Management of Social And

Economic Change
TOPICS

 Contemporary Models of Development and Underdevelopment

 Poverty, Inequality, and Development
 Impact of Population Growth on Economic Development
 Theory and Policy on Urbanization and Rural-Urban Migration
 DEVELOPMENT AND
UNDERDEVELOPMENT:
CONTEMPORARY MODELS
 UNDERDEVELOPMENT AS A
COORDINATION FAILURE

Coordination failure
A situation in which the inability of agents to coordinate their
behavior (choices) leads to an outcome (equilibrium) that
leaves all agents worse off than in an alternative situation that
is also an equilibrium.

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Example:
30 students in a class were given an assignment in a textbook that they can
only buy online for P3,500.
The possibilities are:
1. Nobody buys the book online and nobody does the assignment so every
student fails. It could be because each student has different expectations
and everyone is better off waiting for the “sacrificial student”. This is an
example of a coordination failure.
2. All student will contribute to get a copy but the contribution will not be
even because the cost of the textbook cannot be equally divided among
the 30 students so some must pay higher than the others. This is an
example of a complementarity.
Complementarity
An action taken by one firm, worker, or organization that
increases the incentives for other agents to take similar actions.
Complementarities often involve investments whose return
depends on other investments being made by other agents.

Examples of Complementarity
* Big Push
* O-ring model

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 Theories in economic development
Middle-income trap. A condition in
which an economy begins
development to reach middle-
income status but is chronically
unable to progress to high-income Underdevelopment trap. A poverty
status. Often related to low
capacity for original innovation or
trap in which underdevelopment
for absorption of advanced tends to perpetuate itself over
technology, and may be time. It is caused by lack of capital
compounded by high and credit to people.
inequality.

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 Government policy interventions plays a great role.
Deep intervention. A government policy that can move the
economy to a preferred equilibrium or even to a higher
permanent rate of growth, which can then be self-sustaining so
that the policy need no longer be enforced because the better
equilibrium will then prevail without further intervention.
An example is a government policy in coordinating joint
investments, such as between the workers who want skills that
employers can use and the employers who want equipment
that workers can use.

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MULTIPLE EQUILIBRIA: A DIAGRAMMATIC
APPROACH

Multiple Equilibria. A condition in which more than one

equilibrium exists. These equilibria sometimes may be
ranked, in the sense that one is preferred over another, but
the unaided market will not move the economy to the
preferred outcome.

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In this model, one invests based on his expectation of the average level of investment

• D1 represents a stable
equilibrium with a
coordination failure;
• D2 an unstable equilibrium;
• D3 a stable equilibrium with
a higher level of
investments;
• the equilibrium is stable
when the S-curve intersects
from above.

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For example
The price a farmer can hope
to receive for his produce
depends on the number of
middlemen who are active
in the region, which in turn
depends on the number of
other farmers who
specialize in the same
product

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 STARTING ECONOMIC DEVELOPMENT: THE BIG
PUSH

The big push model is a concept that emphasizes that a firm's

decision whether to industrialize or not depends on its
expectation of what other firms will do. It assumes economies
of scale and oligopolistic market structure and explains when
industrialization would happen.
The big push addresses the problems present in multiple
equilibria
 Cases in Which a Big Push May Be Necessary
1. Intertemporal effects. Multiple equilibria can occur if investment must be undertaken in the
current period to get a more efficient production process in the next period.
2. Urbanization effects. Urban dwellers’ demand is more concentrated in manufactured goods so
there is a need for a big push for urbanization to achieve industrialization.
3. Infrastructure effects. By using infrastructure, such as a railroad or a port, an investing modern
firm helps defray the large fixed costs of that infrastructure. The existence of the infrastructure helps
investing firms lower their own costs.
4. Training effects. There is underinvestment in training facilities because entrepreneurs know that
the workers they train may be enticed away with higher wages offered by rival firms that do not
have to pay these training costs.

