CONTEMPORARY MODELS

OF DEVELOPMENT
UNDERDEVELOPMENT
“ Governments can
certainly deter
entrepreneurship when
they try to do too much;
but they can also deter
entrepreneurship when
they do too little.
—Dani Rodrik, One Economics, Many Recipes, 2007
2
4.1 UNDERDEVELOPMENT AS
COORDINATION FAILURE
4.1 UNDERDEVELOPMENT AS COORDINATION
FAILURE

▪ Many newer theories of economic development

that became influential in the 1990s and the
early years of the twenty-first century have
emphasized complementarities between several
conditions necessary for successful
development.
▪ These theories often highlight the problem that
several things must work well enough, at the
same time, to get sustainable development 4

under way.
4.1 UNDERDEVELOPMENT AS COORDINATION
FAILURE

▪ They also stress that in many important

situations, investments must be undertaken by
many agents in order for the results to be
profitable for any individual agent.
▪ Generally, when complementarities are present,
an action taken by one firm, worker, or
organization increases the incentives for other
agents to take similar actions.
5
4.1 UNDERDEVELOPMENT AS COORDINATION
FAILURE
▪ An important example of a complementarity is
the presence of firms using specialized skills and
the availability of workers who have acquired
those skills.
▪ Another example typical of rural developing areas
concerns the commercialization of agriculture.
▪ As another example, a new or modernizing firm
using new technologies may provide benefits to
other firms that the adopting firm cannot 6
capture.
4.1 UNDERDEVELOPMENT AS COORDINATION
FAILURE

▪ In many cases, the presence of

complementarities creates a classic "chicken
and egg" problem: Which comes first, the skills
or the demand for skills?
▪ Often the answer is that the complementary
investments must come at the same time,
through coordination.

7
4.1 UNDERDEVELOPMENT AS COORDINATION
FAILURE

▪ A coordination failure is a state of affairs in

which agents’ inability to coordinate their
behavior (choices) leads to an outcome
(equilibrium) that leaves all agents worse off
than in an alternative situation that is also an
equilibrium.

8
4.1 UNDERDEVELOPMENT AS COORDINATION
FAILURE

▪ In much of economics, such complementarities

are not present.
▪ For example, in competitive markets, when
there is excess demand, there is
counterpressure for prices to rise, restoring
equilibrium.

9
4.1 UNDERDEVELOPMENT AS COORDINATION
FAILURE

▪ Whenever congestion may be present, these

counterpressures are very strong
▪ Congestion is the opposite of a
complementarity. It is an action taken by one
agent that decreases the incentives for other
agents to take similar actions.

10
4.1 UNDERDEVELOPMENT AS COORDINATION
FAILURE

▪ In cases in which coordination failure leads to an

inferior equilibrium, there is scope for
government intervention.
▪ Many development specialists look actively for
cases in which government policy can still help,
even when government is imperfect, by pushing
the economy toward a self-sustaining, better
equilibrium (deep interventions).
11
4.1 UNDERDEVELOPMENT AS COORDINATION
FAILURE

▪ In much of economics, such complementarities

are not present.
▪ For example, in competitive markets, when
there is excess demand, there is
counterpressure for prices to rise, restoring
equilibrium.

12
4.2 MULTIPLE EQUILIBRIA:
A Diagrammatic Approach
MULTIPLE EQUILIBRIA

▪ A condition in which more than one

equilibrium exists. These equilibria
sometimes may be ranked, in the sense
that one is preferred over another, but
the unaided market will not move the
economy to the preferred outcome.
14
15
Equilibrium

▪ All particpants are doing what is best for

them, given what they expect others to
do,which in turn matches what others are
actually doing.

▪ When function crosses the 45-degree

line. 16
S-shaped “privately rational decision function”

Benefits an agent receives from taking

action depend positively on how many other
agents are expected to take the action or
extent on those action.

17
S-shaped “privately rational
decision function”

Benefits an agent receives

from taking action depend
positively on how many
other agents are expected
to take the action or
extent on those action.

18
PARETO IMPROVEMENT

A situation in which one or more persons

may be made better off without making
anyone worse off.

19
Stable & Unstale Equilibrium

STABLE function UNSTABLE function

crosses the 45 degree crosses the 45 degree
line from above. line from below.

