Political Economy

Submitted By salibut2020
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Political Economy of Developing Countries
Thursday, January 16, 2014

“Modern” growth
How do you explain the huge upshot in economic growth starting ~1850s?
Origins of growth
Accumulation of knowledge
Significant scientific accomplishment
Newton’s laws of physics
Philosophers are beginning to think of ways of implementing/applying their knowledge
Industrial revolution
Machines substitute for human skill
Inanimate replace animate sources of power
Doesn’t come along until after Adam Smith is dead
Pre-industrial (commercial society) vs. industrial society
New type of economic system: a market economy
Free trade of goods and services
Free markets were created by eradicating systematic monopolization; they didn’t just naturally appear
Market forces (e.g. supply and demand) determine prices
Fundamentally throwing out conventional ideas of setting prices
Private property
Previously, most land was owned by the king or the church
No strict property division before
Governed by profit motive
Diffusion of modern growth
Why Britain? (see Sachs, p. 33-35)
Early demise of feudalism
Institutions for political liberty
Center of scientific revolution
Access to waterways for trade
Conducive to agriculture
Less threat of invasion
Endowed with coal
Modern growth spread to other countries
Demand for exports of trading partners
Capital from Britain
Investments
Diffusion of technology
Important for Solow model

Capital accumulation
Capital
Machines in a factory, financial wealth, etc.
Emergence of “third world”
Initially denoted non-aligned countries
First world: capitalist countries
Second world: communist countries
Competing development models
Each “world” tried to project their own development models onto these countries
Big facts from 1962 perspective
Great Depression
Wartime mobilization
Soviet industrialization
Marshall Plan
High amounts of aid went in, growth resulted
Import-substitution in Latin America
Latin American countries were supporters of commodities and imported manufacturing, but Great Depression and WWII disrupted their exports
They then started manufacturing their own goods
Key lessons
Governments can lead industrialization
Integration into world economy unnecessary
Capital accumulation is the key to growth

Harrod-Domar model
Growth is proportional to share of investment spending in GDP
Difficult for poor countries to increase savings rate
Aid required to close the financing gap to achieve a target growth rate
Rostow’s “take-off”
If you can get to a certain level of finance and investment, then the system of growth will take off by itself – it will be sustainable
Increased savings  increased investment  large capital stock  increased output  increased income  increased savings
Failure of capital accumulation paradigm
Does aid lead to investment?
Does investment at “required” rate lead to growth?
Problems with the capital accumulation approach
Incentives
Diminishing returns
Capital and having financial backing matters, but just dumping in money doesn’t do the trick  Solow model

Solow model
Diminishing returns to investment in capital
There is only so much capital that can be used efficiently
Exacerbated by capital’s small share of GDP
All economies tend toward long-run zero growth
Take any savings and appreciation rate, they will eventually get stuck at a steady state (where savings curve = required investment curve) – where capital
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