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 PROBLEMS OF MULTIPLE EQUILIBRIA
1. Inefficient Advantages of Incumbency - The presence of increasing returns in modern industries can
also create another kind of bad equilibrium.
2. Behavior and Norms - Movement to a better equilibrium is especially difficult when it involves many
individuals changing their behavior from one of rent seeking or corruption to honesty and the value of
building a reputation to reap the gains from cooperation (e.g., with business partners).
3. Linkages - Connections between firms based on sales. A backward linkage is one in which a firm buys a
good from another firm to use as an input; a forward linkage is one in which a firm sells to another firm.
Such linkages are especially significant for industrialization strategy when one or more of the industries
(product areas) involved have increasing returns to scale that a larger market takes advantage of.
4. Inequality, Multiple Equilibria, and Growth Poverty trap - A bad equilibrium for a family, community,
or nation, involving a vicious circle in which poverty and underdevelopment lead to more poverty and
underdevelopment, often from one generation to the next.

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 MICHAEL KREMER’S O-RING THEORY OF ECONOMIC DEVELOPMENT

O-ring production function. A production function with strong

complementarities among inputs, based on the products (i.e.,
multiplying) of the input qualities. It represents a particular kind of
complementarity where production consists of a number of tasks all
of which have to be completed for the final product to have full
value. If a mistake occurs in any of the tasks, the value of the final
product is reduced to zero.

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Implications of the O-Ring Theory
 Firms tend to employ workers with similar skills for their various tasks
 Workers performing the same task earn higher wages in a high-skill firm than in a low-
skill firm.
 Wages will be more than proportionally higher in developed countries than would be
predicted from standard
Insertmeasures
Image of skill.
 Workers will consider human capital investments in light of similar investments by
those around them.
 It magnify the impact of local production bottlenecks because such bottlenecks have a
multiplicative effect on other production.
 Bottlenecks also reduce the incentive for workers to invest in skills by lowering the
expected return to these skills.
 Insert Image

THE HAUSMANN-RODRIK-VELASCO GROWTH DIAGNOSTICS

FRAMEWORK

Different countries face different binding constraints on achieving faster rates of

growth and economic development. Ricardo Hausmann, Dani Rodrik, and Andrés
Velasco (HRV) propose a growth diagnostics decision tree framework.

Growth diagnostics - decision tree framework for identifying a country’s most

binding constraints on economic growth.

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 Low returns to investors may
be due to the fact that there
are intrinsically low underlying
social returns to economic
activities
Social returns - profitability of
an investment which both
costs and benefits are
accounted for from the
perspective of society as a
whole

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Causes of Low Social Return:

• Poor geography • Micro and macro risks

• Low human capital • Coordination externalities
• Bad infrastructure • High cost of finance
• Low appropriability • Bad international finance
• Government failures • Bad local finance
• Market failures • Domestic saving
• Poor intermediation
 Conclusions.
•  The coordination failures that may arise in the
presence of complementarities highlight potential
policies for deep interventions that move the
economy to a preferred equilibrium or even to a
higher permanent rate of growth that can then be
self-sustaining

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POVERTY, INEQUALITY,
AND DEVELOPMENT
Two principal measures of inequality or income
distribution:
 Personal or size distribution of income – measures the total
income received by persons or households, regardless of its
source
• Kuznets ratio
• Lorenz ratio
• Gini coefficient

 Functional or distributive factor share – measures the

share that each of the factors of production (labor,
capital, land) receives.

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Kuznets ratio - is the ratio of the income received
by the top 20% and the bottom 40% of the
population.
- measure of degree of inequality
between groups

Lorenz curve - is a diagram that shows

the quantitative relationship between the
% of income recipients and the % of the
total income that they receive.

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The Greater the Curvature of the Lorenz Line, the
Greater the Relative Degree of Inequality

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Gini coefficient (GC) - An aggregate numerical
measure of income inequality ranging from 0
(perfect equality) to 1 (perfect inequality)

If Gini is 0.5 to 0.7 - high inequality

If Gini is 0.2 to 0.35 - relatively equitable

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Estimating the Gini Coefficient

It is measured graphically by
dividing the area between the
perfect equality line and the Lorenz
curve by the total area lying to the
right of the equality line in a Lorenz
diagram. The higher the value of
the coefficient is, the higher the
inequality of income distribution;
the lower it is, the more equal the
distribution of income.

