Traps - University of Hong Kongschiu/6060/History part 1.pdf · 9/19/2015 6 Implications...
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9/19/2015 1 History, Expectations, and Development, part 1 Econ 6060 1 Outline Two approaches to economic development Complementarity A model of demand complementarity A model of Pitfall of partial reforms 2
Transcript of Traps - University of Hong Kongschiu/6060/History part 1.pdf · 9/19/2015 6 Implications...
9/19/2015
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History, Expectations, and
Development, part 1
Econ 6060
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Outline
Two approaches to economic
development
Complementarity
A model of demand complementarity
A model of Pitfall of partial reforms
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Approaches to development
Big bang versus gradualism (or balanced
growth versus unbalanced growth)
Post-World-War II agenda: helping
underdeveloped countries develop
Problem: underdevelopment
Late 1980s: Reforms in Soviet Union,
Central and Eastern Europe, China, etc.
Problem: planned economy
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complementarity
I use facebook because my friends use
I don’t use Wechat because my friends
don’t use Wechat (they use WhatsApp!)
My son’s friends are thinking about
switching to Wechat upon rumors that
WhatsApp will start charging a small
annual fee….What should he do?
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complementarities
When more people taking an action leads
to a bigger tendency for any one person
to take that same action
Fax machine
Telephone
Typing system
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Which typing system should be
used?
Using DvorakUsing QWERTY
0 0
Return from
using
QWERTY
Return from
using Dvorak
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Not every strategic problem has
complementarities
Using cross-harbour tunnel Using western tunnel
0 0
Return from using
western tunnel
Return from
using cross-
harbour tunnel
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Other examples
Technology: iphone versus android smart
phones
Infrastructure: public sector covers fixed
and various cost
Finance: thicker financial market=>high
diversification => easier for individual to
invest => thicker market
Countries are underdeveloped because of
being trapped in a vicious cycle
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Rosenstein-Rodan (1943)
Complementarity suggests we should adopt a big bang approach for reform.
‘Problems of Industrialization of Eastern and South-eastern Europe,” Econ Journal. 1943.
a shoe factory that hires 20,000 workers cannot have its shoe sold to these 20,000 workers
These 20,000 workers will buy other goods, and the shoe factory should find workers of other factories to buy from it.
“The planned creation of such a complementary system reduces the risk of not being able to sell, and, since risk can be considered as cost, it reduces costs. It is in this sense a special case of “external economies.”
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Demand complementarities
(Rosenstein-Rodan 1943)
Industrial expansion raises income,
generates demand for other industries
These models lay a (limited) foundation
for policy debates
Balanced versus unbalanced growth
◦ Rosenstein-Rodan (1943, 1961), Nurkse
(1952, 1953), Hirschman (1958), Streeten
(1956, 1963)
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Implications
Complementarities may result in multiple equilibria
When they do, the equilibria are typically Pareto-ranked.
Two fundamentally identical societies can behave differently.
Formal models of Rosenstain-Rodan’s (1943) ideas are provided in Murphy, Shleifer, Vishny(1989), “Industrialization and the Big Push”, Journal of Political Economy, 1003-1026.
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A model of big push, contd
Resources: labor only, homogenous, can work
◦ in traditional sector: wage rate = 1
◦ in modern sector: wage rate = w >1 (to justify moving to urban area)
Technology: N goods, N is large, each can be produced in the traditional or modern sector
◦ Traditional: one to one technology
◦ Modern: produced by a single enterpriser with technology Li=F+cQi
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A model of big push, contd
Technology:
◦ Modern sector: Li=F + cQi (1)
◦ where Li is labor requirement
◦ F: fixed cost (in terms of labor amount)
◦ c: marginal labor requirement
◦ Qi is the production of good i
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A model of big push, contd
(this model is from Paul Krugman’s paper)
Demand: consumers spend equal amount of spending on each good & don’t care in which sector the good is produced
Static model: no growth, no asset accumulation
Market structure: traditional sector: perfect competition, charging price = 1
Modern sector: each produced by one single entrepreneur, also charging price = 1
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A model of big push, contd
Will production take place in the traditional
or the modern sector?
If no modern sector at all, Qi=L/N
If all modern sector, Qi=(L/N-F)/c
Interesting case:
(L/N-F)/c>L/N (2)
Suppose (2) is satisfied. Can entrepreneurs
profit from starting the modern sector?
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externality
When deciding whether to start the
business, the entrepreneur considers his
own profit.
