Kathmandu University School of Management

Balkumari, Lalitpur

Development Economics

Analytical Assignment #2

Tales of Increasing Returns: Leaks, Matches and Traps

Submitted to: Submitted by:

Mrs. Anupama S. Pant Anamika Shakya

Faculty of Economics Roll No: 18785

Section – ‘C’

BBA 2nd year , 3rd Sem

Date: September 17, 2019

)Explain the importance of knowledge leaks. How can traps of wealth be created?

Knowledge is something that grows through conscious investment in knowledge. Knowledge

definitely has economic payoff and the knowledge leaks is also an essential part of economics.

In the case several example of Desh LTD has been cited to depict the importance and impact of

knowledge leaks. Knowledge leaks can increase the productivity of any firms, it can create

competition among the firms to produce more goods, as well as it not only leads to increase in

private returns but also contributes for social returns. Basically knowledge leakage refers to loss

of technological knowledge intended to stay within the firms boundary.

 Increases productivity :

The knowledge leakage helps in productivity and innovative performance which can be

explained with the example of Desh Ltd. Daewoo’s participation in the collaborative

agreement with Quader’s company is regarded as highly valuable because Daewoo’s had

knowledge how to make shirts and how to sell in the global market. Since it was founded

in 1967, Daewoo’s had created new knowledge that would be helpful to others through

which it could earn money as well. The Desh workers being trained learned quickly about

the process in making shirts as a result of it the sales increased from $55,050 up to

$2billlion for Bangladesh which was all possible due to the knowledge leaks. Therefore,

the investment in the knowledge continued as Daewoo and Desh adapted, Daewoo’s

method to local conditions. But one of the obstacle for Bangladesh was its protectionist

trading system which made the imports of raw material like fabric became highly costly

so the Bangladesh government decided to make a deal called special warehouse system.

Daewoo having the knowledge of its pros and cons passed its knowledge to Desh for

using and applying the system efficiently. Daewoo and Desh explained the Bangladeshi’s
 banks on how to open back to back import letters of credit. This kind of technical

assistance was provided by the knowledge leak that Daewoo provided to Desh regarding

how to produce shirt efficiently, the knowledge about the use of special warehouse

system and the creation of open back to back import letter all assisted Bangladesh for

producing more garments for lower cost.

 Social Benefits

Knowledge leakage is not only beneficial for individual but it is equally beneficial for the

society. A piece of knowledge can be used by many unlike a piece of machine that can

be used by a single individual at a time.

 Increasing returns to scale

New knowledge is complementary to existing knowledge. It means that that there are

increasing returns to investment in knowledge. This means that return to capital increase

as the capital increases. As a society get more and more productive ideas, each additional

ideas contributes more and more for additional production. If the investment in

knowledge leaks to everyone then this new knowledge raises the productivity of all

existing knowledge and machines throughout the economy. The more existing knowledge

there is, the higher is the return to each new bit of knowledge. The knowledge leaks

increases productivity of the economy. As well as rates of return to physical and human

capital will be higher, for a nation with high knowledge economy.

 productivity
increases

Social
benefits
Increase in teturn
to investment
Knowledge
leaks

Employm
economic ent
growth
opportuni
ty

 Employment opportunity

The knowledge is unavoidable most of the times. This results in increase in productivity

of a firm as well as there is increase in returns to investment. This further helps in

generating employment. For example in the case the example of Daewoo and Desh is an

classical example. Here Desh workers watched Daewoo and Noorul Quader create useful

knowledge about making shirts, selling shirts abroad, using special bonded

warehouse systems, and using back to back import letters of credit in Bangladesh.

They took that knowledge with them when they left Desh and started their own
garment firms. By 1985, there were over seven hundred Bangladeshi garment

companies. Previously in 1979 the Desh Garments Ltd. Was a lonely group but with the

knowledge leak the industry expanded to seven hundred. This increased the sale revenue

of Bangladesh from $55050 to $2 billion which ultimately to increase in national income

of the nation. Similarly, the number of increased garment producing industry created

employment opportunity too. There was a higher return to the physical and human capital

with a nation of higher knowledge leak which indicates better living standard of people.

