Economic Growth and Development: A Dynamic Dual Economy Approach (Springer Texts in Business and Economics Book 42)

Growth theory provides a rich and versatile analytical framework through which fundamental questions about economic development can be examined. This book is an introduction to the newer features of growth theory that are particularly useful in examining the issues of economic development. Structural transformation, in which developing countries transition from traditional production in largely rural areas to modern production in largely urban areas, is an important causal force in creating early economic growth, and as such, is made central in this approach. Towards this end, the authors augment the Solow model to include endogenous theories of saving, fertility, human capital, institutional arrangements, and policy formation, creating a single two-sector model of structural transformation. Based on applied research and practical experiences in macroeconomic development, the model in this book presents a more rigorous, quantifiable, and explicitly dynamic dual economy approach to development. Common microeconomic foundations and notation are used throughout, with each chapter building on the previous material in a continuous flow. With its single model and focus on data and policy analysis, this text is intended for beginning graduate students and policy makers interested in economic development. Contents 6 1 Overview 12 1.1 Why a Two-Sector Approach 13 1.2 Early Theory 15 1.3 Outline 17 1.4 Stylized Facts Associated with Economic Development 18 1.5 Policies Examined 18 References 19 Part IIntroduction to Economic Growth 20 2 Neoclassical Growth Theory 21 2.1 Firms, Production, and the Demand for Capital 22 2.2 Household Saving and the Supply of Capital 25 2.2.1 The Supply of Labor and Capital 26 2.2.2 Household Saving 27 2.2.3 Supply of Capital Per Worker 28 2.3 Competitive Equilibrium in a Growing Economy 29 2.3.1 Steady-State Growth---Technical Progress 32 2.4 Intergenerational Transfers 34 2.4.1 Altruism* 36 2.4.2 Explicit Household-Level Solutions in Some Special Cases* 38 2.4.2.1 Exogenous Human Capital 38 2.4.2.2 Endogenous Human Capital 41 2.4.3 Warm Glow 42 2.5 Quantitative Theory 44 2.6 Related Literature 52 2.7 Exercises 53 Appendix* 57 A: Derivative of the Value Function 57 B: Many-Period Models 57 References 59 3 Extensions to Neoclassical Growth Theory 61 3.1 A Theory of Income Differences 62 3.1.1 Households 62 3.1.2 Firms 67 3.1.3 Capital Market Equilibrium 68 3.1.4 Government 69 3.1.5 Steady-State Equilibria 71 3.2 Cross-Country Income Differences 71 3.3 Poverty Traps: A Closer Look 75 3.4 International Financial Institutions and Foreign Aid 77 3.4.1 Conditionality and Ownership 78 3.4.2 Summary 79 3.5 Foreign Aid and Policy Experiments 80 3.5.1 Unconditional Aid---Budget Support 80 3.5.2 Opening the Economy 82 3.5.3 Eliminating the Poverty Trap 85 3.5.4 Fiscal Policy Reform 88 3.6 The Aid Cost of Reform 89 3.7 Aid Failures 90 3.7.1 Unconditional Aid Is Not Growth-Promoting 91 3.7.2 Domestic Conflict Over Growth Policies 91 3.7.3 Prohibitive Aid Cost 91 3.8 Humanitarian Aid 92 3.9 Conclusion 92 3.10 Related Literature 93 3.11 Exercises 93 Appendix* 95 Optimal Fiscal Policy in a Closed Economy 95 Optimal Fiscal Policy in an Open Economy 97 References 97 4 Two-sector Growth Models 100 4.1 From Stagnation to Growth 100 4.1.1 A Traditional Economy 102 4.1.2 Onset of Modern Growth 104 4.2 The Structural Transformation of a Two-sector Economy 106 4.2.1 Labor Market Equilibrium 107 4.2.2 Land Market Equilibrium 108 4.2.3 Steady-state Equilibrium 108 4.2.4 Extensions to Human Capital and Fertility 110 4.3 Two Sectors and Two Goods 111 4.3.1 Labor Market Equilibrium 111 4.3.2 Goods Market Equilibrium 112 4.3.3 Land Market Equilibrium 113 4.3.4 Transition Equation for Capital 113 4.3.5 Steady-state Equilibrium 114 4.3.6 Transitional Dynamics* 115 4.3.7 International Trade 118 4.3.8 Transitional Dynamics in an Open Economy* 120 4.4 Declining Budget Shares Spent on Food 121 4.5 Conclusion 125 4.6 Exercises 126 References 128 Part IIDual Economies 130 5 Wage and Fertility Gaps in Dual Economies 131 5.1 Wage and Fertility Gaps 131 5.2 Perfectly Competitive Markets in the Traditional Sector 134 5.2.1 Urban Unemployment 134 5.2.2 Human Capital Gaps 135 5.2.3 Unmeasured Home Production 136 5.2.4 Taxes, Fees, and Migration Costs 136 5.2.5 Summary 137 5.3 Missing