Chapter 4
Contemporary
Models of
Development and
Underdevelopment
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Underdevelopment as a
Coordination Failure
• Coordination failures occur when agents’
inability to coordinate their actions leads to
an outcome that makes all agents worse off.
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Multiple Equilibria: A
Diagrammatic Approach
• Generally, these models can be
diagrammed by graphing an S-shaped
function and the 45º line
• Equilibria are
– Stable: function crosses the 45º line from above
– Unstable: function crosses the 45º line from
below
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Figure 4.1 Multiple Equilibria
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Starting Economic
Development: The Big Push
• Sometimes market failures lead to a need for public policy intervention
• The Big Push: A Graphical Model, 6 assumptions
– One factor of production
– Two sectors
– Same production function for each sector
– Consumers spend an equal amount on each good
– Closed economy
– Perfect competition with traditional firms operating, limit pricing monopolist with a
modern firm operating
• Conditions for Multiple Equilibria
• Other cases in which a big push may be necessary
– Intertemporal effects
– Urbanization effects
– Infrastructure effects
– Training effects
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Figure 4.2 The Big Push
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Why the Problem Cannot be
Solved by a Super-Entrepreneur
• Super Entrepreneur?
– Capital market failures
– Cost of monitoring managers- Asymmetric
Information
– Communication failures
– Limits to knowledge
– Lack of empirical evidence
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Further Problems of Multiple
Equilibria
• Inefficient advantages of incumbency
• Behavior and norms
• Linkages
• Inequality, multiple equilibria, and growth
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Kremer’s O-Ring Theory of
Economic Development
• The O-Ring Model
– Production is modeled with strong
complementarities among inputs
– Positive assortative matching in production
• Implications of strong complementarities for
economic development and the distribution
of income across countries
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Further Problems of Multiple
Equilibria
• Economic development as self-discovery
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The Hausmann-Rodrik-Velasco
Growth Diagnostics Framework
• Focus on a country’s most binding
constraints on economic growth
• No “one size fits all” in development policy
• Not simple to find the binding constraint.
Uncertainty leads to probabilistic
assessments
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Figure 4.3 Hausmann-Rodrik-Velasco
Growth Diagnostics Decision Tree
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The Hausmann-Rodrik-Velasco
Growth Diagnostics Framework
• Growth diagnostic:
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The Hausmann-Rodrik-Velasco
Growth Diagnostics Framework
• Growth diagnostic:
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Case Study: China
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Concepts for Review
• Agency costs • Congestion
• Agent • Coordination failure
• Aid failure • Deep intervention
• Asymmetric information • Linkage
• Big push • Multiple equilibria
• Complementarities • O-ring model
• Complementary
investments
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Concepts for Review (cont’d)
• O-ring production • Growth diagnostic
function • Technological
• Pareto improvement externalities
• Pecuniary externalities • Underdevelopment
• Poverty trap trap
• Prisoners’ dilemma • Where-to-meet
dilemma
• Public good
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