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Issues of Economic Development

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Chapter 18: Issues of Economic Development

KEY CONCEPT• A transitional economy is a country that has moved (or is moving)

from a command economy to a market economy.

WHY THE CONCEPT MATTERS• Promoting development also promotes good government and

economic opportunity in less developed countries. When a nation’s government is democratic and stable and its citizens are prosperous, the benefits reach the world community.

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Levels of DevelopmentKEY CONCEPTS

• Economists gather data to compare economies of nations– also compare impact of economies on people’s standard of living

• Have defined three major levels of economic development

Definitions of Development

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Levels of Development

Developed Nations • Developed nations have market economies with high standard of

living – high GDP, industrialization, property ownership, stable

governments– U.S., Canada, West Europe, Australia, New Zealand, Japan,

South Korea• Most people healthy, educated, with comfortable lives, urban jobs• Few agricultural workers produce food surplus through technology

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Transitional Economies • Transitional economy—country moving from command to market

economy – China, Russia, various Eastern European countries

• Example of Poland: – democracy and economic freedom improving economy and quality

of life

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Less Developed Countries• Less developed country—lower GDP, less industry, lower living

standard– often ineffective or corrupt governments do not protect property

rights• Middle-income Brazil, Thailand; low-income Mozambique, Cambodia• Low-income lack infrastructure—basic support systems of an

economy – people have little education, poor sanitation, little political freedom

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Standards of Economic Development

KEY CONCEPTS• Economists weigh various factors to evaluate a nations standard of

living– example: television ownership not equally valued in all cultures

– Africa compared to Thailand, expensive to own a TV in Africa compared to Thailand which is cheap

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Per Capita Gross Domestic Product• Per capita gross domestic product—GDP divided by total population

– most popular measure of economic development – to compare nations, figures adjusted for difference in cost of

products

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Health• Health and health care statistics help determine level of development• Infant mortality rate—babies who die in first year per 1,000 births

– low rate is result of good sanitation, health care, nutrition

• Life expectancy—number of years person likely to live Afghanistan 119.41

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Education• Literacy rate—percent of people over 15 who can read and write• Percentage of school-age children actually enrolled an important

statistic• Human development index (HDI)—combines various measures

– real GDP per capita, life expectancy, literacy rate, student enrollment

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Consumption of Goods and Services• How people spend income after food and shelter indicates

development• Increasing consumption of big-ticket items shows economy growing

– also rising living standards • Less developed nations have more growth potential for consumer

consumption • Today North America, Western Europe: 12 percent population, 60

percent consumption

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Energy Use• Electricity, energy contribute to economic development• Average global electricity consumption 2,744 kilowatt-hours per

capita per year– developed nations use over 7,000; less developed use 750

• Energy used for commerce correlates to technology use, other measures

• Projection to 2025: LDC energy use will rise far more than developed

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Labor Force• All economically active people between 15 and 65, employed or not• More developed nations have

– fewer agricultural workers, more manufacturing and service workers

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Reviewing Key Concepts

Explain the relationship between the terms in each of these pairs:

• developed nations and less developed countries• human development index and infant mortality rate

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ResourcesKEY CONCEPTS

• Fertile farmland and appropriate climate help development• Natural resources help• Also must invest in human and physical capital for economic

expansion

A Framework for Economic Development Objectives

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Resources

High Levels of Human Capital • People most valuable resource in a market economy• Commitment to education major element of growing market economy• Educated citizens can make informed decisions for themselves and

children– get health care, vote, take part in civic affairs, avoid poverty

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Resources

High Levels of Physical Capital • Physical capital, including technology, makes people more productive• Technology always being refined in developed nations

– LDCs can copy or import• Copying requires trained people; importing requires foreign

investment– investors prefer LDC with human capital

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Stability

KEY CONCEPTS• Governmental, economic environments must be stable to support

growth– human and economic capital can then be put to best use

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Stability

Effective Government Institutions• Rule of law—made public, applied fairly, used to resolve disputes

– bureaucracy and judges not corrupt• Rule of law means predictability, reduces economic risks of business• Democratic nations have higher rate of economic growth than others

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Stability

Stable Prices• Stable prices, sound fiscal and monetary policies lead to growth

– investors can make long-term plans in nation without dramatic changes

• Investors avoid nations with high inflation, volatile interest rates

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Stability

Protected Property Rights• Guaranteed property rights stimulate entrepreneurship

– businesses assured of reaping rewards if successful• Businesses avoid places where government interferes with

operations– due to corruption, decision to redistribute land to poor

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Opportunity

KEY CONCEPTS• Government can create economic opportunity by

– opening international trade– promoting social mobility– controlling corruption (Thailand)– limiting regulations

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Opportunity

Open International Trade• Fewer restrictions on free trade promote specialization, trade• LDCs often impose tariffs and other protectionist measures

– justify as short-term– costs: higher prices, inefficiency, dependence on barriers

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Opportunity

Increase Social and Economic Mobility• Strongest growth happens when opportunity opens to whole

population– U.S. studies: as people seek personal economic reward, economy

grows• Some cultures restrict women—half of labor force—economically• In cultures with fixed class structure, rich keep control of economy

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Opportunity

Control Corruption• Corruption is abuse of public office for private gain• Corrupt countries fail to develop, poor especially pay the price

