Economic Growth in Developing

and Transitional Economies

Sisdjiatmo K. Widhaningrat

Business Economics
Session 21
BLEMBA – June 2014
1
 Economic Growth in Developing
and Transitional Economies

 The universality of scarcity makes economic

analysis relevant to all nations.
 Economic problems and policy instruments are
different,
 But economic thinking about these problems
can be transferred easily from country to
country.

2
 Scarcity of Resources

 Countries with modern industrialized economies that rely

heavily on markets to allocate resources, but what about
the economic problems facing countries such as Somalia
and Haiti? Can we apply the same economic principles
that we have been studying to these less developed
nations? Yes. All economic analysis deals with the
problem of making choices under conditions of scarcity,
and the problem of satisfying people’s wants and needs is
as real for Somalia and Haiti as it is for the United States,
Germany, and Japan. The universality of scarcity is what
makes economic analysis relevant to all nations,
regardless of their level of material well-being or ruling
political ideology.
3
 Life in the Developing Nations:
Population and Poverty
 In 2010, the population of the world reached over 6.8 billion people. Most of the
world’s morethan 200 nations belong to the developing world, in which about
three-fourths of the world’spopulation lives.
 Although the countries of the developing world exhibit considerable diversity in
both their standards of living and their particular experiences of growth, marked
differences continue to separate them from the developed nations. The
developed countries have a higher average level of material well-being (the
amount of food, clothing, shelter, and other commodities consumed by the
average person). Comparisons of gross national income (GNI) are often used as
a crude index of the level of material well-being across nations. GNI is a new
measure of a nation’s income, computed using a more accurate way of
converting purchasing power into dollars. See Table 36.1, where GNI per-capita
in the industrialmarket economies significantly exceeds GNI of both the low- and
middle-income developing economies.
 Other characteristics of economic development include improvements in basic
health and education. The degree of political and economic freedom enjoyed by
individual citizens might also be part of what it means to be a developed nation.
4
Some of these criteria are easy to quantify
 Developing Countries
 Developing countries continue to have some common differences with
developed countries.

 Economists use gross national income (GNI) to compare income levels in

different countries. GNI uses a more accurate way of converting purchasing
power among currencies.

 Using GNI as the basis for comparison, developed countries have higher
average levels of material well being (including food, clothing, and shelter).

 Developed countries also have better health and education than developing
countries.

 Although difficult to quantify, there is general agreement that citizens of

developed countries generally have greater political and personal freedom
than those living in developing countries.

5
Life in developing countries is very difficult.
 Most meals are the same and consist solely of the country’s
staple crop (rice, wheat, or corn).
 Shelter is primitive with many people sharing a small room.
 Production is on small family farms. Productivity is low because
household plots of land are small and capital is very crude.
 Illiteracy remains chronic.
 Infant mortality is 10 times the rate in the United States.
 There is only one physician per 5,000 people.
 Civil and external wars are common.
 Poverty dominates the developing world.
6
 Business Activities
Competition Pricing

Market demands Tactics

Planning
Activities:
Distribution Goals Promotion
& Objectives

Projections
Managerial performance

Opportunities Obstacles
7
 The Scope of Economics
Examples of microeconomic and macroeconomic concerns
Production Prices Income Employment
Micro- Production/Output in Price of Individual Distribution of Employment by
economics Individual Industries and Goods and Services Income and Wealth Individual
Businesses Businesses &
Industries
Price of medical Wages in the auto Jobs in the steel
How much steel care industry
industry
How many offices Price of gasoline Number of
Minimum wages employees in a firm
How many cars Food prices
Executive salaries
Apartment rents
Poverty
Macro- National Aggregate Price National Income Employment and
economics Production/Output Level Unemployment in
Total wages and the Economy
salaries
Total Industrial Output Consumer prices
Total number of
Gross Domestic Product Producer Prices Total corporate jobs
profits
Growth of Output Rate of Inflation Unemployment rate

