Institutions, Preconditions and Industrialization, Dohan Revised 5/7/14
by Michael R. Dohan, Associate Professor of Economics, Queens College of CUNY, 2013©
Concepts to consider for writing the final report for Eco 207
Use to study for answering the two exam essays
and
the Multiple-Choice/Identification of Concepts/True-False on Final.
Starting Growth and industrialization: the pre-conditions
A culture or social norms or (religious) beliefs that accepts and values economic activity and trade as a socially and morally acceptable profession.
A relative good initial endowment of resources (arable land, coal, forests, water power, iron ore (in the case of England and the USA), building material.
Individuals free to become small business persons and entrepreneurs to make the market produce and work
Relative absence of violence and crime
A stable political environment and the absence of war on the territory
Some sort of transportation infrastructure to ship products around (canals, roads, rivers, and eventually the railroad)
A large fairly accessible market (coast trade, monetization, system of weights and measures
A legal system that works and enforces contracts and property right, internally consistent over time, and not subject to corruption.
Some good number of educated literate people.
An interest throughout society in the development and production of new “technology and science”
Agricultural production above the subsistence level of output to provide food and materials for cities and workers
A (potential) labor force for expansion of economy (unemployed, underemployed, low productivity in current work).
Levels of investment as a % of GDP and the preconditions necessary to raise it, such as reinvestments of profits (before a modern financial system of financial intermediaries evolved to assemble savings and to lend them out).
Consumer sovereignty in the market determines output and affects prices
A Restatement of the page above
Qualitative Institutions and conditions
1. Widespread agreement in the population and acceptance of belief systems consistent with the efficient operation of a market economy, e.g.
· Production and distribution according to market forces (prices, profits, interest), guided by self-centered utility maximization a la Adam Smith
· Acceptance of the concept of profit, prices, interest, wages as principal methods of resource allocation
· Acceptance of the “economic man” is being important in society
· Acceptance or tolerance of change
2. Security: Absence of warfare, bandits and piracy and violence.
3. The existence of entrepreneurs, (usually motivated in part by profit) and “researchers” (some of whom are motivated in part by non-economic goals) who were constantly looking for “ways to do thing better”.
4. A mobile labor force that is free to move and take jobs in response to wages and/or preferences.
· Men vs women vs children
· Upward mobility in society (meritocracy)
· Elimination of the social caste to prevents mobility.
5. Monetization of the economy.
6. A good size market demand for the goods (England and American relied primarily on internal markets but some considerable foreign trade).
7. A source of motive power stronger than humans or horses (water power initially, then the steam engine)
· Human power + sticks
· Horse Power and oxen power and wood ploughs
· Water power for new looms
· Steam engines
o New agricultural machines including steel ploughs, systhes< harvestor)
o Machine-powered agricultural machines (steam): combines threshers
· Gas-powered agricultural traction (tractors, soil preparation,
8. A simple stable financial system (Money, letters of credit, monetary banking/intermediaries)
· facilitating trade (medium of exchange)
· a stable monetary system (unit of account t, store of value)
· for collecting and allocating private savings (a desire to reinvest profits, the economic surplus)
· Today, we would expect to see a effective if simple banking system and other financial institutions)
9. A good infrastructure to support commerce and trade and production (initially very rudimentary in 1750)
· Ports and airports
· Roads and bridges.
· Communication system.
· Transportation system, independent of roads.
· Sources of energy and a distribution network
10. Per capita output greater than the subsistence level
· to permit the collection of taxes
· voluntary savings and investment
· to provide resources for public and private capital and human capital for economic growth
11. Existence of a reasonable system and degree of taxation which effectively collect taxes.
12. A government which permits markets to operate freely (Laissez faire) albeit with
appropriate regulations where the markets fail and prevention of monopoly and restraint of trade.
13. An effective legal system to enforce contracts and intellectual property rights, no corruption
14. An education system based on empirical knowledge (knowledge versus belief)
15. Solid protection of property rights
16. The absence of extensive “arbitrary” corruption and other practices in government and business which raises the transaction costs and information costs and reduces to efficiency of the market economy.
