ECON 114 UCLA Problems of Developing Countries Questions


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Homework 2
ECON 114
Chapter 9
1) Describe briefly five major characteristics or problems of developing countries’
agricultural sectors. Make reference to specific countries or regions where you can.
Chapter 11
1) What economic benefits might a developing country gain by reducing corruption?
Discuss only economic benefits and provide examples from specific developing
Chapter 12
1) What are the terms of trade? What factors lead them to change over time?
2) Evaluate critically the following statement: “In light of the experience of the last two
decades, free trade is the best trade policy for most developing countries.”
Chapter 13
1) Provide a definition of the current account, the capital account, and the cash account.
What is the relationship between the three accounts?
2) An IMF official was quoted as acknowledging that the Fund’s stabilization packages
have often led to adjustment without growth. However, he said, “the Fund is a firefighter,
not a carpenter, and you cannot expect the firefighter to rebuild the house as well as put
out the fire.” Provide a balanced evaluation of this statement.
Chapter 14
1) Why does multinational corporation investment not necessarily offer the advantage of
domestic employment expansion?
2) State at least two major benefits of promoting nongovernmental organizations in
developing countries as sources and conduits of foreign assistance.
Chapter 9: Agricultural Transformation and Rural
? Large part of the explanation for the Rural-Urban migration in
developing countries can be found in the economic stagnation of rural areas.
Remember ? 2/3 of the world’s poorest people are located in rural areas
and engaged primarily in subsistence agriculture, and their basic concern is
Traditionally ? agriculture has been assumed to play a passive and
supportive role; to provide sufficient low-priced food and manpower to the
expanding industrial economy, which was thought to be the dynamic
“leading sector” in any overall strategy of economic development.
Today ? development economists have come to realize that far form
playing a passive role, the agricultural sector must play an indispensable
part, especially for the low-income developing countries.
And identify three minimum components for a successful agriculture- and
employment-based strategy of economic development (integrated rural
1) Accelerated output growth through technological, institutional, and
price incentive changes designed to raise the productivity of small
2) Rising domestic demand for agricultural output derived from an
employment-oriented urban development strategy.
3) Diversified, nonagricultural, labor-intensive rural development
activities that directly and indirectly support and are supported by the
farming community.
Defying some neo-Malthusian predictions, the ability of agricultural
production to keep pace with world population has been impressive.
? Developing countries’ share of global agricultural GDP rose from 56% to
65% from 1980 to 2004, far higher than their 21% share of world nonagricultural GDP.
? Developing countries tend to have the highest share of the labor force in
agriculture, sometimes as much as 80-90%.
As Countries Develop, the Shares of GDP and Labor in Agriculture
Tend to Decline, but with Many Idiosyncrasies
Very rapid GDP growth
Rapid urbanization
Agricultural production continues to rise around the world, but progress has
been uneven, particularly in the Sub-Saharan region where the UN Food
and Agriculture Administration ( has warned of catastrophic
food shortages:
Cereal Yields by World Region, 1960-2005
A major reason for the poor performance of agriculture in low-income
countries has been the neglect of this sector in the development priorities of
their governments, which produces a bias toward investment in the urban
industrial economy.
IN FACT ? One of the most important challenges for agriculture in
development is to get the role of the government right.
? Although agriculture is generally thought as a perfectly competitive
industry, market failures are still present (such as subsidies).
Roles of the Government?
? Poverty alleviation (the lack of health and nutrition can hold back the
agricultural sector).
? Credit and insurance.
? Institutions and provision of infrastructure (roads, ports, water,
electricity, etc).
Three types of countries (World Bank approach):
1) Agriculture-based countries ? Agriculture is still a major source of
economic growth (Sub-Saharan Africa, Laos, Senegal, etc.)
2) Transforming countries ? most of the world’s rural people live in
these countries. Agriculture contributes a smaller fraction to GDP
growth (South and East Asia, North Africa, Middle East, etc.)
3) Urbanized countries ? Half or more of the poor are found in the
cities, and agriculture contributes even a smaller fraction to GDP
growth (Latin America and the Caribbean, Eastern Europe and Central
Agriculture’s Contribution to Growth and the Rural Share in Poverty
in Three Types of Countries
? Of course, regional disparities can be quite large within countries. For
example, India probably has regions that fall within each of three
Peasant Agriculture in Latin America, Asia and Africa
Mainly characterized by high concentration of large areas of land in the
hands of a small class of powerful landowners.
