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Economic Development

T w e l f T h e d i T i o n

Michael P. Todaro New York University

Stephen C. Smith The George Washington University

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Library of Congress Cataloging-in-Publication Data

Todaro, Michael P. Economic development / Michael P. Todaro, New York University, Stephen C. Smith, The George Washington University. -- Twelfth Edition. pages cm Includes bibliographical references and index. ISBN 978-0-13-340678-8 -- ISBN 0-13-340678-4 1. Economic development. 2. Developing countries--Economic policy. I. Smith, Stephen C., Date- II. Title. HD82.T552 2014 338.9009172’4--dc23 2014011530 10 9 8 7 6 5 4 3 2 1

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v

Part One Principles and Concepts 1

1 Introducing Economic Development: A Global Perspective 2

2 Comparative Economic Development 40

3 Classic Theories of Economic Growth and Development 118

4 Contemporary Models of Development and Underdevelopment 164

Part Two Problems and Policies: Domestic 215

5 Poverty, Inequality, and Development 216

6 Population Growth and Economic Development: Causes, Consequences, and Controversies 284

7 Urbanization and Rural-Urban Migration: Theory and Policy 330

8 Human Capital: Education and Health in Economic Development 382

9 Agricultural Transformation and Rural Development 437

10 The Environment and Development 490

11 Development Policymaking and the Roles of Market, State, and Civil Society 541

Part Three Problems and Policies: International and Macro 599

12 International Trade Theory and Development Strategy 600

13 Balance of Payments, Debt, Financial Crises, and Stabilization Policies 678

14 Foreign Finance, Investment, Aid, and Conflict: Controversies and Opportunities 731

15 Finance and Fiscal Policy for Development 781

Brief Contents

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Case Studies and Boxes xvii Preface xix

Part One Principles and Concepts 1

1 Introducing Economic Development: A Global Perspective 2 Prologue: An Extraordinary Moment 2

1.1 How the Other Half Live 4

1.2 Economics and Development Studies 9 The Nature of Development Economics 9 Why Study Development Economics? Some Critical Questions 11 The Important Role of Values in Development Economics 14 Economies as Social Systems: The Need to Go Beyond Simple Economics 15

1.3 What Do We Mean by Development? 16 Traditional Economic Measures 16 The New Economic View of Development 17 Amartya Sen’s “Capability” Approach 18 Development and Happiness 21 Three Core Values of Development 22 The Central Role of Women 24 The Three Objectives of Development 24

1.4 The Future of the Millennium Development Goals 24

1.5 Conclusions 28

■ Case Study 1: Progress in the Struggle for More Meaningful Development: Brazil 30

2 Comparative Economic Development 40 2.1 Defining the Developing World 42

2.2 Basic Indicators of Development: Real Income, Health, and Education 45 Purchasing Power Parity 45 Indicators of Health and Education 49

2.3 Holistic Measures of Living Levels and Capabilities 51 The New Human Development Index 51

2.4 Characteristics of the Developing World: Diversity within Commonality 55 Lower Levels of Living and Productivity 57 Lower Levels of Human Capital 59 Higher Levels of Inequality and Absolute Poverty 60 Higher Population Growth Rates 63

Contents

viii Contents

Greater Social Fractionalization 64 Larger Rural Populations but Rapid Rural-to-Urban Migration 65 Lower Levels of Industrialization and Manufactured Exports 66 Adverse Geography 67 Underdeveloped Markets 69 Lingering Colonial Impacts and Unequal International Relations 70

2.5 How Low-Income Countries Today Differ from Developed Countries in Their Earlier Stages 73 Physical and Human Resource Endowments 74 Relative Levels of Per Capita Income and GDP 75 Climatic Differences 75 Population Size, Distribution, and Growth 75 The Historical Role of International Migration 76 The Growth Stimulus of International Trade 78 Basic Scientific and Technological Research and Development Capabilities 79 Efficacy of Domestic Institutions 79

2.6 Are Living Standards of Developing and Developed Nations Converging? 80

2.7 Long-Run Causes of Comparative Development 85

2.8 Concluding Observations 93

■ Case Study 2: Comparative Economic Development: Pakistan and Bangladesh 96

Appendix 2.1 The Traditional Human Development Index (HDI) 112

3 Classic Theories of Economic Growth and Development 118 3.1 Classic Theories of Economic Development: Four Approaches 119

3.2 Development as Growth and the Linear-Stages Theories 119 Rostow’s Stages of Growth 120 The Harrod-Domar Growth Model 121 Obstacles and Constraints 123 Necessary versus Sufficient Conditions: Some Criticisms of the Stages Model 123

3.3 Structural-Change Models 124 The Lewis Theory of Economic Development 124 Structural Change and Patterns of Development 129 Conclusions and Implications 130

3.4 The International-Dependence Revolution 131 The Neocolonial Dependence Model 131 The False-Paradigm Model 133 The Dualistic-Development Thesis 133 Conclusions and Implications 134

3.5 The Neoclassical Counterrevolution: Market Fundamentalism 135 Challenging the Statist Model: Free Markets, Public Choice, and Market-Friendly Approaches 135 Traditional Neoclassical Growth Theory 137 Conclusions and Implications 139

3.6 Classic Theories of Development: Reconciling the Differences 140

■ Case Study 3: Schools of Thought in Context: South Korea and Argentina 142

Appendix 3.1 Components of Economic Growth 149

Appendix 3.2 The Solow Neoclassical Growth Model 155

Appendix 3.3 Endogenous Growth Theory 159

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4 Contemporary Models of Development and Underdevelopment 164 4.1 Underdevelopment as a Coordination Failure 165

4.2 Multiple Equilibria: A Diagrammatic Approach 168

4.3 Starting Economic Development: The Big Push 174 The Big Push: A Graphical Model 176 Other Cases in Which a Big Push May Be Necessary 181 Why the Problem Cannot Be Solved by a Super-Entrepreneur 182

4.4 Further Problems of Multiple Equilibria 183 Inefficient Advantages of Incumbency 183 Behavior and Norms 184 Linkages 185 Inequality, Multiple Equilibria, and Growth 186

4.5 Michael Kremer’s O-Ring Theory of Economic Development 187 The O-Ring Model 187 Implications of the O-Ring Theory 190

