CHAPTER 1 Introducing Traditional economics is concerned primarily with

the efficient, least-cost allocation of scarce productive

economic development: a resources and with the optimal growth of these

global perspective resources over time so as to produce an ever-

expanding range of goods and services. Traditional
neoclassical economics deals with an advanced
capitalist world of perfect markets; consumer
1.1 How the Other Half Live sovereignty; automatic price adjust- ments; decisions
made on the basis of marginal, private-profit, and
Absolute poverty -A situation of being unable to utility calculations; and equilibrium outcomes in all
meet the minimum levels of income, food, clothing, product and resource markets. It assumes economic
health care, shelter, and other essentials. “rationality” and a purely materialistic,
individualistic, self-interested orientation toward
Subsistence economy - There is little money income
here because most food, clothing, shelter, and worldly economic decision making.
goods are made and consumed by the people
themselves—An economy in which production is Political economy goes beyond traditional economics
mainly for personal consumption and the standard of to study, among other things, the social and
living yields little more than basic necessities of life institutional processes through which certain groups
—food, shelter, and clothing. of economic and political elites influence the
allocation of scarce productive
Development The process of improving the quality of
all human lives and capabilities by raising people’s
levels of living, self-esteem, and freedom.
Traditional economics An approach to economics
that emphasizes utility, profit maximization, market
Developing countries Countries of Asia, Africa, the
effi- ciency, and determination of equilibrium.
Middle East, Latin America, eastern Europe, and the
former Soviet Union that are presently characterized
Political economy The attempt to merge economic
by low levels of living and other development
analysis with practical politics— to view economic
deficits. Used in the develop- ment literature as a
activity in its political context.
synonym for less developed countries.
Development economics The study of how
However, as we shall soon discover, the process in economies are transformed from stagnation to g
developing countries cannot be analyzed real- growth and from low- income to high-income status,
istically without also considering the role of and overcome problems of absolute poverty.
economically developed nations in directly or
indirectly promoting or retarding that development. In addition to being concerned with the efficient
allocation of existing scarce (or idle) productive
resources and with their sustained growth over time, it
1.2 Economics and Development Studies
must also deal with the economic, social, political,
Although one could claim that Adam Smith was the and institutional mechanisms, both public and private,
first “devel- opment economist” and that his Wealth necessary to bring about rapid (at least by historical
of Nations, published in 1776, was the first treatise on standards) and large-scale improvements in levels of
economic development, the systematic study of the living for the peoples of Africa, Asia, Latin America,
problems and processes of economic development in and the formerly socialist transition economies.
Africa, Asia, and Latin America has emerged only
over the past five decades or so.
More developed countries (MDCs) The now things. Economic institu- tions are humanly devised
economically advanced capitalist coun tries of constraints that shape human interactions, including
western Europe, both informal and formal “rules of the game” of
North America, Australia, New Zealand, and Japan. economic life in the widely used framework of
Douglass North.
Less developed countries synonym for developing
countries Income per capita Total gross national income of a
country divided by its total population.
In comparison with the more developed countries
(MDCs), in most less developed countries, Gross national income (GnI) The total domestic and
foreign output claimed by residents of a country. It
commodity and resource markets are typically highly
comprises gross domestic product (GDP) plus factor
imperfect, consumers and producers have limited incomes accruing to residents from abroad, less the
information, major structural changes are taking place income earned in the domestic economy accruing to
in both the society and the economy, the potential for persons abroad.
multiple equilibria rather than a single equilibrium is
more common, and disequilibrium situations often In strictly economic terms, development has
prevail (prices do not equate supply and demand) traditionally meant achieving sus- tained rates of
growth of income per capita to enable a nation to
The Important Role of Values in Development expand its output at a rate faster than the growth rate
Economics of its population. Levels and rates of growth of “real”
per capita gross national income (GnI) (monetary
It is necessary to recognize from the outset that growth of GNI per capita minus the rate of inflation)
ethical or normative value premises about what is or are then used to measure the overall economic well-
is not desirable are central features of the economic being of a population—how much of real goods and
discipline in general and of development economics services is available to the average citizen for
in particular. consumption and investment.

Economies as Social Systems: The Need to Go Indeed, the emphasis is often on increased output,
Beyond Simple Economics measured by gross domestic product (GDP).

Gross domestic product (GDP) The total final

They must be analyzed within the context of the
output of goods and services produced by the
overall social system of a country and, indeed, within country’s economy, within the country’s territory, by
an international, global context as well. residents and nonresidents, regardless of its allocation
between domestic and foreign claims.
Social system The organizational and institutional
structure of a society, including its values, attitudes,
Amartya Sen’s “Capability” Approach
power structure, and traditions.

