9/11/2013 2:49:00 AM
According to the development economists the profitability of capital
invested in agriculture was less than that invested in industry. Why
did they believe that?
o Could be a question about agricultural pessimism.
In what way did the issue of elasticities figure into the thinking of
o What are the key elasticities? What did they imply?
Low elasticity of consumer demand – can’t expand
revenue by lowering the price.
Overvaluation. How did currency overvaluation figure into the ISI
What is the factor of indivisibilities and how did that figure the
thinking of orthodox economists who criticized developed
Real Exchange Rate:
Upward line/slope is a devaluation and a downward line/slope is an
Real exchange rate is a ratio.
Consequences of ISI
Exile of Intellectuals.
Expansion of Bureaucracy
Decline of Public Services.
Metaphor of the Chinese Plate factory: Industrialization based on
protected markets is not likely to succeed. Overvaluation
cheapened the cost of capital.
o Chinese concluded that ISI model is a failed model.
o In order for ISI to work you first need a large domestic
o Wanted a labor-intensive model of industrialization instead of
a capital-intensive model of industrialization.
ISI model brought early success, but not long-term success.
Consequences of ISI: Political Realm.
Authoritarian Rule. Corruption Exile of Intellectuals.
Expansion of Bureaucracy.
Decline of Public Services.
Decline of agricultural sector
Shortages and scarcities
Decline of the banking sector.
Domestic and international indebtedness
Low or negative growth rates. Widening - not narrowing
Explanations of ISI’s Failures
1. The “Left” Explanation – dependency
2. The “Central” Explanation – poor implementation.
o Heterodox model - mixed model that combines some
features of ISI with some of the features of a market-based
approach combined with other ideal factors.
3. The “Orthodox” Explanation – the laws of economics.
o Was the usual winner in this debate.
o Keynesian and Orthodox economics shared certain features.
Most important shared supposition is governmental
Failure discredited the Keynesian school and
government intervention in anything economic.
No single person has been as influential as Anne Krueger.
1. Technical Factors (What Krueger believes is the most influential
factor in the failure of ISI policies).
o Indivisibilities – A factor of production that can’t be
For many categories of production the imports that you
have to buy are only available on a certain scale.
Metaphor of the Steel belted radial factory.
o Factor Mix
2. Economic Factors
o Deadweight Loss
o Monopoly costs – capital intensiveness and moral hazard. Moral Hazard –decentralized authority to spend
resources from a
Small predominantly agricultural economy with a tiny
consumer marketplace. There is going to be a price
level that is going to be inefficient as compared to any
other country. The capital to produce steel belted tires
is not divisible.
Want to achieve cross-complimentarities.
Metaphor of the infant industry approach.
The great contradiction: a huge industrial base
surrounded by many poor and unemployed.
When you artificially cheapen the price of a good,
people will overuse it and it will be gone.
Stimulate industry by subsidizing the cost of capital, but
it will encourage capital-intensive industrialization which
is not something needed for developing countries.
3. Political Economy: Rent-Seeking
o Guaranteed letter of credit – neither the borrower of the
lenders have final responsibility for any losses that might
arise. Banks are held accountable.
No nexus of responsibility. No holding those industrial
managers accountable for their actions. Inefficient
management resulting in overspending and producing
few quality items.
o What factors signal conversion from ISI to market-based
Percentage of annual budget devoted to paying banks
(20%). Outgrowth of guaranteed letters of credit.
o Rent-Seeking – polite euphemism for a bribe and synonym for
Krueger: Rent-seeking. Diversion of a family’s
investable resources away from productive enterprise to
deadweight loss kinds of things. Extent to which culture of investment change sin a
centrally planned economy because the incentives to
the individual and incentives to
It’s not really true that profitability of investment in
industry is greater than that in agriculture. Investment
in education that will get you a job is more profitable
o The Central Explanation
Implication of all those factors is structural adjustment
an using market oriented and market based prices to
replace central allocation.
Macroeconomics is showing a high rate of growth.
Microeconomics data is showing that household incomes
are either stagnant or declining.
Market-based approaches work because they give you a
growth rate, but they aren’t going to solve the poverty
and socio-economic problems.
The industries chosen for industrialization are chosen
for some principal. Problem is that most every country
followed one principal: low demand elasticity among
Tariffs provide an other limit on inefficiency.
Trade Theory and Growth Theory and no spillover benefits
o Original idea (Chenery) - expand output of export-oriented
sector with no spillover benefits.
Can maximize trade form cocoa sector but there will no
be no spillover benefits to agriculturalists in other
Merely exploding the production of one thing would
have spillover benefits in other sectors or people
working in those sectors. Growth theory - trade needs to provide spillover
benefits. Growth involves all sectors. Growth =
o Ex. of Tanzania, Uganda (oil)
o Lowers the domestic prices of traded goods.
o Agricultural sector dependent on imports (fertilizers,
pesticides, irrigation equipment). Study Questions for Final 9/11/2013 2:49:00 AM
1. Hollis Chenery famously said “Factor prices don’t reflect opportunity costs
with any accuracy” What did he mean and how did that fit into development
economics? Why was it important?