Land Markets in the Traditional Sector 137 5.3.1 Modern Sector 139 5.3.2 Traditional Sector 141 5.3.3 Equilibrium 144 5.3.4 Summary 146 5.4 Missing Labor Markets in the Traditional Sector* 146 5.4.1 Endogenous Work 147 5.4.2 Schooling and Fertility 148 5.4.3 Summary 149 5.5 The Forces that Bind Us: Missing Markets and Labor Mobility 150 5.5.1 Missing Land Markets in Historical Development 150 5.5.2 Missing Land Markets in Cities of Currently Developing Countries 151 5.5.3 Missing Credit and Insurance Markets in Current Development 152 5.6 Asian Growth Miracles 153 5.6.1 Asia and Africa 154 5.7 Productivity Gaps: Measurement and Interpretation 155 5.7.1 Average Product of Labor 156 5.7.2 Hours Gap 156 5.7.3 Human Capital Gap 157 5.7.4 Average and Marginal Products of Human Capital 158 5.7.5 The Structural Transformation, Growth, and Economic Efficiency 159 5.8 Rising Fertility in Early Development 160 5.9 One-Child Policy 161 5.10 Conclusion 163 5.11 Exercises 163 References 165 6 Physical Capital in Dual Economies 169 6.1 Farmer-owned Land I---Wages Gap in US History 171 6.1.1 Modern Sector 172 6.1.2 Traditional Sector 172 6.1.3 Households 173 6.1.4 Equilibrium 176 6.1.5 Labor Productivity 179 6.2 Farmer-owned Land II---Deindustrialization in the Ottoman Empire* 182 6.2.1 The Model 183 6.2.2 Migrants 184 6.2.3 Craftsmen 185 6.2.4 Farmers 186 6.2.5 Labor Market Equilibrium 186 6.2.6 Capital Market Equilibrium 187 6.2.7 The Urban/Manufacturing Share and Aggregate Output 188 6.2.8 Calibration 189 6.2.9 Counterfactual Simulation 190 6.3 Other Theories of Trade and Growth 192 6.3.1 Reduced Incentives for Human Capital Investment 192 6.3.2 Efficiency Advantages and External Effects from Urbanization 193 6.3.3 Power of Anti-growth Landowners 194 6.3.4 Volatility and Growth 194 6.4 Large Landowners---Growth and Endogenous Fiscal Policy 195 6.4.1 Households 196 6.4.2 Open Economy 197 6.4.3 Government Policy 197 6.5 Conclusion 200 6.6 Exercises 201 Appendix* 203 References 204 7 A Complete Dual Economy 206 7.1 The Dual Economy 208 7.1.1 Production Technologies and Factor Prices 208 7.1.2 Household Behavior 209 7.1.3 Labor Market Equilibrium and Locational Choice 211 7.1.4 Capital Market Equilibrium 214 7.2 Transitional Growth in the Long Run 215 7.2.1 Calibration and Numerical Analysis 216 7.3 Great Waves of Growth 220 7.4 South Korea: A Development Success Story 222 7.4.1 The Onset of Growth 223 7.4.2 Growth Acceleration 223 7.4.3 Lessons 224 7.4.4 Challenges 225 7.5 Human Capital Extensions 227 7.5.1 Goods Inputs 228 7.5.2 Community Externalities 228 7.5.3 Health Investments 229 7.6 Convergence Revisited 229 7.7 Politics and Growth 232 7.7.1 Natural Resources and the Politics Trap 233 7.8 Conclusion 234 7.9 Exercises 234 References 235 8 Urbanization 238 8.1 Urban Bias 241 8.1.1 Production 241 8.1.2 Households 243 8.1.3 Demographics 245 8.1.4 Migration in Equilibrium 245 8.1.5 Government 246 8.1.6 Efficient Urban Bias 246 8.2 Growth and Urbanization 248 8.2.1 Urbanization with Balanced Growth 248 8.2.2 Urbanization Without Balanced Growth 249 8.2.3 Redistributive Urban Bias 251 8.3 Extensions* 251 8.3.1 Government Transfers 251 8.3.2 Endogenous Taxation 254 8.3.3 Impure Public Goods 255 8.4 City Size and Development 257 8.5 Urbanization Today: New Mechanisms and Consequences 259 8.5.1 Consumption Cities: Urbanization Without Industrialization 259 8.5.2 Mushroom Cities: The Traditional Sector Grows in the City 260 8.5.3 Urbanization Without Growth Revisited 260 8.5.4 Slums 261 8.6 Hukou 262 8.7 De-urbanization: Past and Present 263 8.8 Conclusion 264 8.9 Exercises 265 References 266 9 Conclusion 268 9.1 The Onset of Growth 268 9.1.1 The Appearance of a Modern Sector 268 9.1.2 Poverty Traps and Schooling 269 9.2 The Nature of Modern Growth 270 9.3 Policy Implications 271 9.3.1 Domestic Growth Policy 271 9.3.2 International Trade, Capital Mobility, and Foreign Aid 272 9.4 Ideas for Future Research 273 Index 275 Front Matter....Pages i-x Overview....Pages 1-8 Front Matter....Pages 9-9 Neoclassical Growth Theory....Pages 11-50 Extensions to Neoclassical Growth Theory....Pages 51-89 Two-sector Growth Models....Pages 91-120 Front Matter....Pages 121-121 Wage and Fertility Gaps in Dual Economies....Pages 123-160 Physical Capital in Dual Economies....Pages 161-197 A Complete Dual Economy....Pages 199-230 Urbanization....Pages 231-260 Conclusion....Pages 261-267 Back Matter....Pages 269-272