Values Principles, standards, or qualities that a The view that income and wealth are not ends in
society or groups within it considers worthwhile or themselves but instruments for other purposes goes
desirable. back at least as far as Aristotle. Amartya Sen, the
1998 Nobel laureate in economics, argues that the
Attitudes The states of mind or feelings of an “capability to function” is what really matters for
individual, group, or society regarding issues such as
status as a poor or nonpoor person. As Sen puts it,
material gain, hard work, saving for the future, and
sharing wealth. “the expansion of commodity productions...are
valued, ultimately, not for their own sake, but as
Institutions Norms, rules means to human welfare and freedom.”
of conduct, and generally accepted ways of doing
Functionings What people do or can do with the development economists have placed so much
commodities of given characteristics that they come emphasis on health and education, and more recently
to possess or control.
on social inclu- sion and empowerment, and have
referred to countries with high levels of income but
To make any sense of the concept of human well-
poor health and education standards as cases of
being in general, and poverty in particular, we need to
“growth without development.”
think beyond the availability of commodities and
consider their use: to address what Sen calls
Clearly, happiness is part of human well-being, and
functionings, that is, what a person does (or can do)
greater happiness may in itself expand an individual’s
with the commodities of given characteristics that
capability to function. As Amartya Sen has argued, a
they come to possess or control. Freedom of choice,
person may well regard happiness as an important
or control of one’s own life, is itself a central aspect
functioning for her well-being.
of most understandings of well-being. A function- ing
is a valued “being or doing,” and in Sen’s view, Sustenance The basic goods and services, such as
functionings that people have reason to value can food, clothing, and shelter, that are necessary to
range from being healthy, being well-nourished, and sustain an average human being at the bare mini-
well-clothed, to being mobile, having self-esteem, and mum level of living.
“taking part in the life of the community.” Self-esteem The feeling of worthiness that a society
enjoys when its social, political, and economic
. Sen goes on to note that functioning depends also on systems and institu- tions promote human values such
(1) “social conventions in force in the society in as respect, dignity, integ- rity, and self-determination.
which the person lives, (2) the position of the person
in the family and in the society, (3) the presence or Freedom A situation in which a society has at its
absence of festivities such as marriages, seasonal disposal a variety of alterna- tives from which to
satisfy its wants and individuals enjoy real choices
festivals and other occasions such as funerals, (4) the
according to their preferences.
physical distance from the homes of friends and
11 Many opinion leaders in developing nations hope that
relatives...”
their societies can gain the benefits of development
Indeed, the capacity to maintain valued social without losing traditional strengths such as moral
relationships and to network leads to what James values and trust in others—sometimes called social
Foster and Christopher Handy have termed external capital.
capabilities,
These core values—sustenance, self-esteem, and
Capabilities The freedoms that people have, given freedom—represent common goals sought by all
their personal features and their command over 19
individuals and societies. They relate to
commodities.
fundamental human needs that find their expression in
Principles and Concepts which are “abilities to almost all societies and cultures at all times. Let us
function that are conferred by direct connection or therefore examine each in turn.
relationship with another person.”
Rising per capita incomes, the elimination of absolute
Sen then defines capabilities as “the freedom that a poverty, greater employment opportunities, and
person has in terms of the choice of functionings, lessening income inequalities therefore constitute the
given his personal features (conversion of char- necessary but not the sufficient conditions for
acteristics into functionings) and his command over development.
commodities.” Sen’s perspective helps explain why
Self-esteem: to Be a Person A second universal In September 2000, the 189 member countries of the
component of the good life is self-esteem—a sense of United Nations at that time adopted eight Millennium
worth and self-respect, of not being used as a tool by Development Goals (MDGs), committing
others for their own ends. themselves to making substantial progress toward the
eradication of poverty and achieving other human
Freedom from Servitude: to Be able to Choose A development goals by 2015.
third and final universal value that we suggest should
constitute the meaning of development is the concept 1. Eradicate extreme poverty and hunger
of human freedom.
2. Achieve universal primary education

The Central Role of Women 3. Promote gender equality and empower

women
In light of the information presented so far, it should
4. Reduce child mortality
come as no surprise that development scholars
generally view women as playing the central role in 5. Improve maternal health
the development drama.
6. Combat HIV/AIDS, malaria, and other
Millennium Development Goals (MDGs) A set of diseases
eight goals adopted by the United Nations in 2000: to
eradicate extreme poverty and hunger; achieve 7. Ensure environmental sustainability
universal primary education; promote gender equality
8. Develop a global partnership for development
and empower women; reduce child mortality;
improve maternal health; combat HIV/AIDS, malaria,
and other diseases; ensure environmental
sustainability; and develop a global partner- ship for targets
development. The goals are assigned specific tar- gets
to be achieved by 2015. • Reduce by half the proportion of people living on
less than $1 a day • Reduce by half the proportion of
The Three Objectives of Development people who suffer from hunger

1. To increase the availability and widen the • Ensure that all boys and girls complete a full course
distribution of basic life-sustaining goods such as of primary schooling
food, shelter, health, and protection • Eliminate gender disparity in primary and secondary
education, preferably by 2005, and at all levels by
2. To raise levels of living, including, in addition to 2015
higher incomes, the provi- sion of more jobs, better
education, and greater attention to cultural and human • Reduce by two-thirds the mortality rate among
values, all of which will serve not only to enhance children under 5 • Reduce by three-quarters the
material well- being but also to generate greater maternal mortality ratio
individual and national self-esteem • Halt and begin to reverse the spread of HIV/AIDS
• Halt and begin to reverse the incidence of malaria
3. and other major diseases
Toexpandtherangeofeconomicandsocialchoicesavaila
bletoindividualsand nations by freeing them from • Integrate the principles of sustainable development
servitude and dependence, not only in rela- tion to into country policies and programs; reverse the loss of
other people and nation-states, but also to the forces environmental resources
of ignorance and human misery
• Reduce by half the proportion of people without these dimensions among developing countries that are
sustainable access to safe drinking water important to appreciate and take into account in
development policy. These areas are the following:
• Achieve significant improvement in the lives of at
least 100 million slum dwellers by 2020
1. Lowerlevelsoflivingandproductivity
• Develop further an open, rule-based, predictable,
2. Lowerlevelsofhumancapital
nondiscriminatory trading and financial system;
includes a commitment to good governance,
3. Higherlevelsofinequalityandabsolutepoverty
development, and poverty reduction—both nationally
and internationally
4. Higherpopulationgrowthrates
• Address the special needs of the least developed
5. Greatersocialfractionalization
countries; includes tariff and quota free access for
least developed countries' exports; enhanced program
6. Largerruralpopulationsbutrapidrural-to-
of debt relief for heavily indebted poor countries
urbanmigration
(HIPCs) and cancellation of official bilateral debt;
and more generous official development assistance
7. Lowerlevelsofindustrialization
(ODA) for countries committed to poverty reduction

