Chapter 1.

FOUNDATIONS OF DEVELOPMENT ECONOMICS

1.1Welfare Concept

Human Development Index (HDI) of the United Nations Welfare cannot be measured only by income per capita:

Saudi Arabia and Russia are rich because of natural resources but they are not really “developed”

HDI: life expectancy, education (years of education per capita), income per capita

Figure 1.1 in Akın (2007): Compare GDP per capita and HDI in Republic of South Africa, Turkey, Chile

Table 1.2 in Akın (2007): countries with highest HDI: Norway, İceland, Luxembourg, Canada, etc.

1.1Welfare Concept

Human Development Index Table 1.3: countries with lowest HDI: Niger, Sierra

Leone, Burkina Faso, Mali, Chad, etc.. Compare Norway vs. Niger:

Life Expectancy: 79.4 vs. 42.1 Literacy Rate: 100% vs. 18% GDP per capita (purchasing power parity):

40,000 USD vs. 900 USD.

1.1Welfare Concept Economist Intelligence Unit’s Quality of Life Index

(2005): Significant Factors Are:[http://www.economist.com/media/pdf/quality_of_life.pdf]

Income (GDP) per capita Life Expectancy at Birth (health), Political Stability and Security Family Life (divorce rate per 1000 pop.), Community Life (church attendance or union mem.) Climate and Geography (latitude) Job Security (unemployment rate) Political Freedom (political and civil liberties) Gender Equality (ratio of male/female earnings)

1.1Welfare Concept

EIU does not find following variables significant over and above the other factors’ impacts: Education Levels, Rate of Real GDP growth, Income Inequality (GINI)

Income Inequality

Surprisingly, many other authors think Income Inequality is Important for Long-run Growth: (Engerman and Sokoloff 1994) Countries with unequal income distribution grows slowly

because absence of the middle-class prevents development of aggregate demand. (Ex: Latin America)

Gini Coefficient: Best:0, Worst:1. Table 1.6 in Akın (2007) compares countries.

Turkey and US: 0.4, Germany: 0.28, Denmark: 0.24, Argentina: 0.59 Brazil: 0.52 . Western Europe is better than the rest, Latin (South) America is the worst.

Income Inequality in Turkey How did Income Inequlity evolve in Turkey? There is a gradual improvement

between 1963-2003. Deniz Gökçe quotes TÜSİAD`s study by S.Gürsel, H.Levent and R.Selim in 2000 states that: (http://www.tumgazeteler.com/?a=677512)

Lowest %20 Second %20 Third %20 Fourth %20 Fifth %20 GİNİ Coeff. 1963 4.5 8.5 11.5 18.5 57.0 0.55 1968 3.0 7.0 10.0 20.0 60.0 0.56 1973 3.5 8.0 12.5 19.5 56.5 0.51 1978 2.9 7.4 13.0 22.1 54.7 0.51 1983 2.7 7.0 12.6 21.9 55.8 0.52 1986 3.9 8.4 12.6 19.2 55.9 0.50 1987 5.2 9.6 14.1 21.2 49.9 0.43 1994 4.9 8.6 12.6 19.0 54.9 0.49 2002 5.2 9.7 14.0 20.8 50.2 0.44 2003 5.5 10.0 14.4 20.9 49.3 0.43

Income Inequality in Turkey

Turkey GINI index

0

0,1

0,2

0,3

0,4

0,5

0,6

1963 1968 1973 1978 1983 1986 1987 1994 2002 2003

1.2Determinants of Development Development is a relative concept: Share of sectors

in GDP changes as a country develops: Share of agriculture in GDP: low income countries %35,

high income countries: %4 (Figure 1.2 in Akın). In Turkey, %32,6.

Share of services sector in high income c.: %61, low income c.: %41.

Manufacturing sector in high income: %30, low income: %24.

In development process, share of agriculte in GDP falls, share of services increases.

1.2Determinants of Development Technological development:

Causes share of agriculture to fall. Increases overall productivity. Provides “sustainable development” in the long-run.

If technology is behind, labor-intensive production dominates the economy. In a labor-intensive environment, productivity=output per labor hour is low, so real wage is low. Competition among workers is high: surplus of labor.

How to measure technology? R&D expenditures/ GDP: Fig. 1.3 in Akın Number of researchers / million pop.: Fig. 1.4 in Akın # of Patents registered / year. Pp. 613 in Kepenek &

Yentürk # of İnternet users / 1000 pop.. Pp. 613 in Kepenek &

Yentürk

1.3 Economic Policies for Development Authors such as Weber (2001) states that

“White Protestant Ethic” helped Northern Europe to develop.

But other parts of the world with different culture, religion, language and ethnicity also have developed: Catholic Europe, Southeast Asia, Turkey etc.

If correct economic policies are followed, there is no (or is there do you think?) negative effect of culture on development.

1.3 Economic Policies for Development What are correct economic policies? Building physical and human capital Establishing free market institutions Correcting income inequality: social security

networks Promoting international trade Active & strategic intervention of the

government to the economy: incentives

1.3 Economic Policies for Development Getting rich (high income per capita) and

development are not the same: (Sala-i Martin and Subramanian 2003): High income per capita due to rich natural

resources creates dependency and increases rent incomes, which creates corruption and bribery. This prevents rule of law and institutionalization. Increases income inequality. Ex: Russia and Brazil, gulf oil states, central asia.

Reduces technological and human capital investments.

