Development Economics An Overview

ForthcominginC.B.Barrett,ed.
,DevelopmentEconomics:CriticalConceptsinDevelopmentStudies
4volumes(London:Routledge,2007)
DevelopmentEconomics:AnOverview
ChristopherB.Barrett
I.
UnderstandingHumanWellbeing:AnIntegrativePerspective
WhenRoutledgeinvitedmetoassembleafourvolumecollectiontorepresentthe
bestofdevelopmenteconomics,Iknewitwouldbeastimulatingbutdaunting
challenge.Afirstcutatenumeratingtheessentialreadingsinthefieldyieldeda
monstroustomeofnearly5000pages,morethanthreetimeswhatmyeditorwould
permit.Thewiderangeofexcellentworkbysomanytalentedscholarsimmediately
necessitatedhardthematicchoicesinordertoestablishappropriate,ifinherently
arbitrary,boundariesforthisproject.Muchimportantworkwouldneedtobeleftout
inordertotellthestoryofdevelopmenteconomicscompactlyandcoherently.
Withitsfocusonunderstandinghowresourceallocation,humanbehavior,
institutionalarrangementsandprivateandpublicpolicyjointlyinfluencetheevolution
ofthehumancondition,developmenteconomicsisarguablytheoriginalandmost
fundamentalfieldwithinthedisciplineofeconomics,atleastasitrelatestothesocial
sciencesandhumanitiesmorebroadly.AstheopeningsentenceofT.W.Schultzs1979
NobelPrizelecturedeclared,Mostofthepeopleintheworldarepoor,soifweknew
theeconomicsofbeingpoor,wewouldknowmuchoftheeconomicsthatreally
matters.(Schultz1980,p.639)Ultimately,virtuallyallimportantworkindevelopment
economicsfocusesonimprovingourknowledgeofbeingorbecomingpoorand,
morehopefully,abouttheprocessesbywhichpeopleavoidorescapepovertyandenjoy
improvedstandardsofliving.Suchworkrangesfromunderstandingthedecision
makingprocesses,contractualandextracontractualarrangementswithinandamong
householdsandfirmsthatleadtoinefficiency,exclusion,and/orvulnerability,to
identifyingwhatdeterminestheemergenceanddiffusionofimprovedproduction
technologiesandwhogainsfromnewtradingopportunities,toestablishingthewelfare
costsassociatedwithdifferentsectoralormacropolicies,andthenatureofnational
scaleeconomicgrowthanditsrelationshiptoinequality,tradeandsociopolitical
institutions.
Inthiscollection,Icanthereforereallyonlyscratchthesurface.Myobjectiveinthis
collectionandespeciallyinthisintroductoryessayisthereforenottobecomprehensive,
nortogodeepintothedetailsofthemanyfascinatingthreadsthatjointlymakeupthe
richfabricofdevelopmenteconomics.Rather,theaimistointroducethebroadthemes
ofdevelopmenteconomics,tofamiliarizethereaderwithcentralissuesandseminal
ForthcominginC.B.Barrett,ed.,DevelopmentEconomics:CriticalConceptsinDevelopmentStudies
findingsthathaveguidedthefieldsevolutionofthepasthalfcenturyorso,andtoflag
anumberofkeyadditionalreadingsforthosewhowishtoplumbparticularsubtopics
ingreaterdepth.
Sowhatarethecorethemesofthefield?Developmenteconomicsresearch
ultimatelydescribesandexploresthecausalreasonswhysomecountries,communities
andpeoplearerichandothersarepoor.Whatstructuralfactorsdistinguishthe
experienceofthosewhoenjoyhighand/orrisingstandardsoflivingfromthose
enduringlowand/orstagnantconditions?Ofgreatestpracticalimportance,whatcan
bedonetoreinforcetheexperienceoftheformersubpopulationandtorelievethe
sufferingofthelatter?
Thusfrontierresearchinthefieldhasalwaystakenplaceatmultiplescalesof
analysis,fromthemicrorealmofindividuals,households,andfirms,throughthemeso
rangeofcommunities,groups,networks,regionsandvillages,tothemacrolevelof
nationstates,continentsandtheglobe.Thenaturalintegrationofthesescalespecific
literaturesistoooftenoverlookedaswescholarsspecializeinourownniche.Yetthe
complementarityisthere,justbeneaththesurfaceofthejournalsandmonographs.
Hencethetwocorethemesaroundwhichthisvolumeisorganized:(i)
understandingpatternsofhumanwellbeingand(ii)anintegrativeperspectivethat
bridgesmicroeconomic,macroeconomicandtheoftignoredmiddlelevelormeso
economicscalesofanalysis.Thepapersselectedforinclusionallultimatelyspeakto
thefirstofthesethemes,sometimesquitedirectly,othertimesmoreindirectlyby,for
example,tacklingcriticalintermediatetopicssuchasintersectorallinkagesorfinancial
services.Thesecondthemeemergesmorefromtheallocationofspaceacrosstopics,
especiallythededicationofonevolumeeachtomicro,mesoandmacrolevel
phenomenaandtheexplicitincorporationofpapersthataddresssimilarissuesat
differentscalesofanalysis.Themainissuethatreemergesateachlevelofanalysis
concernsthedynamicsofhumanwellbeing,oftenreflectedingrowthinincome,
wealthorotherwelfaremetrics,andthepossibilityofmultipledynamicequilibria,
includingalowlevelequilibriummorepopularlyknownasapovertytrap.Such
issuescanbestudiedatmultiplelevelsandcommonthemesandinterrelationships
appearroutinely,asdiscussedbelow.1
Rapideconomicgrowthis,inhistoricalterms,arecentphenomenonconfinedtothe
pastthreehundredyearsforlessthanonequarteroftheworldspopulation.Growing
andseeminglypersistentgapsinprosperitybetweenrichandpoorpeoplewithinand
betweencountriescontributestosociopoliticaltensions,affectspatternsofhuman
pressureonthenaturalenvironment,andgenerallytouchesallfacetsofhuman
SeeBarrettandSwallow(2006)foramoredetailedconceptualdiscussionoftheinterrelationshipof
povertytrapsacrossmicro,mesoandmacroscalesofanalysis.
existence.Understandingtheprocessofeconomicdevelopmentisthuscentraltomost
researchineconomicsandthesocialsciencesmorebroadly.Developmenteconomics
nonethelessemergedasadistinctfieldofanalytical,empiricalandinstitutionalresearch
onlyinthepasthalfcenturyorso,withespeciallyrapidprogressinthepastgeneration.
Anideationalrevolutionoccurredinthesocialsciencesinthe1970s.Ineconomics,
thisrevolutionwaswagedbymonetaristsandbypublicchoiceandrational
expectationstheoristsagainsttheKeynesianparadigmthathaddominatedthepost
WorldWarIIworld.Theresultwasageneralreactionagainstgovernment
interventionismandinfavoroffreemarketsandminimalistvariantsofneoclassical
economicthought.Asaconsequence,developmentproblemscametobeseenlargelyas
resultingfromanexcessofgovernmentinterferenceintheeconomy.
Bythe1980s,developmentwasverymuchoutoffavorasasubdisciplinewithin
economics.Throughoutthelatter1980sandearly1990s,manyconcurredwithLals
(1983)assessmentthatdevelopmenteconomicsconstituteslittlemorethanafutilequest
forqueerexceptionstotherulesofmainstreameconomics,andthatthefundamental
fallacyofsuchpursuitswasbeliedbythecatastrophicfailureofstateplanned
economies.Awidespreadassumptionexistedthatdevelopmentoughttobenothing
morethantheextensionofneoclassicalorthodoxytolowandmiddleincome
countries.
Thingshavechanged.Amajorresurgenceisevidentindevelopmenteconomicsas
manyleadingeconomistsandeconomicsdepartmentsaroundtheworldhavebegunto
focusagainondevelopmentissuesoverthepastdecadeortwoandpremierscholarly
recognitionNobelPrizes,JohnBatesClarkMedals,MacArthurgeniusawardsand
thelikehasbeenbestowedoneminentscholarsworkingwithindevelopment
economics.Thisreflectsanaturalreturntodevelopmenteconomicsproperplace
withinthebroaderdiscipline.
Bardhan(1993)pointsoutthatdevelopmenteconomicsrichhistoryhasproduced
muchoflastingimportancetoeconomicsmorebroadly:efficiencywagetheory,
dynamic(pecuniaryandtechnological)externalities,multipleequilibria,principalagent
modeling;adverseselection;rentseekingandpoliticaleconomy;nonlinearpricing,etc.
Tothatlistingonemightadd,fromthepastfifteenyearswork,intrahouseholdissues
andthesocialeconomicsofidentityandnetworks.Todaymanymainstream
economistsrediscoverdevelopmentmodelsandformalizethemwithgreatfanfare(e.g.,
mostendogenousgrowththeorythatexploitsnonconvexities,whichtracesitsoriginsto
Young(1928)andRosensteinRodan(1943andchapter5)).Astheneoclassicalfantasy
ofperfectmarketsandinformation,constantreturnstoscale,etc.crumblesinthe
mainstreamjournals,neoclassicaltheoristshaveturnedbacktodevelopmenteconomics
applicationsandclaimedthemastheirown.Developmenteconomicshasthus
influencedmainstreameconomicsandsocialsciencesinmultipleimportantways.
Thisisbecauseatitscore,thedevelopmenteconomicsliteraturehasevincedaclear
perceptionofboththestrengthsandtheweaknessesoforthodoxneoclassical
economics,especiallyinitsstandardWalrasianformwithconstantreturnstoscale,
perfectcompetition,completeandfrictionlessmarkets,perfectinformation,anonymous
andoneoffexchange.ThewaveofinformationeconomicslaunchedbyStiglitz,
Akerlofandotherslargelyfromwithindevelopmenteconomicshaspermeatedthe
wholeofthediscipline.Historically,developmenteconomistshavedaredtostrayfrom
thewellworngroovesofmainstreameconomics,withoutrejectingthetoolsofrational
choicetheory.Hencetheoccasionalmarginalizationthatoftencomeswithcreativity,
butalsothehighreturnstothebestworkinthefield.
Developmenteconomicsisthedomainofthosewhowishtobeabletoexplainbetter
thebehaviorofpoorindividualsandcommunitiesinorderthatusefulpredictionsand
prescriptionsmightbefeasible.Developmenteconomistsdogoodpositiveanalysisnot
becausethatistheendofgoodeconomicanalysis,butbecausethatisthestart,the
foundationfromwhichonecanofferrigorous,defensibleprescriptiveanalysesinan
efforttoimprovethehumancondition.
Stiglitz(1989,p.19)makesanespeciallyaptofdefenseofdevelopmenteconomics,
likeningittomainstreameconomicsaspathologyistomedicine;[t]hedifferenceis
thatineconomics,pathologyistherule:lessthanaquarterofmankindlivesinthe
developedeconomies.Indeed,Stiglitzseesinthestudyofdevelopingeconomiesthe
keytomorefundamentalunderstandingsofthewayeconomieswork(anddonot
work).AnotherNobelLaureate,AmartyaSen(1988,p.11),emphasizedthat
developmenteconomicsmustbeconcernedwithkeepingalivethefoundational
motivationofthesubjectofeconomicsingeneral.
Thisfourvolumecollectionofseminalpapersindevelopmenteconomicscaptures
muchofthespiritofSensinjunction.Thisfirstvolumeaimstopindownkeythemes,
especiallyrelatedtopovertyandwelfaredynamics,theprincipaldriversoflongterm
improvementinthehumanconditiontechnologicalchangeandmarketparticipation
andtheworkhorseanalyticaltoolsofthefield:householdandintrahouseholdmodels.
Thepapersthatfollowinvolume2provideareasonablythoroughrepresentationofthe
evolutionandcurrentstateoftheartofthefieldofdevelopmentmicroeconomics,
coveringresearchfocusedonindividual,householdandfirmlevelbehaviors(.The
collectionthenmovesontoexploremesolevelinstitutionalphenomenaassociatedwith
communitiesandmarkets(volume3).Theconcludingvolume4aggregatesstill
further,turningtodevelopmentmacroeconomics,withitsemphasisonpatternsof
aggregategrowth,trade,inequalityandpoliticaleconomy.Acrosssectionof
theoreticalandempiricalresearchisincludedineachvolumesoastoprovidean
accuraterepresentationofthebreadthofthefieldofdevelopmenteconomics.
Thepaperschosenforinclusioninthesefourvolumeshavebeenselectedbothfor
theirclarityandfortheircomplementaritytotherestofthecollection,aswellasfor
theirimpactonthinkingwithinthefield.Selectingamere1500pagesfromthevast
developmenteconomicsliteraturewasadaunting,indeedhumblingtask.Space
constraintsnecessitatedomittingseveralentirethreadsoftheliteraturee.g.,on
industrialization,onforeigndirectinvestment,onenvironmentpovertylinks,on
marketintegrationandspatialorintertemporalpricetransmission,onfertilityand
populationissuesindevelopmentaswellasquiteafewtrulyseminalpaperson
topicsincludedinthisset(e.g.,Young1928,Lewis1954,Stiglitz1974),althoughthecore
findingsofthelatterpapersarereflectedinother(typicallymorecompact)papersin
thiscollection.Severaloutstandingreviewpieceslikewisehadtobeomittedbecause
theopportunitycostofincludingtheminwholewassimplytoohigh.Thisintroduction
invokesthosepaperstosupplementexplanationofseminalpointsfromtheworks
selectedforinclusionintheseforvolumes.Interestedreadersarestronglyencouraged
toexploretheseother,keyomittedworksaswelliftheywishtodelvemoredeeplyinto
particularsubliteraturesofinterest.
II.
Development,povertyandwelfaredynamics
A.Conceptsandmetricsofdevelopment
Thenecessaryfirststepinintroducingthefieldofdevelopmenteconomicsisto
definetheelusiveconceptofdevelopment.SenwonaNobelPrizeforhispath
breakingeffortsinthistask.Chapter2thereforegivesSen(1988)thefirstwordinthis
collection.
Whatdoesdevelopmentmean?Mostpeoplewouldreadilyagreethatitrelatesto
improvementinthehumancondition,tobetterstandardsofliving.Butthatmerely
displacesthedefinitionalproblem.Howdoweknowifstandardsoflivingimprove?
Economistsmostcommonlyusemeasuresofoutputandassociatedincomeor
expendituresasmetrics.Theseflowmeasuresaresurelyrelatedtowellbeing,as
virtuallyeveryonewouldprefermoreofsuchthingstoless,allelseheldconstant.But
theinherentstochasticityandtransienceofflowmeasuresencouragesotheranalyststo
focusonstockmeasureslooselyspeaking,assetsasamoredurablerepresentationof
humanwellbeing.Capitalinitsmanyguisesfinancial,human,manufactured,
natural,socialthusplaysaprominentroleinmuchofdevelopmenteconomics.
Theproblemwithsuchstockorflowdefinitions,ofcourse,isthatincomes,
expendituresandassetsallprivilegematerialconditionsandofferatimeboundviewof
thekindoflifepeoplelive.AsSen(1981,1985,1995)hassoeloquentlyarguedina
seriesofseminalbooks,insofarasdevelopmentisconcernedwithhumansexperiencing
abetterlife,thefocusoughttobeonthelengthandqualityofthatlife,oronthe
entitlements,capabilitiesandfunctioningsofpersons.Chapter2developsthese
concepts,theirphilosophicalfoundations,andtheirimplicationsformeasurementand
analysisindevelopmenteconomics.
