Economics 216: The Macroeconomics of Development Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.) Kwoh-Ting Li Professor of Economic Development Department of Economics Stanford University Stanford, CA , U.S.A. Spring WebPages:

Lecture 11 Development Policies and Strategies Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.) Kwoh-Ting Li Professor of Economic Development Department of Economics Stanford University Stanford, CA , U.S.A. Spring WebPages:

Lawrence J. Lau, Stanford University3 Plan versus Market: Achieving an Efficient Allocation of Resources u The objective is to achieve the highest and best use of resources through the market system u The efficiency of the market system depends on achieving the following conditions: u Price = Marginal Revenue for every good (and factor) in every sector and every period u Price = Marginal Cost for every good (and factor) in every sector and every period u The real rate of return on every investment is equal to the rate of discount (rate of time preference) in every sector and every period u These conditions are not always automatically satisfied by a market system

Lawrence J. Lau, Stanford University4 Plan versus Market: Achieving an Efficient Allocation of Resources u Centrally planned command economy u Pre-determined quantities and prices u Pre-determined producers (sellers) and users (buyers) u Feasibility u Material balance u Indicative planning (France, Japan, South Korea, Taiwan) u Public investment u The role of expectations

Lawrence J. Lau, Stanford University5 Market Failures u Infrastructural investment u Human resources u Monopolistic industries u Public ownership u Regulation u Spillover Effects (R&D) u Coordination externalities u Market failure

Lawrence J. Lau, Stanford University6 Failure of Central Planning u Inadequate self-correction--too little, too slow u The disjunction between information and authority--local and central u The incentive for local information collection u The incentive for local information transmission u The incentive for local corrective action u The problem of identification at the center

Lawrence J. Lau, Stanford University7 State versus Non-State Ownership: Soft versus Hard Budget Constraints u Incentive compatibility u Responsiveness to unfavorable outcomes

Lawrence J. Lau, Stanford University8 Balanced versus Unbalanced Growth u Arguments for the Big Push u Economies of Scale u Limitational Factors u Capital u Human Capital u Entrepreneurship u Comparative Advantage u Arguments for Balanced Growth u Complementarity in production u Complementarity in final demand u Limited domestic market

Lawrence J. Lau, Stanford University9 Industrial Policy u Agriculture versus industry u Infrastructure u Human resources u R&D u Pioneering industries (steel mills, automobile manufacturing plants, semiconductor fabrication) u Protection of domestic market u Direct and indirect subsidies u Below market exchange rate u Below market rate of interest u Below market price of land u Tax incentives

Lawrence J. Lau, Stanford University10 Export Promotion versus Import Substitution u Export promotion has been more successful than import substitution u The advantages of specialization (comparative advantage) u Competitive world market versus protected home market

Lawrence J. Lau, Stanford University11 The Infant Industry Argument u Temporary tariff and/or quota protection can be justified for a newly established firm (or firms) in a newly established industry u It takes time for such a firm to attain the scale of the lowest long- term average cost: u Domestic market expansion (supply can, under some circumstances, create its own demand) u ”Learning by doing”--the productive efficiency increases with experience in production, e.g., with cumulative output or investment u Thus, even if the firm or industry is not competitive with imports today, given sufficient time, it will in fact become competitive u The importance of a pre-commitment for the phasing out of protection--a “sunset” clause

Lawrence J. Lau, Stanford University12 The Benefits of Openness u Capital u Technology transfer u Managerial know-how u Efficiency-enhancing competition

Lawrence J. Lau, Stanford University13 The Transition from Plan to Market u “Big Bang” u “The Dual-Track Approach” (“Big Bang Chinese Style”)-- reform without losers u Gradualism

Lawrence J. Lau, Stanford University14 How is Efficiency Achieved in the East Asian NIEs? u Maintenance of a stable macroeconomic environment u Market-directed allocation of new investment, aided by export orientation, promotes efficiency u Private enterprises have the incentives for prompt self- correction