4.6 Economic Development as Self-Discovery 192

4.7 The Hausmann-Rodrik-Velasco Growth Diagnostics Framework 193

4.8 Conclusions 197

■ Case Study 4: Understanding a Development Miracle: China 200

Part Two Problems and Policies: Domestic 215

5 Poverty, Inequality, and Development 216 5.1 Measuring Inequality 218

Size Distributions 218 Lorenz Curves 220 Gini Coefficients and Aggregate Measures of Inequality 222 Functional Distributions 224 The Ahluwalia-Chenery Welfare Index (ACWI) 225

5.2 Measuring Absolute Poverty 226 Income Poverty 226

5.3 Poverty, Inequality, and Social Welfare 230 What’s So Bad about Extreme Inequality? 230 Dualistic Development and Shifting Lorenz Curves: Some Stylized Typologies 232 Kuznets’s Inverted-U Hypothesis 235 Growth and Inequality 239

5.4 Absolute Poverty: Extent and Magnitude 240 The Multidimensional Poverty Index (MPI) 242 Growth and Poverty 248

5.5 Economic Characteristics of High-Poverty Groups 250 Rural Poverty 250 Women and Poverty 251 Ethnic Minorities, Indigenous Populations, and Poverty 255

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5.6 Policy Options on Income Inequality and Poverty: Some Basic Considerations 256 Areas of Intervention 256 Altering the Functional Distribution of Income through Relative Factor Prices 257 Modifying the Size Distribution through Increasing Assets of the Poor 258 Progressive Income and Wealth Taxes 260 Direct Transfer Payments and the Public Provision of Goods and Services 260

5.7 Summary and Conclusions: The Need for a Package of Policies 262

■ Case Study 5: Institutions, Inequality, and Incomes: Ghana and Côte d’Ivoire 264

Appendix 5.1 Appropriate Technology and Employment Generation: The Price Incentive Model 272

Appendix 5.2 The Ahluwalia-Chenery Welfare Index 275

6 Population Growth and Economic Development: Causes, Consequences, and Controversies 284 6.1 The Basic Issue: Population Growth and the Quality of Life 284

6.2 Population Growth: Past, Present, and Future 285 World Population Growth throughout History 285 Structure of the World’s Population 287 The Hidden Momentum of Population Growth 291

6.3 The Demographic Transition 293

6.4 The Causes of High Fertility in Developing Countries: The Malthusian and Household Models 296 The Malthusian Population Trap 296 Criticisms of the Malthusian Model 301 The Microeconomic Household Theory of Fertility 303 The Demand for Children in Developing Countries 305 Implications for Development and Fertility 306

6.5 The Consequences of High Fertility: Some Conflicting Perspectives 307 It’s Not a Real Problem 308 It’s a Deliberately Contrived False Issue 309 It’s a Desirable Phenomenon 309 It Is a Real Problem 311 Goals and Objectives: Toward a Consensus 314

6.6 Some Policy Approaches 315 What Developing Countries Can Do 316 What the Developed Countries Can Do 318 How Developed Countries Can Help Developing Countries with Their Population Programs 319

■ Case Study 6: Population, Poverty, and Development: China and India 321

7 Urbanization and Rural-Urban Migration: Theory and Policy 330 7.1 Urbanization: Trends and Living Conditions 331

7.2 The Role of Cities 339 Industrial Districts 339 Efficient Urban Scale 343

7.3 The Urban Giantism Problem 344 First-City Bias 345 Causes of Urban Giantism 346

xiContents

7.4 The Urban Informal Sector 348 Policies for the Urban Informal Sector 350 Women in the Informal Sector 354

7.5 Migration and Development 355

7.6 Toward an Economic Theory of Rural-Urban Migration 357 A Verbal Description of the Todaro Model 358 A Diagrammatic Presentation 360 Five Policy Implications 362

7.7 Conclusion: A Comprehensive Urbanization, Migration, and Employment Strategy 365

■ Case Study 7: Rural-Urban Migration and Urbanization in Developing Countries: India and Botswana 369

Appendix 7.1 A Mathematical Formulation of the Todaro Migration Model 375

8 Human Capital: Education and Health in Economic Development 382 8.1 The Central Roles of Education and Health 382

Education and Health as Joint Investments for Development 384 Improving Health and Education: Why Increasing Income Is Not Sufficient 385

8.2 Investing in Education and Health: The Human Capital Approach 388

8.3 Child Labor 391

8.4 The Gender Gap: Discrimination in Education and Health 396 Education and Gender 396 Health and Gender 398 Consequences of Gender Bias in Health and Education 399

8.5 Educational Systems and Development 401 The Political Economy of Educational Supply and Demand: The Relationship between

Employment Opportunities and Educational Demands 401 Social versus Private Benefits and Costs 403 Distribution of Education 404

8.6 Health Measurement and Disease Burden 406 HIV/AIDS 412 Malaria 415 Parasitic Worms and Other “Neglected Tropical Diseases” 418

8.7 Health, Productivity, and Policy 420 Productivity 420 Health Systems Policy 422

■ Case Study 8: Pathways Out of Poverty: Progresa/Oportunidades in Mexico 425

9 Agricultural Transformation and Rural Development 437 9.1 The Imperative of Agricultural Progress and Rural Development 437

9.2 Agricultural Growth: Past Progress and Current Challenges 440 Trends in Agricultural Productivity 440 Market Failures and the Need for Government Policy 446

9.3 The Structure of Agrarian Systems in the Developing World 448 Three Systems of Agriculture 448 Traditional and Peasant Agriculture in Latin America, Asia, and Africa 449

xii Contents

Agrarian Patterns in Latin America: Progress and Remaining Poverty Challenges 451 Transforming Economies: Problems of Fragmentation and Subdivision of Peasant Land in Asia 453 Subsistence Agriculture and Extensive Cultivation in Africa 456

9.4 The Important Role of Women 458

9.5 The Microeconomics of Farmer Behavior and Agricultural Development 462 The Transition from Traditional Subsistence to Specialized Commercial Farming 462 Subsistence Farming: Risk Aversion, Uncertainty, and Survival 462 The Economics of Sharecropping and Interlocking Factor Markets 466 The Transition to Mixed or Diversified Farming 468 From Divergence to Specialization: Modern Commercial Farming 469

