Chapter 11: Development
Policymaking and the Roles of
Market, State, and Civil Society
ECON 460: Development Economics
1
A Question of Balance
Roles and limitations of state, market, and civil society/citizen
sector/NGOs in achieving economic development and poverty
reduction
• Venn diagrams:
• Overlapping activities; and
• Extensions of sector activity, illustrated with NGOs substituting for missing
government or private sector activity
2
Venn Diagram: Sector spheres and overlaps
NGOs /
Civil Society
Private Sector Government
A. Sectoral overlap: Differentiation and zones of uncertainty on
organizational comparative advantage
3
Venn Diagram – Sector Overlapping and
Sector Extension: Example of NGOs
NGOs
Markets Government
B. Sectoral extension: Extension beyond standard comparative advantage
depending on specific circumstances
4
Development Planning: Concepts and Rationale
• The Planning Mystique
• In the past, few doubted the importance and usefulness of national
economic plans
• Recently, however, disillusionment has set in
• But a comprehensive development policy framework can play an
important role in accelerating growth and reducing poverty
• The nature of development planning resource mobilization for
public investment
• Economic policy to control private economic activity according to
social objectives formulated by government
5
Development Planning: Concepts and Rationale
(Continued)
• Private sector in mixed economies comprises
• The subsistence sector
• Small scale businesses
• Medium size enterprises
• Larger domestic firms
• Large joint or foreign owned enterprises
• The Rationale for Development Planning
• Market failure
• Resource mobilization and allocation
• Attitudinal or psychological impact
• Requirement to receive foreign aid
6
Three General Forms of Market Failure
• The market cannot function properly or no market exists
• The market exists but implies inefficient resource allocation
• More expansively: the market produces undesirable results
as measured by social objectives other than the allocation
of resources
• Often items such as more equal income distribution, and “merit
goods” such as health, are treated as separate rationales for
policy, outside of economic efficiency
7
Market Failure: A Typology
• Market failures can occur when social costs or benefits differ from private costs or
benefits of firms or consumers
• Market power (monopolistic, monopsonistic)
• Public goods: free riders cannot be excluded except possibly at high cost (Chapter 10)
• Common property resources with lack of (informal or formal) regulation (Chapter 10)
• Externalities: agents do not have to pay all costs of their activities, or are unable to
receive all the benefits (Chapter 10)
• Prisoners’ Dilemmas occur when agents better off if others cooperate but individual
agents better off “defecting”
• Coordination failures can occur when coordination is costly; e.g. where a Big Push
may be needed (Chapter 4)
• Capital markets are particularly prone to failure (Chapter 15 (beyond our class))
8
Market and Government Failure: Broader Arguments
• Government failure: in many cases, politicians and bureaucrats
can be considered utility maximizers (for themselves), not
public interest maximizers
• So we cannot jump to a conclusion that if economic theory says
policy can fix market failures that it will do so in practice
• Analysis of incentives for government failure guides reform, e.g.
civil service reform, constitution design
• Developing countries tend to have both high market failure and
high government failures
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The Development Planning Process: Some Basic Models
• Characteristics of the planning process
• Planning in stages: basic models
• Aggregate growth models
• Multisector input-output, social accounting, and CGE models
• Three stages of planning
• Aggregate
• Sectoral
• Project
10
The Development Planning Process:
Some Basic Models (Continued)
Aggregate Growth Models: Projecting Macro Variables
K (t ) = cY (t ) (11.1)
Where
K(t) is capital stock at time t
Y(t) is output at time t
c is the average and marginal
capital-output ratio
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The Development Planning Process: Some Basic
Models (Aggregate Growth Models)
(11.2)
Where
I(t) is gross investment at time t
s is the savings rate
S is national savings
is the depreciation rate
If g is the targeted rate of output growth, then
(11.3)
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The Development Planning Process: Some Basic Models
(Aggregate Growth Models) (Continued)
(11.4)
(11.5)
(11.6)
Where n is the labor force growth rate and p
is the growth rate of labor productivity
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The Development Planning Process: Some Basic Models
(Aggregate Growth Models) (Continued)
(11.7)
Where W and are wage and profit incomes
(11.8)
Where s and sW are the marginal propensities
to save from wage income and profit
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Aggregate Models: Harrod-Domar with
Differentiated Savings
After some algebra we obtain
(11.9)
One interpretation: Weighted average of savings rates when differ by group
15
The Development Planning Process:
Some Basic Models (Continued)
• Multisector Models and Sectoral Projections
• Interindustry or input-output models
• Can be extended in 2 ways
• Social accounting matrix (SAM) models where data from national accounts,
balance of payments (BOP), and flow-of-funds databases is supplemented
with household survey data
• Computable general equilibrium (CGE) models where utility and production
functions are estimated and impacts of policies are simulated
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The Development Planning Process:
Some Basic Models (Continued)
• Project Appraisal and Social Cost-Benefit Analysis
‒ Basic concepts and methodology
Specify objective function
Compute social measures (shadow prices)
Establish decision criterion
• Computing shadow prices and social discount rates
• Calculating the social rate of discount or social time
preference
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The Development Planning Process: Some Basic
Models (Project Appraisal and Social
Cost-Benefit Analysis) (Continued)
Net present value, or NPV is given by
Bt - Ct
NPV = å t (11.10)
t (1+ r)
Where
Bt is the expected benefit at time t
Ct is the expected cost at time t
r is the social rate of discount used
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11.3 The Development Planning Process: Some Basic
Models (Project Appraisal and Social
Cost-Benefit Analysis) (Continued)
• Choosing projects: some decision criteria
• NPV rule
• Compare the internal rate of return with an interest rate
• Conclusions: planning models and plan consistency
Government Failure and Preferences for Markets
over Planning
• Problems of Plan Implementation and Plan Failure
• Theory versus practice
• Deficiencies in the plans and their implementation
• Insufficient and or unreliable data
• Unanticipated economic disturbances, external and
internal
• Institutional weaknesses
• Lack of political will
• Conflict, post-conflict, and fragile states
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The Market Economy
• Well functioning market economy requires
• Clear property rights
• Laws and courts
• Freedom to establish business
• Stable currency
• Public supervision of natural monopolies
• Provision of adequate information
• Autonomous tastes
• Public management of externalities
• Stable monetary and fiscal policy instruments
• Safety nets
• Encouragement of innovation
• Security from violence
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The Market Economy (Continued)
• The “Washington Consensus” on the Role of the State in
Development and its Limitations
• The consensus reflected a free market approach to
development espoused by the IMF, the World bank, and key
U.S. government agencies
• However, it did not always accord with realities in developing
countries that were successful
22
Development Policy: The Former Washington
Consensus and East Asia
Source: Rodrik, Dani (1996), ‘Understanding economic policy reform,’ Journal of Economic Literature, 34: 17. Reprinted with permission from the American Economic Association
and courtesy of Dani Rodrik.
23
The Washington Consensus on the Role of the State in
Development and Its Subsequent Evolution
• Toward a new consensus
• New emphasis on government’s responsibility toward
poverty alleviation and inclusive growth
• Provision of fundamental public goods
• Importance of health and education
• A recognition that markets can fail
• Governments can help secure conditions for an effective
market based economy
24
Development Roles of NGOs and the Broader
Citizen Sector
• Also referred to as civil society, or the “voluntary sector”
• Potentially important roles in:
• Common property resource management
• Local (such as village or neighborhood level) public goods
• Economic and productive ideas
• These activities are either:
• Excludable but not rival
• Rival but not excludable
• Partly excludable and partly rival
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Development Roles of NGOs and the Broader
Citizen Sector (Continued)
• Rivalry and excludability are two characteristics of
services; but not the only relevant ones
• Other potential comparative advantages of NGOs
• Innovative design and implementation
• Program flexibility
• Specialized technical knowledge
• Provision of targeted local public goods
• Common-property resource management design and
implementation
• Trust and Credibility
• Representation and advocacy
• But NGOs are subject to voluntary sector “failures” - just as there is
market failure and government failure
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Other limitations: “voluntary failure” – NGOs may be…
• Called voluntary failures, referring to the term “voluntary sector”
• Insignificant, owing to small scale and reach.
• Lacking necessary local knowledge to develop and implement an appropriate
mix of programs to address relevant problems
• Selective and exclusionary, elitist, and or ineffective
• Lacking adequate incentives to ensure effectiveness
• Captured by goals of funders rather than intended beneficiaries; may change
priorities one year to the next
• Giving too little attention to means, preventing needed scale...
• Or, means - such as fundraising - can become ends in themselves
• Lacking direct feedback (as private firms get in markets, or elected governments
receive at the polls); this can let the weaknesses go on for some time before
being corrected
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Trends in Governance and Reform
• Tackling the problem of Corruption
• Decentralization
• Development participation- alternate interpretations
• Genuine participation and role of NGOs
• Tackling the problem of corruption
• Corruption is the abuse of public trust for private gain
• A form of theft - even if indirectly
• Corruption has efficiency costs; even if it is less often the “binding
constraint” on growth than often guessed
• Effects of corruption fall disproportionately on the poor
• Good governance is broader than simply an absence of corruption
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Discussion Questions
• What do you think should be the role of the state in contemporary
developing countries?
• Is the choice between markets and government an either/or choice?
Explain your answer.
