Chapter 11

Development
Policymaking
and the Roles of
Market, State,
and Civil Society

Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

System of Economic Management

Mixed economy
• Private sector: profit maximizing business firms
• Public sector: employment maximizing
government agencies

Economic systems
• Capitalism: large private sector, but small public
sector
• Socialism: large public sector, but small private
sector
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-2
Economic Role of the State

• Protect private property and legal rights

• Produce public goods
• Improve market competition
• Improve income distribution
• Preserve the human environment
• Manage the economy

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-3

Development Planning

Economic plan: managing economic activity

• Specific set of quantitative targets

• Given time horizon (three or five years)
• Stated strategies for achieving the targets
• Comprehensive (the entire economy) or
partial (a specific sector or industry)
coverage

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-4

Component of Development Plan

• Government uses domestic saving and

foreign exchange to construct economic
infrastructure

• Government implements economic policy

(taxation, industrialization, foreign
exchange control, trade restriction)

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-5

Rationale for Planning

Reduce market failure:

• Income distribution
• Monopoly power
• Externalities of production and
consumption
• Insufficient information

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-6

Rationale for Planning

• Resource mobilization and allocation

• Psychological effect on achieving

development goals (e.g., reducing
poverty)

• Foreign aid: a requirement to obtain

loans and grants

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-7

Planning Characteristics

• Governmental goals and objectives

• Strategies for achieving goals and objectives
• Government agency for planning
implementation
• Planning coverage: comprehensive or partial
• Planning horizon: medium or long-term
• Planning methodology (macroeconomic mode

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-8

Planning Methodology

Aggregate growth model (Harrod-Domar)

• Investment demand = National saving

• Foreign aid and direct foreign investment

to fill-in the saving gap

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-9

Planning Methodology

Input-Output model

• Outputs of industries serve as inputs of other

industries

• Optimal input mix to produce maximum

output to satisfy the final demand

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-10

Project Appraisal

• Weigh the costs of plans/projects against

their benefits over the planning horizon

• Discount the costs and benefits and

compare their present values

• Find an appropriate “discount factor” above

the internal rate of return”

• “Net” at which present value equal to zero

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-11
Project Appraisal

Net present value, or NPV is given by

Bt  Ct
NPV  
t (1  r )
t

Where
Bt is the expected benefit at time t
Ct is the expected cost at time t
r is the government’s social rate of
discount
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-12
True vs. Actual Market Value

• True market value in the demand-supply

price or scarcity value = shadow price
reflecting social costs and benefits

• Actual market value is the market

exchanged price reflecting private costs
and benefits or the controlled price

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-13

Reasons for Price Divergence

• Inflation and currency control

• Factor price distortions (prices, wages,

interest rates, exchange rate)

• Trade restrictions and import substitution

• Saving deficiency

• Social vs. private rate of return

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-14
Planning Consequences

• Factor price distortion, choice of technology

and employment creation
• Induced R-U migration
• Demand for educational certification leading
to employment problem
• Economic structure

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-15

Reasons for Failure of Planning

• Deficiencies in plans and their

implementations
• External and internal disturbances
• Insufficient and unreliable data
• Institutional weaknesses
• Lack of political will
• Corruption of public servants

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-16

The Planning Mystique

• In the past, few doubted the importance and

usefulness of national economic plans

• Recently, however, disillusionment has set

• But, a comprehensive development policy

framework can play an important role in
accelerating growth and reducing poverty

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-17

Resurgent of Market Orientation

• Failure of planning

• IMF and World Bank policy requirements

for foreign aid and direct foreign
investment

• Joint ventures of domestic and foreign

enterprises

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-18

Requirements for Market Orientation

• Trust
• Law and order
• Security of private property rights
• Balancing between competition and
cooperation
• Division of responsibility and diffusion of
power
• Social safety net
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-19
Requirements for Market Orientation

• Social mobility
• Individualism and materialism
• Deferring gratification to create private
saving
• Rationality and efficiency
• Honesty of government
• Competition of business
• Availability and freedom of information
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-20
Need for Government
Intervention
• Income redistribution through progressive
taxation and transfer payments
• Excess market imperfection on behalf of
domestic and foreign business
• Substantial negative externalities
(pollution and decay)
• Investment in social and human capital
• Structural transformation
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-21
Planning & Market
Reconciliation
• Must achieve “effective” cooperation
• Must reduce market imperfections
• Must eliminate factor price distortions and
price controls
• Must reduce public ownership of economic
enterprises
• Must reduce corruption and red tape

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-22

Non-Government Organizations

• Comparative advantages of NGOs in

– Innovative design and implementation
– Program flexibility
– Specialized technical knowledge
– Provision of targeted local public goods
– Common-property resource management design and
implementation
– Trust and Credibility
– Representation and advocacy

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-23

Corruption and Planning

• Corruption: Abuse of public trust for private gain

• Good governance enhances capability to function

• Effects of corruption fall disproportionately on the

poor

• Good governance is broader than simply an

absence of corruption

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-24

Corruption as a Regressive Tax:
The Case of Ecuador

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-25

The Association between Rule of Law
and Per Capita Income

Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-26