In the case we can see that there is wealth trap. When the wealthy person become more

wealthy he/she wants to stay wealthy, leaving the poor to become poor. Wealth trap is

created due to the increasing return on the knowledge. An educated and skilled group of

people attracts people with similar skills due to the tendency of complementing each

other’s skills. This means that in a developed country there are already skilled people

which attracts further more skilled workers from other nation. For example, even if there

are skilled workers in a poor country that skilled group of people tends to migrate to the

country where there are skilled man power that would match each other skills. This

means that a rich country will become richer with the inflow of skilled workers whereas a

poor country is trapped in the poverty forever. This refers to the wealth trap. Mostly the

wealthy people are concentrated in a single part of a country and they will refuse to go to

other place where there are poor. As a result, the wealth gets trapped as the rich will

become richer whereas poor become poorer

2) How can increase in return to scale takes place with knowledge leaks?Is it possible to have

decreasing returns to scale as well? Justify

Returns to scale is the variation or change in productivity that is the outcome from a

proportionate increase of all the input. An increasing returns to scale occurs when the output

increases by a larger proportion than the increase in inputs during the production process. For

example, if input is increased by 4 times, but output increases by 4.75 times, then the firm or

economy has experienced an increasing returns to scale. Increasing return for a firm is beneficial

as the resources gets utilized to its optimum level that can enhance economic growth with

increased productivity

Knowledge leaks plays a crucial role in increasing the retunes to scale. Knowledge leaks is

mostly unavoidable. New knowledge is complementary to the existing knowledge. If the

investment in knowledge leaks to everyone then this new knowledge raises the productivity of all

existing knowledge and machines throughout the economy. If this knowledge creation and

leaking are strong enough it overwhelms the normal process of diminishing returns to machines.

In the case we can see that that the Quader Company and Daewoo signed an agreement in 1979

and the Desh Company’s workers about 130 of them were sent to South Korea for the training

purpose where they gained the knowledge of producing shirts efficiently. The managers and

workers gained the appropriate knowledge and skills to increase its sales. This resulted the sales

of garment for Desh’s company to increase from $55,050 to $2 billion indication productivity

and increasing returns to scale. This can be illustrated by the given figure
 ur B1

A1

A B

The figure

shows the increase in returns to scale. Let us assume that inputs along the X axis and the initial

point be A whereas the final point be B along the x axis. Similarly let us assume that output is

denoted by the Y axis where the initial point is A1 and the final point is B1.When the factors of

production ie inputs increase from A to B then the output also increases from A1 to B1.In the

case the Desh company was producing garments at A1 level with the input of A workers that

resulted into sales worth of $55050 but as the knowledge leaked from the Daewoo company to

the workers of Desh company, the workers and employees attained better skills and knowledge

and as a result the output increased from A1 to B1 increasing the sale of worth $2 billion.

Knowledge leaks helps to gain increasing returns to skill as knowledge is something that

increases as much as we share it. Talking about the machine, a worker can work on it one at a

time but it is opposite incase of knowledge. Each new ideas contribute more and more additional

production that overcomes the diminishing returns. The more the existing knowledge, the higher
is the return in knowledge. The more the existing knowledge, the higher is the return in

knowledge. The higher the increasing return to new knowledge, the higher is the incentive to

invest in new knowledge.In this way the knowledge leak creates increasing returns to scale.

But sometimes there might be diminishing returns to scale also. A diminishing returns to

scale occurs when the proportion of output is less than the desired increased input during the

production process.

B1

A1

A B

The figure illustrates the diminishing resturns to scale due to knowledge leak.In the figure the x

axis represents the imput wheras the y axis represents the output level.When input increases from

A to B the output also increases from A1 to B1 but this increase in output is less than the inputs

resulting to deminishing scale of returns.

In the case Quarder company collaborated with the Daewoo company, the workers learnt the

necessary skills from the Daewoo company in South korea.Out of 130 of trained workers of

Desh Ltd , 115 of them left the company to start their own garment export firm that diversified to
produce gloves, coats, trousers..It craeted competition among the firms to produce and sell the

garments which might have been less beneficial for Desh company.The benefits of Desh’s initial

investment in knowledge leaked beyond its expectation which might have turned a threat for it

as, Desh’s garment generation became less valauble as it was before due to the increased number

of garment firms.The initial investment in knowledge might have not resulted into higher outputs

and productivity for Desh as it was before the knowledge leak.So, sometimes knowledge leak

can also lead to diminishing returns to scale.

