have high trust of others (social capital) in the
society and enjoy democratic freedoms and have religious faith.
It should be mentioned, however, that increased well-being in Sen’s understanding as increased
functioning is not the same as increased utility or happiness. This is obvious if we think about a person
who is hungry and cannot afford nutritious food, but reduce his hunger with rice (cheap way to satisfy
one’s hunger). This person increase his or her utility or happiness. However, as the person reduces his or
her hunger with food that has a low nutritional content his or her well-being in the sense of health or
capability to function has not increased. Capability to function, then, is freedom that a person has in terms
of the choice of functionings (being able to read a book, have the health to go to work) given his personal
features and command over commodities. From this perspective, well-being as utility or happiness is just a
part of the ability to function.
The most authoritative measure of development - the Human Development Index produced by UN (the
United Nations Development Program UNDP) - is inspired by Sen’s ideas. Thus, standard of living measured
as real per capita gross domestic product is only one outcome of development included in the measure.
The others are longevity as measured by life expectancy at birth, reflecting health and access to nutrition,
and knowledge measured as weighted average of adult literacy and school enrollment. This index is used
to rank all countries on a scale of 0 to 1.
In our next lecture, we will return to and look more in detail into how to measure poverty, inequality and
development and the way the different measures are calculated.
Measuring poverty, inequality and development
Explanations of development and classical theory of how it is attained
Explanations of relative development
Time has come to make you acquainted with the evolution of scholarly theories about why development
has not taken place and how it is brought about. However, in order to judge the appropriateness of the
various theories we need a context that can explain why some countries are developed and other are
Figure 2.11 is extremely informative but, nevertheless, the factors and their interrelationships included in
the figure, is a selection made by the authors. However, they argue that the figure is based on the most
influential recent research literature.
By placing physical geography and climate at the top, the authors emphasize the importance of a recent
scholarly discussion about the importance of geography for differences in development between countries.
There are scholars who reduce the role of arrow 1 and instead emphasize the role of institutions which
they associate with type of colonial regime (see figure). By institutions, then, we mean formal rules like
constitutions and laws, and with regard to laws, development economists have been concerned about
property rights; private or public property. It should be mentioned that institutions also include customs
associated with local cultures and social structures but these institutions are rather constraints on the
There is empirical evidence showing that after accounting for institutional differences, geographic
variables such as distance from the equator and whether countries are landlocked (like Mali) have little
influence on their incomes today. For instance, if geography is crucial, then those regions that were
prosperous before colonialization should continue to be prosperous also today. Thus there is empirical
evidence showing that past population density and past urbanization, which is positively correlated with
income, is negatively correlated with high income today.
The explanation provided is that the European colonizers, in order to extract significant surplus from
colonized peoples, set up extractive institutions in prosperous areas and these institutions have often
persisted to the contemporary period. In Africa, I think extraction of minerals and oil in countries such as
Congo and Nigeria are examples and, as we will find later on, after independence the post-colonial regimes
have retained the same institutions and used export of primary commodities as a strategy for
However, geography has an indirect effect on contemporary per capita incomes as it influence the
mortality rate of the settlers, which has an impact on type of colonial regime (arrow 2). In climate zones
with high health-risks the colonizers established administrations using local people who were loyal to the
colonizers, who did not have to be physically present. Moreover, there where climate was favorable for
plantation agriculture, slavery and other types of mass-exploitation of indigenous labor were introduced
(arrows 6 and 7).
According to the figure, investments in human capital is an important factor explaining a country’s relative
development (arrow 14). But amount of human capital in its turn depends critically on the degree of
inequality generated in the context of a particular colonial regime. The institutions tend to be more
democratic, with more constraints on the elite, in countries with a higher level of education. But there are
cases where dictators have implemented good education programs leading to growth in per capita
incomes, which, in a second step has led to changes in the institutions.
It is interesting to note that there are no arrows that could indicate an influence by indigenous cultural
institutions. With regard to Africa, for instance, customs, gender relationships between men and women
as well as traditions of giving elderly a say with regard to use of land and other natural resources often
replace laws that regulate the use of property and property rights.
Social and cultural institutions such as tribe, religious affiliations and family influence social learning that
affects adaptations of new technology and the diffusion of innovations influencing per capita income.
There is a growing amount of scholarly research on how social and cultural institutions influence
development, but the reason for not including these factors in the figure is that in relation to economic
factors, there are few established results.
You may also lack arrows indicating influence of international integration and trade that explains why some
countries are developed and other are poor. However, in fact evidence shows that after it has been
accounted for the impact of institutions on countries’ contemporary incomes, trade itself explains very
little. This is not contrary to another fact that many post-colonial regimes have used trade policies
successfully as an integrated part of their development strategy, which the new-industrialized countries in
South East Asia such as South Korea and Taiwan are examples of.
With regard to lectures in the following that answer the question of how development is brought about ,
the first section of the lectures concerns theories that disregard international trade and foreign direct
investments, while the second section concerns theories that links strategies for development to changes in
the international economy.
It may be surprising that explanations of why some countries are poor based on trade are so meager as
trade gives access to new technology. Technological change is one of those causes of development that
will be emphasized in the following. The reason is that there is empirical evidence from developed
countries showing that this factor should be considered as a production factor of importance like capital
The fact that international trade has not been a bridge for transferring technology from the rich countries
to the developing countries maybe that the ability to absorb and adapt the new technology in the
developing countries has been poor. There is empirical evidence showing that the absorptive capability
depends on the amount of human capital, and as education depends on qualities of the indigenous
institutions, also the transfer of technology depends on national institutions.
In an article about tropical underdevelopment, Sachs argues that geography has an influence on the
adoption of new technology. He finds that there is empirical evidence showing that the tropical zone has
lagged behind the temperate zone with regard to technology in the two critical areas of health and
agriculture. Contrary to what we found before, he argues that geography has an influence on
underdevelopment as the low diffusion rate for technology in the tropics has “opened a significant income
gap between climate zones”.
Factors such as geography and trade can have a moderate power to explain differences in development
between countries. Nevertheless, they can be important factors in a development strategy designed to
bring about development, which will be discussed in the following that concerns theories of development.
