Development Economics - An Overview

ForthcominginC.B.Barrett,ed.
,DevelopmentEconomics:CriticalConceptsinDevelopmentStudies 4volumes(London:Routledge,2007)
DevelopmentEconomics:AnOverview
ChristopherB.Barrett
I. UnderstandingHumanWellbeing:AnIntegrativePerspective
WhenRoutledgeinvitedmetoassembleafourvolumecollectiontorepresentthe bestofdevelopmenteconomics,Iknewitwouldbeastimulatingbutdaunting challenge.Afirstcutatenumeratingtheessentialreadingsinthefieldyieldeda monstroustomeofnearly5000pages,morethanthreetimeswhatmyeditorwould permit.Thewiderangeofexcellentworkbysomanytalentedscholarsimmediately necessitatedhardthematicchoicesinordertoestablishappropriate,ifinherently arbitrary,boundariesforthisproject.Muchimportantworkwouldneedtobeleftout inordertotellthestoryofdevelopmenteconomicscompactlyandcoherently. Withitsfocusonunderstandinghowresourceallocation,humanbehavior, institutionalarrangementsandprivateandpublicpolicyjointlyinfluencetheevolution ofthehumancondition,developmenteconomicsisarguablytheoriginalandmost fundamentalfieldwithinthedisciplineofeconomics,atleastasitrelatestothesocial sciencesandhumanitiesmorebroadly.AstheopeningsentenceofT.W.Schultzs1979 NobelPrizelecturedeclared,Mostofthepeopleintheworldarepoor,soifweknew theeconomicsofbeingpoor,wewouldknowmuchoftheeconomicsthatreally matters.(Schultz1980,p.639)Ultimately,virtuallyallimportantworkindevelopment economicsfocusesonimprovingourknowledgeofbeingorbecomingpoorand, morehopefully,abouttheprocessesbywhichpeopleavoidorescapepovertyandenjoy improvedstandardsofliving.Suchworkrangesfromunderstandingthedecision makingprocesses,contractualandextracontractualarrangementswithinandamong householdsandfirmsthatleadtoinefficiency,exclusion,and/orvulnerability,to identifyingwhatdeterminestheemergenceanddiffusionofimprovedproduction technologiesandwhogainsfromnewtradingopportunities,toestablishingthewelfare costsassociatedwithdifferentsectoralormacropolicies,andthenatureofnational scaleeconomicgrowthanditsrelationshiptoinequality,tradeandsociopolitical institutions. Inthiscollection,Icanthereforereallyonlyscratchthesurface.Myobjectiveinthis collectionandespeciallyinthisintroductoryessayisthereforenottobecomprehensive, nortogodeepintothedetailsofthemanyfascinatingthreadsthatjointlymakeupthe richfabricofdevelopmenteconomics.Rather,theaimistointroducethebroadthemes ofdevelopmenteconomics,tofamiliarizethereaderwithcentralissuesandseminal
ForthcominginC.B.Barrett,ed.,DevelopmentEconomics:CriticalConceptsinDevelopmentStudies 4volumes(London:Routledge,2007)
findingsthathaveguidedthefieldsevolutionofthepasthalfcenturyorso,andtoflag anumberofkeyadditionalreadingsforthosewhowishtoplumbparticularsubtopics ingreaterdepth. Sowhatarethecorethemesofthefield?Developmenteconomicsresearch ultimatelydescribesandexploresthecausalreasonswhysomecountries,communities andpeoplearerichandothersarepoor.Whatstructuralfactorsdistinguishthe experienceofthosewhoenjoyhighand/orrisingstandardsoflivingfromthose enduringlowand/orstagnantconditions?Ofgreatestpracticalimportance,whatcan bedonetoreinforcetheexperienceoftheformersubpopulationandtorelievethe sufferingofthelatter? Thusfrontierresearchinthefieldhasalwaystakenplaceatmultiplescalesof analysis,fromthemicrorealmofindividuals,households,andfirms,throughthemeso rangeofcommunities,groups,networks,regionsandvillages,tothemacrolevelof nationstates,continentsandtheglobe.Thenaturalintegrationofthesescalespecific literaturesistoooftenoverlookedaswescholarsspecializeinourownniche.Yetthe complementarityisthere,justbeneaththesurfaceofthejournalsandmonographs. Hencethetwocorethemesaroundwhichthisvolumeisorganized:(i) understandingpatternsofhumanwellbeingand(ii)anintegrativeperspectivethat bridgesmicroeconomic,macroeconomicandtheoftignoredmiddlelevelormeso economicscalesofanalysis.Thepapersselectedforinclusionallultimatelyspeakto thefirstofthesethemes,sometimesquitedirectly,othertimesmoreindirectlyby,for example,tacklingcriticalintermediatetopicssuchasintersectorallinkagesorfinancial services.Thesecondthemeemergesmorefromtheallocationofspaceacrosstopics, especiallythededicationofonevolumeeachtomicro,mesoandmacrolevel phenomenaandtheexplicitincorporationofpapersthataddresssimilarissuesat differentscalesofanalysis.Themainissuethatreemergesateachlevelofanalysis concernsthedynamicsofhumanwellbeing,oftenreflectedingrowthinincome, wealthorotherwelfaremetrics,andthepossibilityofmultipledynamicequilibria, includingalowlevelequilibriummorepopularlyknownasapovertytrap.Such issuescanbestudiedatmultiplelevelsandcommonthemesandinterrelationships appearroutinely,asdiscussedbelow.1 Rapideconomicgrowthis,inhistoricalterms,arecentphenomenonconfinedtothe pastthreehundredyearsforlessthanonequarteroftheworldspopulation.Growing andseeminglypersistentgapsinprosperitybetweenrichandpoorpeoplewithinand betweencountriescontributestosociopoliticaltensions,affectspatternsofhuman pressureonthenaturalenvironment,andgenerallytouchesallfacetsofhuman
SeeBarrettandSwallow(2006)foramoredetailedconceptualdiscussionoftheinterrelationshipof povertytrapsacrossmicro,mesoandmacroscalesofanalysis.
existence.Understandingtheprocessofeconomicdevelopmentisthuscentraltomost researchineconomicsandthesocialsciencesmorebroadly.Developmenteconomics nonethelessemergedasadistinctfieldofanalytical,empiricalandinstitutionalresearch onlyinthepasthalfcenturyorso,withespeciallyrapidprogressinthepastgeneration. Anideationalrevolutionoccurredinthesocialsciencesinthe1970s.Ineconomics, thisrevolutionwaswagedbymonetaristsandbypublicchoiceandrational expectationstheoristsagainsttheKeynesianparadigmthathaddominatedthepost WorldWarIIworld.Theresultwasageneralreactionagainstgovernment interventionismandinfavoroffreemarketsandminimalistvariantsofneoclassical economicthought.Asaconsequence,developmentproblemscametobeseenlargelyas resultingfromanexcessofgovernmentinterferenceintheeconomy. Bythe1980s,developmentwasverymuchoutoffavorasasubdisciplinewithin economics.Throughoutthelatter1980sandearly1990s,manyconcurredwithLals (1983)assessmentthatdevelopmenteconomicsconstituteslittlemorethanafutilequest forqueerexceptionstotherulesofmainstreameconomics,andthatthefundamental fallacyofsuchpursuitswasbeliedbythecatastrophicfailureofstateplanned economies.Awidespreadassumptionexistedthatdevelopmentoughttobenothing morethantheextensionofneoclassicalorthodoxytolowandmiddleincome countries. Thingshavechanged.Amajorresurgenceisevidentindevelopmenteconomicsas manyleadingeconomistsandeconomicsdepartmentsaroundtheworldhavebegunto focusagainondevelopmentissuesoverthepastdecadeortwoandpremierscholarly recognitionNobelPrizes,JohnBatesClarkMedals,MacArthurgeniusawardsand thelikehasbeenbestowedoneminentscholarsworkingwithindevelopment economics.Thisreflectsanaturalreturntodevelopmenteconomicsproperplace withinthebroaderdiscipline. Bardhan(1993)pointsoutthatdevelopmenteconomicsrichhistoryhasproduced muchoflastingimportancetoeconomicsmorebroadly:efficiencywagetheory, dynamic(pecuniaryandtechnological)externalities,multipleequilibria,principalagent modeling;adverseselection;rentseekingandpoliticaleconomy;nonlinearpricing,etc. Tothatlistingonemightadd,fromthepastfifteenyearswork,intrahouseholdissues andthesocialeconomicsofidentityandnetworks.Todaymanymainstream economistsrediscoverdevelopmentmodelsandformalizethemwithgreatfanfare(e.g., mostendogenousgrowththeorythatexploitsnonconvexities,whichtracesitsoriginsto Young(1928)andRosensteinRodan(1943andchapter5)).Astheneoclassicalfantasy ofperfectmarketsandinformation,constantreturnstoscale,etc.crumblesinthe mainstreamjournals,neoclassicaltheoristshaveturnedbacktodevelopmenteconomics
applicationsandclaimedthemastheirown.Developmenteconomicshasthus influencedmainstreameconomicsandsocialsciencesinmultipleimportantways. Thisisbecauseatitscore,thedevelopmenteconomicsliteraturehasevincedaclear perceptionofboththestrengthsandtheweaknessesoforthodoxneoclassical economics,especiallyinitsstandardWalrasianformwithconstantreturnstoscale, perfectcompetition,completeandfrictionlessmarkets,perfectinformation,anonymous andoneoffexchange.ThewaveofinformationeconomicslaunchedbyStiglitz, Akerlofandotherslargelyfromwithindevelopmenteconomicshaspermeatedthe wholeofthediscipline.Historically,developmenteconomistshavedaredtostrayfrom thewellworngroovesofmainstreameconomics,withoutrejectingthetoolsofrational choicetheory.Hencetheoccasionalmarginalizationthatoftencomeswithcreativity, butalsothehighreturnstothebestworkinthefield. Developmenteconomicsisthedomainofthosewhowishtobeabletoexplainbetter thebehaviorofpoorindividualsandcommunitiesinorderthatusefulpredictionsand prescriptionsmightbefeasible.Developmenteconomistsdogoodpositiveanalysisnot becausethatistheendofgoodeconomicanalysis,butbecausethatisthestart,the foundationfromwhichonecanofferrigorous,defensibleprescriptiveanalysesinan efforttoimprovethehumancondition. Stiglitz(1989,p.19)makesanespeciallyaptofdefenseofdevelopmenteconomics, likeningittomainstreameconomicsaspathologyistomedicine;[t]hedifferenceis thatineconomics,pathologyistherule:lessthanaquarterofmankindlivesinthe developedeconomies.Indeed,Stiglitzseesinthestudyofdevelopingeconomiesthe keytomorefundamentalunderstandingsofthewayeconomieswork(anddonot work).AnotherNobelLaureate,AmartyaSen(1988,p.11),emphasizedthat developmenteconomicsmustbeconcernedwithkeepingalivethefoundational motivationofthesubjectofeconomicsingeneral. Thisfourvolumecollectionofseminalpapersindevelopmenteconomicscaptures muchofthespiritofSensinjunction.Thisfirstvolumeaimstopindownkeythemes, especiallyrelatedtopovertyandwelfaredynamics,theprincipaldriversoflongterm improvementinthehumanconditiontechnologicalchangeandmarketparticipation andtheworkhorseanalyticaltoolsofthefield:householdandintrahouseholdmodels. Thepapersthatfollowinvolume2provideareasonablythoroughrepresentationofthe evolutionandcurrentstateoftheartofthefieldofdevelopmentmicroeconomics, coveringresearchfocusedonindividual,householdandfirmlevelbehaviors(.The collectionthenmovesontoexploremesolevelinstitutionalphenomenaassociatedwith communitiesandmarkets(volume3).Theconcludingvolume4aggregatesstill further,turningtodevelopmentmacroeconomics,withitsemphasisonpatternsof aggregategrowth,trade,inequalityandpoliticaleconomy.Acrosssectionof
theoreticalandempiricalresearchisincludedineachvolumesoastoprovidean accuraterepresentationofthebreadthofthefieldofdevelopmenteconomics. Thepaperschosenforinclusioninthesefourvolumeshavebeenselectedbothfor theirclarityandfortheircomplementaritytotherestofthecollection,aswellasfor theirimpactonthinkingwithinthefield.Selectingamere1500pagesfromthevast developmenteconomicsliteraturewasadaunting,indeedhumblingtask.Space constraintsnecessitatedomittingseveralentirethreadsoftheliteraturee.g.,on industrialization,onforeigndirectinvestment,onenvironmentpovertylinks,on marketintegrationandspatialorintertemporalpricetransmission,onfertilityand populationissuesindevelopmentaswellasquiteafewtrulyseminalpaperson topicsincludedinthisset(e.g.,Young1928,Lewis1954,Stiglitz1974),althoughthecore findingsofthelatterpapersarereflectedinother(typicallymorecompact)papersin thiscollection.Severaloutstandingreviewpieceslikewisehadtobeomittedbecause theopportunitycostofincludingtheminwholewassimplytoohigh.Thisintroduction invokesthosepaperstosupplementexplanationofseminalpointsfromtheworks selectedforinclusionintheseforvolumes.Interestedreadersarestronglyencouraged toexploretheseother,keyomittedworksaswelliftheywishtodelvemoredeeplyinto particularsubliteraturesofinterest. II. Development,povertyandwelfaredynamics
A.Conceptsandmetricsofdevelopment Thenecessaryfirststepinintroducingthefieldofdevelopmenteconomicsisto definetheelusiveconceptofdevelopment.SenwonaNobelPrizeforhispath breakingeffortsinthistask.Chapter2thereforegivesSen(1988)thefirstwordinthis collection. Whatdoesdevelopmentmean?Mostpeoplewouldreadilyagreethatitrelatesto improvementinthehumancondition,tobetterstandardsofliving.Butthatmerely displacesthedefinitionalproblem.Howdoweknowifstandardsoflivingimprove? Economistsmostcommonlyusemeasuresofoutputandassociatedincomeor expendituresasmetrics.Theseflowmeasuresaresurelyrelatedtowellbeing,as virtuallyeveryonewouldprefermoreofsuchthingstoless,allelseheldconstant.But theinherentstochasticityandtransienceofflowmeasuresencouragesotheranalyststo focusonstockmeasureslooselyspeaking,assetsasamoredurablerepresentationof humanwellbeing.Capitalinitsmanyguisesfinancial,human,manufactured, natural,socialthusplaysaprominentroleinmuchofdevelopmenteconomics. Theproblemwithsuchstockorflowdefinitions,ofcourse,isthatincomes, expendituresandassetsallprivilegematerialconditionsandofferatimeboundviewof