9.6 Core Requirements of a Strategy of Agricultural and Rural Development 471 Improving Small-Scale Agriculture 472 Institutional and Pricing Policies: Providing the Necessary Economic Incentives 473 Conditions for Rural Development 474

■ Case Study 9: The Need to Improve Agricultural Extension for Women Farmers: Kenya 477

10 The Environment and Development 490 10.1 Environment and Development: The Basic Issues 490

Economics and the Environment 490 Sustainable Development and Environmental Accounting 492 Environment Relationships to Population, Poverty, and Economic Growth 493 Environment and Rural and Urban Development 496 The Global Environment and Economy 496 Natural Resource–Based Livelihoods as a Pathway Out of Poverty: Promise and Limitations 498 The Scope of Domestic-Origin Environmental Degradation 499 Rural Development and the Environment: A Tale of Two Villages 500 Environmental Deterioration in Villages 501

10.2 Global Warming and Climate Change: Scope, Mitigation, and Adaptation 502 Scope of the Problem 502 Mitigation 505 Adaptation 506

10.3 Economic Models of Environmental Issues 508 Privately Owned Resources 508 Common Property Resources 513 Public Goods and Bads: Regional Environmental Degradation and the Free-Rider Problem 515 Limitations of the Public-Good Framework 517

10.4 Urban Development and the Environment 518 Environmental Problems of Urban Slums 518 Industrialization and Urban Air Pollution 519 Problems of Congestion, Clean Water, and Sanitation 522

10.5 The Local and Global Costs of Rain Forest Destruction 523

10.6 Policy Options in Developing and Developed Countries 526 What Developing Countries Can Do 526 How Developed Countries Can Help Developing Countries 528 What Developed Countries Can Do for the Global Environment 529

■ Case Study 10: A World of Contrasts on One Island: Haiti and the Dominican Republic 532

xiiiContents

11 Development Policymaking and the Roles of Market, State, and Civil Society 541 11.1 A Question of Balance 541

11.2 Development Planning: Concepts and Rationale 542 The Planning Mystique 542 The Nature of Development Planning 543 Planning in Mixed Developing Economies 543 The Rationale for Development Planning 544

11.3 The Development Planning Process: Some Basic Models 546 Three Stages of Planning 546 Aggregate Growth Models: Projecting Macro Variables 547 Multisector Models and Sectoral Projections 549 Project Appraisal and Social Cost-Benefit Analysis 550

11.4 Government Failure and Preferences for Markets over Planning 554 Problems of Plan Implementation and Plan Failure 554 The 1980s Policy Shift toward Free Markets 556 Government Failure 557

11.5 The Market Economy 558 Sociocultural Preconditions and Economic Requirements 558

11.6 The Washington Consensus on the Role of the State in Development and Its Subsequent Evolution 560

Toward a New Consensus 561

11.7 Development Political Economy: Theories of Policy Formulation and Reform 562 Understanding Voting Patterns on Policy Reform 564 Institutions and Path Dependency 566 Democracy versus Autocracy: Which Facilitates Faster Growth? 567

11.8 Development Roles of NGOs and the Broader Citizen Sector 569

11.9 Trends in Governance and Reform 576 Tackling the Problem of Corruption 576 Decentralization 578 Development Participation 580

■ Case Study 11: The Role of Development NGOs: BRAC and the Grameen Bank 583

Part Three Problems and Policies: International and Macro 599

12 International Trade Theory and Development Strategy 600 12.1 Economic Globalization: An Introduction 600

12.2 International Trade: Some Key Issues 603 Five Basic Questions about Trade and Development 606 Importance of Exports to Different Developing Nations 608 Demand Elasticities and Export Earnings Instability 610 The Terms of Trade and the Prebisch-Singer Hypothesis 610

12.3 The Traditional Theory of International Trade 612 Comparative Advantage 613

xiv Contents

Relative Factor Endowments and International Specialization: The Neoclassical Model 614 Trade Theory and Development: The Traditional Arguments 619

12.4 The Critique of Traditional Free-Trade Theory in the Context of Developing-Country Experience 619

Fixed Resources, Full Employment, and the International Immobility of Capital and Skilled Labor 620 Fixed, Freely Available Technology and Consumer Sovereignty 623 Internal Factor Mobility, Perfect Competition, and Uncertainty: Increasing Returns, Imperfect Competition,

and Issues in Specialization 624 The Absence of National Governments in Trading Relations 626 Balanced Trade and International Price Adjustments 627 Trade Gains Accruing to Nationals 627 Some Conclusions on Trade Theory and Economic Development Strategy 628

12.5 Traditional Trade Strategies and Policy Mechanisms for Development: Export Promotion versus Import Substitution 630

Export Promotion: Looking Outward and Seeing Trade Barriers 632 Expanding Exports of Manufactured Goods 635 Import Substitution: Looking Inward but Still Paying Outward 637 Tariffs, Infant Industries, and the Theory of Protection 637 The IS Industrialization Strategy and Results 639 Foreign-Exchange Rates, Exchange Controls, and the Devaluation Decision 644 Trade Optimists and Trade Pessimists: Summarizing the Traditional Debate 648

12.6 The Industrialization Strategy Approach to Export Policy 651 Export-Oriented Industrialization Strategy 651 The New Firm-level International Trade Research and the Developing Countries 655

12.7 South-South Trade and Economic Integration 655 Economic Integration: Theory and Practice 655 Regional Trading Blocs, the Globalization of Trade, and Prospects for South-South Cooperation 657

12.8 Trade Policies of Developed Countries: The Need for Reform and Resistance to New Protectionist Pressures 659

■ Case Study 12: A Pioneer in Development Success through Trade: Taiwan 663

13 Balance of Payments, Debt, Financial Crises, and Stabilization Policies 678 13.1 International Finance and Investment: Key Issues for Developing Countries 678

13.2 The Balance of Payments Account 679 General Considerations 679 A Hypothetical Illustration: Deficits and Debts 681

13.3 The Issue of Payments Deficits 685 Some Initial Policy Issues 685 Trends in the Balance of Payments 689

13.4 Accumulation of Debt and Emergence of the Debt Crisis in the 1980s 691 Background and Analysis 691 Origins of the 1980s Debt Crisis 693

