Modern Economic Theory and Development

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Modern Economic Theories

- Development is a process of organisational change than a process of capital accumulation

- Fundermentals are not only the deep determinants of economic development

- industrial countries differ from developing countries

1) Level of capital and their human capital

2) Different production functions and are organised in different ways

3) focus on fundamentals like

Resources

Technology

Preference

- 3 Broad interrelated programs

1) economics of information

2) theory of coordination problems

3) institutional economics

- Basic influences on outcomes

Institution

To shift the boundary between

what we black-box (for example, trat as an institutional rigidity) and

what we explain with our models

5 examples of strong implications

Complementarities in industrialisation

Rural Credits

Labour Market

Saving Rates

Political Constrains

The distribution of wealth

transaction costs depend on institutions, that institutions are endogenous, and that the distribution of wealth affects economic efficiency both directly and through its effect on institutions.

How distribution affects wealth

Principal-agent relationship ->focus on the design of the contract to motivate the agent to act in the principal's interest

if the distribution of wealth is so unequal that some individuals have more than enough wealth to put their skills to best use while others have so little wealth that they cannot even obtain credit to undertake a productive project, the catalytic role of wealth will be limited.

wealth distribution affects the market decisions of individuals, it affects macrovariables such as prices and wages, and so the welfare of any single agent depends, in general, on the entire distribution of wealth. - Sharecropping

wealth distribution affects contracts, incentives, and outcomes in one period, it affects the distribution of wealth in the next.

Lack of bargaining power

history

set the preconditions that drive the economy to a particular steady state

affects outcomes by affecting belief

The revelation that any member of the group was dishonest in the past will increase the time it takes for any given agent to establish a reputation for honesty. This will lower the individual’s incentives to be honest and may create a vicious circle of corruption, where “the new members of an organization may suffer from the original sin of their elders long after the latter are gone. (p. 1)” This is an example of path dependency, where the level of a variable in the future depends on its level in the past.

affects exposure to cultural models, which shapes preferences.

ecology

Neoclassical Theory

Every equilibrium is a Pareto optimum

Low capital cannot explain underdevelopment

Coordination failure can be explained through - Government impediments to markets that prevent the economy from working smoothly

rent seeking, inefficient institutes

underinvestment in research and development and training

A Particular set of institution in an economy does not matter

outcomes are determinant by fundamental forces by reflecting the 3 points

the forces lead to Pareto-efficient outcomes

institution do not event influence the choice of the equilibrium

It focuses on the efficiency and productive resources always gravitated through market exchange into the hands of the person who valued them the most.

Multiple equilibria

Although neoclassical economics has failed to provide us with a theoretical framework for thinking about the problems of develop

modern economic theory and development, it has played a critical role in the evolution of development theory. By arguing that institutions do not matter, it has forced us to think about why they do. By arguing that wealth distribution does not matter, it has forced us to think about why it does. And by arguing that the main interactions in an economy are mediated by prices, it has forced us to think about the myriad of other important interactions in our ecosystem.

Coase Theorm

- private bargaining would provide an antidote so that the economy would still be efficient. To be sure, Coase recognized that his theorem would not hold in the presence of transaction costs (McCloskey 1998). If a situation does have transaction costs or information problems, then it does matter how wealth and property rights are distributed. Transaction costs are important, particularly in developing countries.

Solow's neoclassical growth model

there was a unique equilibrium at a moment in time. In his model, equilibrium in the long run did not depend on history, institutions, or the distribution of wealth. The celebrated prediction of his model was the convergence of per capita incomes across economies.

Harberger Triangles and Krueger Rectangle: Distortion

government-induced distortions

stemming from taxes, tariffs, and quotas, for example—are critical to explaining divergent economic performances across economies. Government controls over economic activity not only misallocate resources among productive activities, inducing Harberger (1964) triangles, but also invite competition for government protection that leads to the dissipation of resources in rent-seeking activities such as lobbying. In a limiting case—constant returns to scale in rent-seeking—the rent-seeking activities will dissipate the total value of the rents, producing Krueger (1974) rectangles of deadweight loss.