thekindoflifepeoplelive.AsSen(1981,1985,1995)hassoeloquentlyarguedina seriesofseminalbooks,insofarasdevelopmentisconcernedwithhumansexperiencing abetterlife,thefocusoughttobeonthelengthandqualityofthatlife,oronthe entitlements,capabilitiesandfunctioningsofpersons.Chapter2developsthese concepts,theirphilosophicalfoundations,andtheirimplicationsformeasurementand analysisindevelopmenteconomics. Unfortunately,wehaveonlycrudeindicatorsavailabletorepresenttheseconcepts. Literacy,heathstatus,longevity,etc.allprovideimportantmetricsofwellbeing.But noneareinherentlysuperiortothetraditionaleconomicmeasuresofincomeorwealth. Indeed,inafictionalworldofcompleteandcompetitivemarkets,incomeflowsand/or assetstockswouldsufficetodescribewellbeingsincetheywouldfullydefinepeoples choicesetsandifallthingsworthwhileinlifeweretradable,thechoicesetwould describethefullsetofindividualscapabilities.Sincenosuchworldexists,however, ourusualwelfaremetricsincome,expendituresandassetsmaybethebestscalar measureofdevelopmentavailable,giventhereasonablystrongcorrelationwithmany othermetricsofinterest,buttheyarehighlyandunavoidablyimperfect. Thisissuereallycomestoaheadwhenwetrytocomeupwithpracticalstatisticsto describethehumancondition.Policymakersneedmeasuresbywhichtheycan evaluatewhetherornotprogressisbeingmade;arepeoplebetteroffnowthanbefore? Whoisdoingwellandwhoisnotdoingsowell? Thestandardmacroeconomicmeasure,grossdomesticproduct(GDP)orgross nationalproduct(GNP)commonlyinreal(i.e.,inflationadjusted),percapitaform isahandysummaryoftheaggregateactivityofaneconomy.Butasthesumofall outputorearningsinaneconomydividedbythepopulationinthecaseofpercapita measuresnationalaccountsmeasuresofferanobviouslyweakindicatorofthe experienceofindividuals,givenconsiderablecrosssectionalvariationinstandardsof living. Inparticular,developmenteconomiststypicallyconcernthemselvesprimarilywith thewellbeingofasocietyspoorermembers.Amassiveliteratureonpoverty measurementhasthereforeemergedovertheyears.LiptonandRavallion(1995)and Ravallion(1996)offersuperbsynthesesofthatliteratureasoftheearly1990s. Attheriskofgrosslyoversimplifyingacomplexliterature,therearethree fundamentalquestionsinpovertymeasurement.First,onemustdecideontherelevant metric;economiststypicallyrelyonincomeorconsumptionasameasureofones choiceset.Othermetricsexist:healthstatus,educationalattainment,politicalrights, etc.Thesemeasuresalltendtobecorrelated,thuscoarseaggregatemeasuresare typicallyroughlysimilaracrossmeasures,althoughthisrapidlybreaksdownthemore disaggregatedtheanalysisbecomes.Forthisreason,manydevelopmentscholarsand
policymakershavelongfavoredmultidimensionalrepresentationsofwellbeing.The UnitedNationsDevelopmentProgrammedevelopedandhasregularlyrevisedthe computationofaHumanDevelopmentIndex,reportedinitsannualflagship publication,theHumanDevelopmentReport,preciselytocapturethemultidimensional natureofwellbeing.Ofcourse,thateffort,likeallsuchendeavors,suffersfrom weaknessesassociatedwithanarbitraryweightingofdifferentmetrics. Therehasbeenprogress,however,inmultidimensionalrepresentationsofwell being.Duclos,SahnandYounger(2006,chapter4)reflectsthecurrentstateoftheart Extendingthedominanceapproachtopovertycomparisonsinitiallyadvancedby Atkinson(1987)andFosterandShorrocks(1988a,b),Duclosetal.developand demonstrateanempiricalmethodofmakingmultidimensionalpovertycomparisons. Theirmethodsarequitegeneral,allowingfordifferentdefinitionsofpovertybasedon alternativeaggregationproceduresacrossandwithinindividualdimensionsof measurement. Second,onemustestablishanappropriatepovertyline,aninherentlyarbitrarypoint atwhichoneseparatesthenonpoorfromthepoor.Thisisalongstandingpointof contention,formanyreasons.Thereisnouniversallyagreedthresholdatwhichquality oflifeisdeemedsatisfactory;individualheterogeneityissogreatthatevenwithina community,definingapovertylineisnaturallycontentious.Moreover,spatialand intertemporalvariationinpriceslimittheappropriatenessofanysinglepovertylineto allpeopleinallplacesandatalltimes.Othermajorconcernsincludetheunitsof measurement(doesonestudyindividualsorhouseholds,andifthelatter,howdoes oneaccountproperlyforpossiblescaleeconomieswithinhouseholds(Deaton1997)?), theperiodofaggregation(areweconcernedabouttemporaryorchronicpoverty,or both?),andthedifficultyofestablishinganabsolutemeasureofpoverty,giventhatthe socialdefinitionofwhatconstitutesmaterialnecessityforagoodlifevariesso markedlyacrossculturesandovertime.Theseimportantconcernsnotwithstanding, policymakersneedapovertyline,arbitraryasitmaybe.DatingatleasttoRowntrees (1910)andOrshankys(1965)workintheU.K.andU.S.,povertylineshavecommonly beenbased(ifonlyimplicitly)onestimatesofnutritionalrequirementsandsome multipleofthecostofamarketbasketyieldingthisminimumlevel,withthemultiple intendedtoreflectotherbasicneedsinsomecrude,fixedproportionssense. Thethirdfundamentalquestioninpovertymeasurementrevolvesaroundwhatone countsandhow.Areweinterestedinaheadcountofpeoplelivingbeneaththe povertyline,regardlessofhowcloseorfartheymightbefromthatline?Arewe interestedintheamountofmoneyitwouldtaketoclosethepovertygap,i.e.,tobring everypoorpersonuptothepovertyline?Doweprefertoplaceextraweight,forsocial ethicsreasons,onthepovertyofthepoorestmembersofsociety,sothatimprovingtheir
wellbeinggeneratesgreaterimprovementsinthepovertyindicatorpermonetaryunit transferredthanwouldequivalenttransferstolesspoorindividuals?Theansweris commonlyyestoalloftheabove,asdifferentquestionsaresalientindifferent contexts.Hencetheattractivenessoftheseminalclassofdecomposablepoverty measuresintroducedbyFoster,GreerandThorbecke(1984,chapter3).TheFGT povertymeasures,astheyhavecometobeknown,havebecomethegoldstandardin appliedpovertyanalysisworldwide,enablingdirectcomparisonofpovertyindicators overtimeandacrosscountriesusingsimilaraccountingmethods,albeitdependenton potentiallydifferentpovertylines,measuresofwellbeingandsamplingstrategies. Whilethefinerpointsofpovertymeasurementwillremaincontested,widespread agreementhasnonethelessbeenachievedwithrespecttohowtoidentifytheextentof povertyinagiveneconomyatapointintime.However,povertymeasurementis typicallystatic,offeringasnapshotofasocietyataparticularmomentintimerather thanamoredynamic,cinematicviewofhowindividualwellbeingevolvesovertime withinaparticularsociety.Advancesincollectionandanalysisoflongitudinalmicro leveldatacommonlyknownineconomicsaspaneldatahaveenabledincreased studyofthedynamicsofhumanwellbeing;seeBaulchandHoddinott(2000)orBarrett, CarterandLittle(2007)forrecentcollectionsofsuchwork.Theseemergingstudiesof microlevelwelfaredynamicscreateanaturalbridgeacrossscalesofanalysisin developmenteconomics,towhatisarguablythecentralthemeofdevelopment macroeconomics:growth(seechapters4851). B.Growth:BacktotheFuture Theultimateobjectiveofresearchoneconomicgrowthistoexplaincrosscountry differencesingrowthexperienceandtodeterminewhethersuchexplicabledifferences carryanyusefulimplicationsforraisingpoorcountriesstandardsoflivingtothoseof richernations.OnecanmakeacasethatYoung(1928)andRosensteinRodan(1943; chapter5)launcheddevelopmenteconomicsasweknowittoday.Drawingonand carefullyinvokingAlfredMarshallsdistinctionbetweeninternalandexternal economies,Youngintroducedtheanalyticsofgrowthbasedonincreasingreturns.This providedthecentralconceptsthatunderpintheseminalworksofwhatKrugman(1993) calledhighdevelopmenttheoryofthe1940sand1950s.Thebalancedgrowthmodel ofRosensteinRodan(1943),Myrdals(1957)circularandcumulativecausation, Nelson(1956)andLeibensteins(1957)lowlevelequilibriumtrap,Scitovskys(1954) externaleconomies,Nurkses(1952,1953)bigpushtheory,andlaterformalizations oftheseandrelatedstrandsofthegrowthliteraturereliedonthepecuniaryexternalities andinterfirmorintersectoralcomplementaritiestogenerategrowthprocesses characterizedbymultipleequilibria,morepopularlyknowntodayaspovertytraps.
Thisalsogaverisetomorecarefulattentionpaidtobackwardandforwardlinkages amongsectors,initiallyandeloquentlyexploredbyHirschman(1958)andexpanded uponbyothers,suchasJohnstonandMellor(1961;chapter45),whoemphasizedthe particularimportanceoftheagriculturalsectorduetoitsextraordinarylinkagesto othersectors. TheideasintroducedbyYoungandappliedtodevelopmentproblemsby RosensteinRodanandhissuccessorsfelldormantfordecades,however.Krugman (1993)arguesthatthehighdevelopmenttheoristsinabilityorunwillingnessto formalizetheirinsightsinmathematicalformhelpedenablethemoreprecise formulationsofSolow(1956)tooutcompetethem.Solowsmodel,basedonkey assumptionsofconstantreturnstoscale,competitiveequilibrium,exogenous technologicalchangeandnoexternalities,refinedandextendedthefamiliarHarrod Domarformulation.IntheHarrodDomarformulationthatdominatedanalysesof economicgrowththroughoutthe1940sand1950s,thecapitaloutputratiowasassumed fixedandgrowthratescouldbereadilymanipulatedbychangingsavingsrates.Solow endogenizedthecapitaloutputratio,lettingitvarynaturallywithpercapita availabilityofcapitalintheeconomyandtheresultingmarginalreturnstocapital undertheassumptionofdiminishingreturnstoanysinglefactorofproduction.The implicationoftheSolowgrowthmodelwerepowerful:accumulationofphysicalcapital thenaffectsnotthesteadystategrowthrateinaneconomy,onlythelevelofincome, andtechnologicalprogressbecameakey,exogenousdriverofgrowth.Solowsgrowth modeldominatedthefieldforover30years,eventhoughittreatedsavingsand technologicalprogressascompletelyexogenous. TheneoclassicalSolowmodelspredictionsofconvergentgrowthprocesseswere nonethelesshardtosquarewiththeempiricalevidencethatsuggestedinstead divergence,bigtime(Pritchett1997).EmpiricalresearchbyQuah(1996;chapter50), DurlaufandJohnson(1995;chapter51)andHansen(2000)developedmoreadvanced econometricmethodscapableofidentifyinghighordernonlinearitiesandthreshold effectsinmacrolevelgrowthprocesses.Thegrowingbodyofempiricalevidence againsttheconvergencehypothesisreinforcedadvancesinwhatcametobeknownas endogenousgrowththeory(Romer1986,1990,1993,Lucas1988,1993;seechapters48 and49).Thesemacromodelsofgrowth,likeleadingmicromodelsofpovertytraps (e.g.,Loury1981,Murphy,SchleiferandVishny1989,AzariadisandDrazen1990, BanerjeeandNewman1993,andGalorandZeira1993,MookherjeeandRay2000;see chapters6,52and53),revivedsomeoftheinternalandexternaleconomiesofscale, pecuniaryexternalitiesandcomplementaritiesnotionsoftheearlydevelopment theorists,butnowwiththemathematicalformalismrequiredofcontemporary economictheory.Theliteraturehasgonebacktothefutureinrediscoveringpowerful ideasthatlaydormantformanyyears.
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Theemergenceofdetailedmicrolevelpaneldatasetshassparkedarecentempirical literatureofmicrolevelstudiesofgrowth,manyofwhichfindsuggestiveevidenceof povertytrapsandthepersistenteffectsofshocksonthepoor(Dercon1998,2004, Lybbertetal.2004,Barrettetal.2007).2Thebasicideabehindtheserecentexplorations ofmicrolevelpovertytrapsisanalogoustothatinthemoremacroliterature:locally increasingreturnstoscalemaygeneratemultipleequilibriaandthwarttheabilityof initiallypoorhouseholdstocatchupandconvergewiththeirwealthierneighbors. CarterandBarrett(2006;chapter8)developthereasoningbehindsuchphenomena, discusstheempiricalevidence,andofferarelevantextensionofthefamiliarFoster GreerThorbeckeclassofpovertymeasurestothedynamicrealminthepresenceof potentialassetthresholdsassociatedwithpovertytraps. C.Inequalityandgrowth Oneclearimplicationoftheliteratureonmultipleequilibriaandpovertytrapsis thatdifferencesinlivingstandardsamonghouseholdswithinaneconomycangrow andpersist.Inequalitycanemergenaturallyfromgrowthprocesses.Kuznets(1955)first calledattentiontotheprospectiverelationbetweeneconomicgrowthandinequality, hypothesizingthateconomiesbeginpoorandrelativelyequalasmostmemberssubsist throughcropandlivestockagriculture.Then,asindividualsbegintosaveand diversifyoutofagriculture,bothinequalityandaverageincomesincreasenaturally. Overtime,sectorswithhigheraveragelevelsofincomeattractmoreandmorepeople fromsectorsofferingloweraverageincomes,slowingtherateofincomegrowth hintingatSolowsconvergencehypothesisandreducinginequalitywithinthe population.Plottinginequalityontheyaxisandincomeoroutputonthexaxisofan admittedlyspeculativeempiricalinvestigation,Kuznetscameupwithwhathasever sincebeenknownashisinvertedU.3
Insomecases,theseprocessesappearspecifictodistinctregions,givingrisetoconcernsabout geographicpovertytraps(JalanandRavallion2002).
