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EC207 Lecture Notes - Lecture 3: Per Capita Income, Least Developed Countries, Paul Romer

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yellowfox905
19 Oct 2018
School
WLU
Department
Economics
Course
EC207
Professor
Prof Fatima

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Lesson 1.3: Comparative Economic Development: Long Run Causes, Convergence of Living Standards…
• Identify the factors that many of today’s Least Developed Countries (LDCs)
have in comparison to the position of developed countries on the eve of their
development
1. Physical and Human Resource Endowments: The natural resources that currently developed nations had at
the time when they began their modern growth were more abundant than what today’s developing countries
currently have. Paul Romer1 divides the technology gap between rich and poor nations into two
components: a physical object gap and an idea gap.
2. Per capita incomes and levels of GDP in relation to the rest of the world: Per capita income that the people
living in low-income countries have is, on average, lower than per capita income developed countries had
in the nineteenth century.
3. Climate: The location and climate is critical for many reasons. It is a fact that almost all developing
countries are located in tropical or subtropical climatic zones.
4. Population size, distribution, and growth: Developed countries did not have a fast rise in their population
growth before and during their early growth years. Population growth rates started to increase as a result of
industrialization because of falling death rates but also because of slowly rising birth rates.
5. Historical role of international migration: Historically, migrant labour both within and between countries
was common and did provide some relief for locally depressed areas.
6. International trade benefits: Today’s advanced nations used international free trade as their “engine of
growth” during the nineteenth and early twentieth centuries.
7. Basic scientific and technological research and development capabilities: Research and development
(R&D) is mainly concentrated in developed countries.
8. Efficacy of domestic institutions: There are many differences between economic, political and social
institutions of developing nations and developed nations when they embarked on their development
journey.
• Discuss whether the living standards in developing and developed nations are
starting to converge
First of all, technology transfer is a good reason to expect convergence since developing countries do not have
to invest in research to find the existing technology. It is definitely cheaper to replicate technology compared to
inventing original technology. As a result, developing countries should be able to jump over some of the earlier
stages of technological development which is a solid reason why we expect faster growth among developing
nations than developed nations who are spending large amount of funds to invent new technology.
Second reason to expect convergence if conditions were similar would be more rapid capital accumulation in
developing countries. Developed countries today have high levels of physical and human capital. Due to the law
of diminishing returns, the marginal product of capital and the profitability of investments would be lower in
developed countries.
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Document Summary

Lesson 1. 3: comparative economic development: long run causes, convergence of living standards . First of all, technology transfer is a good reason to expect convergence since developing countries do not have to invest in research to find the existing technology. It is definitely cheaper to replicate technology compared to inventing original technology. Second reason to expect convergence if conditions were similar would be more rapid capital accumulation in developing countries. Developed countries today have high levels of physical and human capital. Due to the law of diminishing returns, the marginal product of capital and the profitability of investments would be lower in developed countries. As a summary, there is strong evidence for convergence among the oecd countries, no convincing evidence for longer-term convergence for the world as a whole, and evidence of divergence for the least developed countries. More than one-third of the world"s people live in these two countries.

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Related Questions

Topic:
How would you explain the finding that people in high-income economies seem happier than people in low-income economies, but, over time, people in high-income economies do not seem to be any happier even if their country grows richer? Briefly discuss.

Optional Reading:

Income and Happiness

The Declaration of Independence in 1776 identified “certain unalienable Rights, that among these are Life, Liberty, and the Pursuit of Happiness.” This did not guarantee happiness but did establish the pursuit of happiness as an “unalienable” right, meaning that right cannot be taken away, given away, or sold. Eighteenth century philosopher and social reformer Jeremy Bentham argued that government policy should promote the greatest happiness for the greatest number of people.

Many people today apparently agree. In recent polls, 77 percent of Australians and 81 percent of Brits believed that a government's prime objective should be promoting the greatest happiness rather than the greatest wealth. The United Nations in 2007 sponsored an international conference on “Happiness and Public Policy.” Thailand now compiles a monthly Gross Domestic Happiness Index. Even China has joined in the fun reporting a happiness index based on polling results about living conditions, income, the environment, social welfare, and employment. Australia, Canada, and the United Kingdom are also developing happiness indexes.

Economists have long shied away from asking people how they feel, preferring instead to observe their behavior. But more now see some value in asking questions. In the most extensive of polls, the Gallup organization asked people in 130 countries: “How satisfied are you with your life, on a scale of zero to ten?” The results, reported in 2007, are not surprising. Most people in the high income areas, such as the United States, Europe, and Japan, said they are happy. Most people in the poor areas, especially in Africa, said they are not. Also, within a given country, income and happiness are positively related. After evaluating all the results of the Gallup world poll, Angus Deaton of Princeton concluded: “The very strong international relationship between per capita GDP and life satisfaction suggests that, on average, people have a good idea of how income, or the lack of it, affects their lives.” 8

So these results are no surprise. What does puzzle economists is that other surveys suggest that in affluent countries people do not seem any happier over time even though each generation became richer than the last. For example, in the United States, the proportion of people who say they are happy has stayed about the same despite 60 years of economic growth. In Japan, happiness responses actually declined despite a substantial increase in real income over the last 50 years.

Here are two possible explanations. First, people begin taking for granted those luxuries they most desired. For example, two generations ago color TVs, automobiles, and major appliances were luxuries, but now they are must-items for most households. Computers and flat screen HDTVs will soon move from luxuries to necessities. As each generation attains a higher standard of living, people become less sensitive to the benefits, they take them for granted, and thus they say they are no happier.

