Developing Countries

1. Inequality promotes growth


Group living has some advantages in the early stage of development:

reduced risk, ability to hunt big games (wild animals, e.g., buffaloes)

Agriculture was invented around 10,000 BC in the fertile Crescent. Syrians grew cereals about 7000 BC. After settling down around river valleys and the population increased, the primitive people built cities and began to develop social life, which increased interpersonal tension. Various taboos were developed to regulate social behavior as the population grew. Roughly half of ten commandments are designed to protect property rights, which were not well defined.

The concept of private properties developed during the Renaissance as international trade expanded.

(property rights) ⇒ give incentives to individuals to accumulate wealth. income inequality.

American Indians had no concept of land ownership ⇒ no economic growth.


In the early stage, a developed country (Greece, Rome) enjoys a higher living standard by military conquests and becomes a role model to the countries. (e.g., the title of Caesar is soon copied by others: Kaizer in Germany, Tsar in Russia.)

Trade soon follows. Even the conquered regions may benefit from trade.

Trade promotes exchange of new ideas, technology,and information.

(The HO model is based on identical technologies)

 printing, school As long as trade and learning are impeded, there will be developing countries. Before the invention of printing, it was difficult to transmit knowledge from one generation to the next.

Plato and Aristotle in one of Raphael's frescoes in the Vatican Museum. (School of Athens, 387 BC)

Library of Alexandria, Egypt (founded in 331 BC by Ptolemy after Alexander's death). The library possessed about 400,000 scrolls. Museion/Museum was derived from Muse (goddess of poets). Destroyed around AD 391. (pagan temples were made illegal.)

LDCs copy DCs

Galleria Vittorio Emmanuele in Milan is the first modern shopping mall, which opened in 1878. It comprised two buildings joined by an arch shaped glass cover. This style was copied extensively in America.

China's grid plan in the 15th century BC was copied by Japan (Kyoto).


The first shopping mall was the Markets of Trajan on the side of Quirinal hill in Rome, opened in 112 AD. There were 150 shops in the mall.




2. Developing Countries

Advanced Nations It is a common practice to arrange all nations according to GDP or income and draw a dividing line between the advanced and the developing countries.

In the category of advanced nations are included the countries of North America and Western Europe, plus Australia, New Zealand and Japan.

Developing countries/

LDCs (less developed countries)

Developing countries are most of those in Africa, Asia, Latin America and the Middle East. (South Korea, Taiwan, Singapore and China are industrial countries at present. The argument that China should be treated as a developing country is becoming increasingly tenuous.
World Trade in 2016

Gross World Product = $72 trillion (2012)

EU = $16.5 trillion, US = $18 trillion, China = $11.4 trillion, Japan = India = $4.7 trillion

World Trade $15 trillion (about 20% of GWP = $78 trillion)

Imports of Developed countries = $8.6 trillion

Exports of Developed countries = $8 trillion (Developed economies have trade balance)

Europe's trade = $5.3 trillion (balanced)

North America (NAFTA)

Exports = $2.4 trillion

Imports = $1.7, Trade deficit = $0.7 trillion (mostly US trade deficit).

China exports = $1.6 trillion, imports = $1.4 trillion, trade surplus = $200 billion.

Newly Industrialized Countries

The terminology was popular in the 1980s, beginning with the Four Asian Tigers (Hong Kong, Singapore, South Korea and Taiwan, but now are classified as high income economies (over $30,000.)

Current NICs: South Africa, Brazil, Mexico + China, India, Indonesia, Malaysia, Philippines, Thailand, + Turkey.
GDP = ($4000, $20,000)

Emerging markets (BRICS)

New Silk Roads binds China to Latin America

Originally, they were called BRIC (Brazil, Russia, India and China), BRICS after 2010, including South Africa.

These are large and newly industrializing countries (NICs) accounts for 13% of world trade.

Population: 3 billion

GDP = $14.8 trillion as of 2013.

Its growth rate is 9%, compared to 2.6% in advanced nations.