17. Stronger Limited Central Government
Later, the government will have to expand its role:
· to making allocative decisions and regulations in areas where the market system fails work well (e.g., in the provision of public goods, managing external costs and benefits, principal-agent problems,
· To provide for the social welfare, working conditions and non-economic goods and services.
· England (unlike China) started to attack the problem of child labor and excessive working hours fairly early in the its industrialization process.
Sources of technology in growing economy
Incentive structure for peasants to grow and market grain
MPPl retained by the peasant after taxes and contract deliveries and its effect on the peasant
Internal price structure
Information system generates inaccurate information
Information system is decentralized through market interaction
Models of industrialization and development
Import-substitution model -> lesser role for foreign trade -> autarky
Export-led expansion
Internal market demand led expansion
Sources of growth
The extensive growth model (adding more capital and labor) Q = Ā(L+∆L)α (K+∆K)β Cobb-Douglas Production function
∆L = adding more labor, ∆K= adding more capital, Ā (technology)= total factor productivity remains constant
As the capital/ labor ratio rises, the marginal productivity of additional capital investment falls because of the law of diminishing marginal returns.
Russia reached this point in the 1970s. It was also misallocating more resources because of the bad price system and fixed technical coefficients in the material balance approach.
China is probably reaching it now that it is running out of labor.
The intensive growth model (adding more capital and labor and promoting technology progress and efficiency so that) Q = (A+∆ A)*(L+∆L)α (K+∆K)β
∆L = adding more labor ∆K= adding more capital ∆A= total factor productivity increases and is not subject to the law of diminishing returns.
So, anything or policy the increase the total factor productivity, say at 3% will make output grow at 3% time whatever growth comes from added capital. Total factor productivity can come from a variety of sources in addition to new technology. For example, simple by improve the way the economy uses existing resources.
Incentive structure for peasants to grow and market grain
MPPl retained by the peasant after taxes and contract deliveries and its effect on the peasant
Internal price structure
Information system generates inaccurate information
Information system is decentralized through market interaction
Conditions for inducing workers to move to were needed )at less two conditions)
Labor conditions in rapidly industrializing countries from the Industrial Revolution on
Incentive (or disincentives) to adopt new technology
Sources of increasing total factor productivity and technology in growing economy
problems in creation of new technology
- Cultural and method of educational training may teach wrong habits. For example, relying on rote memorization instead of critical thinking, of taking risks to be wrong, etc.
- Restricted access to labs and tech staff, working on the projects only of a senior professor (common in Europe at one time, but better now).
- Habit of borrowing, buying or stealing technology prevent their “scientific institutes” from really developing their own. (Chinese high-speed RR was built largly with foreign technology.
Improving science and technology
- Educate more engineers, scientists and provide good funding and salaries.
- Build more research centers and national laboratories
- Ability to patent new technology and profit from it.
- How research labs are organized with state of the art equipment available to all researchers regardless of their rank.
- Impact of intellectual property laws on the transfer of technology
- Protect technology from “pirates” who steal it (Won’t name names here).
Advantages of a market system, profit maximization and utility maximization
Conditions for a market to work EFFICIENTLY: many buyers and sellers, homogeneous products, perfect information (yea, right), profit maximizing producers and utility maximizing consumers (buyers)
Competition for consumer dollar
Prices reflect actual opportunity costs and benefits so that social marginal benefit of producing a product such as bushel of wheat was equal to the social market cost of producing that bushel of wheat. SMB=SMC.
If SMB>SMC, produce more wheat, if SMB<SMC, produce less wheat.
Incentive structure for managers to produce the right mix and quantity of product at the minimized costs and sell at a price where P = MC, so that throughout economy from your micro economics MCB /MCA = PB /PA = MUB /MUA
Incentive structure to minimize costs, e.g. so firm “a” MPPl ax /MPPkax = w/r, and that for firms “a”, “b”,…MPPlx = MPPl x so that the marginal physical products for each input type were equal in all firms producing “X” so that resources can not be shifts from one producer to another producer and increase total output of “x”.