Unfortunately,wehaveonlycrudeindicatorsavailabletorepresenttheseconcepts.
Literacy,heathstatus,longevity,etc.allprovideimportantmetricsofwellbeing.But
noneareinherentlysuperiortothetraditionaleconomicmeasuresofincomeorwealth.
Indeed,inafictionalworldofcompleteandcompetitivemarkets,incomeflowsand/or
assetstockswouldsufficetodescribewellbeingsincetheywouldfullydefinepeoples
choicesetsandifallthingsworthwhileinlifeweretradable,thechoicesetwould
describethefullsetofindividualscapabilities.Sincenosuchworldexists,however,
ourusualwelfaremetricsincome,expendituresandassetsmaybethebestscalar
measureofdevelopmentavailable,giventhereasonablystrongcorrelationwithmany
othermetricsofinterest,buttheyarehighlyandunavoidablyimperfect.
Thisissuereallycomestoaheadwhenwetrytocomeupwithpracticalstatisticsto
describethehumancondition.Policymakersneedmeasuresbywhichtheycan
evaluatewhetherornotprogressisbeingmade;arepeoplebetteroffnowthanbefore?
Whoisdoingwellandwhoisnotdoingsowell?
Thestandardmacroeconomicmeasure,grossdomesticproduct(GDP)orgross
nationalproduct(GNP)commonlyinreal(i.e.,inflationadjusted),percapitaform
isahandysummaryoftheaggregateactivityofaneconomy.Butasthesumofall
outputorearningsinaneconomydividedbythepopulationinthecaseofpercapita
measuresnationalaccountsmeasuresofferanobviouslyweakindicatorofthe
experienceofindividuals,givenconsiderablecrosssectionalvariationinstandardsof
living.
Inparticular,developmenteconomiststypicallyconcernthemselvesprimarilywith
thewellbeingofasocietyspoorermembers.Amassiveliteratureonpoverty
measurementhasthereforeemergedovertheyears.LiptonandRavallion(1995)and
Ravallion(1996)offersuperbsynthesesofthatliteratureasoftheearly1990s.
Attheriskofgrosslyoversimplifyingacomplexliterature,therearethree
fundamentalquestionsinpovertymeasurement.First,onemustdecideontherelevant
metric;economiststypicallyrelyonincomeorconsumptionasameasureofones
choiceset.Othermetricsexist:healthstatus,educationalattainment,politicalrights,
etc.Thesemeasuresalltendtobecorrelated,thuscoarseaggregatemeasuresare
typicallyroughlysimilaracrossmeasures,althoughthisrapidlybreaksdownthemore
disaggregatedtheanalysisbecomes.Forthisreason,manydevelopmentscholarsand
policymakershavelongfavoredmultidimensionalrepresentationsofwellbeing.The
UnitedNationsDevelopmentProgrammedevelopedandhasregularlyrevisedthe
computationofaHumanDevelopmentIndex,reportedinitsannualflagship
publication,theHumanDevelopmentReport,preciselytocapturethemultidimensional
natureofwellbeing.Ofcourse,thateffort,likeallsuchendeavors,suffersfrom
weaknessesassociatedwithanarbitraryweightingofdifferentmetrics.
Therehasbeenprogress,however,inmultidimensionalrepresentationsofwell
being.Duclos,SahnandYounger(2006,chapter4)reflectsthecurrentstateoftheart
Extendingthedominanceapproachtopovertycomparisonsinitiallyadvancedby
Atkinson(1987)andFosterandShorrocks(1988a,b),Duclosetal.developand
demonstrateanempiricalmethodofmakingmultidimensionalpovertycomparisons.
Theirmethodsarequitegeneral,allowingfordifferentdefinitionsofpovertybasedon
alternativeaggregationproceduresacrossandwithinindividualdimensionsof
measurement.
Second,onemustestablishanappropriatepovertyline,aninherentlyarbitrarypoint
atwhichoneseparatesthenonpoorfromthepoor.Thisisalongstandingpointof
contention,formanyreasons.Thereisnouniversallyagreedthresholdatwhichquality
oflifeisdeemedsatisfactory;individualheterogeneityissogreatthatevenwithina
community,definingapovertylineisnaturallycontentious.Moreover,spatialand
intertemporalvariationinpriceslimittheappropriatenessofanysinglepovertylineto
allpeopleinallplacesandatalltimes.Othermajorconcernsincludetheunitsof
measurement(doesonestudyindividualsorhouseholds,andifthelatter,howdoes
oneaccountproperlyforpossiblescaleeconomieswithinhouseholds(Deaton1997)?),
theperiodofaggregation(areweconcernedabouttemporaryorchronicpoverty,or
both?),andthedifficultyofestablishinganabsolutemeasureofpoverty,giventhatthe
socialdefinitionofwhatconstitutesmaterialnecessityforagoodlifevariesso
markedlyacrossculturesandovertime.Theseimportantconcernsnotwithstanding,
policymakersneedapovertyline,arbitraryasitmaybe.DatingatleasttoRowntrees
(1910)andOrshankys(1965)workintheU.K.andU.S.,povertylineshavecommonly
beenbased(ifonlyimplicitly)onestimatesofnutritionalrequirementsandsome
multipleofthecostofamarketbasketyieldingthisminimumlevel,withthemultiple
intendedtoreflectotherbasicneedsinsomecrude,fixedproportionssense.
Thethirdfundamentalquestioninpovertymeasurementrevolvesaroundwhatone
countsandhow.Areweinterestedinaheadcountofpeoplelivingbeneaththe
povertyline,regardlessofhowcloseorfartheymightbefromthatline?Arewe
interestedintheamountofmoneyitwouldtaketoclosethepovertygap,i.e.,tobring
everypoorpersonuptothepovertyline?Doweprefertoplaceextraweight,forsocial
ethicsreasons,onthepovertyofthepoorestmembersofsociety,sothatimprovingtheir
wellbeinggeneratesgreaterimprovementsinthepovertyindicatorpermonetaryunit
transferredthanwouldequivalenttransferstolesspoorindividuals?Theansweris
commonlyyestoalloftheabove,asdifferentquestionsaresalientindifferent
contexts.Hencetheattractivenessoftheseminalclassofdecomposablepoverty
measuresintroducedbyFoster,GreerandThorbecke(1984,chapter3).TheFGT
povertymeasures,astheyhavecometobeknown,havebecomethegoldstandardin
appliedpovertyanalysisworldwide,enablingdirectcomparisonofpovertyindicators
overtimeandacrosscountriesusingsimilaraccountingmethods,albeitdependenton
potentiallydifferentpovertylines,measuresofwellbeingandsamplingstrategies.
Whilethefinerpointsofpovertymeasurementwillremaincontested,widespread
agreementhasnonethelessbeenachievedwithrespecttohowtoidentifytheextentof
povertyinagiveneconomyatapointintime.However,povertymeasurementis
typicallystatic,offeringasnapshotofasocietyataparticularmomentintimerather
thanamoredynamic,cinematicviewofhowindividualwellbeingevolvesovertime
withinaparticularsociety.Advancesincollectionandanalysisoflongitudinalmicro
leveldatacommonlyknownineconomicsaspaneldatahaveenabledincreased
studyofthedynamicsofhumanwellbeing;seeBaulchandHoddinott(2000)orBarrett,
CarterandLittle(2007)forrecentcollectionsofsuchwork.Theseemergingstudiesof
microlevelwelfaredynamicscreateanaturalbridgeacrossscalesofanalysisin
developmenteconomics,towhatisarguablythecentralthemeofdevelopment
macroeconomics:growth(seechapters4851).
B.Growth:BacktotheFuture
Theultimateobjectiveofresearchoneconomicgrowthistoexplaincrosscountry
differencesingrowthexperienceandtodeterminewhethersuchexplicabledifferences
carryanyusefulimplicationsforraisingpoorcountriesstandardsoflivingtothoseof
richernations.OnecanmakeacasethatYoung(1928)andRosensteinRodan(1943;
chapter5)launcheddevelopmenteconomicsasweknowittoday.Drawingonand
carefullyinvokingAlfredMarshallsdistinctionbetweeninternalandexternal
economies,Youngintroducedtheanalyticsofgrowthbasedonincreasingreturns.This
providedthecentralconceptsthatunderpintheseminalworksofwhatKrugman(1993)
calledhighdevelopmenttheoryofthe1940sand1950s.Thebalancedgrowthmodel
ofRosensteinRodan(1943),Myrdals(1957)circularandcumulativecausation,
Nelson(1956)andLeibensteins(1957)lowlevelequilibriumtrap,Scitovskys(1954)
externaleconomies,Nurkses(1952,1953)bigpushtheory,andlaterformalizations
oftheseandrelatedstrandsofthegrowthliteraturereliedonthepecuniaryexternalities
andinterfirmorintersectoralcomplementaritiestogenerategrowthprocesses
characterizedbymultipleequilibria,morepopularlyknowntodayaspovertytraps.
Thisalsogaverisetomorecarefulattentionpaidtobackwardandforwardlinkages
amongsectors,initiallyandeloquentlyexploredbyHirschman(1958)andexpanded
uponbyothers,suchasJohnstonandMellor(1961;chapter45),whoemphasizedthe
particularimportanceoftheagriculturalsectorduetoitsextraordinarylinkagesto
othersectors.
TheideasintroducedbyYoungandappliedtodevelopmentproblemsby
RosensteinRodanandhissuccessorsfelldormantfordecades,however.Krugman
(1993)arguesthatthehighdevelopmenttheoristsinabilityorunwillingnessto
formalizetheirinsightsinmathematicalformhelpedenablethemoreprecise
formulationsofSolow(1956)tooutcompetethem.Solowsmodel,basedonkey
assumptionsofconstantreturnstoscale,competitiveequilibrium,exogenous
technologicalchangeandnoexternalities,refinedandextendedthefamiliarHarrod
Domarformulation.IntheHarrodDomarformulationthatdominatedanalysesof
economicgrowththroughoutthe1940sand1950s,thecapitaloutputratiowasassumed
fixedandgrowthratescouldbereadilymanipulatedbychangingsavingsrates.Solow
endogenizedthecapitaloutputratio,lettingitvarynaturallywithpercapita
availabilityofcapitalintheeconomyandtheresultingmarginalreturnstocapital
undertheassumptionofdiminishingreturnstoanysinglefactorofproduction.The
implicationoftheSolowgrowthmodelwerepowerful:accumulationofphysicalcapital
thenaffectsnotthesteadystategrowthrateinaneconomy,onlythelevelofincome,
andtechnologicalprogressbecameakey,exogenousdriverofgrowth.Solowsgrowth
modeldominatedthefieldforover30years,eventhoughittreatedsavingsand
technologicalprogressascompletelyexogenous.
TheneoclassicalSolowmodelspredictionsofconvergentgrowthprocesseswere
nonethelesshardtosquarewiththeempiricalevidencethatsuggestedinstead
divergence,bigtime(Pritchett1997).EmpiricalresearchbyQuah(1996;chapter50),
DurlaufandJohnson(1995;chapter51)andHansen(2000)developedmoreadvanced
econometricmethodscapableofidentifyinghighordernonlinearitiesandthreshold
effectsinmacrolevelgrowthprocesses.Thegrowingbodyofempiricalevidence
againsttheconvergencehypothesisreinforcedadvancesinwhatcametobeknownas
endogenousgrowththeory(Romer1986,1990,1993,Lucas1988,1993;seechapters48
and49).Thesemacromodelsofgrowth,likeleadingmicromodelsofpovertytraps
(e.g.,Loury1981,Murphy,SchleiferandVishny1989,AzariadisandDrazen1990,
BanerjeeandNewman1993,andGalorandZeira1993,MookherjeeandRay2000;see
chapters6,52and53),revivedsomeoftheinternalandexternaleconomiesofscale,
pecuniaryexternalitiesandcomplementaritiesnotionsoftheearlydevelopment
theorists,butnowwiththemathematicalformalismrequiredofcontemporary
economictheory.Theliteraturehasgonebacktothefutureinrediscoveringpowerful
ideasthatlaydormantformanyyears.
10
Theemergenceofdetailedmicrolevelpaneldatasetshassparkedarecentempirical
literatureofmicrolevelstudiesofgrowth,manyofwhichfindsuggestiveevidenceof
povertytrapsandthepersistenteffectsofshocksonthepoor(Dercon1998,2004,
Lybbertetal.2004,Barrettetal.2007).2Thebasicideabehindtheserecentexplorations
ofmicrolevelpovertytrapsisanalogoustothatinthemoremacroliterature:locally
increasingreturnstoscalemaygeneratemultipleequilibriaandthwarttheabilityof
initiallypoorhouseholdstocatchupandconvergewiththeirwealthierneighbors.
CarterandBarrett(2006;chapter8)developthereasoningbehindsuchphenomena,
discusstheempiricalevidence,andofferarelevantextensionofthefamiliarFoster
GreerThorbeckeclassofpovertymeasurestothedynamicrealminthepresenceof
potentialassetthresholdsassociatedwithpovertytraps.
C.Inequalityandgrowth
Oneclearimplicationoftheliteratureonmultipleequilibriaandpovertytrapsis
thatdifferencesinlivingstandardsamonghouseholdswithinaneconomycangrow
andpersist.Inequalitycanemergenaturallyfromgrowthprocesses.Kuznets(1955)first
calledattentiontotheprospectiverelationbetweeneconomicgrowthandinequality,
hypothesizingthateconomiesbeginpoorandrelativelyequalasmostmemberssubsist
throughcropandlivestockagriculture.Then,asindividualsbegintosaveand
diversifyoutofagriculture,bothinequalityandaverageincomesincreasenaturally.
Overtime,sectorswithhigheraveragelevelsofincomeattractmoreandmorepeople
fromsectorsofferingloweraverageincomes,slowingtherateofincomegrowth
hintingatSolowsconvergencehypothesisandreducinginequalitywithinthe
population.Plottinginequalityontheyaxisandincomeoroutputonthexaxisofan
admittedlyspeculativeempiricalinvestigation,Kuznetscameupwithwhathasever
sincebeenknownashisinvertedU.3
Insomecases,theseprocessesappearspecifictodistinctregions,givingrisetoconcernsabout
geographicpovertytraps(JalanandRavallion2002).
Thisbasicpatternhassubsequentlybeenextendedtoanalysisofotherhypothesizedrelationshipswith
thesameinvertedUrelationtoeconomicgrowth.Forexample,aburgeoningliteratureonthe
environmentalKuznetscurveexploresthepossibilitythatmeasuresofdegradationofthenatural
environmentincreaseinitiallyassocietiesevolvefrompoor,agrarianeconomiesintoindustrializedones,
andthenmeasuresofenvironmentaldegradationdecreaseagainasincomescontinuetoriseasimproved
industrialtechnologiesgeneratecleanermanufacturingprocessesandthetransitiontopostindustrial
servicestakesplace(Dasguptaetal.2002).ThecoreKuznetshypothesis,thatsomeundesirable
phenomenahaveanonmonotonicrelationtoincomessuchthatthingsmustfirstgetworseinthecourse
ofeconomicgrowthbeforetheygetbetter,hashadwiderangingimpact.