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Four highly desirable properties of GC

1. Anonymity – the measure of inequality should

not depend on who has the higher income
2. Scale independence – the measure of inequality
should not depend on the size of the economy or
the way we measure its income
3. Population size independence – the measure of
inequality should not be based on the number of
income recipients
4. Transfer principle - holding all else constant, if we
transfer some income from a richer person to a
poorer person, the resulting new income
distribution is more equal

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Absolute Poverty – the situation of being unable
or only barely able to meet the subsistence
essentials of food, clothing, and shelter. It is
sometimes measured by the number, or
“headcount,” H, of those whose incomes fall below
the absolute poverty line, Y.
Poverty Line – minimum amount of income that
can be used to compare poverty internationally,
typically $1 a day or $2 a day.
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Measuring Absolute Poverty
 Headcount Index - The proportion of a country’s
population living below the poverty line. H/N , where
H is the number of persons who are poor and N is
the total number of people in the economy.
 Total Poverty Gap (TPG) - Measures the total
amount of income necessary to raise everyone who
is below the poverty line up to that line. The sum of
the difference between the poverty line and actual
income levels of all people living below that line.

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 Foster-Greek-Thorbecke Index – measures the degree of
inequality among the poor.

 Multi-dimensional Poverty Measurement - Identification of poverty

status through a dual cutoff:
• First, cutoff levels within each dimension (analogous to falling
below a poverty line for example $1.25 per day for income poverty);
• Second, cutoff in the number of dimensions in which a person
must be deprived (below a line) to be deemed multidimensionally poor.

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Extreme Inequality
1. It leads to ECONOMIC INEFFICIENCY
Example: credit markets – a poor person with a great
business idea but no collateral – the idea will never be
implemented – a loss to society
2. It undermines political and social stability
Inequality makes the rich richer, raises their power
and can yield to outcomes that further exacerbate
inequality
3. It is unfair
Policies for poverty reduction

1. Altering the functional distribution of

income through relative factor prices
2. Modifying the size distribution
through increasing assets of the poor
3. Progressive Income and Wealth Taxes
4. Direct Transfer Payments and the
Public Provision of Goods and
Services

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IMPACT OF POPULATION GROWTH ON
ECONOMIC DEVELOPMENT
 The Basic Issue: Population Growth and the Quality
of Life
• As the 21st century begun, the worlds population was estimated to be
almost 6.1 billion. Projection by UN places figure at more than 9.1 billion by
2050 before reaching a maximum of 11 billion by 2200
• The relation between population growth (PG) and economic development
is a complex one. And the historical quantitative evidence is ambiguous,
particularly what is cause and what is effect.
• Many people would consider that rapid PG in the third world to be a major
obstacle to development
• Yet there are many ways in which PG may be a stimulus to progress

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 THE DEMOGRAPHIC TRANSITION

Demographic transition (DT) - The phasing-out process of

population growth rates from a virtually stagnant growth stage,
characterized by high birth rates and death rates through a rapid-
growth stage with high birth rates and low death rates to a stable,
low-growth stage in which both birth and death rates are low

The DT attempts to explain why all contemporary developed

countries have more or less pass through the same three stages of
modern population history

FABRIKAM
Before their economic modernization
these countries for centuries had
stable or very slow growing
population as combination of high
birth rate and high death rate. This is
stage 1

Stage 2,
The beginning of WE’ s DT, was
initiated around the first quarter of
19th century. When modernization,
associated with better public
health, healthier diets, higher
incomes and other improvements
in life led to marked reduction in
the death rate or in mortality that
gradually raised the life expectancy
from 40 to over 60 years
FABRIKAM 36
However the decline in death rate
was not immediately accompanied
by a decline in fertility. As a result
the growing divergence between
high birth rates and falling death
rates leads to a sharp increase in PG
compared to past centuries

