Lecture notes: Economics of Development

Introduction
What is Development Economics ?
For people all around the world living in poverty it is important that countries in South
East Asia such as South Korea, Taiwan and China, as well as Brazil in South America
recently have been able to get out of the poverty trap. They are not so many, but
there is a group of countries that have essentially completed the transformation to
become developed. I think, for countries in Africa such as the Gambia, it is relevant to
raise questions about the extent to which they can learn from experience of the newly
industrialized countries and if they are potential models for other countries to
follow.
Another question arising is if economics can help us to better understand the
process of development, which is extremely complex, and if economics also can
become an efficient tool for shaping adequate development policies. Sometimes
economists are criticized for being too narrow primarily focusing on the task to
increase economic growth, even if it is empirical evidence that economic growth
often increase inequality and, therefore, does not provide a sustainable solution for
the poor. Furthermore, traditional neoclassical economics have been developed to deal
with developed economies emphasizing market efficiency, while developing
countries usually are lacking market institutions. Neoclassical economics
concerns the determination of equilibrium, while transformation from a
developing to a developed economy is characterized by disequilibrium
processes and transactions out of (traditional) equilibrium.
In addition, with regard to understanding poverty and economic growth in Africa, it is
extremely important to understand the influence of geography; the intersection of
climate, ecology and economic activity is crucial. For example, since long, and in
the Gambia, there has been a negative development of productivity in agriculture
which has depreciated the situation of the poor both in the rural and urban areas. A
policy breaking this trend must be based on analyses that can explain relations
between poverty and environmental destruction, for instance, deforestation
destructing the quality of the soil. It links up with the green revolution by including
measures to increase the rate of technology diffusion that relies on scientific
discoveries of hybrid seed varieties.
In order to take account of the fact that poor countries differ from developed
countries, development economics also draws on other sciences than economics.
When looking at the contribution by economic science, we should admit that before
the neoclassical school became mainstream, the classical economists used the
notion political economy instead of economics. This distinction is important when

it comes to development economics, which stresses the role of institutions.

Accordingly, contemporary theory in the field of development economics has
sometimes pointed at poor governance as main cause of stagnation in developing
countries. It should be an important task to examine this explanation of why poverty
persists which cannot be done unless economic activity is viewed in its political
context taking account of political institutions.
Moreover, recently emphasis has been put on the importance of women for bringing
about economic change in Africa, which suggests that economic development should
be seen in view of another important institution: the extended family.
All in all, economists should recognize that mainstream, neoclassical economics is too
narrow to address issues on economic development. But also T/S view of political
economy as concerned with the relationships between politics and economics does not
fully admit the importance of social and cultural institutions, which were included
in the classical economists understanding of political economy. For example female
genital cutting, which has a tremendous influence on the life of the women and their
ability to contribute to the development of the rural economy. A more complete
understanding of development economics recognizes that this field of study is rapidly
evolving its own distinctive analytical and methodological identity.
T/S are arguing that the ultimate purpose of development economics is to help us
understand developing economies in order to help improve the material lives
of the majority of the global population. More specifically, it is the study of how
economies are transformed from stagnation to growth and from low-income status to
high-income status and to overcome problems of absolute poverty.

What do we mean by development

Not long ago, it was referred to poor countries, not as developing countries or
economies, but as underdeveloped. This was the ethnocentric perspective of the
colonizers, who used the European culture, which was considered as enlightened and
as based on true knowledge, as a model for a developed Africa. The colonizing states
believed that they had a responsibility to transfer this culture, which was seen as
favorable to economic development. Inherent in this view was an idea that Africa had
to pass the same type of industrialization as Europe had done before. This kind of
intellectual orientation is very interestingly described by the Palestinian author
Edward Said in a book called Orientalism.
Even if the way of referring to poor countries was changed, and they were now called
developing countries, the view of the development process was only slightly changed
in the field of development economics. Thus, proposed development policies have
often focused on rapid industrialization, where manufacturing and service industries
increase at the expense of agriculture and rural development. Accordingly,
development has been synonymous to sustained growth in per capita income,
i.e. output is growing faster than the population. This measure brings increases
in gross domestic product (GDI) into the fore, but for the most part the well-being of
the population has been in focus, which should be associated with monetary growth

of real per capita gross national income (GNI) (monetary growth of GNI per
capita minus the growth of inflation).
During the 1970s it became more and more obvious to those working in the field that
even if the economies were growing, a majority of the populations continued to be
poor in combination with growing inequality. Development was redefined instead
emphasizing reduction or elimination of poverty, inequality and unemployment
within the context of a growing economy.
Furthermore, poverty is not just an assessment of income, but it is a fact of life that
influences your self-understanding as a person living a life that is not human as you
are unable to control your hunger, diseases and you know that you are unable to
change this situation. This raises two questions about a how to formulate a more
inclusive definition of development. Firstly, if it is possible to link up with the
notion of utility in economics and define a measure that takes account of how
people think about their lives as more or less satisfactory. Secondly, if we can
define a measure that is concerned with /and here we use the wording of Amartya
Sen/ enhancing the lives we lead and the freedoms we enjoy.
Sen refers to the capability to function as a status of a person that matters for
whether he or she is poor or non-poor. Functionings, then, is what a person does or
can do with commodities of given characteristics that he or she comes to
possess or control. At the same time, individuals value functionings, for instance, to
be nourished, being free from diseases or being able to read.
Individuals also value a high per capita income but there are important disparities
between these two measures of development. For example, a person can have a high
income and, thus, being able to buy food or books. However, when looking at his or
her functionings, we may find that he or she has low or no capability to function, i.e.
has a parasitic disease implying that he or she cannot extract nourishment from food
or is illiterate, and therefore has a low or no well-being in spite of high income.
With regard to finding a method for measuring development, some economists
have linked up with the notion of utility in the sense of happiness and defined
national happiness which they have identified with family relationships, financial
situation, work community, health etc.. It has been found that the average level of
happiness increases with a countrys average income, but evidence also shows
that people are happier when they are not unemployed, not divorced, have
high trust of others (social capital) in the society and enjoy democratic
freedoms and have religious faith.
It should be mentioned, however, that increased well-being in Sens understanding as
increased functioning is not the same as increased utility or happiness. This
is obvious if we think about a person who is hungry and cannot afford nutritious food,
but reduce his hunger with rice (cheap way to satisfy ones hunger). This person
increase his or her utility or happiness. However, as the person reduces his or her
hunger with food that has a low nutritional content his or her well-being in the sense of

health or capability to function has not increased. Capability to function, then, is

freedom that a person has in terms of the choice of functionings (being able
to read a book, have the health to go to work) given his personal features and
command over commodities. From this perspective, well-being as utility or happiness
is just a part of the ability to function.
The most authoritative measure of development - the Human Development Index
produced by UN (the United Nations Development Program UNDP) - is inspired by
Sens ideas. Thus, standard of living measured as real per capita gross domestic
product is only one outcome of development included in the measure. The others are
longevity as measured by life expectancy at birth, reflecting health and access to
nutrition, and knowledge measured as weighted average of adult literacy and
school enrollment. This index is used to rank all countries on a scale of 0 to 1.
In our next lecture, we will return to and look more in detail into how to measure
poverty, inequality and development and the way the different measures are
calculated.