? Just as we draw income Lorenz curves, we can do the same with the
distribution of land and even calculate Land Gini coefficients:
Distribution of Farms and Farmland by Operational Farm Size and Land
Tenure Status In Selected Developing Countries in Asia and Latin America
? Land concentration is very high in Latin America and only relatively high
in Asia.
? However, the distribution of land changes over time (see Table 9.3 in
your textbook).
In the poorest and more backward areas, you can find these agrarian
1) Latifundio-minifundio system in Latin America:
? Latifundio ? very large landholdings, usually defined as farms large
enough to provide employment for more than 12 people, though some
employ hundreds and even thousands.
? Minifundio ? smallest farms, usually defined as farms too small to
provide employment for a single family (2 workers).
FAO stats ? 1.3% of landowners in Latin America hold 71.6% of the land
under cultivation.
A third possibility ? family farms (provide work to 2 to 4 people) or
medium size farms (employ 4 to 12 workers). Common in Brazil, Uruguay
and Venezuela.
Sources of inefficiency in farming LA land:
? Wealthy landowners often value these holdings not for their potential
contributions to national agricultural output, but rather for the
considerable power and prestige they bring.
? Much of the land is left idle or farmed less intensively.
? Transaction costs can be substantial.
Then ? minifundio owners remain in poverty and many latifundios
continue to operate below their productive potential.
2) Fragmented and heavily congested dwarf parcels of land in ASIA.
The basic problem ? Too many people crowded onto too little land.
Why? Three major interrelated forces:
a) Intervention of European Rule
? From villages and common property to parcels and private property
(which produced tenant farmers and sharecroppers)
? Landlords however, are able to avoid much of the taxation on income
(poor fiscal systems and difficulties to enforce regulations).
b) Progressive introduction of monetized transactions and the rise in
power of the moneylender.
? Once private property came into effect, land became a negotiable asset
that could be offered by peasants as security for loans and, in case of default,
could be forfeited and transferred to the often unscrupulous moneylender.
? Loss of land to rich and powerful landlords.
c) Rapid growth of Asian populations.
3) Subsistence Agriculture and Extensive Cultivation in Africa:
African agricultural systems are dominated by 3 major characteristics:
• Subsistence farming in the village community (particularly in tropical
• The existence of some (rapidly diminishing returns) land cultivated in
excess of immediate requirements.
• The rights of each family in a village to have access to land and water
in the immediate territorial vicinity, excluding those that do not
belong to the community even though they may be of the same tribe.
Low-productivity mainly results from:
1) Lack of technology
2) Shifting cultivation (land is intensively cultivated which quickly
produces diminishing returns).
3) Labor is scarce during the busiest part of the growing season, planting
and weeding times.
In addition:
? By 2007, only 4% of the crop-land in sub-Saharan Africa was irrigated.
? Dependence on unimproved seeds sown on unfertilized, rain-fed fields is
a worsening problem given both the depletion of soils and the unreliability
of rainfall.
Expansion of Modern Inputs in the World’s Developing Regions
? Women provide 60% to 80% of agricultural labor in Africa and Asia, and
40% in Latin America.
? Perhaps the most important role of women is providing food security for
the household.
? Government assistance programs tend to reach men, not women (often
because women lack collateral for loans or are barred from owing property
or conducting financial transactions without their husband’s permission).
SKIP PAGES 453-462
Toward an Strategy of Agricultural and Rural Development
The goal ? progressive improvement in rural levels of living achieved
primarily through increases in small-farm incomes, output, and productivity,
along with genuine food security.
The challenges for improving Small-Scale Agriculture
Technology and innovation ? (1) Mechanization of agriculture, increases
productivity but it increases rural unemployment; (2) Biological (hybrid
seeds and biotechnology), water control (irrigation), and chemical
((fertilizer, pesticides, insecticides, etc.) can also raise productivity.
Appropriate Institutional and Pricing Policies ? The social institutions
and government economic policies that accompany the introduction of
technology and innovations often merely serve the needs and vested interests
of the wealthy landowners.
