Developing Countries

1. Inequality promotes growth

 
 

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

(The HO model is based on identical technologies)

  When trade and learning are impeded, there will be developing countries.

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


Building materials were imported. A Basilica in Milan.


Library of Alexandria, Egypt (322 BC?)
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.

 

trajan

 trajan

2. Developing Countries

Advanced Nations It is a common practice to arrange all nations according to real 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.
Emerging markets (BRIC)

New Silk Roads binds China to Latin America

Brazil, Russia, India and China accounts for 13% of world trade. Its growth rate is 9%, compared to 2.6% in advanced nations.

Intra-emerging market trade accounts for half of their trade. (about $2.8 trillion)

Brazil and China are active in Africa.

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

What was life like for the middle class in Europe in the 1600s? 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 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. Capital poor countries cannot afford to invest much in infrastructure. A certain amount of infrastructure investment is necessary to maintain the health of working population, to provide clean water and suitable housing, etc. Lack of good highways raises transportation costs. Urban areas grow because investing infrastructure in urban areas is more profitable than than that in the middle of nowhere.

During the time of Jesus, 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 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.
3. Culture

Gunnar Myrdal thought that South and Southeast Asians are soft socities 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 Countries (South Korea, Singapore, Taiwain and Hong Kong) as well as ASEAN proved his foresight was limited. 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 modernn 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) 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.

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

dependence on Technology: Most 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 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

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
 

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.
When demand is unstable.

Expected gains from price instability = the average area of two trianges, AB'C' and AB"C", which is greater than that of ABC.
 

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. How to Stabilize prices

 
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.
problems

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.

 

10. 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.
   
 problem

(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.
   

12. Multilateral Contracts

Long term contract that establishes price and/or quantity. Such pacts generally stipulate a minimum price at which importers will purchase guaranteed quantities from producing nations, and a maximum price at which producing nations will sell guaranteed amounts to importing nations.


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. (Proverb of the Netherlands)
bruegel Pieter Bruegel, Die Kreuztragung. (Carrying of the Cross?). This painting also shows the country life during the Middle Ages in the Netherlands.