Chapter 23 Economic Growth in Developing and Transitional

Chapter 23 Economic Growth in Developing and Transitional Economies Prepared by: Fernando & Yvonn Quijano © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair

CHAPTER 23: Economic Growth in Developing and Transitional Economies 23 Chapter Outline Life in the Developing Nations: Population and Poverty Economic Development: Sources and Strategies The Sources of Economic Development Strategies for Economic Development Growth versus Development: The Policy Cycle Issues in Economic Development Population Growth Developing-Country Debt Burdens Economies in Transition Political Systems and Economic Systems: Socialism, Capitalism, and Communism Central Planning versus the Market The End of the Soviet Union The Transition to a Market Economy Six Basic Requirements for Successful Transition © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 2

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIC GROWTH IN DEVELOPING AND TRANSITIONAL ECONOMIES The economic problems facing the developing countries are often quite different from those confronting industrialized nations. The policy options available to governments may also differ. Nonetheless, the tools of economic analysis are as useful in understanding the economies of less developed countries as in understanding the U. S. economy. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 3

CHAPTER 23: Economic Growth in Developing and Transitional Economies LIFE IN THE DEVELOPING NATIONS: POPULATION AND POVERTY TABLE 23. 1 Indicators of Economic Development COUNTRY GROUP POPULATION, 2004 GROSS INFANT ANNUAL NATIONAL MORTALITY, URBAN HEALTH INCOME 2003 POPULATION PER EXPENDITURES (DEATHS CAPITA, PER CAPITA BEFORE (PERCENTAGE 2004 AGE 5 PER OF TOTAL), (DOLLARS) 1, 000 BIRTHS) 2002 Low-income 2. 3 billion 510 29 122. 0 30 Lower middle-income 2. 4 billion 1, 580 75 42. 0 47 Upper middle-income 575. 9 million 4, 770 243 29. 7 72 1. 0 billion 32, 040 2, 977 7. 0 76 High-income Source: World Bank, www. worldbank. org While the developed nations account for only about one-quarter of the world’s population, they are estimated to consume three-quarters of the world’s output. This leaves the developing countries with about three-fourths of the world’s people, but only one-fourth of the world’s income. The simple result is that most of our planet’s population is poor. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 4

CHAPTER 23: Economic Growth in Developing and Transitional Economies In the year 2006, the population of the world and the number of nations were: a. 200 billion people and 155 nations. b. 6. 5 billion and over 200 nations. c. 1. 2 billion and more than 2, 000 nations. d. 3. 2 billion and more than 300 nations. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 5

CHAPTER 23: Economic Growth in Developing and Transitional Economies In the year 2006, the population of the world and the number of nations were: a. 200 billion people and 155 nations. b. 6. 5 billion and over 200 nations. c. 1. 2 billion and more than 2, 000 nations. d. 3. 2 billion and more than 300 nations. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 6

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES THE SOURCES OF ECONOMIC DEVELOPMENT Capital Formation vicious-circle-of-poverty hypothesis Suggests that poverty is self-perpetuating because poor nations are unable to save and invest enough to accumulate the capital stock that would help them grow. capital flight The tendency for both human capital and financial capital to leave developing countries in search of higher rates of return elsewhere. Poverty alone cannot explain capital shortages, and poverty is not necessarily selfperpetuating. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 7

CHAPTER 23: Economic Growth in Developing and Transitional Economies The vicious cycle of poverty is an explanation of poverty that emphasizes: a. Income distribution and wealth accumulation. b. Hunger, illiteracy, and malnutrition. c. Consumption, saving, investment, and capital accumulation. d. Agriculture versus industry and imports versus exports. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 8

CHAPTER 23: Economic Growth in Developing and Transitional Economies The vicious cycle of poverty is an explanation of poverty that emphasizes: a. Income distribution and wealth accumulation. b. Hunger, illiteracy, and malnutrition. c. Consumption, saving, investment, and capital accumulation. d. Agriculture versus industry and imports versus exports. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 9

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES Human Resources and Entrepreneurial Ability brain drain The tendency for talented people from developing countries to become educated in a developed country and remain there after graduation. Development cannot proceed without human resources capable of initiating and managing economic activity. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 10