13.5 Attempts at Alleviation: Macroeconomic Instability, Classic IMF Stabilization Policies, and Their Critics 695

The IMF Stabilization Program 695 Tactics for Debt Relief 697

xvContents

13.6 The Global Financial Crisis and the Developing Countries 706 Causes of the Crisis and Challenges to Lasting Recovery 707 Economic Impacts on Developing Countries 710 Differing Impacts and Continuing Challenges across Developing Regions 714 Prospects for Recovery and Stability 717 Opportunities as Well as Dangers? 718

■ Case Study 13: Trade, Capital Flows, and Development Strategy: South Korea 720

14 Foreign Finance, Investment, Aid, and Conflict: Controversies and Opportunities 731 14.1 The International Flow of Financial Resources 731

14.2 Private Foreign Direct Investment and the Multinational Corporation 732 Private Foreign Investment: Some Pros and Cons for Development 736 Private Portfolio Investment: Benefits and Risks 743

14.3 The Role and Growth of Remittances 744

14.4 Foreign Aid: The Development Assistance Debate 747 Conceptual and Measurement Problems 747 Amounts and Allocations: Public Aid 748 Why Donors Give Aid 750 Why Recipient Countries Accept Aid 754 The Role of Nongovernmental Organizations in Aid 755 The Effects of Aid 756

14.5 Conflict and Development 757 The Scope of Violent Conflict and Conflict Risks 757 The Consequences of Armed Conflict 758 The Causes of Armed Conflict and Risk Factors for Conflict 761 The Resolution and Prevention of Armed Conflict 763

■ Case Study 14: Costa Rica, Guatemala, and Honduras: Contrasts and Prospects for Convergence 767

15 Finance and Fiscal Policy for Development 781 15.1 The Role of the Financial System in Economic Development 782

Differences between Developed and Developing-Country Financial Systems 784

15.2 The Role of Central Banks and Alternative Arrangements 787 Functions of a Full-Fledged Central Bank 787 The Role of Development Banking 791

15.3 Informal Finance and the Rise of Microfinance 792 Traditional Informal Finance 792 Microfinance Institutions: How They Work 793 MFIs: Three Current Policy Debates 796 Potential Limitations of Microfinance as a Development Strategy 798

15.4 Formal Financial Systems and Reforms 799 Financial Liberalization, Real Interest Rates, Savings, and Investment 799 Financial Policy and the Role of the State 801 Debate on the Role of Stock Markets 803

xvi Contents

15.5 Fiscal Policy for Development 805 Macrostability and Resource Mobilization 805 Taxation: Direct and Indirect 805

15.6 State-Owned Enterprises and Privatization 810 Improving the Performance of SOEs 811 Privatization: Theory and Experience 812

15.7 Public Administration: The Scarcest Resource 815

■ Case Study 15: African Success Story at Risk: Botswana 817 Glossary 826 Name Index 839 Subject Index 851

xvii

Case Studies 1 Progress in the Struggle for More Meaningful Development: Brazil 30 2 Comparative Economic Development: Pakistan and Bangladesh 96 3 Schools of Thought in Context: South Korea and Argentina 142 4 Understanding a Development Miracle: China 200 5 Institutions, Inequality, and Incomes: Ghana and Côte d’Ivoire 264 6 Population, Poverty, and Development: China and India 321 7 Rural-Urban Migration and Urbanization in Developing Countries: India and Botswana 369 8 Pathways Out of Poverty: Progresa/Oportunidades in Mexico 425 9 The Need to Improve Agricultural Extension for Women Farmers: Kenya 477 10 A World of Contrasts on One Island: Haiti and the Dominican Republic 532 11 The Role of Development NGOs: BRAC and the Grameen Bank 583 12 A Pioneer in Development Success through Trade: Taiwan 663 13 Trade, Capital Flows, and Development Strategy: South Korea 720 14 Costa Rica, Guatemala, and Honduras: Contrasts and Prospects for Convergence 767 15 African Success Story at Risk: Botswana 817

Boxes 1.1 The Experience of Poverty: Voices of the Poor 8 2.1 Computing the New HDI: Ghana 54 2.2 What Is New in the New Human Development Index 56 2.3 FINDINGS The Persistent Effects of Colonial Forced Labor on Poverty and Development 71 2.4 FINDINGS Instruments to Test Theories of Comparative Development: Inequality 91 2.5 FINDINGS Legacy of Colonial Land Tenure and Governance Systems 92 4.1 Synchronizing Expectations: Resetting “Latin American Time” 171 4.2 FINDINGS Village Coordination and Monitoring for Better Health Outcomes 172 4.3 FINDINGS Three Country Case Study Applications of Growth Diagnostics 196 5.1 The Latin America Effect 238 5.2 Problems of Gender Relations in Developing Countries: Voices of the Poor 254 6.1 FINDINGS The 2012 Revised United Nations Population Projections 291 6.2 FINDINGS Social Norms and the Changing Patterns of Fertility in Bangladesh 300 6.3 FINDINGS Contraceptives Need and Use in Developing Countries, 2003 to 2012 317 7.1 FINDINGS The Emergence of Industrial Districts or Clusters in China 341 8.1 Health and Education: Voices of the Poor 384 8.2 Linkages between Investments in Health and Education 385 8.3 FINDINGS Mothers’ Health Knowledge Is Crucial for Raising Child Health 386 8.4 FINDINGS School Impact of a Low-Cost Health Intervention 387 8.5 FINDINGS Cash or Condition? Evidence from Malawi 395

Case Studies and

Boxes

xviii Case Studies and Boxes

8.6 FINDINGS Impacts of Tutor and Computer-Assisted Learning Programs 407 8.7 Health Challenges Faced by Developing Countries 410 8.8 AIDS: Crisis and Response in Uganda 416 9.1 Development Policy Issues: Famine in the Horn of Africa 444 9.2 FINDINGS Learning about Farming: The Diffusion of Pineapple Growing in Ghana 470 10.1 FINDINGS Autonomous Adaptation to Climate Change by Farmers in Africa 508 10.2 One of the World’s Poorest Countries Tries to Prepare for Climate Change: Niger 509 10.3 FINDINGS Elinor Ostrom’s Design Principles Derived from Studies

of Long-Enduring Institutions for Governing Sustainable Resources 516 11.1 The Washington Consensus and East Asia 560 11.2 The New Consensus 562 11.3 FINDINGS Reducing Teacher Absenteeism in an NGO School 576 12.1 FINDINGS Four Centuries of Evidence on the Prebisch-Singer Hypothesis 612 13.1 The History and Role of the International Monetary Fund 682 13.2 The History and Role of the World Bank 686 13.3 Mexico: Crisis, Debt Reduction, and the Struggle for Renewed Growth 700 13.4 “Odious Debt” and Its Prevention 704 14.1 Seven Key Disputed Issues about the Role and Impact of Multinational

Corporations in Developing Countries 740 15.1 FINDINGS The Financial Lives of the Poor 794 15.2 FINDINGS Combining Microfinance with Training 798 15.3 Privatization—What, When, and to Whom? Chile and Poland 814

xix

Preface

Economic Development, Twelfth Edition, presents the latest thinking in eco- nomic development with the clear and comprehensive approach that has been so well received in both the developed and developing worlds.