Measuring poverty, inequality and development

/by Sering/

Explanations of development and classical theory of how it

is attained
Explanations of relative development
Time has come to make you acquainted with the evolution of scholarly theories about
why development has not taken place and how it is brought about. However, in order
to judge the appropriateness of the various theories we need a context that can
explain why some countries are developed and other are poor.
Figure 2.11 is extremely informative but, nevertheless, the factors and their
interrelationships included in the figure, is a selection made by the authors. However,
they argue that the figure is based on the most influential recent research literature.
By placing physical geography and climate at the top, the authors emphasize the
importance of a recent scholarly discussion about the importance of geography for
differences in development between countries. There are scholars who reduce the role
of arrow 1 and instead emphasize the role of institutions which they associate with
type of colonial regime (see figure). By institutions, then, we mean formal rules like
constitutions and laws, and with regard to laws, development economists have
been concerned about property rights; private or public property. It should be
mentioned that institutions also include customs associated with local cultures and
social structures but these institutions are rather constraints on the colonial regime.

There is empirical evidence showing that after accounting for institutional differences,
geographic variables such as distance from the equator and whether countries
are landlocked (like Mali) have little influence on their incomes today. For
instance, if geography is crucial, then those regions that were prosperous before
colonialization should continue to be prosperous also today. Thus there is empirical
evidence showing that past population density and past urbanization, which is
positively correlated with income, is negatively correlated with high income today.
The explanation provided is that the European colonizers, in order to extract
significant surplus from colonized peoples, set up extractive institutions in prosperous
areas and these institutions have often persisted to the contemporary period. In
Africa, I think extraction of minerals and oil in countries such as Congo and Nigeria are
examples and, as we will find later on, after independence the post-colonial regimes
have retained the same institutions and used export of primary commodities as a
strategy for development.
However, geography has an indirect effect on contemporary per capita incomes as
it influence the mortality rate of the settlers, which has an impact on type of colonial
regime (arrow 2). In climate zones with high health-risks the colonizers established
administrations using local people who were loyal to the colonizers, who did not have
to be physically present. Moreover, there where climate was favorable for plantation
agriculture, slavery and other types of mass-exploitation of indigenous labor were
introduced (arrows 6 and 7).
According to the figure, investments in human capital are an important factor
explaining a countrys relative development (arrow 14). But amount of human
capital in its turn depends critically on the degree of inequality generated in
the context of a particular colonial regime. The institutions tend to be more
democratic, with more constraints on the elite, in countries with a higher level of
education. But there are cases where dictators have implemented good education
programs leading to growth in per capita incomes, which, in a second step has led to
changes in the institutions.
It is interesting to note that there are no arrows that could indicate an influence by
indigenous cultural institutions. With regard to Africa, for instance, customs,
gender relationships between men and women as well as traditions of giving
elderly a say with regard to use of land and other natural resources often replace
laws that regulate the use of property and property rights.
Social and cultural institutions such as tribe, religious affiliations and family
influence social learning that affects adaptations of new technology and the
diffusion of innovations influencing per capita income. There is a growing amount of
scholarly research on how social and cultural institutions influence development, but
the reason for not including these factors in the figure is that in relation to economic
factors, there are few established results.

You may also lack arrows indicating influence of international integration and trade
that explains why some countries are developed and other are poor. However, in fact
evidence shows that after it has been accounted for the impact of institutions on
countries contemporary incomes, trade itself explains very little. This is not
contrary to another fact that many post-colonial regimes have used trade policies
successfully as an integrated part of their development strategy, which the newindustrialized countries in South East Asia such as South Korea and Taiwan are
examples of.
With regard to lectures in the following that answer the question of how development
is brought about , the first section of the lectures concerns theories that disregard
international trade and foreign direct investments, while the second section concerns
theories that links strategies for development to changes in the international economy.
It may be surprising that explanations of why some countries are poor based on trade
are so meager as trade gives access to new technology. Technological change is
one of those causes of development that will be emphasized in the following. The
reason is that there is empirical evidence from developed countries showing that this
factor should be considered as a production factor of importance like capital
and labor.
The fact that international trade has not been a bridge for transferring technology
from the rich countries to the developing countries maybe that the ability to absorb
and adapt the new technology in the developing countries has been poor. There is
empirical evidence showing that the absorptive capability depends on the amount of
human capital, and as education depends on qualities of the indigenous institutions,
also the transfer of technology depends on national institutions.
In an article about tropical underdevelopment, Sachs argues that geography has an
influence on the adoption of new technology. He finds that there is empirical evidence
showing that the tropical zone has lagged behind the temperate zone with regard to
technology in the two critical areas of health and agriculture. Contrary to what we
found before, he argues that geography has an influence on underdevelopment as the
low diffusion rate for technology in the tropics has opened a significant income gap
between climate zones.
Factors such as geography and trade can have a moderate power to explain
differences in development between countries. Nevertheless, they can be important
factors in a development strategy designed to bring about development, which will be
discussed in the following that concerns theories of development. In emphasizing
geography, we admit that almost all developing countries are situated in tropical or
sub-tropical zones. Further, climate in combination with global warming and poverty
create environmental degradation in the shape of deforestation and poor soil quality,
which has a negative impact on productivity in agriculture and thus works back on per
capita income and poverty. Two lectures will be devoted to a discussion about
sustainable development that could bring this self-perpetuating process to an end.

Classical theory of how development is attained

It is important to note that the first steps in establishing development economics as a
branch of economic science was taken by scholars in the colonizing countries after the
second world war and, thus, reflect the scholarly thinking in Europe and the US during
1950s and 60s. The dominating perspective was the linear-stages approach to
development according to which all countries have to pass the same stages as
the rich countries in Europe. These were made explicit in Rostows stages-ofgrowth model, where all societies starts as traditional agrarian economies that
find a development strategy for a takeoff into self-sustaining growth.
In these theories increased domestic saving in combination with transfers of
capital from the rich countries either privately or as foreign aid to accelerate
investments was considered as an important condition for takeoff and regular
growth. Thus, today many governments in developing countries base their
development policies on an aggregate growth model inspired by the Harrod-Domar
growth model.
/Math I here/
The logic behind using this model is that capital formation is the main obstacle to
development. Labor is excluded as this factor has been considered as abundant in
developing countries. It is a difference with regard to innovation and technological
change which is a scarce factor in most poor countries in Africa. This factor can be
incorporated into the Harrod-Domar model as a reduction in k over time. That is, as
time passes, less savings and investments are needed to produce a given income.
/Math II here/
The weakness of this way of dealing with technological change is that innovation and
technological change is exogenous, i.e. we are lacking a theory of innovation, to which
we will return later in this course.
When using the Harrod-Domar model, some governments apply the two-gap model
comparing savings gap and foreign- exchange gap to determine which is the
binding gap.
Let us assume that it turns out that the savings gap dominates, which means that the
foreign exchange gap is binding for capital formation. This could be a situation where
the national elite uses foreign exchange, including foreign-aid, for luxury consumption
abroad. As the government wish to increase the per capita incomes by increasing the
growth rate, it is reasonable that it tries to encourage the elite to reallocate their
incomes from consumption to investments. Alternatively, they try to increase foreign
exchange by means of foreign aid and foreign direct investments. You can read more
about the two-gap model on pp 702 703
Implicit in the linear stages approach to development , where all countries pass the
same stages of development, is the idea that regular growth after takeoff is
synonymous to industrialization and the development of a modern sector