8
 Ranking of Population

RANK NEGARA PDDK 2005 PDDK 2050

1 Cina 1.304 1.628
2 India 1.104 1.437
3 Amerika Serikat 296 420
4 Indonesia 222 308
5 Brazil 184 260
6 Pakistan 162 295
7 Bangladesh 144 231

Sumber : World Pop. Data Sheet 2005. 9

 Population & Poverty (2001-2002)
 Low-Income Countries : Income per capita : $ 430, Health
Expenditures per capita $ 21,5, Infant Mortality : 121 per
1000 births.
 Lower Middle-Income Countries : Income per capita : $
1,390, Health Expenditures per capita $ 72,3, Infant Mortality
: 40,6 per 1000 births.
 Upper Middle-Income Countries :
Income per capita : $ 5,040, Health Expenditures per capita
$ 308.9, Infant Mortality : 22 per 1000 births.
 Industrial Market Economies Countries : Income per
capita : $ 26,310, Health Expenditures per capita $ 2,736,
Infant Mortality : 6,6 per 1000 births.
10
 Life in the Developing Nations:
Population and Poverty
Indicators of Economic Development

INFANT
GROSS MORTALITY,
NATIONAL ANNUAL HEALTH 2001
INCOME EXPENDITURES (DEATHS PERCENTAGE OF
POPULATION PER CAPITA, PER CAPITA BEFORE POPULATION IN
(MILLIONS) 2002 2001 AGE FIVE PER URBAN AREAS,
COUNTRY GROUP 2002 (DOLLARS) (DOLLARS) 1,000 BIRTHS) 2001
Low-income 2,495 430 21.5 121.7 32
(e.g., China, Ethiopia,
Haiti, India)

Lower middle-income 2,411 1,390 72.3 42.2 42

(e.g., Guatemala, Poland,
Philippines, Thailand)

Upper middle-income 331 5,040 308.9 28.6 76

(e.g., Brazil, Malaysia,
Mexico)

Industrial market economies 965 26,310 2,736 7.1 79

(e.g., Japan, Germany,
New Zealand, United States)

Source: World Bank, WWW.WORLDBANK.ORG

11
 Life in the Developing Nations:
Population and Poverty

 In the year 2,002, the world population reached over 6.2 billion
people. Most of the world’s more than 200 nations belong to
the developing world.

 While the developed nations account for only about one-

quarter of the world’s population, they consume about three-
quarters of the world’s output.

 Developing countries have three-fourths of the world’s

population, but only one-fourth of the world’s income.

12
The Vicious Circle of Poverty

LOW
PER CAPITA
INCOME

RAPID
LOW LOW LEVEL LOW LEVEL
POPULATION
PRODUCTIVITY OF SAVING OF DEMAND
GROWTH

LOW LEVELS OF
INVESTMENT IN
PHYSICAL AND
HUMAN CAPITAL
13
39-13
Persentasi penduduk dibawah garis kemiskinan
(< US 2 per hari), 2002.

Wilayah Persentasi
Sub-Saharan Africa 75 %
South-Central Asia 75 %
China 47 %
North Africa 29 %
Latin America 26 %
Eastern Europe 14 %
World 53 %
Internationally defined poverty line : US $ 2 per day. 14
 Penduduk Indonesia

Tahun Jumlah penduduk (Juta orang)

1950 79,5
1961 97,0
1971 119,2
1980 147,5
1990 179,4
2000 206,3
15
 Population of Indonesia

 Population of Indonesia in 2009 : about

230 million people.

 Assuming rate of population growth 1,2 %

per year :

Doubling Time : about 58,3 years.

