development econ intro and chapter 1

This book provides an introduction to development economics, a subject that studies the economic
transformation of developing countries. My objective is to make a large literature accessible, in a
unified way, to a student or interested individual who has some training in basic economic theory. It is
only fair to say that I am not fully satisfied with the final product: in attempting to provide a wellstructured
treatment of the subject, I have had to sacrifice comprehensiveness. Nevertheless, I do
believe that the book goes quite far in attaining the original objective, within the limitations created
by an enormous and unwieldy literature and the constraints imposed by my own knowledge and
understanding.
The primary target for this book is the senior undergraduate or masters level student with training
in introductory or intermediate economic theory. I also recommend this book as background or
supplementary reading for a doctoral course in development economics, along with the original
articles on the subject.
Mathematical requirements are kept to a minimum, although some degree of mathematical maturity
will assist understanding of the material. In particular, I have eschewed the use of calculus altogether
and have attempted to present theoretical material through verbal argument, diagrams, and
occasionally elementary algebra. Because the book makes some use of game-theoretic and statistical
concepts, I have included two introductory appendixes on these subjects. With these appendixes in
place, the book is self-contained except for occasional demands on the reader’s knowledge of
introductory economic theory.
I begin with an overview of developing countries (Chapter 2). I discuss major trends in per capita
income, inequality, poverty, and population, and take a first look at the important structural
characteristics of development. Chapters 3–5 take up the study of economic growth from several
aspects.
Chapters 6–8 shift the focus to an analysis of unevenness in develepment: the possibility that the
benefits of growth may not accrue equally to all. In turn, these inequalities may influence aggregate
trends. This interaction is studied from many angles. Chapter 9 extends this discussion to population
growth, where the relationship between demography and economics is explored in some detail.
Chapter 10 studies unevenness from the viewpoint of structural transformation: the fact that
development typically involves the ongoing transfer of resources from one sector (typically
agriculture) to another (typically industry and services). This chapter motivates a careful study of the
agricultural sector, where a significant fraction of the citizens of developing countries, particularly
the poor, live and work.
Chapters 11–15 study informal markets in detail, with particular emphasis on the rural sector. We
analyze the land, labor, credit and insurance markets.
Chapter 16 introduces the study of trade and development. Chapter 17 motivates and studies the
instruments of trade policy from the point of view of a single country. Finally, Chapter 18 studies
multilateral and regional policies in trade.

For programs that offer a single semester course in economic development, two options are
available: (1) if international economic issues can be relegated to a separate course, cover all the
material up to the end of Chapter 15 (this will require some skimming of chapters, such as Chapters
4–6 and 11–15); (2) if it is desirable to cover international issues in the same course, omit much or
most of the material in Chapters 11–15. A year-long course should be able to adequately cover the
book, but some supplementary material may be required for international economics, as well as
financial issues in development, such as inflation and monetary policy.

