1. Contemporary Models of Development and Underdevelopment
Chapter 4
Contemporary Models of Development and Underdevelopment
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2. New Growth Theory: Endogenous Growth
Motivation for the new growth theory
Technological Progress as an exogenous factor
i.e. main cause of growth goes unexplained
The Romer model (Paul Romer, 1986, a Ph.D. thesis offshoot)
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3. New Growth Theory: Endogenous Growth
The Romer model
Idea: Capital includes knowledge capital, some of which – in principle - has a public good character and will diffuse in technology spillovers
Consequence: an increase in the average capital stock of all sectors of an economy increases the productivity of each sector
Increasing returns to scale at an aggregate level
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4. New Growth Theory: Endogenous Growth
The Romer model
(4.1)
(4.2)
(4.3)
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5. New Growth Theory Criticisms:
Still relies on many „perfectness“ assumptions and simplifications not relevant for developing countries
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6. Underdevelopment as a Coordination Failure
Coordination failures occur when agents’ inability to coordinate their actions leads to an outcome that makes all agents worse off
We’ll consider
“Big push” models
The ‘O-ring’ model
The “meeting-in-a-restaurant-problem” as a generic example
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7. Coordination failures: examples
Complementary investments
R&D spillovers
Network of firms
Human capital and firms demanding it
Complementary specialization
From subsistence to market agriculture
A role for a “big player” able to commit
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8. Multiple Equilibria: A Diagrammatic Approach
Generally, these models can be diagrammed by graphing an S-shaped function and the 45º line
Equilibria are
Stable when the function crosses the 45º line from above
Unstable when the function crosses the 45º line from below
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9. Figure 4.1
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10. Starting Economic Development: The Big Push
Sometimes market failures lead to an a priori role for public policy intervention
The general intuition
A firm creating demand by paying (high) wages is only receiving a small part of this demand as demand for its own products
Moods, expectations or government incentives or demand may be necessary!
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11. Starting Economic Development: The Big Push: Assumptions
Assumptions of this specific model
Perfect competition in traditional sector, natural monopolies (increasing returns!) in the modern sector
Only labor as a factor, in trad. Sector, one worker produces one unit of output
w = 1 in traditional sector w > 1 in modern sector
Increasing returns modeled through to minimal worker requirement F
Each good is receiving a constant share of demand
P = 1 in both sectors (entry deterrence!)
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12. Graphical Analysis
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13. Other Cases in Which a Big Push May Be Necessary
Intertemporal effects: intertemporal demand externality
Urbanization effects: if demand for modern sector goods is primarily urban
Infrastructure effects,Training effects: joint use of intermediate input
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14. Why the problem cannot be solved by a “super-entrepreneur”
Imperfect capital market
Too large agency costs (monitoring, inefficiencies) in the super-firm
Inefficient competition for the role of super-entrepreneur
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15. Further Problems of Multiple Equilibria
Inefficient advantages of incumbency: Getting stuck with an outmoded technology of a monopolist
Behavior and norms: Being good pays if everybody is good
Inequality, multiple equilibria, and growth
High inequality harms especially through imperfect credit markets (entrepreneurship, education)
Linkages as a tool to target government intervention
Backward, forward, final-demand
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16. Kremer’s O-Ring Theory of Economic Development
Ideas: Quality of production is determined by highly complementary tasks: The weakest link determines quality!
Workers of different quality are not substitutable
Central result: Assortative matching of workers to firms
May also apply across firms!
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17. Implications of the O-ring theory
Investment of any one in skills may be dependent on investment of all
High income and low income clusters (nations, regions, ...)
Extreme income differences between clusters
Brain-Drain!
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18. Figure 4.3
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19. Concepts for Review Agency costs Agent Aid failure
Asymmetric information
Big push
Complementarities
Complementary investments
Congestion
Coordination failure
Deep intervention
Endogenous growth theory
Linkage
Multiple equilibria
New growth theory
O-ring model
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20. Concepts for Review (cont’d)
O-ring production function
Pareto improvement
Pecuniary externalities
Poverty trap
Prisoners’ dilemma
Public good
Romer’s endogenous growth model
Solow residual
Technological externalities
Underdevelopment trap
Where-to-meet dilemma
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