: Economics of Development

Lecture notes: Economics of Development

Introduction

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, deforestationdestructing 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  economistsused 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 institutions.

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 AmartyaSen/ “enhancing the lives we lead and the freedoms we enjoy”.

Sen refers to the capability to functionas 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  foodor 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 withrice (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 knowledgemeasured 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

/by Sering/

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 poor.

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 colonial regime.

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 development.

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 turndepends critically onthe 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 familyinfluence social learningthat  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 tradethat 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  likecapital and labor.

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 followingthat 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 an end.  

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 economiesthat find a development strategy for a “takeoff”into self-sustaining growth.

In these theories increased domestic saving in combination with transfers of capital from the rich countries either privately or as foreign aidto 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 modelcomparing 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 employment.

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 incomefor 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, onedifficulty 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 Modelthat become popular among development economists from the 1980s. According to this model developing countriesare considered as belonging to the periphery and the developed countriesconstitute 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 conditionedby 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 Modelcould 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. DaniRodrik 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 fromabsolute povertyand 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 butwages 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 American countries.

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 curveare 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 economic growth.

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 tothe 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 askwhy 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 countries.

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, whereall 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 levelsare 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 theorchards 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 economiesfrom 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 underdevelopment traps.

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/

Growth diagnostic

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 sector.

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 institutionsare crucial characteristics of an agrarian system. In the African systemthe 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 original village.

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)?  Acommonly used way of thinking about the evolution of agrarian systemsis in three stages. 1)issubsistence farming widely used in Africa. 2)ismixed 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 populationto 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 inAfrican 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 gardens.

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 bydiffusion of technologysuch 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 adoptionsby farmers being irrational and backwards,economists should recognize thatfarmers usually are rational, given their informationand 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 arearguing, 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 thatmaximization 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 thecosts 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 learning costs.

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 assurethe 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 populationmarginal 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

 

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 ElinorOstrom 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 ElinorOstrom 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  thegrowing 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, andthereby  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)