Public Policy

Lecture 4

The Role of Resources in Economic Development

RESOURCES are Limited

• Poor people are lack of resources
• Poor countries are lack of resources
• Growing population is trouble because of limited resources
• There is not enough resources for all
• Because of limited resources economic growth in one country lead to the shrinking of another economy,
• Sustainable growth is impossible because it is limited by resources and at the end to be followed by stagnation or even a falling standards of living

​

​

"Money doesn't buy happiness , but poverty doesn't buy anything"

RESOURCES are Limited

• Poor people are lack of resources
• Poor countries are lack of resources
• Growing population is trouble because of limited resources
• There is not enough resources for all
• Because of limited resources economic growth in one country lead to the shrinking of another economy,
• Sustainable growth is impossible because it is limited by resources and at the end to be followed by stagnation or even a falling standards of living

​

​

Classical growth theory

• Thomas Malthus (1766 – 1834) was an English cleric, scholar and influential economist in the fields of political economy and demography.
• In 1798 book "An Essay on the Principle of Population" he proposed a theory, known as Malthusian theory or Malthusian trap: geometric (exponential) growth of population and arithmetic (linear) food supply growth.
• The theory was leading in economics at least until the Industrial revolution, but officially a new theory came to replace it only in 1987 - Neoclassical growth theory
• Malthusians say that it today’s global population of 7.9 billion explodes to 11 billion by 2050 and 35 billion by 2300, we will run out of resources, real GDP per person will decline, and we will return to a primitive standard of living.
• So we must control population growth. This leads to the idea of "redundant and unnecessary people", the need for wars, the inevitability of epidemics.

Classical growth theory - Disproof.

The assumption that the population growth rate is primarily determined by economic growth with a positive relationship has no basis in reality: the opposite, birth rates are lowering with economic growth

Food production is much more effective with modern technologies, so total shortage is not an issue any more

Natural resources are limited, but many are Inexhaustible and some renewable or replaceable. Maintenance and reasonable management could solve the problem.

Classical growth theory�Disproof

Food supply (Kcal/capita/day)

Developing countries have problems with food quality

Economic growth.

An increase in economic growth can be caused by two tendencies:

• by more efficient use of inputs (increased productivity of labor, physical capital, energy or materials) is referred to as intensive growth.

​

• by only increases in the amount of inputs available for use (increased population, new territory) is called extensive growth.
• This type of economic growth has no effect on GDP per-capita values in the long-run.
• Extensive growth was first step in economic development before Industrialization and well known for draining resources.
• Malthusian theory was the result of observing this process.

The difference between intensive and extensive growth

Extensive growth, in economics, is based on the expansion of the quantity of inputs in order to increase the quantity of outputs, in contrast to intensive growth, which is achieved through the efficient use of output.

​

• GDP growth caused only by increases of territory, resources or their exploitation - mining, deforestation, irrigation of agricultural land, using unskilled labor, fishing, foraging - is extensive growth

​

• Developing countries are poor not because they don't have enough resources, but because they use extensive production methods.

Intensive growth is key requirement for the successful economic development

Neoclassical growth theory

In 20^th century population speedy growth eventually ended, the birth rate fell, there was necessity of new theory.

• The key reasons: woman’s labor, technological and healthcare advances.

In eastern countries it was idea of Socialism

a political and economic theory of social organization which advocates that the means of production, distribution, and exchange should be owned or regulated by the community as a whole.

Socialism denied the Malthus ideas as inhumane and suggested that with modest appetite there is enough resources for everybody. But finding solution with bottom line (nobody was hungry) there were no incentives for growing and developing. Socialism collapsed as soon as main source of money (gas and oil) dried out.

Western world didn't share this point because the basis of Capitalism is profit and Market economy was considered as only solution.

​

Neoclassical growth theory

In the 1950s MIT scientists Robert Solow and Trevor Swan have suggested the most popular version of this growth theory (“Solow growth model” Nobel Prize 1987) - Neoclassical growth theory

​

Main features:

• Population growth rate is independent of real GDP and the real GDP growth rate.
• Technological changes influence the economic growth rate but economic growth does not influence the pace of technological change.
• It is assumed that technological change results from a chance.
• Capital. The high profit rates that result from technological change bring increased saving and capital accumulation.
• But the mote capital is accumulated, the more projects are undertaken that have lower rates of return. So there is necessary to find the countries with higher rates of return. When this process become global, capital per worker will be constant.