Intra-emerging market trade accounts for about 30% of global consumption. Increasingly, emerging markets begin to denominate trade contracts in nondollar currencies.

Old guard currencies ($, euro, yen) are likely to depreciate as BRICS grow.

Brazil and China are active in Africa.

Emerging markets


One of numerous brass plates from Benin City. British Museum.

Economic growth accelerated with the printing press.

What was life like for the middle class in Europe in the 1600s (before land ownership was established)? It was much worse than that of a developing country in the world today. The printing press had been just invented, but newspapers were not widely circulated yet.

Economic development did not take place before the printing press (invented c. 1440) became widespread in Europe (c. 1500) Economic conditions of developing countries today are like those of European countries during the pre-industrial revolution period.

3. Why Developing Countries Are Poor

1. Lack of Infrastructure

Developing countries have not invested enough to build the infrastructure that enhances the productivity of both labor and capital inputs. Infrastructure installation is costly, and hence requires a large capital expenditure.

Infrastructure is public capital that can be used by all private sectors. Capital poor countries cannot afford to invest much in infrastructure. A minimal amount of infrastructure investment is necessary to maintain production in the modern world: the healthy working population, clean water, suitable housing, schools, and highways, etc. Lack of good highways raises transportation costs. Urban areas grow because investing infrastructure in urban areas is more profitable than that in the middle of nowhere.

Conquest of major infectious diseases was necessary for urban development. During the first century AD, life expectancy was a little more than 20-30, which did not change much through the Middle Ages. The average life expectancy rose to 47 years around 1900, and to 77 years in 2000.

2. Lack of Skills and Technology

Laborers in LDCs are generally employed in industries that require unskilled labor or self-employed as in agriculture. Skilled workers are employed generally in capital intensive industries. Capital intensive industries are located in areas with substantial infrastructure.

LDCs lack skilled workers and use unskilled workers intensively. Inward FDI should be welcome as it brings new technologies and stimulates learning.

3. Religious and Cultural effects on economy

Gunnar Myrdal thought that South and Southeast Asians are soft societies with low expectations. He said that they are lazy and do not demand much. As a result, they do not grow. However, the rise of Japan, the emergence of China as an industrial giant, and the Newly Industrializing Economies (South Korea, Singapore, Taiwain and Hong Kong now graduated from this list) as well as ASEAN proved his foresight was limited.

In Mongolia during the 1920s, one third of the male population were monks. 25 percent of the mail population were monks in Tibet during the 1950s. In 1733 there were 319,270 monks in Central Tibet when its population was 2.5 million. About 26 percent of the males were monks. (Population and Society in Contemporary Tibet, Rong Ma, 2011)

In France, it is almost impossible to fire a worker, as exhibited by the outcry and sabotage of French workers to modify labor practices. It is an indication of monopoly or monopsony power in a segment of the society (e.g., labor union). Such a system is not conducive to developing a flexible modern economy. Long dinner hours in some European countries cut into their working hours.

4. Insufficient trade with the West

Developing countries do not fully exploit trade opportunities with the West. Trade raises the wage of export sectors in developing countries. Free trade with the west will eventually raise the wage of developing countries to that of the West. (Factor price equalization)

Trade accounted for 4% in the former Soviet Union (1985).

LDCs can accumulate trade surplus to build infrastructure and raise capital stock. Those who are successful in this transformation become newly industrializing countries (NICs).

Trade rather than Aid!

5. Lack of Incentives

In the early state of development, some inequality stimulates human desires to achieve a better life. Lack of private ownership did not contribute much to economic growth in the former Soviet Union. The rich or aristocrats provide a role model for the poor to reach higher income levels.

Welfare programs destroy incentives for the poor to work. In the former Soviet Union, people were reluctant to work because pay was not linked to work.


4. Trade Characteristics of Developing Nations

Dependence on developed economies

Developing nations are highly dependent on the advanced or developed nations.

Developing countries excluding Asia account for about 20% of world trade. If Asia is included, their export share of world trade is 40% in 2005. China will soon be exluded from this group.

