Chapter 22 - Macro policy in developing countries. After reading this chapter, you should be able to: State some comparative statistics on rich and poor countries, differentiate growth from development and explain how those differences affect macroeconomic policy, explain the particular problems of monetary policy in a developing country context, list seven obstacles facing developing countries.
Introduction: Thinking Like an Economist CHAPTER 22 Macro Policy in Developing Countries Rise up, study the economic forces which oppress you…They have emerged from the hand of man just as the gods emerged from his brain You can control them – McGrawHill/Irwin Paul LaFargue Copyright © 2013 by The McGrawHill Companies, Inc. All rights reserved Macro Policy in Developing Countries 221 Chapter Goals Ø Ø Ø Ø State some comparative statistics on rich and poor countries Differentiate growth from development and explain how those differences affect macroeconomic policy Explain the particular problems of monetary policy in a developing country context List seven obstacles facing developing countries 222 Macro Policy in Developing Countries 221 Developing Countries in Perspective Ø Ø Ø Ø 5.5 billion people live in developing countries Per capita income in developing countries is around $500 per year compared to nearly $50,000 in the U.S Americans and Europeans who are classified as poor find it hard to contemplate what life is really like in a truly poor country You can’t judge just an economy; you must judge the entire culture • Often economically poor societies have cultures that provide individuals with a deep sense of fulfillment and satisfaction 223 Macro Policy in Developing Countries 221 Growth versus Development Ø Development refers to an increase in productive capacity and output brought about by a change in a country’s underlying institutions • Ø Development occurs through a change in the production function Growth refers to an increase in output brought about by an increase in inputs, given a production function 224 Macro Policy in Developing Countries 221 Differences Between Developed and Developing Economies Ø Different weighting of normative goals due to differences in wealth • Ø Developing countries face basic economic needs, like adequate food, shelter, and clothing Differences in institutions • Political differences and laissez-faire • Dual economy • Fiscal systems • Financial institutions 225 Macro Policy in Developing Countries 221 Differing Institutions Political Differences and Laissez-Faire • In many developing countries, institutional checks and balances on government leaders often not exist • In these circumstances, economists who would favor an activist macroeconomic policy in a developed country might favor laissez-faire policies in developing countries 226 Macro Policy in Developing Countries 221 Differing Institutions The Dual Economy Ø Ø A developing country’s economy is usually a dual economy Dual economy is the existence of two sectors: • • A traditional sector which does business in local currency and produces in traditional ways An internationally oriented modern market sector which is often indistinguishable from a Western economy 227 Macro Policy in Developing Countries 221 Differing Institutions Fiscal Structure of Developing Economies Ø Ø Developing countries may experience a regime change, which is a change in the entire atmosphere within which the government and the economy interrelate A policy change is a change in one aspect of government’s actions, such as monetary or fiscal policy 228 Macro Policy in Developing Countries 221 Monetary Policy in Developing Countries Ø Ø Ø The primary goal of central banks in developing countries is to keep the economy running Central banks in developing countries are generally less independent than ones in developed countries Buying and selling foreign currencies in order to stabilize the exchange rate is an important function 229 Macro Policy in Developing Countries 221 Various Types of Convertibility Ø Ø Ø Full convertibility is when individuals may change their currency into any currency they want for whatever legal purpose they want Convertibility on the current account is a system that allows people to exchange currencies freely to buy goods and services, but not assets in other countries Limited capital account convertibility is a system that allows full current account convertibility and partial capital account convertibility 2210 Macro Policy in Developing Countries 221 Conditionality and Balance of Payments Constraints Ø Ø Ø Developing countries often rely on advice from the International Monetary Fund (IMF) The IMF is a major source of temporary loans to stabilize their currencies The basis for most IMF loans is conditionality which is the making of loans that are subject to specific conditions, usually that deficits be lowered and money supply growth be limited 2211 Macro Policy in Developing Countries 221 Obstacles to Economic Development Seven problems facing developing countries are: Political instability Corruption Lack of appropriate institutions Lack of investment Inappropriate education Overpopulation Health and disease 2212 Macro Policy in Developing Countries 221 Chapter Summary Ø Ø Ø Ø Per capita income in developing countries is about 1/100 of per capita income in the U.S Societies should not be judged by income alone Development refers to an increase in productive capacity and output brought about by a change in underlying institutions, while growth refers to an increase in output brought about by an increase in inputs Many developing countries have serious political problems that make it impossible for government to take an active, positive role in the economy Many developing countries have dual economies 2213 Macro Policy in Developing Countries 221 Chapter Summary Ø Ø Ø Ø Developing countries need regime change rather than policy change Although developing countries know that printing too much money leads to inflation, their choices are limited Some central banks lack independence and for others the only alternative is the collapse of government Seven obstacles to economic development are political instability, corruption, lack of appropriate institutions, lack of investment, inappropriate education, overpopulation, and poor health and disease 2214 ... differences and laissez-faire • Dual economy • Fiscal systems • Financial institutions 22 5 Macro Policy in Developing Countries 221 Differing Institutions Political Differences and Laissez-Faire • In many... macroeconomic policy in a developed country might favor laissez-faire policies in developing countries 22 6 Macro Policy in Developing Countries 221 Differing Institutions The Dual Economy Ø Ø A developing... of investment Inappropriate education Overpopulation Health and disease 22 12 Macro Policy in Developing Countries 221 Chapter Summary Ø Ø Ø Ø Per capita income in developing countries is about