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Ecomomics evelopment 10th y p todaro and smith chapter 11

Chapter 11
Development
Policymaking
and the Roles of
Market, State,
and Civil Society

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System of Economic Management
Mixed economy
• Private sector: profit maximizing business firms
• Public sector: employment maximizing
government agencies
Economic systems
• Capitalism: large private sector, but small public
sector
• Socialism: large public sector, but small private
Copyright
sector © 2009 Pearson AddisonWesley. All rights reserved.


11-2


Economic Role of the State


Protect private property and legal rights



Produce public goods



Improve market competition



Improve income distribution



Preserve the human environment



Manage the economy

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11-3


Development Planning
Economic plan: managing economic activity



Specific set of quantitative targets




Given time horizon (three or five years)



Stated strategies for achieving the targets



Comprehensive (the entire economy) or partial (a specific sector or industry) coverage

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11-4


Component of Development Plan


Government uses domestic saving and foreign exchange to construct economic infrastructure



Government implements economic policy (taxation, industrialization, foreign exchange control, trade restriction)

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11-5


Rationale for Planning
Reduce market failure:



Income distribution



Monopoly power



Externalities of production and consumption



Insufficient information

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11-6


Rationale for Planning


Resource mobilization and allocation



Psychological effect on achieving development goals (e.g., reducing poverty)



Foreign aid: a requirement to obtain loans and grants

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11-7


Planning Characteristics


Governmental goals and objectives



Strategies for achieving goals and objectives



Government agency for planning implementation



Planning coverage: comprehensive or partial



Planning horizon: medium or long-term



Planning methodology (macroeconomic model)

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11-8


Planning Methodology
Aggregate growth model (Harrod-Domar)



Investment demand = National saving



Foreign aid and direct foreign investment to fill-in the saving gap

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11-9


Planning Methodology
Input-Output model



Outputs of industries serve as inputs of other industries



Optimal input mix to produce maximum output to satisfy the final demand

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11-10


Project Appraisal


Weigh the costs of plans/projects against their benefits over the planning horizon



Discount the costs and benefits and compare their present values



Find an appropriate “discount factor” above the internal rate of return”



“Net” at which present value equal to zero

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11-11


Project Appraisal
Net present value, or NPV is given by

Bt − Ct
NPV = ∑
t
t (1 + r )
Where
Bt is the expected benefit at time t
Ct is the expected cost at time t
r is the government’s social rate of
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Addisondiscount
Wesley. All rights reserved.

11-12


True vs. Actual Market Value


True market value in the demand-supply price or scarcity value = shadow price reflecting social costs and
benefits



Actual market value is the market exchanged price reflecting private costs and benefits or the controlled price

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11-13


Reasons for Price Divergence


Inflation and currency control



Factor price distortions (prices, wages, interest rates, exchange rate)



Trade restrictions and import substitution



Saving deficiency



Social vs. private rate of return

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11-14


Planning Consequences


Factor price distortion, choice of technology and employment creation



Induced R-U migration



Demand for educational certification leading to employment problem



Economic structure

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11-15


Reasons for Failure of Planning


Deficiencies in plans and their implementations



External and internal disturbances



Insufficient and unreliable data



Institutional weaknesses



Lack of political will



Corruption of public servants

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11-16


The Planning Mystique


In the past, few doubted the importance and usefulness of national economic plans



Recently, however, disillusionment has set



But, a comprehensive development policy framework can play an important role in accelerating growth and reducing
poverty

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11-17


Resurgent of Market Orientation


Failure of planning



IMF and World Bank policy requirements for foreign aid and direct foreign investment



Joint ventures of domestic and foreign enterprises

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11-18


Requirements for Market Orientation


Trust



Law and order



Security of private property rights



Balancing between competition and cooperation



Division of responsibility and diffusion of power



Social safety net

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11-19


Requirements for Market Orientation


Social mobility



Individualism and materialism



Deferring gratification to create private saving



Rationality and efficiency



Honesty of government



Competition of business



Availability and freedom of information

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11-20


Need for Government
Intervention


Income redistribution through progressive taxation and transfer payments



Excess market imperfection on behalf of domestic and foreign business



Substantial negative externalities (pollution and decay)



Investment in social and human capital



Structural transformation

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11-21


Planning & Market
Reconciliation


Must achieve “effective” cooperation



Must reduce market imperfections



Must eliminate factor price distortions and price controls



Must reduce public ownership of economic enterprises



Must reduce corruption and red tape

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11-22


Non-Government Organizations
• Comparative advantages of NGOs in
Innovative design and implementation
Program flexibility
Specialized technical knowledge
Provision of targeted local public goods
Common-property resource management design and
implementation
– Trust and Credibility
– Representation and advocacy






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11-23


Corruption and Planning
• Corruption: Abuse of public trust for private gain
• Good governance enhances capability to function
• Effects of corruption fall disproportionately on the
poor
• Good governance is broader than simply an
absence of corruption
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11-24


Corruption as a Regressive Tax:
The Case of Ecuador

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11-25


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