• Address the special needs of landlocked countries 8. Adversegeography

and small-island developing states • Deal
comprehensively with the debt problems of 9. Underdevelopedfinancialandothermarkets
developing countries through
10. Lingering colonial impacts such as poor
national and international measures in order to make institutions and often external dependence.
debt sustainable in the long term • In cooperation with
developing countries, develop and implement
strategies for An organization known as an “international financial
institution” that provides development funds to
decent and productive work for youth developing countries in the form of interest-bearing
• In cooperation with pharmaceutical companies, loans, grants, and technical assistance.
provide access to affordable essential
Low-income countries (LICs) In the World Bank
drugs in developing countries classification, countries with a GNI per capita of less
• than $1,025 in 2011.
Incooperationwiththeprivatesector,makeavailabletheb
enefitsofnewtechnologies, Middle-income countries In the World Bank
classification, countries with a GNI per capita
especially information and communications between $1,025 and $12,475 in 2011.

A subset (part) of an economy, with four usages in The most common way to define the developing
economic development: technology (modern and world is by per capita income. Several international
traditional sectors); activity (industry or product agencies, including the Organization for Eco- nomic
sectors); trade (export sector); and sphere (private and Cooperation and Development (OECD) and the
public sectors)
United Nations, offer classifications of countries by
their economic status, but the best-known system is
2 Comparative Economic that of the International Bank for Reconstruction and
Development Develop- ment (IBRD), more commonly known as
the World Bank. (The World Bank is examined in
In each case, we also discover that behind these
detail in Box 13.2). In the World Bank’s classification
averages are very substantial differences in all of
system, 213 economies with a population of at least 30, with 15 of them in Africa) and small island
30,000 are ranked by their levels of gross national developing states (of which there are 38).
income (GNI) per capita. These economies are then
classified as low-income countries (LICs), lower- Finally, the term emerging markets was introduced at
middle-income countries (LMCs), upper- middle- the International Finance Corporation to suggest
income countries (UMCs), high-income OECD progress (avoiding the then-standard phrase Third
countries, and other high-income countries. (Often, World that investors seemed to associate with
LMCs and UMCs are informally grouped as the stagnation). While the term is appealing, we do not
middle-income countries.) use it in this text for three reasons. First, emerging
market is widely used in the financial press to suggest
Newly industrializing countries (NICs) Countries at the presence of active
a relatively advanced level of economic develop-
ment with a substantial and dynamic industrial sector
and with close links to the inter- national trade,
finance, and investment system. stock and bond markets; although financial deepening
is important, it is only one aspect of economic
Least developed countries
development. Second, referring to nations as markets
A UN designation of countries with low income, low may lead to an underemphasis on some non-market
human capital, and high economic vulnerability. priorities in development. Third, usage varies, and
there is no established or generally accepted designa-
Human capital Productive investments in people,
tion of which markets should be labeled as emerging
such as skills, values, and health resulting from
expenditures on education, on-the-job training and which as yet to emerge (the latter now sometimes
programs, and medical care. dubbed frontier markets in the financial press).

advanced manufacturing sectors as newly 2.2 Basic Indicators of Development: Real Income,
industrializing countries (NICs). Yet another way to
classify the nations of the developing world is Health, and Education
through their degree of international indebtedness; the
Gross national income
World Bank has classified countries as severely (GNI) The total domestic and foreign output claimed
indebted, moderately indebted, and less indebted. The by residents of a country, consist- ing of gross
United Nations Development Programme (UNDP) domestic product (GDP) plus factor incomes earned
classifies countries according to their level of human by foreign residents, minus income earned in the
development, including health and education domestic economy by non- residents.
attainments as low, medium, high, and very high. We
Value added The portion of a product’s final value
consider the traditional and new UNDP Human that is added at each stage of production.
Development Indexes in detail later in the chapter.
Depreciation (of the capital stock) The wearing out
Another widely used classification is that of the least of equipment, buildings, infra- structure, and other
developed countries, a UN designation that as of forms of capital, reflected in write-offs to the value of
2012 included 49 countries, 34 of them in Africa, 9 in the capital stock.
Asia, 5 among Pacific Islands, plus Haiti. For
Capital stock The total amount of physical goods
inclusion, a country has to meet each of three criteria: existing at a particular time that have been produced
low income, low human capital, and high economic for use in the production of other goods and services.
vulnerability. Other special UN classifications include
landlocked developing countries (of which there are Gross domestic product (GDP) The total final
output of goods and services produced by the
country’s economy within the country’s territory by healthy life as measured by life expectancy at birth;
residents and nonresidents, regardless of its allocation knowledge as measured by a combination of average
between domestic and foreign claims.
schooling attained by adults and expected years of
Purchasing power parity (PPP) Calculation of GNI schooling for school-age children; and a decent
using a common set of inter- national prices for all standard of living as measured by real per capita
goods and services, to provide more accurate gross domestic product adjusted for the differing
comparisons of living standards. purchasing power parity of each country’s currency to
reflect cost of living and for the assumption of
researchers have tried to compare relative GNIs and diminishing marginal utility of income.
GDPs by using purchasing power parity (PPP)
instead of exchange rates as conversion factors. PPP Diminishing marginal utility The concept that the
is calculated using a common set of international subjective value of additional consump- tion lessens
prices for all goods and services. In a sim- ple as total consump- tion becomes higher.
version, purchasing power parity is defined as the
number of units of a for- eign country’s currency 2.4 Characteristics of the Developing World:
required to purchase the identical quantity of goods
Diversity within Commonality
and services in the local developing country market as
$1 would buy in the United States.
Lower Levels of Living and Productivity

