Development Economics

1. Development is a Multidimensional Goal, Beyond Just Income.

The debate implicit in the two quotations is not about what development means, on which there is possibly widespread agreement. It is really about a view of the world—about the possibility of finding a smaller set of variables that correlates well with the multifaceted process of development.

Beyond simple metrics. While per capita income is a common yardstick, true development encompasses much more. It includes improvements in health, education, life expectancy, and access to basic services like sanitation and clean water. Focusing solely on income risks missing crucial aspects of human well-being.

Human development. Indicators like literacy rates, infant mortality, and life expectancy capture the physical quality of life. The Human Development Index (HDI) attempts to combine these with income, highlighting that countries with similar incomes can have vastly different human development outcomes, often due to inequality or policy choices.

Correlation vs. Causation. The debate isn't whether income is development, but whether income growth automatically leads to other desired outcomes. While income correlates strongly with many development indicators, the relationship is imperfect, suggesting that targeted policies are necessary to ensure broad-based improvements in human welfare.

2. Vast Global Income Disparities Persist, With Uneven Mobility Between Nations.

Economic development is probably more like a treacherous road, than a divided highway where only the privileged minority is destined to ever drive the fast lane.

Staggering inequality. The gap between the richest and poorest nations is immense, with the top 5% having per capita incomes around 29 times that of the bottom 5%. Even adjusting for purchasing power parity (PPP) doesn't erase these vast differences, although it does reduce them somewhat by accounting for lower prices of non-traded goods in poorer countries.

Uneven progress. While the overall global distribution has been relatively stable, individual countries experience significant upward and downward mobility. East Asian economies have seen meteoric rises, while many in sub-Saharan Africa and Latin America faced stagnation or decline in recent decades, illustrating that progress is possible but not guaranteed.

History matters. Analysis of country mobility suggests that middle-income countries are more likely to change their relative position than the very rich or very poor. This indicates that a history of poverty or wealth can create sticky situations, challenging the simple notion that poorer countries should grow faster due to advantages like adopting existing technology.

3. High Inequality Within Developing Countries is Both an Ethical Concern and a Barrier to Progress.

The presence of inequality affects the way in which an economy works and prevents (or perhaps promotes!) some other goal that we are interested in.

Double burden. People in developing countries often face a double disadvantage: living in a country with low average income and experiencing high levels of inequality within that country. This means the poorest segments of the population are particularly vulnerable.

Functional role. Beyond ethical concerns, inequality has functional impacts on development.

• Savings rates: Inequality can affect aggregate savings depending on how marginal savings vary with income.
• Political stability: High inequality can fuel social unrest and political demands for redistribution.
• Growth: Some evidence suggests initial inequality can retard subsequent economic growth, possibly through political instability or by limiting access to opportunities.

Measurement challenges. Measuring inequality accurately is complex, involving choices about income vs. wealth, temporary vs. chronic disparities, and household vs. individual focus. Tools like the Lorenz curve and measures like the Gini coefficient help quantify inequality, but comparisons can be ambiguous when distributions cross.

4. Poverty is a Widespread, Multidimensional Scourge With Self-Perpetuating Mechanisms.

Poverty was a medieval scourge for a good reason: the world was generally poor then. There is little excuse for living with poverty today.

Beyond income thresholds. Poverty is defined by a lack of access to basic needs and acceptable participation in society, often measured against a poverty line. However, it's also about vulnerability, lack of assets, undernutrition, and limited access to health and education.

Characteristics of the poor:

• Often live in large households with high dependency ratios.
• Disproportionately female-headed households.
• Concentrated in rural areas, often among the landless or near-landless.
• Low levels of human capital (education, health).
• High incidence of undernutrition.

Functional impacts. Poverty isn't just an outcome; it's a cause of further problems.

• Credit/Insurance: Lack of collateral and high risk aversion limit access to formal financial markets.
• Labor: Undernutrition reduces work capacity, creating a vicious cycle of low income and poor health.
• Household: Extreme poverty can lead to unequal resource allocation within households, often disadvantaging women and the elderly.

5. Population Growth Follows a Predictable Transition, Driven by Socioeconomic Change.

The question of how population growth affects development runs into an immediate difficulty. How do we value the lives of the people yet unborn?

The demographic transition. Historically, societies move through phases: high birth/death rates, falling death rates with high birth rates (population explosion), and finally falling birth rates. Developing countries are undergoing this transition at an accelerated pace compared to developed nations' past experiences.

Determinants of fertility. Fertility decisions are influenced by:

• Mortality rates: High child mortality encourages higher birth rates for security.
• Missing markets: Lack of social security or insurance makes children valuable for old-age support.
• Costs of children: Opportunity costs (especially women's wages) and direct costs influence family size.
• Social norms: Traditions regarding family size, marriage age, and gender bias play a significant role.

Impact on development. Population growth has complex effects.

• Negative: Dilutes per capita resources, increases dependency ratios, strains infrastructure and environment.
• Positive: Provides a larger labor force, potentially spurs innovation (demand- or supply-driven), and increases market size.

6. Economic Development Involves a Fundamental Structural Shift from Rural to Urban.

By far the most important structural feature of developing countries is the distinction between the rural and the urban sector.

Dual economy. Development often involves the movement of resources from a traditional (often rural/agricultural) sector to a modern (often urban/industrial) sector. This creates a dual economy with distinct characteristics.

Resource flows. Key interactions include:

• Labor migration: People move from rural to urban areas seeking better opportunities.
• Agricultural surplus: Food produced in excess of farmers' needs feeds the non-agricultural workforce.
• Demand/Supply: Urban industries demand agricultural inputs and supply manufactured goods and services to rural areas.