A huge challenge ? how to ensure low agricultural prices to the expanding
urban sector while keeping the prices high enough to ensure a minimum
standard of living for those producing agricultural goods?
Conditions for Rural Development
1) Land Reform
? Farm structures and land tenure patterns must be adapted to the dual
objectives of increasing food production and promoting a wider distribution
of the benefits of the agrarian process, allowing further progress against
2) Supportive Policies
? The full benefits of small-scale agricultural development cannot be
realized unless government support systems are created that provide the
necessary incentives, economic opportunities, and access to needed credit
and inputs to enable small cultivators to expand their output and raise their
3) Integrated Development Objectives
? Attention to increasing the living standard in rural areas
? Attention to decreasing inequality of rural incomes and to lessen the
disparities between urban and rural areas
? Attention to environmental sustainability
Chapter 11: Development Policymaking and the Roles of
Market, State and Civil Society
Amartya Sen:
To be generically against markets or governments is almost as strange as to
be generically against conversations. Some conversations do harm, even to
those doing the conversing, but this is not a reason to be against
conversations in general. Something similar happens with both markets and
? A key challenge is to find the proper balance between private markets
and public policy.
After WWII and until the 1980s:
? National planning was widely believed to offer the essential and perhaps
the only institutional and organizational mechanism for overcoming the
major obstacles to development and for ensuring a sustained high rate of
economic growth.
? This was particularly true in the developing world. Unfortunately,
national plans did not deliver what it was expected and disillusionment with
planning is now widespread.
Economic Planning ? a deliberate government attempt to coordinate
economic decision making over the long run and to influence, direct and in
some cases even control the level and growth of the nation’s principal
economic variables (income, consumption, employment, investment,
savings, exports, etc.) to achieve a predetermined set of development
? This is achieved through an Economic Plan (partial or comprehensive).
? Most development plans have been formulated and carried out within the
framework of the mixed economies of the developing world.
Mixed economies ? are characterized by the existence of an institutional
setting in which some of the productive resources are privately owned and
operated and some are controlled by the public sector.
Early acceptance of planning as development tool rested on 4 main reasons:
1) Market Failure ? Occurs when there is an inefficient allocation of
goods and services in a market. Market failures can be viewed as scenarios
where individuals’ pursuit of pure self-interest leads to results that are not
efficient – that can be improved upon from the societal point-of-view.
2) Resource Mobilization and Allocation ? Ensuring that the limited
resources are employed in the most efficient way and where they are most
productive from a social point of view (as opposed to markets which are
viewed as generating less investment in areas of social priority).
3) Attitudinal or Psychological Impact ? Having a national plan can
succeed in mobilizing the people –cutting across class, race, religion, etc.behind the government in a national campaign to eliminate poverty or
disease or something else, overcoming the divisive forces of sectionalism
and traditionalism in a common quest for material and social progress.
4) Foreign Aid ? The formulation of a detailed plan has often been a
necessary condition for the receipt of bilateral and multilateral foreign aid.
Most development plans have traditionally been based initially on some
more or less formalized macroeconomic model.
? Most of these plans and models are still extensively used by the World
Bank and other development agencies.
Aggregate Growth Models
? Deal with the entire economy in terms of a limited set of macroeconomic
variables deemed most critical to the determination of levels and growth
rates of national output: savings, investments, capital stock, exports, imports,
foreign assistance, etc.
? Most models are some sort of variation of the already discussed HarrodDomar model.
Multisector Models and Sectoral Projections
? Deal with a more detailed and sophisticated approach to development
? They mostly employ the so-called input-output (IO) model, which is a
matrix representation of a nation’s (or a region’s) economy to predict the
effect of changes in one industry on others and by consumers, government,
and foreign suppliers on the economy.
Project Appraisal and Social Cost-Benefit Analysis
Project Appraisal (microeconomic technique) ? the methodology rests on
the theory and practice of social cost-benefit analysis.
The basic idea is simple ? To decide on the worth of projects involving
public expenditure, it is necessary to weigh the advantages (benefits) and the
disadvantages (costs) to society as a whole.
NOTE ? the normal yardstick of commercial profitability that guides the
investment decisions of private investors may not be appropriate guide for
public-investment decisions.
Problems of Plan Implementation and Plan Failure
? The results of development planning have been generally disappointing.