2.3 Holistic Measures of Living Levels and This is known as a

poverty trap or what Nobel
Capabilities laureate Gunnar Myrdal called “circular and
13
cumulative causation.” However, it is important to
The New Human Development Index
stress that there are ways to escape from low income,
Human Development Index (HDI) An index as you will see throughout this book. Further, the low-
measuring national socioeconomic devel- opment, income countries are themselves a very diverse group
based on combining measures of education, health, 14
with greatly differing development challenges.
and adjusted real income per capita.
Resource endowment A nation’s supply of usable
The most widely used measure of the comparative factors of production, including mineral deposits, raw
status of socioeconomic development is presented by materials, and labor.
the United Nations Development Programme (UNDP)
in its annual series of Human Development Reports. Underdeveloped Markets Imperfect markets and
The centerpiece of these reports, which were initiated incomplete information are far more prevalent in
in 1990, is the construction and refinement of its developing countries, with the result that domestic
informative Human Development Index (HDI). markets, notably but not only financial markets, have
This section examines the New HDI, initiated in 2010
worked less efficiently, as examined in Chapters 4,
(the well-known traditional HDI—the UNDP
11, and 15. In many developing countries, legal and
centerpiece from 1990–2009—is examined in detail
in Appendix 2.1). Box 2.2 summarizes “What Is New institutional founda- tions for markets are extremely
in the New HDI.” weak.

The New HDI, like its predecessor, ranks each Facilities that enable economic activity and markets,
such as transportation, communication and
country on a scale of 0 (lowest human development)
distribution networks, utili- ties, water, sewer, and
to 1 (highest human development) based on three energy supply systems
goals or end products of development: a long and
Some aspects of market underdevelopment are that Lingering Colonial Impacts and Unequal
they often lack (1) a legal system that enforces International Relations
contracts and validates property rights; (2) a sta- ble
and trustworthy currency; (3) an infrastructure of Colonial Legacy Most developing countries were
roads and utilities that results in low transport and once colonies of Europe or otherwise dominated by
communication costs so as to facilitate interre- gional European or other foreign powers, and institutions
trade; (4) a well-developed and efficiently regulated created during the colonial period often had
system of banking and insurance, with broad access pernicious effects on development that in many cases
and with formal credit markets that select projects and have persisted to the present day. Despite important
allocate loanable funds on the basis of relative varia- tions that proved consequential, colonial era
economic profit- ability and enforce rules of institutions often favored extrac- tors of wealth rather
repayment; (5) substantial market information for than creators of wealth, harming development then
consumers and producers about prices, quantities, and and now. Both domestically and internationally,
qualities of products and resources as well as the developing countries have more often lacked
creditworthiness of potential borrowers; and (6) social institutions and formal organizations of the type that
norms that facilitate successful long-term business have bene- fited the developed world: Domestically,
relationships. on average, property rights have been less secure,
constraints on elites have been weak, and a smaller
Imperfect market A market in which the theoretical
segment of society has been able to gain access to and
assumptions of perfect com- petition are violated by
the existence of, for example, a small number of take advantage of economic opportunities. Problems
buyers and sellers, barriers to entry, and incomplete with governance and public administration (see
information. Chapter 11), as well as poorly performing markets,
often stem from poor institutions.
Incomplete information The absence of information
that producers and consumers need to make efficient External Dependence Relatedly, developing
deci- sions resulting in underperforming markets. countries have also been less well organized and
The acknowledged right to use and benefit from a influential in international relations, with sometimes
tangible adverse consequences for development. For example,
agreements within the World Trade Organization
(e.g., land) or intangible (e.g., intellectual) entity that (WTO) and its predecessors concerning matters such
may include owning, using, deriving income from, as agricultural subsidies in rich countries that harm
selling, and disposing
developing-country farmers and one-sided regulation
The extent to which these of intellectual property rights have often been
imperfect markets and relatively unfavorable to the developing world. The
incomplete information systems justify a more “Doha Development Round”
active role for gov- ernment (which is also subject to
similar problems of incomplete and imperfect Thus the developing world endures what may be
information) is an issue that we will be dealing with called environmental dependence, in which it must
in later chapters. But their existence remains a rely on the developed world to cease aggravating the
common characteristic of many developing nations problem and to develop solu- tions, including
and an important contributing factor to their state of mitigation at home and assistance in developing
underdevelopment. countries. This topic is explored further in Chapter
10.
2.5 How Low-Income Countries Today Differ from

Developed Countries in Their Earlier Stages

The position of developing countries today is in many Climatic Differences Almost all developing
important ways sig- nificantly different from that of
countries are situated in tropical or subtropical
the currently developed countries when they
climatic zones
embarked on their era of modern economic growth.
We can identify eight signifi- cant differences in
Population Size, Distribution, and Growth In
initial conditions that require a special analysis of the
Chapter 6, we will examine in detail some of the
growth prospects and requirements of modern
economic development: development problems and issues associated with
rapid population growth.
1. Physicalandhumanresourceendowments
2. 2.PercapitaincomesandlevelsofGDPinrelationtoth The Historical Role of International Migration
erestoftheworld
3. 3. Climate In the nineteenth and early twentieth centuries, a
4. Populationsize,distribution,andgrowth major outlet for rural populations was international
migration, which was both widespread and large-
PART ONE Principles and Concepts scale.