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES Social Overhead Capital social overhead capital Basic infrastructure projects such as roads, power generation, and irrigation systems. The governments of developing countries can do important and useful things to encourage development, but many of their efforts must be concentrated in areas that the private sector would never touch. If government action in these realms is not forthcoming, economic development may be curtailed by a lack of social overhead capital. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 11

CHAPTER 23: Economic Growth in Developing and Transitional Economies Which of the following statements is correct? a. Poverty alone cannot explain capital shortages, and poverty is not necessarily self perpetuating. b. Development cannot proceed without human resources capable of initiating and managing economic activity. c. The governments of developing countries can do important and useful things to encourage development, especially in areas that the private sector would never touch. d. All of the above statements are correct. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 12

CHAPTER 23: Economic Growth in Developing and Transitional Economies Which of the following statements is correct? a. Poverty alone cannot explain capital shortages, and poverty is not necessarily self perpetuating. b. Development cannot proceed without human resources capable of initiating and managing economic activity. c. The governments of developing countries can do important and useful things to encourage development, especially in areas that the private sector would never touch. d. All of the above statements are correct. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 13

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES FOR ECONOMIC DEVELOPMENT Agriculture or Industry? TABLE 23. 2 The Structure of Production in Selected Developed and Developing Economies 2003 PER-CAPITA GROSS NATIONAL INCOME (GNI) PERCENTAGE OF GROSS DOMESTIC PRODUCT AGRICULTURE INDUSTRY 330 45 16 39 440 21 27 53 China 1, 290 15 51 35 Colombia 2, 000 13 0 87 Thailand 2, 540 10 44 46 Brazil 3, 090 5 17 78 Korea (Rep. ) 13, 980 3 35 62 United States 41, 400 2 Japan 37, 180 1 30 68 COUNTRY Tanzania Bangladesh $ SERVICES Source: World Bank, www. worldbank. org, 2005. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 14

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES Exports or Import Substitution? import substitution An industrial trade strategy that favors developing local industries that can manufacture goods to replace imports. export promotion A trade policy designed to encourage exports. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 15

CHAPTER 23: Economic Growth in Developing and Transitional Economies When imports of manufactured goods become relatively expensive in the domestic market, while exports become relatively inexpensive world markets, a country would naturally tend to choose: a. Import substitution over export promotion. b. Export promotion over import substitution. c. Both import substitution and export promotion. d. Neither import substitution nor export promotion. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 16

CHAPTER 23: Economic Growth in Developing and Transitional Economies When imports of manufactured goods become relatively expensive in the domestic market, while exports become relatively inexpensive world markets, a country would naturally tend to choose: a. Import substitution over export promotion. b. Export promotion over import substitution. c. Both import substitution and export promotion. d. Neither import substitution nor export promotion. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 17

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES Central Planning or the Market? International Monetary Fund (IMF) An international agency whose primary goals are to stabilize international exchange rates and to lend money to countries that have problems financing their international transactions. World Bank An international agency that lends money to individual countries for projects that promote economic development. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 18

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES GROWTH VERSUS DEVELOPMENT: THE POLICY CYCLE structural adjustment A series of programs in developing nations designed to (1) reduce the size of their public sectors through privatization and/or expenditure reductions, (2) decrease their budget deficits, (3) control inflation, and (4) encourage private saving and investment through tax reform. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 19

CHAPTER 23: Economic Growth in Developing and Transitional Economies ISSUES IN ECONOMIC DEVELOPMENT POPULATION GROWTH The Consequences of Rapid Population Growth Rapid population growth is characteristic of many developing countries. Large families can be economically rational for parents who need support in their old age, or because children offer an important source of labor. However, having many children does not mean a net benefit to society as a whole. Rapid population growth can put a strain on already overburdened public services such as education and health. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 20

CHAPTER 23: Economic Growth in Developing and Transitional Economies ISSUES IN ECONOMIC DEVELOPMENT FIGURE 23. 1 The Growth of World Population, Projected to 2020 A. D. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 21

CHAPTER 23: Economic Growth in Developing and Transitional Economies Thomas Malthus, England’s first professor of political economy, expressed his fears about: a. Excessive industrialization leading to worker exploitation. b. Geometric growth in population but diminishing marginal productivity of the land. c. The limitations that population growth imposes on saving and investment. d. The inability of societies to improve human capital through nutrition and formal education when population grows too rapidly. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 22