 Total population of Indonesia in 2067 :

460 million people.
16
 Population of Indonesia, 2008
Propinsi Jml. Pddk. Propinsi Jml. Pddk. Propinsi Jml. Pddk.
NAD 4.228.726 Jabar 40.707.250 Kaltim 3.088.322
Sum. Utara 13.319.525 Banten 9.245.075 Sulut 2.199.701
Sum. Barat 4.549.356 Jateng 34.034.177 Gorontalo 945.001
Riau 4.715.437 DIY 3.441.613 Sulteng 2.521.327
Kep. Riau 1.393.897 Jatim 37.872.044 Sulsel 7.606.500
Jambi 2.805.297 Bali 3.372.335 Sulbar --
Sum. Sel. 7.508.091 NTB 4.124.491 Sultenggara 2.003.744
Kep Ba. Bel. 1.059.481 NTT 4.230.028 Maluku 1.407.921
Bengkulu 1.715.689 Kalbar 4.165.308 Mal Ut 731.202
Lampung 7.348.623 Kalteng 2.019.117 Papua 2.152.823
DKI 7.706.175 Kalsel 3.407.423 Irian Jaya/ Papua 690.358
Barat
Indonesia 227.366.98517
Percentage of education, Indonesia 2000.

Pendidikan Laki-laki Perempuan Total

Belum tamat SD 33,05 % 37,54 % 35,29 %

Sekolah Dasar 33,51 % 34,93 % 34,22 %

SLP 14,24 % 12,89 % 13,57 %

SLA 15,79 % 12,17 % 13,98 %

D1/D2 0,56 % 0,52 % 0,54 %

D 3/Akademi/PT 2,83 % 1,93 % 2,38 %

Total 100 % 100 % 100 %

18
 Ekonomic indicator APEC, 2008.
Negara PDB PDB per Pertumbuhan
(US$ milliar) Kapita (US$) PDB 2008
Australia 822,1 39.320 2,5 %
Brunei 12,0 31.298 - 0, 5%
Kanada 1.266,4 38.382 0,6 %
Chile 149,6 9.026 4,5 %
China 3.051,2 2.310 9,7 %
Hongkong 201,8 28.982 4,1 %
Indonesia 407,5 1.812 6,1 %
Jepang 4.302,1 33.668 0,5 %
Korea Selatan 943,0 19.485 4,1 %
Malaysia 160,6 5.982 5,8 %
Meksiko 897,3 8.530 1,9 %
Selandia Baru 114,3 27.285 0,6 %
PNG 4,3 685 5,8 %
Peru 100,6 3.584 9,2 %
Filipina 133,3 1.503 4,4 %
Rusia 1.166,6 8.209 7,0 %
Singapore 146,1 32.506 3,6 %
Taiwan 365,3 15.759 3,8 %
Thailand 219,4 3.304 4,7 %
USA 13.770,3 45.490 1,5 %
Vietnam 68,3 798 6,3 % 19
The Circular Flow of Income

20
Flow of economic globalization

21
Business Organization External Environment

Return 22
 Penduduk Miskin, Indonesia 2006

SUSENAS :
FEBRUARI 2005 MARET 2006
Jumlah penduduk 220 juta 222 juta
Jml. Penduduk Miskin 35,1 juta 39,05 juta
(15,97 %) (17,75 %)
Garis kemiskinan (per
kapita/bulan) *) : Rp. Rp.
- Kota 150.799 175.324
- Desa 117.259 131.256
- Total 129.108 152.847
*) Pengeluaran untuk memenuhi kebutuhan dasar makanan dan bukan makanan.
23
 Kriteria Rumah Tangga Miskin
(Bantuan Langsung Tunai)
1. Luas lantai bangunan tempat tinggal kurang dari 8 m2 per orang.