3
11
TheempiricalliteraturetestingforKuznetsinvertedUhasgenerallyrefutedthat
hypothesis,4althoughmanyofthecoreideascontinuetotantalizedevelopment
economists.Inadditiontothesortofwealthandsavingseffectsoriginallyhypothesized
byKuznets,thesubsequentliteraturehasaddedapoliticaleconomyexplanationfora
relationbetweeneconomicgrowthandinequality.Thecoreideaisthatinequality
fosterspressuresforredistributionthatretardgrowthbecause(i)taxationtoeffect
redistributionofassetsnecessarilycreatesinefficiencies,and(ii)thecostlypolitical
competitionoverthescopeandtermsofanyredistributiondivertscarceresourceto
directlyunproductiverentseekingactivities(PerssonandTabellini1991,Alesinaand
Rodrik1994;chapter54).Theseeffects,likethewealtheffectsarguments,implya
negativeandfundamentallynonlinearrelationbetweeninequalityandgrowthand
makeempiricalidentificationofanysuchrelationchallenging,asBanerjeeandDuflo
(2003;chapter55)explain.Hencethequitemixedempiricalevidenceonthispoint.
D.Investmentinhumancapital
Improvementsineducation,healthandnutritionareimportantforintrinsicreasons
assourceofpleasuretoindividualsaswellasinstrumentalonesduetopotential
effectsonfuturelaborproductivityandearnings.Theseareamongthebestindicators
ofwellbeing,reflectingquitedirectlyonindividualslivingconditionsandcapabilities.
Hencedevelopmenteconomistslongstandinginterestintrackingchangesin
educationalattainment,healthandnutritionalstatusandinincorporatingthesein
multidimensionalpovertymeasures,asexemplifiedbyDuclosetal.(2006;chapter4).
Alongstandingempiricalissueofbroadinteresttodevelopmenteconomistsishow
changesinincomeorexpendituresaffectfoodconsumptionpatterns,humannutrition,
and,derivatively,humanhealthandwellbeing.Acentraldebaterevolvesaround
Engelcurves,whichdescribetheexpansionpathforgoodswithrespecttoincome.If
Engelcurvesfornutrientsandhealtharereasonablysteep,meaningthatfood
consumption,nutrientintake,andhumanhealthrespondreasonablystronglyto
increasesinincomeatleastamongvulnerablesubpopulations,ifnotamongthe
populationasawholethenincomegrowthcanbroadlyachievenonwelfaristgoalsof
improvedhumannutritionandhealth.Bycontrast,iffoodconsumption,nutrient
intake,andhumanhealthrespondweaklyornotatalltoincome,thengrowthbased
developmentstrategiesareunlikelytobeespeciallyeffectiveinadvancingnutritional
andhealthobjectives.Structuralinterventions(e.g.,cleanwater,solidwastedisposal,
primaryhealthcare,education,credit,marketaccessinfrastructure)maythenbemore
effectiveinterventionsifonewishestoimprovethephysicalwellbeingofpoorpersons.
SeeFields(2001)foranexcellentsummaryoftherelevantliterature.
12
Sothedebateaboutincomeelasticitiesoffoodandnutrientdemandisfairlycentralto
thequestionofhowbesttoadvancephysicalwellbeinginthedevelopingworld.
EngelsLawpositsthatfoodisanormalgood,butanecessity,i.e.,foodhasan
incomeorexpenditureelasticityofdemandbetweenzeroandone.Thepoorspenda
muchlargershareoftheirincomeonfoodthandowealthierpersons.Thisbasicfact
suggeststhatincomeelasticitiesofdemandarelow.Butthedropinbudgetshares
appearsrelativelynonlinearinthedata(SubramanianandDeaton1996;chapter23).
Thatisprobablygoodnews,inthatifwehopethatincomegrowthwillcontribute
significantlytothereductionofhunger,foodinsecurityandpoorhealthamongthe
poor,thenwewouldhopethatthemarginalpropensitytoconsumefoodandmore
specifically,nutrientsoutofincomeisreasonablyhighamongthepoor.
Publishedincomeelasticitiesforfood/nutrientsrangeessentiallyfromzerotoone.
Thereisalongstandingassumptionwithreasonableempiricalsupportthatthe
elasticityfallswithincomeorwealth,butthattheelasticityissufficientlyhighsoasto
makeincomegrowthasufficientconditionforimprovednutrition.Overthepast
twentyyears,however,theincomenutritionrelationhasbeensubjecttoheated
reevaluationasseveralstudieshavefoundmuchlowerincomeelasticitiesofnutrient
intakethandidearlierresearch.BehrmanandDeolalikar(1987;chapter22)andBouis
andHaddad(1992)areoftcitedexamplesofstudiesthatfindincomeelasticities
strikinglyclosetoorstatisticallyinsignificantlydifferentfromzero.Others,suchas
SubramanianandDeaton(1996;chapter23)findhigherincomeelasticities,especially
amongthepoor.Thefindingofalowincomeelasticityoffoodconsumptionornutrient
intakesendsthemessagetopolicymakerswithnonwelfaristobjectivesthatincome
growthisapoormeansofimprovingnutritionandhealth.Theprovisionofbasicneeds
thenseemstoholdmoreappealthandoesstimulusofincomegrowth.Evenmore
fundamentally,ifthestrengthoftherelationshipbetweenincomegrowthandother
indicatorsofwellbeing(e.g.,nutritionalstatus)isweak,thatcallsintoquestionthe
appropriatenessofincomeandwealthmetricsofdevelopment,onwhichtheeconomics
disciplineleansheavily.Sothisisnotjustanarcanedebateaboutasinglepoint
estimate(orseriesofpointestimates).Rather,theliteratureontherelationbetween
incomeorexpenditureandfoodconsumptionandnutritionisfundamentalto
developmenteconomics,asmetaphorasmuchasforthetopicoffoodconsumption
itself.
Sincehumanhealthandnutritionareinherentlydynamic,itmakessensetotryto
explorethedynamicsoffoodconsumptionsrelationshiptohealthandincome.Inthe
standardlifecyclemodel,withthesubjectivediscountrateequaltotheprevailing
interestrate,consumptioneachperiodsimplyequalspermanentincome.So
consumptiononlyvariesacrossperiodsinsofarastherearenonstationaryshocksto
13
incomeorhealthstatus,orthereexistmarketimperfectionsthatlimitindividuals
abilitytosave,borroworinsure.Thenthepermanentincomehypothesisfails.Health
irreversibilitiescreateanincentivetoshiftincometowardscurrentconsumptionsoasto
increasetheprobabilityofavoidingthresholdsbelowwhichpermanentimpairment
becomeslikely,whileliquidityconstraintsmaycausehouseholdstoexperience
unwantedvolatilityinconsumptionifincomeisstochasticordeterministically
fluctuating(i.e.,varieswithcertaintyacrosstime,perhapsduetotheseasonalityof
agriculturalproduction).Addtothisthefactthatthemarginalphysicalproductivityof
nutrientintakemaynotbeequalacrosstimeduetoseasonalityinworkeffortor
diseaseincidenceandwehaveyetmorereasontodoubttheintertemporalconstancy
offoodconsumptionbehavior.
Behrmanetal.(1997;chapter24)explorethedynamicsofthenutrientintakeincome
relationusingpaneldataonPakistanifarmhouseholds.Theyfindthattheincome
elasticityofcalorieavailabilitydependsimportantlyonthetimingandanticipationof
income.Duringtheplantingperiod,foodpricesandinterestratesarehigh,making
caloriesexpensive;moreover,calorieintakealsoaffectsfarmprofitabilitybecausepre
harvestlaborproductivityisnotdirectlyobservableandthusissubjecttomoralhazard.
Forthesereasons,incomeearnedduringtheleanseasoncanhavearelativelystrong
effectoncalorieconsumption.Bycontrast,harveststageincomehasatbestasmall
effectonconsumptionwhenfoodisrelativelyplentifulandlabormarketimperfections
areabsentbecauseproductivityisdirectlyobservable.Thesefindingsareconsistent
withthebeliefthatnutrientintakeaffectshealthstatusandthereforelaborproductivity
andincome,aswellaswiththerelatedbeliefthatsucheffectsarenotuniformacross
seasons,yearsorhouseholds,thusbothcrosssectionalandperiodicintraandinter
annualvariationaretobeexpected.TheBehrmanetal.paperunderscoresthat
interventionsimpactsmaydependontheirtiming:forexample,providingincome
supportinleanperiodsinordertoimprovechildhealthandnutritioniftheincome
elasticityofnutrientavailabilityishighestatthattime.
Thereisaseconddimensioninwhichhumancapitalreflectedineducation,health
andnutritionhaslonginteresteddevelopmenteconomists.Becauseindividualslabor
powerbothphysicalandcreativeisakeyproductiveassetinalleconomies,and
oftentheprimaryoronlyproductiveassetheldbythepoorestmembersinasociety,the
studyofhumancapitalaccumulationalsobecomescentralforinstrumentalreasons,
duetotheroleitplaysinexplainingpovertyandgrowthpatterns.Endogenousgrowth
theory(e.g.,Lucas1993;chapter48;Ljungqvist1993)andmodernmodelsofpoverty
traps(e.g.,BanerjeeandNewman1993,chapter6;Dasgupta1997,chapter7)especially
emphasizethecentralroleofhumancapitalformationingivingrisetomultiple
equilibria.
14
Onekeythreadofthisliteraturefocusesontheselfreinforcingeffectsoflowinitial
humancapital.Theparadigmaticexampleisthenutritionalpovertytrappositedat
leastsinceLeibenstein(1957)butperhapsmostelegantlydevelopedbyDasgupta(1997;
chapter7),includingincollaborationwithRay(DasguptaandRay1986,1987).The
coreideaisreasonablysimple.Giventhesignificantminimumenergy(andother
nutrient)requirementsforapurelyrestingmetabolism,anonconvexityisintroduced
intheproductionfunctionforhumanlaborpower;theenergypeoplehaveavailablefor
workisanincreasingfunctionofintakeonlyafterclearingthatminimumthreshold.
Theresultinglocallyincreasingreturnstonutrientintakecreatemultipleequilibria.In
oneequilibrium,littleornoenergyisexpendedbyanunemployedworkerunableto
affordthenutrientsnecessarytowork.Intheother,higherlevelequilibrium,labor
earningspayforfoodenoughtoreproducetheworkerslaborpower.Whilethese
modelscanbeandoftenhavebeeninterpretedtooliterally,theyareinstructive
aboutthecomplexdynamicrelationshipbetweennutritionandproductivity.One
particularmanifestationofanutritionalpovertytrapcanarisethroughinvoluntary
unemploymentassociatedwithanutritionalefficiencywage,althoughthisisnotthe
onlyfeasiblemeans.Dynastictransmissionfromundernourishedandpoorly
compensatedadultstotheirchildrencanperpetuatethecycle,muchasloweducational
attainmentandresultinglow,unskilledearningsamongparentscancausechildrento
fallintodynasticpovertytraps(Loury1981).
Thenutritionalpovertytrapliteratureunderscoresthatillhealthisacauseaswellas
aconsequenceofbeingandbecomingpoor.GertlerandGruber(2002;chapter25)
similarlyfindthatmajorillnessescreatemajor,andlargelyuninsured,economicshocks
forhouseholds.Conversely,asStraussandThomas(1999)reportinanexcellentsurvey
article,arangeofstudiesindicatethatbetterhealthisassociatedwithimprovedlabor
marketoutcomes,particularlyinlowincomesettings.Theexactcausalmechanisms
underlyingtheseassociationsremainunclear,however,butseemtodependasmuchon
behaviorsasonbiophysicalprocesses.
Theimpactofnutritionandhealthonlabormarketreturnsalsoshedssomelighton
oftobservedintrahouseholdinequalityofnutrientintakeandothermeasuresofwell
being(HaddadandKanbur1990,chapter15).Incultureswherephysicallaboris
commonandworkrolesaresharplydifferentiatedbyageandgender,themarginal
impactsofnutrientintakeonhouseholdincomemayvarymarkedlyamonghousehold
membersbasedonageandgender.Undersuchconditions,inequalityaversionwithin
ahouseholdcanattenuateobservedintrahouseholdinequalityrelativetothe
distributionofconsumptionthatwouldmaximizehouseholdincome(Pittetal.1990;
chapter16).
15
Theeffectsofhumancapitalonwellbeingrelatenotjusttoequilibriumbehavior
withrespecttoallocationofeducation,healthandnutritiontoindividualsorhuman
capitalsimpactonproductivityasafactorofproduction.Clearlyeducationandhealth
areimportantasproductiveinputs,bothdirectlyandduetotheircomplementary
effectsonotherinputs.5Buteducation(andexperience)playanunderappreciatedrole
infacilitatingoutofequilibriumperformance,partlythroughlearningbydoingand
fromothers(FosterandRosenzweig1995;chapter42;MoserandBarrett2006)butalso
byfacilitatingmorerapidadaptationtodisequilibriacausedbytheemergenceofnew
technologiesandmarketopportunitiesandbymacroeconomicshocks(Schultz1975;
chapter26).Inspiteofsomesuggestiveevidence(e.g.,GlewweandHall1998,Barrett,
SherlundandAdesina2006),improvingourunderstandingofeducationsdynamic
effectsonabilitytodealwithshocks,bothpositiveandnegative,nonethelessremains
anunderexplored,ifverypromisingareaofdevelopmenteconomicsresearch.
III.
Technologicalchangeandmarketparticipation
A.Technologydevelopmentanddiffusion
Therearethreewaysbywhichanindividualproducerorbyextension,an
economycanexpandoutput:(i)increaseproductivitygivenexistinginputsand
technologies,i.e.,increasingtechnicalefficiencybymovingclosertotherelevant
productionpossibilityfrontier,(ii)increasetheinputs(e.g.,capital,labor,land)applied,
holdingefficiencyandtechnologiesconstant,or(iii)orimprovetechnologies,i.e.,
expandingtheproductionfrontierwhileholdingtechnicalefficiencyandinputs
constant.Wediscussthefirsttwooptionsbelow.Butthehistoricalevidencesuggests
thatthemajordriveroflongruneconomicgrowthandimprovedlivingconditionsis
technologicaladvance.Thisisthereforethefirsttopicofdiscussion.
Itbordersonthetautologicaltosaythatlowincomecountriesaresaddledwith
rudimentarytechnologies.Relativelyunproductivetechnologiesarebothcauseand
consequenceoflowincomes.Thecontemporarymacroeconomicliteratureon
developmentfocusesdisproportionatelyontechnologicalchangeasanengineof
economicgrowthandthepossibilitiesforexternalitiesasasourceofendogenous
growth.Elegantasthesemodelsmightbe,theyoftenlackacompellingmicroeconomic
foundation,especiallyonethathasstrongempiricalsupport.Inparticular,theprocess
oftechnologydevelopmentandadoptionisassumedtoberelativelyfrictionless.The
microlevelliteratureontechnologyadoption,instarkcontrast,paintsapictureofslow,
halting,andusuallyultimatelyincompleteadoptionofimprovedinputsorproduction
processes.