5. Historicalroleofinternationalmigration The emigration of highly educated and skilled

6. Internationaltradebenefits
professionals and technicians from the developing
7. countries to the developed world
Basicscientificandtechnologicalresearchanddevelopm
entcapabilities 8. Efficacyofdomesticinstitutions Since the great majority of these migrants move on a
permanent basis, this perverse brain drain not only
We will discuss each of these conditions with a view represents a loss of valuable human resources but
toward formulating requirements and priorities for could also prove to be a serious constraint on the
generating and sustaining economic growth in future economic progress of developing nations.
developing countries.
Paradoxically, a potential benefit is that the mere
Physical and Human Resource Endowments possibility of skilled emigration may encourage many
Contemporary developing countries are often less more workers to acquire information technology or
well endowed with natural resources than the other skills than are ultimately able to leave, leading
currently developed nations were at the time when the to a net increase in labor force skills. At least in
latter nations began their modern growth. theory, the result could actually be a “brain gain.”

Trade in which goods can be imported and exported

Relative Levels of Per Capita Income and GDP without any barriers in the forms of tariffs, quotas, or
The people living in low-income countries have, on other restrictions.
average, a lower level of real per capita income than
International free trade has been called the “engine
their developed-country counterparts had in the
of growth” that propelled the development of today’s
nineteenth century. First of all, nearly 40% of the
economically advanced nations during the nineteenth
population of developing countries is attempting to and early twentieth centuries.
subsist at bare minimum levels.
The ratio of a country’s average export price to its
average import price.
Divergence A tendency
Their terms of trade (the price they receive for their
for per capita income (or output) to grow faster in
exports relative to the price they have to pay for higher-income countries than in lower-income
imports) declined over several decades. countries so that the income gap widens across
countries over time (as was seen in the two centuries
Basic Scientific and Technological Research and after industrialization began).
Development Capabilities
Convergence The tendency for per capita income (or
output) to grow faster in lower-income countries than
Basic scientific research and technological
in higher-income countries so that lower-income
development have played a crucial role in the modern countries are “catching up” over time. When
economic growth experience of contemporary countries are hypoth- esized to converge not in all
developed countries. Their high rates of growth have cases but other things being equal (particularly
been sustained by the interplay between mass savings rates, labor force growth, and production
applications of many new technological innovations technologies), then the term conditional convergence
based on a rapid advancement in the stock of is used.
scientific knowledge and further addi- tions to that
Even if incomes did not eventually turn out to be
stock of knowledge made possible by growing surplus
identical, they would at least tend to converge
wealth. And even today, the process of scientific and
conditional on (i.e., after also taking account of any
technological advance in all its stages, from basic
systematic differences in) key variables such as
research to product development, is heavily
population growth rates and savings rates (this
concentrated in the rich nations, despite the
argument is formalized in the neoclassical growth
emergence of China and India as destinations for
model examined in Chapter 3 and Appendix 3.2).
research and development (R&D) activities of
Given the huge differences in capital and technology
multinational corporations. Moreover, research funds
across countries, if growth con- ditions were similar,
are spent on solving the economic and technological
we should see tendencies for convergence in the data.
problems of concern to rich countries in accordance
with their own economic priorities and resource Relative Country Convergence The most widely
endowments. used approach is simply to examine whether poorer
countries are growing faster than richer countries. As
Research and development (R&D) Scientific
investigation with a view toward improving the long as this is happening, poor countries would be on
existing quality of human life, products, prof- its, a path to eventually “catch up” to the income levels of
factors of production, or knowledge. rich countries. In the meantime, the relative gap in
incomes would be shrinking, as the income of richer
Efficacy of Domestic Institutions Another difference countries would become a smaller multiple of income
between most developing countries and most of poorer countries (or looked at from the other
developed countries at the time of their early stages of perspective, incomes of poor countries would become
economic development lies in the efficacy of an increas- ingly large fraction of income of rich
countries).
domestic economic, political, and social institutions.
Absolute Country Convergence With the recent
2.6 Are Living Standards of Developing and rapid growth in China, and the acceleration of growth
in South Asia as well, these regions are currently on a
Developed Nations Converging?
path of relative country convergence.
Population-Weighted Relative Country Belgium’s King Leopold II over the Congo (today’s
Convergence The high growth rate in China and Democratic Repub- lic of Congo) was arguably an
India is particularly important, because more than ultimate cause of the oppressive Mobutu reign after
one- third of the world’s people live in these two independence.
countries.
2.8 Concluding Observations
World-as-One-Country Convergence An
alternative approach to the study of convergence is to History matters. We have learned that conditions
think of the world as if it were one country. prevailing in a developing nation when European
colonialism began had a large impact on the
Sectoral Convergence Despite evidence that
subsequent history of inequality and institutional
economies are not converging unconditionally, there
development in the nation in ways that either
can be cross-national convergence of economic
facilitated or thwarted participation in modern
sectors, which in turn may signal the potential for
economic growth after the Industrial Revolution
future convergence.
arrived in the late eighteenth century.

