First Generation Development Economists

The need to accelerate capital accumulation for fast industrialization.

Various theories (the vicious circles, the big push, critical minimum efforts, balanced growth), along with the Harrod-Domar and Solow growth models insisted on the need to accelerate physical capital accumulation to achieve higher per-capita income. Also foreign aid was rationalized on basis of accelerating investment (the two-gap model). Chronic and serious market failure in the LDCs. Serious market imperfections (rigidities, monopolies), absence of certain important markets, and absence of entrepreneurs. Thus, the LDCs do not face adequate and trustworthy price structure. The public sector should take the lead and should execute the duties of coordination and resource allocation.

Export pessimism: the inelastic demand on exports. The chronic discrepancy

between demand elasticities for raw materials and agricultural products on the one hand and for the manufactured products on the other made the export-led growth an impossible choice for the LDCs. The alternative is to depend on the home market, control the exchange rate and adopt an import-substitution industrialization strategy.

Structural Inflation. Inflation in the LDCs is due to rigidities of domestic supply or external shocks. It is an inevitable consequence of growth efforts. Adopting standard stabilization measures will be at the cost of development itself.

Structural versus Monetarist Inflation

Structural inflation with feed-back loops
Autonomous disturbance
(crop failure & rise in prices)

Monetarist inflation with expectations adjustments

Increase in money stock (M) Rise in real budget deficit

Wage rises

Income growth Expectations

Induced increase in money stock (M)

Rate of inflation

Rate of inflation

Second Generation Development Economists

One single macroeconomics: the failure is due to poor incentives and not to inresponsiveness. Economic agents in the LDCs, just like those in the DCs, are rational optimizing actors. Thus, the same macroeconomic theory, with the traditional emphasis on incentives and stabilization, is valid also in the poor countries. Failure to achieve development is due to bad policies not to adverse external conditions: The rise of the counter revolution in development economics: bad policies have materialized in three forms: a) over emphasis on physical capital formation, b) over extended public sector, and c) the highly distorting effects of price control: Get the prices right. New areas of investigations: Development economists started to pay more attention to micro studies, to econometric investigations, and to rural development. Some new major areas of research are successfully well-established now. They helped to shed light on new aspects and, in certain cases, succeeded in re-affirming some of the observations made by the first generation economists. New Growth Theory. With the aim to endogenize technical progress.

New political economy of the state and the Strategic trade theory. With the aim to endogenize the acts and decision of the state, along with incorporating power relations in international trade affairs.
Institutional Economics. Stressing the importance of various forms of institutions (which are usually taken as neutral in the neoclassic framework) on the behaviour of economic agents. New market failure. Imperfect information, absence of risk and future markets, transaction cost, etc.

The Evolution of Development Thought

Meier, 2000

THE EVOLUTION OF THGOUGHTS IN DEVELOPMENT ECONOMICS

LEFT
Growth is self-limiting: the Classical (Smith, Malthus, Marx) 1776-1865 Theory of imperialism: Lenin 1916 Out of paradigm Big Bush: Rosentan-Rodan 1943 Balanced Growth: Nurkse 1952 Critical Minimum Effort: Leibenstein 1957 Cumulative Causality & Vicious Circles: Myrdal 1955. Dualism: Boeke 53 Unbalanced growth &Linkages: Hirschman 1958 One sector Growth Model: Harrod & Domar 1939/47 Structuralisms: Prebisch, Singer, Seers1950s Labour Surplus Model: Lewis 1954 Neoclassic Growth Model, Solow 1956 Re-defining Development Growth with Redistribution: Lefeber 1970s Basic Human Needs: ILO 1977, Streeten 1981 Adjustment with Human Face: Stewart 1988

RIGHT

Stages of Development: Rostow 1959

Efficient but Poor: Schultz 1964

Dependency/ Neo Marxism: Gunder-Frank, Fortado, Amin, Baran, Emmanuel 1970s

The Counter Revolution: 1980/1 Baur, Lal, and Balassa Washington Consensus: the IMF & WB Adjustment programmes 1980s

Institutional Economics: Coase, North, Stiglitz 1986 New (Endogenous) Growth Theory: Romer 90, Lucas

Macroeconomics in LDCs- An Introduction

Nevertheless, development macroeconomics stresses that the LDCs face specific peculiar circumstances, which are substantially different from those in the developed world. These particular circumstances and conditions justify particular types of policies and recommendations which are perhaps different from the traditional prescription of the standard theory. In that sense, many economists maintain that the less developed countries are not a mirror image of the developed countries before 100 or 200 years.

The particular features of the LDCs.

What are the particular features in the LDCs which call for a development macroeconomics?

1) Openness to trade and dependency on external factors: external terms of trade, fixed exchange rates, limited trade in capital, dependency on foreign borrowing (and high indebtness), great sensitivity to external shocks. 2) Long-term supply behaviour: complementarity between public and private investments. The point is that the domestic productive capacity is weak; therefore the policy of pure stabilization is either doomed to failure or can only be achieved at low and unacceptable living standards. 3) Short-run supply behaviour: high dependency on imported inputs (thus devaluation may not lead to substitution of imports by domestic products), the high share of bank loans in financing the firms running capital (thus higher interest rates may affect current output negatively), the strong institutional constraints on wage rate movements and the segmentation between formal and in-formal labour markets.

The particular features of the LDCs.

4) The financial market. Financial repression: artificially low interest rates which punish savers and necessitate rationing of cheap credits. Absence of financial markets: a single financial institution (commercial banks), no capital or bonds markets (thus the overlapping of monetary and fiscal policies), low monetization and the existence of large informal sector. 5) Government budget: low share of GDP, low share of direct taxes, difficulties of issuing internal public debt. 6) Private sector behaviour and stability of policies: high level of uncertainty, the effect of hysteresis with respect to high inflation rates and the prolonged future effects of past instability and crisis.