The government failure argument ? (or non-market failure) is the public
sector analogy to market failure and occurs when a government intervention
causes a more inefficient allocation of goods and resources than would occur
without that intervention.
Reasons for Plan Failure
1) Deficiencies in the plan ? Overambitious and with conflicting
objectives, too much planning.
2) Insufficient and unreliable data ? When data are weak, unreliable, or
nonexistent, as in many poor countries, the accuracy and internal
consistency of economy wide quantitative plans are greatly diminished.
3) Unanticipated economic disturbances ? Lack of control over external
unexpected shocks.
4) Institutional weaknesses ? Corruption, incompetence, bureaucracy, etc.
5) Lack of political will ? Lack of commitment on behalf of country
leaders and high-level decision makers.
Consequently, a growing number of developing countries have “adopted” a
more free-market oriented economic system:
? The 1980s and the 1990s witnessed the reemergence of free-market
economics as part of the ever-changing development orthodoxy.
? U.S. President Ronald Reagan made a famous reference to the “magic of
the marketplace” in a 1981 speech in Cancun, Mexico.
A well-functioning market system requires special social, institutional,
legal and cultural preconditions (often absent in the developing world):
? Trust in the financial sector.
? Law and order (enforcement of contracts)
? Security of property and persons
? Balance between competition and cooperation
? Division of responsibility and diffusion of power
? Community altruism (social safety nets)
? Social mobility and toleration of competitiveness
? Materialistic values as a stimulus to greater production
? Deferring gratification to generate private saving
? Rationality unconstrained by tradition
? Honesty in government
? Efficient forms of competition (limits to market power)
? Freedom of information (and protection of privacy)
? Free flows of information (no favoritism)
In addition, a well-functioning market system requires at least the following
market-facilitating legal and economic practices:
? Clear property rights
? Laws and courts to enforce them (contract and bankruptcy laws)
? Freedom to establish business
? Stable currency and reliable banking system
? Public supervision of natural monopolies
? Provision of adequate information to buyers and sellers
? Autonomous tastes
? Public management of externalities
? Stable monetary and fiscal policy instruments
? Safety nets
? Encouragement of innovation (patents and copyrights)
THUS ? It is clear that market reforms involve much more than merely
eliminating price distortions, privatizing public enterprises, and declaring
markets free.
Role and Limitations of the Market in LDCs
LDCs in general are not able to rely on the market mechanism for a variety
of reasons:
? In most LDCs markets are in reality characterized my widespread
imperfections (such as lack of information and uncertainty).
? Presence of substantial externalities: many goods have a high social
value that is not reflected in the market price (education and health services
for example). Since these goods must be provided at a price below their cost,
the private sector has no incentive to produce them and the government must
often be responsible for providing these goods.
? Government must intervene to ensure an efficient allocation of
resources: through fiscal and monetary policies, the government plays a
major role in accumulating capital (infrastructure in particular).
? Income distribution is generally an issue: even if markets are efficient,
they do not guarantee an equal distribution of income.
? Structural change: markets are generally not very good in producing the
kind of structural change for long-term economic development. The
government must intervene in such sectors to ensure that they adapt and
The Washington Consensus on the Role of the State
? The consensus reflected a free market approach to development
espoused by the IMF, the World Bank, and key Government agencies (U.S.
Treasury, Federal Reserve, etc.)
Prevalent in this consensus were the views that:
? Government was more likely to make things worse than better.
? Poverty would be taken care by growth and was not a major obstacle.
? South Korea and Taiwan have been frequently cited as examples, but
they did not really apply the elements of the consensus.
The Washington Consensus and East Asia
Toward a New Consensus?
Changes started occurring in the so-called New Consensus or Santiago
Consensus, at the April 1998 Summit of the Americas in Santiago, Chile:
? More emphasis on government’s responsibility to focus on poverty
alleviation, but the heavy emphasis on the market-based approach remains.
SKIP PAGES 544-559
It is increasingly recognized that development success also depends on a
vigorous citizen sector (NGOs, nonprofit, voluntary, independent, civil
society, etc.)
? At least 2,250 NGOs had consultative status with the UN in 2003.
? NGOs receiving Nobel Peace Prize: Doctor without Borders (1999),
Grammen Bank (2006), etc.