In emphasizing geography, we admit that almost all developing countries are situated in tropical or sub-
tropical zones. Further, climate in combination with global warming and poverty create environmental
degradation in the shape of deforestation and poor soil quality, which has a negative impact on
productivity in agriculture and thus works back on per capita income and poverty. Two lectures will be
devoted to a discussion about sustainable development that could bring this self-perpetuating process to
Classical theory of how development is attained
It is important to note that the first steps in establishing development economics as a branch of economic
science was taken by scholars in the colonizing countries after the second world war and, thus, reflect the
scholarly thinking in Europe and the US during 1950s and 60s. The dominating perspective was the linear-
stages approach to development according to which all countries have to pass the same stages as the rich
countries in Europe. These were made explicit in Rostow’s stages-of-growth model, where all societies
starts as traditional agrarian economies that find a development strategy for a “takeoff” into self-
In these theories increased domestic saving in combination with transfers of capital from the rich
countries either privately or as foreign aid to accelerate investments was considered as an important
condition for “takeoff” and regular growth. Thus, today many governments in developing countries base
their development policies on an aggregate growth model inspired by the Harrod-Domar growth model.
/Math I here/
The logic behind using this model is that capital formation is the main obstacle to development. Labor is
excluded as this factor has been considered as abundant in developing countries. It is a difference with
regard to innovation and technological change which is a scarce factor in most poor countries in Africa. This
factor can be incorporated into the Harrod-Domar model as a reduction in k over time. That is, as time
passes, less savings and investments are needed to produce a given income.
/Math II here/
The weakness of this way of dealing with technological change is that innovation and technological change
is exogenous, i.e. we are lacking a theory of innovation, to which we will return later in this course.
When using the Harrod-Domar model, some governments apply the two-gap model comparing savings
gap and foreign- exchange gap to determine which is the binding gap.
Let us assume that it turns out that the savings gap dominates, which means that the foreign exchange gap
is binding for capital formation. This could be a situation where the national elite uses foreign exchange,
including foreign-aid, for luxury consumption abroad. As the government wish to increase the per capita
incomes by increasing the growth rate, it is reasonable that it tries to encourage the elite to reallocate their
incomes from consumption to investments. Alternatively, they try to increase foreign exchange by means
of foreign aid and foreign direct investments. You can read more about the two-gap model on pp 702 – 703
Implicit in the linear stages approach to development , where all countries pass the same stages of
development, is the idea that regular growth after “takeoff” is synonymous to industrialization and the
development of a modern sector replacing traditional agriculture. However, targets for the growth of the
modern sector should be judged in view of the amount of surplus labor in agriculture, which was
considered as overpopulated with a marginal productivity of labor equal to zero. Thus, it was believed
that labor could be withdrawn from traditional agriculture without any loss of output. At the same time,
marginal productivity in the modern economy was larger than zero implying that wages were higher than
in agriculture. As people were assumed to move from regions with lower wages to regions with higher
wages, rural-urban migration was expected to grow fuelled by a modern sector characterized by full
Development strategies in this situation was analyzed within the context of Lewis two-sector model that
dominated the field of development economics during 1960s and the beginning of 1970s. Lewis assumed
that the capitalists operating the modern sector reinvest all their profits. If we also assume that the
workers in the sector use all their income for consumption, then this model takes for given that
investments are equal to savings which means that it predictions made by this model can easily be
coordinated with predictions made by the Harrod-Domar model of aggregate growth.
/presentation of the model 116 – 120/
Self-sustaining growth continues until all surplus labor has been transferred to the modern sector. This is
Lewis turning point, where the slope of the labor supply curve becomes positive and further labor cannot
be removed without costs in terms of reduction in the food produced in subsistence farming.
One weakness of this model is that it does not take into consideration the possibility that the capitalists
invest in laborsaving capital equipment.
/figure 3.2 p 119/
One implication is that the wage-share of total value produced in the modern sector declines (and the
capital share increases) and economic growth does not create any new jobs. This may be called
“antidevelopment” economic growth.
When seen in view of the contemporary discussions about development strategies, one difficulty with
Lewis’s model is that it neglects the importance of agriculture, which is reduced to a secondary sector.
With the new understanding of development emphasizing reduction of poverty and inequality,
development of agriculture comes into the fore as most of the poor people are living in rural areas.
These two linear stages approaches to development is based on the idea that all countries in principle are
alike in the sense that they pass the same development stages. This is a completely different paradigm for
development as compared with the Neocolonial Dependence Model that become popular among
development economists from the 1980s. According to this model developing countries are considered as
belonging to the periphery and the developed countries constitute the center connected to the periphery
(developing countries) through power relationships. Thus, the development of the developing countries is
not the same as for the developed countries as, according to these relationships, their development
complies with dependent capitalism, where the economy of the countries in the periphery is conditioned
by the development and expansion of the countries in the center.
Unlike the linear stages approaches that stresses the importance of internal constraints to development
such as insufficient savings and investments, the Neocolonial Dependence Model defines the development
strategies in relation to external constraints and the need of restructuring the world capitalistic system.
This agrees with figure 2.11, where the main explanation of differences in development between poor and
rich countries is institutional characteristics associated with the type of colonial regime.
When looking at possible development strategies, it is also important to note changes in the international
system from anarchy and conflicts between national states to increased collaboration and the
establishment of international organizations. Thus, the Neocolonial Dependence Model recognize an elite
ruling class in the developing countries, which is rewarded by and serve international organizations such
as the World Bank, IMF and various organizations of the UN. They share the ideology and interest of the
ruling elite in the center.
For example, there are rules in the international system defined by the governments in the developed
countries, saying that the foremanship of the World Bank always is allocated to an American (the US) and
the foremanship of the IMF is always allocated to an European. Being a collaboration between national
states in Europe, the EU is another international organization. Through its Structural Funds, and by using
tariffs the EU protects agriculture in Europe from trade in agricultural products, which is very harmful for
the African farmers.
From this perspective, an efficient development strategy, could be one that changes the rules for
allocating foremanships in international organization, transferring power of these organizations to
developing countries and to form alliances with those forces in Europe that are working for changes in the
European agricultural policy. Furthermore, it was mentioned before that international trade has not been
a bridge for transferring technology from the rich countries to the developing countries, and we explained
that by the ability of developing countries to absorb and adapt the new technology. However, now we are
in a position to discover a second factor of importance. It is referred to neoclassical economics that
consider knowledge (technology is knowledge about how to produce services and commodities) as a public
good free for use. However, in practice a lot of technologies that could be useful for developing countries
are owned and controlled through patents by companies with domicile in the developed countries.