Second, research suggests that what matters is not just the absolute level of income but income relative other people in the reference group. Imagine you have a choice between (1) earning $50,000 a year while others in your reference group make $25,000 or (2) earning $100,000 a year while others make $250,000 (suppose, too, that prices remain the same, so $100,000 is double the real income of $50,000). Which would you prefer? Studies show that when people face this hypothetical choice, most pick the $50,000 option. That is, they prefer to make more than others even if that means a lower real income. Thus, if all incomes rise on average over time, this does not affect that aspect of happiness linked to one’s relative standing. As the social critic H. L. Mencken long ago observed, "A wealthy man is one who earns $100 a year more than his wife's sister's husband."

SOURCES: Daniel Gilbert, Stumbling On Happiness, (New York: Knopf, 2006); Marina Kamenev, “Rating Countries for the Happiness Factor,” Business Week, 11 October 2006; Angus Deaton, “Income, Aging, Health, and Wellbeing Around the World: Evidence from the Gallup World Poll,” Princeton Working Paper, (August 2007); and “Where Money Seems to Talk,” Economist, 12 July 200

Hello, could you please assist with this discussion question for the Economics course? Thank you.

5) Go to the internet and find an article that discusses the problems of income inequality in the U.S. economy, summarize key points, and post in the Discussions area.

http://neweconomics.org/2014/12/why-inequality-is-an-economic-problem/

Why Inequality Is An Economic Problem

Rising economic inequality was a major driver of the financial crisis. With the OECD recently debunking ‘trickle-down’ economics, our new report sets out the links between inequality, the growth in scale and influence of the financial sector, and the dangers for financial stability.

A fragile recovery

A return to growth in economies such as the UK and USA has been welcomed as a sign of recovery from the 2008 financial crisis. But as GDP picks up, so too has the widening gap between rich and poor.

The crisis may be over for the wealthy but the aftermath for ordinary workers depressed wages and growing debt is only getting worse.

Most nations have mustered only negligible growth and this has failed to benefit the vast majority of those nation's populations.

In the seven years following the crash, the UK has suffered the longest sustained decline in real wages since records began.

This decline hasn't has been shared equally across the income spectrum latest annual data up to the end of 2013 shows real earnings for the top 10% increasing by 3.9% and a 2.4% fall for the remaining 90%.

Households are once again piling on risky personal debt at a rate of almost $1billion a year.

Globally, wealth grew by 8.3% last year to $263 trillion, even as living standards stagnate for the majority. Income inequality has seen a sharp return the top 1% of earners have reaped 95% of the USA's economic gains since the crash.

Inequality increases as economies are financialised

Over the past four decades, financial sectors have been extensively deregulated and have expanded enormously as a result, particularly in the UK and USA.

This deregulation produced two systemic outcomes: finance has been freed to become the motor of the economy while the pursuit of greater equality of citizens, as was the focus after the second world war, has been abandoned.

Instead, the notion that unrestrained pursuit of wealth would trickle-down from rich to the poor has been embraced in the mainstream political and economic arenas.

Financial markets, products, and firms now play a much larger role in many areas; from pensions and social insurance to homes and public infrastructure.

Privatization and the doctrine of maximizing value for shareholders have increased the amount of economic activity focused on extracting the largest possible short-term profit. These trends are referred to collectively as ‘financialisation’.

Until now the connections between this increasing prevalence of financial activities and the steady increase in economic inequality have not been clear. But when these two trends reached a boiling point in the mid-2000s they fuelled a global collapse of financial systems.

The polarization of wealth and incomes fed asset bubbles, risky financial activity,, and necessitated vast levels of household debt – resulting in the 2008 financial crash. With little done since to address these interconnected drivers, the threat of another crisis is very real.

This diagram lays out the seven indicators of economic instability, each fuelled by rising inequality and increasing financial sector activity:

Our report describes how these indicators laid the path for the 2008 crash, and threaten to do the same again:

Increasing inequality depresses demand since consumption levels depend more on the wages of those at the lower end of the income scale than the profits of the wealthy

In the face of stagnating wages, households rely increasingly on debt to maintain their lifestyles with rising asset prices, especially in residential housing, worsening this.

Financial liberalization allows money to flood into countries with trade deficits, such as the USA and the UK, providing the funds for debt-led consumption.

Snowballing wealth at the top increases risky financial speculation.

Inequality doesn't bring growth, it brings economic instability

In recent years there has been a marked slowing of growth across the world's wealthiest economies, with none returning to the growth trends experienced before the crisis. Many have begun to speculate that this stagnation could, in fact, be a permanent development meaning that wealthy economies are fundamentally unable to create enough demand to keep growing.

The mainstream political consensus has for decades now suggested that inequality is a price worth paying for economic growth.

But new research from the Organisation for Economic Co-operation and Development (OECD) shows definitively that this inequality/growth trade-off is false adding to a growing body of research showing that inequality actually prevents economies from growing. This points to a fundamental structural flaw in the economy: if the proceeds of growth are not shared, the pie stops growing.

The pursuit of higher returns for the already wealthy within this dwindling pie cannot persist forever. With wealth refusing year on year to trickle down, debt has been used to plug the wage-consumption gap for the rest.

The signals are showing quite plainly that this pursuit of growth, via inequality, is ineffective and unsustainable.