SeeGlewwe(2002)foranexcellentsurveyarticleontheeconomicsofeducationindevelopingcountries.
16
Thisraisesseveralkeyissuesthatpervadethedevelopmenteconomicsliterature:
whyarentmoreproductivetechnologiessuitableforlowincomesettingsdeveloped
andadoptedandwhatcanbedonetostimulateadoptionofexistingtechnologies?The
developmenteconomicsliteraturehaspaidrelativelylittleattentiontoquestionsof
technologydevelopment.Towardthatend,Ruttan(1997;chapter9)callsforthe
developmentofamoregeneraltheoryofthesourcesoftechnicalchange.Themain
theoryinuseistheinducedinnovationmodelofHayamiandRuttan(1971)and
BinswangerandRuttan(1978).Undertheinducedinnovationhypothesis,technical
innovationsareguidedbychangesinrelativeincentives.Asaninputbecomesdearer
relativetoprospectivesubstituteinputs,thereisanincentivetodevelopatechnology
thatmakesrelativelygreateruseofthecheaperinputandlessofthedearerone.The
hypothesisofinducedinnovationsuggeststhatHicksbiasedtechnicalchangeis
causallydrivenbychangesinrelativepricesthatinduceeitherprofitseeking
innovationbyprivatefirmsorpoliticaldemandsforpublicresearchtorelieve
increasinglybindingconstraints.Theempiricalevidenceontheinducedinnovation
hypothesisissomewhatmixed,however,possiblyduetothestochasticnatureofmany
discoveriesandthepathdependenceassociatedwithnonconvexitiesthatmaylockin
evenarelativelyinefficienttechnologies(David1985,Arthur1994).
Explainingpatternsofadoptionoftechnologiesalreadydevelopedisnolessserious
achallengefordevelopmenteconomists.Muchoftheliteratureonthebarriersto
technologyadoptiontracesdirectlybacktotheseminalworkofGriliches(1957),who
studiedtheadoptionofhighyieldingcornvarietiesintheUnitedStates,theroleof
researchinoutputgrowth,andtheroleofextensionandeducationinpromoting
technologyadoptionandaggregateproductivitygrowth.Sincethattime,alarge
literaturehasfocusedonunderstandingbetterwhowilladoptagiventechnology,
especiallywhowilladoptfirst.Federetal.(1985;chapter10)offerastillclassic
summaryoftheliteraturefromtheGreenRevolutionperiod.Notsurprisingly,early
adopterswerefoundtobethosewiththemosttogain,thelowestcostaccesstothe
technology,andthelowestevaluationcosts,includingtheleastuncertaintyaboutthe
technology).Arecentresurgenceofinterestintechnologyadoptionquestionshas
focusedanewonthedynamicsoftechnologydiffusion(BesleyandCase1993;chapter
11),particularlytoprocessesoflearningbydoingandlearningfromothers(Fosterand
Rosenzweig1995;chapter42,alsoBandieraandRasul2006,MoserandBarrett2006).
Theorderinwhichdifferentagentsadoptanewtechnologycanhavesignificant
distributionalimplicationsandcanreinforcepreexistingpatternsofinequality,as
Cochrane(1958)observedinpositingatechnologicaltreadmillinagriculture.The
ideaissimplebutpowerful.Inasmallopeneconomyinwhichproducersface
infinitelyelasticdemand,thesocialgainsfromanytechnologicalchangeaccrueentirely
toproducersintheformofhigherprofits.Bycontrast,ifdemandisperfectlyinelastic,
17
allthesocialgainsaccruetoconsumersintheformoflowerprices.Thedistributionof
thegainsfromtechnicalchangethereforedependcruciallyonthepriceelasticityof
demandfortheproduct.Sincemostagriculturalproductsexhibithighlyinelastic
demand,whetherbecauseofphysiologicallimitstofoodconsumptionorbecause
transactionscostscausefrictionsintradingwiththebroaderglobaleconomy,producers
inaggregatetendtoloseinthelongrunfromtechnologicalchange.Producersadopt
newtechnologiesbecausetheyreduceunitcosts,therebyincreasingproductivity;butin
generalequilibrium,wheneveryoneadoptsthecostreducingtechnology,thisshiftsthe
aggregatesupplycurvesuchthatpricesfalltoo,potentiallyleavingproducersworseoff
thanbeforeifdemandissufficientlyinelastic.
Thisrevealsanimportantfallacyofcomposition:whatiswelfareenhancingand
optimalinthesmallmayprovewelfarereducinginthelarge.Forthisreason,thestate
ofagriculturalmarketswhichdeterminethepriceelasticityofdemandfacedby
producersandthedynamicsofadoptionarecentraltothedistributionaleffectsof
technologyadoption.Earlyadoptersbenefit,atleasttemporarily,whilelateadopters
andnonadoptersneverbenefitorevensufferwelfarelossesduetodiffusionof
improvedtechnologies.Relatedly,becausethebenefitsfromagriculturaltechnology
developmentaccrueinpart(often,largely)toconsumersintheformoflowerprices,it
maybesociallyoptimaltopayfortechnologydevelopmentwithtaxrevenuespaidby
consumers.Whenresearchanddevelopmentisprivateandintellectualpropertyrights
protecttherightstoprofitfromaninnovation,firmscapturethiscostthroughroyalties
andmonopolyrentsearnedfromconsumers.Butwhenresearchanddevelopmentis
public,asforsmallholderproducersinlowincomeagriculture,themeansoffinancing
technologydevelopmentcanbecometricky,especiallyifthedomestictaxbaseisthin
andinternationalaidislimited.Sothefutureoftechnologydevelopmentforlow
incomeagricultureremainsaseriouschallenge.
Alongstandingdebatehasrevolvedaroundtherelativeimportanceoftechnology
developmenttoexpandtheproductionpossibilityfrontierforpoorfarmers,versus
improvingproductivitywithintheexistingproductionfrontier.Widespreadevidence
intheliteratureoftechnicalinefficiencyamongsmallfarmershasoftenfuelled
argumentsthatinvestmentinnewtechnologiesmightnotbeasvaluableasinvestment
inextensionservicestoincreaseadoptionandimprovetheuseofexistingtechnologies.6
ThisclaimisatoddswithSchultzs(1964)famouspoorbutefficienthypothesis,
whicharguesthatsmallfarmersarehighlyefficientinusingwellestablished
technologies.Whattheymostneedareimprovedtechnologies,inordertoproduce
morefromthesamestockoflandandlabor,andthehumancapitalnecessaryto
SeeAliandByerlee(1991)foragoodreviewoftherelevantliteratureandBarrett(1997)foracritiqueof
muchofthatliterature.
6
18
facilitaterapiduptakeofnewtechnologies.Indeed,themorerecentliteratureon
smallholderefficiencylargelyreinforcesSchultz.AsSherlundetal.(2002;chapter34)
note,productiondecisionsaremadeinanenvironmentwherecrucialinputsare
stochasticandbeyondtheproducerscontrol.Thusfailuretoaccountforcross
sectionalorintertemporalvariationinexogenousproductioninputs(e.g.,rainfall,plant
disease,plotslope,soilfertility)implicitlypitsallproducersagainsttheonewiththe
luckiestdrawfromnatureandleadstoupwardbiasinestimatesoftechnical
inefficiency.
B.Marketparticipation,intersectoralandinternationallinkages
Iftechnologicalprogressisonekeyengineofgrowth,specializationaccordingto
comparativeadvantagesoastoreapgainsfromtradeisanother.Goingbackatleastto
AdamSmithandDavidRicardo,thewelfaregainsfromopennesstotradehavebeena
stapleofeconomicreasoning,eveniftheyareonlyoneoff,transitionalgains.
Developmentmacroeconomistshavedevotedconsiderableefforttotheorizingabout
andempiricallyinvestigatingthisrelation,especiallythedynamiceffectsoftradeon
growthandpoverty.Especiallywithincreasedglobalizationinrecentdecadesdueto
improvedcommunications,informationandtransporttechnologiesthathaveshrunk
thecostsofcommerceinternationallybutalsodomesticallytheimpactofincreased
economicintegrationonpovertyandgrowthhavebecomecentralresearchquestions
again.
DollarandKraay(2004;chapter58)offerperhapsthemostwellknownrecent
empiricalstudy,showingthatdevelopingcountriesthathavecuttariffratesand
substantiallyincreasedtradevolumesenjoyedacceleratinggrowthratesandstable
incomeinequality,thusincreasedincomesforpoorhouseholds,onaverage.Induced
totalfactorproductivitygrowthseemsakeymechanismforgeneratingthese
apparentlysalutaryeffectsoftradeonpovertyandgrowth(Edwards,1998;chapter57).
Productivitygrowthmightemergelessthroughconventional,Ricardianmechanisms
associatedwithfactorallocationthanthroughtheeffectinteractionamongdistinct
communitieshasinhelpingclosetheideagapsthatcausepoorercountries,regions
andhouseholdstolagbehind(Romer1993;chapter49).
Theanalyticalsimilaritiesbetweentechnologyadoptionchoicesandmarket
participationchoicesarestriking,althoughlargelyoverlooked.Ifatechnologyisquasi
concaveandmonotone,thenexchangefitsthegeneralcharacteristicofatechnology.To
seethisassumeanagentcanproduceaconsumptiongood,y,fromsomemixofinputs
x,describedbyawellbehavedproductionfunctionf(.)suchthat,y=f(x).Alternatively,
ifsheiswillingtoincurfixedcostsofmarketaccess,fc,shecanpurchaseanynumberof
unitsofyforaunitpriceofpandcansellforaunitpriceqanynumberofunitsof
19
anothergood,z,thatshecanproduceusingadifferenttechnologybutthesameinputs,
z=g(x).Theremayalsobeaproportionalvariablecostperunitsold,vc,akintoanad
valoremtariff.Theproductionfunctiong(x)likewisesatisfiesthestandardquasi
concavityandmonotonicitypropertiesofatechnology.Theneffectivelythisagenthas
accesstotwodistincttechnologiesforproducingy:f(x)andfM(x)=(1vc)(q/p)g(x)fc.
SincefM(x)isjustanaffinetransformofthemonotone,quasiconcaveg(x),bothf(x)and
fM(x)havethesamebasicquasiconcavityandmonotonicityproperties.Sothechoiceof
whethertoproduceagoodortopurchaseitinthemarketisqualitativelyidenticalto
thechoiceamongalternativeproductiontechnologiesforagood.
Inboththetechnologyadoptionandmarketparticipationcases,fixedcostsplayan
importantrole,mirroringtheirimportancetomoregeneraltheoriesofimperfect
competitionandofmultipleequilibriaandpovertytraps.Romer(1994;chapter56)
reintroducedthiscoreideaofnonconvexitiesintothediscussionofthewelfarecostsof
tradepolicy.Hiscorepointisthatwhenoneallowsforgoodstoappearordisappear
basedonachievingacriticalmarketmass,theefficiencylossesassociatedtrade
distortionscanbecomequitelarge.ThispointbuildsonHirschmans(1958)ideaof
backwardandforwardlinkages,whichlikewiserestfundamentallyonthenotionof
pecuniaryexternalitieslinkedtoeconomiesofscale,andonwhatFleming(1955)
referredtoasverticalexternaleconomiesassociatedwiththecosteffectsassociated
withexpandedintermediategoodsproduction.Whenexpansionofanindustrydrives
downinputpricesforadownstreamsectorwithwhichithasatradingrelationship,it
cannotonlyhaveastandardmultipliereffect,inthepresenceoffixedandsunkcosts
orothersourcesofnonconvexitiesitcanalsomakeemergenceofentiresectors
suddenlyprofitable,leadingtoverylargesocialreturnstoinvestmentintheupstream
sector.JohnstonandMellor(1961;chapter45)helpedmakethecaseformassive
investmentsinimprovingagriculturaltechnologiesbyexplainingtheperhapsunique
roleagriculturecanplayinstimulatingeconomicdevelopment.Haggbladeetal.(1991;
chapter46)andanextensiverelatedliteraturedevelopedtheempiricalevidencein
supportoftheJohnstonMellorhypothesis,carefullydocumentingextraordinarilyhigh
growthmultipliersassociatedwithexpandingagriculturalsupplyandmarketsfor
distributingagriculturalproductstointermediateprocessingindustries.
Giventheapparentmassivestaticanddynamicgainsfromtrade,itmaytherefore
seempuzzlingthatwhilefewnationsarefullydisengagedfrominternationalmarkets
anylonger,therearenonethelessmanyhouseholdsthatoptoutofmarketexchangefor
quitearangeofgoodsandservices.Theissueofmarketparticipationrevolvesaround
thetensionbetweengainsfromspecializationandthecorrespondingincreasesin
transactionscostsfromspecialization.Transactionscostsvarywitheconomicdistance
fromtradingpoints,wherethisdistanceisdefinedoverspace,time,form,or
expectations.Sofixedandvariablecostsareidiosyncratic.Theyarealsoendogenous
20
becausepeopleknowexchangeiscostly,andchooseproductionandexchange
strategiesrecognizingthattheyareimplicitlychoosingtransactionscosts,too.As
Kranton(1996)emphasizes,thecostsofmarketparticipationarenotindependentofthe
incidenceofpersonalized,reciprocalexchangeinsteadofmarketbasedexchange.That
is,increasinglywidespreaduseofmarketexchangereducessearchcosts,inducing
furthersubstitutionofmarketexchangeforreciprocal,nonmarkettransactions.The
tensionbetweenthegainsfromspecializationandthecorrespondingincreasein
transactionscostthatresultfromdependingmoreonthemarkettoprocureonesneeds
helpsexplainwhysomefarmersforegoyieldincreasingtechnologiesandoptfor
activitydiversificationnotforreasonsofselfinsurancebutratherbecauseofdemand
forconsumptionvarietyinthefaceofcostlycommerce.Moregenerally,ignoringthat
marketfailureisidiosyncraticandendogenouscanleadtomistakeninferenceaboutthe
rationalityofsmallholderbehavior(deJanvryetal.1991,chapter14;Goetz1992,Keyet
al.2000,chapter12;BellemareandBarrett2006).Formany,autarkicbehaviorisalow
levelequilibrium.
Thenatureofmarketsandmarketparticipationalsohasafundamentaleffectonthe
basicmodelingmethodsusedbydevelopmentmicroeconomists.Whenmarketswork
well,consumptionandproductiondecisionsareseparable(Singhetal.1986;chapter
13).Butwhenriskortransactionscostsofmarketparticipationdriveawedgebetween
buyerandsellerprices,householdscanoptimallyselfselectoutofmarkets.Then
consumptionandproductiondecisionsbecomenonseparable(deJanvryetal.1991;
chapter14).Theaddedcomplexitiescausedbytreatingeverythingasendogenously
determinednaturallygiverisetotestsoftheseparabilityhypothesistoseewhenone
mightdefensiblyusesimpler,separablehouseholdmodelformulations(Benjamin
1993).TheproblemisthattheArrowDebreuseparabilityassumptionofcompleteand
competitivemarketsseemsratherfarfetched,givenwhatthesocialscienceshave
documentedaboutmarketsinlowincomesettingsgenerally.