2. Lantai tempat tinggal terbuat dari tanah/bambu/kayu murahan.

3. Jenis dinding tempat tinggal terbuat dari bambu/rumbia/kayu berkualitas rendah/tembok tanpa
diplester.

4. Tidak memiliki fasilitas buang air besar/ber-sama2 dengan rumah tangga lain.

5. Penerangan rumah tangga tidak menggunakan listrik.

6. Sumber air minum dari sumur/mata air tidak terlindung/sungai/air hujan.

7. Bahan bakar untuk memasak se-hari2 adalah kayu bakar/arang/minyak tanah.

8. Hanya mengkonsumsi daging/susu/ayam satu kali dalam seminggu.

9. Hanya membeli satu setel pakaian baru dalam setahun.

10. Hanya sangu makan sebanyak satu/dua kali dalam sehari.

11. Tidak sanggup membayar biaya pengobatan di Puskesmas/Poliklinik.

12. Sumber Penghasilan Kepala RT : Petani dgn luas lahan 0,5 HA, buruh tani, nelayan, buruh bangunan,
buruh perkebunan, atau pekerjaan lainnya dengan pendapatan dibawah Rp. 600.000 per bulan.

13. Pendidikan tertinggi KRT : Tidak sekolah/Tidak tamat SD/Hanya SD.

14. Tidak memiliki tab/brg yg mudah dijual dgn nilai min Rp. 500.000 seperti spd motor (kredit/non-kredit),
emas, ternak, kapal motor, atau barang modal lain. 24
 Perincian kemiskinan

 Inflasi Feb 2005 – Maret 2006 = 17,95 %

 Makanan berkontribusi 70,54 % thd garis kemiskinan
 Komoditi non-makanan a.l. : perumahan, sandang, pendidikan
dan kesehatan.
 Tanpa pelaksanaan program kompensasi pengurangan subsidi
BBM, jumlah penduduk miskin akan menjadi 50,8 juta (22,8 %
penduduk).
 BLT ke 19,2 juta Rumah Tangga, Raskin, BOS  memperkuat
pemenuhan dasar penduduk miskin
 Dari 39,1 juta miskin di 2006  19,8 juta sudah miskin tahun
sebelumnya, 9,9 juta hampir miskin, 7,3 juta hampir tidak miskin,
2,1 juta tidak miskin.
25
 Economic Development:
Sources and Strategies
 Sources of Economic Development :
 Capital formation
 Human Resources and Entrepreneurial Ability
 Social Overhead Capital
 Strategies for Economic Development :
 Agriculture or Industry
 Exports or Import Substitution
 Central planning or the Market
 Microfinance : a new idea
26
 Economic Development:
Sources and Strategies
 Growth versus Development : the Policy Cycle
 Two examples of Development : China and
India.
 Issues in Economic Development :
 Population Growth

27
 The transition to a Market Economy
Six Basic Requirements for Successful Transition
 Macroeconomic Stabilization
 Deregulation of Prices and Liberalization of
trade
 Privatization
 Market-Supporting Institutions
 Social Safety Net
 External Assistance
 Shock Therapy or Gradualism
28
 Country Classifications

 Industrially advanced countries

 High income nations
 Well-developed market economies
 Per capita income $36,608 in 2006
 Developing countries
 Middle income nations
 Low income nations
 Wide variation in income per capita
29
39-29
 2006 Comparisons

 U.S. GDP $13.2 trillion

 Combined GDP of developing countries
$11.7 trillion
 U.S. has 5% of population but produces
27% of world’s output
 U.S. per capita GDP 186 times that of
Sierra Leone
 Wal-Mart’s annual revenue greater than all
but 19 nation’s GDP

30
39-30
 The Rich and the Poor
 Some developing countries have
grown considerably
 China, Malaysia, Chile, Thailand
 Some developing countries have
become high-income
 Singapore, Greece, Hong Kong
 Income gap has widened
 Developingcountries must grow faster to
narrow the gap
31
39-31
 Obstacles to Development
 The path to economic development
 Use existing resources more
efficiently
 Expand available supplies of
resources
 Simple generalizations are not
possible

