DEVELOPMENT ECONOMICS FINAL TAKE-HOME EXAM

by OTCHIA CHRISTIAN 301001073

Q.1. Discuss why some countries are poorer than the others in term of average per capita income, and why some countries are growing faster than the others. In answering to these questions, use growth(s) models of your choice in order to provide analytical discussion. The question on why some countries are poorer than the others in term of average per capita income, and why some countries are growing faster than the others is discussed nowadays in a convergence or catch-up theories. The idea of convergence is the hypothesis that poorer economies' per capita incomes will tend to grow at faster rates than richer economies. As a result, all economies should eventually converge in terms of per capita income. But in reality, this convergence is not happening for many developing countries expect small cases like Asian Tigers. Here, this question can be discussed using a Two-Sector Nonscale Growth Model of capital accumulation that incorporates endogenous technological change and population growth. This model is in many respects a hybrid of neoclassical and endogenous-growth models1. Conversely to others growth model which focus on output, this model insist technology and productivity of capital. We focus on a centrally planned economy and use social production functions, in which externalities are internalized. The population, N, is assumed to grow at the steady rate
N N

= n. The economy produces final output, Y, and

new technology, A, utilizing the social stocks of technology, labor, and physical capital, K, according to the Cobb-Douglas production functions:

where F , j represent exogenous technological shift factors to the production functions and is the fraction of labor employed in the nal good sector, i , i are the productive elasticities, and A represents the rate of depreciation of technology. According to equations (1a) and (1b), physical capital is specic to the production of nal output, whereas new technology is a nonexclusive nonrival public good to both sectors. Labor is the only factor subject to intersectoral allocation. Physical capital accumulates residually, after aggregate consumption, C, and depreciation needs, K K have been met
This model was developed by THEO S. EICHER on his study on Convergence in a Two-Sector Nonscale Growth Model, December 1999.
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The planners problem is to maximize the intertemporal utility of the representative agent:

where C/N denotes per capita consumption, subject to the production and accumulation constraints, (1a) to (1c), and the usual initial conditions. His decision variables are (1) the rate of per capita consumption, C/N; (2) the sectoral allocation of labor, and (3) the rates of accumulation of physical capital and technology. In accordance with the stylized empirical facts (Romer, 1989), we assume that the output/capital ratio, Y/K, is constant. A key feature of the nonscale model is that the equilibrium percentage growth rates of technology and capital and K, respectively, are determined entirely by the A production conditions. Taking the differentials of the production functions (1b) and (1c) and solving we nd:

and thus the per capita growth rate of output (capital) is

From this model, we see that larger shares of technology in the R&D sector increase the speed of convergence and influence the other reason of converge which is the growth rate. Hence countries converge to identical growth rates, if either their production technologies are identical or their production functions are constant returns to scale. If production technologies differ across countries, growth rates exhibit condition convergence. So far from this model, we learned also that countries are not converging because of the convergence rates differ significantly across countries and over time. Another point to focus is human capital and innovation. The investment of human capital and spillover of knowledge brings increasing return of scale. This framework can explain also why the Democratic Republic of Congo, which was
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the same development level with South Africa in 1960s cannot catch-up. During both before and after independence period, the Total factor Productivity and factor accumulation were the source of growth whereas human capital (mostly Belgium) didnt explain economic growth before independence. However after independence, the lack of human capital, the mismanagement and the political instability damaged the Total Factor Productivity and physical capital accumulation and became the source of the economy decline. Q. 2. Discuss the forces of markets that you have learned in our market experiments. What do you think that markets can do in providing goods and services necessary for us to have decent economic and social life? What should the roles of government be in a market-oriented development strategy? In answering to this question, you should also refer to some examples from development experience of your own country. Under the socialistic egalitarian society, nobody is excluded in the market but the gain is lower when compared to a market oriented capitalistic society with public competition. If market is competitive, the welfare increases but inefficient producer and poor are excluded. Thus, the role of government in the market-oriented development strategy is crucial here because the government can create social safety net with the surplus and redistribute it to the excluded. However in the Democratic Republic of Congo (DRC), the market is competitive but the government doesnt intervene in terms of social welfare programs. Poor are excluded and abandoned to themselves. That creates the gap between rich and poor and increase inequality. Most of time, the government support the producer because most of the government officers are businessmen or involved in corruption so that the surplus is not used to improve productivity but it is used to subside their own consumption. That is why for many years, our economy doesnt gain in dynamic way. Its generally thought that when the market is fragmented, the total gain of the society is very small compared to the country with united market. However, there must be strong infrastructure such as internet to make it efficient. In the DRC, there are not such infrastructures. The cost of transportation is very high and in some area, there is no even physical infrastructure to link the rural production to market. Therefore providing connection physically through internet, distribution network using middle men and logistic system is important for creating market. The role of government in the poverty
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reduction strategy should be to create rural infrastructure since 80% of poor in DRC live in rural area. Instead of selling to the middle men with lower price, infrastructure can help farmers in rural area to sell directly in a competitive city market and gain high margin, even thought there are not physically connected or their product is not connected to the city market. Infrastructure penalizes farmers in Congo. The government is willing to encourage importation of some commodities while they are produced by local farmers because they are not competitive in terms of price and the corrupted government wants to earn more in import tax. As far as I concerned, I think that the higher price of local commodities are due to the cost of transportation. When there is collusion, the market becomes less efficient. The total gain for the society even for colluders will decline. When there is seller collusion, there will be a few number of colluder who gains more but as a whole, the sellers gain will be low. The same is happening when the buyers collude. Thus, collusion creates smaller and smaller gain to the society and smaller number of supplier of goods and services as you increase the elements of collusion. Therefore, information is important to sharpen the market and make it more efficient. In country with less perfect information control quality as the Democratic Republic of Congo, the government intervention in quantity control and central planning match making is not efficient. When both sellers and buyers tell lie, price seems to be stable. Sellers often over report their purchase cost, the supply side shifts up while the demand curve shifts down when the buyers under report the purchasing power and the intersection is closed to the technical price. That is why the government has to increase the total gain of the society by using price control policy such as tariff instead of quantity control. Q. 3. Read the Post-war Development of the Japanese Economy Development/Asian style- and discuss some elements that you found relevant (either positive or negative) to the development process of your country. Right after the independence in 1960s, the Democratic Republic of Congo (DRC) was leaded by a dictatorship government who drove 40 years later our economy among the poorest in the world. Another consequence of this mismanagement is the increase in corruption and inequality that weakened the national cohesion. This created a room for