IV.
Marketimperfections
Theprecedingdiscussionpointstoafewkeythemesthatemergerepeatedlyinthe
literature.Thefirstistheimportanceofmultiplefactormarketfailuresininducing
differentialreturnsacrosshouseholds.Whenasinglemarketfails,allothermarketscan
adjusttoasinglefixedfactorofproductionwithoutcausingsystemicinefficiency.But
whenmultiplemarketsfail,shadowpricesnecessarilybecomeidiosyncratic(i.e.,
householdspecific)andsooptimalinputuseintensityandconsequentlyproductivity
willvaryacrossproductionunits,leadingtocrosssectionalvariationinincomes,
expendituresandothermeasuresofwellbeing.Asecondkeythemeisthatimperfect
informationandassociatedriskaccountformanyofthemarketfailuresobservedinthe
21
developingworld.FollowingfromStiglitzspathbreakingwork,theeconomicsof
imperfectinformationhaspermeatedallcornersofdevelopmenteconomicsoverthe
pastquartercentury.
Themanyobviousimperfectionsinlowincomeeconomiesmeanthatoneis
necessarilyoperatinginthedomainofsecondbestbehaviorsandinstitutions,aworld
ofmultipledistortions,theconsequencesofwhicharenotalwayseasytopredict.
Gettinggovernmentpoliciesandfirmandhouseholdlevelbehaviorrightisofspecial
importanceinthisenvironment;farmorethaninafictionalfirstbestworld.AsRomer
(1994;chapter56)pointsout,policieshaveonlysecondorderwelfareeffectsinafirst
bestworld,butfirstorderwelfareeffectsinasecondbestworld.Greenwaldand
Stiglitz(1986)similarlyemphasizethattheconsequencesofminorinefficienciesbyone
firmorhouseholdcancreatesignificantaggregatedistortionsinthebroadereconomy,
givendistortionsintheunderlyingeconomyduetoincompletemarketsandimperfect
information.
AstheLucascritiquecautions,gettingpoliciesrightdemandsasolidunderstanding
ofthemicroeconomicsofconsumerandproducerbehaviorandofthefunctioningof
marketsandnonmarketinstitutions.Towardthatend,developmenteconomistshave
spentanextraordinaryamountofenergyunderstandingpatternsofcontractingamong
agents,especiallywithrespecttolandandlaborthekeyelementsofagricultural
productionandwithrespecttofinancialservicescredit,insuranceandsavings
essentialtomanagingresourceallocationovertimeandacrossstatesofnature.
A.Agrariancontracts
Oneoftheprincipalobstaclestoimprovingthewelfareofpoorruralpeopleinlow
incomecountriesistheneedtoincreaseagriculturaloutputresultingfromthe
applicationofexistinginputs.Thereisrelativelylittleecologicalcapacityfor
agriculturalextensification,soataminimumyields(outputperunitareacultivated)
mustincreasesignificantlyiffoodavailabilityistoincrease,anecessaryconditionfor
appreciablereductionofhungerandfoodinsecurityinthemediumterm.Moreover,
sincethepoorareendowedchieflywithlaborpowerandinthecaseoftheruralpoor,
secondlywithlandimprovinglaborandlandproductivityiscentraltoanyeffective
andsustainableruralpovertyalleviationstrategy.Soidentifyinghowbesttoachieve
theseobjectivesnecessarilyinvolvesasolidunderstandingofcurrentproduction
technologies,theirperformance,andtheeffectsandperformanceofrelatedfactorand
productmarkets.Together,thesearetheingredientsthatdeterminetheproductivityof
smallholderagriculture.
22
Ithaslongbeennotedthatpartialortotalfactorproductivitymeasuresroutinely
appearnonconstantinlowincomeagriculture.Typically,aninverserelationship
existsbetweenyields(outputperunitareacultivated)orlaboruseperhectareandfarm
size.Conversely,apositiverelationshiptypicallyexistsbetweencredituseorthe
probabilityofmoderntechnologyadoptionandfarmsize,andinsomecircumstances
theseeffectsseemtooverwhelmthelaboreffectstogenerateapositiverelationship
betweenfarmsizeandyield(Kevane1996).Neoclassicaltheorytellsusthatfactor
productivityshouldbeequalizedacrossproductionunitselsethehighmarginal
productivityusershouldpurchaseorrentthefactorfromalowproductivityuserata
mutuallyattractiveprice,therebygeneratinggreateraggregateoutputandwelfare.So
theexistenceofarelationshipbetweenfarmproductivityandfarmsize,andespecially
thetypicalinverserelationshipbetweenthetwovariables,hasattractedmuchattention
asperhapsindicativeofkeymarketfailures.
Thegenesisoftherelationshipbetweenfarmsizeandproductivityhasimportant
practicalimplications.Forexample,ifsmallfarmsareinherentlymoreefficientina
givensetting,thismakesastrongcaseforredistributivelandreformasasourceofboth
equityandefficiencygains.Ifthesourceoftheproductivitygradientismarkets
failures,thissuggeststhatthefundamentalwelfaretheoremsofneoclassicaleconomics
donotholdinthesetting,socompetitivemarketsdonotnecessarilyyieldPareto
optimaldistributions,providingatheoreticaljustificationforgovernmentinterventions
intoruralmarkets.Conversely,iftheinverserelationshipispurelyastatisticalartifact
attributabletotheomissionofhardtoobservevariables(e.g.,levelsofnutrientsinthe
soil)andintruththereisnovariationinproductivityacrossfarmsizes,thentherural
economydoesseemtofunctionaspredictedbyWalrasiantheoryandmarket
interventionswillgenerallyproveinefficient.Soexplainingtheoftobservedinverse
relationshipbetweenfarmsizeandproductivityhasbeenanimportantcottageindustry
fordevelopmenteconomistsformanydecades.
TheseminaltheoreticalexplanationofsizevaryingproductivityisduetoFeder
(1985;chapter33).Heestablishesthatinthefaceofjustonemarketfailure(e.g.,for
landorforlabor),productivityisinvarianttofarmsize.Themobilefactors(hiredlabor,
land,capital)movetotheimmobilefactor(familylabor,inhismodel).Putdifferently,
inaneoclassicalworldofalmostcomplete,perfectmarketswithconstantreturnsto
scale,allvariableinputsandfixedfactorsareappliedinequalproportionsacrossfarms
sotherecanbenoyielddifferences.Butwhenthereisasecondmarketfailure,then
optimalfarmsizeandlaborapplicationrateswillingeneralvarywiththeamountof
landowned.Ifcreditconstraintsdominate,thenlargerfarmerswillbemore
productive,whileiflaborsupervisionconstraintsaremostlimiting,smallerfarmerswill
23
enjoyhigheryields,leadingtoaninversefarmsizeproductivityrelationship.7Alarge
literaturefindsstrongevidenceofbothcreditconstraintsandmoralhazard(e.g.,Foster
andRosenzweig1994;chapter29).
Marketimperfectionslikewiseaffecttheorganizationoftheagriculturalsector,the
particularmannerinwhichland,labor,andotherinputscombineforproductive
purposes.Whenmarketimperfectionsexist,individualscaneither(i)participateinthe
market,adjustingbehaviortosuittheirspecificnetcostsorbenefits(shadowprices)of
marketparticipation,(ii)optoutofthemarketandpracticeautarkicproduction,or(iii)
contractdirectlywithacounterpartyratherthanundertakingasemiautonomousopen
markettransaction.Theveryinformationfailuresandriskcharacteristicsthattypically
bedevilmarketsalsomakecontractingcomplexandhighlyvariable.Indeed,itisthe
variabilityofthecontractsoneobservesinlowincomeagriculturethatmakesthe
subjectofagrariancontractssofascinatingandimportanttoasolidunderstandingof
themicroeconomicsofdevelopment.
Animportantunderlyingthemeindevelopmentmicroeconomicsisthatmarket
imperfectionsofonesort(e.g.,inlabororinsurance)areoftentransmittedtoother,
relatedmarkets(e.g.,forland).Thefundamentalinterrelationshipofvariousfactor
marketsmeanstheinefficienciesinoneoftenaffectanotherandthatmeansofresolving
problemsinonefactormarketoftenturnonarrangementsinvolvingoneormoreother
factormarkets.Explicitinterlinkagesemergeandpersistnaturallyduetotheexistence
oftransactionscosts,uninsuredriskandexogenousbarrierstofactormovements(Basu
1983;chapter30).Butevenwithoutexplicitinterlinkageamongcontractsaswhen
creditandforwardcropsalescontractsarebundledtogethertoreducetherisksfaced
bybothborrowerandlendermarketsaretypicallyimplicitlyinterlinkedby
contractualarrangementsprevailinginmanylowincomeeconomies.
Therearemultiplereasonsforthis.Oneisthatwhenonemarketisostensibly
missing,residualdemandforandsupplyofthenonmarketedgoodorservicecanstill
besatisfiedimplicitlythroughadjustmentstothetermsofexchangeinothermarkets.
So,forexample,whenagovernmentdeclareslandmarketsillegalandenforcesa
prohibitiononlandexchange,therearealternative(e.g.labormarket)mechanismsto
accommodaterepresseddemandandsupplyforland.Distortionsarecommonly
displacedintoothermarketswithinaneconomy.
Anotherreasonisthattheanonymousandindependenttransactionsofthestandard
Walrasianmodeldonotcapturetherepeatedandmultifacetedinteractionsof
Whenindividualsmakedecisionsnoncooperatively,multiplemarketfailurescanevenresultinintra
householdproductivitygradients,providingstrongevidenceoftheallocativeinefficiencyresultingfrom
marketimperfections(Udry1996;chapter17).
7
24
individualslivinginruralcommunities.Iftherearefixedcoststoeachtransaction,it
maybemoreefficienttobundleseveralexchangestogetheratoncethantonegotiate
separatelyovereachfactorexchangedbetweenthesametwoparties.Theresulting,
explicitlyinterlinkedcontractsnecessarilyenmeshmarketfailuresinonedomainwith
equilibriumcontractualarrangementsinanother.
Themaincontractualarrangementsstudiedbydevelopmenteconomistshave
concernedsharecroppingandlabor.Inaworldofperfectinformation,completeand
perfectlycompetitivemarketswithnouncertaintyandconstantreturnstoscale
productiontechnologiesdefinedoverinputsoflandandlabor,itwouldmakeno
differencewhetherlandownershiredlaborersorwhetherlaborersrentedinland.
Wagelaborerswouldbepaidtheirmarginalrevenueproduct,withtheresidualoutput
accruingtolandownersonaconstantperhectarebasis.Afixedrentalcontractyielding
thesamerentperhectare(sothatthelandownerisindifferentbetweenrentingoutthe
landorhiringinthelaborers)yieldstheequilibriumwagerateastheresidualpaidto
thetenant,leavinghimorherindifferentaswellbetweenrentinginlandorhiringout
theirlabor.Insuchafictional,perfectworld,thereshouldbenosharecropping,
however,asitexplicitlycreatesanexternalitybymakingthelandownerabeneficiaryof
thetenantsadditionallaboreffort,andisthereforesociallyinefficient.
Inamorerealisticsettingwhereuncertaintyandimperfectmarkets(andperhaps
nonconstantreturns)prevail,thealternativemeansofallocatingfactorsofproduction
willnotbeequivalent,however.Indeedsharecroppingbecomescommonplacebecause
itstrikesapotentiallyoptimalbalanceamongcompetingmarketimperfectionsdueto
asymmetricinformationproblemsandincompletemarketsforriskorcreditasStiglitz
(1974)famouslyshowed.ThesemissingmarketsresultinParetoinefficiencythathelps
accountforsomeoftheobservedlowproductivityofagriculturallandsandworkersin
lowincomeeconomies.
Theheterogeneouspatterninbothcrosssectionandtimeseriesofobserved
contractformshasdrawnmuchattentionfromdevelopmenteconomists.Otsukaetal.
(1992)emphasizeagencytheoryasthemaindeviceneededtonesttogetherparallel
theoriesoflaborcontracts,landcontracts,andtheubiquitousobservationthatowner
cultivationdominatesallotherformsoforganizationinbothfrequencyand
productivityterms.Therelativeefficiencyofdifferentcontractualformsandtheex
antedistributionoflandownershiparethecriticalingredientsdeterminingprevailing
agrarianinstitutionalarrangements.Agencytheoryhighlightsthetradeoffsinvolved
betweenworker(dis)incentivesdueto,ontheonehand,asymmetricinformationand
effortorqualityshirking(thelatterbeingattributabletocarelessnessinwork,
regardlessofeffortlevel,thatcausesdamagetotheproduce),and,ontheotherhand,
thelimitedriskbearingorborrowingcapacitiesofpoortenantsorincreasingreturnsto
25
scaleinparticulartypesofagriculture(e.g.,mechanizedorexportorientedplantation
agriculture).
EswaranandKotwal(1985b,chapter31)offerperhapsthemostcompactandelegant
modeltodateexplainingtheobservedheterogeneityofagrariancontracts.Intheir
view,differentcontractsreflectdifferenttechniquesofcombiningnonmarketed
productiveinputs.Theequilibriuminstitutionalarrangementsforagricultural
productionarisefromtheoptimizingdecisionsofbothpartiestothecontract,theland
ownerandthetenant/worker,givenprevailingtechnologies,marketconditions,etc.In
thissetting,sharecroppingcanbeunderstoodastheoutcomewhenessential
intermediateinputs(laborsupervisionandmanagerialabilityintheirmodel)arenon
tradablebuteachpartytothecontractholdssufficientcomparativeadvantageinoneor
theotherinputastomaketheircominglingthroughjointproductionoptimal.Ifthe
inputscouldbefreelytradedonthemarket,sharecroppingwouldneverarise.
Moreover,astherelativeadvantagesoflandlordsandtenantsshiftovertime,in
particularsinceaccesstoinformationandcredittendstoequalizeintheprocessof
development,thereisanaturalevolutionincontractualform,generallyawayfrom
sharecroppingandtowardfixedrentcontractsinwhichthegapinlaborsupervision
abilityremainswhilethegapinmanagerialabilityvanishes.
Thetheoreticalliteratureonagrariancontractssuggestssomedisagreementasto
whethersharecroppingistrulyinefficientatthelevelofindividualproducers,thatis,
whetherMarshallianlabormonitoringproblemsaresignificantandwhetherlongterm
contractsperhapsresolveanysuchmoralhazardproblemsthroughrepeated
interaction.Followingalineofilluminatingempiricalinquiryonthisquestion(e.g.,Bell
1977,Shaban1987),LaffontandMatoussi(1995,chapter32),explorethesequestions
directlyintheirstudyofsharecroppinginTunisia,whereintheyalsoexplorewhether
riskaversionorfinancialconstraintsseemabetterexplanationofsharecroppings
existence.Althoughtheyfindlowerefficiencyonsharecroppedthanonownedland,
presumablybecausethesharecropperslaboreffortisreducedinlinewithreductionsin
hisshareofoutput,thelengthofthesharecroppingcontractalsohasapositiveand
statisticallysignificanteffectundermultiplealternativespecifications,signalingthatthe
contractdurationmayindeedhelptoresolvesomeoftheinefficiencyassociatedwith
sharecropping,followingthepredictionsoftheFolkTheorem.