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Opportunity

Limit Regulation• Reasonable tax levels and regulations create economic opportunity

– investors attracted to nations with little “red tape”• Many LDCs have significantly high number of regulations

– businesses get around them by paying off government officials

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Financing Development

KEY CONCEPTS• Four sources available for financing economic development:

– internal investment – foreign investment – foreign government aid– international agencies

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Internal Investment• Banks within a nation invest in infrastructure

– very poor nations: personal savings low, banks have little to invest• Wealthy citizens sometimes want safer, more productive investment

– result is capital flight: sources of capital are sent abroad • Government may provide funds or seek foreign investment

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Foreign Investment• Foreign portfolio investment—participation in financial markets• Foreign direct investment—establishing business in foreign country

– multinationals provide jobs and training, benefit from cheap labor• Foreign investment has grown dramatically since 1990

– LDCs have tried to create more attractive business climate

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Loans and Aid• External debt—money borrowed from foreign banks or governments

– has become problem in some countries in South America, Africa• Default—nations inability to pay interest or principle on a loan • Nations may also seek foreign aid—money from other nations

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International Help Agencies• World Bank—provides loans, policy advice, technical assistance • United Nations Development Program (UNDP)—fights poverty

– in 2006 had active programs in 174 nations

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International Help Agencies• International Monetary Fund (IMF)—international organization

– promotes monetary cooperation, fosters economic growth – also gives temporary assistance to ease balance of payments

adjustment• Helps with debt restructuring—altering debt agreements for

advantage • Stabilization programs—reforms required of economy likely to

default

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Anne Krueger: Reforming IMF Development PolicyA New Role for IMF

• As First Deputy Director, Krueger proposed new role for IMF – oversee restructuring of LDC debt rather than provide bailout

funds– let creditor supermajority overrule creditor wanting more pay than

able• Opposed forgiving debt, says debtors do not spend funds helping

poor• Agreed to forgive 18 nations’ debt that created development policies

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Explain the relationship between these terms:• International Monetary Fund and stabilization program

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New ChallengesKEY CONCEPTS

• China, former Soviet Union, Eastern Europe adopting market economy

• Government, individuals, businesses must find new answers to problems

Transition to a Market Economy

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New Challenges

Challenge 1: Poor Infrastructure • Market economy needs good infrastructure for production, distribution• Command economies had poor infrastructure

– lack of competition meant little incentive to be efficient• Transitional economies need to modernize infrastructure

– to support and spread goods and services produced

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New Challenges

Challenge 2: Privatization • Privatization—transferring state-owned property, businesses to

people • Three basic methods

– auction, leaves little savings so few people have needed funds – selling shares of businesses through vehicle like the stock market– giving vouchers to people to purchase shares of a business

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New Challenges

Challenge 3: Rise in Prices• In command economy, some goods have artificially low prices• Price controls must be removed for market to operate• In 1990, Poland began shock therapy

– abrupt shift from command to market economy– in first month inflation was 78 percent, then slowly eased

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Economic Change in the Former Soviet Bloc

KEY CONCEPTS• In 1980s, Mikhail Gorbachev introduced perestroika:

– gradually incorporate markets into Soviet Union’s economy• People called for political freedom; Soviet Union dissolved in 1991

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Example 1: Russia• Shock therapy led to high inflation—lack of goods, many

bankruptcies• Government could not perform many functions, such as tax collection • Privatization program favored politically well-connected people• President Putin reluctant to adopt democratic reforms, market

economy– combined with corruption and organized crime undermines

development

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Example 2: Former Soviet Republics• Latvia, Lithuania, Estonia did better than others, had less inflation• Baltic republics Armenia, Belarus, Kazakhstan have increased output

Higher quality goods and services produced in many nations • In other nations, economic growth stifled by

– poor infrastructure, bureaucracy, corruption, undeveloped property laws

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Example 3: Eastern Europe• Eastern European nations have had varying degrees of success• Czech Republic, Hungary, Poland joined EU, progress apparent• Problems all face include

– outdated infrastructure; costly phone and internet services – confusing business laws; high unemployment

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China Moves Toward a Market Economy

KEY CONCEPTS• China became Communist in 1949

Began transition to free market economy in 1978

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China Moves Toward a Market Economy

Example: Rapid but Uneven Growth• In 1958, began building collective farms, steel industry; much poverty • Late 1970s, agricultural reforms enacted; 1980s industrial reforms • Special economic zones—areas with different economic laws

– goal to increase foreign investment • SEZs have developed rapidly; western rural areas still poor

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Explain the difference between these terms:• shock therapy and perestroika

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China’s Campaign for Economic Power

Background• In 1978, Deng Xiaoping began the “four modernizations” (agriculture,

industry, science and technology, and defense).• China established several special economic zones, opened 14 coastal cities

to foreign investment in 1984, and joined the World Trade Organization in 2001.

What’s the Issue• What accounts for China’s successful transition to a market economy?

Thinking Economically1. What key element of financing development does document A cite as a

component of China’s success in international trade?2. The documents show that the rest of the world is uneasy with China’s

economic growth and that China has problems at home.3. Discuss these fears and problems in the context of what you’ve learned

throughout Chapter 18.

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