copyright © 2009 pearson addison-wesley. all rights reserved. chapter 11 development policymaking...

Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

Chapter 11

Development Policymaking and the Roles of Market, State, and Civil Society

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-2

System of Economic Management

Mixed economy

• Private sector: profit maximizing business firms

• Public sector: employment maximizing government agencies

Economic systems

• Capitalism: large private sector, but small public sector

• Socialism: large public sector, but small private sector


Economic Role of the State

• Protect private property and legal rights

• Produce public goods

• Improve market competition

• Improve income distribution

• Preserve the human environment

• Manage the economy


Development Planning

Economic plan: managing economic activity

• Specific set of quantitative targets

• Given time horizon (three or five years)

• Stated strategies for achieving the targets

• Comprehensive (the entire economy) or partial (a specific sector or industry) coverage


Component of Development Plan

• Government uses domestic saving and foreign exchange to construct economic infrastructure

• Government implements economic policy (taxation, industrialization, foreign exchange control, trade restriction)


Rationale for Planning

Reduce market failure:

• Income distribution

• Monopoly power

• Externalities of production and consumption

• Insufficient information


Rationale for Planning

• Resource mobilization and allocation

• Psychological effect on achieving development goals (e.g., reducing poverty)

• Foreign aid: a requirement to obtain loans and grants


Planning Characteristics

• Governmental goals and objectives

• Strategies for achieving goals and objectives

• Government agency for planning implementation

• Planning coverage: comprehensive or partial

• Planning horizon: medium or long-term

• Planning methodology (macroeconomic model)


Planning Methodology

Aggregate growth model (Harrod-Domar)

• Investment demand = National saving

• Foreign aid and direct foreign investment to fill-in the saving gap


Planning Methodology

Input-Output model

• Outputs of industries serve as inputs of other industries

• Optimal input mix to produce maximum output to satisfy the final demand


Project Appraisal

• Weigh the costs of plans/projects against their benefits over the planning horizon

• Discount the costs and benefits and compare their present values

• Find an appropriate “discount factor” above the internal rate of return”

• “Net” at which present value equal to zero


Project Appraisal

t

ttt

r

CBNPV

)1(

Net present value, or NPV is given by

WhereBt is the expected benefit at time tCt is the expected cost at time tr is the government’s social rate of

discount


True vs. Actual Market Value

• True market value in the demand-supply price or scarcity value = shadow price reflecting social costs and benefits

• Actual market value is the market exchanged price reflecting private costs and benefits or the controlled price


Reasons for Price Divergence

• Inflation and currency control

• Factor price distortions (prices, wages, interest rates, exchange rate)

• Trade restrictions and import substitution

• Saving deficiency

• Social vs. private rate of return


Planning Consequences

• Factor price distortion, choice of technology and employment creation

• Induced R-U migration

• Demand for educational certification leading to employment problem

• Economic structure


Reasons for Failure of Planning

• Deficiencies in plans and their implementations

• External and internal disturbances

• Insufficient and unreliable data

• Institutional weaknesses

• Lack of political will

• Corruption of public servants


The Planning Mystique

• In the past, few doubted the importance and usefulness of national economic plans

• Recently, however, disillusionment has set

• But, a comprehensive development policy framework can play an important role in accelerating growth and reducing poverty


Resurgent of Market Orientation

• Failure of planning

• IMF and World Bank policy requirements for foreign aid and direct foreign investment

• Joint ventures of domestic and foreign enterprises


Requirements for Market Orientation

• Trust

• Law and order

• Security of private property rights

• Balancing between competition and cooperation

• Division of responsibility and diffusion of power

• Social safety net


Requirements for Market Orientation

• Social mobility

• Individualism and materialism

• Deferring gratification to create private saving

• Rationality and efficiency

• Honesty of government

• Competition of business

• Availability and freedom of information


Need for Government Intervention

• Income redistribution through progressive taxation and transfer payments

• Excess market imperfection on behalf of domestic and foreign business

• Substantial negative externalities (pollution and decay)

• Investment in social and human capital

• Structural transformation


Planning & Market Reconciliation

• Must achieve “effective” cooperation

• Must reduce market imperfections

• Must eliminate factor price distortions and price controls

• Must reduce public ownership of economic enterprises

• Must reduce corruption and red tape


Non-Government Organizations

• Comparative advantages of NGOs in

– Innovative design and implementation

– Program flexibility

– Specialized technical knowledge

– Provision of targeted local public goods

– Common-property resource management design and implementation

– Trust and Credibility

– Representation and advocacy


Corruption and Planning

• Corruption: Abuse of public trust for private gain

• Good governance enhances capability to function

• Effects of corruption fall disproportionately on the poor

• Good governance is broader than simply an absence of corruption


Corruption as a Regressive Tax: The Case of Ecuador


The Association between Rule of Law and Per Capita Income

copyright © 2009 pearson addison-wesley. all rights reserved. chapter 11 development policymaking...

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