​

Neoclassical growth theory

What happens with profit, capital and innovations:

• Investment of capital, of course, expect the profit.
• Since the competition squeeze profits (prices have to be competitive), producers will seek lower-cost methods for production or invent new and better products for which people are ready to pay higher price.
• Investors can maintain a profit only for several years (patent or copyright), then new discovery is copied and is spreading, so profit disappear.
• So more research and development are required.

​

Neoclassical growth theory

Neoclassical growth theory is the proposition that real GDP per person grows because technological change induces a level of saving and investment that makes capital per hour of labor grow.

Growth ends only if technological change stops because of decrease returns to both labor and capital.

In simple words: the more you save and invest – the more and faster your wealth grow (from individual level to country level), but as soon the rates of return drop, the grow stops.

Neoclassical growth theory says that prosperity will last, but growth will not, unless technology keeps advancing, but not all inventions give the immediate or high profit.

This process was a real reason for spreading fiat type of money in the world.

Neoclassical growth theory conceptual flaws

• Since historically financial capital has not flowed to the countries with less capital/worker, the advantage gets only by developed countries.
• Idea, that technological advances bring new profit opportunities goes to expanding the business, but it has limit, because it require investment from saving. It worked at end of 20^th century, but not now.

​

• This type of economic growth is still Extensive.

​

• Expecting of fast profit “drain” resources of developing countries and do not contribute to long run development

New growth Theory

It was developed by Paul Romer of Stanford University in 1980s (2018 Nobel prize). The theory was based on ideas of Joseph Schumpeter from 1930s.

• New growth theory builds on neoclassical theory by examining more closely the role of technology and the factors that influence technological advances.

​

• New growth theory holds that real GDP per person grows because of choices that people make in the pursuit of profit and that growth can persist indefinitely. It is known as “ Perpetual Motion Economy”

​

​

​

“ Perpetual Motion Economy”

New growth Theory

• The main idea – the new technology is not determined by chance, but by demand from people, who are looking for inventions.
• The profit is advantage for technological change, but not the requirement.
• The main driving force

is knowledge.

​

Free resources and endless growth:

• Discoveries are (at least eventually) a public capital good (i.e. free resources involved)
• Knowledge is a capital that is not the subject to diminishing marginal returns
• Public good means that no one can be excluded from using this good and one individual does not reduce availability to others. This is in contrast to a common good which is non-excludable but is subject of compete to a certain degree. Examples - knowledge, official statistics, national security, common language(s), flood control systems, lighthouses, street lighting…
• diminishing marginal returns means that knowledge do not lead to limitations of profit
• Labor productivity grows indefinitely as people discover new technology - both labor and machines more productive.
• The growth rate depends only on people’s motivations and ability to innovate = People are the ultimate economic resource

All three theories seemed correct at the time.

Each teaches us something to value:

​

• Classical theory – physical resources are limited and without advances in technology economic growth will stop
• Neoclassical – reminds, that growth is impossible only with accumulating the physical capital. We must invest in human capital and be more creative in using scarce resources.
• New – emphases the capacity of human resources. This theory fits the facts today’s world.

​

​

Estonia

agricultural land: 22.2%

forest: 52.1%

​

positive net export 4% (only country in EU)

national debt 6% (US 108%, Japan 236%)

unemployment 6.1%

inflation 12.01% (Turkey 69.97%, US 8.3%., EU 8.1%)

​

Poverty rate 21.70%

Less than $1.90/day 0.50%

Less than $3.2/day 0.80%

less than $10/day 2.9% (US 2.75%)

Countries that rely on their natural resources for economic growth underperform compared to countries that rely on human resources.

Population 1,211,596 (2022)

Density 79.3/sq mi (148th)

GDP (PPP) per capita $44,778 (39th)

A member of the European Union

GDP Labor force

by sector of origin by occupation

​

​

agriculture: 2.8% agriculture: 2.7%

industry: 29.2% industry: 20.5%

services: 68.1% services: 76.8%

Estonia has consistently ranked highly in international rankings for quality of life, education, press freedom, equality and the prevalence of technology companies.

Policies for Achieving Faster Growth

Growth accounting tell us that to achieve faster economic growth we must either:

increase the growth rate of capital per hour of labor or

increase the pace of technological change.