Another example of a development strategy in the spirit of the Neocolonial Dependence Model could be to
make efforts to change the international patent laws.
The neoclassical counterrevolution
In the 1980a and 1990s, it became common that international organizations such as UNDP and UNCTAD
took on board the market ideology propagated by the World Bank and IMF controlled by the developed
countries. In many countries, for instance, in Africa it was called for privatization of public companies and
dismantling of governmental regulation. These views were supported by economists at foremost well-
known American universities, who argued that the bad performance in the developed economies
depended on inefficient public regulations. Fields in economics such as public choice became popular at
the universities using classical approaches in neoclassical economics to analyze different forms of public
failure and argued in favor of an increased role of market allocation.
While scholars belonging to the dependency school in development economics argued that the lack of
development in poor countries depends on their colonial heritage, advocates of the neoclassical
counterrevolution argued that underdevelopment results from poor resource allocation due to incorrect
pricing and too much state intervention by developing- nation governments.
Because of their association with the World Bank, IMF and key US government agencies, it is sometimes
referred to these ideas as the Washington Consensus. Dani Rodrik characterizes the Washington consensus
in ten points (Table 11.1 p. 530) and there is not anything in these points that indicates the importance of
eliminating absolute poverty. Obviously, the basic idea is that a high economic growth rate will take care of
poverty. He also compare the ten points with the development strategy applied by the most successful
Asian countries such as South Korea and Taiwan and find that the state has had a broader role in these
countries than encapsulated by the Washington Consensus.
I think T/S conclusion that in an environment with widespread institutional rigidity and severe
socioeconomic inequality, both markets and governments will typically fail. It is a matter of assessing each
country on a case-by-case-basis.
Contemporary explanations of how to attain development
Development strategies and reduction of poverty and inequality
According to modern perspectives on development, contemporary theory of development should
emphasize the problem how a society escape from absolute poverty and how inequality is reduced. It is
obvious that bringing people out of poverty should be crucial, but why is inequality important.
There are at least three reasons:
1) Inequality is inefficient as it reduces saving (the middle class has the highest propensity for saving). The
saving of the small group of very rich is proportionally small as the use money for luxury consumption,
travels abroad and capital flight. Furthermore, investments are also hampered as a majority of the people
cannot provide the collateral necessary for getting loans. With regard to investments in human capital,
inequality creates a bias towards higher education, while development often is better served by increased
investments in higher quality of primary and intermediate education.
2) Inequality destroy social capital such as trust relationships and solidarity by promoting rent seeking by a
small elite using bribes and corruption leading to cronyism.
Yet, there are economists arguing that some inequality is necessary for development as equality tends to
reduce the incentive for working hard. If you know that there is a possibility for increasing your income, to
get a position with higher salary, then you are prepared to increase your productivity. The counter
argument is that there is a wealth effect involved in social engineering directed to the determination of the
optimal inequality with regard to working incentives. Inequality implies for the majority of the population
with the lowest incomes that they cannot afford to buy food with the nourishments, and have the housing
conditions, necessary for a healthy life. Due to poor health, they will not work more but less than in a
situation with a more equal distribution of wealth.
3) The third reason for considering inequality in a development strategy is that it is not fair. At this point,
Rawl’s notion of the “veil of ignorance” should be mentioned. He outline a laboratory experiment, where a
group of people is told to imagine that they do not know their future income and wealth. Thus, all have the
same probability to belong to those with the lowest incomes or to those with high incomes. Under these
conditions, they are asked if they would prefer an income distribution that was more equal or one that is
less equal than those they see around themselves. If the degree of inequality had no influence on the
incomes, than most of the people would probably choose a distribution that is almost equal.
Obviously, it seems reasonable to rank developing countries with regard degree of development using
properties of the Lorentz curves. How can this be done? (highly unequal countries have a large Gini
coefficient and vise-versa). Modern explanations of how development is attained are more concerned
about difficulties to reduce inequality and escape poverty traps than the classical explanations.
There are empirical evidence of how efficient the two linear stages approaches to development discussed
before are to promote development.
1) Modern sector enlargement in a two sector economy like in Lewis’ model, where the modern sector is
growing constantly but wages in both the traditional and the modern sector are constant. This
development strategy has been practiced in East Asia by countries such as China, South Korea and Taiwan.
2) Modern sector enrichment growth, where the growth is limited to a fixed number of people in the
modern sector when, at the same time, the number of workers in the traditional sector and their wages
have been constant. This is the type of development has been practiced in many African and Latin
3) The traditional sector enrichment, where growth has benefited workers in traditional sectors with little
growth in the modern sector. This is typical for countries that have given priority to fighting poverty at a
low growth rate and low per capita income (Sri Lanka and Kerala in India).
In 1), absolute incomes are increased and absolute poverty is reduced, but as the Lorenz curves are
crossing (figure 5.9) there is no clear evidence of changes in inequality. In 2), inequality is increased and no
change in poverty. 3) The growth (relatively lower) results in higher incomes with a more equal
distribution of income (figure 5.7)
It is sometimes held that rapid growth is bad for the poor, as they will be bypassed by structural change.
This argument is supported by 2), which has no effect on poverty, while 3) with lower growth rate improves
the situation of the poor. Furthermore, advocates of the inverted U Kuznets curve are arguing that in early
stages of economic growth when the per capita income still is low, the distribution of incomes will be
worsen; only at later stages it will be improved (figure 5.10). With Lewis model in mind, increased
inequality at early stages, probably, depends on few jobs with relatively high productivity and wages in the
modern sector. If we look more specifically at investments in human capital and supply and demand of
skilled labor in the modern sector, we also have an explanation of why equality increases at later stages of
the development process. At the early stages, skilled labor demanded by the modern sector is short in
supply pushing wages in this sector upwards, while at later stages the supply of skilled workers reducing the
number of unskilled.
