Fundamental Questions

1.How is poverty measured?

2.Why are some countries poorer than others?

3.What strategies can a nation use to increase its economic growth?

How are savings in one nation used to speed development in other nations?

What microeconomic issues are involved in the transition from socialism?

What macroeconomic issues are involved in the transition from socialism?

Teaching Objectives

The primary purpose of this chapter is to discuss the plight of developing countries.

The unique features of the chapter include a presentation of the concepts of absolute and relative poverty and a discussion of the social and political obstacles to economic growth. The chapter also looks at the strategies that countries have employed to foster their development and concludes with a discussion of foreign investment and foreign aid. Included in a discussion of the development problems of countries in the transition from socialism to capitalism.

Special attention should be given to the difference between absolute and relative poverty. The areas of development strategies and foreign aid will generate useful and interesting class discussion.

Key Term Review

expropriation
primary product
import substitution
export substitution
terms of trade
dual economy
foreign direct investment
portfolio investment
commercial bank loan
trade credit
foreign aid
bilateral aid
multilateral aid
privatize
monetary overhang
currency convertibility

Chapter 19

Lecture Outline and Teaching Strategies

1. The Developing World

1.a. Measuring poverty: Poverty is sometimes measured as an absolute concept, with income compared to some minimum criterion. Poverty is also measured in relative terms, with one person's income compared to that of others in the region or country.

Teaching Strategy: Ask your class which it believes is most appropriate, the absolute or the relative concept of poverty.

1.b. Basic human needs: One alternative to an absolute measure of poverty is to assess how well an economy meets a set of basic human needs.

Teaching Strategy: Ask your students to list the items that they would include in a human development index.

2. Obstacles to Growth

Given similar resources, different economies may have different rates of growth because of social and political obstacles.

2.a. Political obstacles

Teaching Strategy: Emphasize the importance of politics in the economics of development.

2.a.1. Lack of administrative skills: This occurs particularly in countries with a long history of colonization.

2.a.2. Political instability and risk: To foster development, foreign investors must be able to have confidence that their property rights will be protected and that their investments will not be expropriated.

2.a.3.Corruption: Research shows that there is a negative relationship between the level of corruption in a country and investment and growth.

2.a.4. Good economics as bad politics: Political pressures may force a government to work toward more immediate objectives than economic growth.

Teaching Strategy: Ask your students how they think a government might overcome the negative political results of a "good" economic development program.

2.b. Social obstacles

2.b.1. Lack of entrepreneurs: Entrepreneurs tend to be immigrants in developing countries.

2.b.2. Rapid population growth: This is linked to less capital per worker, higher consumption, and less investment in infrastructure.

3. Development Strategies

3.a. Inward-oriented strategies: Countries often attempt to substitute domestic production for imported goods, or they adopt protectionist policies against foreign goods.

3.b. Outward-oriented strategies: Such strategies focus on developing export markets for a country's goods.

Teaching Strategy: Ask your students to compare the political implications of inward- versus outward-oriented development strategies.

3.c. Comparing strategies: Countries that have chosen outward-oriented strategies have experienced the highest rates of economic growth.

4. Foreign Investment and Aid

4.a. Foreign savings flows: For developing countries capital does not often come from internal savings. Rather, foreign savings flow into developing countries in the form of direct private investment or foreign government grants and loans.

4.b. Benefits of foreign investment

4.b.1. New jobs: Foreign investment stimulates new employment.

4.b.2. Technology transfer: Technology is usually transferred to developing countries through direct foreign investment.

4.b.3. Foreign exchange earnings: Developing countries expect foreign investment to improve their balance of payments, but if a foreign firm sends its profits back to its industrial country headquarters, it can create a larger deficit in the host country.

4.c. Foreign aid: This can be provided bilaterally or multilaterally.

5. Economies in Transition from Socialism

An economy in transition poses special development problems as it moves from socialism to a market-based economy.

5.a. The primary microeconomic issue facing socialist economies is the creation of markets where none existed before.

5.a.1. Privatization: Resources that were owned by the socialist states must be converted to private ownership for capitalism to flourish.

Teaching Strategy: If you have students from a former socialist country, ask them to recount the techniques that have been used to privatize resources in their economies.

5.a.2. Price reform: In a market system prices serve a critical role in signaling shortages and surpluses. This role must be restored in socialist economies.

Teaching Strategy: To give students an idea of how difficult it is to allocate scarce resources without markets, bring some Lindt chocolate bars or some other items to class and discuss how they can be allocated in an efficient manner. The lines in front of the most desirable rides at Disneyland or other amusement parks are good examples of how scarce resources (seats on the rides) are allocated in the absence of markets and prices.

5.a.3. Social safety net: As reforms are enacted it is very important that a minimal set of social programs exist to maintain incomes as unemployment rises.

5.b. Macroeconomic Issues

5.b.1. Monetary policy: monetary overhang can result in inflation unless there are additional assets or goods and services for citizens to pay. The role of monetary policy in a socialist system just beginning the transformation to capitalism should be to maintain a low and steady rate of inflation.

5.b.2. Fiscal policy: To reform fiscal policy, government subsidies and budget deficits must be reduced.

5.c. The Sequencing of Reforms

There is an ongoing debate regarding the proper order of reforms.