replacing traditional agriculture. However, targets for the growth of the modern
sector should be judged in view of the amount of surplus labor in agriculture, which
was considered as overpopulated with a marginal productivity of labor equal to
zero. Thus, it was believed that labor could be withdrawn from traditional agriculture
without any loss of output. At the same time, marginal productivity in the modern
economy was larger than zero implying that wages were higher than in agriculture.
As people were assumed to move from regions with lower wages to regions with
higher wages, rural-urban migration was expected to grow fuelled by a modern
sector characterized by full employment.
Development strategies in this situation were analyzed within the context of Lewis
two-sector model that dominated the field of development economics during 1960s
and the beginning of 1970s. Lewis assumed that the capitalists operating the modern
sector reinvest all their profits. If we also assume that the workers in the sector use all
their income for consumption, then this model takes for given that investments are
equal to savings which means that it predictions made by this model can easily be
coordinated with predictions made by the Harrod-Domar model of aggregate growth.
/presentation of the model 116 120/
Self-sustaining growth continues until all surplus labor has been transferred to the
modern sector. This is Lewis turning point, where the slope of the labor supply
curve becomes positive and further labor cannot be removed without costs in terms
of reduction in the food produced in subsistence farming.
One weakness of this model is that it does not take into consideration the possibility
that the capitalists invest in laborsaving capital equipment.
/figure 3.2 p 119/
One implication is that the wage-share of total value produced in the modern sector
declines (and the capital share increases) and economic growth does not create any
new jobs. This may be called antidevelopment economic growth.
When seen in view of the contemporary discussions about development strategies,
one difficulty with Lewiss model is that it neglects the importance of agriculture,
which is reduced to a secondary sector. With the new understanding of development
emphasizing reduction of poverty and inequality, development of agriculture comes
into the fore as most of the poor people are living in rural areas.
These two linear stages approaches to development is based on the idea that all
countries in principle are alike in the sense that they pass the same development
stages. This is a completely different paradigm for development as compared with the
Neocolonial Dependence Model that become popular among development
economists from the 1980s. According to this model developing countries are
considered as belonging to the periphery and the developed countries constitute
the center connected to the periphery (developing countries) through power
relationships. Thus, the development of the developing countries is not the same as

for the developed countries as, according to these relationships, their development
complies with dependent capitalism, where the economy of the countries in the
periphery is conditioned by the development and expansion of the countries in the
center.
Unlike the linear stages approaches that stresses the importance of internal
constraints to development such as insufficient savings and investments, the
Neocolonial Dependence Model defines the development strategies in relation to
external constraints and the need of restructuring the world capitalistic system.
This agrees with figure 2.11, where the main explanation of differences in
development between poor and rich countries is institutional characteristics
associated with the type of colonial regime.
When looking at possible development strategies, it is also important to note changes
in the international system from anarchy and conflicts between national states to
increased collaboration and the establishment of international organizations. Thus,
the Neocolonial Dependence Model recognize an elite ruling class in the
developing countries, which is rewarded by and serve international
organizations such as the World Bank, IMF and various organizations of the
UN. They share the ideology and interest of the ruling elite in the center.
For example, there are rules in the international system defined by the governments in
the developed countries, saying that the foremanship of the World Bank always is
allocated to an American (the US) and the foremanship of the IMF is always allocated
to an European. Being a collaboration between national states in Europe, the EU is
another international organization. Through its Structural Funds, and by using tariffs
the EU protects agriculture in Europe from trade in agricultural products, which is very
harmful for the African farmers.
From this perspective, an efficient development strategy, could be one that
changes the rules for allocating foremanships in international organization,
transferring power of these organizations to developing countries and to form
alliances with those forces in Europe that are working for changes in the
European agricultural policy. Furthermore, it was mentioned before that
international trade has not been a bridge for transferring technology from the rich
countries to the developing countries, and we explained that by the ability of
developing countries to absorb and adapt the new technology. However, now we are
in a position to discover a second factor of importance. It is referred to neoclassical
economics that consider knowledge (technology is knowledge about how to produce
services and commodities) as a public good free for use. However, in practice a lot
of technologies that could be useful for developing countries are owned and
controlled through patents by companies with domicile in the developed
countries. Another example of a development strategy in the spirit of the Neocolonial
Dependence Model could be to make efforts to change the international patent
laws.

The neoclassical counterrevolution

In the 1980a and 1990s, it became common that international organizations such as
UNDP and UNCTAD took on board the market ideology propagated by the World Bank
and IMF controlled by the developed countries. In many countries, for instance, in
Africa it was called for privatization of public companies and dismantling of
governmental regulation. These views were supported by economists at foremost
well-known American universities, who argued that the bad performance in
the developed economies depended on inefficient public regulations. Fields in
economics such as public choice became popular at the universities using classical
approaches in neoclassical economics to analyze different forms of public failure and
argued in favor of an increased role of market allocation.
While scholars belonging to the dependency school in development economics argued
that the lack of development in poor countries depends on their colonial heritage,
advocates of the neoclassical counterrevolution argued that underdevelopment results
from poor resource allocation due to incorrect pricing and too much state intervention
by developing- nation governments.
Because of their association with the World Bank, IMF and key US government
agencies, it is sometimes referred to these ideas as the Washington Consensus.
Dani Rodrik characterizes the Washington consensus in ten points (Table 11.1 p. 530)
and there is not anything in these points that indicates the importance of eliminating
absolute poverty. Obviously, the basic idea is that a high economic growth rate will
take care of poverty. He also compare the ten points with the development strategy
applied by the most successful Asian countries such as South Korea and Taiwan and
find that the state has had a broader role in these countries than encapsulated by the
Washington Consensus.
I think T/S conclusion that in an environment with widespread institutional rigidity and
severe socioeconomic inequality, both markets and governments will typically fail. It is
a matter of assessing each country on a case-by-case-basis.