32
39-32
 Obstacles to Development
 Lack of natural resources
 Overpopulation
 9 out of 10 people born in a DVC
 Reduced standard of living
 Less saving and investment
 Lower productivity
 Resource overuse
 Urban problems
 Qualifications
33
39-33
 Obstacles to Development
 Unemployment
 Underemployment
 Low labor productivity
 Brain drain
 Capital accumulation is key
 Domestic capital formation
 Savings potential
 Capital flight
34
39-34
 Obstacles to Development
 Investment obstacles
 Lack of infrastructure
 Technological advance
 Borrowed technology
 Sociocultural obstacles
 Institutional obstacles
 Land reform

35
39-35
 Role of Government
 A positive role
 Law and order
 Lack of entrepreneurship
 Infrastructure
 Forced saving and investment
 Social-institutional problems
 Public sector problems
 Corruption

36
39-36
 Economic Development:
Sources and Strategies
 Almost all developing nations have a scarcity of physical
capital relative to other resources, especially labor.

 Human Resources and Entrepreneurial Ability

 Capital Formation

 The vicious-circle-of-poverty hypothesis suggests

that poverty is self-perpetuating because poor nations
are unable to save and invest enough to accumulate the
capital stock that would help them grow.
 Poverty alone cannot explain capital shortages, and
poverty is not necessarily self-perpetuating.
37
 The Sources of
Economic Development

 Capital flight is the tendency for both human

capital and financial capital to leave developing
countries in search of higher rates of return
elsewhere.
 Price ceilings, import controls, and expropriation are
some of the policies that discourage investment.
 The absence of productive capital prevents income
from rising.

38
 The Sources of
Economic Development

 Just as financial capital seeks the highest

return, so does human capital:
 Brain drain is the tendency for talented people
from developing countries to become educated in a
developed country and remain there after
graduation.
 Development cannot proceed without human resources
capable of initiating and managing economic activity.

39
 The Sources
of Economic Development

 Social overhead capital is the basic

infrastructure projects such as roads, power
generation, and irrigation systems that add to a
nation’s productive capacity.
 In developing economies, government provision of
public goods is highly deficient, and many socially
useful projects cannot be successfully undertaken
by the private sector.

40
 Strategies for Economic Development

 A developing economy with insufficient human

and physical capital faces some very basic
trade-offs. Three of these trade-offs are:
 Agriculture versus industry.
 Exports versus import substitution.
 Central planning versus the market.

41
 Agriculture or Industry?

 Industry has some apparent attractions over agriculture:

 The building of factories is an important step toward increasing the
stock of capital.
 Developed economies have experienced a structural transition from
agriculture to industrialization and greater provision of services.

 However, industrialization in many developed countries has not

brought the benefits that were expected.

42
 Agriculture or Industry?

The Structure of Production in Selected Developed and Developing Economies, 2001

PER CAPITA PERCENTAGE OF GROSS DOMESTIC PRODUCT

GROSS NATIONAL
COUNTRY INCOME (GNI) AGRICULTURE INDUSTRY SERVICES
Tanzania $ 270 45 16 39

Bangladesh 360 23 25 52

China 840 15 57 34

Thailand 1,440 10 41 49

Colombia 1,890 13 30 57

Brazil 3,070 9 34 57

Korea 9,460 4 42 54

United States 34,280 2 25 73

Japan 35,610 1 32 67

Source: World Bank, WWW.WORLDBANK.ORG, 2003.

43
 Exports or Import Substitution?

 Import substitution is an industrial trade

strategy that favors developing local industries
that can manufacture goods to replace imports.

44
 Exports or Import Substitution?
 The import-substitution strategy has failed almost everywhere
for the following reasons:
 Domestic industries, sheltered from international competition, develop
major economic inefficiencies.
 Import substitution encouraged the production of capital-intensive
production methods, which limited the creation of jobs.
 The cost of the resulting output was far greater than the price of that
output in world markets.