Concept of Pareto efficiency: Remember the story of the sole peasant farming his own plot of land and knew only of his own marginal utilities and the marginal product of his resources (land and labor) and the marginal (opportunity) cost of producing one good A instead of another good B. He still had the challenge of allocating his labor and land the maximize his utility, even though he did not refer to prices. He still had to produce where MCB /MCA = MUB /MUA
Don’t mess with a good equilibrium price system or you will get inefficiencies. EXCEPT IF THERE IS MARKET FAILURE WITH EXTERNALITIES OR PUBLIC GOODS.
Problem with gas subsidy in Nigeria
Rice subsidies in China
Corruption the increases the extra transaction costs and drives a wedge between what the buyer pays and
what the seller receives - leads to a misallocation of resources.
What motivates managers in allocating resources
Manager’s motivation based on profit maximization in the market place
Manager’s motivation based on value of output
Manager’s motivation based on target fulfillment
Manager’s motivation based on non-monetary (non-material) rewards
Raising the domestic saving and investment rate
- Make sure that macro-economic policy ALWAYS maintains full employment.
- Use periods of unemployment (wasted resources which are actually savings) to build investment goods.l
- Income distribution ( hi GINI coefficient) and its controversial role in economic growth,
More unequal income distribution could create saving from the rich (although they may not be entrepreneurs) Makes real resources available for investment. Often, however, in third and second world economies, the rich waste this on conspicuous consumption (Veblen) like the new Russians and rich Chinese, or stash the money offshore.
- Some cultures have naturally high savings rate.
- Corporations who reinvest retained earnings and depreciation are large SAVERS and Investors in real plant and equipment usually.
- Encourage households to save adequately for retirement (about 20% of income) from a young age in addition to the modest pensions paid buy social security.
Investment in infrastructure (transportation, communication, education)
Investment in heavy industry (A industries in Soviet Russia)
Investment in agriculture
Investment in consumer goods (B industries in Soviet Russia)
Investment in housing (Often neglected or building the wrong type like in China)
Role of foreign investment and foreign debt. Don’t let corruption take a big chunk of the money, or you will get little.
Inflation and monetary policy and macro economic policy.
Hyper-inflation can destroy an economy.
Too little demand wastes resources.
Building the wrong thing or super-big low return show projects wastes resources.
Method of allocating investments:
a. Allocated by banks according to plan
b. Allocated by state politicians according to “national something” such as the show projects in China or Russia or some of the oil states.
c. Allocated by planners to meet the demands of the Politburo – whether needs or noth
d. Allocated according to profit and the cost of capital and interest rates
Things affecting Total Factor Productivity
What firms in which economies adjust their labor force requirements for changes in output and technology.
Weak intellectual property laws.
Incentive to adopt new technology
Cultural and educational training and the creation of new technology
Impact of intellectual property laws on the transfer of technology
Corporate governance (the various forms): advantages and disadvantages
Corruptions as a major barrier to growth, sound infrastructure, income distribution, etc.)
Chinese Economic Reforms and Growth 1980-2010
High household savings rates
General problems in China Today
Prices are influenced by the consideration of their political effect on the population
Social safety net for unemployed laborers
Soft budget constraints on SOE firm and its impact on efficiency
Loss of competitive advantage in the export led model because of rising labor costs and China’s solution
Small domestic market (purchasing power and taste for foreign goods) for domestic manufactured consumer goods
Diminishing marginal product of capital as K/L ratios rise.
Rising per unit labor costs relative to other nations
State-owned enterprises operating below capacity or losing money and operating on a soft budget constraint.
Weak private property laws, for example, in agricultural land.
Need to use middle consumer market to guide many production and consumption decisions
Initial problems in Soviet industrialization and in China in 1958
Problem of getting grain from peasants for export and/or for feeding urban and industrial workers
Inherent Problems in a Command Economy
Factory Directors and Gosnab (Supply Ministry) had the real information about market equilibrium and the length of queues to buy goods and services. Asymmetric information distorted the planning and statistical system and the material balances methodology required to develop a balanced plan which depended on this information.