Alongsidesharecroppingandrelatedagrariancontracts,theotherfactormarketof
longstandinginteresttodevelopmenteconomistsconcernslabor.Multipleequilibriain
labormarketshavealwaysattractedattention,whetherduetonutritionalefficiency
wages(Leibenstein1957;DasguptaandRay1986,1987)ortotheemergenceofdistinct
marketsforpermanentandcasual(i.e.,day)labor.EswaranandKotwal(1985a,
chapter27)refertothelatterphenomenonasatwotieredlabormarket.This,too,isa
26
multipleequilibriumresult,consistentwithmuchofthecoredevelopmenteconomics
literaturealreadydiscussed.Justasinthesharecroppingliterature,theyhypothesize
thatmarketimperfectionsassociatedwithlaborsupervisioncreateincentivesfor
employerstoofferhigherwagestopermanentworkersthantocasuallaborersinorder
tobeabletoinduceloyaltyamongtheformersufficienttoobviatetheneedtodevote
resourcestolaborsupervision.Theresultingthresholdcontractseparatingequilibrium
elicitsoptimallaboreffortfromworkers.
Whoisabletoattractthesehigherpayingjobs?Thisobviouslydependson
individualattributes,suchaseducationandhealth.ButasMunshi(2003;chapter44)
demonstrates,thismayalsodependononessocialnetworks,foreshadowingacentral
themeofthiscollectionsthirdvolume:theimportanceofnetworksandother
nonmarketinstitutionstoeconomicperformance.Socialnetworkscanaffectlabor
marketperformancethroughanyofseveralmechanisms.Theycanreducesearchcosts
forworkers,searchandscreeningcostsforemployers,andcanevenprovidedefacto
interlinkedcontracts,aswhenareferringemployeeeffectivelyguaranteesthe
productivityofareferredassociate.Munshifindsthatreferralsandsupportprovided
bymoreestablishedmembersofMexicansocialnetworkshaveapronouncedimpacton
migrantworkerperformanceintheUnitedStateslabormarket.
Labormarketsareofinterestmorebroadly,notjustbecauseofthepotentialfor
multipleequilibria.Muchendogenousgrowththeoryandmanyoftheearlymodelsof
balancedgrowthandeconomiesofscalesuchasRosensteinRodan(1943)relyonan
elasticsupplyoflabortogeneratethepecuniaryexternalitiesthatpropelgrowth
spillovers.Lewis(1954)seminaldualeconomymodelmadethisassumptionmost
explicit,makingthelimitingassumptionthatthemarginalproductivityoflaborin
backwardsectorssuchasagriculturewaszero.Thisclearlyextremeassumption
reallyjustmotivatedamilder,crucialassumptionofhighlyelasticlaborsupply
originatinginunemployedorunderemployedworkersinprimaryproductionsectors.
Thequestionofhowelasticlaborsupplyisappliesquitebroadlyindevelopment
economics.Whereaconsiderableproportionofasocietyspoorrelyextensivelyon
labormarketearnings,theeffectsofpolicychangeonequilibriumwageratesand
employmentlevelsmayhaveimportantconsequencesforthewelfareofthepoor.But
ingeneralequilibriumorinthepresenceofnonseparableconsumption,production
andlaborsupplydecisionswageratesandemploymentlevelsdependnotonlyonthe
demandforlabor,butalsoonhouseholdssupplyoflabor,whichisanendogenous
resultofhouseholdchoice.Similarly,programsdesignedtoimprovethewelfareof
vulnerablesubpopulationstypicallycreatedefactoincometransfersthatlikelyinduce
laborsupplyresponsebyrecipienthouseholds.Consumersubsidies,foodstamps,cash
transfers,andthelikewill,ingeneral,notbeconsumedsolelyasadditionalunitsofthe
27
subsidizedgoodoradditionalexpenditures,butalsointheformofincreasedleisure,
assumingleisuretobeanormalgood.Thismattersespeciallyifpolicymakers,donors,
orothersareconcernednotwithoverallwelfare,butwithspecificindicatorssuchas
nutritionalstatus,foodexpenditures,etc.Undernonwelfaristcriteria,theeffectiveness
ofpublicinterventionsdependscruciallyonlaborsupplybehavior,i.e.,theextentto
whichpeoplediverttransfersextendedintheformofcashorfoodintowelfaregains
enjoyedintheformofincreasedleisure.
Thecommonpointisthatareasonableunderstandingoflaborsupplybehavioris
centraltomuchappliedworkaimedatimprovingthewelfareofthepoor.Weknow
fromthehouseholdmodelingliteraturethathouseholdsrespondtochangesin
exogenousvariables(e.g.,prices,income,technologies,risk,etc.)notonlybyadjusting
demandforhiredlabor,butalsobyadjustingsupplyoflabortotheirownfarm,aswell
astothemarket(Singhetal.1986,chapter13;deJanvryetal.1991,chapter14).Soby
observingsuchadjustments,oneshouldbeabletotraceoutalaborsupplyfunction.
Thetrick,ofcourse,isthatinlowincomesettings,alargeshare(frequentlyamajority)
ofworkisnotforwagesorsalarybutratherisselfemployment,infarming,commerce,
pettymanufacturing,orservices.Sohowdoesoneestimatelaborsupplyintheabsence
ofwagedata?
Thecleversolutiontothisprobleminvolveshouseholdmodelingtechniques.
Jacoby(1993;chapter28)exploitstherelationshipsimpliedbyutilitymaximization
withintraditionalhouseholdmodels,inparticulartheobservations(i)thathouseholds
respondtoshadowprices,inthiscaseshadowwagesforlabor,and(ii)thathouseholds
maximizeshadowprofitsbysettingtheshadowpriceofaninputequaltoitsmarginal
revenueproduct.Onecantherebyderivetheshadowwageforselfemployedworkers
byestimatingthereturnstolaborinownproductionandusingtheresultingestimated
marginalrevenueproductoflabortoproxyforunobservedwages.Fafchamps(1993)
similarlydevelopsandappliesaclevereconometrictechniquetostudytheallocationof
unwagedhouseholdlabor,inhiscaseacrossseasonsonfarmssubjecttoconsiderable
exogenousproductionriskduetorainfall.LikeJacoby,hetoofindsthatevenwithout
theobservablemotivationofmarketwages,farmlaborallocationappearstorespond
robustlytomarginalproductivity,astheorysuggestsitshould.Whatsometimes
appearsassluggishresponsivenesstoincentivesmerelyreflectstheimpactof
uninsurableriskonresourceallocation.
B.Riskmanagementandfinancialservices
Muchoftheliteratureindevelopmentmicroeconomicsexploresandexplainswhy
seeminglyinefficientbehaviorisinfactoptimalgiventheriskandliquidityconstraints
facedbythepoorThesetwochallengesbecomemostacuteandcloselyintertwined
28
whenoneexploreschoicesovertime,suchasthoserelatedtoinvestmentortechnology
adoption.Akeyprobleminintertemporaloptimizationistemporaluncertaintywith
respecttothebudgetconstraint.Bothpricesandincomesvaryunpredictablyovertime.
Thisisperhapsespeciallytrueinrainfedagricultureinareasofthedevelopingworld
withpoorspatialandintertemporalintegrationofmarkets.Mostofthepopulationin
lowincomecountriesareemployedinagriculture,asectorinwhichinelasticdemand
generallyleadstohighpricevariabilityintheabsenceofstrongmarketintegrationand
inwhichagroclimaticshocksleadtohighyieldvariability.Theendresultmaybe
substantialexposuretoriskbeyondagentsdirectcontrol.Forvulnerableandliquidity
constrainedpersons,abadyearcanbedeadly,soconsumptionsmoothingmotivescan
beoverwhelmedbyconcernfordisasteravoidance.Ifconsumptionfallstoomuchin
agivenyear,theadverseconsequencescanbeirreversible:illness,injury,evendeath.
Indeed,ifthereexistpovertytrapsassociatedwithinferiordynamicequilibriaina
systemcharacterizedbymultipleequilibria,transitoryshockscanhavepermanent
consequencesifadverseshocksdrivepeoplefromonedesirableequilibriuminto
another,undesirableone.Exploringsuchpossibilitieshasbecomeaveryactiveareain
thedevelopmenteconomicsliteratureinrecentyears.
Economistshavethusdevotedconsiderableenergytoinvestigatingtheextentto
whichhouseholdsareinfactabletosmoothconsumptionandthemechanismstheyuse
toovercomeincomevariabilitytoachieverelativelymorestableconsumption.
Friedman(1957)famouslyhypothesizedthatinthepresenceofcompleteand
competitivemarkets,peopleconsumetheirpermanentincomeandsaveordissaveany
transitorycomponentssoastosmoothconsumption.Friedmanspermanentincome
hypothesisanditsconsumptionsmoothingcorollaryhaveprovidedrichfodderfor
economistsingeneral,includingbutnotexclusivelyinthefieldofdevelopment.
Thebasicpolicyissuesrevolvearoundwhetheritisnecessaryorappropriateto
intervenetostabilizeincomesortoprovidepublicsafetynetsinordertoensurestable
consumptionandsotokeeppeoplefromfallingintopovertytraps.Ifpeopleareableto
smoothconsumptionthemselvesbysavingincashorinkind,byborrowing,bypooling
riskthroughformalorinformalinsurancemechanisms,orbydiversifyingtheir
incomes,thentheneedforinterventionstostabilizeconsumptionislessobvious.If
privateriskmanagementcomesatasteeppriceintermsofefficiencylosses,however,
orifriskmanagementmechanismsareavailableonlytoparticular,relativelyprivileged
subpopulations,theremaybeneedforpublicassistancetocomplementexistingprivate
riskmanagementinstitutionsandmarkets.
Thisalsoopensupquestionsofpublicsectordisplacementofprivatesectorrisk
management.Forexample,doesgovernmentdisasterassistancetohomeownersin
coastalareaspronetohurricanesencouragessuperoptimalprivaterisktaking(moral
29
hazard)?Dostatefundedcropinsuranceschemessimilarlyincreasefarmersrisk
takingbeyondwhatissociallyoptimal?Dopublictransferscrowdoutprivatesocial
insurance,sothatthevalueaddedofpublicprogramsarelowandtheinefficiencies
associatedwithtaxbasedrevenuegenerationmaycausemoreharmthangood?
Thereisalsoanimportantquestionofwhenandhowpeopleundertakerisk
management.Iftheyareabletoreduceriskexantethroughmitigationbehavior(e.g.,
precautionarysavings,selectionoflowriskportfolios),then(i)theneedforemergency
responsemaybereducedbut(ii)itisalsoeasytounderstatethemagnitudeoftherisks
perceivedbythehouseholdssincetheytakeactionexantetoavertundesiredvariability
(Morduch1995;chapter18).Observedvariabilityofincomes,forexample,isalmost
surelydampenedbyindividualsmitigationefforts.Ifhouseholdsinsteadprimarily
copeexpostwithshocks,thenshocksareinprinciplefullyidentifiableinthedata,but
rapidresponsemaybeespeciallyimportant.
Ifweunderstandintertemporalsavingsasmotivatedbyconsumptionsmoothing
motiveswhichmaynotbeaccurate,giventheimportanceofsavingsinkindasa
meansofproductiveinvestment,aswediscussbelowtheninsurance,credit,savings
andinterpersonaltransfersaresubstitutesforoneanother.Whenthemarketforoneis
limited,oneoftheotherscantakeovertheriskmanagementfunction.Behrmanetal.s
(1997)studyofdynamicsavingsdecisionsfindsthatinruralPakistan,interpersonal
transfersarethemorelikelyconsumptionsmoothingmechanismemployedwhen
formalfinancialinstitutionsareunavailable,providingsomeempiricalvalidationthat
informaltransfersbehavelargelylikecreditorformalinsurance,inthattheyserveto
stabilizeconsumptionintraannuallyrelativetoincome.Therealproblemsemerge
whenhouseholdsaccesstoeachofthesevehiclesisconstrained,inwhichcasetheir
abilitytomanageriskisradicallyattenuated.
Indeed,Besley(1995)advocatesapproachingissuesofsavings,credit,andinsurance
fromatradetheoreticperspective,recognizingthatsavingsandcreditaremeansof
intertemporaltradeandthatinsuranceissimplytradeacrossstatesofnature.When
marketsarecompleteandsuchtradeisunfettered,thereexistuniqueinterestratesand
insurancepremiainequilibriumandhouseholdswill,ingeneral,achievePareto
efficiencyintheirmanagementofrisk.Whenbarrierstotradeacrosstimeorstatesof
natureexist,however,differenthouseholdsorindividualsmayfacedifferentshadow
pricesofcapitalandthereare,ingeneral,foregonegainsfromtrade,i.e.,potential
Paretoimprovementsmayexist.
Oneneedstoproceedcarefully,however,astheremaybeefficientreasonsfor
differentialaccesstofinancialservices.Thereasonsforobstaclestosuchtradetypically
revolvearoundinformationasymmetries,enforcementproblems,andcovariaterisk.
Notallfinancialinstitutionaldeliverymechanismssuffertheseproblemsequally.
30
Muchrecentworkhasfocusedonhowcomplementaryinstitutionaldesignsmaystitch
togethermuch,thoughlikelynotall,oftheholesinanyonemechanismsprovisionof
tradeopportunitiestoavoidrisk.
Becauseimperfectinformationandcontingentclaimsproblemsmaymake
prospectivetradesinfeasibleorunenforceable,evenseeminglyfragmentedsystems
maybeconstrainedParetoefficient.Nonetheless,GreenwaldandStiglitzs(1986)point
aboutunrecognizedexternalitiesisagainpertinenthere.Whereoneindividualsorone
marketsbehavioraffectsanothers(asistrue,forexample,incasesofstatistical
discriminationorwhenthereareexternaleconomiesofscaleinamarket),thenthere
maybeforegonegainsfromtradeeventakingintoaccounttheinformationand
enforcementproblemsplaguingfinancialexchangesacrosstimeandstatesofnature.
Soitisdifficultexantetoassesswhetherthereisaviableroleforpolicyorproject
interventionstoimproveriskmanagementamongpoorpopulations.Certainlythefirst
placetostartiswithabasicassessmentofhowwelllowincomepopulationsare
presentlyabletosmoothconsumption.