Thisbasicpatternhassubsequentlybeenextendedtoanalysisofotherhypothesizedrelationshipswith thesameinvertedUrelationtoeconomicgrowth.Forexample,aburgeoningliteratureonthe environmentalKuznetscurveexploresthepossibilitythatmeasuresofdegradationofthenatural environmentincreaseinitiallyassocietiesevolvefrompoor,agrarianeconomiesintoindustrializedones, andthenmeasuresofenvironmentaldegradationdecreaseagainasincomescontinuetoriseasimproved industrialtechnologiesgeneratecleanermanufacturingprocessesandthetransitiontopostindustrial servicestakesplace(Dasguptaetal.2002).ThecoreKuznetshypothesis,thatsomeundesirable phenomenahaveanonmonotonicrelationtoincomessuchthatthingsmustfirstgetworseinthecourse ofeconomicgrowthbeforetheygetbetter,hashadwiderangingimpact.

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TheempiricalliteraturetestingforKuznetsinvertedUhasgenerallyrefutedthat hypothesis,4althoughmanyofthecoreideascontinuetotantalizedevelopment economists.Inadditiontothesortofwealthandsavingseffectsoriginallyhypothesized byKuznets,thesubsequentliteraturehasaddedapoliticaleconomyexplanationfora relationbetweeneconomicgrowthandinequality.Thecoreideaisthatinequality fosterspressuresforredistributionthatretardgrowthbecause(i)taxationtoeffect redistributionofassetsnecessarilycreatesinefficiencies,and(ii)thecostlypolitical competitionoverthescopeandtermsofanyredistributiondivertscarceresourceto directlyunproductiverentseekingactivities(PerssonandTabellini1991,Alesinaand Rodrik1994;chapter54).Theseeffects,likethewealtheffectsarguments,implya negativeandfundamentallynonlinearrelationbetweeninequalityandgrowthand makeempiricalidentificationofanysuchrelationchallenging,asBanerjeeandDuflo (2003;chapter55)explain.Hencethequitemixedempiricalevidenceonthispoint. D.Investmentinhumancapital Improvementsineducation,healthandnutritionareimportantforintrinsicreasons assourceofpleasuretoindividualsaswellasinstrumentalonesduetopotential effectsonfuturelaborproductivityandearnings.Theseareamongthebestindicators ofwellbeing,reflectingquitedirectlyonindividualslivingconditionsandcapabilities. Hencedevelopmenteconomistslongstandinginterestintrackingchangesin educationalattainment,healthandnutritionalstatusandinincorporatingthesein multidimensionalpovertymeasures,asexemplifiedbyDuclosetal.(2006;chapter4). Alongstandingempiricalissueofbroadinteresttodevelopmenteconomistsishow changesinincomeorexpendituresaffectfoodconsumptionpatterns,humannutrition, and,derivatively,humanhealthandwellbeing.Acentraldebaterevolvesaround Engelcurves,whichdescribetheexpansionpathforgoodswithrespecttoincome.If Engelcurvesfornutrientsandhealtharereasonablysteep,meaningthatfood consumption,nutrientintake,andhumanhealthrespondreasonablystronglyto increasesinincomeatleastamongvulnerablesubpopulations,ifnotamongthe populationasawholethenincomegrowthcanbroadlyachievenonwelfaristgoalsof improvedhumannutritionandhealth.Bycontrast,iffoodconsumption,nutrient intake,andhumanhealthrespondweaklyornotatalltoincome,thengrowthbased developmentstrategiesareunlikelytobeespeciallyeffectiveinadvancingnutritional andhealthobjectives.Structuralinterventions(e.g.,cleanwater,solidwastedisposal, primaryhealthcare,education,credit,marketaccessinfrastructure)maythenbemore effectiveinterventionsifonewishestoimprovethephysicalwellbeingofpoorpersons.
SeeFields(2001)foranexcellentsummaryoftherelevantliterature.
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Sothedebateaboutincomeelasticitiesoffoodandnutrientdemandisfairlycentralto thequestionofhowbesttoadvancephysicalwellbeinginthedevelopingworld. EngelsLawpositsthatfoodisanormalgood,butanecessity,i.e.,foodhasan incomeorexpenditureelasticityofdemandbetweenzeroandone.Thepoorspenda muchlargershareoftheirincomeonfoodthandowealthierpersons.Thisbasicfact suggeststhatincomeelasticitiesofdemandarelow.Butthedropinbudgetshares appearsrelativelynonlinearinthedata(SubramanianandDeaton1996;chapter23). Thatisprobablygoodnews,inthatifwehopethatincomegrowthwillcontribute significantlytothereductionofhunger,foodinsecurityandpoorhealthamongthe poor,thenwewouldhopethatthemarginalpropensitytoconsumefoodandmore specifically,nutrientsoutofincomeisreasonablyhighamongthepoor. Publishedincomeelasticitiesforfood/nutrientsrangeessentiallyfromzerotoone. Thereisalongstandingassumptionwithreasonableempiricalsupportthatthe elasticityfallswithincomeorwealth,butthattheelasticityissufficientlyhighsoasto makeincomegrowthasufficientconditionforimprovednutrition.Overthepast twentyyears,however,theincomenutritionrelationhasbeensubjecttoheated reevaluationasseveralstudieshavefoundmuchlowerincomeelasticitiesofnutrient intakethandidearlierresearch.BehrmanandDeolalikar(1987;chapter22)andBouis andHaddad(1992)areoftcitedexamplesofstudiesthatfindincomeelasticities strikinglyclosetoorstatisticallyinsignificantlydifferentfromzero.Others,suchas SubramanianandDeaton(1996;chapter23)findhigherincomeelasticities,especially amongthepoor.Thefindingofalowincomeelasticityoffoodconsumptionornutrient intakesendsthemessagetopolicymakerswithnonwelfaristobjectivesthatincome growthisapoormeansofimprovingnutritionandhealth.Theprovisionofbasicneeds thenseemstoholdmoreappealthandoesstimulusofincomegrowth.Evenmore fundamentally,ifthestrengthoftherelationshipbetweenincomegrowthandother indicatorsofwellbeing(e.g.,nutritionalstatus)isweak,thatcallsintoquestionthe appropriatenessofincomeandwealthmetricsofdevelopment,onwhichtheeconomics disciplineleansheavily.Sothisisnotjustanarcanedebateaboutasinglepoint estimate(orseriesofpointestimates).Rather,theliteratureontherelationbetween incomeorexpenditureandfoodconsumptionandnutritionisfundamentalto developmenteconomics,asmetaphorasmuchasforthetopicoffoodconsumption itself. Sincehumanhealthandnutritionareinherentlydynamic,itmakessensetotryto explorethedynamicsoffoodconsumptionsrelationshiptohealthandincome.Inthe standardlifecyclemodel,withthesubjectivediscountrateequaltotheprevailing interestrate,consumptioneachperiodsimplyequalspermanentincome.So consumptiononlyvariesacrossperiodsinsofarastherearenonstationaryshocksto
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incomeorhealthstatus,orthereexistmarketimperfectionsthatlimitindividuals abilitytosave,borroworinsure.Thenthepermanentincomehypothesisfails.Health irreversibilitiescreateanincentivetoshiftincometowardscurrentconsumptionsoasto increasetheprobabilityofavoidingthresholdsbelowwhichpermanentimpairment becomeslikely,whileliquidityconstraintsmaycausehouseholdstoexperience unwantedvolatilityinconsumptionifincomeisstochasticordeterministically fluctuating(i.e.,varieswithcertaintyacrosstime,perhapsduetotheseasonalityof agriculturalproduction).Addtothisthefactthatthemarginalphysicalproductivityof nutrientintakemaynotbeequalacrosstimeduetoseasonalityinworkeffortor diseaseincidenceandwehaveyetmorereasontodoubttheintertemporalconstancy offoodconsumptionbehavior. Behrmanetal.(1997;chapter24)explorethedynamicsofthenutrientintakeincome relationusingpaneldataonPakistanifarmhouseholds.Theyfindthattheincome elasticityofcalorieavailabilitydependsimportantlyonthetimingandanticipationof income.Duringtheplantingperiod,foodpricesandinterestratesarehigh,making caloriesexpensive;moreover,calorieintakealsoaffectsfarmprofitabilitybecausepre harvestlaborproductivityisnotdirectlyobservableandthusissubjecttomoralhazard. Forthesereasons,incomeearnedduringtheleanseasoncanhavearelativelystrong effectoncalorieconsumption.Bycontrast,harveststageincomehasatbestasmall effectonconsumptionwhenfoodisrelativelyplentifulandlabormarketimperfections areabsentbecauseproductivityisdirectlyobservable.Thesefindingsareconsistent withthebeliefthatnutrientintakeaffectshealthstatusandthereforelaborproductivity andincome,aswellaswiththerelatedbeliefthatsucheffectsarenotuniformacross seasons,yearsorhouseholds,thusbothcrosssectionalandperiodicintraandinter annualvariationaretobeexpected.TheBehrmanetal.paperunderscoresthat interventionsimpactsmaydependontheirtiming:forexample,providingincome supportinleanperiodsinordertoimprovechildhealthandnutritioniftheincome elasticityofnutrientavailabilityishighestatthattime. Thereisaseconddimensioninwhichhumancapitalreflectedineducation,health andnutritionhaslonginteresteddevelopmenteconomists.Becauseindividualslabor powerbothphysicalandcreativeisakeyproductiveassetinalleconomies,and oftentheprimaryoronlyproductiveassetheldbythepoorestmembersinasociety,the studyofhumancapitalaccumulationalsobecomescentralforinstrumentalreasons, duetotheroleitplaysinexplainingpovertyandgrowthpatterns.Endogenousgrowth theory(e.g.,Lucas1993;chapter48;Ljungqvist1993)andmodernmodelsofpoverty traps(e.g.,BanerjeeandNewman1993,chapter6;Dasgupta1997,chapter7)especially emphasizethecentralroleofhumancapitalformationingivingrisetomultiple equilibria.
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Onekeythreadofthisliteraturefocusesontheselfreinforcingeffectsoflowinitial humancapital.Theparadigmaticexampleisthenutritionalpovertytrappositedat leastsinceLeibenstein(1957)butperhapsmostelegantlydevelopedbyDasgupta(1997; chapter7),includingincollaborationwithRay(DasguptaandRay1986,1987).The coreideaisreasonablysimple.Giventhesignificantminimumenergy(andother nutrient)requirementsforapurelyrestingmetabolism,anonconvexityisintroduced intheproductionfunctionforhumanlaborpower;theenergypeoplehaveavailablefor workisanincreasingfunctionofintakeonlyafterclearingthatminimumthreshold. Theresultinglocallyincreasingreturnstonutrientintakecreatemultipleequilibria.In oneequilibrium,littleornoenergyisexpendedbyanunemployedworkerunableto affordthenutrientsnecessarytowork.Intheother,higherlevelequilibrium,labor earningspayforfoodenoughtoreproducetheworkerslaborpower.Whilethese modelscanbeandoftenhavebeeninterpretedtooliterally,theyareinstructive aboutthecomplexdynamicrelationshipbetweennutritionandproductivity.One particularmanifestationofanutritionalpovertytrapcanarisethroughinvoluntary unemploymentassociatedwithanutritionalefficiencywage,althoughthisisnotthe onlyfeasiblemeans.Dynastictransmissionfromundernourishedandpoorly compensatedadultstotheirchildrencanperpetuatethecycle,muchasloweducational attainmentandresultinglow,unskilledearningsamongparentscancausechildrento fallintodynasticpovertytraps(Loury1981). Thenutritionalpovertytrapliteratureunderscoresthatillhealthisacauseaswellas aconsequenceofbeingandbecomingpoor.GertlerandGruber(2002;chapter25) similarlyfindthatmajorillnessescreatemajor,andlargelyuninsured,economicshocks forhouseholds.Conversely,asStraussandThomas(1999)reportinanexcellentsurvey article,arangeofstudiesindicatethatbetterhealthisassociatedwithimprovedlabor marketoutcomes,particularlyinlowincomesettings.Theexactcausalmechanisms underlyingtheseassociationsremainunclear,however,butseemtodependasmuchon behaviorsasonbiophysicalprocesses. Theimpactofnutritionandhealthonlabormarketreturnsalsoshedssomelighton oftobservedintrahouseholdinequalityofnutrientintakeandothermeasuresofwell being(HaddadandKanbur1990,chapter15).Incultureswherephysicallaboris commonandworkrolesaresharplydifferentiatedbyageandgender,themarginal impactsofnutrientintakeonhouseholdincomemayvarymarkedlyamonghousehold membersbasedonageandgender.Undersuchconditions,inequalityaversionwithin ahouseholdcanattenuateobservedintrahouseholdinequalityrelativetothe distributionofconsumptionthatwouldmaximizehouseholdincome(Pittetal.1990; chapter16).
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Theeffectsofhumancapitalonwellbeingrelatenotjusttoequilibriumbehavior withrespecttoallocationofeducation,healthandnutritiontoindividualsorhuman capitalsimpactonproductivityasafactorofproduction.Clearlyeducationandhealth areimportantasproductiveinputs,bothdirectlyandduetotheircomplementary effectsonotherinputs.5Buteducation(andexperience)playanunderappreciatedrole infacilitatingoutofequilibriumperformance,partlythroughlearningbydoingand fromothers(FosterandRosenzweig1995;chapter42;MoserandBarrett2006)butalso byfacilitatingmorerapidadaptationtodisequilibriacausedbytheemergenceofnew technologiesandmarketopportunitiesandbymacroeconomicshocks(Schultz1975; chapter26).Inspiteofsomesuggestiveevidence(e.g.,GlewweandHall1998,Barrett, SherlundandAdesina2006),improvingourunderstandingofeducationsdynamic effectsonabilitytodealwithshocks,bothpositiveandnegative,nonethelessremains anunderexplored,ifverypromisingareaofdevelopmenteconomicsresearch. III. Technologicalchangeandmarketparticipation A.Technologydevelopmentanddiffusion Therearethreewaysbywhichanindividualproducerorbyextension,an economycanexpandoutput:(i)increaseproductivitygivenexistinginputsand technologies,i.e.,increasingtechnicalefficiencybymovingclosertotherelevant productionpossibilityfrontier,(ii)increasetheinputs(e.g.,capital,labor,land)applied, holdingefficiencyandtechnologiesconstant,or(iii)orimprovetechnologies,i.e., expandingtheproductionfrontierwhileholdingtechnicalefficiencyandinputs constant.Wediscussthefirsttwooptionsbelow.Butthehistoricalevidencesuggests thatthemajordriveroflongruneconomicgrowthandimprovedlivingconditionsis technologicaladvance.Thisisthereforethefirsttopicofdiscussion. Itbordersonthetautologicaltosaythatlowincomecountriesaresaddledwith rudimentarytechnologies.Relativelyunproductivetechnologiesarebothcauseand consequenceoflowincomes.Thecontemporarymacroeconomicliteratureon developmentfocusesdisproportionatelyontechnologicalchangeasanengineof economicgrowthandthepossibilitiesforexternalitiesasasourceofendogenous growth.Elegantasthesemodelsmightbe,theyoftenlackacompellingmicroeconomic foundation,especiallyonethathasstrongempiricalsupport.Inparticular,theprocess oftechnologydevelopmentandadoptionisassumedtoberelativelyfrictionless.The microlevelliteratureontechnologyadoption,instarkcontrast,paintsapictureofslow, halting,andusuallyultimatelyincompleteadoptionofimprovedinputsorproduction processes.