I invite you to study what is surely the most important and perhaps the most complex of all economic
issues: the economic transformation of those countries known as the developing world. A definition
of “developing countries” is problematic and, after a point, irrelevant.1 The World Development
Report (World Bank [1996]) employs a threshold of $9,000 per capita to distinguish between what it
calls high-income countries and low- and middle-income countries: according to this classification,
well over 4.5 billion of the 5.6 billion people in the world today live in the developing world of
“low- and middle-income countries.” They earn, on average, around $1,000 per capita, a figure that
is worth contrasting with the yearly earnings of the average North American or Japanese resident,
which are well above $25,000. Despite the many caveats and qualifications that we later add to these
numbers, the ubiquitous fact of these astonishing disparities remains.
There is economic inequality throughout the world, but much of that is, we hope, changing. This
book puts together a way of thinking about both the disparities and the changes.
There are two strands of thought that run through this text. First, I move away from (although do
not entirely abandon) a long-held view that the problems of all developing countries can be
understood best with reference to the international environment of which they are a part.2 According
to this view, the problems of underdevelopment must first and foremost be seen in a global context.
There is much that is valid in this viewpoint, but I wish to emphasize equally fundamental issues that
are internal to the structure of developing countries. Although a sizeable section of this book
addresses international aspects of development, the teacher or reader who wishes to concentrate
exclusively on these aspects will not find a comprehensive treatment here.
The second strand is methodological: as far as possible, I take a unified approach to the problems
of development and emphasize a recent and growing literature that takes a level-headed approach to
market failure and the potential for government intervention. It is not that markets are intrinsically bad
or intrinsically good: the point is to understand the conditions under which they fail or function at an
inefficient level and to determine if appropriate policies grounded in an understanding of these
conditions can fix such inefficiencies. These conditions, I argue, can be understood best by a serious
appreciation of subjects that are at the forefront of economic theory but need to permeate more
thoroughly into introductory textbooks: theories of incomplete information, of incentives, and of
strategic behavior. Few people would disagree that these considerations lie at the heart of many
observed phenomena. However, my goal is to promote a student’s understanding of such issues as a
commonplace model, not as a set of exceptions to the usual textbook paradigm of perfect competition
and full information.
Because I take these two strands to heart, my book differs from other textbooks on development in
a number of respects. Most of these differences stem from my approach to exposition and choice of
subject matter. Although I do not neglect the historical development of a line of research or inquiry, I
bring to bear a completely modern analytical perspective on the subject. Here are some instances of
what I mean.(1) The story of economic underdevelopment is, in many ways, a story of how informal,
imaginative institutions replace the formal constructs we are accustomed to in industrialized
economies. The landlord lends to his tenant farmer, accepting labor as collateral, but a formal credit
market is missing. Villagers insure each other against idiosyncratic shocks using their greater
information and their ability to impose social sanctions, but a formal insurance market is missing.
Institutions as diverse as tied labor, credit cooperatives, and extended families can be seen as
responses to market failure of some sort, precipitated in most cases by missing information or by the
inability of the legal system to swiftly and efficiently enforce contracts. This common thread in our
understanding is emphasized and reemphasized throughout the book.
(2) The absence or underfunctioning of markets gives rise to two other features. One is the
creation of widespread externalities. Proper classification of these externalities provides much
insight into a variety of economic phenomena, which appear unconnected at first, but which (in this
sense) are just the common expression of a small variety of external effects. So it is that simple
concepts from game theory, such as the Prisoners’ Dilemma or the coordination game, yield insights
into a diverse class of development-related problems. Again, the common features of the various
problems yield a mental classification system—a way of seeing that different phenomena stem from a
unified source.
(3) A fundamental implication of missing markets is that inequality in the distribution of income
or wealth plays a central role in many development problems. It isn’t that inequality has not received
attention in treatises on development; it certainly has. However, what has recently begun to receive
systematic analytical treatment is the functional role of inequality: the possibility that inequality,
quite apart from being of interest in its own right, has implications for other yardsticks of economic
performance such as the level of per capita income and its rate of growth. The emphasis on the
functional role of inequality runs through the book.
(4) It is necessary to try to integrate, in an intuitive and not very abstract way, recent theoretical
and empirical literature with the more standard material. This isn’t done to be fashionable. I do this
because I believe that much of this new work has new things to teach us. Some important models of
economic growth, of income distribution and development, of coordination failures, or of incomplete
information are theories that have been developed over the last decade. Work on these models
continues apace. Although some of the techniques are inaccessible to a student with little formal
training, I do believe that all the ideas in this literature that are worth teaching (and there are many)
can be taught in an elementary way. In this sense this book coincides with existing texts on the subject:
the use of mathematics is kept to a minimum (there is no calculus except in an occasional footnote).
Partly because other development texts have been around for a good while, and perhaps in part
because of a different approach, this text departs significantly from existing development texts in the
points cited in the preceding text and indeed in its overall methodological approach.
Combining the complementary notions of incomplete information, a weak legal structure (so far as
implementation goes), and the resulting strategic and economic considerations that emerge, we begin
to have some idea of what it is that makes developing countries somehow “different.” Economic
theorists never tire of needling their friends with questions in this regard. Why is the study of
developing countries a separate subject? Why can’t we just break it up into separate special cases of
labor economics, international trade, money, and finance, and so on? Certainly, they have a point, but
that’s only one way to cut the cake. Another way to do so is to recognize that developing countries, in
their different spheres of activity, display again and again these common failures of information and
legal structures, and therefore generate common incentive and strategic issues that might benefit from
separate, concentrated scrutiny.
This approach also serves, I feel, as an answer to a different kind of objection: that developing
countries are all unique and very different, and generalizations of any kind are misleading or, at best,
dangerous. Although this sort of viewpoint can be applied recursively as well within countries,
regions, districts and villages until it becomes absurd, there is some truth to it. At the same time,
while differences may be of great interest to the specialized researcher, emphasizing what’s common
may be the best way to get the material across to a student. Therefore I choose to highlight what’s
common, while trying not to lose sight of idiosyncrasies, of which there are many.
A final bias is that, in some basic sense, the book is on the theory of economic development.
However, there is no theory without data, and the book is full of empirical studies. At the same time, I
am uninterested in filling up page after page with tables of numbers unless these tables speak to the
student in some informative way. So it is with case studies, of which there will be a number in the
text.3 I try to choose empirical illustrations and case studies throughout to illustrate a viewpoint on the
development process, and not necessarily for their own sake.
I started off writing a textbook for undergraduates, for the course that I have loved the most in my
fourteen years of teaching. I see that what emerged is a textbook, no doubt, but in the process
something of myself seems to have entered into it. I see now that the true originality of this book is not
so much the construction of new theory or a contribution to our empirical knowledge, but a way of
thinking about development and a way of communicating those thoughts to those who are young,
intelligent, caring, and impressionable. If a more hard-bitten scholar learns something as a byproduct,
that would be very welcome indeed.
My commitment as the author is the following: armed with some minimal background in economic
theory and statistics, and a healthy dose of curiosity, sympathy, and interest, if you study this book
carefully, you will come away with a provocative and interesting introduction to development
economics as it is practiced today Put another way, although this book offers (as all honest books in
the social sciences do) few unambiguous answers, it will teach you how to ask the right questions.