CHAPTER 23: Economic Growth in Developing and Transitional Economies Thomas Malthus, England’s first professor of political economy, expressed his fears about: a. Excessive industrialization leading to worker exploitation. b. Geometric growth in population but diminishing marginal productivity of the land. c. The limitations that population growth imposes on saving and investment. d. The inability of societies to improve human capital through nutrition and formal education when population grows too rapidly. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 23

CHAPTER 23: Economic Growth in Developing and Transitional Economies ISSUES IN ECONOMIC DEVELOPMENT Causes of Rapid Population Growth fertility rate The birth rate. Equal to (the number of births per year divided by the population) x 100. mortality rate The death rate. Equal to (the number of deaths per year divided by the population) x 100. natural rate of population increase The difference between the birth rate and the death rate. It does not take migration into account. Any nation that wants to slow its rate of population growth will probably find it necessary to have in place economic incentives for fewer children as well as family planning programs. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 24

CHAPTER 23: Economic Growth in Developing and Transitional Economies The difference between the birth rate and the death rate is called: a. The fertility rate. b. The mortality rate. c. The natural rate of population increase. d. The labor force participation rate. e. The stabilization rate. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 25

CHAPTER 23: Economic Growth in Developing and Transitional Economies The difference between the birth rate and the death rate is called: a. The fertility rate. b. The mortality rate. c. The natural rate of population increase. d. The labor force participation rate. e. The stabilization rate. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 26

CHAPTER 23: Economic Growth in Developing and Transitional Economies ISSUES IN ECONOMIC DEVELOPMENT DEVELOPING-COUNTRY DEBT BURDENS debt rescheduling An agreement between banks and borrowers through which a new schedule of repayments of the debt is negotiated; often some of the debt is written off and the repayment period is extended. stabilization program An agreement between a borrower country and the International Monetary Fund in which the country agrees to revamp its economic policies to provide incentives for higher export earnings and lower imports. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 27

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIES IN TRANSITION For 40 years, between the end of World War II and the mid-1980 s, a powerful rivalry existed between the Soviet Union and the United States. We reflect on historical political rivalries in an economics text for two reasons. • First, the 40 -year struggle between the United States and the Soviet Union was fundamentally a struggle between two economic systems: market -based capitalism (the U. S. system) and centrally planned socialism (the Soviet system). • Second, the Cold War ended so abruptly in the late 1980 s because the Soviet and Eastern European economies virtually collapsed during that period. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 28

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIES IN TRANSITION POLITICAL SYSTEMS AND ECONOMIC SYSTEMS: SOCIALISM, CAPITALISM, AND COMMUNISM socialist economy An economy in which most capital is owned by the government instead of private citizens. Also called social ownership. capitalist economy An economy in which most capital is privately owned. communism An economic system in which the people control the means of production (capital and land) directly, without the intervention of a government or state. Comparing economies today, the real distinction is between centrally planned socialism and capitalism, not between capitalism and communism. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 29

CHAPTER 23: Economic Growth in Developing and Transitional Economies Which of the following systems is characterized by social ownership of capital? a. A capitalist economy. b. A socialist economy. c. Communism. d. A market-socialist economy. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 30

CHAPTER 23: Economic Growth in Developing and Transitional Economies Which of the following systems is characterized by social ownership of capital? a. A capitalist economy. b. A socialist economy. c. Communism. d. A market-socialist economy. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 31

CHAPTER 23: Economic Growth in Developing and Transitional Economies ECONOMIES IN TRANSITION CENTRAL PLANNING VERSUS THE MARKET Just as there are no pure capitalist and no pure socialist economies, there are no pure market economies and no pure planned economies. Generally, socialist economies favor central planning over market allocation, while capitalist economies rely to a much greater extent on the market. Nonetheless, some variety exists. market–socialist economy An economy that combines government ownership with market allocation. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 32

CHAPTER 23: Economic Growth in Developing and Transitional Economies When comparing economies today, the real distinction is between: a. Centrally planned communism and market socialism. b. Centrally planned socialism and capitalism. c. Capitalism and communism. d. Transitional economies and purely communist economies. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 33

CHAPTER 23: Economic Growth in Developing and Transitional Economies When comparing economies today, the real distinction is between: a. Centrally planned communism and market socialism. b. Centrally planned socialism and capitalism. c. Capitalism and communism. d. Transitional economies and purely communist economies. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 34