SeeGlewwe(2002)foranexcellentsurveyarticleontheeconomicsofeducationindevelopingcountries.
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Thisraisesseveralkeyissuesthatpervadethedevelopmenteconomicsliterature: whyarentmoreproductivetechnologiessuitableforlowincomesettingsdeveloped andadoptedandwhatcanbedonetostimulateadoptionofexistingtechnologies?The developmenteconomicsliteraturehaspaidrelativelylittleattentiontoquestionsof technologydevelopment.Towardthatend,Ruttan(1997;chapter9)callsforthe developmentofamoregeneraltheoryofthesourcesoftechnicalchange.Themain theoryinuseistheinducedinnovationmodelofHayamiandRuttan(1971)and BinswangerandRuttan(1978).Undertheinducedinnovationhypothesis,technical innovationsareguidedbychangesinrelativeincentives.Asaninputbecomesdearer relativetoprospectivesubstituteinputs,thereisanincentivetodevelopatechnology thatmakesrelativelygreateruseofthecheaperinputandlessofthedearerone.The hypothesisofinducedinnovationsuggeststhatHicksbiasedtechnicalchangeis causallydrivenbychangesinrelativepricesthatinduceeitherprofitseeking innovationbyprivatefirmsorpoliticaldemandsforpublicresearchtorelieve increasinglybindingconstraints.Theempiricalevidenceontheinducedinnovation hypothesisissomewhatmixed,however,possiblyduetothestochasticnatureofmany discoveriesandthepathdependenceassociatedwithnonconvexitiesthatmaylockin evenarelativelyinefficienttechnologies(David1985,Arthur1994). Explainingpatternsofadoptionoftechnologiesalreadydevelopedisnolessserious achallengefordevelopmenteconomists.Muchoftheliteratureonthebarriersto technologyadoptiontracesdirectlybacktotheseminalworkofGriliches(1957),who studiedtheadoptionofhighyieldingcornvarietiesintheUnitedStates,theroleof researchinoutputgrowth,andtheroleofextensionandeducationinpromoting technologyadoptionandaggregateproductivitygrowth.Sincethattime,alarge literaturehasfocusedonunderstandingbetterwhowilladoptagiventechnology, especiallywhowilladoptfirst.Federetal.(1985;chapter10)offerastillclassic summaryoftheliteraturefromtheGreenRevolutionperiod.Notsurprisingly,early adopterswerefoundtobethosewiththemosttogain,thelowestcostaccesstothe technology,andthelowestevaluationcosts,includingtheleastuncertaintyaboutthe technology).Arecentresurgenceofinterestintechnologyadoptionquestionshas focusedanewonthedynamicsoftechnologydiffusion(BesleyandCase1993;chapter 11),particularlytoprocessesoflearningbydoingandlearningfromothers(Fosterand Rosenzweig1995;chapter42,alsoBandieraandRasul2006,MoserandBarrett2006). Theorderinwhichdifferentagentsadoptanewtechnologycanhavesignificant distributionalimplicationsandcanreinforcepreexistingpatternsofinequality,as Cochrane(1958)observedinpositingatechnologicaltreadmillinagriculture.The ideaissimplebutpowerful.Inasmallopeneconomyinwhichproducersface infinitelyelasticdemand,thesocialgainsfromanytechnologicalchangeaccrueentirely toproducersintheformofhigherprofits.Bycontrast,ifdemandisperfectlyinelastic,
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allthesocialgainsaccruetoconsumersintheformoflowerprices.Thedistributionof thegainsfromtechnicalchangethereforedependcruciallyonthepriceelasticityof demandfortheproduct.Sincemostagriculturalproductsexhibithighlyinelastic demand,whetherbecauseofphysiologicallimitstofoodconsumptionorbecause transactionscostscausefrictionsintradingwiththebroaderglobaleconomy,producers inaggregatetendtoloseinthelongrunfromtechnologicalchange.Producersadopt newtechnologiesbecausetheyreduceunitcosts,therebyincreasingproductivity;butin generalequilibrium,wheneveryoneadoptsthecostreducingtechnology,thisshiftsthe aggregatesupplycurvesuchthatpricesfalltoo,potentiallyleavingproducersworseoff thanbeforeifdemandissufficientlyinelastic. Thisrevealsanimportantfallacyofcomposition:whatiswelfareenhancingand optimalinthesmallmayprovewelfarereducinginthelarge.Forthisreason,thestate ofagriculturalmarketswhichdeterminethepriceelasticityofdemandfacedby producersandthedynamicsofadoptionarecentraltothedistributionaleffectsof technologyadoption.Earlyadoptersbenefit,atleasttemporarily,whilelateadopters andnonadoptersneverbenefitorevensufferwelfarelossesduetodiffusionof improvedtechnologies.Relatedly,becausethebenefitsfromagriculturaltechnology developmentaccrueinpart(often,largely)toconsumersintheformoflowerprices,it maybesociallyoptimaltopayfortechnologydevelopmentwithtaxrevenuespaidby consumers.Whenresearchanddevelopmentisprivateandintellectualpropertyrights protecttherightstoprofitfromaninnovation,firmscapturethiscostthroughroyalties andmonopolyrentsearnedfromconsumers.Butwhenresearchanddevelopmentis public,asforsmallholderproducersinlowincomeagriculture,themeansoffinancing technologydevelopmentcanbecometricky,especiallyifthedomestictaxbaseisthin andinternationalaidislimited.Sothefutureoftechnologydevelopmentforlow incomeagricultureremainsaseriouschallenge. Alongstandingdebatehasrevolvedaroundtherelativeimportanceoftechnology developmenttoexpandtheproductionpossibilityfrontierforpoorfarmers,versus improvingproductivitywithintheexistingproductionfrontier.Widespreadevidence intheliteratureoftechnicalinefficiencyamongsmallfarmershasoftenfuelled argumentsthatinvestmentinnewtechnologiesmightnotbeasvaluableasinvestment inextensionservicestoincreaseadoptionandimprovetheuseofexistingtechnologies.6 ThisclaimisatoddswithSchultzs(1964)famouspoorbutefficienthypothesis, whicharguesthatsmallfarmersarehighlyefficientinusingwellestablished technologies.Whattheymostneedareimprovedtechnologies,inordertoproduce morefromthesamestockoflandandlabor,andthehumancapitalnecessaryto
SeeAliandByerlee(1991)foragoodreviewoftherelevantliteratureandBarrett(1997)foracritiqueof muchofthatliterature.
6
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facilitaterapiduptakeofnewtechnologies.Indeed,themorerecentliteratureon smallholderefficiencylargelyreinforcesSchultz.AsSherlundetal.(2002;chapter34) note,productiondecisionsaremadeinanenvironmentwherecrucialinputsare stochasticandbeyondtheproducerscontrol.Thusfailuretoaccountforcross sectionalorintertemporalvariationinexogenousproductioninputs(e.g.,rainfall,plant disease,plotslope,soilfertility)implicitlypitsallproducersagainsttheonewiththe luckiestdrawfromnatureandleadstoupwardbiasinestimatesoftechnical inefficiency. B.Marketparticipation,intersectoralandinternationallinkages Iftechnologicalprogressisonekeyengineofgrowth,specializationaccordingto comparativeadvantagesoastoreapgainsfromtradeisanother.Goingbackatleastto AdamSmithandDavidRicardo,thewelfaregainsfromopennesstotradehavebeena stapleofeconomicreasoning,eveniftheyareonlyoneoff,transitionalgains. Developmentmacroeconomistshavedevotedconsiderableefforttotheorizingabout andempiricallyinvestigatingthisrelation,especiallythedynamiceffectsoftradeon growthandpoverty.Especiallywithincreasedglobalizationinrecentdecadesdueto improvedcommunications,informationandtransporttechnologiesthathaveshrunk thecostsofcommerceinternationallybutalsodomesticallytheimpactofincreased economicintegrationonpovertyandgrowthhavebecomecentralresearchquestions again. DollarandKraay(2004;chapter58)offerperhapsthemostwellknownrecent empiricalstudy,showingthatdevelopingcountriesthathavecuttariffratesand substantiallyincreasedtradevolumesenjoyedacceleratinggrowthratesandstable incomeinequality,thusincreasedincomesforpoorhouseholds,onaverage.Induced totalfactorproductivitygrowthseemsakeymechanismforgeneratingthese apparentlysalutaryeffectsoftradeonpovertyandgrowth(Edwards,1998;chapter57). Productivitygrowthmightemergelessthroughconventional,Ricardianmechanisms associatedwithfactorallocationthanthroughtheeffectinteractionamongdistinct communitieshasinhelpingclosetheideagapsthatcausepoorercountries,regions andhouseholdstolagbehind(Romer1993;chapter49). Theanalyticalsimilaritiesbetweentechnologyadoptionchoicesandmarket participationchoicesarestriking,althoughlargelyoverlooked.Ifatechnologyisquasi concaveandmonotone,thenexchangefitsthegeneralcharacteristicofatechnology.To seethisassumeanagentcanproduceaconsumptiongood,y,fromsomemixofinputs x,describedbyawellbehavedproductionfunctionf(.)suchthat,y=f(x).Alternatively, ifsheiswillingtoincurfixedcostsofmarketaccess,fc,shecanpurchaseanynumberof unitsofyforaunitpriceofpandcansellforaunitpriceqanynumberofunitsof
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anothergood,z,thatshecanproduceusingadifferenttechnologybutthesameinputs, z=g(x).Theremayalsobeaproportionalvariablecostperunitsold,vc,akintoanad valoremtariff.Theproductionfunctiong(x)likewisesatisfiesthestandardquasi concavityandmonotonicitypropertiesofatechnology.Theneffectivelythisagenthas accesstotwodistincttechnologiesforproducingy:f(x)andfM(x)=(1vc)(q/p)g(x)fc. SincefM(x)isjustanaffinetransformofthemonotone,quasiconcaveg(x),bothf(x)and fM(x)havethesamebasicquasiconcavityandmonotonicityproperties.Sothechoiceof whethertoproduceagoodortopurchaseitinthemarketisqualitativelyidenticalto thechoiceamongalternativeproductiontechnologiesforagood. Inboththetechnologyadoptionandmarketparticipationcases,fixedcostsplayan importantrole,mirroringtheirimportancetomoregeneraltheoriesofimperfect competitionandofmultipleequilibriaandpovertytraps.Romer(1994;chapter56) reintroducedthiscoreideaofnonconvexitiesintothediscussionofthewelfarecostsof tradepolicy.Hiscorepointisthatwhenoneallowsforgoodstoappearordisappear basedonachievingacriticalmarketmass,theefficiencylossesassociatedtrade distortionscanbecomequitelarge.ThispointbuildsonHirschmans(1958)ideaof backwardandforwardlinkages,whichlikewiserestfundamentallyonthenotionof pecuniaryexternalitieslinkedtoeconomiesofscale,andonwhatFleming(1955) referredtoasverticalexternaleconomiesassociatedwiththecosteffectsassociated withexpandedintermediategoodsproduction.Whenexpansionofanindustrydrives downinputpricesforadownstreamsectorwithwhichithasatradingrelationship,it cannotonlyhaveastandardmultipliereffect,inthepresenceoffixedandsunkcosts orothersourcesofnonconvexitiesitcanalsomakeemergenceofentiresectors suddenlyprofitable,leadingtoverylargesocialreturnstoinvestmentintheupstream sector.JohnstonandMellor(1961;chapter45)helpedmakethecaseformassive investmentsinimprovingagriculturaltechnologiesbyexplainingtheperhapsunique roleagriculturecanplayinstimulatingeconomicdevelopment.Haggbladeetal.(1991; chapter46)andanextensiverelatedliteraturedevelopedtheempiricalevidencein supportoftheJohnstonMellorhypothesis,carefullydocumentingextraordinarilyhigh growthmultipliersassociatedwithexpandingagriculturalsupplyandmarketsfor distributingagriculturalproductstointermediateprocessingindustries. Giventheapparentmassivestaticanddynamicgainsfromtrade,itmaytherefore seempuzzlingthatwhilefewnationsarefullydisengagedfrominternationalmarkets anylonger,therearenonethelessmanyhouseholdsthatoptoutofmarketexchangefor quitearangeofgoodsandservices.Theissueofmarketparticipationrevolvesaround thetensionbetweengainsfromspecializationandthecorrespondingincreasesin transactionscostsfromspecialization.Transactionscostsvarywitheconomicdistance fromtradingpoints,wherethisdistanceisdefinedoverspace,time,form,or expectations.Sofixedandvariablecostsareidiosyncratic.Theyarealsoendogenous
