Econ

• Causes of the wealth of nations

  • 1. A system that ensures the efficient employment of resources
  • 2. Application of technology
  • 3. Distribution of benefits throughout society
• 3 goes beyond economics into the realm of politics and conflict
• Simplest measure of wealth is Gross National Product (Income, GDP or GNI) per head, GNPpc
• GNPpc must be measured in a common currency (usually $)
• Market exchange rates can be distorted so we should use purchasing power parity exchange rates, these compare the relative cost of same bundle of goods across countries
• GNP per head is simply the average income of the country
• What about how the income is distributed across the population?
• A country with high GNPpc may have a small elite living in luxury while the majority struggle to survive
• Development should also pay attention to poverty levels, health, education, environment
• Human Development indices (HDI)


  Weighted averages of GNPpc and other factors
• There is controversy as to what to include in the HDI, there is more than just life expectancy, schooling and GNPpc
• The choice of weights in the HDI can be controversial
• New Zealand with GNPpc about 60% of US level ranks one place above USA despite similar life expectancy and years of schooling
• Classical theories of trade, growth and development


  • Malthus - economy constrained by diminishing marginal returns, Ricardo - 'iron law of wages' both imply wages return to subsistence level
  • Smith - optimistic that economy can endogenously generate the productivity gains required to escape the Malthusian trap, likely through efficiency gains due to division of labour
• Industrial revolution enables Europe to escape Malthusian trap


  1. Through 19th century Europe colonises much of world

  2. Colonies become exporters of primary products

  3. Colonies experience inflow of capital to exploit their primary goods and establish transport networks for exporting to Europe

  4. Colonies experience inflow of migrants from densely populated Europe
• All parties gained from colonisation, but for the colonies extent of gain depended on how well capital inflow used and the terms of trade
• Within countries the distribution of gains varied much, if land ownership concentrated (as in Latin America) inequality became huge, usually indigenous population came off worse
• In Europe landed aristocracy lost out to cheap food imports
• This era crunched to a halt with the turmoil of the world wars and great depression
• After World War 2 poorer countries observed the west adopting interventionist measures, some even concluded that Soviet style command economies were desirable
• Following independence many colonies distrusted capitalism and so adopted protectionism and economic planning to develop their economy
• Walt Rostow's Stages of Economic Growth


  • 1. Traditional society - most work in subsistence agriculture, little saving or investment
  • 2. Establishing pre-conditions - agricultural productivity rises and merchant class established
  • 3. The take off - increased investment and growth in a key sector lifts whole economy
  • 4. The drive to maturity - success broadly spread and self-sustaining
  • 5. The age of mass consumption - living standards of all are increased
• Arthur Lewis' dualistic economy model


  • 1. A modern capitalist sector, typically urban and industrial
  • 2. A larger traditional subsistence sector, tied to the land and subject to classical diminishing marginal returns
• Traditional sector employs bulk of population, there is just sufficient average product for each family to survive
• Society gains by transferring workers from traditional to modern sector, as modern sector is guaranteed cheap labour and workers earn more
• Growth is achieved by transferring underutilised workers from traditional to modern sector, profit gained by increased efficiency can be used for further capital accumulation
• Lewis model predictions for economies with surplus labour

  • Wages should be low (relative to developed world) to ensure labour is employed
  • Profits must be invested in productive capital (not used for consumption)
  • Investment should be appropriate to the economy, to ensure labour is fully employed and to avoid creation of a highly skilled elite
  • Inequalities will rise at first, wealth will be concentrated in the modern sector until traditional sector is able to integrate
• Note the Lewis model need not show urban bias
• Import substituting industrialisation


  • 1. Protect industries while they are 'infants'
  • 2. Direct consumption towards domestic production
  • Through learning by doing new skills are learnt and new products and resources can be developed
  • But as markets in developing countries are imperfect and traditional society may hinder change, the state should take a lead
• Case for protection in import substituting industrialisation


  • Without protection international price signals can override domestic ones
  • Internationally valued resources may leave developing country, such as through 'brain drain' or sale of mineral rights to multinational corporations or accumulated savings be lost through capital flight
  • With astute government industry can develop to no longer need protection
• Case against protection in import substituting industrialisation


  • If there are large publicly owned manufacturing firms, pressure to maintain status quo comes from within the public sector
  • Managers in private sector may find it easy to get favours from officials they went to university with
  • Price signals become distorted as an overvalued exchange rate makes imported resources cheap, while quotas and tariffs protect firms from cheap imports
  • The overvalued exchange rate makes capital cheap to import, but these economies have surplus labour and so don't yet need the capital
• In India 1950-70 industrial output growth significantly outstripped employment growth
• Urban Bias


  • Lewis model is a good approximation of China's development rapid growth - releasing surplus rural labour, but Lewis recommended an urban/rural wage differential of 30% to achieve this not the 300% China has, which may yet cause unrest
  • The urban bias in import substitution is worst when agricultural prices are suppressed, investment is diverted away from agriculture and too few industrial are jobs created, leading to shanty towns with limited public services
• Note agriculture need not stay backward, with pro-market agricultural policies the sector can modernise
• Amartya Sen's views


  • Famines tend to be less severe in democracies as the poor have voice
  • The problem is not income so much as rights
  • If the world were populated by the sort of rational beings that exist in economic theory human society would be much more miserable, the homo economicus can only be a starting point for analysis
• Key to growth is factor productivity which leads to positive externalities and exponential growth
• Market economies can be characterised by positive feedback, investment by rich raises income of all, but this is conditional on good institutions and policies
• 1798 Malthus predicted everlasting poverty, 1972 Limits to Growth predicted the world would run out of oil and other key resources by 2000, but they were proved wrong because they underestimated the ability of price signals to modify human behaviour
• Not all environmental resources have a price, in this case regulation is essential to ensure that producers face the full cost of their activity
• The non-market economies of communism polluted much more, suggesting the market must be improved not abandoned