3)According to the article, where do poverty traps come from?How can they overcome the

poverty traps?Discuss

Poverty trap is a vicious cycle which forces an individual.society and a nation to remain in

poverty for an endless period.There are many factors that may lead to poverty trap.Knowledge

leak is one of the key factor for the poverty trap.

In the case we can see that Daewoo knowledge regarding efficient garment production got leaked

as a result other firms could also get benefit from it.Daewoo knowlegde helped it to gain profits,

seeing this several investor invested in the garment industry which resulted into higher

productivity and ultimately higher sales revenue.The initial investment was done by Daewoo in

knowledge that yielded further more investment and higher returns that created a virtuous

cycle.But it is not necessary that there will always be virtuous cycle instead there can be virtuous

cycle.

In case of Desh Ltd it was lucky enough that it utilized the knowledge of Daewoo to increase its

productivity which was made possible due to government cooperation for making exporter

dutyfree for imports.The government policy also matters a lot when it comes to investment.

Another obstacle is the individual is not rewarded for the social contributions he makes when he

invests. When he invests in knowledge, he increases the stock of knowledge available to

everyone. He gets no reward so he has now less incentive to make such contributions to social

knowledge.

Further if the rate of return is falling below the minimum, then a single individual's

investment is too small to move the whole industry or the whole economy above the

threshold. All the individual is going to see is that he is making investment which is below
the minimum rate thus is demotivated to make any such investment in knowledge as a

consequence everyone face a below minimum returns and it creates a poverty trap.

The matching effect causes income differences in the country.The skilled worker are highly

concentrated in one part.they tend to atrract more skilled workers as they could complement each

other in the work so in a rich country, the skilled workers raises each others productivity whereas

in poor country with unskilled workers they will lower each other productivity.the worse part is

the one who is skilled in a poor country tends to migrate to the country with skilled workers

which causes the cycle of low productivity .The high skilled ones donot want to work with low

skilled worker and the low skilled workers productivity decline as there is no high skilled

workers to create the knowledge leak.this leads to low return in investment and further in future

it leads no investment in knowledge and a vicious cycle of poverty gets created.Similarly, social

taboo,norms, ethnicity also make it impossible for the poor to get uplifted fromtheir level to a

better level and their incentives are always less incompared to that of the rich ones.

The poverty trapped can be overcomed with the effective government intervention.The

government intervention can help the economy to get out of the trap by subsidizing the

investment in new knowledge. The government should solve the cordination problem.It should

encourage the well off investors to invest more so that it could provide employment to the poor

that could uplift their level too.The government should adopt suitable policies that would

ecnourage the private firms to invest in knowledge and skills.Another way to get out of the trap

is to have high expectations for investors.If an investor expect investment in a sector from other

investors too then it will lead to increase in knowledge,that creates higher rate of investment,

further in future investment will increase gradually and it helps to get rid of the poverty trap.
4) What have you learnt over and above the economic theories?

Knowledge is something that expands as much as we share it.Any new additional ideas adds and

helps in additional production.Knowledge leaks has its own pros and cons as well.Knowledge

leaks seems to be beneficial as it create social benefits instead of only private benefits,creates

employment, increses productivity in the economy, brings the increasing return to scale and so

on.It benefits economy in various ways.The whole case deals with the importance of

knowledge,talks about the poverty trap,matching effects,effective ways o get out the trap to

create a virtuous cycle instead of viscious cycle.

Knowledge can be used in various ways, it gives rise to further new ideas and innovation

,generates new working models.It xpands the knowledge regarding how to expand human

capital,generate investment for the sustainability in the economy.Knowledge is an essential part

of the economy, it is a foundation that can multiply and create more ideas and innovations.But

knowledge leakage may also lead to poverty trap where the highly skilled and educated people

remain in power, they create a virtuous cyce but the unskilled remain in same state of lack of

progress as low skilled people cannot pursue higher knowledge and get stuck into the poverty

trap.The effective government intervention is extremely necessary for an economy of any nation

to uplift.

In conclusion we can learn that knowledge, new ideas are one the key factors that is necessary

for the economy to prosper.

Honor code:

On my honor as a student, I pledge that I have neither given nor received aid on this assignment.
Anamika Shakya