? The citizen sector mainly relies on voluntary efforts and influence, to
promote their values and to further social and economic development.
Activities in which NGOs have a comparative advantage typically lie
between conventional private and public goods:
? These goods tend to be partially rival, partially excludable, rival but not
excludable (natural resources such as fisheries, pastures or forests), or
excludable but not rival (technology).
Typology of Goods
Comparative advantages of NGOs (over government and markets)
? Innovative design and implementation: they can play a key role in the
design and implementation of programs focused in poverty reduction and
other development goals.
? Program flexibility: they are not constrained by the limits of public policy
or other agendas such those of donor-country foreign assistance priorities or
domestic national or governmental programs.
? Specialized technical knowledge: they can be greater repositories of
technical expertise and specialized knowledge than governments or
companies (and thus increasing the possibility of making a better use of this
? Provision of targeted local public goods: some public goods (public
health facilities, nonformal education, specialized village
telecommunications and computing facilities, community mapping and
registration, etc.) can be better designed and provided by NGOs since they
know and work with socially excluded populations.
? Common-property resource management design and implementation:
they can play an important role in insuring the sustainability of forests,
lakes, and other commons.
? Trust and Credibility: local presence and relationships, frequent
interaction and communication, and greater avenues for participation
generally produce greater trust and credibility among the poor and other
? Representation and advocacy: they may hold advantages in understanding
the needs of the socially excluded populations, who are otherwise often
excluded from political processes and even local community deliberations.
NOTE on Voluntary Failure ? NGOs are also vulnerable to weaknesses:
? NGOs may be insignificant (owing to limited resources), selective and
exclusionary, elitist and or ineffective, particularly in the developing world.
The Corruption Problem
Corruption ? the abuse of public trust for private gain.
In general ? Corruption indexes rate the incidence of corruption far higher
in developing than in developed countries.
Transparency International (TI) is an international non-governmental
organization fighting corruption and trying to raise public awareness of it.
This includes, but is not limited to, political corruption. It publishes every
year its Corruption Perceptions Index, a comparative listing of corruption
worldwide. The international headquarters is located in Berlin, Germany.
Elimination of corruption is important for several reasons, for example:
? Good governance enhances capability to function.
? Effects of corruption fall disproportionately on the poor.
Corruption as a Regressive Tax: The Case of Ecuador
The Association between Rule of Law and Per Capita Income
HOWEVER ? Good governance is broader than simply an absence of
Decentralization? is basically the process of dispersing decision-making
governance closer to the people and/or citizen.
Long-term trend in developed countries ? US, Canada, Germany and
More recently ? In Latin America and Eastern Europe.
Goal ?? Genuine participation and increased role of NGOs.
? Pragmatism is needed in dealing with the role and limitations of
economic policies in LDCs.
? Regardless of ideology, governments in LDCs have been heavily
involved in the economy.
? LDC governments shouldn’t necessarily do less, but do better.
Chapter 12: International Trade Theory and
Development Strategy
Globalization ? many interpretations
Core economic meaning of Globalization ? The increased openness of
economies to international trade, financial flows, and foreign direct
? Globalization carries benefits and opportunities, as well as costs and
Concerns with globalization center on the unevenness of the process,
particularly for poorer countries:
? If they become locked into a pattern of dependence, if dualism in LDCs
sharpens, or if some of the poor are entirely bypassed by globalization, the
poor may end up in poverty traps that are all the harder to break out without
concerted public action.
+ Much attention to trade and development issues has been focused on
understanding the spectacular export success of East Asia (Taiwan, South
Korea, etc.)
+ In Latin America, Africa and the Middle East ? primary product
exports (coffee, cotton, cacao, sugar, palm oil, bauxite, copper, etc.) have
traditionally accounted for a sizeable share of GDP (up to 25% or more),
particularly in oil-producing countries (over 70%).
+ Because the markets and prices for these exports are often unstable,
primary-product export dependence carries with a degree of risk and
uncertainty that few nations desire.
+ Many developing nations rely on the importation of materials, machinery,
capital goods, intermediate goods, etc. to fuel their industrial expansion ?
Which is made very difficult when they don’t generate foreign reserves.
+ To pay for these imports, many countries rely foreign private and public
lending and investment ? paying them represents significant burden.