2.7 Long-Run Causes of Comparative 3 Classic Theories

of Economic Growth and Development
Development What explains the extreme variations

in development achievement to date among 3.1 Classic Theories of Economic Development:

developing and developed countries? The next two

chapters examine theories of economic growth and Four Approaches

development processes and policy challenges; The classic post–World War II literature on economic
development has been dominated by four major and
Economic Institutions sometimes competing strands of thought: (1) the
“Humanly devised” con- straints that shape interac- linear-stages-of-growth model, (2) theories and
tions (or “rules of the game”) in an economy, patterns of structural change, (3) the international-
including formal rules embodied in constitutions, dependence revolution, and (4) the neoclassical, free-
laws, contracts, and market regulations, plus informal market counterrevolution. In recent years, an eclectic
rules reflected in norms of behavior and con- duct, approach has emerged that draws on all of these
values, customs, and generally accepted ways of classic theories.
doing things.
This linear-stages approach was largely replaced in
Precolonial comparative advantage may also have
the 1970s by two competing schools of thought. The
interacted with the timing of European development
first, which focused on theories and patterns of
in influencing institutions in that settlers in later-
structural change, used modern economic theory and
colonized temperate zones arrived with more
statistical analysis in an attempt to portray the internal
knowledge and more advanced technology. In
process of structural change that a “typical”
particular, Europeans brought better agricultural
developing country must undergo if it is to succeed in
techniques to the later-settled areas such as North
generating and sustaining rapid economic growth.
America
The second, the international-dependence revolution,
The type of regime had enormous influence on was more radical and more political. It viewed
postco- lonial institutional quality, reflected by underdevelopment in terms of international and
Arrow 10. For example, the depraved rule of domestic power relationships, institutional and
structural economic rigidities, and the resulting The most influential and outspoken advocate of the
proliferation of dual economies and dual societies stages-of-growth model of development was the
both within and among the nations of the world. American economic historian Walt W. Rostow.
Dependence theories tended to emphasize external According to Rostow, the transition from
and internal institutional and political constraints on underdevelopment to development can be described
economic development. Emphasis was placed on the in terms of a series of steps or stages through which
need for major new policies to eradicate poverty, to all countries must proceed. As Rostow wrote in the
provide more diversified employment opportunities, opening chapter of The Stages of Economic Growth:
and to reduce income inequalities. These and other
egalitarian objectives were to be achieved within the Stages-of-growth model
of development A theory of economic development,
context of a growing economy, but economic growth
associated with the American economic historian
per se was not given the exalted status accorded to it Walt W. Rostow, according to which
by the linear-stages and structural-change models. a country passes through sequential stages in
achieving development.
Throughout much of the 1980s and 1990s, a fourth
approach prevailed. This neoclassical (sometimes Harrod-Domar growth model
called neoliberal) counterrevolution in economic
A functional economic relationship in which the
thought emphasized the beneficial role of free
growth rate of gross domestic product (g) depends
markets, open economies, and the privatization of directly on the national net savings rate (s) and
inefficient public enterprises. Failure to develop, inversely on the national capital-output ratio (c).
according to this theory, was not due to exploitive
external and internal forces as expounded by Capital-output ratio A ratio that shows the units of
dependence theorists. Rather, it was primarily the capital required to produce a unit of output over a
given period of time.
result of too much government intervention and
regulation of the economy. Today’s eclectic approach Net savings ratio Savings expressed as a proportion
draws on all of these perspectives, and we will of disposable income over some period of time
highlight the strengths and weaknesses of each.
Suppose that this relationship, known in economics as
the capital-output ratio, is roughly 3 to 1. If we
3.2 Development as Growth and the Linear-Stages
define the capital-output ratio as k and assume further
Theories that the national net savings ratio, s, is a fixed
proportion of national output (e.g., 6%) and that total
When interest in the poor nations of the world really new investment is determined by the level of total
began to materialize following World War II, savings, we can construct the following simple model
economists in the industrialized nations were caught of economic growth:

1. Net saving (S) is some proportion, s, of natio

PART ONE Principles and Concepts
A condition that must be present,
off guard. They had no readily available conceptual
apparatus with which to analyze the process of Necessary condition
economic growth in largely agrarian societies that
lacked modern economic structures. although it need not be in itself sufficient, for an event
to occur. For example, capital formation may be a
necessary condition for sustained eco- nomic growth
Rostow’s Stages of Growth
(before growth in output can occur, there must be
tools to produce it). But for this growth to continue,
social, institutional, and attitudinal changes may have portion of the rural labor force whose marginal
to occur. productivity is zero or negative.