1.3 Economic Policies for Development Building physical and human capital: Physical capital: increase production of capital goods and

intermediate goods. Ex: Instead of cement, produce ready-mixed concrete, the idea is to increase value-added. Increase productivity and automation: multi-head electronic textile machines. (output surplusunemployment)

Measuring Physical capital: Table 1.7 in Akın from Artadi and Sala-i Martin (2003): prices of capital goods: Africa:123, OECD:70.

Human Capital: 3 Measures for education & health Primary school enrollment: Africa:42%, OECD:97% Life Expectancy: Africa:42, OECD:68 Contagious diseases index: Africa:80%, OECD:0% Objective: Increase productivity = output per labor hour.

1.3 Economic Policies for Development Establishing free market institutions

Adam Smith (1776): Specialization and division of labor has been the foundation of development since the Industrial Revolution. (Ex: Smith’s “needle factory” http://www.anst.uu.se/larsoest/pmwiki.php?n=Research.NeedleIndustryExample).

Everyone specializes in producing the good that she has comparative advantage in, and purchases all of her other needs from other people.

1.3 Economic Policies for Development Necessary conditions for Free market institutions

to work: The market has to be sufficiently wide: urbanization.

Wide enough to sell my surplus output and find all of the goods that I need. Optimum country (market) scale and the EU?

The market cannot be established if there is no Rule of Law (Sachs 2005). When there is no rule of law, decisions are made arbitrarily by a particular person or a political group (party). This is an indicator of weak institutionalization.

1.3 Economic Policies for Development Institutionalization:

Rules of the game must be very clear, simple, certain, and easy to follow.

Regulators must find low-cost ways to punish those who violate rules.

From the perspective of players, the benefit of violating the rules must be greater than following them. Example: taxes must be low and easy to pay, but the penalties of tax evasion must be very high: high enough to discourage tax evasion (Ex: Al Capone).

How is it in Turkey? If you want to be 100% straight with taxes, it is impossible to do business! So complex and heavy.

1.3 Economic Policies for Development Free markets does not only mean free prices. Need 5

Supporting Institutions for free markets to work: 1. Strong Property Rights. Terminate mafia. Ex: Illegal forces in

Russia. Is it easy to sell lemon in neighborhood vegetable bazaar or sell toys on İstiklal Street?

2. Institutions that are responsible for complete disclosure, transparency, regulation, supervision and monitoring of economic units: firms, banks, govt’s etc. Ex: Banking Regulation and Supervision Agency after the 2001 financial crisis of TR.

3. These institutions must be objective, free from ideology and politics. Ex: Central Bank, The Council of Higher Education, Constitutional Court, etc. Do we all know what these institutions are responsible for? What is the scope of their authority? Can the citizens hold them accountable for their decisions?

1.3 Economic Policies for Development Supporting Institutions for free markets (cont’d)

4. Institutions such as Social security, unemployment insurance, deposit insurance must work. In US, social securtiy system started after great depression. Life-long job security system in Japan

5. Enhance social peace: reduce ethnical, religious, ideological conflicts. Participatory democracy, non-governmental organizations (NGO), freedom of language, minority representation in parliament, independent justice, promoting social aid to poor. OBJECTİVE: Limiting the riches of the very rich and limiting the losses of the very poor.

1.3 Economic Policies for Development If institutionalization is not established:

Individuals do not plan long-term investments because they fear that their property could be stolen or confiscated anytime. Short-term investments and speculation is most popular. Short-term investments increase fragility in the economy. (Ex: Do you think more capital will flow to Turkey after the “wher did you find” law abolished?)

How frequently do laws change? Are they enforced? Do heads of institutions like central bank, etc. change

everytime the government changes? Confidence, decreases, uncertainty increases, instability

increases

1.4 Development Strategies and the Role of Government Import-substitution policies

Production structure depends on domestic demand. Closed to international trade and competition, domestic industry protected by tariffs: “infant industry hypothesis”: Domestic industry must be protected until it reaches a certain

scale. Why? Because average costs decrease by scale: Assuming increasing returns to scale.

Growth is limited because: domestic demand is limited, insufficient domestic competition, limited quality growth

Government chooses and invests in certain industries BUT is this efficient?

1.4 Development Strategies and the Role of Government Export-led Growth (SE Asia)

Depends on Global demand Increases competition and quality Requires the government to promote exports by

affordable credit (Eximbank), low-cost raw materials, energy, land, support for imports of capital-goods, etc.

Increases sensitivity to global demand and exchange rates. Might create “balance of payments” or “currency” crisis, consequently “financial crisis” and finally “real private sector” crisis. This happened in Asia 1997-98, Mexico 1994, Russia 1998, Turkey and Argentina 2001 among others.

1.4 Development Strategies and the Role of Government Designing economic policies & strategies and

applying them. Import-substitution can be applied but only

temporarily. In SE Asia, traditional industries are liberalized and opened to global competition, but new industries are protected until they reach a certain scale. After that, they are also liberalized.

After World War II, Africa ve SE Asia had the same income per capita. In 50 years, SE Asia showed miraculous growth. Africa, Middle East and Latin America did not grow. Why?

1.4Role of Government Because government institutions are controlled

by minority elites, political liberties and democracy are weak.

Establish Coordination between universities and industry’s human capital needs:

where can a nuclear or agriculture engineer work in Turkey?

shortage of intermediate technical personnel: must everyone get a university degree?

1.4Role of Government

Regional Inequalities and convergence across regions: In some regions (east of TR, west of China), government

and private sector does not want to work. Economy is backwards.

Govt. gives wage and other incentives for the East, but are these sufficient?

Do investment incentives work? Do farm subsidies work? Does the govt. supervise

whether they work? Most people think they don’t. Does the govt. prevent subsidy abuse?