1 Development Economics Lecture 5 Development Policy & Strategy Options

2 Trade Policies - EP or IS?  Export Promotion (EP) - Outward oriented  Policies  encourage free trade in goods  free movement of capital and labor  encourage multinationals, their tech. and products  encourage manufactures in practice

3 Trade Policies - EP or IS?  Justifications - theoretical  increased output and growth arising from comparative advantage  economies of scale  increased competition and efficiency  modern technology  Protectionist policies result in higher prices and lower output  Justifications - practical success  Asian tigers  Other NICs, like Brazil, Malaysia  Other LDCs, like China, Vietnam

4 Trade Policies - EP or IS?  Problems  Limited growth of world demand for primary exports  Worsening terms of trade for primary producing nations  Protectionism of DCs Labor-intensive industries suffer the most from LDC competition and hurt the relatively poor in DCs Labor-intensive industries suffer the most from LDC competition and hurt the relatively poor in DCs The more LDCs there are to adopt EP, the more likely there will be protectionism in DCs The more LDCs there are to adopt EP, the more likely there will be protectionism in DCs But, counter-arguments But, counter-arguments  LDC growth offers market potential to DC exports  Intra-LDC trade can also grow as incomes rise

5 Trade Policies - EP or IS?  Import substitution (IS) - Inward Oriented  Policies  Encourage self-reliance in the manufactures  Erect tariff barriers against imports  Restrict movement of labor and capital  Restrict MNCs with inappropriate tech. and products

6 Trade Policies - EP or IS?  Theoretical justifications  Problems with trade theory (see Lecture 4)  Problems with EP policies (above)  Infant Industry argument  Practical experience - not very successful  Low growth  “Infants” never grow up  Benefits went to the rich  Inappropriate technology  Examples: Argentina, India, Peru, Ghana Argentina, India, Peru, Ghana

7 Trade Policies - EP or IS?  Exchange rate policies  High fixed rates  Tax on exporters Exporters receive less local currency than true market value Exporters receive less local currency than true market value Primary producers are the ones often penalized Primary producers are the ones often penalized  Subsidy on importers Importers get more foreign currency to buy imports Importers get more foreign currency to buy imports  Excess demand for foreign exchange Exchange controls Exchange controls Corruption, evasion, black market Corruption, evasion, black market

8 Overall Policy - Plan or Market? Overall Policy - Plan or Market?  Rationale for Planning  Markets in LDCs often imperfect or non-existent  Poor information and uncertainty  Lack of effective competition Economies of scale and small national markets Economies of scale and small national markets Market power and high prices Market power and high prices  Substantial externalities Social vs private costs Social vs private costs Short-term vs long-term: especially important to growth Short-term vs long-term: especially important to growth  Result: Relative prices do not reflect scarcity and relative social opportunity cost

9 Overall Policy - Plan or Market?  Capital formation  LDCs have low saving rates  LDCs have poor financial system  Human capital gov’t should provide education gov’t should provide education

10 Overall Policy - Plan or Market?  Resource allocation  LDCs cannot afford to waste their limited financial and skilled manpower resources  Investment decisions must be made in the context of an overall development program, including external economies external economies indirect repercussions indirect repercussions long-term objectives long-term objectives

11 Overall Policy - Plan or Market?  Income distribution  Market system will not improve income inequality, may actually exacerbate the problem  Attitudinal or psychological impact  Statement of national economic objective has rallying effect on an often fragmented population  Foreign aid  formulation of detailed plan is a necessity for receipt of foreign aid provides a “shopping list” of projects to persuade DC gov’ts provides a “shopping list” of projects to persuade DC gov’ts criticism: Plan becomes a charade criticism: Plan becomes a charade

12 Overall Policy - Plan or Market?  Plan Failures  Deficiencies in plans and their implementation  over-ambitious, not specific enough, difficult to implement  Insufficient or unreliable data  especially in LDCs  Unanticipated economic disturbances - external or internal  Most LDCs vulnerable to changes in int’l markets

13 Overall Policy - Plan or Market?  Institutional weaknesses  separation of planning agency from day-to-day decision-makers in gov’t  incompetent civil servants, bureaucratic procedures, self-interests of politicians  Lack of political will  political instability  resistance to reforms - entrenched interests

14 Overall Policy - Plan or Market?  Problems of gov’t intervention in general  Use previous learning from Microeconomics  Gov’t and private sector COOPERATION  Korea, Taiwan