Sufficient condition A condition that when present

causes or guarantees that an event will or can occur;
in economic models, a condition that logically The Lewis Theory of Economic Development
requires that a statement must be true (or a result must
hold) given other assumptions. Basic Model One of the best-known early theoretical
models of development that focused on the structural
Necessary versus Sufficient Conditions: Some transformation of a primarily subsistence economy
Criticisms of the Stages Model was that formulated by Nobel laureate W. Arthur
Lewis in the mid-1950s and later modified,
Unfortunately, the mechanisms of development
formalized, and extended by John Fei and Gustav
embodied in the theory of stages of growth did not
Ranis. The Lewis two-sector model became the
always work. And the basic reason they didn’t work
general theory of the development process in surplus-
was not because more saving and investment isn’t a
labor developing nations during most of the 1960s
necessary condition for accelerated rates of
and early 1970s, and it is sometimes still applied,
economic growth but rather because it is not a
particularly to study the recent growth expe- rience in
sufficient condition.
China and labor markets in other developing
countries.
Structural-change theory
In the Lewis model, the underdeveloped economy
The hypothesis that underde- velopment is due to consists of two sectors: a traditional, overpopulated,
underuti- lization of resources arising from structural rural subsistence sector characterized by zero
or institutional factors that have their origins in both marginal labor productivity—a situation that permits
domestic and interna- tional dualism. Development Lewis to classify this as surplus labor in the sense
therefore requires more than just accelerated capital
that it can be withdrawn from the traditional agri-
formation.
cultural sector without any loss of output—and a
Structural transformation high-productivity modern, urban industrial sector into
which labor from the subsistence sector is grad- ually
The process of transforming transferred. The primary focus of the model is on both
an economy in such a way that the contribution to
the process of labor transfer and the growth of output
national income by the manufacturing sector
eventually surpasses the contribution by the and employment in the modern sector.
agricultural sector. More generally, a major alteration
Production function
in the industrial composition of any economy.
A technological or engineering relationship between
Lewis two-sector model A theory of development in
the quantity of a good produced and the quantity of
which surplus labor from the traditional agricultural
inputs required to produce it.
sector is transferred to the modern industrial sector,
the growth of which absorbs the surplus labor,
promotes industrialization, and stimulates sustained The upper diagram shows how subsistence food
development. production varies with increases in labor inputs. It is a
typical agricultural production function in which the
Surplus labor The excess supply of labor over and total output or product (TPA) of food is determined by
above the quantity demanded at the going free-market changes in the amount of
wage rate. In the Lewis two-sector model of
economic development, surplus labor refers to the
Average product Total output or product divided by Like the earlier Lewis model, the patterns-of-
total factor input (e.g., the average product of labor is development analysis of structural change focuses
equal to total output divided by the total amount of
on the sequential process through which the
labor used to produce that output).
economic, industrial, and institutional structure of an
Marginal product The increase in total output underdeveloped economy is trans- formed over time
resulting from the use of one additional unit of a to permit new industries to replace traditional
variable factor of production (such as labor or agriculture as the engine of economic growth.
capital). In the Lewis two-sector model, surplus labor
is defined as workers whose marginal product is zero. Conclusions and Implications
the only variable input, labor (LA), given a fixed
The structural changes that we have described are the
quantity of capital, KA , and unchanging traditional
“average” patterns of development that Chenery and
technology, tA. In the lower-right diagram, we have his colleagues observed among countries in time-
the average and marginal product of labor curves, series and cross-sectional analyses. The major
APLA and MPLA, which are derived from the total hypothesis of the structural- change model is that
product curve shown immediately above. The development is an identifiable process of growth and
quantity of agricultural labor (QLA) available is the change, whose main features are similar in all
same on both horizontal axes of the right-hand side of countries
the figure and is expressed in millions of workers, as
DEPENDENCE
Lewis is describing an underdeveloped economy
where much of the population lives and works in rural The reliance of developing countries on developed-
areas. country economic policies to stimulate their
own economic growth. Dependence can also mean
Self-sustaining growth that the developing countries adopt developed-
country education systems, technology, economic and
Economic growth that continues over the long run political systems, attitudes, consumption pat- terns,
based on saving, investment, and complementary dress, and so on.
private and public activities
Dominance In international affairs, a situation in
This process of modern-sector self-sustaining which the developed countries have much greater
growth and employment expansion is assumed to power than the less developed countries in decisions
continue until all surplus rural labor is absorbed in the affecting important international economic issues,
new industrial sector. such as the prices of agricul- tural commodities and
raw materials in world markets.
Criticisms of the Lewis Model Although the Lewis
Neocolonial dependence model A model whose
two-sector development model is simple and roughly main proposition is that underdevelopment exists in
reflects the historical experience of economic growth developing countries because of continuing
in the West, four of its key assumptions do not fit the exploitative eco- nomic, political, and cultural
institutional and economic realities of most policies of former colonial rulers toward less
contemporary developing countries. developed countries.

Patterns-of-development analysis An attempt to

identify characteristic features of the internal process
of structural transformation that a “typical”
developing economy undergoes as it generates and
sustains modern economic growth and development.
Underdevelopment An economic situation The False-Paradigm Model
characterized by persistent low levels of living in
conjunction with absolute poverty, low income per A second and less radical international-dependence
capita, low rates of economic growth, low
approach to development, which we might call the
consumption levels, poor health services, high death
rates, high birth rates, dependence on foreign false-paradigm model, attributes underdevelopment
economies, and limited freedom to choose among to faulty and inappropriate advice provided by well-
activities that satisfy human wants. meaning but often uninformed, biased, and
ethnocentric international “expert” advisers from
Center In dependence theory, the economically developed-country assistance agencies and
developed world.
multinational donor organizations
Periphery In dependence theory, the developing
countries. DUALISM The coexistence of two situations or
phenomena (one desirable and the other not) that are
mutually exclusive to different groups of society—for
3.4 The International-Dependence Revolution
example, extreme poverty
During the 1970s, international-dependence models and affluence, modern and traditional economic
gained increasing support, especially among sectors, growth and stagnation, and higher education
developing-country intellectuals, as a result of among a few amid large-scale illiteracy.
growing disenchantment with both the stages and
The Dualistic-Development Thesis
structural-change models.