CHAPTER 23: Economic Growth in Developing and Transitional Economies THE END OF THE SOVIET UNION The Soviet Union grew rapidly through the mid-1970 s. During the late 1950 s, the Soviet Union’s economy was growing much faster than that of the United States. The key to early Soviet success was rapid planned capital accumulation. In the late 1970 s, things began to deteriorate. Dramatic reforms were finally introduced by Mikhail Gorbachev after his rise to power in 1985. Nonetheless, the Soviet economy collapsed in 1991. The Soviet Union was dissolved, and the new president of the Russian Republic, Boris Yeltsin, was left to start the difficult task of transition to a market system. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 35

CHAPTER 23: Economic Growth in Developing and Transitional Economies THE TRANSITION TO A MARKET ECONOMY SIX BASIC REQUIREMENTS FOR SUCCESSFUL TRANSITION Economists generally agree on six basic requirements for a successful transition from socialism to a marketbased system: (1) macroeconomic stabilization; (2) deregulation of prices and liberalization of trade; (3) privatization of state-owned enterprises and development of new private industry; (4) establishment of market-supporting institutions such as property and contract laws, accounting systems, and so forth; (5) a social safety net to deal with unemployment and poverty; and (6) external assistance. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 36

CHAPTER 23: Economic Growth in Developing and Transitional Economies THE TRANSITION TO A MARKET ECONOMY Macroeconomic Stabilization To achieve a properly functioning market system, prices must be stabilized. Deregulation of Prices and Liberalization of Trade An unregulated price mechanism ensures an efficient allocation of resources across industries. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 37

CHAPTER 23: Economic Growth in Developing and Transitional Economies THE TRANSITION TO A MARKET ECONOMY Privatization Private ownership provides a strong incentive for efficient operation, innovation, and hard work that is lacking when ownership is centralized and profits are distributed to the people. tragedy of commons The idea that collective ownership may not provide the proper private incentives for efficiency because individuals do not bear the full costs of their own decisions but do enjoy the full benefits. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 38

CHAPTER 23: Economic Growth in Developing and Transitional Economies Which of the following is an initiative for countries in transition to avoid the tragedy of commons? a. Macroeconomic stabilization. b. Deregulation of prices and liberalization of trade. c. Privatization. d. Market-supporting institutions. e. A social safety net and external assistance. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 39

CHAPTER 23: Economic Growth in Developing and Transitional Economies Which of the following is an initiative for countries in transition to avoid the tragedy of commons? a. Macroeconomic stabilization. b. Deregulation of prices and liberalization of trade. c. Privatization. d. Market-supporting institutions. e. A social safety net and external assistance. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 40

CHAPTER 23: Economic Growth in Developing and Transitional Economies THE TRANSITION TO A MARKET ECONOMY Market-Supporting Institutions The capital market, which channels private saving into productive capital investment in developed capitalist economies, is made up of hundreds of different institutions. Social Safety Net This social safety net might include unemployment insurance, aid for the poor, and food and housing assistance. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 41

CHAPTER 23: Economic Growth in Developing and Transitional Economies Which of the following are market supporting institutions? a. Private property. b. The right to profits. c. The enforcement of contracts and property rights. d. All of the above. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 42

CHAPTER 23: Economic Growth in Developing and Transitional Economies Which of the following are market supporting institutions? a. Private property. b. The right to profits. c. The enforcement of contracts and property rights. d. All of the above. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 43

CHAPTER 23: Economic Growth in Developing and Transitional Economies THE TRANSITION TO A MARKET ECONOMY External Assistance Very few believe the transition to a market system can be achieved without outside support and some outside financing. Shock Therapy or Gradualism? shock therapy The approach to transition from socialism to market capitalism that advocates rapid deregulation of prices, liberalization of trade, and privatization. © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 44

CHAPTER 23: Economic Growth in Developing and Transitional Economies REVIEW TERMS AND CONCEPTS brain drain capital flight capitalist economy communism debt rescheduling export promotion fertility rate import substitution International Monetary Fund (IMF) market–socialist economy mortality rate natural rate of population increase shock therapy social overhead capital socialist economy stabilization program structural adjustment tragedy of commons vicious-circle-of-poverty hypothesis World Bank © 2007 Prentice Hall Business Publishing Principles of Economics 8 e by Case and Fair 45