20
• To achieve stable equilibrium,
firms must be able to coordinate
their investment decisions that all
firms benefit from each other’s
investment.

• Government intervention may be

needed.
21
4.3 Starting
Economic
Development:
The Big Push
22
Six Assumptions

Factors. We assume Factor payments. Technology.

that there is only The labor market We assume that
one factor of has two sectors. We there are N types of
production—labor. It assume that products, where N
has a fixed total workers in the is a large number.
supply, L. traditional sector For each product in
receive a wage of 1. the traditional
Workers in the sector, one worker
modern sector produces one unit
receive a wage W > 1 of output.
23
Domestic demand. International supply Market structure. We
We assume that and demand. We assume perfect
each good receives assume that the competition in the
a constant and economy is closed. traditional sector, with
equal share of This makes the model free entry and no
consumption out of easy to develop. The economic profits.
national income. most important Therefore, the price of
conclusions will each good will be 1, the
remain when trade is marginal cost of labor.
allowed, provided that We assume that at
there are advantages most, one modern- 24
to having a domestic sector firm can enter
market. each market.
Conditions for Multiple Equilibria

To begin, suppose that we have a traditional

economy with no modern production in any
market. Given the size of the fixed cost, the
answer depends on two considerations:
(1) how much more efficient the modern sector
is than the traditional sector and
(2) how much higher wages are in the modern
sector than in the traditional sector. 25
Other Cases in Which a Big Push May Be
Necessary

▪ Intertemporal effects
▪ Urbanization effects
▪ Infrastructure effects
▪ Training effects

26
4.4 Further Problems of
Multiple Equilibria
Inefficient Advantages of Incumbency

▪ The presence of increasing returns in modern

industries can also create another kind of bad
equilibrium. Once a modern firm has entered, it
has an advantage over any rivals because its
large output gives it low average costs. So if an
even better modern technology becomes
available to a potential rival, it may not be easy
for the new technology to supplant the old. 28
Even though the new technique has a lower per-unit
cost for any given level of output, the firm with the
old technique has an advantage because its large
output lets it produce at a lower per-unit cost than
that of the new technique, which starts out with a
small customer base and a large fixed cost. As a
result, firms may need access to significant
amounts of capital to cover losses while they build
their customer base.

29
Behavior and Norms

▪ Movement to a better equilibrium is

especially difficult when it involves many
individuals changing their behavior from one
of rent seeking or corruption to honesty and
the value of building a reputation to reap the
gains from cooperation (e.g., with business
partners). Your choice of partner may
determine much. 30
If you naively cooperate with an opportunistic,
predator type, you may be worse off than by going it
alone. Only by cooperating with other good-willed
cooperators may you reach the best outcome. We
cannot rely on good organizations to prevail in
competition if the rules of the game tend to reward
the bad organizations. Rather, the critical
importance of policies for developing or reforming
institutions is highlighted, such as reform of the
framework of property rights, antitrust, clean
government rules, and other laws, regulations, and
industry association norms that set the rules of the 31

game for economic life.

Linkages

There are several ways to undertake a big push,

encouraging the simultaneous expansion of the
modern sector in many industries. One strategy
for solving coordination problems is to focus
government policy on encouraging the
development of industries with key backward or
forward linkages.
32
This could mean subsidies or quid pro quos for
domestic industries to enter these key industries,
as was done in South Korea; it could mean
incentives for multinational firms to enter in key
industries and provide advanced training, a policy
followed in Singapore; or it could mean establishing
a few key public enterprises to act as pioneers in an
industry (that could later be sold), as was done in
South Korea and Taiwan. The theory of linkages
stresses that when certain industries are
developed first, their interconnections or linkages
with other industries will induce or at least 33

facilitate the development of new industries.

Backward linkages raise demand for an activity,
while forward linkages lower the costs of using an
industry’s output; both may involve interactions
between the size of the market and increasing
returns to scale and hence pecuniary externalities.

34
Inequality, Multiple Equilibria, and Growth

Other important work being done on growth and

multiple equilibria addresses the impact of
inequality on growth. The traditional view has been
that some inequality may enhance growth because
the savings of the rich are higher than those of the
poor. If at least some savings to be mobilized for
investment purposes must come from within a
country, then according to this view, too high a 35

degree of equality could compromise growth.