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becausepeopleknowexchangeiscostly,andchooseproductionandexchange strategiesrecognizingthattheyareimplicitlychoosingtransactionscosts,too.As Kranton(1996)emphasizes,thecostsofmarketparticipationarenotindependentofthe incidenceofpersonalized,reciprocalexchangeinsteadofmarketbasedexchange.That is,increasinglywidespreaduseofmarketexchangereducessearchcosts,inducing furthersubstitutionofmarketexchangeforreciprocal,nonmarkettransactions.The tensionbetweenthegainsfromspecializationandthecorrespondingincreasein transactionscostthatresultfromdependingmoreonthemarkettoprocureonesneeds helpsexplainwhysomefarmersforegoyieldincreasingtechnologiesandoptfor activitydiversificationnotforreasonsofselfinsurancebutratherbecauseofdemand forconsumptionvarietyinthefaceofcostlycommerce.Moregenerally,ignoringthat marketfailureisidiosyncraticandendogenouscanleadtomistakeninferenceaboutthe rationalityofsmallholderbehavior(deJanvryetal.1991,chapter14;Goetz1992,Keyet al.2000,chapter12;BellemareandBarrett2006).Formany,autarkicbehaviorisalow levelequilibrium. Thenatureofmarketsandmarketparticipationalsohasafundamentaleffectonthe basicmodelingmethodsusedbydevelopmentmicroeconomists.Whenmarketswork well,consumptionandproductiondecisionsareseparable(Singhetal.1986;chapter 13).Butwhenriskortransactionscostsofmarketparticipationdriveawedgebetween buyerandsellerprices,householdscanoptimallyselfselectoutofmarkets.Then consumptionandproductiondecisionsbecomenonseparable(deJanvryetal.1991; chapter14).Theaddedcomplexitiescausedbytreatingeverythingasendogenously determinednaturallygiverisetotestsoftheseparabilityhypothesistoseewhenone mightdefensiblyusesimpler,separablehouseholdmodelformulations(Benjamin 1993).TheproblemisthattheArrowDebreuseparabilityassumptionofcompleteand competitivemarketsseemsratherfarfetched,givenwhatthesocialscienceshave documentedaboutmarketsinlowincomesettingsgenerally. IV. Marketimperfections
Theprecedingdiscussionpointstoafewkeythemesthatemergerepeatedlyinthe literature.Thefirstistheimportanceofmultiplefactormarketfailuresininducing differentialreturnsacrosshouseholds.Whenasinglemarketfails,allothermarketscan adjusttoasinglefixedfactorofproductionwithoutcausingsystemicinefficiency.But whenmultiplemarketsfail,shadowpricesnecessarilybecomeidiosyncratic(i.e., householdspecific)andsooptimalinputuseintensityandconsequentlyproductivity willvaryacrossproductionunits,leadingtocrosssectionalvariationinincomes, expendituresandothermeasuresofwellbeing.Asecondkeythemeisthatimperfect informationandassociatedriskaccountformanyofthemarketfailuresobservedinthe
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developingworld.FollowingfromStiglitzspathbreakingwork,theeconomicsof imperfectinformationhaspermeatedallcornersofdevelopmenteconomicsoverthe pastquartercentury. Themanyobviousimperfectionsinlowincomeeconomiesmeanthatoneis necessarilyoperatinginthedomainofsecondbestbehaviorsandinstitutions,aworld ofmultipledistortions,theconsequencesofwhicharenotalwayseasytopredict. Gettinggovernmentpoliciesandfirmandhouseholdlevelbehaviorrightisofspecial importanceinthisenvironment;farmorethaninafictionalfirstbestworld.AsRomer (1994;chapter56)pointsout,policieshaveonlysecondorderwelfareeffectsinafirst bestworld,butfirstorderwelfareeffectsinasecondbestworld.Greenwaldand Stiglitz(1986)similarlyemphasizethattheconsequencesofminorinefficienciesbyone firmorhouseholdcancreatesignificantaggregatedistortionsinthebroadereconomy, givendistortionsintheunderlyingeconomyduetoincompletemarketsandimperfect information. AstheLucascritiquecautions,gettingpoliciesrightdemandsasolidunderstanding ofthemicroeconomicsofconsumerandproducerbehaviorandofthefunctioningof marketsandnonmarketinstitutions.Towardthatend,developmenteconomistshave spentanextraordinaryamountofenergyunderstandingpatternsofcontractingamong agents,especiallywithrespecttolandandlaborthekeyelementsofagricultural productionandwithrespecttofinancialservicescredit,insuranceandsavings essentialtomanagingresourceallocationovertimeandacrossstatesofnature. A.Agrariancontracts Oneoftheprincipalobstaclestoimprovingthewelfareofpoorruralpeopleinlow incomecountriesistheneedtoincreaseagriculturaloutputresultingfromthe applicationofexistinginputs.Thereisrelativelylittleecologicalcapacityfor agriculturalextensification,soataminimumyields(outputperunitareacultivated) mustincreasesignificantlyiffoodavailabilityistoincrease,anecessaryconditionfor appreciablereductionofhungerandfoodinsecurityinthemediumterm.Moreover, sincethepoorareendowedchieflywithlaborpowerandinthecaseoftheruralpoor, secondlywithlandimprovinglaborandlandproductivityiscentraltoanyeffective andsustainableruralpovertyalleviationstrategy.Soidentifyinghowbesttoachieve theseobjectivesnecessarilyinvolvesasolidunderstandingofcurrentproduction technologies,theirperformance,andtheeffectsandperformanceofrelatedfactorand productmarkets.Together,thesearetheingredientsthatdeterminetheproductivityof smallholderagriculture.
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Ithaslongbeennotedthatpartialortotalfactorproductivitymeasuresroutinely appearnonconstantinlowincomeagriculture.Typically,aninverserelationship existsbetweenyields(outputperunitareacultivated)orlaboruseperhectareandfarm size.Conversely,apositiverelationshiptypicallyexistsbetweencredituseorthe probabilityofmoderntechnologyadoptionandfarmsize,andinsomecircumstances theseeffectsseemtooverwhelmthelaboreffectstogenerateapositiverelationship betweenfarmsizeandyield(Kevane1996).Neoclassicaltheorytellsusthatfactor productivityshouldbeequalizedacrossproductionunitselsethehighmarginal productivityusershouldpurchaseorrentthefactorfromalowproductivityuserata mutuallyattractiveprice,therebygeneratinggreateraggregateoutputandwelfare.So theexistenceofarelationshipbetweenfarmproductivityandfarmsize,andespecially thetypicalinverserelationshipbetweenthetwovariables,hasattractedmuchattention asperhapsindicativeofkeymarketfailures. Thegenesisoftherelationshipbetweenfarmsizeandproductivityhasimportant practicalimplications.Forexample,ifsmallfarmsareinherentlymoreefficientina givensetting,thismakesastrongcaseforredistributivelandreformasasourceofboth equityandefficiencygains.Ifthesourceoftheproductivitygradientismarkets failures,thissuggeststhatthefundamentalwelfaretheoremsofneoclassicaleconomics donotholdinthesetting,socompetitivemarketsdonotnecessarilyyieldPareto optimaldistributions,providingatheoreticaljustificationforgovernmentinterventions intoruralmarkets.Conversely,iftheinverserelationshipispurelyastatisticalartifact attributabletotheomissionofhardtoobservevariables(e.g.,levelsofnutrientsinthe soil)andintruththereisnovariationinproductivityacrossfarmsizes,thentherural economydoesseemtofunctionaspredictedbyWalrasiantheoryandmarket interventionswillgenerallyproveinefficient.Soexplainingtheoftobservedinverse relationshipbetweenfarmsizeandproductivityhasbeenanimportantcottageindustry fordevelopmenteconomistsformanydecades. TheseminaltheoreticalexplanationofsizevaryingproductivityisduetoFeder (1985;chapter33).Heestablishesthatinthefaceofjustonemarketfailure(e.g.,for landorforlabor),productivityisinvarianttofarmsize.Themobilefactors(hiredlabor, land,capital)movetotheimmobilefactor(familylabor,inhismodel).Putdifferently, inaneoclassicalworldofalmostcomplete,perfectmarketswithconstantreturnsto scale,allvariableinputsandfixedfactorsareappliedinequalproportionsacrossfarms sotherecanbenoyielddifferences.Butwhenthereisasecondmarketfailure,then optimalfarmsizeandlaborapplicationrateswillingeneralvarywiththeamountof landowned.Ifcreditconstraintsdominate,thenlargerfarmerswillbemore productive,whileiflaborsupervisionconstraintsaremostlimiting,smallerfarmerswill
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enjoyhigheryields,leadingtoaninversefarmsizeproductivityrelationship.7Alarge literaturefindsstrongevidenceofbothcreditconstraintsandmoralhazard(e.g.,Foster andRosenzweig1994;chapter29). Marketimperfectionslikewiseaffecttheorganizationoftheagriculturalsector,the particularmannerinwhichland,labor,andotherinputscombineforproductive purposes.Whenmarketimperfectionsexist,individualscaneither(i)participateinthe market,adjustingbehaviortosuittheirspecificnetcostsorbenefits(shadowprices)of marketparticipation,(ii)optoutofthemarketandpracticeautarkicproduction,or(iii) contractdirectlywithacounterpartyratherthanundertakingasemiautonomousopen markettransaction.Theveryinformationfailuresandriskcharacteristicsthattypically bedevilmarketsalsomakecontractingcomplexandhighlyvariable.Indeed,itisthe variabilityofthecontractsoneobservesinlowincomeagriculturethatmakesthe subjectofagrariancontractssofascinatingandimportanttoasolidunderstandingof themicroeconomicsofdevelopment. Animportantunderlyingthemeindevelopmentmicroeconomicsisthatmarket imperfectionsofonesort(e.g.,inlabororinsurance)areoftentransmittedtoother, relatedmarkets(e.g.,forland).Thefundamentalinterrelationshipofvariousfactor marketsmeanstheinefficienciesinoneoftenaffectanotherandthatmeansofresolving problemsinonefactormarketoftenturnonarrangementsinvolvingoneormoreother factormarkets.Explicitinterlinkagesemergeandpersistnaturallyduetotheexistence oftransactionscosts,uninsuredriskandexogenousbarrierstofactormovements(Basu 1983;chapter30).Butevenwithoutexplicitinterlinkageamongcontractsaswhen creditandforwardcropsalescontractsarebundledtogethertoreducetherisksfaced bybothborrowerandlendermarketsaretypicallyimplicitlyinterlinkedby contractualarrangementsprevailinginmanylowincomeeconomies. Therearemultiplereasonsforthis.Oneisthatwhenonemarketisostensibly missing,residualdemandforandsupplyofthenonmarketedgoodorservicecanstill besatisfiedimplicitlythroughadjustmentstothetermsofexchangeinothermarkets. So,forexample,whenagovernmentdeclareslandmarketsillegalandenforcesa prohibitiononlandexchange,therearealternative(e.g.labormarket)mechanismsto accommodaterepresseddemandandsupplyforland.Distortionsarecommonly displacedintoothermarketswithinaneconomy. Anotherreasonisthattheanonymousandindependenttransactionsofthestandard Walrasianmodeldonotcapturetherepeatedandmultifacetedinteractionsof
Whenindividualsmakedecisionsnoncooperatively,multiplemarketfailurescanevenresultinintra householdproductivitygradients,providingstrongevidenceoftheallocativeinefficiencyresultingfrom marketimperfections(Udry1996;chapter17).