​

The standard suggestions for achieving these objectives are:

Stimulate Saving and Accumulation the Capital

• Saving finances investment. So higher saving rates might increase physical capital growth.
• Tax incentives might be provided to boost saving.
• However this measures are meaningless with high inflation and lack of legal infrastructure – usual features in poor countries
• Provide International financial Aid to Developing Countries shows zero or a negative effect: investment and growth indicate no increase.

1

Policies for Achieving Faster Growth

• capital accumulation and technological change redistribute the demand for the labor. It increases the demand for both types of labor—high skill and complementary labor.
• Steady income eventually will lead to capital accumulation, and demand for technological innovations – to supply of local inventions and new products
• People must acquire more skills—some people learn to work with the new capital, some learn how to maintain it in good condition, some learn how to build it, some learn how to market and sell it, some learn to design new ways of using it, some work on thinking up new goods and services to produce with it, and so on.
• So all these people are more productive that they were before.

​

​

Policies for Achieving Faster Growth

Stimulate Research and Development

• Because the fruits of basic research and development efforts can be used by everyone, not all the benefit of a discovery falls to the initial discoverer.
• So the market might allocate too few resources to research and development.
• Government subsidies and direct funding might stimulate basic research and development – this is most modern way of “Government intervention”

New technologies that create new products have even more obvious effects on productivity. The development of the CD in the early 1980s is a good example:

Suddenly thousands of people became very productive converting the heritage of recorded music into digital format, cleaning up the sound, and making and selling millions of CDs. The same type of thing is now happening with the DVD and Blu-ray.

2

Policies for Achieving Faster Growth

Improve the Quality of Education

The benefits from education spread beyond the person being educated, so there is a tendency to under invest in education.

Encourage International Trade

Free international trade stimulates growth by extracting all the available gains from specialization and trade (quantity and quality).

The fastest growing nations are the ones with the fastest growing exports and imports.

3

4

International trade is important:

• International trade allows countries to participate in a global economy, encouraging the opportunity of foreign direct investment (FDI), which is the amount of money that individuals invest into foreign companies and other assets.
• In theory, economies can, therefore,
• grow more efficiently and can more easily become competitive economic participants.
• These raise employment levels, lead to a growth in the gross domestic product.
• For the investor, FDI offers company expansion and growth, which means higher profits.

International trade is important:

• Global trade allows wealthy countries to use their resources—whether labor, technology or capital— more efficiently.
• Global trade allows poor countries to increase the demand on their products and decrease unemployment
• Relocation of high technology manufacturing in developing countries improve the working skills of local labor force and expands markets for secondary employment (services and supplies)
• Because countries are endowed with different assets and natural resources (land, labor, capital and technology), some countries may produce the same good more efficiently and therefore sell it more cheaply than other countries.
• If a country cannot efficiently produce an item, it can obtain the item by trading with another country that can. This is known as specialization in international trade.

​

​

​

However:

What happens when a country counts on economic development of a specific sector of industry – narrow economic specialization?

In economics, the apparent causal relationship between the increase in the economic development of a specific sector (for example natural resources) and a decline in other sectors (like the manufacturing sector or agriculture) is known as the Dutch disease.

The term was used in 1977 by The Economist to describe the decline of the manufacturing sector in the Netherlands after the discovery of the large Groningen natural gas field in 1959.

​

Dutch disease (3.5min)

The explanation for why some countries with natural resources see their economies weaken and jobs disappear.

Dutch disease - what happens?

When one specific sector is growing, its revenues increase, the nation's currency becomes stronger (compared to currencies of other nations).

At the same time the nation's other exports becoming more expensive for other countries to buy, and imports becoming cheaper, making those sectors less competitive.

​

While it most often refers to natural resource discovery, it can also refer to "any development that results in a large inflow of foreign currency, including a sharp surge in natural resource prices, foreign assistance, and foreign direct investment".

Christine Ebrahim-Zadeh, (March 2003), Back to Basics – Dutch Disease: Too much wealth managed unwisely. Finance and Development, IMF.

Conclusions

Resources are the central topic of macroeconomic analysis, however their availability does not guarantee the steady and successful development of:

• human resources, such as labor and management,
• natural resources, such as land and minerals,
• financial resources
• capital goods
• technology
• Developing countries could count not only on spill over from rich economies, but by demanding new inventions take equal part in global development
• The low growth rates in developing countries can be explained by people's lack of motivation and the necessary knowledge to innovate.
• Economic resources will work properly only with an appropriate system of policy. The creation and operation of an effective policy system requires significant economic resources…