However, few development economists would argue that the Kuznets curve is inevitable, but depends on
type of development strategy chosen. This is evident from the differences between 2) and 3) above.
It is sometimes argued that redistribution from the rich to the poor will reduce economic growth as the
poor save less. However, figure 5.13 does not support this conclusion. It reflects the fact that the low
inequality East Asia is growing faster than the high-inequality Latin America and Sub-Saharan Africa and
changes in the Gini-coefficient was small within the groups between 1960 – 1990. With regard to savings,
there is empirical evidence that the middle-class has the highest saving rate, and reduction of poverty is
synonymous to social mobility increasing this class. Moreover, when poor increase their incomes they save
and invest in education of their children and in improved health. Altogether has a positive effect on
Recent economic perspectives on how development is attained
Contemporary models have been enriched by discussions among development economists about the
suitability of market fundamentalism as expressed by the Washington Consensus. These discussions have
led to the development of new tools to better understand problems related to market failures. They have
provided significant insights into why markets fail to coordinate various actors. The new models are better
to handle problems related to the notion of economies of scale and its connection with learning by doing
and the neglect by the Washington Consensus of poverty has led to strong focus on why communities get
stuck in poverty traps. The latter has intensified studies of economic processes with multiple equilibriums.
Big Push models
T/S ask why it is so difficult to start modern growth, where traditional methods of production are replaced
by new methods. According to market fundamentalists it is a matter of transferring new technology from
the developed countries and establish efficient institutions for securing free markets in the developing
An example from the traditional rural economy may illustrate. In the Gambia, bee keepers remove bees
from trees by smoke and, therefore, have sometimes been made scapegoats for bushfires. When this mode
of producing honey actually leads to bushfires, beekeeping becomes extremely harmful to women, who by
tradition use the forest for collecting firewood, which afterwards is sold at the market. This is an example
of negative externalities in the traditional rural economy. Pecuniary externalities are positive or negative
spillover effects on an agent’s costs or revenues.
Instead of using wild beehives in trees in the forests, beekeepers can buy separate beehives , which they
place close to their villages. This is a new technology without negative pecuniary externalities. Contrary,
bees are pollinators, and if the women have gardens with fruit trees, activities by the beekeepers may
increase the incomes of the women. Opposite, the orchards the women keep constitute a positive
pecuniary externality for the beekeepers as they help the bees to produce more honey.
However, the yields from the beehives depend on how many orchards the women will establish. This brings
us back to the original question about why it is difficult to start modern growth. In order to answer this
question we notice, firstly, that in this illustration there are complementarities involved, which indicate that
there may be an equilibrium that is better than the traditional. Complementarities, then, are present when
an action taken by one economic agent increases the incentives for other economic agents to take similar
actions. Secondly, even if both the women and the beekeepers would prefer the equilibrium with modern
growth, there may be a coordination failure that leads the agents to an equilibrium, where all are worse
off than in an alternative equilibrium. They cannot get to the alternative “better” equilibrium because of
difficulties to coordinate their actions even if they have full information and therefore know that the
modern-growth equilibrium is better for all than the traditional one.
Coordination failures appear; either because they have different expectations about one another’s
behavior or because of free riding where everyone is better off waiting for another to be the first mover.
Figure 4.1 illustrates the situation with coordination failure in case of multiple-equilibria. The S-shape of
the individual decision curve is explained by the fact that investments in new technology is associated with
a critical mass of investments, i.e. the benefits of an individual’s action depends on how many other
agents take the same action or on the extent of their actions.
We associate the traditional equilibrium with origo. Some agents invest individually in the new technology
(Y1 in figure 4.1) expecting that no one else will make any investments. Since the average is higher than
expected, the agents adjust their expectations to the average and increase their investments. Since the
individual investments are based on expectations about the average investment level, it is only when the
individual investment levels are equal to the average investments that the process is in equilibrium.
There are three equilibriums out of which D1 and D3 are stable equilibriums. These are stable as a small
increase in the expectations would lead to individual investment levels below the expected average, which
would lead to a return to the original equilibrium /similar reasoning for reduction in expectations and for
showing that D2 is unstable/
The utility of D1 and D2 is not the same. For instance, D2 with the high average level of investments may
be associated with farms, where the women have set up life fences of cashew-nut trees (a practice found in
the Gambia) to protect the orchards from wind and animals. This increase the soil quality and the amount
of fruit produced and due to the complementarities it will also increase incentives in investing in bee hives.
All in all moving from D1 to D2 represents a Pareto improvement. However, since D1 is stable, and a small
change in expectations and investments will bring the village economy back to D1, the move from D1 to D2
cannot usually be brought about by individual decisions and market mechanisms.
To solve the problem of coordination failure, there is usually a need of an external agent – a
governmental body or an NGO – to bring about Pareto improvements . A more detailed analysis of this
agent is provided in my next lecture.
In the literature, Issues on how to start modern development have often been discussed under the
heading of the “big push”. Here I will discuss a model used for analyzing these issues which have been
proposed by P Krugman, and is discussed on p 165 in T/S. In this model, like in most of the recent
discussions about the problem how to start development, the barrier preventing free markets to bring
about Pareto improvements by moving the economies from the traditional equilibrium to a modern one
has been associated with high wages in the modern sector.
This model is based on a few crucial assumptions:
1) Technology: Contemporary models usually associate the modern sector with Increasing Returns to
Scale (IRTS). For developing countries, one interesting interpretation is that the technology is new, and
therefore, has to be “learned by doing”, there is a learning effect involved in the sense that every time the
production process is repeated the efficiency will be increased. There are N products in the economy.
2)Labor is the only production factor. In the traditional sector, and for each product, one worker is used
for the production of one unit of output. In the modern sector, IRTS is taken into account in terms of a
fixed cost expressing that the product cannot be produced without a minimum of F workers. We may think
about the F workers as instructors needed for training the workers to increase the learning effect.
Producing a product within the modern sector requires the following number of workers: L = F + cQ, where
c < 1.
3) Factor payments: In the traditional sector workers receive a wage equal to 1 and in the modern sector
w > 1. Remember; high wages in the modern sector have often been used as an explanation of
4) Competition. Models by Krugman I am acquainted with are usually based on the assumptions of perfect
competition in the traditional sector and monopolistic competition in the modern sector. The latter is
logical, with regard to the assumption about IRTS in the sector. However, when a firm producing in the
modern sector enter a product market, the assumption about perfect competition in traditional production
implies, if it sets a price higher than 1 (MC = 1 = p) it will lose all its customers to traditional producers.