Contemporary explanations of how to attain development

Development strategies and reduction of poverty and
inequality
According to modern perspectives on development, contemporary theory of
development should emphasize the problem how a society escapes from absolute
poverty and how inequality is reduced. It is obvious that bringing people out of
poverty should be crucial, but why is inequality important.
There are at least three reasons:
1) Inequality is inefficient as it reduces saving (the middle class has the highest
propensity for saving). The saving of the small group of very rich is proportionally

small as the use money for luxury consumption, travels abroad and capital flight.
Furthermore, investments are also hampered as a majority of the people cannot
provide the collateral necessary for getting loans. With regard to investments in
human capital, inequality creates a bias towards higher education, while development
often is better served by increased investments in higher quality of primary and
intermediate education.
2) Inequality destroy social capital such as trust relationships and solidarity by
promoting rent seeking by a small elite using bribes and corruption leading to
cronyism.
Yet, there are economists arguing that some inequality is necessary for development
as equality tends to reduce the incentive for working hard. If you know that there is a
possibility for increasing your income, to get a position with higher salary, then you
are prepared to increase your productivity. The counter argument is that there is a
wealth effect involved in social engineering directed to the determination of the
optimal inequality with regard to working incentives. Inequality implies for the majority
of the population with the lowest incomes that they cannot afford to buy food with the
nourishments, and have the housing conditions, necessary for a healthy life. Due to
poor health, they will not work more but less than in a situation with a more equal
distribution of wealth.
3) The third reason for considering inequality in a development strategy is that it is
not fair. At this point, Rawls notion of the veil of ignorance should be mentioned.
He outline a laboratory experiment, where a group of people is told to imagine that
they do not know their future income and wealth. Thus, all have the same probability
to belong to those with the lowest incomes or to those with high incomes. Under these
conditions, they are asked if they would prefer an income distribution that was more
equal or one that is less equal than those they see around themselves. If the degree
of inequality had no influence on the incomes, than most of the people would probably
choose a distribution that is almost equal.
Obviously, it seems reasonable to rank developing countries with regard degree of
development using properties of the Lorentz curves. How can this be done? (highly
unequal countries have a large Gini coefficient and vise-versa). Modern explanations
of how development is attained are more concerned about difficulties to reduce
inequality and escape poverty traps than the classical explanations.
There are empirical evidence of how efficient the two linear stages approaches to
development discussed before are to promote development.
1) Modern sector enlargement in a two sector economy like in Lewis model,
where the modern sector is growing constantly but wages in both the traditional and
the modern sector are constant. This development strategy has been practiced in East
Asia by countries such as China, South Korea and Taiwan.
2) Modern sector enrichment growth, where the growth is limited to a fixed
number of people in the modern sector when, at the same time, the number of

workers in the traditional sector and their wages have been constant. This is the type
of development has been practiced in many African and Latin American countries.
3) The traditional sector enrichment, where growth has benefited workers in
traditional sectors with little growth in the modern sector. This is typical for countries
that have given priority to fighting poverty at a low growth rate and low per capita
income (Sri Lanka and Kerala in India).
In 1), absolute incomes are increased and absolute poverty is reduced, but as
the Lorenz curves are crossing (figure 5.9) there is no clear evidence of changes in
inequality. In 2), inequality is increased and no change in poverty. 3) The
growth (relatively lower) results in higher incomes with a more equal
distribution of income (figure 5.7)
It is sometimes held that rapid growth is bad for the poor, as they will be bypassed by
structural change. This argument is supported by 2), which has no effect on poverty,
while 3) with lower growth rate improves the situation of the poor. Furthermore,
advocates of the inverted U Kuznets curve are arguing that in early stages of
economic growth when the per capita income still is low, the distribution of incomes
will be worsen; only at later stages it will be improved (figure 5.10). With Lewis
model in mind, increased inequality at early stages, probably, depends on few jobs
with relatively high productivity and wages in the modern sector. If we look more
specifically at investments in human capital and supply and demand of skilled labor in
the modern sector, we also have an explanation of why equality increases at later
stages of the development process. At the early stages, skilled labor demanded by the
modern sector is short in supply pushing wages in this sector upwards, while at later
stages the supply of skilled workers reducing the number of unskilled.
However, few development economists would argue that the Kuznets curve is
inevitable, but depends on type of development strategy chosen. This is evident
from the differences between 2) and 3) above.
It is sometimes argued that redistribution from the rich to the poor will reduce
economic growth as the poor save less. However, figure 5.13 does not support this
conclusion. It reflects the fact that the low inequality East Asia is growing faster than
the high-inequality Latin America and Sub-Saharan Africa and changes in the Ginicoefficient was small within the groups between 1960 1990. With regard to savings,
there is empirical evidence that the middle-class has the highest saving rate, and
reduction of poverty is synonymous to social mobility increasing this class. Moreover,
when poor increase their incomes they save and invest in education of their children
and in improved health. Altogether has a positive effect on economic growth.

Recent economic perspectives on how development is attained

Contemporary models have been enriched by discussions among development
economists about the suitability of market fundamentalism as expressed by the
Washington Consensus. These discussions have led to the development of new tools
to better understand problems related to market failures. They have provided

significant insights into why markets fail to coordinate various actors. The new models
are better to handle problems related to the notion of economies of scale and its
connection with learning by doing and the neglect by the Washington Consensus
of poverty has led to strong focus on why communities get stuck in poverty traps.
The latter has intensified studies of economic processes with multiple equilibriums.

Big Push models

T/S ask why it is so difficult to start modern growth, where traditional methods of
production are replaced by new methods. According to market fundamentalists it is a
matter of transferring new technology from the developed countries and establish
efficient institutions for securing free markets in the developing countries.
An example from the traditional rural economy may illustrate. In the Gambia, bee
keepers remove bees from trees by smoke and, therefore, have sometimes been made
scapegoats for bushfires. When this mode of producing honey actually leads to
bushfires, beekeeping becomes extremely harmful to women, who by tradition use the
forest for collecting firewood, which afterwards is sold at the market. This is an
example of negative externalities in the traditional rural economy. Pecuniary
externalities are positive or negative spillover effects on an agents costs or
revenues.
Instead of using wild beehives in trees in the forests, beekeepers can buy separate
beehives, which they place close to their villages. This is a new technology without
negative pecuniary externalities. Contrary, bees are pollinators, and if the women
have gardens with fruit trees, activities by the beekeepers may increase the incomes
of the women. Opposite, the orchards the women keep constitute a positive pecuniary
externality for the beekeepers as they help the bees to produce more honey.
However, the yields from the beehives depend on how many orchards the women will
establish. This brings us back to the original question about why it is difficult to start
modern growth. In order to answer this question we notice, firstly, that in this
illustration there are complementarities involved, which indicate that there may be an
equilibrium that is better than the traditional. Complementarities, then, are present
when an action taken by one economic agent increases the incentives for
other economic agents to take similar actions. Secondly, even if both the women
and the beekeepers would prefer the equilibrium with modern growth, there may be a
coordination failure that leads the agents to an equilibrium, where all are
worse off than in an alternative equilibrium. They cannot get to the alternative
better equilibrium because of difficulties to coordinate their actions even if they
have full information and therefore know that the modern-growth equilibrium is better
for all than the traditional one.
Coordination failures appear; either because they have different expectations about
one anothers behavior or because of free riding where everyone is better off waiting
for another to be the first mover. Figure 4.1 illustrates the situation with coordination
failure in case of multiple-equilibria. The S-shape of the individual decision curve is
explained by the fact that investments in new technology is associated with a critical