In dependence theory, local elites who act as fronts Implicit in structural-change theories and explicit in
for foreign investors. international-dependence theories is the notion of a
world of dual societies, of rich nations and poor
Comprador group nations and, in the developing countries, pockets of
wealth within broad areas of poverty. Dualism is the
In short, the neo-Marxist, neocolonial view of
existence and persistence of substantial and even
underdevelopment attributes a large part of the
increasing divergences between rich and poor nations
developing world’s continuing poverty to the
and rich and poor peoples on various levels.
existence and policies of the industrial capitalist
Specifically, although research continues, the
countries of the northern hemisphere and their
traditional concept of dualism embraces four key
extensions in the form of small but powerful elite or
arguments:
comprador groups in the less developed
countries.Underdevelopment is thus seen as an 1. Different sets of conditions, of which some are
externally induced phenomenon, in contrast to the “superior” and others “inferior,” can coexist in a
linear-stages and structural-change theories’ stress on given space. Examples of this element of dualism
internal constraints, such as insufficient savings and
investment or lack of education and skills. possible with the developed countries and instead
pursue a policy of autarky, or inwardly directed
False-paradigm model The proposition that development, or at most trade only with other
developing countries have failed to develop because
developing countries. But large countries that
their devel- opment strategies (usually given to them
by Western economists) have been based on an embarked on autarkic policies, such as China and, to a
incorrect model of development, one that, for significant extent, I
example, overstresses capital accumulation or market
liber- alization without giving due consideration to A closed economy that attempts to be completely
needed social and institutional change. self-reliant.
 Public-choice theory (new political economy
3.5 The Neoclassical Counterrevolution: Market approach) The theory that self-interest guides all
Fundamentalism individual behavior and that governments are
inefficient and corrupt because people use gov-
ernment to pursue their own agendas.
Challenging the Statist Model: Free Markets,
Public Choice, and Market-Friendly Approaches Market-friendly approach

In the 1980s, the political ascendancy of conservative The notion historically pro- mulgated by the World
governments in the United States, Canada, Britain, Bank that successful development policy requires
governments to create an environment in which
and West Germany came with a neoclassical
markets can operate efficiently and to intervene only
counterrevolution in economic theory and policy. In selectively in the economy in areas where the market
developed nations, this counterrevolution favored is inefficient.
supply-side macroeconomic policies, rational expec-
tations theories, and the privatization of public Market failure A market’s inability to deliver its
corporations. In developing a closed economy that theo- retical benefits due to the exis- tence of market
imperfections such as monopoly power, lack of factor
attempts to be completely self-reliant.
mobility, sig- nificant externalities, or lack of
Autarky knowledge. Market failure often provides the
justification for government intervention to alter the
Neoclassical counterrevolution working of the free market.

The 1980s resurgence of neoclassical free-market ori- Capital-labor ratio The number of units of capital
entation toward development problems and policies, per unit of labor.
counter to the interventionist depen- dence revolution
of the 1970s. Solow neoclassical growth model Growth model in
which there are diminishing returns to each factor of
FREE MARKET pro- duction but constant returns to scale. Exogenous
techno- logical change generates long- term economic
The system whereby prices of commodities or growth.
services freely rise or fall when the buyer’s demand
for them rises or falls or the seller’s supply of them Solow neoclassical growth model in particular
decreases or increases. represented the seminal contribution to the
neoclassical theory of growth and later earned Robert
Free-market analysis argues that markets alone are Solow the Nobel Prize in economics. It differed from
efficient—product markets provide the best signals the Harrod-Domar formulation by adding a second
for investments in new activities; labor markets factor, labor, and introducing a third independent
respond to these new industries in appropriate ways; variable, technology, to the growth equation. Unlike
producers know best what to produce and how to the fixed-coefficient, constant- returns-to-scale
produce it efficiently; and product and factor prices assumption of the Harrod-Domar model, Solow’s
reflect accurate scarcity values of goods and resources neoclassical growth model exhibited diminishing
now and in the future. returns to labor and capital separately and constant
returns to both factors jointly. Technological progress
Free-market analysis
became the residual factor explaining long-term
Theoretical analysis of the properties of an economic growth, and its level was assumed by Solow and other
system operating with free markets, often under the neoclassical growth theorists to be determined
assumption that an unregulated market performs exogenously, that is, independently of all other factors
better than one with government regulation. in the model.
More formally, the standard exposition of the Solow pattern of insights and under- standings, reflecting in
neoclassical growth model uses an aggregate part improved data and emergence of new technol-
production function in which ogies and new institutions, that together provide the
basis for examining the possibilities of contemporary
α 1-α development of the diverse nations of Africa, Asia,
Y = K 1AL2
and Latin America.
governments, according to neoclassical growth
theory, will retard growth

Solow neoclassical growth model Growth model in

which there are diminishing returns to each factor of
pro- duction but constant returns to scale. Exogenous
techno- logical change generates long- term economic
growth.

Closed economy An economy in which there are no

foreign trade transactions or other economic contacts
with the rest of the world.

Open economy An economy that practices foreign

trade and has extensive financial and nonfinancial
contacts with the rest of the world.

Closed economies (those with no external activities)

with lower savings rates (other things being equal)
grow more slowly in the short run than those with
high savings rates and tend to converge to lower per
capita income levels. Open economies (those with
trade, foreign investment, etc.), however, experience
income convergence at higher levels as capital flows
from rich countries to poor countries where capital-
labor ratios are lower and thus returns on investments
are higher.

3.6 Classic Theories of Development: Reconciling

the Differences

In this chapter, we have reviewed a range of

competing theories and approaches to the study of
economic development. Each approach has its
strengths and weaknesses. The fact that there exists
such controversy—be it ideological, theoretical, or
empirical—is what makes the study of economic
development both challenging and exciting. Even
more than other fields of economics, development
economics has no universally accepted doctrine or
paradigm. Instead, we have a continually evolving