The pace and scope of economic development continues its rapid, uneven, and sometimes unexpected evolution. This text explains the unprecedented progress that has been made in many parts of the developing world but fully confronts the enormous problems and challenges that remain to be addressed in the years ahead. The text shows the wide diversity across the developing world and the differing positions in the global economy that are held by developing countries. The principles of development economics are key to understanding how we got to where we are, how great progress has been made in recent years, and why many development problems remain so difficult to solve. The princi- ples of development economics are also key to the design of successful economic development policy and programs as we look ahead.

The field of economic development is versatile and has much to contribute re- garding these differing scenarios. Thus, the text also underlines common features that are exhibited by a majority of developing nations, using the insights of the study of economic development. The few countries that have essentially com- pleted the transformation to become developed economies, such as South Korea, are also examined as potential models for other developing countries to follow.

Both theory and empirical analysis in development economics have made major strides, and the Twelfth Edition brings these ideas and findings to stu- dents. Legitimate controversies are actively debated in development econom- ics, and so the text presents contending theories and interpretations of evi- dence, with three goals. The first goal is to ensure that students understand real conditions and institutions across the developing world. The second is to help students develop analytic skills while broadening their perspectives of the wide scope of the field. The third is to provide students with the resources to draw independent conclusions as they confront development problems, their sometimes ambiguous evidence, and real-life development policy choices— ultimately, to play an informed role in the struggle for economic development and ending extreme poverty.

New to This Edition

• Global crisis. This edition includes a major update and expansion of the new section on the impacts and potential longer-term implications of the recent global financial crisis on economic development, examining

xx Preface

conditions that caused the crisis, its aftermath, and possible broader im- plications and large differences across developing nations and regions.

• Prologue in Chapter 1. Chapter 1 is launched with a new introductory sec- tion that describes for students how much has changed over the past two decades in a majority of countries in the developing world and in greater autonomy and nascent leadership of some developing countries in inter- national economic and political relationships. The chapter compares con- ditions today to those prevailing in 1992—a pivotal period in a number of ways, which is also close to the time when many students were born.

• Violent conflict. The Eleventh Edition provided an entirely new major sec- tion on the causes and consequences of violent conflict, postconflict re- covery and development, and prevention of conflict through an improved understanding of its major causes; the Twelfth Edition more fully devel- ops and extends this section, incorporating recent developments.

• Findings Boxes. The Eleventh Edition also introduced a new textbook fea- ture of Findings boxes, reporting on empirical research results in the field that are wide-ranging in both methods and topics. New Findings boxes ad- dress such topics as long-lasting impacts of colonial institutions (Peru); how coordination and monitoring by villagers leads to better health outcomes (Uganda); how social norms facilitated or constrained changing patterns of fertility (Bangladesh); and comparative impacts of conditional versus un- conditional cash transfers to the poor (Malawi). Other boxes examine global findings such as unmet contraceptives demand across countries. The num- ber of Findings boxes has been approximately doubled for the Twelfth Edi- tion. The Findings boxes also illustrate empirical methods for students—in an intuitive introductory manner—such as the use of instruments; random- ized control trials; regression discontinuity; and fixed effects; as well as the painstaking design, implementation, and robust analysis of survey data; growth diagnostics; and systematically applied qualitative research. The Findings boxes in this edition are listed on pages xvii-xviii.

• Policy Boxes. Other boxes address policy issues. New policy boxes examine such topics as the efforts of Niger—one of the world’s poorest countries— to adapt to the climate change already impacting the country and to build resilience against unknown future climate change; and what we learned from the 2011–2012 famine in the Horn of Africa. Other new policy boxes address global findings, such as the extent of contraception use and the extent of still-unmet demand for contraceptives in developing countries; and the UN’s new unexpectedly increased population projections through this century. Policy boxes in this edition are listed on pages xvii-xviii.

• New, full-length, three-way comparative case study of Costa Rica, Guate- mala, and Honduras. The full-length, end-of-chapter comparative case studies have long been one of the most popular features of the text. For this edition, an entirely new three-way comparative case study of Costa Rica, Guatemala, and Honduras is introduced at the end of Chapter 14, which addresses topics of conflict, foreign investment, remittances, and foreign aid; the study also addresses the themes of very long-term com- parative development addressed in some of the existing and updated case

xxiPreface

studies, such as those comparing Ghana and Côte d’Ivoire; Pakistan and Bangladesh; and Haiti and the Dominican Republic. Each of the compara- tive cases also has a special theme, such as human development, poverty, environment, and structural transformation.

• New topics. Other new topics briefly introduced in this edition include short sections on the new firm-level international trade research and the develop- ing countries; the emergence of “Sustainable Development Goals” as suc- cessors to the MDGs; corporate social responsibility; and food price trends.

• New measures. Measurement is an ever-present issue in the field of eco- nomic development. The United Nations Development Program released its Multidimensional Poverty Index in August 2010 and its New Human Development Index in November 2010. The text examines the index for- mulas, explains how they differ from earlier indexes, reports on findings, and reviews issues surrounding the active debate on these measures. Each has been updated since its initial release, as covered in the Twelfth Edition. Note: From surveys we know many instructors are still using the tradi- tional Human Development Index (HDI), which is reasonable, since it per- meates a majority of the literature on the subject. So, we have maintained a very substantial and detailed section on the traditional HDI, which now appears in a new Appendix 2.1 in Chapter 2; it includes a number of coun- try applications and extensions, as in previous editions. You can teach ei- ther or both of the indexes, without losing the thread in later chapters.