So this stage 2 thus marks the

beginning of the DT

FABRIKAM 37
Finally stage 3 was
entered when the forces
and influences of
modernization and
development caused the
beginning of a decline in
fertility, falling birth
rates converged with
lower death rates,
leaving little or no
population growth

FABRIKAM 38
 In the last decade, fertility rates
in many of the poorest
countries , such as Bangladesh
and most of the countries in
Africa, have experienced an
impressive decline
 This decline is the result of more
widespread availability of family
planning
 Although this change helps to set
the stage for an opportunity for
successful development in
coming years, but developed
countries need to do their part in
providing expanded development
assistance, especially efforts
focused on the need and
opportunity to greatly reduce the
incidence of poverty, which
remains the biggest cause of high
rates of fertility

FABRIKAM 39
 The Malthusian Population Trap
The threshold population level anticipated by Thomas Malthus
(1766–1834) at which population increase was bound to stop
because life sustaining resources, which increase at an
arithmetic rate, would be insufficient to support human
population, which would increase at a geometric rate.

FABRIKAM 40
 Assumptions
• No possibility of technological progress
• Land and other natural resources are fixed in quantity
• Presence of diminishing return to scale
• Birth rates and death rates are equal at initial stage
• Population grows only when income (or food
production) grows
• The idea is associated with demographic transition

FABRIKAM 41
• According to modern-day neo-Malthusians, poor
nations will never be able to rise much above their
subsistence levels of per capita income unless they
initiate preventive checks (birth control) on their
population growth
• In the absence of such preventive checks, Malthusian
positive checks (starvation, disease, wars) on
population growth will inevitably provide the
restraining force

FABRIKAM
The Malthusian population trap provides a theory of the
relationship between population growth and economic
development. Unfortunately, it is based on a number of
simplistic assumptions and hypotheses that do not stand the
test of empirical verification.

We can criticize the population trap on two major grounds

• First, the model ignores the enormous impact of technological
progress in offsetting the growth-inhibiting forces of rapid
population increases

• The second criticism of the trap focuses on its assumption that

national rates of population increase are directly related to the
level of national per capita income.

FABRIKAM
There may be rational reasons why families in developing
countries choose to have many children

• Religious taboos and norms

• High rates of infant mortality
• Status of women in society
• Security in old age
• Desire for a son by men
• Age of marriage
• Status /symbol/ prestige
• Child labor

FABRIKAM 44
 The Consequences of High Fertility: Some Conflicting
Perspectives

Three general lines of argument on the part of people who assert

that population growth is not a cause for concern:
• The problem is not population growth but other issues.
• Population growth is a false issue deliberately created by dominant
rich country agencies and institutions to keep developing countries
in their dependent condition.
• For many developing countries and regions, population growth is in
fact desirable.
Other Issues
Many observers from both rich and poor nations argue that the
real problem is not population growth per se but one or all of
the following four issues:
1. Underdevelopment
2. World Resource Depletion and Environmental
Destruction
3. Population Distribution
4. Subordination of Women

FABRIKAM 46
 Three arguments on the negative economic, social, and
environmental consequences of population growth

• The Extremist Argument: Population and Global Crisis

It is regarded as the principal cause of poverty, low levels of living, malnutrition, ill health,
environmental degradation, and a wide array of other social problems

• The Theoretical Argument: Population-Poverty Cycles and the Need for

Family-Planning Programs
Population growth is believed to retard the prospects for a better life for the already born
by reducing savings rates at the household and national levels. It also severely draws
down limited government revenues simply to provide the most rudimentary economic,
health, and social services to the additional people. This, in turn, further reduces the
prospects for any improvement in the levels of living of the existing generation and helps
transmit poverty to future generations of low-income families.