45
 Exports or Import Substitution?

 Export promotion is a trade policy designed to

encourage exports.
 Several countries including Japan, the “four little
dragons,” Brazil, Colombia, and Turkey, have had
some success with outward-looking trade policy.
 Government policies to promote exports include
subsidies to export industries and the maintenance of
a favorable exchange rate environment.

46
 Microfinance
 In the mid 1970s, Muhammad Yunus, a young Bangladeshi economist created the
Grameen Bank in Bangladesh. Yunus, who trained at Vanderbilt University and
was a former professor at Middle Tennessee State University, used this bank as a
vehicle to introduce microfinance to the developing world. In 2006, Yunus received
a Nobel Peace Prize for his work. Microfinance is the practice of lending very small
amounts of money, with no collateral, and accepting very small savings deposits.2
It is aimed at introducing entrepreneurs in the poorest parts of the developing world
to the capital market. By 2002, more than 2,500 institutions were making these
small loans, serving over 60 million people.
 Two-thirds of borrowers were living below the poverty line in their own countries,
the poorest of the poor. Yunus, while teaching economics in Bangladesh, began
lending his own money to poor households with entrepreneurial ambitions. He
found that with even very small amounts of money, villagers could start simple
businesses: bamboo weaving or hair dressing. Traditional banks found these
borrowers unprofitable: The amounts were too small, and it was too expensive to
figure out which of the potential borrowers was a good risk.With a borrower having
no collateral, information about his or her character was key but was hard for a big
bank to discover.
 Local villagers, however, typically knew a great deal about one another’s
characters. This insight formed the basis for Yunus’s microfinance enterprise.
Within a village, people who are interested in borrowing money to start businesses
are asked to join lending groups of five people.
 Loans are then made to two of the potential borrowers, later to a second two, and
finally to the last. As long as everyone is repaying their loans, the next group
receives theirs. But if the first borrowers fail to pay, all members of the group are
47
denied subsequent loans.What does this do?
 Microfinance
 It makes community pressure a substitute for collateral.Moreover,
once the peer lending mechanism is understood, villagers have
incentives to join only with other reliable borrowers. The mechanism
of peer lending is a way to avoid the problems of imperfect
information described in an earlier chapter.
 The Grameen model grew rapidly. By 2002, Grameen was lending to
two million members.
 Thirty countries and thirty U.S. states have microfinance lending
copied from the Grameen model. Relative to traditional bank loans,
microfinance loans are much smaller, repayment begins very quickly,
and the vast majority of the loans are made to women (who, in many
cases, have been underserved by mainstream banks).
 A growing set of evidence shows that providing opportunities for poor
women has stronger spillovers in terms of improving the welfare of
children than does comparable opportunities for men.While the field
of microfinance has changed considerably since Yunus’s introduction
and some people question how big a role it will ultimately play in
spurring major development and economic growth, it has changed
many people’s views about the possibilities of entrepreneurship for
the poor of the world.
48
 Central Planning or the Market?

 Today, planning takes many forms in

developing nations.
 The economic appeal of planning lies in its
ability to channel savings into productive
investment and to coordinate economic
activities that otherwise might not exist.
 The reality of central planning is that it is
technically difficult, highly politicized, and
difficult to administer.

49
 Central Planning or the Market?

 Market-oriented reforms recommended by

international agencies include:
 the elimination of price controls,
 privatization of state-run enterprises, and
 reductions in import restraints.

50
 Central Planning or the Market?

 The International Monetary Fund is an

international agency whose primary goals are
to stabilize international exchange rates and to
lend money to countries that have problems
financing their international transactions.

51
 Central Planning or the Market?

 The World Bank is an international agency

that lends money to individual countries for
projects that promote economic development.

52
 Growth Versus Development:
The Policy Cycle
• Structural adjustment is a series of programs in developing
nations designed to:
1. reduce the size of their public sectors through privatization and/or
expenditure reductions,
2. decrease their budget deficits,

3. control inflation, and

4. encourage private saving and investment through tax reform.