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individualslivinginruralcommunities.Iftherearefixedcoststoeachtransaction,it maybemoreefficienttobundleseveralexchangestogetheratoncethantonegotiate separatelyovereachfactorexchangedbetweenthesametwoparties.Theresulting, explicitlyinterlinkedcontractsnecessarilyenmeshmarketfailuresinonedomainwith equilibriumcontractualarrangementsinanother. Themaincontractualarrangementsstudiedbydevelopmenteconomistshave concernedsharecroppingandlabor.Inaworldofperfectinformation,completeand perfectlycompetitivemarketswithnouncertaintyandconstantreturnstoscale productiontechnologiesdefinedoverinputsoflandandlabor,itwouldmakeno differencewhetherlandownershiredlaborersorwhetherlaborersrentedinland. Wagelaborerswouldbepaidtheirmarginalrevenueproduct,withtheresidualoutput accruingtolandownersonaconstantperhectarebasis.Afixedrentalcontractyielding thesamerentperhectare(sothatthelandownerisindifferentbetweenrentingoutthe landorhiringinthelaborers)yieldstheequilibriumwagerateastheresidualpaidto thetenant,leavinghimorherindifferentaswellbetweenrentinginlandorhiringout theirlabor.Insuchafictional,perfectworld,thereshouldbenosharecropping, however,asitexplicitlycreatesanexternalitybymakingthelandownerabeneficiaryof thetenantsadditionallaboreffort,andisthereforesociallyinefficient. Inamorerealisticsettingwhereuncertaintyandimperfectmarkets(andperhaps nonconstantreturns)prevail,thealternativemeansofallocatingfactorsofproduction willnotbeequivalent,however.Indeedsharecroppingbecomescommonplacebecause itstrikesapotentiallyoptimalbalanceamongcompetingmarketimperfectionsdueto asymmetricinformationproblemsandincompletemarketsforriskorcreditasStiglitz (1974)famouslyshowed.ThesemissingmarketsresultinParetoinefficiencythathelps accountforsomeoftheobservedlowproductivityofagriculturallandsandworkersin lowincomeeconomies. Theheterogeneouspatterninbothcrosssectionandtimeseriesofobserved contractformshasdrawnmuchattentionfromdevelopmenteconomists.Otsukaetal. (1992)emphasizeagencytheoryasthemaindeviceneededtonesttogetherparallel theoriesoflaborcontracts,landcontracts,andtheubiquitousobservationthatowner cultivationdominatesallotherformsoforganizationinbothfrequencyand productivityterms.Therelativeefficiencyofdifferentcontractualformsandtheex antedistributionoflandownershiparethecriticalingredientsdeterminingprevailing agrarianinstitutionalarrangements.Agencytheoryhighlightsthetradeoffsinvolved betweenworker(dis)incentivesdueto,ontheonehand,asymmetricinformationand effortorqualityshirking(thelatterbeingattributabletocarelessnessinwork, regardlessofeffortlevel,thatcausesdamagetotheproduce),and,ontheotherhand, thelimitedriskbearingorborrowingcapacitiesofpoortenantsorincreasingreturnsto
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scaleinparticulartypesofagriculture(e.g.,mechanizedorexportorientedplantation agriculture). EswaranandKotwal(1985b,chapter31)offerperhapsthemostcompactandelegant modeltodateexplainingtheobservedheterogeneityofagrariancontracts.Intheir view,differentcontractsreflectdifferenttechniquesofcombiningnonmarketed productiveinputs.Theequilibriuminstitutionalarrangementsforagricultural productionarisefromtheoptimizingdecisionsofbothpartiestothecontract,theland ownerandthetenant/worker,givenprevailingtechnologies,marketconditions,etc.In thissetting,sharecroppingcanbeunderstoodastheoutcomewhenessential intermediateinputs(laborsupervisionandmanagerialabilityintheirmodel)arenon tradablebuteachpartytothecontractholdssufficientcomparativeadvantageinoneor theotherinputastomaketheircominglingthroughjointproductionoptimal.Ifthe inputscouldbefreelytradedonthemarket,sharecroppingwouldneverarise. Moreover,astherelativeadvantagesoflandlordsandtenantsshiftovertime,in particularsinceaccesstoinformationandcredittendstoequalizeintheprocessof development,thereisanaturalevolutionincontractualform,generallyawayfrom sharecroppingandtowardfixedrentcontractsinwhichthegapinlaborsupervision abilityremainswhilethegapinmanagerialabilityvanishes. Thetheoreticalliteratureonagrariancontractssuggestssomedisagreementasto whethersharecroppingistrulyinefficientatthelevelofindividualproducers,thatis, whetherMarshallianlabormonitoringproblemsaresignificantandwhetherlongterm contractsperhapsresolveanysuchmoralhazardproblemsthroughrepeated interaction.Followingalineofilluminatingempiricalinquiryonthisquestion(e.g.,Bell 1977,Shaban1987),LaffontandMatoussi(1995,chapter32),explorethesequestions directlyintheirstudyofsharecroppinginTunisia,whereintheyalsoexplorewhether riskaversionorfinancialconstraintsseemabetterexplanationofsharecroppings existence.Althoughtheyfindlowerefficiencyonsharecroppedthanonownedland, presumablybecausethesharecropperslaboreffortisreducedinlinewithreductionsin hisshareofoutput,thelengthofthesharecroppingcontractalsohasapositiveand statisticallysignificanteffectundermultiplealternativespecifications,signalingthatthe contractdurationmayindeedhelptoresolvesomeoftheinefficiencyassociatedwith sharecropping,followingthepredictionsoftheFolkTheorem. Alongsidesharecroppingandrelatedagrariancontracts,theotherfactormarketof longstandinginteresttodevelopmenteconomistsconcernslabor.Multipleequilibriain labormarketshavealwaysattractedattention,whetherduetonutritionalefficiency wages(Leibenstein1957;DasguptaandRay1986,1987)ortotheemergenceofdistinct marketsforpermanentandcasual(i.e.,day)labor.EswaranandKotwal(1985a, chapter27)refertothelatterphenomenonasatwotieredlabormarket.This,too,isa
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multipleequilibriumresult,consistentwithmuchofthecoredevelopmenteconomics literaturealreadydiscussed.Justasinthesharecroppingliterature,theyhypothesize thatmarketimperfectionsassociatedwithlaborsupervisioncreateincentivesfor employerstoofferhigherwagestopermanentworkersthantocasuallaborersinorder tobeabletoinduceloyaltyamongtheformersufficienttoobviatetheneedtodevote resourcestolaborsupervision.Theresultingthresholdcontractseparatingequilibrium elicitsoptimallaboreffortfromworkers. Whoisabletoattractthesehigherpayingjobs?Thisobviouslydependson individualattributes,suchaseducationandhealth.ButasMunshi(2003;chapter44) demonstrates,thismayalsodependononessocialnetworks,foreshadowingacentral themeofthiscollectionsthirdvolume:theimportanceofnetworksandother nonmarketinstitutionstoeconomicperformance.Socialnetworkscanaffectlabor marketperformancethroughanyofseveralmechanisms.Theycanreducesearchcosts forworkers,searchandscreeningcostsforemployers,andcanevenprovidedefacto interlinkedcontracts,aswhenareferringemployeeeffectivelyguaranteesthe productivityofareferredassociate.Munshifindsthatreferralsandsupportprovided bymoreestablishedmembersofMexicansocialnetworkshaveapronouncedimpacton migrantworkerperformanceintheUnitedStateslabormarket. Labormarketsareofinterestmorebroadly,notjustbecauseofthepotentialfor multipleequilibria.Muchendogenousgrowththeoryandmanyoftheearlymodelsof balancedgrowthandeconomiesofscalesuchasRosensteinRodan(1943)relyonan elasticsupplyoflabortogeneratethepecuniaryexternalitiesthatpropelgrowth spillovers.Lewis(1954)seminaldualeconomymodelmadethisassumptionmost explicit,makingthelimitingassumptionthatthemarginalproductivityoflaborin backwardsectorssuchasagriculturewaszero.Thisclearlyextremeassumption reallyjustmotivatedamilder,crucialassumptionofhighlyelasticlaborsupply originatinginunemployedorunderemployedworkersinprimaryproductionsectors. Thequestionofhowelasticlaborsupplyisappliesquitebroadlyindevelopment economics.Whereaconsiderableproportionofasocietyspoorrelyextensivelyon labormarketearnings,theeffectsofpolicychangeonequilibriumwageratesand employmentlevelsmayhaveimportantconsequencesforthewelfareofthepoor.But ingeneralequilibriumorinthepresenceofnonseparableconsumption,production andlaborsupplydecisionswageratesandemploymentlevelsdependnotonlyonthe demandforlabor,butalsoonhouseholdssupplyoflabor,whichisanendogenous resultofhouseholdchoice.Similarly,programsdesignedtoimprovethewelfareof vulnerablesubpopulationstypicallycreatedefactoincometransfersthatlikelyinduce laborsupplyresponsebyrecipienthouseholds.Consumersubsidies,foodstamps,cash transfers,andthelikewill,ingeneral,notbeconsumedsolelyasadditionalunitsofthe
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subsidizedgoodoradditionalexpenditures,butalsointheformofincreasedleisure, assumingleisuretobeanormalgood.Thismattersespeciallyifpolicymakers,donors, orothersareconcernednotwithoverallwelfare,butwithspecificindicatorssuchas nutritionalstatus,foodexpenditures,etc.Undernonwelfaristcriteria,theeffectiveness ofpublicinterventionsdependscruciallyonlaborsupplybehavior,i.e.,theextentto whichpeoplediverttransfersextendedintheformofcashorfoodintowelfaregains enjoyedintheformofincreasedleisure. Thecommonpointisthatareasonableunderstandingoflaborsupplybehavioris centraltomuchappliedworkaimedatimprovingthewelfareofthepoor.Weknow fromthehouseholdmodelingliteraturethathouseholdsrespondtochangesin exogenousvariables(e.g.,prices,income,technologies,risk,etc.)notonlybyadjusting demandforhiredlabor,butalsobyadjustingsupplyoflabortotheirownfarm,aswell astothemarket(Singhetal.1986,chapter13;deJanvryetal.1991,chapter14).Soby observingsuchadjustments,oneshouldbeabletotraceoutalaborsupplyfunction. Thetrick,ofcourse,isthatinlowincomesettings,alargeshare(frequentlyamajority) ofworkisnotforwagesorsalarybutratherisselfemployment,infarming,commerce, pettymanufacturing,orservices.Sohowdoesoneestimatelaborsupplyintheabsence ofwagedata? Thecleversolutiontothisprobleminvolveshouseholdmodelingtechniques. Jacoby(1993;chapter28)exploitstherelationshipsimpliedbyutilitymaximization withintraditionalhouseholdmodels,inparticulartheobservations(i)thathouseholds respondtoshadowprices,inthiscaseshadowwagesforlabor,and(ii)thathouseholds maximizeshadowprofitsbysettingtheshadowpriceofaninputequaltoitsmarginal revenueproduct.Onecantherebyderivetheshadowwageforselfemployedworkers byestimatingthereturnstolaborinownproductionandusingtheresultingestimated marginalrevenueproductoflabortoproxyforunobservedwages.Fafchamps(1993) similarlydevelopsandappliesaclevereconometrictechniquetostudytheallocationof unwagedhouseholdlabor,inhiscaseacrossseasonsonfarmssubjecttoconsiderable exogenousproductionriskduetorainfall.LikeJacoby,hetoofindsthatevenwithout theobservablemotivationofmarketwages,farmlaborallocationappearstorespond robustlytomarginalproductivity,astheorysuggestsitshould.Whatsometimes appearsassluggishresponsivenesstoincentivesmerelyreflectstheimpactof uninsurableriskonresourceallocation. B.Riskmanagementandfinancialservices Muchoftheliteratureindevelopmentmicroeconomicsexploresandexplainswhy seeminglyinefficientbehaviorisinfactoptimalgiventheriskandliquidityconstraints facedbythepoorThesetwochallengesbecomemostacuteandcloselyintertwined
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whenoneexploreschoicesovertime,suchasthoserelatedtoinvestmentortechnology adoption.Akeyprobleminintertemporaloptimizationistemporaluncertaintywith respecttothebudgetconstraint.Bothpricesandincomesvaryunpredictablyovertime. Thisisperhapsespeciallytrueinrainfedagricultureinareasofthedevelopingworld withpoorspatialandintertemporalintegrationofmarkets.Mostofthepopulationin lowincomecountriesareemployedinagriculture,asectorinwhichinelasticdemand generallyleadstohighpricevariabilityintheabsenceofstrongmarketintegrationand inwhichagroclimaticshocksleadtohighyieldvariability.Theendresultmaybe substantialexposuretoriskbeyondagentsdirectcontrol.Forvulnerableandliquidity constrainedpersons,abadyearcanbedeadly,soconsumptionsmoothingmotivescan beoverwhelmedbyconcernfordisasteravoidance.Ifconsumptionfallstoomuchin agivenyear,theadverseconsequencescanbeirreversible:illness,injury,evendeath. Indeed,ifthereexistpovertytrapsassociatedwithinferiordynamicequilibriaina systemcharacterizedbymultipleequilibria,transitoryshockscanhavepermanent consequencesifadverseshocksdrivepeoplefromonedesirableequilibriuminto another,undesirableone.Exploringsuchpossibilitieshasbecomeaveryactiveareain thedevelopmenteconomicsliteratureinrecentyears. Economistshavethusdevotedconsiderableenergytoinvestigatingtheextentto whichhouseholdsareinfactabletosmoothconsumptionandthemechanismstheyuse toovercomeincomevariabilitytoachieverelativelymorestableconsumption. Friedman(1957)famouslyhypothesizedthatinthepresenceofcompleteand competitivemarkets,peopleconsumetheirpermanentincomeandsaveordissaveany transitorycomponentssoastosmoothconsumption.Friedmanspermanentincome hypothesisanditsconsumptionsmoothingcorollaryhaveprovidedrichfodderfor economistsingeneral,includingbutnotexclusivelyinthefieldofdevelopment. Thebasicpolicyissuesrevolvearoundwhetheritisnecessaryorappropriateto intervenetostabilizeincomesortoprovidepublicsafetynetsinordertoensurestable consumptionandsotokeeppeoplefromfallingintopovertytraps.Ifpeopleareableto smoothconsumptionthemselvesbysavingincashorinkind,byborrowing,bypooling riskthroughformalorinformalinsurancemechanisms,orbydiversifyingtheir incomes,thentheneedforinterventionstostabilizeconsumptionislessobvious.If privateriskmanagementcomesatasteeppriceintermsofefficiencylosses,however, orifriskmanagementmechanismsareavailableonlytoparticular,relativelyprivileged subpopulations,theremaybeneedforpublicassistancetocomplementexistingprivate riskmanagementinstitutionsandmarkets. Thisalsoopensupquestionsofpublicsectordisplacementofprivatesectorrisk management.Forexample,doesgovernmentdisasterassistancetohomeownersin coastalareaspronetohurricanesencouragessuperoptimalprivaterisktaking(moral
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hazard)?Dostatefundedcropinsuranceschemessimilarlyincreasefarmersrisk takingbeyondwhatissociallyoptimal?Dopublictransferscrowdoutprivatesocial insurance,sothatthevalueaddedofpublicprogramsarelowandtheinefficiencies associatedwithtaxbasedrevenuegenerationmaycausemoreharmthangood? Thereisalsoanimportantquestionofwhenandhowpeopleundertakerisk management.Iftheyareabletoreduceriskexantethroughmitigationbehavior(e.g., precautionarysavings,selectionoflowriskportfolios),then(i)theneedforemergency responsemaybereducedbut(ii)itisalsoeasytounderstatethemagnitudeoftherisks perceivedbythehouseholdssincetheytakeactionexantetoavertundesiredvariability (Morduch1995;chapter18).Observedvariabilityofincomes,forexample,isalmost surelydampenedbyindividualsmitigationefforts.Ifhouseholdsinsteadprimarily copeexpostwithshocks,thenshocksareinprinciplefullyidentifiableinthedata,but rapidresponsemaybeespeciallyimportant. Ifweunderstandintertemporalsavingsasmotivatedbyconsumptionsmoothing motiveswhichmaynotbeaccurate,giventheimportanceofsavingsinkindasa meansofproductiveinvestment,aswediscussbelowtheninsurance,credit,savings andinterpersonaltransfersaresubstitutesforoneanother.Whenthemarketforoneis limited,oneoftheotherscantakeovertheriskmanagementfunction.Behrmanetal.s (1997)studyofdynamicsavingsdecisionsfindsthatinruralPakistan,interpersonal transfersarethemorelikelyconsumptionsmoothingmechanismemployedwhen formalfinancialinstitutionsareunavailable,providingsomeempiricalvalidationthat informaltransfersbehavelargelylikecreditorformalinsurance,inthattheyserveto stabilizeconsumptionintraannuallyrelativetoincome.Therealproblemsemerge whenhouseholdsaccesstoeachofthesevehiclesisconstrained,inwhichcasetheir abilitytomanageriskisradicallyattenuated. Indeed,Besley(1995)advocatesapproachingissuesofsavings,credit,andinsurance fromatradetheoreticperspective,recognizingthatsavingsandcreditaremeansof intertemporaltradeandthatinsuranceissimplytradeacrossstatesofnature.When marketsarecompleteandsuchtradeisunfettered,thereexistuniqueinterestratesand insurancepremiainequilibriumandhouseholdswill,ingeneral,achievePareto efficiencyintheirmanagementofrisk.Whenbarrierstotradeacrosstimeorstatesof natureexist,however,differenthouseholdsorindividualsmayfacedifferentshadow pricesofcapitalandthereare,ingeneral,foregonegainsfromtrade,i.e.,potential Paretoimprovementsmayexist. Oneneedstoproceedcarefully,however,astheremaybeefficientreasonsfor differentialaccesstofinancialservices.Thereasonsforobstaclestosuchtradetypically revolvearoundinformationasymmetries,enforcementproblems,andcovariaterisk. Notallfinancialinstitutionaldeliverymechanismssuffertheseproblemsequally.