5) Demand. To make things simple, it is assumed that the economy is closed and each domestic product
market receives the same share of the total national income Y: Y/N
/present the model analysis on the board pp 168 -169/
It is not easy to define an appropriate strategy to attain development in, for instance, the Gambia. We have
focused on possibilities for exploiting complementarities and on difficulties to avoid coordination failures.
Even if these issues have been an important concern for many development economists, we shall not make
the mistake and belief that we have found the final solution.
To many interested in this field, it is evident that each country is unique and probably need its specific
strategy. Among those sharing this knowledge it is popular to apply a model called “the growth diagnostic
framework”. Like a medical doctor apply an hierarchical procedure for testing different diagnoses and
exclude illnesses, the economist apply a diagnostic tree to identify different possible limitations to growth
and afterwards suggest treatments for the expected disease.
The model sets out from a postulate with a broad acceptance (many people would agree): A high level of
private investments and entrepreneurship are good and should be promoted by a development strategy.
One advantage of the diagnostic tree is that it shows that it shows how the various analytic tools discussed
in different parts of this course is related to different limitations to development. For instance,
“coordination failure” makes “low private appropriability” severe limitation to growth, while “low domestic
savings” (discussed in a previous lecture) makes “high costs of finance” a limitation on growth.
/eventually discuss figure 4.3 more in detail/
Be careful, do not think that the practice of a medical doctor can be directly transferred into the field of
development economics. When targeting a specific limitation to growth, remember that the diagnosis is
based on a probability, and assume that the probability of your diagnosis is significantly lower than in the
case of a medical doctor. The most important contribution of “growth diagnostic”, probably, is that it tells
us that there is no medicine that can be used for all countries.
Sustainable agricultural transformation
Since poverty should be a concern of development economics (cf. pp 219 – 221), and the core problems of
poverty originate in the economic stagnation in rural areas, the rural economy must play an indispensable
role in any strategy of economic progress. This perspective on development differs from Lewis’ two-sector
model, where agriculture plays a passive role to provide food and manpower to the “leading” industrial
The agrarian system in Africa
One lesson to be learned from studies of development is that developing countries are different and
therefore have to be dealt with differently. In Latin America and in parts of Asia the trend is toward
concentration of large land areas in the hands of a small class of landowners, while in Africa a relative
availability of unused land has led to other types of farming. At the same time, due to subdivision of land,
there is a trend both in Asia and Africa that the size of individual farms are becoming smaller. In order to
better understand the importance of these differences, we need a tool by means of which we can classify
countries with regard the agricultural activity.
T/S introduce the notion of agricultural system and tries to identify an African agrarian system as well as
one in Latin America and another one in Asia. We have already mentioned empirical evidence of ownership
(ownership to land) and patterns of land distribution. These two variables are included in the
characterization of an agrarian system. Even if farm-sizes tend to decrease over time in all three systems,
table 9.3 in T/S, which shows the variation in farm sizes for individual countries, does not show a clear
differences between the systems with regard to average farm size. For those countries included, the
average size is larger in Latin America than in the other two systems. But Bangladesh and India in Asia have
about the same small size as many countries in Africa. On the other hand, an African country such as
Botswana has an average larger than Thailand and Pakistan in Asia.
The size of farms are an indicator of the type of management; if the farms are mainly directed towards
subsistence farming or cash crops; if they are managed as a firm employing workers or as a family farm. In
Africa, the family farm owned and operated by a single family is common, while in Latin America Latifundio
owned by a small number of landlords employing more than 12 (sometimes 1.000) workers is the most
common way of organizing agrarian activities.
Social and cultural institutions are crucial characteristics of an agrarian system. In the African system the
allocation of control of resources depends on kinship both by descent and by marriage implying that
husband and wife usually have their own separate economy and the oldest son takes over the
responsibility for the family after the father. Furthermore, in the Gambia, we have the traditions associated
with the village Alkali, who allocates land to inhabitants of the village, which is a discrimination of those
coming from other villages, who are unable to get land in the village. I have heard that this institution is
changing when the price of land increases????
More specifically, the African agrarian system has three characteristics:
1) Subsistence farming is important (type of management): The majority of farming families in Africa plan
their output primarily for their own subsistence. Only small areas can be planted and weeded as traditional
tools (hoe,the axe and panga) are used. Donkey, small horses and cows are used to make work more easy,
but most work is performed by labor.
Another limitation is the access to fertilizer implying that farmers have to rely on shifting cultivation (slash
and burn with fallow). However, with a growing population, the fallow period have to be made shorter or
new farmland has to be created by clearing the forests.
I do not think subsistence farming is sustainable in its present form. A continuation will increase the harm
of deforestation and desertification. One alleviation mentioned in the literature is genetic engineering
creation new crop species. In my next lecture, I will point at soil management as another possibility.
A third factor that put limitation on the future growth of subsistence farming is the scarcity of labor during
the rain, growing, planting and weeding season.
2) The existence of some land in excess of the immediate requirements. Institutions for private
ownership to land have been less important than in parts of Asia and Latin America, with powerful classes
of landlords. Instead of relying on private property, in Africa there are traditions for common property and
local customs for allocating land, for instance, the Gambian alkali (ownership)
3) The right of each family in a village to have access to land and water (social and cultural institution).
This rule of the traditional system is an insurance the villagers have. One drawback, can be that the rule
impede innovations. Newcomers in a village bring new ideas about how farming can be done and as this
institution is a barrier for emigrants that have land, novelties are never brought to the village. There is
evidence that villages provide land to newcomers in the neighbourhood to the village, and afterwards
connections between the two villages have been established, which have brought improvement into the
Transition from subsistence to mixed and specialized farming
How do we think about a transformation of the subsistence economy using the notion of capability to
function as measure of development (cf. A Sen)? A commonly used way of thinking about the evolution of
agrarian systems is in three stages. 1) is subsistence farming widely used in Africa. 2) is mixed or
diversified farming partly devoted to production of food for the family, but also producing a significant
share for the market as cash crop. 3), finally, is high productivity specialized farming producing only for the
market as we find in developed economies.