However, the poor save at much higher rates than
previously believed, when savings are properly
measured to include expenditures on health,
children’s education, and improvements on a home.
Similarly, if the poor lack access to credit, they may
not be able to obtain loans to finance otherwise very
productive schooling. If the poor are unable to
bequeath much to their next generation, families
can be trapped in poverty from generation to
generation; however, if schooling could somehow
be achieved, they could escape from this poverty
trap. 36
4.5 Michael Kremer’s
O-Ring T heory of
Economic
Development
37
O-Ring Theory

White Black
Is the color of milk and Is the color of coal, ebony,
fresh snow, the color and of outer space. It is the
produced by the darkest color, the result of
combination of all the the absence of or
colors of the visible complete absorption of
spectrum. light.

38
Economic Development as
Self-Discovery
3 “building blocks” of Hausmann and Rodrik
theory

▪ There is uncertainty about what products a

country can produce efficiently;
▪ there is a need for local adaptation of
imported technology so that it cannot be
used productively “off the shelf”;
▪ and once these two obstacles have been
overcome, imitation is often rapid (reducing
the profitability of pioneers). 40
4.7 The Hausmann-Rodrik-
Velasco Growth
Diagnostics Framework

Encouraging efficient investment and

widespread entrepreneurship plays a prominent
role in accelerating growth and promoting
development more broadly. But the once
popular idea of finding a “one size fits all” policy
for economic development is now generally
recognized as a myth.
42
Different countries face different binding
constraints on achieving faster rates of growth and
economic development. A key mission for economic
development specialists is to help determine the
nature of the constraints for each country. Ricardo
Hausmann, Dani Rodrik, and Andrés Velasco (HRV)
propose a growth diagnostics decision tree
framework for zeroing in on a country’s most
binding constraints on economic growth. HRV
explain that targeting the most binding constraint
has important advantages over other approaches to
policy selection. 43
44
In sum, one size does not fit all in development
policy. Economic development strategies focusing
on resource mobilization through foreign assistance
and other capital flows, along with increased
domestic national saving, can be most effective
when domestic returns are both high and privately
appropriable. In contrast, strategies focusing on
market liberalization and opening up the economy
can be most effective when social returns are high
and the most serious obstacle to private
appropriation are government-imposed excessive
taxes and restrictions. 45
4.8 CONCLUSION/SUMMARY

▪ Important note is not that people keep on

doing inefficient things.

▪ The purpose of economic development

theory is not only to understand
underdevelopment but also to devise
effective policies to redress it.
46
The contributions of the new theories of
development include

▪ a better understanding of the causes and

effects of poverty traps,
▪ achieved by more precisely pinning down
roles of different types of strategic
complementarities,
▪ explaining the role of expectations,
▪ clarifying the importance of externalities, 47
 illuminating the potential scope for deep
interventions,
 Finally, the new approaches point out more clearly
the real potential contributions of outside
development assistance

48
THANKS!
Prepared by:
Dangase, Meliza P.
Estrella, Mikhaila Andrea R.
Gocio, Yujne Naomi
Bendebel, Cedric James D.
49
IN TWO OR THREE COLUMNS

Yellow Blue Red

Is the color of gold, Is the colour of the Is the color of blood,
butter and ripe clear sky and the and because of this it
lemons. In the deep sea. It is has historically been
spectrum of visible located between associated with
light, yellow is found violet and green on sacrifice, danger and
between green and the optical spectrum. courage.
orange.

50
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THOUSAND WORDS

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sed do eiusmod tempor. sed do eiusmod tempor. dolor sit amet elit, sed do eiusmod tempor.

53
AND TABLES TO COMPARE DATA

A B C

Yellow 10 20 7

Blue 30 15 10

Orange 5 24 16

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LET’S REVIEW SOME CONCEPTS

Yellow Blue Red

Is the color of gold, butter and Is the colour of the clear sky and Is the color of blood, and
ripe lemons. In the spectrum of the deep sea. It is located because of this it has
visible light, yellow is found between violet and green on the historically been associated
between green and orange. optical spectrum. with sacrifice, danger and
courage.

Yellow Blue Red

Is the color of gold, butter and Is the colour of the clear sky and Is the color of blood, and
ripe lemons. In the spectrum of the deep sea. It is located because of this it has
visible light, yellow is found between violet and green on the historically been associated
between green and orange. optical spectrum. with sacrifice, danger and
courage.
59
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