FABRIKAM 47
• Other Empirical Arguments: Seven Negative Consequences of
Population Growth
1. Economic Growth. Evidence shows that although it is not the culprit behind economic stagnation,
rapid population growth lowers per capita income growth in most developing countries
2. Poverty and Inequality. The negative consequences of rapid population growth fall most heavily
on the poor because they are the ones who are made landless, suffer first from cuts in government
health and education programs, and bear the brunt of environmental damage.
3. Education. Rapid population growth causes educational expenditures to be spread more thinly,
lowering quality for the sake of quantity.
4. Health. High fertility harms the health of mothers and children.
5. Food. Feeding the world’s population is made more difficult by rapid population growth.
6. Environment. Rapid population growth contributes to environmental degradation in the form of
forest encroachment, deforestation, fuelwood depletion, soil erosion, declining fish and animal
stocks, inadequate and unsafe water, air pollution, and urban congestion.
7. International Migration. Many observers consider the increase in international migration, both
legal and illegal, to be one of the major consequences of developing countries’ population growth.

FABRIKAM 48
Three policy goals and objectives in the issue of population growth
in developing countries.

1. In countries or regions where population size, distribution, and growth are

viewed as an existing or potential problem, the primary objective of any strategy
to limit further growth must deal not only with the population variable per se
but also with the underlying social and economic conditions of
underdevelopment.
2. To bring about smaller families through development-induced motivations,
family-planning programs providing both the education and the technological
means to regulate fertility for people who wish to regulate it should be
established.

FABRIKAM 49
Three policy goals and objectives in the issue of population growth
in developing countries.

3. Developed countries should help developing countries achieve their lowered

fertility and mortality objectives, not only by providing contraceptives and
funding family-planning clinics, but also, even more important, by curtailing
their own excessive depletion of nonrenewable world resources through
programs designed to cut back on the unnecessary consumption of products
that intensively use such resources; by making genuine commitments to
eradicating poverty, illiteracy, disease, and malnutrition in developing countries
as well as their own; and by recognizing in both their rhetoric and their
international economic and social dealings that development is the real issue,
not simply population control.

FABRIKAM 50
Urbanization and
Rural-Urban
Migration:
Theory and Policy
Urbanization: Trends and
Living Conditions
• As a pattern of development, the more
developed the economy, the more
urbanized.
Urbanization rates increase whenever
urban population growth exceeds rural
population growth. The positive association
between urbanization and per capita
income is one of the most obvious and
striking “stylized facts” of the development
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process.
The share of urban population in developing countries is projected
to increase rapidly

According to UN,
2005-2030 world
population will
grow at a 1.78%
average annual
rate.

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Urban bias - The notion that most governments in developing countries
favor the urban sector in their development policies, thereby creating a
widening gap between the urban and rural economies.

Rural-Urban Migration - The movement of people from rural

villages, towns, and farms to urban centers (cities) in search of jobs.

Industrial modernization, technological sophistication, and metropolitan

growth created a substantial geographic imbalance in economic
opportunities and contributed significantly to the accelerating influx of
rural migrants into urban areas.

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The Role of Cities
An economic definition of a city is “an area with relatively high
population density that contains a set of closely related activities.”

To a large degree, cities are formed because they provide cost

advantages to producers and consumers through what are called
agglomeration economies.

Agglomeration economies.
Cost advantages to producers and consumers from location in cities and
towns, which take the forms of urbanization economies and localization
economies.
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 TWO FORMS OF AGGLOMERATION ECONOMIES

Urbanization economies.
Agglomeration effects associated with the general growth of a
concentrated geographic region.
Localization economies.
Agglomeration effects captured by particular sectors of the
economy, such as finance or autos, as they grow within an
area.
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Industrial Districts - Clustering of firms of same type.
Localization economies encourage emergence of industrial districts.