Thereiswidespreadevidenceofconsumptionsmoothingrelativetostochastic
incomesfromdatasetsacrosstheglobeandthewealthandincomedistribution.8
Peopleindeedappeartosaveanddissavesoastosmoothconsumptioninthefaceof
stochasticincomestreams.Moreover,peopletapintoinformalinsuranceamong
householdstostabilizeconsumptioninthefaceofshocks.Insomesettingsandby
sometests,thisinsuranceseemsremarkablycomprehensive(Townsend1994,chapter
20;Deaton1997;DeWeerdtandDercon2006,chapter41).Inothersettingsandforat
leastsomeshocks,insurancemightbefarlesscomplete.Forexample,Gertlerand
Gruber(2002;chapter25)findthatwhilehouseholdscanfullyinsuretheeconomiccosts
ofillnessesthatdonotaffectphysicalfunctioning,coverageagainsttheeconomiccosts
associatedwithillnessesthatmoderatelyorseverelylimitphysicalfunctioningisonly
71and38percent,respectively,intheIndonesianpaneldatatheystudy.Whilethe
cautionarypolicyimplicationoffindingreasonablyeffectiveinformalinsurance
coverageisthatpublicsafetynetschemesmayinadvertentlycrowdoutprivate
insurance,thesuggestionofevidencesuchasGertlerandGrubersisthatsocial
protectiontargetedtoparticulartypesofshocksareunlikelytocrowdoutprivate
informalinsuranceandcouldwellreducedamagingriskexposurethatisalmostsurely
substantialenoughtoaffectuninsuredhouseholdsbehavior.Asignificantbodyof
evidence(e.g.,Alderman1996,JalanandRavallion1999),alsosuggeststhattherich
Morduch(1995,chapter18)andDeaton(1997)offerexcellentreviewsoftheliterature.Amongthemany
importantexamplesofsuchstudiesindevelopmenteconomics,keyonesincludeLucasandStark(1985;
chapter47),RosenzweigandStark(1989;chapter40),Paxson(1991),Deaton(1992),Rosenzweigand
Wolpin(1993),Udry(1994),Behrmanetal.(1997),Grimard(1997),andRose(1999).
31
provefarmoresuccessfulatsmoothingconsumptionthandothepoor(Morduch1995,
chapter18).
Ofcourse,savingsarenotheldsimplyforthepurposeofriskavoidancethrough
selformutualinsurance,butalsobecauseindividualswishtoaccumulatewealthorto
enjoythesocialstatusassociatedwithownershipofparticularsortsofassets(e.g.,
livestock,houses,vehicles,spouses,etc.).Thenriskconsiderationsenterinadifferent
contextbecausehouseholdsaremakingportfoliochoicesoverassets(including
intangibles,suchasstatus)andactivities,atleastsomeofwhichofferuncertainreturns.
Ifriskpreferencesarerelatedtoexantewealth,portfoliochoicesmightreinforcepre
existingwealthdistributions.RosenzweigandBinswanger(1993,chapter19)indeed
findthatwealthierhouseholdsholdhigherrisk,higherexpectedreturnportfoliosin
ruralIndia,whichnaturallyleadstodifferentgrowthratesandincreasinginequality
overtime.9
Theobservationthatsavingsareoftenheldforinvestmentpurposesimplicitlycalls
intoquestionFriedmans(1957)crucialassumptionthatincomefollowsanexogenous
stochasticprocess.Earlierwediscussedhowlaborproductivitydependsonhealth
status,whichinturndependsonfoodconsumption,therebyrenderingincome
endogenous(tomorrowsincomedependsontodaysconsumptionandtherefore
savingsaswell).Moregenerally,futureincomedependsonfuturestocksofproductive
assetsandthereforeoncurrentinvestmentpatternsandsavingsandborrowing
behavior.Whenfutureincomeisendogenous,liquidatingassetsbecomeslessattractive
andtheconsumptionsmoothingpredictionsoftheFriedmanitepermanentincome
hypothesismayfailashouseholdstradeoffcurrentconsumptionagainstnotonly
futureconsumptionbutalsofutureincome(McPeak2004,Hoddinott2006).
ZimmermanandCarter(2003,chapter21)jointhesetwopoints,demonstratinghow
poorerhouseholdsmaynotonlyendogenouslyoptforassetportfoliosoflower
expectedreturnandriskinthefaceofassetpriceriskandincompletefinancialmarkets,
buthowtheymayalsointentionallydestabilizeconsumptioninordertosmoothassets
overtime.
Notethatthereisanimportantconceptualandempiricaldistinctionbetweentheuse
ofsavings,creditorinsurancetosmoothconsumptioninthefaceofexogenous,
stochasticincome,andtheadaptationofproductionandlaborsupplybehaviorsoasto
reduceincomeriskinordertoreduceconsumptionrisk.Theformerisperfectly
consistentwithseparablehouseholdmodels,sinceagentsshouldoptimallymaximize
incomeandthenmanagerisksolelyaspartofsecondstageconsumptionallocation
decisionsThelatterobviouslyimpliesnonseparabilitybetweenconsumptionand
production(i.e.,incomegeneration)activities.Theexistenceofincomesmoothing
SeeBardhan,BowlesandGintis(2000)foranicesurveyoftherelevantliterature.
32
behavior(i.e.,incomeisendogenouslystochastic)raisesquestionsaboutthemeansby
whichweestimatetheexogenousriskfacedbyhouseholds.Justasindividualswill
adjustconsumptionbehaviorwhentheyareawareofcredit,insurance,orsavings
constraints(aswediscussedwithrespecttoprecautionarysavingsandliquidity
constraints),weshouldlikewiseexpectthemtoadjustlaborsupplyandproduction
behaviorssinceriskgenerallyrendershouseholdchoicesnonseparable.Inparticular,
wewouldexpecthouseholdstoactontheirpreferenceswithrespecttorisk.Ifthis
reducesobservedincomevariability,itbecomesveryeasytounderstateexanterisk
exposure.Justasportfoliomanagementandinsuranceaccessmayvaryincrosssection
accordingtowealth,sodoesitappearthatformalcreditmarketsaremissingor
incompleteformanyprospectiveborrowersinlowincomeeconomies.Insomeplaces
formalfinancialinstitutionssimplydonotexistortheinstitutionsliquidityisitself
constrainedbytheabsenceofinterbankmarketssothattheyhavetorationcredit,either
byprice(e.g.,highinterestrates)orbyquantity(i.e.,lendingonlytoasubsetof
prospectiveborrowersandgivingborrowersonlyaportionofthecredittheyrequest).
Intheformercase,manypeoplewillselfselectoutofthecreditmarket.Inthelatter
case,equilibriumcreditrationingmusttakeintoaccountthefixedcosts(e.g.,checking
creditworthiness,etc.)associatedwithloans.Thus,ingeneralsmallervolume(i.e.,
poorer)borrowerswillberationedoutofthemarketbecauseaveragefixedcosts(i.e.,
totalfixedcostsdividedbytheloanvolume)arehigherforthemthanforlarger
borrowers,inlargemeasureduetolowerborrowingconstraints,giventhelimited
collateralthepoorhavetoofferlenders(Carter1988,Besley1995).Inthequantity
rationingcase,therewillbeunmetexcessdemandforcreditfromtheformalsectorat
prevailingcreditterms,butthesocialprocessofrationingwillcommonlyleadtosimilar
rationingfromthetop,whereinlocalelitesareincludedandmoremarginalized
subpopulationsarecommonlyexcluded.
Thisdiscussionofimperfectionsinmarketsforfinancialservicesandrisk
managementleadsustobacktothelongstandingthemeofpathdependence,thatthe
growthpathfollowedbyahousehold(oranindividualornation)maydepend
fundamentallyonitsinitialwealth.Iffinancial(savings,creditandinsurance)markets
areincomplete,individualsmayfaceconsiderableresidualriskexposureagainstwhich
theywishtoselfinsure.
Inducedchangesinbehaviorduetouninsurableriskexposureareaprimarymeans
bywhichpeoplefindthemselvestrappedinchronicpoverty.Butthereisanotherrisk
basedmechanismthatcanleadtolongtermpoverty.Shockscanhavepersistenteffects
inthepresenceofhysteresisthatgeneratesirreversibilityordifferentialratesof
recovery.Theseeffectssuggestimportantnonlinearitiesintherelationshipbetween
assetsstocksandincomegrowth,nonlinearitiescommonlyassociatedwithmultiple
dynamicequilibriaandpovertytraps.Moreover,themereexistenceofuninsurablerisk
33
withimportantirreversibilitiesmayinducebehavioralchangethatlimitsoptimalrates
ofassetaccumulation,improvedtechnologyadoptionormarketparticipationbyvery
poorpeople.
If,however,poorhouseholdsarerationedoutofcreditmarketsoriftheylack
sociallymediatedaccesstocapital,astheymayinmanypolarizedsocieties(Mogues
andCarter2005,chapter43),thenthepoorhouseholdsonlyoptionwouldbetomove
forwardslowlywithanautarkicsavingsstrategy.Thisautarkicapproachwouldrequire
substantialshorttermsacrificethroughdiminishedconsumption,withlittlereturneven
inthemediumtermasmarginalreturnstonewassetsarelowuntilthehousehold
reachesthethresholdpoint.Ifthepoorhouseholdfindsitdesirableandfeasibleand
makesthissacrifice,thenitwillwithsufficienttimereachtheassetlevelnecessaryto
achievethehigherreturnsandwilleventuallyconvergetowardtheassetandincome
levelsofinitiallywealthierhouseholds.Ifapoorhouseholdoptsnottoundertake
extraordinarysavings,itthensettlesintoalowlevel,povertytrapequilibrium.Thekey
drivingforcebehindthesemultipleequilibriaareexclusionarymechanisms,marketor
nonmarketforcesthatsomehowimpedecertainagentsaccesstohigherreturn
strategies.
V.
Marketsandnonmarketinstitutions
A.Markets
Perhapsthemostdistinguishingfeatureofdevelopingeconomiesoverthepast
quartercenturyhasbeentheirsharp,nearlyuniversalmovementtowardreasonably
openmarketsthroughliberalizationandprivatization.Thestatistmodelofgovernment
controlofmarketsthatprevailedinvariousdegreesandformsinmostlowand
middleincomecountriespriortoabout1980gavewaybythelate1980sand1990stoa
modelofmarketbaseddevelopment.ThefalloftheBerlinWallandthecrumblingof
theformerSovietempirewasthemostdramaticexpressionofthisratherabruptshift,
butthepatternhadalreadyappearedonothercontinentsandhasextendedthroughout
theworldoverthepasttwodecades.
Despitethefaitheconomistsandmanypolicymakersplaceinmarketsasameansfor
fosteringanefficient,evenequitable,allocationofresources,wespendshockinglylittle
timestudyingmarketsdirectly.TheWalrasianfictionoffrictionlessequilibrationof
demandandsupplyor,tobemoreprecise,eliminationofallexcessdemandistoo
rarelyembellishedbyexplicitexaminationoftheinstitutionalunderpinningsofmarkets
andtheimpactoftheresultingequilibria.Butifsocietiespinmanyhopesfor
developmentandpovertyalleviationonmarkets,moreexplicitexplorationofmodesof
34
exchange,notjustthefamiliardomainsofproductionandconsumption,promiseshigh
returns.
Developmenteconomistshavehistoricallypushedthesetopicsfarmorethanhave
otherfieldswithinthediscipline.Werecognizethatgeneralequilibriumtheoryquietly
andunsatisfyinglyrestsonthreecrucialassumptions:(a)propertyrightsareclearly
defined,universallyaccepted,andcostlesslyenforced,(b)auniquesetofrules
governingexchangeexistsandisuniversallyunderstood,obeyed,andenforcedbyall
transactors,and(c)allactorsbelongtothesamemarket,i.e.,noexclusionary
mechanismsexist.Intheabsenceofsuchassumptions,sociallycostlybehaviorse.g.,
lying,stealing,cheating,foregoneprofittakingmaybeindividuallyrationalactsand
interventionsinoneplacemaynotaffecttheincentivesfacedbyagentsinanother.All
ofthesephenomenamaycontributetopersistentpoverty.
Therootcauseoftheproblemistheunrealisticassumptionofuniversallyaccessible
perfectinformation,thustheproblemsofmarketorganizationfollowdirectlyfromthe
sourcesofmarketimperfectionsthathavelongpreoccupieddevelopmenteconomists.
Ifinformationisincompleteorimperfectbetweenpartiestoanexchange,then
opportunitiesariseforstrategicbehaviorsthatcausenegativeexternalities(Platteau
2000,chapter35;Fafchamps2004).
Theunderexplorationofmarketswithinthedisciplineispeculiargiventhe
emphasiscommonlyplacedontradeincontemporarygrowththeoryandthe
indisputablefactthattheefficiencyofthemarketingsystemaffectsbothproducer
incomeandconsumercostofliving.Neoliberalscommonlyassumeawaythe
possibilityoffrictionsinthesystemofexchangebetweeninitialproducerandfinal
consumerwhileneoMarxistscommonlyassumemiddlemenareexploitative
monopolists/monopsonists.Suchbeliefs,althoughwidespreadandimportanttoones
visionofappropriatedevelopmentpolicy,restonthinandfragileempirical
foundations.
Inatleastonesense,acasecanbemadethatmarketsaremoreimportantinlow
incomeeconomiesthaninhighincomeones.Unlikeinhighincomeeconomieswhere
large,verticallyintegratedcorporationscommonlyinternalizesequencesof
transactions,commonlyusingformalcontractsovermultipleattributesofthegoods
and/orservicesexchangednotjustpriceinlowincomeeconomiesthesmallscaleof
mostfirmsnecessitatesalargernumberofinterfirmexchangesinthepassagefrom
firststageproducertofinalconsumer.Theoverwhelmingmajorityofthoseexchanges
arespotmarkettransactionsnotunderpinnedbyformalcontracts;asFafchampsand
Minten(2001)vividlyputit,marketarrangementsareoftenakintoafleamarket
economy.Largescalefirmsareconspicuouslyabsentinmostlowincomesettings.So
spotmarketbasedexchangebecomesextraordinarilyimportant.Inthissense,
35
extraordinarydependenceonmarketsandthegreatnumberofverticaltransaction
linkagesarewhatdefinedevelopingeconomies,nottheirabsence.
Atthesametime,idiosyncraticmarketfailuresduetohightransactionscosts,risk,
etc.mayinducehouseholdstoselfselectoutofmarketsintosemiautarky.Soina
different,butequallyimportantsense,marketsarelesswidelyusedinlowincome
economiesbecausemarketexchangeismorecomplexandcostlythaninthemore
advancedeconomies.Thisparadoxofmarketsthatareatoncemoreimportant
vertically(inlinkingproducerstoconsumers)andlessimportanthorizontally(because
manyindividualsselfselectoutofmarkets)helpsmotivateasignificantrecentpushin
theliteraturetounderstandthefunctioningofmarketsbetter(Platteau2000,Fafchamps
2004).
Ifmarketsdonotworkwell,thescopeforallocativeinefficiencyintheeconomy
becomesenormous.Indeed,theideathatstatecontrolledmarketsareallocatively
inefficientundergirdedmostliberalizationeffortsinthe1980sand1990s.Overthepast
decadeorso,developmenteconomistshavegraduallybegunacknowledgingthat
privatemarketsmaylikewisebecharacterizedbyconsiderableallocativeinefficiency.
Understandingthesourcesandpotentialcorrectivesforthisinefficiencyandits
implicationsforgrowthandequityremainimportantbutunderresearchedtopics.
