Economics of the Developing World

I.     Who Are the Poor?

Concentrated in Sub-Saharan Africa, India, and elsewhere in South Asia. The Chinese poverty rate was much higher than the developing country average in 1990, but already much lower than average in 2005. Income and literacy rates are relatively high in Latin America, but poverty rates are also high because incomes are distributed unevenly. With the exception of Sub-Saharan Africa, all regions met their Millennium Development Goal of reducing poverty by 50 percent from its 1990 level by 2015. In 2015, the new Sustainable Development Goals were adopted, calling on nations to "eradicate extreme poverty for all people everywhere" by 2030. World Bank projections make it clear that progress toward that ambitious goal has been interrupted by the COVID-19 crisis.

Extreme Poverty to 2018

II.   Obstacles to Development

A.   Introduction - To grow, a country must produce an output beyond its subsistence needs, and must invest that surplus in productive means rather than in extravagant consumption, the military, or civic monuments, or transferring it abroad.      

B.   Physical Environment and Demography- The average developing country has half the arable land per capita of industrial countries. Most poor countries are located in tropics, with extremes of heat, rain, and insects.
Recent research
by Spolaore and Wacziarg in JEL finds that a small set of geographic variables (absolute latitude, the percentage of a country’s land area located in tropical climates, whether the country is landlocked or an island) can account for 44 percent of contemporary variation in log per capita income, with quantitatively the largest effect coming from absolute latitude. they also find that countries using the most advanced technologies in the year 1000 B.C. tend to remain the users of the most advanced technologies in 1500 and today, particularly if we correct for their populations’ changing ancestry. 

C.   Culture - Economic development is supported by cultural norms that encourage honesty, trust, cooperation, hard work, saving (delayed gratification), honesty, gender and racial equality, and peaceful resolution of problems.  These norms can be influenced by geography (i.e., separation of people by rivers, mountains), climate (ability to engage in hard labor), history (experience with colonialism, slavery, etc.), religion, and other factors. We have seen recent research by Joseph Henrich on the religious influence on marriage customs, reducing tribalism, and strengthening trust and cooperation. Some "cultural determinists" have noted that most high-income nations are predominantly Christian or Confucian. They blame problems of Latin America on an authoritarian culture and strict brand of Catholicism imported from Spain. Aspects of Hinduism, such as caste system, may have complicated development in South Asia, and aspects of Islam, such as the legal and finance systems, may have slowed the Middle East.

D.   The Economic System - Some institutional structures retard development.  In many poor countries, absence of fair and effective legal institutions. Limited monetary exchange. In much of Africa and Asia, land is held in common or worked on a sharecropping basis; poor incentive for improvement.  Limited quality and quantity of financial intermediation in many developing countries, usually organized around a few large, heavily regulated banks.  Securities markets are rudimentary. Interest rates are controlled and taxed; provide small incentive for saving.

E.   Vicious Circles of Poverty - The population in a poor country cannot afford to invest in capital goods, education, and health programs that are needed to promote development.  Also, poverty breeds crime, political instability, and excessive population growth, which perpetuate poverty..

:  Jeffrey Sachs of Columbia University has pointed to another vicious circle.  Scientific research tends to follow market demand, so the technological needs of developing countries (malaria and AIDS vaccines, tropical biotechnology, etc.) are neglected. Solution: guarantee a market to technology firms for developing country needs.


F.    Colonialism, Imperialism, and Dependency - Most would agree that colonial rule was often exploitive - even the American Revolution was prompted by exploitive British taxes.  Some would argue that foreign investment and trade are also exploitive and promote "dependent development."
UPDATE: According to the research by Acemoglu, Johnson, Robinson, Europeans adopted more exploitive, extractive institutions in countries where the physical environment and health conditions made it difficult for them to settle.  These institutions persisted, they say, through the years, and now explain approximately three-quarters of the income per capita differences across former colonies. Once they control for the effect of institutions, they find that countries in Africa or those farther away from the equator do not have lower incomes.