• Updated statistics. Change continues to be very rapid in the developing world. Throughout the text, data and statistics have been updated to re- flect the most recent available information at the time of revision, typically 2011 or 2012, and sometimes 2013.

• Additional updates. Other updates include a further expansion of the sec- tion on microfinance, including new designs, potential benefits, successes to date, and some limitations; further expanded coverage of China; and expanded coverage and analysis of the growing environmental problems facing developing countries.

Audience and Suggested Ways to Use the Text

• Flexibility. This book is designed for use in courses in economics and other social sciences that focus on the economies of Africa, Asia, and Latin America, as well as developing Europe and the Middle East. It is written for students who have had some basic training in economics and for those with little formal economics background. Essential concepts of economics that are relevant to understanding development problems are highlighted in boldface and explained at appropriate points throughout the text, with glossary terms defined in the margins as well as collected together at the end of the book in a detailed Glossary. Thus, the book should be of special value in undergraduate development courses that attract students from a variety of disciplines. Yet the material is sufficiently broad in scope and rigorous in coverage to satisfy any undergraduate and some graduate economics requirements in the field of development. This text has been

xxii Preface

widely used both in courses taking relatively qualitative and more quan- titative approaches to the study of economic development and emphasiz- ing a variety of themes, including human development.

• The text features a 15-chapter structure, convenient for use in a comprehen- sive course and corresponding well to a 15-week semester but with enough breadth to easily form the basis for a two-semester sequence. However, the chapters are now subdivided, making it easier to use the text in targeted ways. To give one example, some instructors have paired the sections on conflict (14.5) and on informal and micro finance (15.4) with Chapter 5 on poverty.

• Courses with a qualitative focus. For qualitatively oriented courses, with an institutional focus and using fewer economic models, one or more chap- ters or subsections may be omitted, while placing primary emphasis on Chapters 1, 2, 5, 6, 8, and 9, plus parts of Chapters 7 and 10, and other se- lected sections, according to topics covered. The text is structured so that the limited number of graphical models found in those chapters may be omitted without losing the thread, while the intuition behind the models is explained in detail.

• Courses with a more analytic and methods focus. These courses would focus more on the growth and development theories in Chapter 3 (including Ap- pendices such as 3.3 on endogenous growth) and Chapter 4, and highlight and develop some of the core models of the text, including poverty and in- equality measurement and analysis in Chapter 5, microeconomics of fertil- ity and relationships between population growth and economic growth in Chapter 6, migration models in Chapter 7, human capital theory, including the child labor model and empirics in Chapter 8, sharecropping models in Chapter 9, environmental economics models in Chapter 10, tools such as net present benefit analysis and multisector models along with political economy analysis in Chapter 11, and trade models in Chapter 12. Regard- ing methods, these courses could also expand on material introduced in some of the Findings boxes and subsections into more detailed treatments of methods topics such as use of instrumental variables, randomization, regression discontinuity, and growth empirics, including origins of com- parative development and analysis of convergence (which is examined in Chapter 2). Endnotes and sources suggest possible directions to take. The text emphasizes in-depth institutional background reading accompanying the models that help students to appreciate their importance.

• Courses emphasizing human development and poverty alleviation. The Twelfth Edition can be used for a course with a human development focus. This would typically include the sections on Amartya Sen’s capabil- ity approach and Millennium Development Goals in Chapter 1, the new section on conflict in Chapter 14, the discussion of microfinance institu- tions in Chapter 15, and a close and in-depth examination of Chapters 2 and 5. Sections on population policy in Chapter 6; diseases of poverty and problems of illiteracy, low schooling, and child labor in Chapter 8; prob- lems facing people in traditional agriculture in Chapter 9; relationships between poverty and environmental degradation in Chapter 10; and roles of nongovernmental organizations (NGOs) in Chapter 11 would be likely highlights of this course.

xxiiiPreface

• Courses emphasizing macro and international topics. International and macro aspects of economic development could emphasize sections 2.6 and 2.7 on convergence, and long-run growth and sources of comparative de- velopment; Chapter 3 on theories of growth (including the three detailed appendixes to that chapter); Chapter 4 on growth and multiple-equilibrium models; and Chapters 12 through 15 on international trade, international fi- nance, debt and financial crises, direct foreign investment, aid, central bank- ing, and domestic finance. The book also covers other aspects of the interna- tional context for development, including the new section on financial crisis (13.6), implications of the rapid pace of globalization and the rise of China (Chapter 12 and such case studies as Brazil in Chapter 1 and China in Chap- ter 4), the continuing struggle for more progress in sub-Saharan Africa, and controversies over debt relief and foreign aid (Chapter 14).

• Broad two-semester course using supplemental readings. Many of the chap- ters contain enough material for several class sessions, when their topics are covered in an in-depth manner, making the text also suitable for a yearlong course or high-credit option. The endnotes and sources offer many starting points for such extensions.

Guiding Approaches and Organization

The text’s guiding approaches are the following:

1. It teaches economic development within the context of a major set of prob- lems, such as poverty, inequality, population growth, the impact of very rapid urbanization and expansion of megacities, persistent public health challenges, environmental decay, and regions experiencing rural stagna- tion, along with the twin challenges of government failure and market failure. Formal models and concepts are used to elucidate real-world de- velopment problems rather than being presented in isolation from these problems.

2. It adopts a problem- and policy-oriented approach, because a central objec- tive of the development economics course is to foster a student’s ability to understand contemporary economic problems of developing countries and to reach independent and informed judgments and policy conclusions about their possible resolution.

3. It simultaneously uses the best available data from Africa, Asia, Latin Amer- ica, and developing Europe and the Middle East, as well as appropriate theoretical tools to illuminate common developing-country problems. These problems differ in incidence, scope, magnitude, and emphasis when we deal with such diverse countries as India, Pakistan, Bangladesh, China, the Philippines, Kenya, Botswana, Nigeria, Ghana, Côte d’Ivoire, Argentina, Brazil, Chile, Mexico, Haiti, and the Dominican Republic. Still, a majority face some similar development problems: persistent poverty and large in- come and asset inequalities, population pressures, low levels of education and health, inadequacies of financial markets, and recurrent challenges in international trade and instability, to name a few.

xxiv Preface

4. It focuses on a wide range of developing countries, not only as independent nation-states, but also in their growing relationships to one another, as well as in their interactions with rich nations in a globalizing economy.