+ Intervention of multilateral agencies (IMF, World Bank, etc.) forcing
developing countries in debt to adopt policies that do not always produce
desirable effects.
Five Basic Questions:
1) How does international trade affect economic growth? ? Can trade be the
“engine of growth”?
2) How does trade alter the distribution of income? ? Is trade a force for
international and domestic equality or inequality?
3) How can trade promote development?
4) Can LDCs determine how much they trade?
5) Is an outward-looking or an inward-looking trade policy best?
Importance of Exports to Different Developing Nations
Developing countries are in general more dependent on trade than developed
countries are:
? Developing countries tend to devote a larger share of their output as
merchandise exports than developed countries do.
? The exports of developed countries are much less diversified (in terms of
products and in geographical terms as well).
Merchandise Exports in Perspective: Selected Countries, 2005
Demand Elasticity, Exports Earnings Instability and Declining
Terms of Trade
TERMS OF TRADE: the relative price of a country’s exports
compared to its imports (Px/Pm)
? As the global economy grows, the relative demand for primary
products declines (low income elasticity for agricultural products).
Declining terms of trade for primary products reflected the
argument that as the prices of the sophisticated goods rose,
developing countries would need to export more and more oranges
and wheat to pay for the more expensive technological machinery.
? Without technology, developing countries had little hope for
? The “Commodity Lottery”: The luck on natural endowment and
agricultural advantage determine winners and losers in the international
export market.
? Single commodity exports were unstable for balanced and sustained
economic growth:
? Development policy is preoccupied with the needs of the export sector
with little attention to the links with domestic production and consumption.
EXAMPLE: Banana production was dominated by U.S. multinationals
that contributed little to the development of Costa Rica
(United Fruit Company) – repatriation of profits.
More modern MNCs ? CHIQUITA and DOLE
Dutch Disease ? conditions that produce a distorted pattern of
development when resources concentrate in a “hot”
sector or good; international resources are drawn in
overvaluing the exchange rate.
MOREOVER ? single commodity exports were characterized by a high
concentration in market destination.
Developing countries have responded to new international demands from
industrialization by providing raw materials and food (primary products).
1723-1790: Adam Smith ? “WEALTH OF NATIONS” (1776)
1772-1823: David Ricardo ? “COMPARATIVE ADVANTAGE”
The modern (orthodox) theory of International Trade ? The HeckscherOhlin (H-O) Theory (Swedish economists 1919 and 1930’s)
• World output is not fixed ? International trade IS NOT a zero-sum
• International trade can increase output and THEREFORE trading
partners benefit.
Division of Labor and Specialization:
? Each nation specializes in producing and trading the good with
comparative advantage.
? World resources are used more efficiently (due to specialization) =>
world output increases.
? At least one country is better off with trade, and this country’s gain is not
at the expense of the other country:
• Within each country output expands for the product in which the
country has a comparative advantage.
• The shift from no trade to trade results in more efficient world
• The quantity consumed of the importable product in each country will
Most important implications of the theory:
? The main conclusion of the neoclassical model is that all countries gain
from trade
? World output increases with trade
? Countries will tend to specialize in products that use their abundant
resources intensively
? International wage rates and capital costs will gradually tend toward
? Returns to owners of abundant resources will rise relatively
? Trade will stimulate economic growth
Trade theory and Development: The Traditional Arguments
1) Trade stimulates economic growth
2) Trade promotes international and domestic equality
3) Trade promotes and rewards sectors of comparative advantage
4) International prices and costs of production determine trading volumes
5) Outward-looking international policy is superior to isolation
The Critique of the Theory in the Context of the Developing World
• Fixed resources, full employment, and international factor MOBILITY
? World economy is characterized by rapid change, and factors of
production are fixed neither in quantity nor in quality; and are not fully
• Fixed, freely available technology and consumer sovereignty
? Technology is not fixed and is not available to every country (role of
patents and international intellectual property rights).
? Rapid technological change is profoundly affecting world trade.
• Internal factor mobility and perfect competition
? Factors are not mobile across sectors (labor in particular) and markets
are characterized by imperfect competition.
• Governmental non-interference in trade
? Definite role for State
? Industrial policy is crafted by governments (subsidies)
? Commercial policies instruments (tariffs, quotas) are state constructs
? International policies can result in uneven d