Announcements “Employment of Married Women and Economic Development: Evidence from Latin America” Today (9/10) 3:30-5:00 (HCB 305) Manuelita Ureta, Texas A&M University “Where Are We Two Years After 9/11?” Tomorrow (9/11) 7:30-9:00 p.m., Bennett Auditorium Panelists: Stephen Gardner (Economics), Mark Long (ME Studies), Christopher Marsh (Pol. Sci.), and Jerold Waltman(Pol. Sci.), all from Baylor, and Norton Mezvinsky (History, Central Connecticut State University)

Chapter 5 History, Expectations, and Development ECO/INB 4334 September 10, 2003 Steve Gardner (your humble substitute teacher while the real guy is away)

Chapter Questions Why have living standards failed to converge (as suggested by the Solow model)? Why do investment rates differ between developing countries? How can equal savings rates lead to different economic growth rates? How do historical forces and expectations influence current rates of growth?

Channels History and Expectations influence growth performance through two channels: Complementarities Increasing Returns

Complementarities Defined: If the fact that other people in society are taking a certain action makes it more beneficial (higher payoff or less costly) for me to take the same action, the actions are said to be complementary.

Complementarities Multiple Equilibria and Dominance When we have choices between complementary actions, we have the possibility of multiple equilibria, meaning that society may coordinate around any one of the possible actions, and exclude others. These societal choices often are influenced by accidents of history

Complementarities Examples QWERTY vs Dvorak typewriters Mac vs PC computers Drive on left or right side of street Full-bodied or token money More or less investment

Complementarities Depending on historical circumstances, complementarities may cause society to coordinate exclusively on an inferior choice (higher cost curve or less payoff) QWERTY over Dvorak (see next slide) PC over Mac Left over right driving in UK Less over more investment

(Anti)Complementarities When the cost of an action increases with more adopters, the action is anti- complementary. Anticomplementary actions will not encourage uniform behavior (adoption of a single equilibrium) by all members of society. In the following slide, commuters will divide between routes.

Complementarities Coordination Failure Coordination is required for society to switch from an inferior to a superior complementary action, but societies often fail to accomplish this. So, a poor country can “lock in” a uniform low rate of investment, which could change with proper coordination.

Complementarities Coordination is particularly important when there are strong linkages between industries (Albert Hirschman) Forward linkage—one industry provides inputs for another (steel for railways) Backward linkage—one industry provides demand for another (steel for coal)

Complementarities Balanced versus Unbalanced Growth Rosenstein-Rodan thought coordination would require the government to give a simultaneous (balanced) “big push” of all industries at the same time. Hirschman argued that unbalanced support of selected industries with strong linkages (Walt Rostow’s “leading sectors”) could stimulate a coordinated expansion of all sectors (Rostow’s “takeoff”).

Complementarities History versus expectations In the following graph, if the population expected a move from old to new, that would cause individuals to choose a move to new. But that requires expectations to adjust from historical experience. Problem exacerbated by delay – benefits of adjustment are not immediate, so we hope others will begin the adjustment without us.

Increasing Returns Defined: A production activity for which an increase in the scale of operation leads to lower unit costs.

Increasing Returns Transition Cost, Time, & Financial Markets Savings from increasing returns do not accrue immediately (partly because of consumer inertia), so producers experience cost increases hopefully temporary) when they switch from an old, but widely used, technology to a new one (see next slide). This problem would be less serious if capital markets were perfect, which is far from true in developing countries.

Increasing Returns Increasing Returns and Market Size: Interaction Limitations on market size can limit gains from external (rather than internal) economies (inter-firm division of labor, “roundaboutness” of production, complex intermediate goods, etc. Vicious or virtuous circle of demand, market size, industry-wide productivity, and income growth.

Competition and International Trade International trade may be able to alleviate some of the difficulties we have discussed Success on export markets can alleviate the “market size” limitations on efficiency. Access to international markets for intermediate and final goods can provide “linkages”

Other Roles for History Social norms See, for example, Question 17a The status quo Change usually creates winners and losers, even if the gains are greater than the losses Compensation of losers may not be credible or implementable