Income dependence: Most of exports of developing nations go to the developed nations.

dependence on Technology: Most of imports of developing nations originate in the developed countries (medicine, new machines). Trade among developing nations is minor.

Primary products

Exports of developing nations are primary products (agricultural goods, raw materials, and fuels).

Some countries export drugs and low tech military goods to gain international currencies.

Shares of manufactured exports tend to be less than 10% among African countries.

Labor intensive exports

Exports of manufactured goods tend to be labor intensive (such as textiles). The absolute value of manufactured goods produced by the developing nations is low.

The rise in the shares of manufactured goods in developing nations is due to a handful of newly industrializing countries (NICs) such as Korea, Taiwan, and Singapore until 1980s. However, these countries have lost their export markets to China, which has emerged as an industrial giant in the 1990s.


5. Trade Problems of Developing Nations Excluding BRICs

Unstable Export Markets

One characteristic of many developing nations is that their exports are concentrated in a small number of primary products. Dependence on primary products, 1992

Country         Major Export Product       Major Export Product as
                                           a % of total exports

Saudi Arabia           oil                  87%
Zambia                 copper               85
Burundi                coffee               79
Liberia                iron ore             64
Rwanda                 coffee               57
Mauritania             iron ore             42
Bolivia                natural gas          36
Bangladesh             jute goods           26
Inelastic Demand and Supply
Kopi Luwak, the most expensive coffee

6. Revenue and price elasticity of demand (PED)

Revenue and PED There is a straightforward relationship between TR and price elasticity of demand, PED. TR is defined by PQ, and is described by the rectangular area generated by a point on a given demand curve.
Hat calculus

Let Z be the product of two variables, X and Y,

Z = XY.

Let the new value of Z be denoted by Z'. Then

Z' = (X+ΔX)(Y+ΔY) = (1 + ^X)X(1 + ^Y)Y = (1 + ^X + ^Y + ^X^Y)XY

^Z = ^X + ^Y + ^X ^Y.

When the percentage changes are small,

Z = XY => ^Z = ^X + ^Y.

Z = 1/X => ^Z = - ^X. ( ^(1/X) + ^X = ^(1) = 0)

Z = X/Y => ^Z = ^X - ^Y.


^R = ^P + ^Q = ^P(1 + ^Q/^P) = ^P(1 - ε).

ε = price elasticity of demand = -^Q/^P.

Inelastic Demand.


ε < 1. Thus, ^P and ^R move in the same direction.

ex: ε = 0.5. If ^P = -10%, then ^R = - 10%(1 - 0.5) = - 5%.

In this situation, farmers are worse off when they harvest a good crop, because ^Q and ^R move in the opposite directions.

Implication: A good harvest means low prices and low revenue for farmers.

Elastic Demand

ε > 1. Thus, ^P and ^R move in the opposite direction.

ex: ε = 2. ^P = - 10%. ^R = - 10%(1 - 2) = 10%.

Unitary Elastic Demand ε = 1, and hence ^R = 0.


7. Stabilizing Commodity Prices

  In an attempt to stabilize export earnings, developing countries have pressed for international commodity agreements. ICAs are typically agreements between leading producing and consuming nations about stabilizing commodity prices, assuring adequate supplies to consumers, and promoting economic development of producers.
Who wants price stability? Farmers want stable prices.
Gains from price instability

Do Consumers want price stabilization? No.

Consumer gains from a price fall: the apparent red trapezoid (BCC"B")

Consumer losses from a price increase: the apparent green trapezoid (BCC'B').

Expected gains from price instability = (1/2)(BCC"B" -BCC'B') > 0.


Using positively sloped supply curve, one can also demonstrate that producer surplus is greater when prices are unstable. Thus, producers should also prefer random prices.

However, producers are more easily organized than consumers to persuade the government to stabilize farm prices and that the stabilized prices should be higher than the mean prices. They do not mind high prices, but asks the government to gaurantee minimum prices.

