Ecomomics evelopment 10th y p todaro and smith chapter 11

Chapter 11 Development Policymaking and the Roles of Market, State, and Civil Society Copyright © 2009 Pearson Addison-Wesley All rights reserved System of Economic Management Mixed economy • Private sector: profit maximizing business firms • Public sector: employment maximizing government agencies Economic systems • Capitalism: large private sector, but small public sector • Socialism: large public sector, but small private Copyright sector © 2009 Pearson AddisonWesley All rights reserved 11-2 Economic Role of the State • Protect private property and legal rights • Produce public goods • Improve market competition • Improve income distribution • Preserve the human environment • Manage the economy Copyright © 2009 Pearson AddisonWesley All rights reserved 11-3 Development Planning Economic plan: managing economic activity • Specific set of quantitative targets • Given time horizon (three or five years) • Stated strategies for achieving the targets • Comprehensive (the entire economy) or partial (a specific sector or industry) coverage Copyright © 2009 Pearson AddisonWesley All rights reserved 11-4 Component of Development Plan • Government uses domestic saving and foreign exchange to construct economic infrastructure • Government implements economic policy (taxation, industrialization, foreign exchange control, trade restriction) Copyright © 2009 Pearson AddisonWesley All rights reserved 11-5 Rationale for Planning Reduce market failure: • Income distribution • Monopoly power • Externalities of production and consumption • Insufficient information Copyright © 2009 Pearson AddisonWesley All rights reserved 11-6 Rationale for Planning • Resource mobilization and allocation • Psychological effect on achieving development goals (e.g., reducing poverty) • Foreign aid: a requirement to obtain loans and grants Copyright © 2009 Pearson AddisonWesley All rights reserved 11-7 Planning Characteristics • Governmental goals and objectives • Strategies for achieving goals and objectives • Government agency for planning implementation • Planning coverage: comprehensive or partial • Planning horizon: medium or long-term • Planning methodology (macroeconomic model) Copyright © 2009 Pearson AddisonWesley All rights reserved 11-8 Planning Methodology Aggregate growth model (Harrod-Domar) • Investment demand = National saving • Foreign aid and direct foreign investment to fill-in the saving gap Copyright © 2009 Pearson AddisonWesley All rights reserved 11-9 Planning Methodology Input-Output model • Outputs of industries serve as inputs of other industries • Optimal input mix to produce maximum output to satisfy the final demand Copyright © 2009 Pearson AddisonWesley All rights reserved 11-10 Project Appraisal Net present value, or NPV is given by Bt − Ct NPV = ∑ t t (1 + r ) Where Bt is the expected benefit at time t Ct is the expected cost at time t r is the government’s social rate of Copyright © 2009 Pearson Addisondiscount Wesley All rights reserved 11-12 True vs Actual Market Value • True market value in the demand-supply price or scarcity value = shadow price reflecting social costs and benefits • Actual market value is the market exchanged price reflecting private costs and benefits or the controlled price Copyright © 2009 Pearson AddisonWesley All rights reserved 11-13 Reasons for Price Divergence • Inflation and currency control • Factor price distortions (prices, wages, interest rates, exchange rate) • Trade restrictions and import substitution • Saving deficiency • Social vs private rate of return Copyright © 2009 Pearson AddisonWesley All rights reserved 11-14 Planning Consequences • Factor price distortion, choice of technology and employment creation • Induced R-U migration • Demand for educational certification leading to employment problem • Economic structure Copyright © 2009 Pearson AddisonWesley All rights reserved 11-15 Reasons for Failure of Planning • Deficiencies in plans and their implementations • External and internal disturbances • Insufficient and unreliable data • Institutional weaknesses • Lack of political will • Corruption of public servants Copyright © 2009 Pearson AddisonWesley All rights reserved 11-16 The Planning Mystique • In the past, few doubted the importance and usefulness of national economic plans • Recently, however, disillusionment has set • But, a comprehensive development policy framework can play an important role in accelerating growth and reducing poverty Copyright © 2009 Pearson AddisonWesley All rights reserved 11-17 Resurgent of Market Orientation • Failure of planning • IMF and World Bank policy requirements for foreign aid and direct foreign investment • Joint ventures of domestic and foreign enterprises Copyright © 2009 Pearson AddisonWesley All rights reserved 11-18 Requirements for Market Orientation • Trust • Law and order • Security of private property rights • Balancing between competition and cooperation • Division of responsibility and diffusion of power • Social safety net Copyright © 2009 Pearson AddisonWesley All rights reserved 11-19 Requirements for Market Orientation • Social mobility • Individualism and materialism • Deferring gratification to create private saving • Rationality and efficiency • Honesty of government • Competition of business • Availability and freedom of information Copyright © 2009 Pearson AddisonWesley All rights reserved 11-20 Need for Government Intervention • Income redistribution through progressive taxation and transfer payments • Excess market imperfection on behalf of domestic and foreign business • Substantial negative externalities (pollution and decay) • Investment in social and human capital • Structural transformation Copyright © 2009 Pearson AddisonWesley All rights reserved 11-21 Planning & Market Reconciliation • Must achieve “effective” cooperation • Must reduce market imperfections • Must eliminate factor price distortions and price controls • Must reduce public ownership of economic enterprises • Must reduce corruption and red tape Copyright © 2009 Pearson AddisonWesley All rights reserved 11-22 Non-Government Organizations • Comparative advantages of NGOs in Innovative design and implementation Program flexibility Specialized technical knowledge Provision of targeted local public goods Common-property resource management design and implementation – Trust and Credibility – Representation and advocacy – – – – – Copyright © 2009 Pearson AddisonWesley All rights reserved 11-23 Corruption and Planning • Corruption: Abuse of public trust for private gain • Good governance enhances capability to function • Effects of corruption fall disproportionately on the poor • Good governance is broader than simply an absence of corruption Copyright © 2009 Pearson AddisonWesley All rights reserved 11-24 Corruption as a Regressive Tax: The Case of Ecuador Copyright © 2009 Pearson AddisonWesley All rights reserved 11-25 The Association between Rule of Law and Per Capita Income Copyright © 2009 Pearson AddisonWesley All rights reserved 11-26 ... But, a comprehensive development policy framework can play an important role in accelerating growth and reducing poverty Copyright © 2009 Pearson AddisonWesley All rights reserved 11- 17 Resurgent... gap Copyright © 2009 Pearson AddisonWesley All rights reserved 11- 9 Planning Methodology Input-Output model • Outputs of industries serve as inputs of other industries • Optimal input mix to produce... maximum output to satisfy the final demand Copyright © 2009 Pearson AddisonWesley All rights reserved 11- 10 Project Appraisal • Weigh the costs of plans/projects against their benefits over the planning