mass of investments, i.e. the benefits of an individuals action depends on

how many other agents take the same action or on the extent of their
actions.
We associate the traditional equilibrium with origo. Some agents invest individually in
the new technology (Y1 in figure 4.1) expecting that no one else will make any
investments. Since the average is higher than expected, the agents adjust their
expectations to the average and increase their investments. Since the individual
investments are based on expectations about the average investment level, it is only
when the individual investment levels are equal to the average investments
that the process is in equilibrium. There are three equilibriums out of which D1 and
D3 are stable equilibriums. These are stable as a small increase in the expectations
would lead to individual investment levels below the expected average, which would
lead to a return to the original equilibrium /similar reasoning for reduction in
expectations and for showing that D2 is unstable/
The utility of D1 and D2 is not the same. For instance, D2 with the high average level
of investments may be associated with farms, where the women have set up life
fences of cashew-nut trees (a practice found in the Gambia) to protect the orchards
from wind and animals. This increase the soil quality and the amount of fruit produced
and due to the complementarities it will also increase incentives in investing in bee
hives. All in all moving from D1 to D2 represents a Pareto improvement. However,
since D1 is stable, and a small change in expectations and investments will bring the
village economy back to D1, the move from D1 to D2 cannot usually be brought about
by individual decisions and market mechanisms.
To solve the problem of coordination failure, there is usually a need of an
external agent a governmental body or an NGO to bring about Pareto
improvements. A more detailed analysis of this agent is provided in my next lecture.
In the literature, Issues on how to start modern development have often been
discussed under the heading of the big push. Here I will discuss a model used for
analyzing these issues which have been proposed by P Krugman, and is discussed on
p 165 in T/S. In this model, like in most of the recent discussions about the problem
how to start development, the barrier preventing free markets to bring about
Pareto improvements by moving the economies from the traditional equilibrium
to a modern one has been associated with high wages in the modern sector.
This model is based on a few crucial assumptions:
1) Technology: Contemporary models usually associate the modern sector with
Increasing Returns to Scale (IRTS). For developing countries, one interesting
interpretation is that the technology is new, and therefore, has to be learned by
doing, there is a learning effect involved in the sense that every time the production
process is repeated the efficiency will be increased. There are N products in the
economy.

2)Labor is the only production factor. In the traditional sector, and for each
product, one worker is used for the production of one unit of output. In the modern
sector, IRTS is taken into account in terms of a fixed cost expressing that the product
cannot be produced without a minimum of F workers. We may think about the F
workers as instructors needed for training the workers to increase the learning effect.
Producing a product within the modern sector requires the following number of
workers: L = F + cQ, where c < 1.
3) Factor payments: In the traditional sector workers receive a wage equal to 1
and in the modern sector w > 1. Remember; high wages in the modern sector
have often been used as an explanation of underdevelopment traps.
4) Competition. Models by Krugman I am acquainted with are usually based on the
assumptions of perfect competition in the traditional sector and monopolistic
competition in the modern sector. The latter is logical, with regard to the assumption
about IRTS in the sector. However, when a firm producing in the modern sector
enter a product market, the assumption about perfect competition in traditional
production implies, if it sets a price higher than 1 (MC = 1 = p) it will lose all its
customers to traditional producers.
5) Demand. To make things simple, it is assumed that the economy is closed and
each domestic product market receives the same share of the total national
income Y: Y/N
/present the model analysis on the board pp 168 -169/

Growth diagnostic
It is not easy to define an appropriate strategy to attain development in, for instance,
the Gambia. We have focused on possibilities for exploiting complementarities and on
difficulties to avoid coordination failures. Even if these issues have been an important
concern for many development economists, we shall not make the mistake and belief
that we have found the final solution.
To many interested in this field, it is evident that each country is unique and
probably need its specific strategy. Among those sharing this knowledge it is
popular to apply a model called the growth diagnostic framework. Like a
medical doctor apply an hierarchical procedure for testing different diagnoses and
exclude illnesses, the economist apply a diagnostic tree to identify different possible
limitations to growth and afterwards suggest treatments for the expected disease.
The model sets out from a postulate with a broad acceptance (many people would
agree): A high level of private investments and entrepreneurship are good
and should be promoted by a development strategy. One advantage of the diagnostic
tree is that it shows that it shows how the various analytic tools discussed in different
parts of this course is related to different limitations to development. For instance,
coordination failure makes low private appropriability severe limitation to growth,

while low domestic savings (discussed in a previous lecture) makes high costs of
finance a limitation on growth.
/eventually discuss figure 4.3 more in detail/
Be careful, do not think that the practice of a medical doctor can be directly
transferred into the field of development economics. When targeting a specific
limitation to growth, remember that the diagnosis is based on a probability, and
assume that the probability of your diagnosis is significantly lower than in the case of
a medical doctor. The most important contribution of growth diagnostic, probably, is
that it tells us that there is no medicine that can be used for all countries.

Sustainable agricultural transformation

Since poverty should be a concern of development economics (cf. pp 219 221), and
the core problems of poverty originate in the economic stagnation in rural areas, the
rural economy must play an indispensable role in any strategy of economic progress.
This perspective on development differs from Lewis two-sector model, where
agriculture plays a passive role to provide food and manpower to the leading
industrial sector.

The agrarian system in Africa

One lesson to be learned from studies of development is that developing countries
are different and therefore have to be dealt with differently. In Latin America and
in parts of Asia the trend is toward concentration of large land areas in the hands of a
small class of landowners, while in Africa a relative availability of unused land has led
to other types of farming. At the same time, due to subdivision of land, there is a
trend both in Asia and Africa that the size of individual farms are becoming smaller. In
order to better understand the importance of these differences, we need a tool by
means of which we can classify countries with regard the agricultural activity.
T/S introduce the notion of agricultural system and tries to identify an African
agrarian system as well as one in Latin America and another one in Asia. We have
already mentioned empirical evidence of ownership (ownership to land) and
patterns of land distribution. These two variables are included in the
characterization of an agrarian system. Even if farm-sizes tend to decrease over
time in all three systems, table 9.3 in T/S, which shows the variation in farm sizes
for individual countries, does not show a clear differences between the systems with
regard to average farm size. For those countries included, the average size is larger
in Latin America than in the other two systems. But Bangladesh and India in Asia
have about the same small size as many countries in Africa. On the other hand, an
African country such as Botswana has an average larger than Thailand and Pakistan in
Asia.
The size of farms are an indicator of the type of management; if the farms are
mainly directed towards subsistence farming or cash crops; if they are managed
as a firm employing workers or as a family farm. In Africa, the family farm owned