war and ethnical conflict.

Described as Africas First World War or as the worlds

deadliest conflict since World War II, the conflict in the Democratic Republic of Congo has involved seven nations. There have been a number of complex reasons, including conflicts over basic resources such as water, access and control over rich minerals and other resources as well as various political agendas. This has been fueled and supported by various national and international corporations and other regimes which have an interest in the outcome of the conflict. Since the outbreak of fighting in August 1998, some 5.4 million people have died.

At the time of its independence in 1960, DRC was the second most industrialized country in Africa after South Africa. From 1961 to 2002, the GDP per capita of the DRC has been falling and even became negative for the period including 1987 2001. As for the Japanese post-war development experience, my country should focus first on the catch-up process. The starting points are democratization, reestablishment of State Capacities and Legitimacy and building credible institution, given the role of institutions as a fundamental determinant of economic development. Good institution creates a good climate for affairs. It secures property rights and struggle against corruption and impunity. As a recall, the lack of property rights protection led the DRC government to expropriate all the foreigner owning firms in Congo in 1973. Most recipients were ministers, members of the party's political bureau, and top army officers. Smaller properties were allocated to local notables. This measure, called Zairianization, was one of the causes of the downwards on our economy.

The stress on democratization and reconciliation is an impetus for promoting the national cohesion. One of the Japan success in the post-war catching-up process was a common goal for development. Japan succeeded to put together household, business and the government sector and defined a common purpose to catch-up with North American and European industrial economies. As for DRC, there are more than 300 ethnics with different local language. Then if the president is from one region or group ethnics, the other group who are not directly closed to the presidents region will be marginalized and cant identify themselves in that government. The reason is that the
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government cabinet is composed by mostly by people originally for the same region than the president. This led the marginalized to boycott every development effort since its coming from them. Therefore, reconciliation done by a credible government is required to bring together all ethnics group and take away our differences so that we can bear a common development goal.

Another way to make reconciliation is by execution several economic reforms. Imitating Japan with Zaibatsu dissolution, Agrarian reform and labor market reform that followed the war will be a driver to reduce inequality and strengthen the national cohesion. The Zairianization created a vast pool of goods and money for personal distribution to loyal family members and the political class composed mainly of government and army officials. Until now, those heirs are enjoying the benefit of Zairianization. I think that the DRC has to carry out reforms whose aims will be to confiscate all goods acquired from Zairianization and redistribute them to the population in need. This reform will be extent to land reform as well as labor market and banks. Congolese dont trust in banks anymore. This is a result from a fail of the government monetary reform in 1991. The reform was made in order to mobilize saving. Initially the government promised monthly returns of around 500% for people volunteering to invest their money during even shorter periods. Eventually the investment period was 2 days, during which the investment was doubled. But the government could not reimburse the money and went to bankrupt. This policy is known in Congo as Bindo Promotion. Now, many Congolese are keeping their cash under the mattress or covert them into nonperishable goods. Thus, the government should restore the confidence to the population in order to mobilize interior saving. Actually the reverse is done by private microfinance institution but they cant reinvest the saving into key industry since their aim is to get rapid returns. In the case of Japan, the government via financial institutions was in charge of collecting saving and directing the funds to key industries for dynamic economic growth. Even kids were asked to save in order to promote economic development of the country. In Congo, the central bank is sometimes in conflict with commercial banks. Since 90% of the transactions are in US$ and done in cash, the
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central banks doesnt have enough power to execute its monetary policies because money is kept by consumers who dont trust in bank. Therefore, a coperate governance built on cross-share holdings among business and with other financial institution is required.

Moreover, government should create main bank system, own development bank so that they can provide long term credits for industrial promotion. Here comes also a major policy that Japan carried out and which can be very useful for the DRC. Japan identified key industries capable to induce development. Those industries were steel, coal mining, electricity, shipbuilding, marine transportation, railways, chemical, etc. As far as the DRC is concerned, the key industry is mining but only based on exporting raw materials to western economy. Giving an added value by local transformation of the raw material can be a starting point of economic growth. The dependence of the economy in exporting raw materials makes it fragile due to fluctuation of international price. That is why diversification of the economic is also important. This can be done by microeconomic reforms and strengthening industrial competitiveness. A remark here is that the DRC government always emphasis on the macroeconomic aspect but there are not consequently microeconomic and market based policy for growth and economic development. They forgot that macroeconomic is the sum up if microeconomic behavior.

Thus, the government intervention and public policies are important in order to catch-up with advanced economies. The government can intervene in the market in order to reallocated resource and drive the economy to the goal.