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Muchrecentworkhasfocusedonhowcomplementaryinstitutionaldesignsmaystitch togethermuch,thoughlikelynotall,oftheholesinanyonemechanismsprovisionof tradeopportunitiestoavoidrisk. Becauseimperfectinformationandcontingentclaimsproblemsmaymake prospectivetradesinfeasibleorunenforceable,evenseeminglyfragmentedsystems maybeconstrainedParetoefficient.Nonetheless,GreenwaldandStiglitzs(1986)point aboutunrecognizedexternalitiesisagainpertinenthere.Whereoneindividualsorone marketsbehavioraffectsanothers(asistrue,forexample,incasesofstatistical discriminationorwhenthereareexternaleconomiesofscaleinamarket),thenthere maybeforegonegainsfromtradeeventakingintoaccounttheinformationand enforcementproblemsplaguingfinancialexchangesacrosstimeandstatesofnature. Soitisdifficultexantetoassesswhetherthereisaviableroleforpolicyorproject interventionstoimproveriskmanagementamongpoorpopulations.Certainlythefirst placetostartiswithabasicassessmentofhowwelllowincomepopulationsare presentlyabletosmoothconsumption. Thereiswidespreadevidenceofconsumptionsmoothingrelativetostochastic incomesfromdatasetsacrosstheglobeandthewealthandincomedistribution.8 Peopleindeedappeartosaveanddissavesoastosmoothconsumptioninthefaceof stochasticincomestreams.Moreover,peopletapintoinformalinsuranceamong householdstostabilizeconsumptioninthefaceofshocks.Insomesettingsandby sometests,thisinsuranceseemsremarkablycomprehensive(Townsend1994,chapter 20;Deaton1997;DeWeerdtandDercon2006,chapter41).Inothersettingsandforat leastsomeshocks,insurancemightbefarlesscomplete.Forexample,Gertlerand Gruber(2002;chapter25)findthatwhilehouseholdscanfullyinsuretheeconomiccosts ofillnessesthatdonotaffectphysicalfunctioning,coverageagainsttheeconomiccosts associatedwithillnessesthatmoderatelyorseverelylimitphysicalfunctioningisonly 71and38percent,respectively,intheIndonesianpaneldatatheystudy.Whilethe cautionarypolicyimplicationoffindingreasonablyeffectiveinformalinsurance coverageisthatpublicsafetynetschemesmayinadvertentlycrowdoutprivate insurance,thesuggestionofevidencesuchasGertlerandGrubersisthatsocial protectiontargetedtoparticulartypesofshocksareunlikelytocrowdoutprivate informalinsuranceandcouldwellreducedamagingriskexposurethatisalmostsurely substantialenoughtoaffectuninsuredhouseholdsbehavior.Asignificantbodyof evidence(e.g.,Alderman1996,JalanandRavallion1999),alsosuggeststhattherich
Morduch(1995,chapter18)andDeaton(1997)offerexcellentreviewsoftheliterature.Amongthemany importantexamplesofsuchstudiesindevelopmenteconomics,keyonesincludeLucasandStark(1985; chapter47),RosenzweigandStark(1989;chapter40),Paxson(1991),Deaton(1992),Rosenzweigand Wolpin(1993),Udry(1994),Behrmanetal.(1997),Grimard(1997),andRose(1999).
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provefarmoresuccessfulatsmoothingconsumptionthandothepoor(Morduch1995, chapter18). Ofcourse,savingsarenotheldsimplyforthepurposeofriskavoidancethrough selformutualinsurance,butalsobecauseindividualswishtoaccumulatewealthorto enjoythesocialstatusassociatedwithownershipofparticularsortsofassets(e.g., livestock,houses,vehicles,spouses,etc.).Thenriskconsiderationsenterinadifferent contextbecausehouseholdsaremakingportfoliochoicesoverassets(including intangibles,suchasstatus)andactivities,atleastsomeofwhichofferuncertainreturns. Ifriskpreferencesarerelatedtoexantewealth,portfoliochoicesmightreinforcepre existingwealthdistributions.RosenzweigandBinswanger(1993,chapter19)indeed findthatwealthierhouseholdsholdhigherrisk,higherexpectedreturnportfoliosin ruralIndia,whichnaturallyleadstodifferentgrowthratesandincreasinginequality overtime.9 Theobservationthatsavingsareoftenheldforinvestmentpurposesimplicitlycalls intoquestionFriedmans(1957)crucialassumptionthatincomefollowsanexogenous stochasticprocess.Earlierwediscussedhowlaborproductivitydependsonhealth status,whichinturndependsonfoodconsumption,therebyrenderingincome endogenous(tomorrowsincomedependsontodaysconsumptionandtherefore savingsaswell).Moregenerally,futureincomedependsonfuturestocksofproductive assetsandthereforeoncurrentinvestmentpatternsandsavingsandborrowing behavior.Whenfutureincomeisendogenous,liquidatingassetsbecomeslessattractive andtheconsumptionsmoothingpredictionsoftheFriedmanitepermanentincome hypothesismayfailashouseholdstradeoffcurrentconsumptionagainstnotonly futureconsumptionbutalsofutureincome(McPeak2004,Hoddinott2006). ZimmermanandCarter(2003,chapter21)jointhesetwopoints,demonstratinghow poorerhouseholdsmaynotonlyendogenouslyoptforassetportfoliosoflower expectedreturnandriskinthefaceofassetpriceriskandincompletefinancialmarkets, buthowtheymayalsointentionallydestabilizeconsumptioninordertosmoothassets overtime. Notethatthereisanimportantconceptualandempiricaldistinctionbetweentheuse ofsavings,creditorinsurancetosmoothconsumptioninthefaceofexogenous, stochasticincome,andtheadaptationofproductionandlaborsupplybehaviorsoasto reduceincomeriskinordertoreduceconsumptionrisk.Theformerisperfectly consistentwithseparablehouseholdmodels,sinceagentsshouldoptimallymaximize incomeandthenmanagerisksolelyaspartofsecondstageconsumptionallocation decisionsThelatterobviouslyimpliesnonseparabilitybetweenconsumptionand production(i.e.,incomegeneration)activities.Theexistenceofincomesmoothing
SeeBardhan,BowlesandGintis(2000)foranicesurveyoftherelevantliterature.
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behavior(i.e.,incomeisendogenouslystochastic)raisesquestionsaboutthemeansby whichweestimatetheexogenousriskfacedbyhouseholds.Justasindividualswill adjustconsumptionbehaviorwhentheyareawareofcredit,insurance,orsavings constraints(aswediscussedwithrespecttoprecautionarysavingsandliquidity constraints),weshouldlikewiseexpectthemtoadjustlaborsupplyandproduction behaviorssinceriskgenerallyrendershouseholdchoicesnonseparable.Inparticular, wewouldexpecthouseholdstoactontheirpreferenceswithrespecttorisk.Ifthis reducesobservedincomevariability,itbecomesveryeasytounderstateexanterisk exposure.Justasportfoliomanagementandinsuranceaccessmayvaryincrosssection accordingtowealth,sodoesitappearthatformalcreditmarketsaremissingor incompleteformanyprospectiveborrowersinlowincomeeconomies.Insomeplaces formalfinancialinstitutionssimplydonotexistortheinstitutionsliquidityisitself constrainedbytheabsenceofinterbankmarketssothattheyhavetorationcredit,either byprice(e.g.,highinterestrates)orbyquantity(i.e.,lendingonlytoasubsetof prospectiveborrowersandgivingborrowersonlyaportionofthecredittheyrequest). Intheformercase,manypeoplewillselfselectoutofthecreditmarket.Inthelatter case,equilibriumcreditrationingmusttakeintoaccountthefixedcosts(e.g.,checking creditworthiness,etc.)associatedwithloans.Thus,ingeneralsmallervolume(i.e., poorer)borrowerswillberationedoutofthemarketbecauseaveragefixedcosts(i.e., totalfixedcostsdividedbytheloanvolume)arehigherforthemthanforlarger borrowers,inlargemeasureduetolowerborrowingconstraints,giventhelimited collateralthepoorhavetoofferlenders(Carter1988,Besley1995).Inthequantity rationingcase,therewillbeunmetexcessdemandforcreditfromtheformalsectorat prevailingcreditterms,butthesocialprocessofrationingwillcommonlyleadtosimilar rationingfromthetop,whereinlocalelitesareincludedandmoremarginalized subpopulationsarecommonlyexcluded. Thisdiscussionofimperfectionsinmarketsforfinancialservicesandrisk managementleadsustobacktothelongstandingthemeofpathdependence,thatthe growthpathfollowedbyahousehold(oranindividualornation)maydepend fundamentallyonitsinitialwealth.Iffinancial(savings,creditandinsurance)markets areincomplete,individualsmayfaceconsiderableresidualriskexposureagainstwhich theywishtoselfinsure. Inducedchangesinbehaviorduetouninsurableriskexposureareaprimarymeans bywhichpeoplefindthemselvestrappedinchronicpoverty.Butthereisanotherrisk basedmechanismthatcanleadtolongtermpoverty.Shockscanhavepersistenteffects inthepresenceofhysteresisthatgeneratesirreversibilityordifferentialratesof recovery.Theseeffectssuggestimportantnonlinearitiesintherelationshipbetween assetsstocksandincomegrowth,nonlinearitiescommonlyassociatedwithmultiple dynamicequilibriaandpovertytraps.Moreover,themereexistenceofuninsurablerisk
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withimportantirreversibilitiesmayinducebehavioralchangethatlimitsoptimalrates ofassetaccumulation,improvedtechnologyadoptionormarketparticipationbyvery poorpeople. If,however,poorhouseholdsarerationedoutofcreditmarketsoriftheylack sociallymediatedaccesstocapital,astheymayinmanypolarizedsocieties(Mogues andCarter2005,chapter43),thenthepoorhouseholdsonlyoptionwouldbetomove forwardslowlywithanautarkicsavingsstrategy.Thisautarkicapproachwouldrequire substantialshorttermsacrificethroughdiminishedconsumption,withlittlereturneven inthemediumtermasmarginalreturnstonewassetsarelowuntilthehousehold reachesthethresholdpoint.Ifthepoorhouseholdfindsitdesirableandfeasibleand makesthissacrifice,thenitwillwithsufficienttimereachtheassetlevelnecessaryto achievethehigherreturnsandwilleventuallyconvergetowardtheassetandincome levelsofinitiallywealthierhouseholds.Ifapoorhouseholdoptsnottoundertake extraordinarysavings,itthensettlesintoalowlevel,povertytrapequilibrium.Thekey drivingforcebehindthesemultipleequilibriaareexclusionarymechanisms,marketor nonmarketforcesthatsomehowimpedecertainagentsaccesstohigherreturn strategies. V. Marketsandnonmarketinstitutions A.Markets Perhapsthemostdistinguishingfeatureofdevelopingeconomiesoverthepast quartercenturyhasbeentheirsharp,nearlyuniversalmovementtowardreasonably openmarketsthroughliberalizationandprivatization.Thestatistmodelofgovernment controlofmarketsthatprevailedinvariousdegreesandformsinmostlowand middleincomecountriespriortoabout1980gavewaybythelate1980sand1990stoa modelofmarketbaseddevelopment.ThefalloftheBerlinWallandthecrumblingof theformerSovietempirewasthemostdramaticexpressionofthisratherabruptshift, butthepatternhadalreadyappearedonothercontinentsandhasextendedthroughout theworldoverthepasttwodecades. Despitethefaitheconomistsandmanypolicymakersplaceinmarketsasameansfor fosteringanefficient,evenequitable,allocationofresources,wespendshockinglylittle timestudyingmarketsdirectly.TheWalrasianfictionoffrictionlessequilibrationof demandandsupplyor,tobemoreprecise,eliminationofallexcessdemandistoo rarelyembellishedbyexplicitexaminationoftheinstitutionalunderpinningsofmarkets andtheimpactoftheresultingequilibria.Butifsocietiespinmanyhopesfor developmentandpovertyalleviationonmarkets,moreexplicitexplorationofmodesof
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exchange,notjustthefamiliardomainsofproductionandconsumption,promiseshigh returns. Developmenteconomistshavehistoricallypushedthesetopicsfarmorethanhave otherfieldswithinthediscipline.Werecognizethatgeneralequilibriumtheoryquietly andunsatisfyinglyrestsonthreecrucialassumptions:(a)propertyrightsareclearly defined,universallyaccepted,andcostlesslyenforced,(b)auniquesetofrules governingexchangeexistsandisuniversallyunderstood,obeyed,andenforcedbyall transactors,and(c)allactorsbelongtothesamemarket,i.e.,noexclusionary mechanismsexist.Intheabsenceofsuchassumptions,sociallycostlybehaviorse.g., lying,stealing,cheating,foregoneprofittakingmaybeindividuallyrationalactsand interventionsinoneplacemaynotaffecttheincentivesfacedbyagentsinanother.All ofthesephenomenamaycontributetopersistentpoverty. Therootcauseoftheproblemistheunrealisticassumptionofuniversallyaccessible perfectinformation,thustheproblemsofmarketorganizationfollowdirectlyfromthe sourcesofmarketimperfectionsthathavelongpreoccupieddevelopmenteconomists. Ifinformationisincompleteorimperfectbetweenpartiestoanexchange,then opportunitiesariseforstrategicbehaviorsthatcausenegativeexternalities(Platteau 2000,chapter35;Fafchamps2004). Theunderexplorationofmarketswithinthedisciplineispeculiargiventhe emphasiscommonlyplacedontradeincontemporarygrowththeoryandthe indisputablefactthattheefficiencyofthemarketingsystemaffectsbothproducer incomeandconsumercostofliving.Neoliberalscommonlyassumeawaythe possibilityoffrictionsinthesystemofexchangebetweeninitialproducerandfinal consumerwhileneoMarxistscommonlyassumemiddlemenareexploitative monopolists/monopsonists.Suchbeliefs,althoughwidespreadandimportanttoones visionofappropriatedevelopmentpolicy,restonthinandfragileempirical foundations. Inatleastonesense,acasecanbemadethatmarketsaremoreimportantinlow incomeeconomiesthaninhighincomeones.Unlikeinhighincomeeconomieswhere large,verticallyintegratedcorporationscommonlyinternalizesequencesof transactions,commonlyusingformalcontractsovermultipleattributesofthegoods and/orservicesexchangednotjustpriceinlowincomeeconomiesthesmallscaleof mostfirmsnecessitatesalargernumberofinterfirmexchangesinthepassagefrom firststageproducertofinalconsumer.Theoverwhelmingmajorityofthoseexchanges arespotmarkettransactionsnotunderpinnedbyformalcontracts;asFafchampsand Minten(2001)vividlyputit,marketarrangementsareoftenakintoafleamarket economy.Largescalefirmsareconspicuouslyabsentinmostlowincomesettings.So spotmarketbasedexchangebecomesextraordinarilyimportant.Inthissense,
