Economic Development

Economic Development TENTH

EDITION

Michael P. Todaro New York University and the Population Council {

Stephen C. Smith The George Washington University

ADDISON-WESLEY xn imprint of Pearson Education Harlow, England • London • New York • Boston • San Francisco • Toronto Sydney • Tokyo • Singapore • Hong Kong • Seoul • Taipei • New Delhi Cape Town • Madrid • Mexico City • Amsterdam • Munich • Paris • Milan

Contents

Preface Case Studies

Part One Principles and Concepts 1 Economics, Institutions, and Development: A Global Perspective How the Other Half Live ^ Economics and Development Studies

Vll

xxvii

1: 2 2 6

The Nature of Development Economics 7 Why Study Development Economics? Some Critical Questions 9 The Important Role of Values in Development Economics 12

Economies as Social Systems: The Need to Go Beyond Simple Economics What Do We Mean by Development?

13 14

Traditional Economic Measures 14 The New Economic View of Development 15 Sen's "Capabilities" Approach 16 Three Core Values of Development 20 The Central Role of Women 22 The Three Objectives of Development 22 The Millennium Development Goals 22

Conclusions 25 EJ Case Study: Progress in the Struggle for More Meaningful Development: Brazil

2 Comparative Economic Development Defining the Developing World Measuring Development for Quantitative Comparison across Countries Some Basic Indicators of Development

28

39 41 43 48

A Holistic Measure of Living Levels: The Human Development Index 49

Characteristics of the Developing World: Diversity within Commonality

56

Lower Levels of Living and Productivity 56 xv

xvi

Contents Lower Levels of Human Capital 58 Higher Levels of Inequality and Absolute Poverty 59 Higher Population Growth Rates 62 Greater Social Fractionalization 63 Larger Rural Populations but Rapid Rural-to-Urban Migration 64 Lower Levels of Industrialization and Manufactured Exports 65 Adverse Geography 66 Underdeveloped Financial and Other Markets 67 Lingering Colonial Impacts 68 Relative Importance of the Public and Private Sectors and Civil Society 70 How Low-Income Countries Today Differ from Developed Countries in Their Earlier Stages Physical and Human Resource Endowments 72 Relative Levels of Per Capita Income and GDP 72 Climatic Differences 73 Population Size, Distribution, and Growth 73 The Historical Role of International Migration 74 The Growth Stimulus of International Trade 76 Basic Scientific and Technological Research and Development Capabilities 77 Efficacy of Domestic Institutions -77 Are Living Standards of Developing and Developed Nations Converging? Long-Run Causes of Comparative Development Conclusion Case Study: Divergent Development: Pakistan and Bangladesh

Classic Theories of Economic Growth and Development Classic Theories of Economic Development: Four Approaches Development as Growth and the Linear- Stages Theories Rostow's Stages of Growth 111 The Harrod-Domar Growth Model 112 Obstacles and Constraints 114 Necessary versus Sufficient Conditions: Some Criticisms of the Stages Model 114 Structural-Change Models The Lewis Theory of Development 115 Structural Change and Patterns of Development 120 Conclusions and Implications 121 The International-Dependence Revolution The Neocolonial Dependence Model 122 The False-Paradigm Model 124 N The Dualistic-Development Thesis 124 Conclusions and Implications 125 The Neoclassical Counterrevolution: Market Fundamentalism Challenging the Statist Model: Free Markets, Public Choice, and Market-Friendly Approaches 126

71

78 82 88 91

109 109 110

115

122

126

Contents

Traditional Neoclassical Growth Theory 128 Conclusions and Implications 129 Classic Theories of Development: Reconciling the Differences E3 Case Study: Schools of Thought in Context: South Korea and Argentina Appendix 3.1 Components of Economic Growth Appendix 3.2 The Solow Neoclassical Growth Model Appendix 3.3 Endogenous Growth Theory

1 Contemporary Models of Development and Underdevelopment

xvii

131 133 142 147 151

158

Underdevelopment as a Coordination Failure

159

Multiple Equilibria: A Diagrammatic Approach "-y~ Starting Economic Development: The Big Push The Big Push: A Graphical Model 168 Other Cases in Which a Big Push May Be Necessary 173 Why the Problem Cannot Be Solved by a Super-Entrepreneur 174 Further Problems of Multiple Equilibria

162 167

Kramer's O-Ring Theory of Economic Development The O-Ring Model 179 Implications of the O-Ring Theory 182 Economic Development as Self-Discovery e The Hausmann-Rodrik-Velasco Growth Diagnostics Framework Conclusions 188 El Case Study: Understanding a Development Miracle: China