and operated by a single family is common, while in Latin America Latifundio owned
by a small number of landlords employing more than 12 (sometimes 1.000) workers is
the most common way of organizing agrarian activities.
Social and cultural institutions are crucial characteristics of an agrarian system. In
the African system the allocation of control of resources depends on kinship
both by descent and by marriage implying that husband and wife usually have
their own separate economy and the oldest son takes over the responsibility for
the family after the father. Furthermore, in the Gambia, we have the traditions
associated with the village Alkali, who allocates land to inhabitants of the
village, which is a discrimination of those coming from other villages, who are unable
to get land in the village. I have heard that this institution is changing when the price
of land increases????
More specifically, the African agrarian system has three characteristics:
1) Subsistence farming is important (type of management): The majority of farming
families in Africa plan their output primarily for their own subsistence. Only small areas
can be planted and weeded as traditional tools (hoe,the axe and panga) are used.
Donkey, small horses and cows are used to make work more easy, but most work is
performed by labor.
Another limitation is the access to fertilizer implying that farmers have to rely on
shifting cultivation (slash and burn with fallow). However, with a growing
population, the fallow period have to be made shorter or new farmland has to be
created by clearing the forests.
I do not think subsistence farming is sustainable in its present form. A continuation will
increase the harm of deforestation and desertification. One alleviation mentioned
in the literature is genetic engineering creation new crop species. In my next lecture, I
will point at soil management as another possibility.
A third factor that put limitation on the future growth of subsistence farming is the
scarcity of labor during the rain, growing, planting and weeding season.
2) The existence of some land in excess of the immediate requirements.
Institutions for private ownership to land have been less important than in parts
of Asia and Latin America, with powerful classes of landlords. Instead of relying on
private property, in Africa there are traditions for common property and local
customs for allocating land, for instance, the Gambian alkali (ownership)
3) The right of each family in a village to have access to land and water
(social and cultural institution). This rule of the traditional system is an insurance the
villagers have. One drawback, can be that the rule impede innovations. Newcomers in
a village bring new ideas about how farming can be done and as this institution is a
barrier for emigrants that have land, novelties are never brought to the village. There
is evidence that villages provide land to newcomers in the neighbourhood to the

village, and afterwards connections between the two villages have been established,
which have brought improvement into the original village.

Transition from subsistence to mixed and specialized farming

How do we think about a transformation of the subsistence economy using the notion
of capability to function as measure of development (cf. A Sen)? A commonly used
way of thinking about the evolution of agrarian systems is in three stages. 1) is
subsistence farming widely used in Africa. 2) is mixed or diversified farming
partly devoted to production of food for the family, but also producing a significant
share for the market as cash crop. 3), finally, is high productivity specialized
farming producing only for the market as we find in developed economies.
Are there any strategies for moving from the first stage to the second and the
third stages that increase the capability of the population to function and, thus, can be
considered as development? Many economists in the field of development economics
point to export markets as lever for development. Thus, the vent-for-surplus theory
of international trade provides a strategy for moving from subsistence to mixed
family farming. However, this theory is based on the assumption that there are
resources in the subsistence farming system that are unemployed.
/figure 12.2 about here/
In referring to the Gambia, we may think about Export as rice, which is a staple food
in this region. At the same time, the nourishment of rice has a lower quality than that
of vegetables and fruit. If Import consists of fruit and vegetables, then moving from
V to C increase the level of development in the sense that the capability for function
has increased. Yet, as mentioned before, it is not clear that there are any
unemployed land and labor in the Gambia any longer, which makes this strategy
less adequate.
There are other difficulties with a move from the first to the second stage, which
become obvious when looking at the role women by tradition has played in African
subsistence farming. Gender- relations are crucial determinants of many social and
cultural institutions in African farming. Thus, the provision of food security for the
family is, probably, one of the most important role of women. Therefore, it is not
surprising that in an agrarian system where subsistence farming dominates as in
Africa, 60 80% of agricultural labor is provided by women; to be compared with 40%
in Latin America. But when traditional subsistence farming is transformed through
commercialization and increased role of cash crops (crops produced entirely for the
market), then the role of women in agriculture tend to be reduced. Instead, the
amount of resources controlled by men increases. Cash cropping increases at the
expense of womens vegetable gardens.
It should be noted that this transformation may reduce the well-being of the
whole family. The responsibility for the provision of the familys food security still

stay with the women, who now have to buy a larger share of nourishments on the
market with less money than before. If the increased incomes of the husbands do not
compensate for reductions in women-incomes, or the husbands refuse to reallocate
income to the women, then the well-being of the whole family decreases.
Of different reasons already mentioned subsistence farming in its present form is not
sustainable (shifting cultivation cause deforestation and desertification). Using the
growth diagnostic framework (p 182) we may say that the environment is the
most binding constraint on economic growth. Attention is thus drawn to the
need of innovations in the method of shifting cultivation. Accordingly, many policy
makers and researchers in the field have focused on increasing agricultural
productivity by diffusion of technology such as new seed varieties, use of fertilizers
and irrigation. However, we are asking for transformation of an agrarian system
occupied by small and usually poor farmers, who usually are risk averse and
successful adoption of new technology is uncertain making innovations risky.
Instead of explaining failures of development strategies for new technology adoptions
by farmers being irrational and backwards, economists should recognize that farmers
usually are rational, given their information and ability to interpret this
information. Economist studying new technology adoption have applied frameworks
for analyzing decisions at the farm level; usually based on standard theory for profit
maximization. For example, maximization of expected profit subject to land and credit
availability. Technology is chosen from a mix of traditional and modern technology.
However, as T/S are arguing, the knowledge about various technologies are limited
and the transaction costs for obtaining information are high. Another modification of
the standard model of new technology adoptions in subsistence farming suggested by
the authors take into consideration the facts that farmers are in a poverty trap,
implying that maximization of income is not the main decision criterion, but the
familys chances for survival.
Adoption of new technology, for the most part, means that you only have some
information about the new technology and the information is complete only after the
technology is fully adopted. To introduce new technology, thus, is a learning process
where you step by step increase your knowledge about new fertilizers, new
seed or livestock varieties. This learning is costly and the costs are often excluded
in the standard neoclassical model of economic decisions. This is a severe weakness
when the model is applied to increase our understanding of the transition from
subsistence to mixed and specialized farming as the transition concerns peasants
exposed to real danger of starvation and therefore cannot afford these learning costs.
As many farmers are unable to read and training is limited, learning by doing is
common. Cultivation depends on rainfall and the livestock is exposed to various
diseases. With regard to endemic breeds of livestock and native crops farmers have
learned by own experience and know quite well how the traditional crops function in
case of rainfall or draught and with regard to livestock they know the threats of
different diseases. If adapting new technology in the shape of new seed varieties

and livestock breeds they are less certain about how these varieties and breeds
function in the actual climate. For a subsistence farmer , producing close to the
minimum consumption level, who make decisions that assure the familys chances for
survival, it is rational not to adapt the new technologies.
T/S analyze the behavior by poor farmers assuming that they are risk-averse
/figure 9.6 about here/
The authors refer to crop yield, while I will illustrate by yield of livestock. Endemic
livestock in West Africa are well adapted and productive in tsetse infested areas, they
are tolerant to heat and resistant/resilient to certain diseases flourishing in the region.
However, despite their multiple adaptive attributes, endemic breeds are often
perceived by farmers as inferior to new alien breeds in terms of productivity and
marketing. Consequently, their habitats degrade threating the survival of the endemic
livestock.
Endemic livestock with lower average yield is associated with technique A and new
alien breeds are associated with technique B. Since the variance in yields is larger for
B than A, the risk is also higher for B than A and B therefore will be rejected by a poor
risk-averse farmer. In doing this choice, the poor pay a self-insurance equal to the
difference in average yield.
It should be mentioned, however, to be able to draw the probability distributions in
figure 9.6, the farmers need more information than they usually have.