 III.       Development Strategies

A.   Laissez Faire vs. Intervention -- Adam Smith argued that economic progress is natural. Governments should maintain peace, sanctity of contracts, administration of justice, and public projects. Excessive interference will stop economic progress. In 1940s and 1950s, Ragnar Nurske argued that growth was stalled by "vicious circles," and Paul Rosenstein-Rodan argued that a "big push" was necessary to provide minimum speed or size of investment for sustained development.

       NOTE: As an alternative to the “big push,” micro-credits:

In 1976, the Bangladeshi economics professor Muhammad Yunus tried an experiment. From his pocket, he lent the equivalent of $26 to a group of 42 workers. With that 62 cents per person, they bought the materials for a day’s work weaving chairs or making pots. They soon paid back the loan, and Yunus went on to establish the Grameen Bank, which launched the microcredit revolution.  In 2006, the Bank and Yunus were awarded the Nobel Peace Prize, and microfinance has spread throughout the world.

However, the effectiveness of microfinance and many other micro-interventions (such as distribution of textbooks) has been called into question by some of the research of Michael Kremer, Esther Duflo, and Abhijit Banerjee who received the 2019 Economics Nobel for their work on Randomized Controlled Trials (RCTs) in economic development studies. See our article by Seema Jayachandran, describing their work on remedial education.

On the other hand, the micro-approach of both Yunus and Kremer/Duflo/Banerjee is criticized by Yao Yang, who points out that economic growth ultimately relies on the large-scale savings and investments that were discussed by earlier authors.

Saving Rates


B.   Balanced vs. Unbalanced Growth -- Nurske argued industrialization requires balanced growth in all sectors for production balance and because of Say's Law--the demand for one product is generated by the production of others.  Walt Rostow argued for unbalanced development of "leading sectors" and Albert Hirschman emphasized importance of sectors with strong backward linkages (required industrial inputs) and forward linkages (produces important industrial inputs).

C.   Import Substitution and Export Promotion - What industrial sectors should develop first? Perhaps, begin with products with demonstrated domestic demand--import substitution.  Hopefully, will reduce payments imbalances, but distorts allocation of resources and reduces benefits of comparative advantage. Invites bribery and corruption. Import reduction decreases demand for foreign currency, raises the exchange rate, and makes it difficult to market exports.  Instead, export promotion keeps the nation open to foreign trade, encourages efficiency, reaps benefits of international specialization, and imposes cost on inflationary policies and overvalued exchange rates.  On the other hand, it may increase dependence on foreign trade (vulnerability to trade wars) and create enclave of exporters with weak links to the local economy. Part of Washington Consensus.

UPDATE:  Thomas Friedman argues that Globalization 2.0 was the era of "Reform Wholesale," which emphasized the top-down macroeconomic provisions of the Washington Consensus:

        1. Privatization of state-owned companies
        2. Deregulation of financial markets
        3. Exchange rate liberalization
        4. Openness and encouragement of foreign direct investment
        5. Reduction of trade barriers
        6. Introduction of more flexible labor laws

He argues that these are still necessary, but not sufficient. The flat world of Globalization 3.0 calls for "Reform Retail" which involves a detailed microeconomic analysis of infrastructure, regulatory institutions, education, and culture.  

UPDATE: Justin Yifu Lin was born in Taiwan, defected to mainland China (swam from Kinmen Island to Xiamen) in 1979, later earned a PhD in economics at U. Chicago, returned to China to teach at Peking University, and served as chief economist of the World Bank from 2008-2012. Today, at Peking University, he is Dean of the Institute of New Structural Economics, which "maintains that developing countries or regions should develop industries that conform to their comparative advantages based on their factor endowments structure. It seeks synergies between an effective market and a facilitating government in an effort to achieve economic transformation and upgrading as well as economic and social development." In other words, unlike the Washington Consensus, NS emphasizes that developing countries need to have robust governmental involvement to address market failures. With the right mix of policies, Lin has argued, "Every developing country has the potential to grow continuously at 8% or more for several decades, and to become a middle-income or even a high-income country in one or two generations…".