Part Two Problems and Policies: Domestic 5 Poverty, Inequality, and Development Measuring Inequality and Poverty Measuring Inequality 210 Measuring Absolute Poverty 217 Poverty, Inequality, and Social Welfare What's So Bad about High Inequality? 222 Dualistic Development and Shifting Lorenz Curves: Some Stylized Typologies 224 Kuznet's Inverted-U Hypothesis 227 Growth and Inequality 232 Absolute Poverty: Extent and Magnitude Growth and Poverty 236 Economic Characteristics of Poverty Groups Rural Poverty 238

176 179

184 185 193

] 207| 208 210

222

233 238

xviii

Contents Women and Poverty 239 Ethnic Minorities, Indigenous Populations, and Poverty 243 Policy Options: Some Basic Considerations Areas of Intervention 244 Policy Options 245 Summary and Conclusions: The Need for a Package of Policies • Case Study: Making Microfinance Work for the Poor:

244

250

The Grameen Bank of Bangladesh

252

Appendix 5.1 Appropriate Technology and Employment Generation: The Price Incentive Model

266

Appendix 5.2 The Ahluwalia-Chenery Welfare Index

269

6 Population Growth and Economic Development: Causes, Consequences, and Controversies The Basic Issue: Population Growth and the Quality of Life Population Growth: Past, Present, and Future

273 274 275

World Population Growth throughout History 275 Structure of the World's Population 277 The Hidden Momentum of Population Growth 281

s

The Demographic Transition The Causes of High Fertility in Developing Countries: The Malthusian and Household Models

283 286

1J

The Malthusian Population Trap 286 Criticisms of the Malthusian Model 289 The Microeconomic Household Theory of Fertility 291 The Demand for Children in Developing Countries 293 Some Empirical Evidence 294 Implications for Development and Fertility 295 The Consequences of High Fertility: Some Conflicting Opinions It's Not a Real Problem 296 It's a Deliberately Contrived False Issue 297 It's a Desirable Phenomenon 298 It Is a Real Problem 299 1 Goals and Objectives: Toward a Consensus

Some Policy Approaches What Developing Countries Can Do 304 What the Developed Countries Can Do 307 How Developed Countries Can Help Developing Countries with Their Population Programs 308 Conclusion • Case Study: Population, Poverty, and Development: China and India

295

302 303

309 310

Contents

7 Urbanization and Rural-Urban Migration: Theory and Policy The Migration and Urbanization Dilemma

xix

320 320

Urbanization Trends and Projections 321

The Role of Cities

327

Industrial Districts 327 Efficient Urban Scale 329

The Urban Giantism Problem

331

First-City Bias 332 Causes of Urban Giantism 333

The Urban Informal Sector

335

Policies for the Urban Informal Sector 337 Women in the Informal Sector 340

Migration and Development Toward an Economic Theory of Rural-Urban Migration x

342 344

A Verbal Description of the Todaro Model 345 A Diagrammatic Presentation 347 Five Policy Implications 350

Summary and Conclusions: A Comprehensive Migration and Employment Strategy H Case Study: Rural-Urban Migration and Urbanization in Developing Countries: India and Botswana Appendix 7.1: A Mathematical Formulation of the Todaro Migration Model

8 Human Capital: Education and Health in Economic Development The Central Roles of Education and Health Education and Health as Joint Investments for Development Improving Health and Education: Why Increasing Income Is Not Sufficient Investing in Education and Health: The Human Capital Approach Child Labor The Gender Gap: Women and Education

352 355 366

369 369 372 373 375 378 382

Consequences of Gender Bias in Health and Education 384

Educational Systems and Development

387

The Political Economy of Educational Supply and Demand: The Relationship between Employment Opportunities and Educational Demands 387 Social versus Private Benefits and Costs 389 •, Distribution of Education 392 Education, Inequality, and Poverty 394 Education, Internal Migration, and the Brain Drain 396

Health Systems and Development Measurement and Distribution 397

397

xx

Contents c

Disease Burden 400 HIV/AIDS 402 Malaria 407 Parasitic Worms and Other "Neglected Tropical Diseases" 408 Health and Productivity 409 Health Systems Policy 413 B Case Study: Pathways out of Poverty: Progresa/Oportunidades

