Chapter 4

Contemporary
Models of
Development and
Underdevelopment

Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

New Growth Theory: Endogenous
Growth

 Motivation for the new growth theory

 The Romer model
 1 
Yi  AKi L K i
(4.1)

   1
Y  AK L (4.2)

n
g n 
1     
(4.3)

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-2

New Growth Theory: Endogenous
Growth

 Motivation for the new growth theory

 The Romer model
 Criticisms of the new growth theory

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-3

Underdevelopment as a
Coordination Failure

 Coordination failures occur when agents’

inability to coordinate their actions leads to
an outcome that makes all agents worse off
 We’ll consider
– “Big push” models
– The ‘O-ring’ model

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-4

Multiple Equilibria: A
Diagrammatic Approach
 Generally, these models can be
diagrammed by graphing an S-shaped
function and the 45º line
 Equilibria are
– Stable when the function crosses the 45º line
from above
– Unstable when the function crosses the 45º line
from below

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-5

Figure 4.1

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-6

Starting Economic Development:
The Big Push

 Sometimes market failures lead to a need

for public policy intervention
 The big push: a graphical model
– Assumptions

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-7

Starting Economic Development:
The Big Push

 Sometimes market failures lead to a need

for public policy intervention
 The big push: a graphical model
– Assumptions
– Conditions for multiple equilibria
– Other cases in which a big push may be
necessary

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-8

Figure 4.2

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-9

Other Cases in Which a Big Push
May Be Necessary

 Intertemporal effects
 Urbanization effects

 Infrastructure effects

 Training effects

Why the problem cannot be solved by a

“super-entrepreneur”

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-10

Further Problems of Multiple
Equilibria

 Inefficient advantages of incumbency

 Behavior and norms
 Linkages
 Inequality, multiple equilibria, and growth

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-11

Figure 4.3

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-12

Kremer’s O-Ring Theory of
Economic Development

 Implications of the O-ring theory

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-13

Concepts for Review

 Agency costs  Congestion

 Agent  Coordination failure
 Aid failure  Deep intervention
 Asymmetric  Endogenous growth
information theory
 Big push  Linkage
 Complementarities  Multiple equilibria
 Complementary  New growth theory
investments  O-ring model
Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-14
Concepts for Review (cont’d)

 O-ring production  Romer’s endogenous

function growth model
 Pareto improvement  Solow residual
 Pecuniary externalities  Technological
 Poverty trap externalities
 Prisoners’ dilemma  Underdevelopment
 Public good trap
 Where-to-meet
dilemma
Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-15