Are there any strategies for moving from the first stage to the second and the third stages that increase
the capability of the population to function and, thus, can be considered as development? Many
economists in the field of development economics point to export markets as lever for development. Thus,
the vent-for-surplus theory of international trade provides a strategy for moving from subsistence to
mixed family farming. However, this theory is based on the assumption that there are resources in the
subsistence farming system that are unemployed.
/figure 12.2 about here/
In referring to the Gambia, we may think about “Export” as rice, which is a staple food in this region. At the
same time, the nourishment of rice has a lower quality than that of vegetables and fruit. If “Import”
consists of fruit and vegetables, then moving from V to C increase the level of development in the sense
that the capability for function has increased. Yet, as mentioned before, it is not clear that there are any
unemployed land and labor in the Gambia any longer, which makes this strategy less adequate.
There are other difficulties with a move from the first to the second stage, which become obvious when
looking at the role women by tradition has played in African subsistence farming. Gender- relations are
crucial determinants of many social and cultural institutions in African farming. Thus, the provision of food
security for the family is, probably, one of the most important role of women. Therefore, it is not surprising
that in an agrarian system where subsistence farming dominates as in Africa, 60 – 80% of agricultural labor
is provided by women; to be compared with 40% in Latin America. But when traditional subsistence
farming is transformed through commercialization and increased role of cash crops (crops produced
entirely for the market), then the role of women in agriculture tend to be reduced. Instead, the amount of
resources controlled by men increases. Cash cropping increases at the expense of women’s vegetable
It should be noted that this transformation may reduce the well-being of the whole family. The
responsibility for the provision of the family’s food security still stay with the women, who now have to buy
a larger share of nourishments on the market with less money than before. If the increased incomes of the
husbands do not compensate for reductions in women-incomes, or the husbands refuse to reallocate
income to the women, then the well-being of the whole family decreases.
Of different reasons already mentioned subsistence farming in its present form is not sustainable (shifting
cultivation cause deforestation and desertification). Using “the growth diagnostic framework” (p 182) we
may say that the environment is the most binding constraint on economic growth. Attention is thus drawn
to the need of innovations in the method of shifting cultivation. Accordingly, many policy makers and
researchers in the field have focused on increasing agricultural productivity by diffusion of technology such
as new seed varieties, use of fertilizers and irrigation. However, we are asking for transformation of an
agrarian system occupied by small and usually poor farmers, who usually are risk averse and successful
adoption of new technology is uncertain making innovations risky.
Instead of explaining failures of development strategies for new technology adoptions by farmers being
irrational and backwards, economists should recognize that farmers usually are rational, given their
information and ability to interpret this information. Economist studying new technology adoption have
applied frameworks for analyzing decisions at the farm level; usually based on standard theory for profit
maximization. For example, maximization of expected profit subject to land and credit availability.
Technology is chosen from a mix of traditional and modern technology.
However, as T/S are arguing, the knowledge about various technologies are limited and the transaction
costs for obtaining information are high. Another modification of the standard model of new technology
adoptions in subsistence farming suggested by the authors take into consideration the facts that farmers
are in a poverty trap, implying that maximization of income is not the main decision criterion, but the
family’s chances for survival.
Adoption of new technology, for the most part, means that you only have some information about the new
technology and the information is complete only after the technology is fully adopted. To introduce new
technology, thus, is a learning process where you step by step increase your knowledge about new
fertilizers, new seed or livestock varieties. This learning is costly and the costs are often excluded in the
standard neoclassical model of economic decisions. This is a severe weakness when the model is applied to
increase our understanding of the transition from subsistence to mixed and specialized farming as the
transition concerns peasants exposed to real danger of starvation and therefore cannot afford these
As many farmers are unable to read and training is limited, learning by doing is common. Cultivation
depends on rainfall and the livestock is exposed to various diseases. With regard to endemic breeds of
livestock and native crops farmers have learned by own experience and know quite well how the traditional
crops function in case of rainfall or draught and with regard to livestock they know the threats of different
diseases. If adapting new technology in the shape of new seed varieties and livestock breeds they are less
certain about how these varieties and breeds function in the actual climate. For a subsistence farmer ,
producing close to the minimum consumption level, who make decisions that assure the family’s chances
for survival, it is rational not to adapt the new technologies.
T/S analyze the behavior by poor farmers assuming that they are risk-averse
/figure 9.6 about here/
The authors refer to crop yield, while I will illustrate by yield of livestock. Endemic livestock in West Africa
are well adapted and productive in tsetse infested areas, they are tolerant to heat and resistant/resilient to
certain diseases flourishing in the region. However, despite their multiple adaptive attributes, endemic
breeds are often perceived by farmers as inferior to new alien breeds in terms of productivity and
marketing. Consequently, their habitats degrade threating the survival of the endemic livestock.
Endemic livestock with lower average yield is associated with technique A and new alien breeds are
associated with technique B. Since the variance in yields is larger for B than A, the risk is also higher for B
than A and B therefore will be rejected by a poor risk-averse farmer. In doing this choice, the poor pay a
self-insurance equal to the difference in average yield.
It should be mentioned, however, to be able to draw the probability distributions in figure 9.6, the farmers
need more information than they usually have.
Rural development and the environment
One lesson to be learned from the previous lecture is that poverty is a crucial characteristic of subsistence
farming as it prevents development. When trying to attain a transition of the rural economy to a system for
mixed or specialized farming it is also important that a new agrarian system is in accord with the conditions
for sustainable development. This notion will be defined later on, but for the time being we imaging as a
necessary condition for this kind of development that it ends the environmental degradation associated
with subsistence farming.
In real life, reducing poverty is intimately connected with sustainable development, as poverty both causes
environmental degradation and is itself a result of environmental degradation. But usually definitions of
sustainable development concern how to safeguard the natural environment in a way that meets the need
of the present generation without compromising the needs of future generations. This requires that the
stock of overall capital assets remain constant or rises over time. Natural resources or the natural capital is
included, but as natural capital can be substituted for other forms of capital only to a certain extent, it is
important to incorporate some kind of environmental accounting into any strategy for the growth of mixed
farming. Such an account is discussed in T/S, but will not be discussed here.