Centraltotheobjectiveofanimprovedunderstandingofhowmarketsfunctionand
whetherandwhyallocativeinefficienciesariseiscarefulconsiderationofthemeansby
whichorderismaintainedinmarkets.Bywhatmechanismsareorcanubiquitous
problemsofasymmetricinformationandcontractmonitoringandenforcementbe
resolved?Thereisnouniquemechanismthatsuitsalleconomies.Platteau(2000;
chapter35)andFafchamps(2004)emphasizethatthereareinherentcomplementarities
betweendifferenttypesofmarketordermechanisms.Themostwidespread
mechanismisendogenouslyselfenforcingcontractsthatdonotrequireanyexerciseof
stateauthority,backedbyrepeatedinteractionsamongprospectivetransactorsorby
reputationmechanisms.Butthescopeforsucharrangementstoresolveasymmetric
informationandcontractenforcementproblemsisnecessarilylimited.Privateorder
mechanisms,inwhichprivatefirms(e.g.,creditratingagencies)resolvecoordination
failuresandtherebycreateandsharethegainsfromcoordination,canhelpfillthe
breach.Socanpublicorderinstitutionsbackedbythepolicepowerofthestatethrough
establishing,promotingandenforcinggradesandstandards,contractlaw,etc.
Oneofthemostimportantinstitutionsconcernspropertyrights.AsBesley(1995;
chapter37)andalongliteratureindevelopmenteconomicsshow,thestrengthof
individualrightsoverproductiveassetssuchaslandisfundamentaltodetermining
investmentincentives.Becauseinvestmentinaccumulatingproductiveassets,
adoptingimprovedtechnologiesandengaginginpotentiallyremunerativemarketsis
36
akeyengineofgrowthatbothmicroandmacrolevel,propertyrightsbecomekey.But
asCarterandOlinto(2003;chapter38)demonstrateinaseminalempiricalexampleof
thetheoremofthesecondbest,resolvingoneimperfectionincompleteandinsecure
propertyrightsinlanddoesnotnecessarilyleadtoefficientandequitableequilibria
whenanothermarketimperfectioninCarterandOlintosParaguayancase,credit
constraintspersists.Becauseofthepervasivenessofmarketimperfectionsin
developingcountries,theimportanceofnonmarketinstitutionstoeconomicincentives
andperformanceisbroughtintostarkrelief.
B.NonmarketInstitutions:Identities,NetworksandPower
Humansdonotliveinisolation,thustheirbehaviornecessarilydependsonthe
relationsthatshapetheirworld.Variationinrelationshipscanperhapsleadto
predictablevariationinbehaviorsandthusinoutcomes,suchasstandardsofliving,
whichcaninturnaffectsocialrelationshipsthroughsubtlefeedbackmechanisms.
Partlyasaconsequence,thereisgrowinginterestinthedynamicsofhumaninteraction
andhowthismightaffectpersistentpoverty(Barrett2005).Butthisisafarnewerline
ofresearchindevelopmenteconomics.Moreover,itisadomaininwhichthecomplex
interrelationshipswiththeothersocialsciencesandtheanalyticalintractabilityand
empiricalidentificationproblemsassociatedwithmanyinstitutionalissuesposeserious
methodologicalchallenges.Theliteratureinthisareaisthereforesomewhatless
cohesiveandauthoritativethaninmuchoftherestofthefield.Butthepromiseof
workinthisareaisespeciallygreat,bothwithindevelopmenteconomicsitselfandfor
economicsandthesocialsciencesmorebroadly.
Thelinkbetweenhumanrelationshipsandbehaviorcanoperatethroughanyof
severaldifferentpathways.First,individualpreferencesarenotimmutablygivendeus
exmachina.Rather,theyadaptwithinthecommunitiestowhichtheseindividuals
belong.Norarepreferencesoverexclusivelymaterialthings.Peoplevaluesocial
relationships(includingdevianceorconformity),integrity,friendship,love,etc.,and
theirbehaviorsmanifestthevalorizationofthenonmaterial.
Second,therulesandexpectationsgoverningindividualinteractionareshapedby
formalgroupsandinformalnetworks,beitincontractingforgoodsorservices,in
supportingotherswhosufferadverseshocks,incommunicatingpotentiallyvaluable
information,orotherinterpersonalphenomena.Socialrelationscreateveryreal
constraintsonsomeindividualchoicesandrelaxconstraintsonotherchoices.
Third,andcloselyrelatedtotheprecedingtwopathways,theincentivesfacedby
individualsareshapedbymoralandsocialforces.Thiscanoccur,forexample,through
priceadjustmentsbasedonnetworkorpositionalexternalities,orthroughnonprice
37
premiaassociatedwithprestigeorstigmaeffects.Followingtheseminalworkof
AkerlofandKranton(2000)andPlatteau(2000),agrowingliteratureindevelopment
economicsemphasizestheimportanceofsocialandpsychologicalidentitiesto
understandinghowindividualscanbetrappedinpersistentpoverty.Whetherby
influencingindividualidentities,preferences,ortheconstraintsorincentivesfacedby
individualdecisionmakers,thesocialandmoralmilieuinwhichchoiceoccursplainly
matters,asthechaptersinthisbookdemonstrate.
Furthermore,outcomesaffectindividualsendogenousconstructionand
reconstructionofthesocialenvironmentsinwhichtheyplaceorfromwhichthey
extricatethemselves.Bychangingthecostsandbenefitsofmakingormaintaining
extantcontacts,economicperformancenecessarilyinducesupdatingoftheattributes
thatdefineidentitiesandcommunitiesandoftheformalandinformalmatching
processesthatdefinegroupsandnetworks.Thisfeedbackbetweenindividualand
groupbehaviorinjectsarichnessintoanalysisthatistoooftenabsentinsocialscience
researchbasedexcessivelyoneithermethodologicalindividualismorcultural
determinism(DurlaufandYoung2001).Forexample,theendogenousemergenceof
individualidentitiescancriticallyshapebehaviorsthatsubsequentlyreinforcethose
identities.Thisfeedbackmechanismgeneratesmultipleequilibria.Onesuch
equilibriumisassociatedwithpoorperformanceinschool,othersarethelowratesof
adoptionofimprovedproductiontechnologies,thelimitedprovisionoflocalpublic
goods,andotherdysfunctionalgroupandindividualbehaviors.Althoughsuch
outcomesareParetoinferiorrelativetoavailablealternatives,thebehaviorsthatleadto
undesirableoutcomescanproveindividuallyrationalduetothereinforcingfeedback
loopcreatedbythesocialcontextinwhichindividualsmakebehavioralchoices(Barrett
2005).
Thesocialcontextiscommonlydefinedbythesocialnetworksthroughwhich
finance,information,laborandlandflowinmanylowincomesocieties.Individual
accesstoresourcesistypicallyconditionedbythenetwork(s)towhichonebelongs,and
networkmediatedaccessistypicallynontransferableevenwithinnuclearhouseholds.
Thusgroupandnetworkmembershipoftenmattertoeconomicperformance
(DeWeerdtandDercon2006,chapter41;MoguesandCarter2005,chapter43;Munshi
2003,chapter44).Recognizingthis,peopleoftenstructuretheirsocialnetworks,
includingfamilyrelations,inordertoimproveeconomicoutcomes(Rosenzweigand
Stark1989;chapter40).
Althoughitistruethatsocialgroupscanobviatemarketfailuressuchascredit
rationing,imperfectcontractenforcementandlimitedaccesstoinsurance,andthereby
facilitateinvestmentandgrowthinstandardsofliving,perhapsespeciallyforthepoor,
sotoocangroupsproveexclusionary,effectivelythrowingsandinthewheelsof
38
progressforexcludedindividualsandgroups.Inmoreextremecases,exclusionary
processesoftenturnviolent,withthepoorsufferingadisproportionateshareofthe
resultinghardship,asvividlymanifestinrecurrentinterethnicandinterfaithviolence
insubSaharanAfricaandsouthAsiainrecentyears.Powerandviolencecanoftengo
handinhand(Basu1986;chapter39),leadingtobotheconomicexploitationand
increasedrisktothosewhoarerelativelypowerless.
Theapparentimportanceofnonmarketinstitutionsassociatedwithsocialrelations
shouldnotobscurethefundamentalimportanceofthepoliticalinstitutionsofnations.
AsKruegeretal.(1988,chapter59)emphasize,economywidepoliciesdrivenby
nationallevelpoliticstendtohavefargreater,albeitindirect,impactonmicrolevel
incentivesthandosectorspecificpolicies.Oneconcernisthatnationallevelpolitics
andmacroeconomicmanagementhavesooftenprovedcorruptindevelopingcountries
(Bardhan1997).Thenaturalinclinationisthereforetoaimtoreducecorruptionunder
thebeliefthatthisisanexogenousvariablethatcanbeadjustedwithsalutaryeconomic
effects.Coupledwithwidespreadbeliefinthecriticalimportanceofmarketbased
resourceallocation,concernsaboutcentralgovernmentcorruptionhavefuelledkeen
interestindecentralizationofdecisionmakingauthorityindevelopingcountries.
Widespreadcentralgovernmentfailureshaveattractedmuchattention,ashavemarket
failures.Butintherecententhusiasmforcommunitybasedsolutionsfosteredby
decentralizationofresourceallocationandbroaderpoliticalauthority,the
commonalityofcommunityfailuresthatareoftenasseriousasmarketorstate
failuresonwhicheconomistsmorefrequentlyfocus(Bardhan2002,chapter61).
Moreover,asSachs(2005)arguesforcefully,however,corruptionmaybeasmucha
consequenceasacauseofpoverty,thusthecurrentfashionwithindevelopment
agenciesforemphasizingcorruptionasarootcauseofslowgrowthandpersistent
povertymayproveshortlived.Institutionalfactorsplainlymattertothecourseof
development;whatremainslesscleariswhichfactorsandwhy.
Thehistoricalevidencesuggeststhatinitialmaterialfactorendowments(e.g.,
climate,soils,minerals,proximitytonavigableriversandports,etc.)predisposed
certaincountriestowardparticulardevelopmentpaths,butthatthecolonialexperience
ofdevelopingeconomiesplayedamajorroleinshapingthelegalandpolitical
institutionsthataffectedthedistributionofpoliticalpowerandassets,aswellas
incentivestoinvestandinnovate(North1990,SokoloffandEngerman2000,chapter60).
Inparticular,societiescharacterizedbygreaterinitialinequality,elitesmoreoften
succeededinestablishingalegalframeworkthatsecuredforthemdisproportionate
politicalpowerthattheyusedtoperpetuateinequality,oftenbycreatingexclusionary
mechanismsthatlimitedtheoptionsofthepoorermembersofsociety(Acemogluetal.
2001,chapter62).Exantedifferencesininequality,humancapitalendowmentsand
politicalpower,perhapsrootedinthematerialfactorendowmentsofparticularplaces,
39
thusappeartohavehelpedshapetheoftendisappointinggrowthandpoverty
dynamicsofmanylowincomeeconomiestodaythroughasortofinstitutionalpath
dependencethatmirrorsthemultipleequilibriumprocessesaroundwhichsomuchof
thedevelopmenteconomicshasemerged(SokoloffandEngerman2000,Acemogluetal.
2001).
VI.
Conclusions
Withtheworldspoliticalleadersplacingmoreemphasisonglobalpovertyand
hungerissuesthantheyhaveindecades,developmenteconomicsisflourishingagain.
Wellequippedwiththeformaltoolkittheeconomicsdisciplinehasdevelopedoverthe
pastseveraldecades,acertainamountoftheinnovationintheliteratureisa
rediscoveryoflongstandingthemes:povertytraps,humancapital,thecriticalityof
technologyadoptionandmarketparticipation,theobstaclesposedbycoordination
failures,theimportanceofinstitutions,andinterlinkagesacrosscontractsandsectors.
Thesetimetestedthemesremaincentraltotheongoingexplorationofthecausal
reasonswhysomecountries,communitiesandpeoplearerichwhileotherssuffer
grindingpovertythattoooftenpersistsforgenerations.
Thoseofuswhohavededicatedyearstothestudyofdevelopmenteconomics
continuetodelightinnewempirical,methodologicalandtheoreticaldiscoveriesthat
helpusinchalongthepathofrelievinghumansufferingthroughscholarship.Because
thechallengesofdevelopmentaresocomplexandintertwined,manyoftherichest
insightscomefrombuildingbridgesacrossthemesandscalesofanalysisordeveloping
toolsorfindingsthatarebroadlyapplicabletoawideclassofproblems.
Hencethiscollectionofpapers.Ithasbeencompiled,andthisintroductoryessay
written,principallywithyoungscholarsinmindadvancedundergraduatesand
graduatestudentsineconomics,agriculturaleconomics,developmentstudies,public
policyandinternationalrelationsprogramsaswellasadventurousyoungscholars
fromcognatesocialsciences.Thesevolumesoffersuchreadersanintroductiontothe
field.ButasIhavepersonallydiscoveredineditingthese1600pages,acollectionsuch
asthisoffersawonderfulopportunityforaninterludeofsynthesisbetweenthevarious
narrowlydefinedprojectsinwhichwescholarsarealwaysengaged,achanceperhaps
toseetheforestforthetrees.
Thechaptersthatfollowreprintaselectionunfortunately,spaceconstraintspermit
onlyaselectionofthefinestworkindevelopmenteconomics,spanningtopics,
decadesandcontinents,includingtheworkofluminariesaswellassomeseminal
papersbyscholarswhoseworkunfortunatelygetslessattentioninthemainstreamof
theprofession.Ultimately,thekeycriterioninselectingthesepaperswasnotthatthey
40
evincebrilliance,ahighbutfrequentlyattainedstandard.Rather,thekeycriterionwas
thefartougherstandardthatthesepapersorthebodyofliteraturetheyrepresent
discretelyadvancethestockofeconomicknowledgethatisusefultoimproving
standardsoflivingforthoselessfortunatethanmostofuswhohavetheprivilegeofan
academicprofession.Myshelvesarechockablockwithbooksandmyfiles
overflowingwithpapersthatofferusefulfindingsandinsightsbutonlybearone
carefulreading.ThepapersIchoseforthesevolumesIhavereadmultipletimes,each
timelearningsomethingnewanduseful.Ihopereadersfindsimilarrichesinthepages
thatfollow.
Whyshouldonetakeonthetaskofreading,suchabroadranging,immenseand
admittedly,sometimesdensecollectionofpapers?Noneofuscanworkalltheseams
oftherichintellectualminethatisdevelopmenteconomics,andpreciousfewproduce
realgemsregularly.Butbyfamiliarizingourselveswiththecentralthemesandseminal
workofthefieldwenotonlyenjoythecollectivebrillianceofmanyscholars
noteworthyindividualcontributions,wereapthebenefitsofintellectualarbitragefrom
parallelsubliteratureswithinthevastareaofdevelopmenteconomicsand,most
importantly,webetterequipourselvestohelpaddressthemanypracticalsocietal
challengesthatdevelopmenteconomistsareprivilegedtoresearchanddebate.Because
thetaskofhelpingtoreducehumansufferingandtofosterimprovedstandardsof
livingissovitallyimportant,wedevelopmenteconomistsmustcontinuouslyinvestin
buildingandextendingsoundtheory,rigorousmethodsandaconvincingbodyof
empiricalevidence.Wemustregularlychallengepopularbeliefs,eschewideologically
purebutempiricallyunsupportablemodels,andhumblyrevisittheforgottenwisdom
ofourpredecessors.Butinordertodooriginal,valuableresearch,wemustfirstdoour
homework.Learningthetheories,methodsandexistingbodyofempiricalevidence
welliscentraltotheevengreatertaskofdoinggood.
41
VII.
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