Rural development and the environment

One lesson to be learned from the previous lecture is that poverty is a crucial
characteristic of subsistence farming as it prevents development. When trying to
attain a transition of the rural economy to a system for mixed or specialized farming it
is also important that a new agrarian system is in accord with the conditions for
sustainable development. This notion will be defined later on, but for the time being
we imaging as a necessary condition for this kind of development that it ends the
environmental degradation associated with subsistence farming.
In real life, reducing poverty is intimately connected with sustainable development, as
poverty both causes environmental degradation and is itself a result of environmental
degradation. But usually definitions of sustainable development concern how to
safeguard the natural environment in a way that meets the need of the present
generation without compromising the needs of future generations. This requires that
the stock of overall capital assets remain constant or rises over time. Natural
resources or the natural capital is included, but as natural capital can be substituted
for other forms of capital only to a certain extent, it is important to incorporate some
kind of environmental accounting into any strategy for the growth of mixed farming.
Such an account is discussed in T/S, but will not be discussed here.

Two types of environmental degradation will be used to illustrate how the

environmental factor can be taken into consideration in a policy for transforming
subsistence farming into mixed farming. The first factor is deforestation understood
as clearing of forested land either through extension of farmland as shifting cultivation
is land demanding or for logging and collection of firewood. The second factor is soil
erosion and other types of reductions of the soil quality. When the forest cover
decreases, for instance through deforestation, topsoil will blow away or will be washed
away by rainfall. Furthermore, when there are no trees, there will be no litter for
nourishing the farmland and forests provide catchments for water that can improve
the quality of the farmland.
There are many interrelationships between poverty and environmental degradation
that produce downward spirals leading away from sustainable development, and,
therefore, should be considered in a strategy for transforming subsistence farming into
mixed farming. For example, poor people use firewood as their main source of energy,
and the collection of firewood is sometimes made the scapegoat of deforestation.
Furthermore, to keep the soil quality when land is constantly used it must be
maintained by fertilizers but poor people cannot afford to add fertilizers.
Consequently, to provide food for a growing population marginal land has to be used.
This creates a negative spiral as the well-being of the poor is further reduced because
they must live on degraded land that is less expensive.
From this perspective, transforming subsistence farming to mixed farming becomes a
matter of identifying positive spirals, where measures reducing environmental
degradation increase the well-being of the poor, which, in a second step, lead to
further reductions in environmental degradation and so on. T/S are arguing that the
most important factor preventing environmental degradation associated with the poor
is to provide institutional support for the poor. Land tenure rights may be one
example here. In the Gambia, for instance, you are not permitted to plant trees on
farmland you rent. Changing this institution giving the landless the right to intercrop
trees with other crops (agroforestry) would improve the soil quality and probably also
their well-being. Another example is the Gambian government that tries to align the
protection of forest resources with the interests of local people by transferring the
responsibility for forest resources and legal ownership (secured tenure both on the
land and resources) to local populations represented by Community Forest
Committees. I will return to this later on.
Before that, I will use theory about the energy ladder to illustrate how poor change
in their consumption of energy when their income increases, which suggests a positive
spiral between reduction of poverty and reduction of environmental degradation.
When incomes increase people move up the energy ladder from firewood to charcoal
or kerosene and then to butane gas (LPG), natural gas or electricity for cooking. A
recent study conducted in urban Ouagadougou confirms these findings (Ouedraogo
2006). Accordingly, the World Bank report argues when population growth overrides
increases in incomes people move down the ladder and return to biomass fuel. It

might well be that this theory explain behavior of the urban population, But what
about poor farmers?
One question arising is if the positive spiral suggested by the theory of the energy
ladder can be generalized and applied to the whole society. This brings us to the
environmental Kuznets curve, which suggests that at this level the situation is more
complex. According to this curve, environmental degradation increases when incomes
increase and then decreases like an inverted U-curve. Since this curve describes the
development of the whole society, it might well be that the non-poor increase the
environmental degradation while environmental degradation by the poor decreases
when income increases. The net effect may be negative.
Instead the environmental Kutznets curve is questionable with regard to if there is a
turning point, where aggregated environmental degradation begins to decrease. When
it comes to greenhouse gases containing carbon, it is rather the reverse that
environmental damages increase with increases in incomes. Even if a strategy for
transforming subsistence agriculture in developing countries is targeted to increase
the forest cover, which will reduce the emission by enhancing the forest carbon stock,
this is probably not enough to balance the carbon emissions in the rich countries.

Example of institutional support

Usually, the poor farmers cannot afford to introduce new technology such as using
manufactured, synthetic fertilizer to improve the soil quality in a way that bring them
from subsistence to mixed farming. Less costly methods for soil management, that can
replace slash-and-burn agriculture, has to be found. The soil management system
discussed in this example uses forests cover, cashew trees and livestock to increase
agricultural productivity (figure 1).

Figure 1: Soil management system considered in the project

5)
1)

Forest
cover3)
)
Soil

4)

Cashew
trees

6)

Livesto
ck
2) quality

Agricultural
productivity
(livestock and
The arrows depict:
1) Food supply; 2) Manure; 3) Plant litter, reduced erosion, forest catchment area for
water;
4) Pollination; 5) Firebreak protection (against bushfires), 6)
Protection against illegal forest degradation
In the spirit of T/S we argue that the soil management in figure 1 cannot be
implemented unless the poor is provided by institutional support. Gambian
institutions for Community forests that transfer the legal ownership to forests to local
populations represented by Community Forest Committees may be an example of this
type of support. We may think about these institutions as increasing the forest cover
(see figure 1). At the same time, arrow 6) is working back from agricultural
productivity to forest cover. It is associated with reduced costs of protecting the forest
against illegal forest degradation when farmers incomes increase. That is, the costs of
counteracting illegal logging are reduced having a positive influence on the growth of
the forest cover.