But the workers hired will have a higher
wage (w>1), hence bringing extra demand
for goods from other firms.
A positive externality not taken into
account by the entrepreneur.
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If only one
entrepreneur
innovates, he will sell
a quantity of L/N and
employ LA.
His profit is L/N-w
LA
Li
Qi
L/NF
L/N
(L/N-F)/c
A
LA
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CASE 1: w-1>0 is sufficiently small
The business is viable
There is a unique equilibrium, so all entrepreneurs will start their business, and only the modern sector exists
Li
Qi
L/NF
L/N
(L/N-F)/c
A
LA
Total cost
wLi
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CASE 2: w -1>0 is of intermediate
range
The business is not
viable
Two equilibria
◦ Only traditional sector
◦ Only modern sector
Li
Qi
L/NF
L/N
(L/N-F)/c
A
LA
Total cost
wLi
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CASE 3: w-1>0 is sufficiently large
The business is not
viable
Unique equilibrium:
only traditional
sector
Li
Qi
L/NF
L/N
(L/N-F)/c
A
LA
Total cost
wLi
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Pitfalls of Partial Reforms
Murphy, Shleifer, and Vishny (QJE, 1992)
in response to reform experiences in
Soviet Union in late 80s
Partial reform started in 1988
The GNP fell 2% in 1990; fell 8% in the 1st
quarter of 1991
Did partial reforms cause output fall?
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An analogue
Suppose the state of Washington
produces apples which are sold
throughout the US.
Let the market clearing price be 15.
Suppose all states impose a price ceiling
at 10.
Then supply falls and apples are rationed.
There may be lines and speculation as
well.
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An analogue
Suppose, now, only 30 states have the price ceiling and other states don’t have it. What happens?
Consumers in the unconstrained 20 states get all the apples they want at the price of 10 (because they can bid epsilon above 10, defeating the other 30 states).
Consumers in the constrained 30 states get the remainder.
Downstream firms (e.g., apple juice makers) in these 30 states have to cut down their production.
Hence, liberalizing some states actually makes things worse!
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A model of supply diversion
Three goods: a) timber, and b) boxcars and c) houses
1. The official price of timber, P, is below the market clearing price
2. The price P is what the buyers actually pay
3. Producers of timber are on their supply curves
4. Initially, timber is rationed efficiently
5. After reform, the timber industry can choose to whom to sell its output
6. After reform, the boxcar industry cannot bid more than P for timber, but the industry sector can.
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A model of supply diversion
All sectors are state owned
Db, Dh are marginal value product curves
p*: market clearing price
Timber rationed efficiently, hence Qb and Qh
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Before reform
A model of supply diversion
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A model of supply diversion
Welfare loss in the
boxcars sector: A +
B
Welfare gain in the
house sector: C
Total welfare change:
C - A – B < 0
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A model of supply diversion
The welfare loss is higher when the
demand for timber by the housing sector
is more elastic and the demand for timber
by the boxcar sector is less elastic
For several reasons, the case of elastic
demand for timber the free sector and
inelastic demand in the state sector is
realistic.
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Sell to housing only when meeting
boxcars’ demand We now assume that the state uses quantity
controls to force the delivery of timber to the boxcar industry a the price P.
Take the case where the boxcar sector got all the timber in wanted under rationing, and assume even after the liberalization of the housing sector the state can still enforce the delivery of that same amount of timber to the boxcar sector.
In timber sector delivers its lowest production cost units to the boxcar sector, and then sells what it produces afterwards to the housing at an equilibrium price.
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Sell to housing only when meeting
boxcars’ demand
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Suppose
the timber
industry is
required to
supply Qb
at p to
boxcar
industry.
Then
partial
reform is
welfare
improving!
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China versus Russia reforms
This sheds light on an important
difference between partial reforms in the
former Soviet Union and in China.
China has pursued partial reforms but the
central government maintained extremely
strict enforcement of state quotas and
allowed firms to sell only the units above
the state quotas to private buyers. Hence
containing the supply diversion problem.
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Conclusion
Big bang versus gradualism
A model of big push (concerned about
development)
A model of partial reform (concerned
about transition from planned to market
economy)
The outcome of partial reform is very
detail specific.
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Readings
Krugman: “The rise & fall of development
economics”, found in
http://web.mit.edu/krugman/www/dishpan.html
“The Transition to a Market Economy: pitfalls of
Partial Reform”, Murphy, Shleifer, and Vishny
(Quarterly Journal of Economics,1992)
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