5. Relatedly, the text views development in both domestic and international contexts, stressing the increasing interdependence of the world economy in ar- eas such as food, energy, natural resources, technology, information, and financial flows.

6. It recognizes the necessity of treating the problems of development from an institutional and structural as well as a market perspective, with appropriate modifications of received general economic principles, theories, and poli- cies. It thus attempts to combine relevant theory with realistic institutional analyses. Enormous strides have been made in the study of these aspects of economic development in recent years, which are reflected in this edition.

7. It considers the economic, social, and institutional problems of underdevel- opment as closely interrelated and requiring coordinated approaches to their solution at the local, national, and international levels.

8. The book is organized into three parts. Part One focuses on the nature and meaning of development and underdevelopment and its various manifes- tations in developing nations. After examining the historical growth ex- perience of the developed countries and the long-run experience of the developing countries, we review four classic and contemporary theories of economic development, while introducing basic theories of economic growth. Part Two focuses on major domestic development problems and policies, and Part Three focuses on development problems and policies in international, macro, and financial spheres. Topics of analysis include eco- nomic growth, poverty and income distribution, population, migration, urbani zation, technology, agricultural and rural development, education, health, the environment, international trade and finance, debt, financial crises, domestic financial markets, direct foreign investment, foreign aid, violent conflict, and the roles of market, state, and nongovernmental or- ganizations in economic development. All three parts of the book raise fundamental questions, including what kind of development is most de- sirable and how developing nations can best achieve their economic and social objectives.

9. As part of the text’s commitment to its comprehensive approach, it covers some topics that are not found in other texts on economic development, in- cluding growth diagnostics, industrialization strategy, innovative policies for poverty reduction, the capability approach to well-being, the central role of women, child labor, the crucial role of health, new thinking on the role of cities, the economic character and comparative advantage of nongovern- mental organizations in economic development, emerging issues in environ- ment and development, financial crises, violent conflict, and microfinance.

10. A unique feature of this book is the in-depth case studies and compara- tive case studies appearing at the end of each chapter. Each chapter’s case study reflects and illustrates specific issues analyzed in that chapter. In- chapter boxes provide shorter case examples.

xxvPreface

Comments on the text are always welcome; these can be sent directly to Stephen Smith at ssmith@gwu.edu.

Supplementary Materials

The Twelfth Edition comes with PowerPoint slides for each chapter, which have been expanded and fully updated for this edition.

The text is further supplemented with an Instructor’s Manual by Chris Marme of Augustana College. It has been thoroughly revised and updated to reflect changes to the Twelfth Edition. Both the PowerPoint slides and the Instructor’s Manual can also be downloaded from the Instructor’s Resource Center at www.pearsonhighered.com/irc.

Acknowledgments

Our gratitude to the many individuals who have helped shape this new edition cannot adequately be conveyed in a few sentences. However, we must record our immense indebtedness to the hundreds of former students and contemporary colleagues who took the time and trouble during the past several years to write or speak to us about the ways in which this text could be further improved. We are likewise indebted to a great number of friends (far too many to mention individually) in both the developing world and the developed world who have directly and indirectly helped shape our ideas about development economics and how an economic development text should be structured. The authors would like to thank colleagues and students in both developing and developed countries for their probing and challenging questions.

We are also very appreciative of the advice, criticisms, and suggestions of the many reviewers, both in the United States and abroad, who provided detailed and insightful comments for the Eighth, Ninth, Tenth, Eleventh, and Twelfth Editions:

U.S. Reviewers

Mohammed Akacem, METROPOLITAN STATE UNIVERSITY OF DENVER William A. Amponsah, GEORGIA SOUTHERN UNIVERSITY Erol Balkan, HAMILTON COLLEGE Karna Basu, HUNTER COLLEGE, CITY UNIVERSITY OF NEW YORK Valerie R. Bencivenga, UNIVERSITY OF TEXAS, AUSTIN

www.pearsonhighered.com/irc
xxvi Preface

Sylvain H. Boko, WAKE FOREST UNIVERSITY Michaël Bonnal, UNIVERSITY OF TENNESSEE AT CHATTANOOGA Milica Z. Bookman, ST. JOSEPH’S UNIVERSITY Jim Cobbe, FLORIDA STATE UNIVERSITY Michael Coon, HOOD COLLEGE Lisa Daniels, WASHINGTON COLLEGE Fernando De Paolis, MONTEREY INSTITUTE Luc D’Haese, UNIVERSITY OF GHENT Quentin Duroy, DENISON UNIVERSITY Can Erbil, BRANDEIS UNIVERSITY Yilma Gebremariam, SOUTHERN CONNECTICUT STATE UNIVERSITY Abbas P. Grammy, CALIFORNIA STATE UNIVERSITY, BAKERSFIELD Caren Grown, AMERICAN UNIVERSITY Kwabena Gyimah-Brempong, UNIVERSITY OF SOUTH FLORIDA Bradley Hansen, MARY WASHINGTON COLLEGE John R. Hanson II, TEXAS A&M UNIVERSITY Seid Hassan, MURRAY STATE UNIVERSITY Jeffrey James, TILBURG UNIVERSITY Barbara John, UNIVERSITY OF DAYTON Pareena G. Lawrence, UNIVERSITY OF MINNESOTA, MORRIS Tung Liu, BALL STATE UNIVERSITY John McPeak, SYRACUSE UNIVERSITY Michael A. McPherson, UNIVERSITY OF NORTH TEXAS Daniel L. Millimet, SOUTHERN METHODIST UNIVERSITY Camille Soltau Nelson, TEXAS A&M UNIVERSITY Thomas Osang, SOUTHERN METHODIST UNIVERSITY Elliott Parker, UNIVERSITY OF NEVADA, RENO Julia Paxton, OHIO UNIVERSITY Meenakshi Rishi, SEATTLE UNIVERSITY James Robinson, UNIVERSITY OF CALIFORNIA, BERKELEY Monthien Satimanon, MICHIGAN STATE AND THAMMASAT UNIVERSITY Andreas Savvides, OKLAHOMA STATE UNIVERSITY Rodrigo R. Soares, UNIVERSITY OF MARYLAND Michael Twomey, UNIVERSITY OF MICHIGAN, DEARBORN Wally Tyner, PURDUE UNIVERSITY Nora Underwood, UNIVERSITY OF CALIFORNIA, DAVIS Jogindar Uppal, STATE UNIVERSITY OF NEW YORK Evert Van Der Heide, CALVIN COLLEGE Adel Varghese, ST. LOUIS UNIVERSITY Sharmila Vishwasrao, FLORIDA ATLANTIC UNIVERSITY Bill Watkins, CALIFORNIA LUTHERAN UNIVERSITY Janice E. Weaver, DRAKE UNIVERSITY Jonathan B. Wight, UNIVERSITY OF RICHMOND Lester A. Zeager, EAST CAROLINA UNIVERSITY