9 Agricultural Transformation and Rural Development

416

431

The Imperative of Agricultural Progress and Rural Development

431

Agricultural Growth: Past Progress and Current Challenges

433

The Structure of Agrarian Systems in the Developing World 438 Peasant Agriculture in Latin America, Asia, and Africa 439 Agrarian Patterns in Latin America: Progress and Remaining Poverty Challenges 441 Transforming Economies: Problems of Fragmentation and Subdivision of Peasant Land in Asia 444 Subsistence Agriculture and Extensive Cultivation in Africa 447 The Important Role of Women 450

n

The Economics of AgriculturaLDevelopment: Transition from Peasant Subsistence to Specialized Commercial Farming Subsistence Farming: Risk Aversion, Uncertainty, and Survival 454 The Transition to Mixed and Diversified Farming 460 From Divergence to Specialization: Modern Commercial Farming 461 Toward a Strategy of Agricultural and Rural Development: Some Main Requirements Improving Small-Scale Agriculture 462 Conditions for Rural Development 465 B Case Study: The Need to Improve Agricultural Extension for Women Farmers: Kenya

10 The Environment and Development Economics and the Environment Environment and Development: The Basic Issues ' Sustainable Development and Environmental Accounting 485 Population, Resources, and the Environment 486 Poverty and the Environment 486 Growth versus the Environment 487 Rural Development and the Environment 487 Urban Development and the Environment 488 The Global Environment and Economy 488 The Nature and Pace of Greenhouse Gas-Induced Climate Change 489 Natural Resource-Based Livelihoods as a Pathway out of Poverty: Promise and Limitations 489

453

462

468

483 483 485

Contents

xxi

The Scope of Environmental Degradation: An Overview

490

Rural Development and the Environment: A Tale of Two Villages Global Warming and Climate Change Traditional Economic Models of the Environment Privately Owned Resources 497 Common Property Resources 499 Public Goods and Bads: Regional Environmental Degradation and the Free-Rider Problem 501 Limitations of the Public-Good Framework 503 Urban Development and the Environment The Ecology of Urban Slums 503 Industrialization and Urban Air Pollution 505 Problems of Congestion, Clean Water, and Sanitation 508 :~

491 494 497

c

The Need for Policy Reform The Local and Global Costs of Rain Forest Destruction Policy Options in Developing and Developed Countries

503

509 510 512

s

What Less Developed Countries Can Do 512 How Developed Countries Can Help LDCs 514 What Developed Countries Can Dt> for the Global Environment 515 O Case Study: Economic Growth and Environmental Sustainability: The Philippines

11 Development Policymaking and the Roles of Market, State, and Civil Society The Planning Mystique The Nature of Development Planning Basic Concepts 532 Planning in Mixed Developing Economies '" 532 The Rationale for Development Planning The Planning Process: Some Basic Models Aggregate Growth Models: Projecting Macro Variables * Multisector Models and Sectoral Projections Project Appraisal and Social Cost-Benefit Analysis Conclusions: Planning Models and Plan Consistency 542 Problems of Plan Implementation and Plan Failure Theory versus Practice 543 Reasons for Plan Failure 544 Government Failure and the Resurgent Preference for Markets over Planning The Market Economy Sociocultural Preconditions and Economic Requirements 546 Role and Limitations of the Market in LDCs 549

517

530 531 532

533 535 535 538 539 543

545 546

xxii

Contents The Washington Consensus on the State Role in Development and Its Limitations Toward a New Consensus 552 Development Political Economy: Theories of Policy Formulation and Reform

551

554

Understanding Voting Patterns on Policy Reform 556 Institutions and Path Dependency 557 Democracy versus Autocracy: Which Facilitates Faster Growth? 558 Development Roles of NGOs and the Broader Citizen Sector 560

Trends in Governance and Reform Tackling the Problem of Corruption 566 Decentralization 568 Development Participation 570

566

'

;i

Development Policy and the State: Concluding Observations Case Study: The Role of Development NGOs: The BRAC Model

572 574

Part Three Problems and Policies: International and Macro

587

12 International Trade Theory and Development Strategy

588

Globalization: An Introduction International Trade and Finance: Some Key Issues Five Basic Questions about Trade and Development Importance of Exports to Different Developing Nations Demand Elasticities and Export Earnings Instability The Terms of Trade and the Prebisch- Singer Thesis The Traditional Theory of International Trade

588 591 594 595 597 598 599

Comparative Advantage 599 Relative Factor Endowments and International Specialization: The Neoclassical Model 600 Trade Theory and Development: The Traditional Arguments 605

The Critique of Traditional Free-Trade Theory in the Context of Developing-Country Experience