Private and common property

10.4 about economic models of environmental issues are discussed in other courses,
for instance in Advanced Micro - and will therefore be excluded. However, as there has
been a debate recently about if improved property rights for the poor could help them
out of the poverty trap and transform subsistence farming, I will say a few words about
the sections on private and common property.
A farmer who do not own the land they use always face a hold-up problem. The
landlord can always increase the land rent to a level that the farmer cannot afford.
This risk increases if the farmer makes efforts to increase the soil quality increasing
the yield of land. Probably, it reduces the interests of the farmer to adopt new
technology, plant trees to intercrop with other crops or set up buildings on the land.
What about farmers rights to land as allocated through the Alkali
In the literature the appearance of co-specialized assets are usually associated with
hold-up problems, and it is argued that they are avoided if these assets are owned by
the same owner. Property rights that can be given to farmers are characterized by four
conditions:

/see page 482/

However, as Elinor Ostrom shows in her book Governing the Commons there are
resources - common-pool resources (CPR) that can be allocated efficiently in spite of
common ownership. CPR is usually associated with natural resources such as forests,
grazing commons or fisheries to which many people have access and thus usually are
owned in common.
Forests are used as example to illustrate what in the literature sometimes is called
the tragedy of the common. If the farmers individually decide how many cows they
will send to the forest to have their food inefficiencies will arise. According to
neoclassical economic theory this inefficiency is due to an externality that is not taken
into account when food supply from the forest is allocated through common
ownership. The individual farmer consider the average value of the cows and continue
to send cows to the forest as long as this value is larger than the marginal cost, i.e. the
cost of buying a cow. However, when sending one cow it will cause a damage to the
forest resources that reduces the food supply and value of all cows.
/figure 10.3 page 483/
In the Gambia the tragedy of the common has primarily been associated with stateowned forest which now are transferred into Community Forests to which whole
villages have the ownership. Alternatively, the state owned forests could have been
divided into smaller lots owned as private property by individual farmers. In theory this
solution would solve the problem of inefficiency in figure 10.3. In addition, to
increasing the agricultural productivity in figure 1, private forests could also be
collateral helping the farmers to get bank loans.
However, in practice it is questionable if privatization would help the poor. Firstly, if
they are unable to repay their loans to the bank, they will lose their ownership to the
forest and, thus, be equipped with less resources than before when the forest was
state-owned. Secondly, it is doubt whether poor farmers are able to protect their
ownership as they cannot afford to set up a fence that keep other farmers livestock
out of the forest or protect the forest against illegal logging. Furthermore, in case of a
conflict about property rights, they are probable unable to pay for a lawsuit.
As already mentioned Elinor Ostrom shows that the social optimum in figure 10.3 can
be attained even in case of common ownership to the forest (Community Forest) by
villagers negotiation binding contracts to commit themselves to a cooperative
strategy. The villagers have to negotiate an agreement about the number of cattle
each compound is allowed to send to the community forest when the total number is
equal to X, and they have to agree about an external actor who enforce the
agreement. The bargaining costs and the costs of enforcement is paid from the
surplus.

International trade and development

Inward- and outward-looking development policies
So far we have neglected the importance of international trade and investments for
development strategies. Historically, since long there has been a divide in
development economics between advocates of an inward-looking development policy
perspective emphasizing trade protection and barriers to FDI. The most extreme
example of self-reliance was found in Cambodia after the independence in the 1970.
One interesting African example is Algeria after the independence. The government
launched a national technology policy to support new industries based on modern
technology. The idea behind this strategy for development was to exploit forward and
backward technological linkages.
This was an early version of the European Airbus programme. A modern airplane use
advanced technology within a lot of areas: IT, material, aerodynamics etc. Through
backward linkages the Airbus-program was expected to reduce the technology-gap
between Europe and the US and create a platforms for growth within a lot of different
areas. Another development strategy with an inward looking perspective are various
forms of catch ups like the early Japanese industrial policy of copying technology
developed in other countries and at the same time protect the infant industry through
trade barriers.
The outward-looking development policy perspective stresses the importance of
international trade and FDI as lever for development. Advocates of this perspective
usually argue in favor of free trade. One example of special importance for African
farmers is EUs Common Agricultural Policy (CAP) where European farmers are
subsidized and protected through trade barriers making it difficult for farmers in
developing countries to compete on the European markets. A foreign policy by
developing countries trying to remove these subsidies and barriers is an example of
outward-looking development policy.
In my final lectures, we will discuss two types of outward-looking development
policies: Export promotion and import substitution. The latter can be seen as
development through two stages. In the first stage, imported consumer goods are
replaced by domestic production. In a first step, a developing country begin replace
imported fish for its own consumption by establishing own fisheries. In a second stage,
the same country substitutes imported more advanced products, for instance, facilities
for cold houses, for cold houses from domestic production. If the second stage of
import substitution turns out to be successful, the country can even develop into
becoming an exporter of fish.
Import-substitution will be discussed in my next lecture.

Export promotion strategies

Export promotion strategies includes the traditional strategy for many African
countries to promote export of primary commodities deriving from mines and
plantations (often owned by foreigners). Already before, the Vent-for-Surplus Theory

of Trade was mentioned /figure 12.2 p. 585/. This theory is based on the assumption
that there are resources in the subsistence farming system that are unemployed. But
with growing farmer populations and environmental degradation, it is doubtful whether
there are any unemployed resources left.
Another problem with primary commodity export (except for oil and some rare
minerals) is that they are growing more slowly than total world trade. The reasons are
low income and price elasticity for these commodities as well as stagnating population
growth. The latter is not through for Africa, where the populations unlike the
development in in Asia and Latin America - continue to grow.
Primary commodity exporting countries suffer from low income- and price elasticity of
demand (IED anPED). Therefore, difficulties for developing countries that let their
development strategy rely on this type of export, has led to useful tools for analyzing
this type of export promotion strategy.
Low IED imply that the growing incomes in the developed countries has not been
enough to absorb a growing export of primary commodities. Low PED implies in case
of shortages and surpluses on the international markets, cause large and volatile price
fluctuations. Erratic movements in export prices cause Export Earning Instability in
countries relying on this development strategy.
Another tool for judging strategies for the promotion of export of primary commodities
is the Prebish-Singer hypothesis. In this case, we look at the total export earnings ( TE
=

Px X

) and total exchange expenses associated with import (TI=

Pm I . A

developing country that wishes to increase its import of manufactured goods with high
PED and IED, has to reduce the prices of its export of primary commodities
considerably, and thereby increase the volumes of its export - also this considerably to be able to pay for the import. This is due to low IED and PED of primary products.
In looking into this problem more in detail, we define commodity terms of trade as

Px / Pm . The Prebish-Singer hypothesis is that there is a long-term decline in terms

of trade of primary- commodity exporters. This is due to low income and price
elasticity of primary commodities. To finance a growing import in manufactured goods,
they have to increase their export of primary commodities. This increase become
larger because of falling

Px .

The solution suggested to the problem decreasing terms of trade of primarycommodity exporters has been a development strategy called import substitution. By
replacing part of the import of manufactured goods with domestic production, the
need of export earnings to finance expenses for import will be reduced. To some
extent this strategy will reduce the Export Earning Instability, as well as the transfer of
values from poor to rich countries that follows this unfavorable terms of trade. Another
strategy chosen by primary-commodity exporters has been to establish international

commodity agreements that set overall output limits, assign quotas to producing
nations and stabilize prices.
UN Conference on Trade and Development (UNCTAD) have tried to establish a common
fund to finance buffer stocks. How can buffer stocks serve the interests of primary
commodity exporters? (p. 596)