Chapter 4A

Contemporary Models of Development and Underdevelopment

4.1 Underdevelopment as a Coordination Failure 0 A newer school of thought on problems of economic development 0 Coordination failures occur when agents’ inability to coordinate their actions leads to an outcome that makes all agents worse off. 0 This can occur when actions are complementary, i.e., 0 Actions taken by one agent reinforces incentives for others to take similar actions


2 Multiple Equilibria: A Diagrammatic Approach 0 Often. these models can be diagrammed by graphing an S-shaped function and the 45º line 0 Equilibria are 0 Stable: function crosses the 45º line from above 0 Unstable: function crosses the 45º line from below Figure 4.4.1 Multiple Equilibria 2 .

limit pricing monopolist with a modern firm operating 0 Conditions for Multiple Equilibria 0 A big push may also be necessary when there are: 0 0 0 0 Intertemporal effects Urbanization effects Infrastructure effects Training effects 3 .3 Starting Economic Development: The Big Push 0 Sometimes market failures lead to a need for public policy intervention 0 The Big Push: A Graphical Model. 6 assumptions 0 0 0 0 0 0 One factor of production Two sectors Same production function for each sector Consumers spend an equal amount on each good Closed economy Perfect competition with traditional firms operating.4.

2 The Big Push Why the Problem Cannot be Solved by a Super-Entrepreneur  Super Entrepreneur?  Capital market failures  Cost of monitoring managersAsymmetric Information  Communication failures  Limits to knowledge  Lack of any empirical evidence that would suggest this is possible 4 .Figure 4.

In a Nutshell: Big Push Mechanisms 0 Raising total demand 0 Reducing fixed costs of later entrants 0 Redistributing demand to later periods when other industrializing firms sell 0 Shifting demand toward manufacturing goods (usually produced in urban areas) 0 Help defray costs of essential infrastructure (a similar mechanism can hold when there are costs of training. and other shared intermediate inputs) 5 .

4. Multiple Equilibria.5 Michael Kremer’s O-Ring Theory of Economic Development 0 The O-Ring Model 0 Production is modeled with strong complementarities among inputs 0 Positive assortative matching in production 0 Implications of strong complementarities for economic development and the distribution of income across countries 6 .4 Further Problems of Multiple Equilibria 0 Inefficient Advantages of Incumbency 0 Behavior and Norms 0 Linkages 0 Inequality. and Growth 4.

” because there are thousands of them 0 Industrial policy may help to identify true direct and indirect domestic costs of potential products to specialize in.4.6 Economic Development as Self-Discovery 0 Hausmann and Rodrik: A Problem of Information 0 Not enough to say developing countries should produce “labor intensive products. by: 0 Encouraging exploration in first stage 0 Encouraging movement out of inefficient sectors and into more efficient sectors in the second stage 7 .

reasons for Bangladesh’s efficiency in hats vs Pakistan’s in bedsheets is not clear) 0 Need for local adaptation (evidence: seen in cases such as shipbuilding in South Korea) 0 Imitation can be rapid (e.6 Economic Development as Self-Discovery 0 Three building blocks of the theory. and case examples of their reasonableness in practice: 0 Uncertainty about products can produce efficiently (evidence: India’s success in information technology was unexpected. the spread of cut flower exporting in Colombia) 8 .g.4.

7 The Hausmann-Rodrik-Velasco Growth Diagnostics Framework 0 Focus on a country’s most binding constraints on economic growth 0 No “one size fits all” in development policy 0 Requires careful research to determine the most likely binding constraint 9 .4.

Growth Diagnostics (GD)– once efficient investment & entrepreneurship are accepted for economic growth & development. Need for the local adaption of imported technology to prevent easy entry – might require local reverse engineering. It shows as many countries who are labor-intensive will produce different labor intensive products. there is need for country-specific binding constraints.e. Specialization – specifics beyond comparative advantage. GD is a decision tree for identifying the most binding constraints for each country currently and in future. b. 10 .1 1. With (a) and (b) in place. c. Uncertainty about what a developing country can produce costeffectively and also profitably. 3.The Hausmann-Rodrik-Velasco Growth Diagnostics Framework. The idea behind “self-discovery” --figuring out what the impediments to growth are. i. The building towards self-discovery recognizes 3 building blocks: a. labor- intensive activities is hardly enough. “imitation” is very rapid. 2.

e. 3. The initial causes could be (a) low return to economic activity and (b) high cost of finance. 0 Not simple to find the binding constraint. The decision tree identifies the-how-to-solve the problem.2 1. Focus on a country’s most binding constraints on economic growth & alleviating pressing constraints. Suppose a country is constrained by low level of private investment & entrepreneurship.The Hausmann-Rodrik-Velasco Growth Diagnostics Framework. i. GD is a much more broader approach to development policy that complements econometric modelling. 2. This shows that No “one size fits all” in development policy. Uncertainty leads to probabilistic assessments 11 . Not that the solution to these binding constraints are so many and multi-dimensional.

Figure :Hausmann-Rodrik-Velasco Growth Diagnostics Decision Tree 12 .

The Hausmann-Rodrik-Velasco Growth Diagnostics Framework. 2. Financial sector constraints –credit and loans Signals Problem of “arriving late” for public events Illustrates the idea of multiple equilibria --. Key constraint is inadequacy of public goods especially on 2 emerging sectors (tourism & light manufacturing).moving from one inferior equilibrium to a superior one 4-13 .3 Growth diagnostics 1.

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