Two types of environmental degradation will be used to illustrate how the environmental factor can be
taken into consideration in a policy for transforming subsistence farming into mixed farming. The first
factor is deforestation understood as clearing of forested land either through extension of farmland as
shifting cultivation is land demanding or for logging and collection of firewood. The second factor is soil
erosion and other types of reductions of the soil quality. When the forest cover decreases, for instance
through deforestation, topsoil will blow away or will be washed away by rainfall. Furthermore, when there
are no trees, there will be no litter for nourishing the farmland and forests provide catchments for water
that can improve the quality of the farmland.
There are many interrelationships between poverty and environmental degradation that produce
downward spirals leading away from sustainable development, and, therefore, should be considered in a
strategy for transforming subsistence farming into mixed farming. For example, poor people use firewood
as their main source of energy, and the collection of firewood is sometimes made the scapegoat of
deforestation. Furthermore, to keep the soil quality when land is constantly used it must be maintained by
fertilizers but poor people cannot afford to add fertilizers. Consequently, to provide food for a growing
population marginal land has to be used. This creates a negative spiral as the well-being of the poor is
further reduced because they must live on degraded land that is less expensive.
From this perspective, transforming subsistence farming to mixed farming becomes a matter of identifying
positive spirals, where measures reducing environmental degradation increase the well-being of the poor,
which, in a second step, lead to further reductions in environmental degradation and so on. T/S are arguing
that the most important factor preventing environmental degradation associated with the poor is to
provide institutional support for the poor. Land tenure rights may be one example here. In the Gambia, for
instance, you are not permitted to plant trees on farmland you rent. Changing this institution giving the
landless the right to intercrop trees with other crops (agroforestry) would improve the soil quality and
probably also their well-being. Another example is the Gambian government that tries to align the
protection of forest resources with the interests of local people by transferring the responsibility for forest
resources and legal ownership (secured tenure both on the land and resources) to local populations
represented by Community Forest Committees. I will return to this later on.
Before that, I will use theory about the “energy ladder” to illustrate how poor change in their consumption
of energy when their income increases, which suggests a positive spiral between reduction of poverty and
reduction of environmental degradation. When incomes increase people move up the energy ladder from
firewood to charcoal or kerosene and then to butane gas (LPG), natural gas or electricity for cooking. A
recent study conducted in urban Ouagadougou confirms these findings (Ouedraogo 2006). Accordingly, the
World Bank report argues when population growth overrides increases in incomes people move down the
ladder and return to biomass fuel. It might well be that this theory explain behavior of the urban
population, But what about poor farmers?
One question arising is if the positive spiral suggested by the theory of the energy ladder can be generalized
and applied to the whole society. This brings us to the environmental Kuznets curve, which suggests that at
this level the situation is more complex. According to this curve, environmental degradation increases
when incomes increase and then decreases like an inverted U-curve. Since this curve describes the
development of the whole society, it might well be that the non-poor increase the environmental
degradation while environmental degradation by the poor decreases when income increases. The net
effect may be negative.
Instead the environmental Kutznets curve is questionable with regard to if there is a turning point, where
aggregated environmental degradation begins to decrease. When it comes to greenhouse gases containing
carbon, it is rather the reverse that environmental damages increase with increases in incomes. Even if a
strategy for transforming subsistence agriculture in developing countries is targeted to increase the forest
cover, which will reduce the emission by enhancing the forest carbon stock, this is probably not enough to
balance the carbon emissions in the rich countries.
Example of institutional support
Usually, the poor farmers cannot afford to introduce new technology such as using manufactured, synthetic
fertilizer to improve the soil quality in a way that bring them from subsistence to mixed farming. Less costly
methods for soil management, that can replace slash-and-burn agriculture, has to be found. The soil
management system discussed in this example uses forests cover, cashew trees and livestock to increase
agricultural productivity (figure 1).
Figure 1: Soil management system considered in the project
Forest cover Cashew trees
1) 3) 4) 6)
(livestock and cashew)
The arrows depict:
1) Food supply; 2) Manure; 3) Plant litter, reduced erosion, forest catchment area for water; 4)
Pollination; 5) Firebreak protection (against bushfires), 6) Protection against illegal forest degradation
In the spirit of T/S we argue that the soil management in figure 1 cannot be implemented unless the poor is
provided by institutional support. Gambian institutions for Community forests that transfer the legal
ownership to forests to local populations represented by Community Forest Committees may be an
example of this type of support. We may think about these institutions as increasing the forest cover (see
figure 1). At the same time, arrow 6) is working back from agricultural productivity to forest cover. It is
associated with reduced costs of protecting the forest against illegal forest degradation when farmers’
incomes increase. That is, the costs of counteracting illegal logging are reduced having a positive influence
on the growth of the forest cover.
Private and common property
10.4 about economic models of environmental issues are discussed in other courses, for instance in
Advanced Micro - and will therefore be excluded. However, as there has been a debate recently about if
improved property rights for the poor could help them out of the poverty trap and transform subsistence
farming, I will say a few words about the sections on private and common property.
A farmer who do not own the land they use always face a hold-up problem. The landlord can always
increase the land rent to a level that the farmer cannot afford. This risk increases if the farmer makes
efforts to increase the soil quality increasing the yield of land. Probably, it reduces the interests of the
farmer to adopt new technology, plant trees to intercrop with other crops or set up buildings on the land.
What about farmers’ rights to land as allocated through the Alkali
In the literature the appearance of co-specialized assets are usually associated with hold-up problems, and
it is argued that they are avoided if these assets are owned by the same owner. Property rights that can be
given to farmers are characterized by four conditions:
/see page 482/
However, as Elinor Ostrom shows in her book “Governing the Commons” there are resources - common-
pool resources (CPR) – that can be allocated efficiently in spite of common ownership. CPR is usually
associated with natural resources such as forests, grazing commons or fisheries to which many people have
access and thus usually are owned in common.
Forests are used as example to illustrate what in the literature sometimes is called “the tragedy of the
common”. If the farmers individually decide how many cows they will send to the forest to have their food
inefficiencies will arise. According to neoclassical economic theory this inefficiency is due to an externality
that is not taken into account when food supply from the forest is allocated through common ownership.