Clustering also has spill-over benefits:

a. Flexible Specialization: greater opportunity to contract outworks
b. Learning: firms can more easily learn from each other regarding
production processes, business practices, rules and regulations,
business opportunities
c. Training and Technological Development: easier to develop training
facilities; easier to develop, learn and adopt new technologies
d. Social Capital: easier to resolve shared concerns through collective
action.
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The Urban Giantism Problem

In a country with poor transportation network, there might

emerge one or two big cities. Most of the firms and economic
activities might be concentrated in one or two big cities. This
may not be efficient from the social point of view. By
diversifying the location of firms and economic activities, one
can reduce the cost of production and commuting as well as
congestion. Urban giantism may lead to first-city bias, in which
the biggest city receives a disproportionate share of public
investment, which aggravates the problem of urban giantism
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 Causes of Urban Giantism
• Import substitution industrialization – Less int’l trade,
concentrate is in single city to avoid transportation cost
• Bread and circuses – to prevent unrest (stable democracies
vs unstable dictatorships)
• Hub and spoke transport system – makes transport costs
high for small cities
• Compounding effect of locating the national capital in the
largest city
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URBAN INFORMAL SECTOR

One striking feature of the urbanization in developing countries

is the presence of a large informal (unorganized, unregulated,
unregistered) sector. Between 30% to 70 % of urban labor force
works in the informal sector

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Advantages of Encouraging Urban Informal Sector 
a. Informal sector has higher productivity than the rural sector and generates more
surplus. This surplus can be utilized to promote the formal sector.
b. It has low capital-intensity. This sector is quite suitable for the factor endowment of
developing countries (relatively scarce capital and abundant labor). It can create
employment opportunities much faster.
c. It provides learning experience for both wage workers and self-employed and thus
enhances human capital.
d. It generates demand for unskilled and semi-skilled workers which are again
relatively more abundant in developing countries.
e. Since, poor are concentrated in the informal sector, its promotion would
ensure more equitable distribution of the benefits of development and
faster reduction in poverty 61
Disadvantages of Encouraging Urban Informal Sector 
a. Increased migration and aggravating the problem of urban
giantism.
b. Increased urban unemployment.
c. Discrimination against formal sector bad in the long run.

Policies to Encourage Urban Informal Sector 

d. Remove policies which discourage informal sector.
e. Provide information and training facilities.
f. Increased access to capital and credit 62
MIGRATION AND DEVELOPMENT

Migration worsens rural-urban structural imbalances in two direct ways.

1. Migration increases the labor supply in the urban areas depletes the
human capital in rural areas.
2. Job-creation in urban areas requires more resources relative to urban
areas, reducing the resources available to rural areas
ECONOMIC THEORY OF RURAL-URBAN
MIGRATION
Todaro migration model
 A theory that explains rural-urban migration as an economically
rational process despite high urban unemployment. Migrants calculate
urban expected income (or its equivalent) and move if this exceeds average rural
income.
Basic Characteristics
1. Migration is a rational decision, by economic considerations
2. The decision to migrate depends on expected rather than actual urban-rural
real wage differential
3. The probability of obtaining a city job is inversely related to the urban
unemployment rate
4. High rates of migration are outcomes of rural urban imbalances 64
Harris-Todaro model
 An equilibrium version of the Todaro migration
model that predicts that expected incomes will
be equated across rural and urban sectors when ta
king into account informal-
sector activities and outright unemployment

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 Five Policy Implications
1. Imbalances in urban-rural employment opportunities caused by the
urban bias, particularly first-city bias, of development strategies must
be reduced.
2. Urban job creation is an insufficient solution for the urban
unemployment problem.
3. Indiscriminate educational expansion will lead to further migration
and unemployment.
4. Wage subsidies and traditional scarcity factor pricing can be counter
productive. Finally, programs of integrated rural development should
be encouraged
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 Elements of Comprehensive Migration and Employment
Strategy

a) Creating an appropriate rural-urban economic balance.

b) Expansion of small-scale, labor-intensive industries.
c) Eliminating factor-price distortions.
d) Choosing appropriate labor-intensive technologies of production.
e) Modifying the linkage between education and employment.
f) Reducing population growth.
g) Decentralizing authority to cities and neighborhoods.
 THANK YOU

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