606

Fixed Resources, Full Employment, and the International Immobility of Capital and Skilled Labor 607 Fixed, Freely Available Technology and Consumer Sovereignty 610 Internal Factor Mobility, Perfect Competition, and Uncertainty: Increasing Returns, Imperfect Competition, and Issues in Specialization 611 The Absence of National Governments in Trading Relations 613 Balanced Trade and International Price Adjustments 614 Trade Gains Accruing to Nationals 614

Some Conclusions on Trade Theory and Economic Development Strategy

615

Contents

xxiii

Traditional Trade Strategies for Development: Export Promotion versus Import Substitution Export Promotion: Looking Outward and Seeing Trade Barriers 620 Import Substitution: Looking Inward but Still Paying Outward 623 The IS Industrialization Strategy and Results 626 Foreign-Exchange Rates, Exchange Controls, and the Devaluation Decision 631 Trade Optimists and Trade Pessimists: Summarizing the Traditional Debate Trade Pessimist Arguments 635 o Trade Optimist Arguments 636 The Industrialization Strategy Approach to Export Policy Reconciling the Arguments: The Data and the Consensus

618

635

637 640

South-South Trade and Economic Integration: Looking Outward and Inward ~ Economic.Integration: Theory and Practice 641 Regional Trading Blocs and the Globalization of Trade 643 Trade Policies of Developed Countries: The Need for Reform • Xase Study: A Development Success Story: Taiwan

641

645 649

13 Balance of Payments, Developing-Country Debt, and the Macroeconomic Stabilization Controversy The Balance of Payments Account General Considerations 668 A Hypothetical Illustration: Deficits and Debts 670 Financing and Reducing Payments Deficits Some Initial Policy Issues 671 Trends in LDC Balance of Payments 673 The Debt Crisis of the 1980s Background and Analysis 674 Origins of the Debt Crisis 676 Attempts at Alleviation: Macroeconomic Instability, IMF Stabilization Policies, and Their Critics The IMF Stabilization Program 679 Tactics for Debt Relief 681 "Odious Debt" and Its Prevention Resolution and Continued Vulnerabilities • Case Study: Trade, Capital Flows, and Development Strategy: South Korea Appendix 13.1: A Brief History and Analysis of the International Monetary Fund and the World Bank

14 Foreign Finance, Investment, and Aid: Controversies and Opportunities The International Flow of Financial Resources

667 668

671

674

„ 679

688 689 693 704

714 714

xxiv

Contents Private Foreign Direct Investment and the Multinational Corporation Multinational Corporations: Size, Patterns, and Trends 716 Private Foreign Investment: Some Pros and Cons for Development 719 Private Portfolio Investment: Boon or Bane for LDCs? 725

715

The Role and Growth of Remittances

726

Foreign Aid: The Development Assistance Debate Conceptual and Measurement Problems 728 Amounts and Allocations: Public Aid 730 Why Donors Give Aid 731 Why LDC Recipients Accept Aid 735 The Role of Nongovernmental Organizations in Aid and Evaluation 736 The Effects of Aid 737 El Case Study: African Success Story at Risk: Botswana - ^

15 Finance and Fiscal Policy for Development The Role of the Financial System The Bumpy Road to Macroeconomic Stability Differences between MDC and LDC Financial Systems The Role of Central Banks 756"" The Role of Development Banking 758 Informal Finance 760 Microfinance Institutions i

Reforming Financial Systems Financial Liberalization, Real Interest Rates, Savings, and Investment 764 Financial Policy and the Role of the State 765 Debate on the Role of Stock Markets 767 Fiscal Policy for Development Macrostability and Resource Mobilization 769 Taxation: Direct and Indirect 769 Public Administration: The Scarcest Resource

728

739

750 751 752 753

761 764

769

774

State-Owned Enterprises Improving the Performance of SOEs 777 Privatization: Theory and Experience 778

776

Military Expenditures and Economic Development

780

0 Case Study: Privatization—What, When, and to Whom? Chile and Poland

16 Some Critical Issues for the Twenty-First Century

784

798

Global Interdependence and the Growth of Developing-World Markets

798

The Global Environment and the Developing World Rain Forest Preservation as a Public Good: Who Should Pay? 801 Searching for Global Solutions: The 1992,1997, and 2002 Summits and Follow-Ups 803

799

Contents

xxv

The Crisis in Sub-Saharan Africa Globalization and International Financial Reform Concluding Remarks

805 807 810

Glossary Name Index Subject Index

815 845 857