The individual farmer consider the average value of the cows and continue to send cows to the forest as
long as this value is larger than the marginal cost, i.e. the cost of buying a cow. However, when sending one
cow it will cause a damage to the forest resources that reduces the food supply and value of all cows.
/figure 10.3 page 483/
In the Gambia the tragedy of the common has primarily been associated with state-owned forest which
now are transferred into Community Forests to which whole villages have the ownership. Alternatively, the
state owned forests could have been divided into smaller lots owned as private property by individual
farmers. In theory this solution would solve the problem of inefficiency in figure 10.3. In addition, to
increasing the agricultural productivity in figure 1, private forests could also be collateral helping the
farmers to get bank loans.
However, in practice it is questionable if privatization would help the poor. Firstly, if they are unable to
repay their loans to the bank, they will lose their ownership to the forest and, thus, be equipped with less
resources than before when the forest was state-owned. Secondly, it is doubt whether poor farmers are
able to protect their ownership as they cannot afford to set up a fence that keep other farmers´ livestock
out of the forest or protect the forest against illegal logging. Furthermore, in case of a conflict about
property rights, they are probable unable to pay for a lawsuit.
As already mentioned Elinor Ostrom shows that the social optimum in figure 10.3 can be attained even in
case of common ownership to the forest (Community Forest) by villagers negotiation binding contracts to
commit themselves to a cooperative strategy. The villagers have to negotiate an agreement about the
number of cattle each compound is allowed to send to the community forest when the total number is
equal to X’’, and they have to agree about an external actor who enforce the agreement. The bargaining
costs and the costs of enforcement is paid from the surplus.
International trade and development
Inward- and outward-looking development policies
So far we have neglected the importance of international trade and investments for development
strategies. Historically, since long there has been a divide in development economics between advocates of
an inward-looking development policy perspective emphasizing trade protection and barriers to FDI. The
most extreme example of self-reliance was found in Cambodia after the independence in the 1970. One
interesting African example is Algeria after the independence. The government launched a national
technology policy to support new industries based on modern technology. The idea behind this strategy for
development was to exploit forward and backward technological linkages.
This was an early version of the European Airbus programme. A modern airplane use advanced technology
within a lot of areas: IT, material, aerodynamics etc. Through backward linkages the Airbus-program was
expected to reduce the technology-gap between Europe and the US and create a platforms for growth
within a lot of different areas. Another development strategy with an inward looking perspective are
various forms of catch ups like the early Japanese industrial policy of copying technology developed in
other countries and at the same time protect the infant industry through trade barriers.
The outward-looking development policy perspective stresses the importance of international trade and
FDI as lever for development. Advocates of this perspective usually argue in favor of free trade. One
example of special importance for African farmers is EU’s Common Agricultural Policy (CAP) where
European farmers are subsidized and protected through trade barriers making it difficult for farmers in
developing countries to compete on the European markets. A foreign policy by developing countries trying
to remove these subsidies and barriers is an example of outward-looking development policy.
In my final lectures, we will discuss two types of outward-looking development policies: Export promotion
and import substitution. The latter can be seen as development through two stages. In the first stage,
imported consumer goods are replaced by domestic production. In a first step, a developing country begin
replace imported fish for its own consumption by establishing own fisheries. In a second stage, the same
country substitutes imported more advanced products, for instance, facilities for cold houses, for cold
houses from domestic production. If the second stage of import substitution turns out to be successful, the
country can even develop into becoming an exporter of fish.
Import-substitution will be discussed in my next lecture.
Export promotion strategies
Export promotion strategies includes the traditional strategy for many African countries to promote export
of primary commodities deriving from mines and plantations (often owned by foreigners). Already before,
the “Vent-for-Surplus Theory of Trade” was mentioned /figure 12.2 p. 585/. This theory is based on the
assumption that there are resources in the subsistence farming system that are unemployed. But with
growing farmer populations and environmental degradation, it is doubtful whether there are any
unemployed resources left.
Another problem with primary commodity export (except for oil and some rare minerals) is that they are
growing more slowly than total world trade. The reasons are low income and price elasticity for these
commodities as well as stagnating population growth. The latter is not through for Africa, where the
populations – unlike the development in in Asia and Latin America - continue to grow.
Primary commodity exporting countries suffer from low income- and price elasticity of demand (IED
anPED). Therefore, difficulties for developing countries that let their development strategy rely on this type
of export, has led to useful tools for analyzing this type of export promotion strategy.
Low IED imply that the growing incomes in the developed countries has not been enough to absorb a
growing export of primary commodities. Low PED implies in case of shortages and surpluses on the
international markets, cause large and volatile price fluctuations. Erratic movements in export prices cause
Export Earning Instability in countries relying on this development strategy.
Another tool for judging strategies for the promotion of export of primary commodities is the Prebish-
Singer hypothesis. In this case, we look at the total export earnings ( TE = ) and total exchange
expenses associated with import (TI= . A developing country that wishes to increase its import of
manufactured goods with high PED and IED, has to reduce the prices of its export of primary commodities
considerably, and thereby increase the volumes of its export - also this considerably - to be able to pay for
the import. This is due to low IED and PED of primary products.
In looking into this problem more in detail, we define commodity terms of trade as / . The Prebish-
Singer hypothesis is that there is a long-term decline in terms of trade of primary- commodity exporters.
This is due to low income and price elasticity of primary commodities. To finance a growing import in
manufactured goods, they have to increase their export of primary commodities. This increase become
larger because of falling .
The solution suggested to the problem decreasing terms of trade of primary-commodity exporters has
been a development strategy called import substitution. By replacing part of the import of manufactured
goods with domestic production, the need of export earnings to finance expenses for import will be
reduced. To some extent this strategy will reduce the Export Earning Instability, as well as the transfer of
values from poor to rich countries that follows this unfavorable terms of trade. Another strategy chosen by
primary-commodity exporters has been to establish international commodity agreements that set overall
output limits, assign quotas to producing nations and stabilize prices.
UN Conference on Trade and Development (UNCTAD) have tried to establish a common fund to finance
“buffer stocks”. How can “buffer stocks” serve the interests of primary commodity exporters? (p. 596)