International Commodity Agreement Commodity agreements are usually made between producing and consuming nations that want to introduce stability in the otherwise unstable commodity markets. Agreements among producers within a single country are usually outlawed by Antitrust laws, but such laws do not have jurisdiction over the national territory. Thus, it is possible to have agreements on price stabilization schemes with other producing nations.
Agreement                           Membership         Stabilization tools
International Cocoa Organization    26 C + 18 P        buffer stock, export quota
International Tin agreement         16 C + 4 P         buffer stock, export control
International Coffee Organization   24 C + 43 P        export quota
International Sugar Organization    26 P + 41 C        export quota, buffer stock
International Wheat Agreement       41 C + 10 P        multilateral contract

C = consuming nation, P = producing nation

8. Producion and Export Control

How to face a global recession

Producer revenue can be riased with production control.

Specifically, the blue rectangle can be larger than the red rectange, which represents revenue with production control. The area of the blue rectangle is greater than that of the red when demand is price inelastic.


9. Grow Together vs Grow Apart

Special Message to the Congress, Jan 25, 1962

Trade Expansion Act of 1962.

(i) asked for authority to reduce tariffs by 50% in reciprocal negotiations.

(ii) introduced trade adjustment assistance.

  "The two great Atlantic markets [EEC and the US] will either grow together or they will grow apart. The meaning and range of free economic choice will either be widened for the benefit of free men everywhere--or confused and constricted by new barriers and delays. "
Outcome Kennedy Round reduced tariffs by 30%.
  Grow alone policy vs grow together policy



10. Effect of Price Stabilization in Developed Countries

Export controls

Producers' associations have adopted export quotas. Export quotas must also be accompanied by production control.

e.g., OPEC

Buffer Stock A stabilization agency needs to maintain Buffer Stock.
price ceiling
price floor
Maximum price

Maximum price is a price ceiling which government imposes to protect consumers by releasing surplus grains. Price will not rise above the maximum price.

Minimum price

Minimum price is a price floor that government imposes to protect producers by purchasing grains at the minimum price. The price does not fall below the minimum price.


In principle, the government can make money when it buys grains at low price and sell at high prices.

It can be a price support program
Storage cost can be high. In the long run, profits from price stabilization must be positive, i.e., (selling price - buying price)Q - storage cost > 0.

Governments in LDCs don't have money to support prices.

e.g., India's protest against the elimination of a fuel subsidy.


11. Buffer stock program


 The US government set up the Commodity Credit Corporation in 1933 to stabilize farm prices.

Farmers lobby for price stabilization, which in fact becomes a price subsidy program.

With a buffer stock program, the government establishes a minimum price and buys surplus grains, and sells the surplus when price is higher.


(i) The government must set aside a large amount to enable itself to purchase the surplus grains.

(ii) The government must also use resources to manage the buffer stock, including storage facilities.

(iii) storage cost is high.

(iv) one-year old grains are not highly valued. 



11. Deficiency Payment program

 Deficiency Payments

The government let the market price fall to the equilibrium price, and pays farmers the difference d = pmin - p*. The cost of deficiency payments program is

C = Q(pmin - p*) 

 Inelastic demand

 Demand for grains are generally price inelastic.

Accordingly, revenue from consumers (blue rectangle) is smaller under the deficient payment program than under the buffer stock scheme.

This means that deficiency payment program costs more than the buffer stock scheme for given price ceiling.

However, there is no storage cost associated with the deficiency payments program.

For this reason, the US government uses the deficiency payments program, and let farmers manage the storage problem.

Supply of grains are also price inelastic.

 Developing countries  Surplus grains are dumped in developing countries, which now demand removal of export subsidies in EU.

Life during the Middle Ages

Return from the Inn, Pieter Bruegel the Younger (circa 1620) illustrates the farm life in a developing country.

bruegel Pieter Bruegel, Die niederlaendischen Sprichwoerter. (Proverbs of the Netherlands) This painting also shows the country life during the Middle Ages in the Netherlands.