Urban structure. The urban sector often comprises a formal sector (regulated, higher wages) and a large informal sector (unregulated, low wages, easy entry). The informal sector often absorbs migrants who don't find formal jobs.

Lewis model. This framework describes development driven by labor transfer from a traditional sector with surplus labor (zero or low marginal product) to a modern sector limited by capital accumulation. It highlights the importance of agricultural surplus to support industrial workers and the potential for development with "unlimited supplies of labor."

7. Rural Markets for Land, Labor, Credit, and Insurance are Shaped by Information, Incentives, and Risk.

An essential property of imperfect markets is that they are contagious: a market failure in some sector can lead to problems in other markets.

Interconnected imperfections. Unlike idealized competitive markets, rural markets for land, labor, credit, and insurance are deeply intertwined and often fail due to:

• Information asymmetry: One party knows something the other doesn't (e.g., tenant effort, borrower risk).
• Incentive problems: Contracts can't perfectly align interests (e.g., sharecropping disincentives).
• Enforcement limits: Legal systems are weak, making contracts hard to enforce (e.g., loan repayment, insurance claims).

Land markets. Inequality in land ownership is common. Rental markets (fixed rent, sharecropping) and labor markets emerge to balance operational use. Sharecropping, despite potential inefficiency (Marshallian argument), persists due to risk sharing benefits for risk-averse tenants.

Labor markets. Casual labor (easy to monitor tasks) and permanent labor (harder tasks, long-term ties) coexist. Permanent contracts can provide incentives (threat of firing) or insurance (income smoothing), but are limited by information flow and enforcement.

Credit and Insurance. These markets are particularly prone to failure. Lack of collateral, limited liability, and information asymmetry lead to credit rationing and high interest rates. Insurance is limited by verification problems, moral hazard, and enforcement, often leading to informal, community-based arrangements.

8. Trade Patterns Reflect Comparative Advantage, But Policy and Market Failures Create Complex Realities.

This observation, along with Figure 16.1, appears to support the following general hypothesis: LDCs export primary products and import manufactured goods, whereas developed countries export manufactures.

Comparative advantage. Countries specialize and trade based on relative production costs, driven by differences in technology (Ricardian model) or factor endowments (Heckscher-Ohlin model). This predicts LDCs export labor/resource-intensive goods and DCs export capital/skill-intensive goods.

Beyond simple models. Real-world trade is more complex:

• Intra-industry trade: Developed countries trade similar manufactured goods, driven by demand for variety and economies of scale.
• Preferences: Varying demand patterns (e.g., food share declines with income) can dampen trade between dissimilar countries.
• Market failures: Capital market imperfections, externalities (learning by doing), and coordination failures can create a case for trade policy intervention.

Trade policy. Governments intervene through import substitution (tariffs, quotas) or export promotion (subsidies, preferential credit). These policies aim to protect domestic industries, foster dynamic comparative advantage, or address other market failures, but can create distortions and vested interests.

Structural adjustment. Crises (like the 1980s debt crisis) often force countries to abandon inward-looking policies for outward orientation, involving trade liberalization, devaluation, and fiscal/monetary discipline, often under the guidance of international organizations.

9. History and Expectations Play a Crucial Role in Determining Development Paths.

The fact of the matter is that people the world over are intrinsically the same: they are all human beings, with the same hopes and desires.

Path dependence. Initial conditions and past events can significantly shape future development trajectories. This isn't necessarily due to intrinsic differences between people, but how historical context influences economic interactions.

Complementarities. Situations where the benefit of taking an action increases with the number of others taking the same action (e.g., adopting a technology, investing in an industry) can lead to multiple equilibria.

• Low-level traps: Economies can get stuck in undesirable outcomes if expectations of low activity are self-fulfilling.
• Coordination failure: Individuals may fail to coordinate on a better outcome due to lack of trust or the cost of "going first."

Increasing returns. Industries with declining average costs as production scales up can also lead to historical lock-in. Early entrants gain an advantage, making it hard for new firms (even more efficient ones) to compete, especially with imperfect capital markets.

Policy implications. Understanding path dependence suggests that temporary interventions (like a "big push" or targeted linkages) might have lasting effects by shifting the economy to a better equilibrium. However, the stickiness of history can make such shifts difficult.

10. Market Failures, Information Asymmetry, and Enforcement Limits Drive Many Development Challenges.

Institutions as diverse as tied labor, credit cooperatives, and extended families can be seen as responses to market failure of some sort, precipitated in most cases by missing information or by the inability of the legal system to swiftly and efficiently enforce contracts.

Core problems. Many seemingly disparate issues in development economics stem from fundamental market imperfections. These include:

• Missing markets: Markets for certain goods or services (like insurance against idiosyncratic shocks) may not exist.
• Incomplete markets: Existing markets may not cover all relevant contingencies or time periods.
• Imperfect competition: Markets may be dominated by a few players with market power.

Underlying causes. These failures are often rooted in:

• Information asymmetry: One party in a transaction has more or better information than the other (e.g., borrower risk, worker effort).
• Enforcement problems: Contracts cannot be costlessly written, monitored, and enforced by a third party (like a court).

Consequences. These imperfections lead to:

• Inefficiency: Resources are not allocated to their most productive uses (e.g., credit rationing, underinvestment in human capital).
• Inequality persistence: Initial disparities in assets or opportunities are reinforced rather than smoothed over time.
• Suboptimal outcomes: Societies may get stuck in low-level equilibria (e.g., poverty traps, coordination failures).

Informal institutions. In the absence of formal markets or strong legal systems, societies develop informal institutions (like interlinked contracts, community insurance, social norms) as second-best solutions to cope with these fundamental constraints.

Last updated: June 12, 2025