53
 Issues in Economic Development

 The growth of the population in developing nations is about 1.7

percent per year, compared to only 0.5 percent per year in
industrial market economies.

 Thomas Malthus, England’s first professor of political

economy, believed populations grow geometrically. He
believed that due to the diminished marginal productivity of
land, food supplies grow much more slowly.

54
The Growth of World Population, Projected
to 2020 A.D.

55
 Population Growth

 Population growth is determined by the relationship between

births and deaths.

 The fertility rate, or birth rate, equals:

n
u
mbe
ro
fb
ir
t
hspe
ry
ea
r

10
0
po
pu
la
ti
on

• The mortality rate, or death rate, equals:

n
u
mbe
ro
fd
ea
t
hsp
e
ry
ea
r

10
0
po
pu
la
t
io
n
56
 Population Growth

 The natural rate of population increase is the difference

between the birth rate and the death rate. It does not take
migration into account.

 Any nation that wants to slow its rate of population growth will
probably find it necessary to have in place economic incentives
for fewer children as well as family planning programs.

57
 Developing-Country Debt Burdens

 Debt rescheduling is an agreement between banks and

borrowers through which a new schedule of repayments of
the debt is negotiated; often some of the debt is written off
and the repayment period is extended.

 A stabilization program is an agreement between a

borrower country and the International Monetary Fund in
which the country agrees to revamp its economic policies to
provide incentives for higher export earnings and lower
imports.

58
 Political Systems and Economic Systems:
Socialism, Capitalism, and Communism
 Democracy and dictatorship refer to political
systems.
 A democracy is a system of government in which
ultimate power rests with the people, who make
governmental decisions either directly through voting or
indirectly through representatives.
 A dictatorship is a political system in which ultimate
power is concentrated in either a small elite group or a
single person.

59
 Political Systems and Economic Systems:
Socialism, Capitalism, and Communism

 Two major economic systems have existed:

socialism and capitalism.

• A socialist economy is one in which most capital—

factories, equipment, buildings, railroads, and so
forth—is owned by the government rather than by
private citizens. Social ownership is another term
that is used to describe a socialist economy.

60
 Political Systems and Economic Systems:
Socialism, Capitalism, and Communism

 Two major economic systems have

existed: socialism and capitalism.

• A capitalist economy is one in which most capital

is privately owned.

61
 Political Systems and Economic Systems:
Socialism, Capitalism, and Communism

 Communism is an economic system in

which the people control the means of
production (capital and land) directly,
without the intervention of a government
or state.

62
 Political Systems and Economic Systems:
Socialism, Capitalism, and Communism

 Comparing economies today, the real distinction is between

centrally planned socialism and capitalism, not between
capitalism and communism.

 No pure socialist economies and no pure capitalist

economies exist.

 The United States supports many government enterprises,

including the postal system, although public ownership is the
exception.

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 Political Systems and Economic Systems:
Socialism, Capitalism, and Communism

 Whether particular kinds of political systems tend to be

associated with particular kinds of economic systems is
debatable.

 There are capitalist economies with democratic political

institutions; socialist economies that maintain strong democratic
traditions; and democratic countries with strong socialist
institutions.

 At the heart of both the market system and democracy is

individual freedom.

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 Central Planning Versus the Market

 Just as there are no pure capitalist and no pure

socialist economies, there are no pure market
economies and no pure planned economies.
 A market-socialist economy is an economy
that combines government ownership with
market allocation.

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 The Transition to a Market Economy

• Economists generally agree on six basic requirements for a

successful transition from socialism to a market-based
system:

1. macroeconomic stabilization;

2. deregulation of prices and liberalization of

trade;
3. privatization of state-owned enterprises and
development of new private industry;

66
 The Transition to a Market Economy

• Economists generally agree on six basic requirements for a

successful transition from socialism to a market-based
system:

1. the establishment of market-supporting institutions, such

as property and contract laws, accounting systems, and
so forth;
2. a social safety net to deal with unemployment and
poverty; and
3. external assistance.