U.K. Reviewers

Arild Angelsen, AGRICULTURAL UNIVERSITY OF NORWAY David Barlow, NEWCASTLE UNIVERSITY

xxviiPreface

Sonia Bhalotra, UNIVERSITY OF BRISTOL Bernard Carolan, UNIVERSITY OF STAFFORDSHIRE Matthew Cole, UNIVERSITY OF BIRMINGHAM Alex Cunliffe, UNIVERSITY OF PLYMOUTH Chris Dent, UNIVERSITY OF HULL Sanjit Dhami, UNIVERSITY OF NEWCASTLE Subrata Ghatak, KINGSTON UNIVERSITY Gregg Huff, UNIVERSITY OF GLASGOW Diana Hunt, SUSSEX UNIVERSITY Michael King, TRINITY COLLEGE DUBLIN Dorothy Manning, UNIVERSITY OF NORTHUMBRIA Mahmood Meeskoub, UNIVERSITY OF LEEDS Paul Mosley, UNIVERSITY OF SHEFFIELD Bibhas Saha, UNIVERSITY OF EAST ANGLIA Colin Simmons, UNIVERSITY OF SALFORD Pritam Singh, OXFORD BROOKES UNIVERSITY Shinder Thandi, UNIVERSITY OF COVENTRY Paul Vandenberg, UNIVERSITY OF BRISTOL

Their input has strengthened the book in many ways and has been much ap- preciated.

Our thanks also go to the staff at Pearson in both the United States and the United Kingdom, particularly David Alexander, Lindsey Sloan, Liz Napoli- tano, and Kate Brewin.

Finally, to his lovely wife, Donna Renée, Michael Todaro wishes to express great thanks for typing the entire First Edition manuscript and for providing the spiritual and intellectual inspiration to persevere under difficult circum- stances. He reaffirms here his eternal devotion to her for always being there to help him maintain a proper perspective on life and living and, through her own creative and artistic talents, to inspire him to think in original and some- times unconventional ways about the global problems of human development.

Stephen Smith would like to thank his wonderful wife, Renee, and his chil- dren, Martin and Helena, for putting up with the many working Saturdays that went into the revision of this text.

Michael P. Todaro

Stephen C. Smith

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Pa rt O n e Principles and Concepts

Prologue: An Extraordinary Moment

Two pictures of the developing world compete in the media for the public’s attention. The first is misery in places like rural Africa or unsanitary and overcrowded urban slums in South Asia. The second is extraordinary dyna- mism in places like coastal China. Both pictures convey important parts of the great development drama. Living conditions are improving significantly in most, though not all, parts of the globe—if sometimes slowly and unevenly. The cumulative effect is that economic development has been giving rise to unprecedented global transformations.

Consider the world of 1992, a time when the divide between the rich developed nations and the low-income developing nations was apparently widening. Rich countries were growing faster than poor countries; and the dominance of high-income industrialized nations in the global order was clear-cut. The United States had just won the Cold War, with the Soviet Union disintegrating in the last days of 1991. The end of the Cold War also saw the European Union in the ascendency, full of confidence with its high- profile Europe ‘92 Single Market project. The real estate and stock market bubble in Japan was just beginning to deflate, with almost no one predicting

2

Introducing Economic Development: A Global Perspective

Development can be seen . . . as a process of expanding the real freedoms that people enjoy. —Amartya Sen, Nobel laureate in economics

Our vision and our responsibility are to end extreme poverty in all its forms in the context of sustainable development and to have in place the building blocks of sustained prosperity for all.

—Report of the High-Level Panel of Eminent Persons on the Post-2015 Development Agenda, 2013

Under necessaries, therefore, I comprehend, not only those things which nature, but those things which the established rules of decency, have rendered necessary to the lowest rank of people.

—Adam Smith, The Wealth of Nations

We are at an auspicious moment in history when successes of past decades and an increasingly favorable economic outlook combine to give developing countries a chance—for the first time ever—to end extreme poverty within a generation.…to create a world for our children which is defined not by stark inequities but by soaring opportunities. A sustainable world where all households have access to clean energy. A world where everyone has enough to eat. A world where no one dies from preventable diseases. A world free of poverty.

—Jim Yong Kim, World Bank President, 2013

1

3CHAPTER 1 Introducing Economic Development: A Global Perspective

the protracted stagnation that would follow Japan’s long period of high eco- nomic growth.

Yet in 1992, many developing nations, including Brazil, Russia, India, China, and South Africa (now sometimes grouped by the media as the “BRICS”), found themselves in precarious conditions if not full-scale crisis. Brazil—like most of Latin America—was still struggling to emerge from the 1980s’ debt crisis. Russia was descending into depression after the collapse of its Soviet economy. India was trying to rebound from its worst economic crisis since independence. China had launched its period of very rapid growth, but the 1989 massacre in Tiananmen Square was a fresh memory and future prospects for reform and growth in China were uncertain. Meanwhile, the end of apartheid was still being negotiated in South Africa, while the continent as a whole was entering its second consecutive lost decade of slow economic growth, and pessimism prevailed. Despite pressing development needs, there were widespread concerns that with the end of the Cold War, the rich world would lose interest in development assistance. And at the 1992 Earth Summit, while the world was taking its first tentative steps to acknowledge and try to restrain climate change due to global warming, almost no one imag- ined that 20 years later China and India would be among the top three green- house gas emitters.