67
 The Transition to a Market Economy

• The tragedy of commons is the idea that

collective ownership may not provide the
proper private incentives for efficiency
because individuals do not bear the full costs
of their own decisions but do enjoy the full
benefits.

68
 The Transition to a Market Economy

• Shock therapy is the approach to transition

from socialism to market capitalism that
advocates rapid deregulation of prices,
liberalization of trade, and privatization.
• Advocates of a gradualist approach believe that
the best course of action is to build up market
institutions first, gradually decontrol prices, and
privatize only the most efficient government
enterprises.

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 Six Basic Requirements for Successful Transition
Economists generally agree on six basic requirements
for a successful transition to a marketbased system:
 macroeconomic stabilization,
 deregulation of prices and liberalization of trade,
 privatization of state-owned enterprises and development
of new private industry,
 establishment of market-supporting institutions such as
property and contract laws and accounting systems,
 a social safety net to deal with unemployment and
poverty, and
 external assistance. We now discuss each component.
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 Summary
 The economic problems facing the developing countries are often
quite different from those confronting industrialized nations. The
policy options available to governments may also differ.
Nonetheless, the tools of economic analysis are as useful in
understanding the economies of less developed countries as in
understanding the U.S. Economy
 LIFE IN THE DEVELOPING NATIONS: POPULATION AND
POVERTY p. 714
 The central reality of life in the developing countries is
poverty. Although there is considerable diversity across
the developing nations, most of the people in most
developing countries are extremely poor by U.S.
standards.
71
 Summary : ECONOMIC DEVELOPMENT : SOURCES
AND STRATEGIES p. 715
 Almost all developing nations have a scarcity of physical capital
relative to other resources, especially labor. The vicious-circle-of-
poverty hypothesis says that poor countries cannot escape from
poverty because they cannot afford to postpone consumption—that is,
to save—to make investments. In its crude form, the hypothesis is
wrong inasmuch as some prosperous countries were at one time
poorer than many developing countries are today. However, it is often
difficult to mobilize saving efficiently in many developing nations.
 Human capital — the stock of education and skills embodied in the
workforce—plays a vital role in economic development.
 Developing countries are often burdened by inadequate social
overhead capital, ranging from poor public health and sanitation
facilities to inadequate roads, telephones, and court systems. Such
social overhead capital is often expensive to provide, and many
governments are not in a position to undertake many useful projects
72
because they are too costly.
 Summary : ECONOMIC DEVELOPMENT :
SOURCES AND STRATEGIES p. 715
 Inefficient and corrupt bureaucracies also play a role in retarding
economic development in places
 Among the many questions governments in developing nations
must answer as they seek a road to growth and development is
how much to rely on free working markets versus central planning.
In recent decades, the pendulum has shifted toward market based
strategies, with governments playing more of a role in creating
institutions supportive of markets.
 Because developed economies are characterized by a large share
of output and employment in the industrial sector, many developing
countries seem to believe that development and industrialization
are synonymous. In many cases, developing countries have
pursued industry at the expense of agriculture, with mixed results.
Recent evidence suggests that some balance between industry and
agriculture leads to the best outcome. 73
 Summary : ECONOMIC DEVELOPMENT :
SOURCES AND STRATEGIES p. 715
 Import-substitution policies, a trade strategy that favors developing
local industries that can manufacture goods to replace imports,
were once very common in developing nations. In general, such
policies have not succeeded as well as those promoting open,
export-oriented economies.
 The failure of many central planning efforts has brought increasing
calls for less government intervention and more market orientation
in developing economies.
 Microfinance—lending small amounts to poor borrowers using peer
lending groups—has become an important new tool in encouraging
entrepreneurship in developing countries.
 China and India have followed quite different paths in recent
development.
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