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extraordinarydependenceonmarketsandthegreatnumberofverticaltransaction linkagesarewhatdefinedevelopingeconomies,nottheirabsence. Atthesametime,idiosyncraticmarketfailuresduetohightransactionscosts,risk, etc.mayinducehouseholdstoselfselectoutofmarketsintosemiautarky.Soina different,butequallyimportantsense,marketsarelesswidelyusedinlowincome economiesbecausemarketexchangeismorecomplexandcostlythaninthemore advancedeconomies.Thisparadoxofmarketsthatareatoncemoreimportant vertically(inlinkingproducerstoconsumers)andlessimportanthorizontally(because manyindividualsselfselectoutofmarkets)helpsmotivateasignificantrecentpushin theliteraturetounderstandthefunctioningofmarketsbetter(Platteau2000,Fafchamps 2004). Ifmarketsdonotworkwell,thescopeforallocativeinefficiencyintheeconomy becomesenormous.Indeed,theideathatstatecontrolledmarketsareallocatively inefficientundergirdedmostliberalizationeffortsinthe1980sand1990s.Overthepast decadeorso,developmenteconomistshavegraduallybegunacknowledgingthat privatemarketsmaylikewisebecharacterizedbyconsiderableallocativeinefficiency. Understandingthesourcesandpotentialcorrectivesforthisinefficiencyandits implicationsforgrowthandequityremainimportantbutunderresearchedtopics. Centraltotheobjectiveofanimprovedunderstandingofhowmarketsfunctionand whetherandwhyallocativeinefficienciesariseiscarefulconsiderationofthemeansby whichorderismaintainedinmarkets.Bywhatmechanismsareorcanubiquitous problemsofasymmetricinformationandcontractmonitoringandenforcementbe resolved?Thereisnouniquemechanismthatsuitsalleconomies.Platteau(2000; chapter35)andFafchamps(2004)emphasizethatthereareinherentcomplementarities betweendifferenttypesofmarketordermechanisms.Themostwidespread mechanismisendogenouslyselfenforcingcontractsthatdonotrequireanyexerciseof stateauthority,backedbyrepeatedinteractionsamongprospectivetransactorsorby reputationmechanisms.Butthescopeforsucharrangementstoresolveasymmetric informationandcontractenforcementproblemsisnecessarilylimited.Privateorder mechanisms,inwhichprivatefirms(e.g.,creditratingagencies)resolvecoordination failuresandtherebycreateandsharethegainsfromcoordination,canhelpfillthe breach.Socanpublicorderinstitutionsbackedbythepolicepowerofthestatethrough establishing,promotingandenforcinggradesandstandards,contractlaw,etc. Oneofthemostimportantinstitutionsconcernspropertyrights.AsBesley(1995; chapter37)andalongliteratureindevelopmenteconomicsshow,thestrengthof individualrightsoverproductiveassetssuchaslandisfundamentaltodetermining investmentincentives.Becauseinvestmentinaccumulatingproductiveassets, adoptingimprovedtechnologiesandengaginginpotentiallyremunerativemarketsis
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akeyengineofgrowthatbothmicroandmacrolevel,propertyrightsbecomekey.But asCarterandOlinto(2003;chapter38)demonstrateinaseminalempiricalexampleof thetheoremofthesecondbest,resolvingoneimperfectionincompleteandinsecure propertyrightsinlanddoesnotnecessarilyleadtoefficientandequitableequilibria whenanothermarketimperfectioninCarterandOlintosParaguayancase,credit constraintspersists.Becauseofthepervasivenessofmarketimperfectionsin developingcountries,theimportanceofnonmarketinstitutionstoeconomicincentives andperformanceisbroughtintostarkrelief. B.NonmarketInstitutions:Identities,NetworksandPower Humansdonotliveinisolation,thustheirbehaviornecessarilydependsonthe relationsthatshapetheirworld.Variationinrelationshipscanperhapsleadto predictablevariationinbehaviorsandthusinoutcomes,suchasstandardsofliving, whichcaninturnaffectsocialrelationshipsthroughsubtlefeedbackmechanisms. Partlyasaconsequence,thereisgrowinginterestinthedynamicsofhumaninteraction andhowthismightaffectpersistentpoverty(Barrett2005).Butthisisafarnewerline ofresearchindevelopmenteconomics.Moreover,itisadomaininwhichthecomplex interrelationshipswiththeothersocialsciencesandtheanalyticalintractabilityand empiricalidentificationproblemsassociatedwithmanyinstitutionalissuesposeserious methodologicalchallenges.Theliteratureinthisareaisthereforesomewhatless cohesiveandauthoritativethaninmuchoftherestofthefield.Butthepromiseof workinthisareaisespeciallygreat,bothwithindevelopmenteconomicsitselfandfor economicsandthesocialsciencesmorebroadly. Thelinkbetweenhumanrelationshipsandbehaviorcanoperatethroughanyof severaldifferentpathways.First,individualpreferencesarenotimmutablygivendeus exmachina.Rather,theyadaptwithinthecommunitiestowhichtheseindividuals belong.Norarepreferencesoverexclusivelymaterialthings.Peoplevaluesocial relationships(includingdevianceorconformity),integrity,friendship,love,etc.,and theirbehaviorsmanifestthevalorizationofthenonmaterial. Second,therulesandexpectationsgoverningindividualinteractionareshapedby formalgroupsandinformalnetworks,beitincontractingforgoodsorservices,in supportingotherswhosufferadverseshocks,incommunicatingpotentiallyvaluable information,orotherinterpersonalphenomena.Socialrelationscreateveryreal constraintsonsomeindividualchoicesandrelaxconstraintsonotherchoices. Third,andcloselyrelatedtotheprecedingtwopathways,theincentivesfacedby individualsareshapedbymoralandsocialforces.Thiscanoccur,forexample,through priceadjustmentsbasedonnetworkorpositionalexternalities,orthroughnonprice
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premiaassociatedwithprestigeorstigmaeffects.Followingtheseminalworkof AkerlofandKranton(2000)andPlatteau(2000),agrowingliteratureindevelopment economicsemphasizestheimportanceofsocialandpsychologicalidentitiesto understandinghowindividualscanbetrappedinpersistentpoverty.Whetherby influencingindividualidentities,preferences,ortheconstraintsorincentivesfacedby individualdecisionmakers,thesocialandmoralmilieuinwhichchoiceoccursplainly matters,asthechaptersinthisbookdemonstrate. Furthermore,outcomesaffectindividualsendogenousconstructionand reconstructionofthesocialenvironmentsinwhichtheyplaceorfromwhichthey extricatethemselves.Bychangingthecostsandbenefitsofmakingormaintaining extantcontacts,economicperformancenecessarilyinducesupdatingoftheattributes thatdefineidentitiesandcommunitiesandoftheformalandinformalmatching processesthatdefinegroupsandnetworks.Thisfeedbackbetweenindividualand groupbehaviorinjectsarichnessintoanalysisthatistoooftenabsentinsocialscience researchbasedexcessivelyoneithermethodologicalindividualismorcultural determinism(DurlaufandYoung2001).Forexample,theendogenousemergenceof individualidentitiescancriticallyshapebehaviorsthatsubsequentlyreinforcethose identities.Thisfeedbackmechanismgeneratesmultipleequilibria.Onesuch equilibriumisassociatedwithpoorperformanceinschool,othersarethelowratesof adoptionofimprovedproductiontechnologies,thelimitedprovisionoflocalpublic goods,andotherdysfunctionalgroupandindividualbehaviors.Althoughsuch outcomesareParetoinferiorrelativetoavailablealternatives,thebehaviorsthatleadto undesirableoutcomescanproveindividuallyrationalduetothereinforcingfeedback loopcreatedbythesocialcontextinwhichindividualsmakebehavioralchoices(Barrett 2005). Thesocialcontextiscommonlydefinedbythesocialnetworksthroughwhich finance,information,laborandlandflowinmanylowincomesocieties.Individual accesstoresourcesistypicallyconditionedbythenetwork(s)towhichonebelongs,and networkmediatedaccessistypicallynontransferableevenwithinnuclearhouseholds. Thusgroupandnetworkmembershipoftenmattertoeconomicperformance (DeWeerdtandDercon2006,chapter41;MoguesandCarter2005,chapter43;Munshi 2003,chapter44).Recognizingthis,peopleoftenstructuretheirsocialnetworks, includingfamilyrelations,inordertoimproveeconomicoutcomes(Rosenzweigand Stark1989;chapter40). Althoughitistruethatsocialgroupscanobviatemarketfailuressuchascredit rationing,imperfectcontractenforcementandlimitedaccesstoinsurance,andthereby facilitateinvestmentandgrowthinstandardsofliving,perhapsespeciallyforthepoor, sotoocangroupsproveexclusionary,effectivelythrowingsandinthewheelsof
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progressforexcludedindividualsandgroups.Inmoreextremecases,exclusionary processesoftenturnviolent,withthepoorsufferingadisproportionateshareofthe resultinghardship,asvividlymanifestinrecurrentinterethnicandinterfaithviolence insubSaharanAfricaandsouthAsiainrecentyears.Powerandviolencecanoftengo handinhand(Basu1986;chapter39),leadingtobotheconomicexploitationand increasedrisktothosewhoarerelativelypowerless. Theapparentimportanceofnonmarketinstitutionsassociatedwithsocialrelations shouldnotobscurethefundamentalimportanceofthepoliticalinstitutionsofnations. AsKruegeretal.(1988,chapter59)emphasize,economywidepoliciesdrivenby nationallevelpoliticstendtohavefargreater,albeitindirect,impactonmicrolevel incentivesthandosectorspecificpolicies.Oneconcernisthatnationallevelpolitics andmacroeconomicmanagementhavesooftenprovedcorruptindevelopingcountries (Bardhan1997).Thenaturalinclinationisthereforetoaimtoreducecorruptionunder thebeliefthatthisisanexogenousvariablethatcanbeadjustedwithsalutaryeconomic effects.Coupledwithwidespreadbeliefinthecriticalimportanceofmarketbased resourceallocation,concernsaboutcentralgovernmentcorruptionhavefuelledkeen interestindecentralizationofdecisionmakingauthorityindevelopingcountries. Widespreadcentralgovernmentfailureshaveattractedmuchattention,ashavemarket failures.Butintherecententhusiasmforcommunitybasedsolutionsfosteredby decentralizationofresourceallocationandbroaderpoliticalauthority,the commonalityofcommunityfailuresthatareoftenasseriousasmarketorstate failuresonwhicheconomistsmorefrequentlyfocus(Bardhan2002,chapter61). Moreover,asSachs(2005)arguesforcefully,however,corruptionmaybeasmucha consequenceasacauseofpoverty,thusthecurrentfashionwithindevelopment agenciesforemphasizingcorruptionasarootcauseofslowgrowthandpersistent povertymayproveshortlived.Institutionalfactorsplainlymattertothecourseof development;whatremainslesscleariswhichfactorsandwhy. Thehistoricalevidencesuggeststhatinitialmaterialfactorendowments(e.g., climate,soils,minerals,proximitytonavigableriversandports,etc.)predisposed certaincountriestowardparticulardevelopmentpaths,butthatthecolonialexperience ofdevelopingeconomiesplayedamajorroleinshapingthelegalandpolitical institutionsthataffectedthedistributionofpoliticalpowerandassets,aswellas incentivestoinvestandinnovate(North1990,SokoloffandEngerman2000,chapter60). Inparticular,societiescharacterizedbygreaterinitialinequality,elitesmoreoften succeededinestablishingalegalframeworkthatsecuredforthemdisproportionate politicalpowerthattheyusedtoperpetuateinequality,oftenbycreatingexclusionary mechanismsthatlimitedtheoptionsofthepoorermembersofsociety(Acemogluetal. 2001,chapter62).Exantedifferencesininequality,humancapitalendowmentsand politicalpower,perhapsrootedinthematerialfactorendowmentsofparticularplaces,
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thusappeartohavehelpedshapetheoftendisappointinggrowthandpoverty dynamicsofmanylowincomeeconomiestodaythroughasortofinstitutionalpath dependencethatmirrorsthemultipleequilibriumprocessesaroundwhichsomuchof thedevelopmenteconomicshasemerged(SokoloffandEngerman2000,Acemogluetal. 2001). VI. Conclusions
Withtheworldspoliticalleadersplacingmoreemphasisonglobalpovertyand hungerissuesthantheyhaveindecades,developmenteconomicsisflourishingagain. Wellequippedwiththeformaltoolkittheeconomicsdisciplinehasdevelopedoverthe pastseveraldecades,acertainamountoftheinnovationintheliteratureisa rediscoveryoflongstandingthemes:povertytraps,humancapital,thecriticalityof technologyadoptionandmarketparticipation,theobstaclesposedbycoordination failures,theimportanceofinstitutions,andinterlinkagesacrosscontractsandsectors. Thesetimetestedthemesremaincentraltotheongoingexplorationofthecausal reasonswhysomecountries,communitiesandpeoplearerichwhileotherssuffer grindingpovertythattoooftenpersistsforgenerations. Thoseofuswhohavededicatedyearstothestudyofdevelopmenteconomics continuetodelightinnewempirical,methodologicalandtheoreticaldiscoveriesthat helpusinchalongthepathofrelievinghumansufferingthroughscholarship.Because thechallengesofdevelopmentaresocomplexandintertwined,manyoftherichest insightscomefrombuildingbridgesacrossthemesandscalesofanalysisordeveloping toolsorfindingsthatarebroadlyapplicabletoawideclassofproblems. Hencethiscollectionofpapers.Ithasbeencompiled,andthisintroductoryessay written,principallywithyoungscholarsinmindadvancedundergraduatesand graduatestudentsineconomics,agriculturaleconomics,developmentstudies,public policyandinternationalrelationsprogramsaswellasadventurousyoungscholars fromcognatesocialsciences.Thesevolumesoffersuchreadersanintroductiontothe field.ButasIhavepersonallydiscoveredineditingthese1600pages,acollectionsuch asthisoffersawonderfulopportunityforaninterludeofsynthesisbetweenthevarious narrowlydefinedprojectsinwhichwescholarsarealwaysengaged,achanceperhaps toseetheforestforthetrees. Thechaptersthatfollowreprintaselectionunfortunately,spaceconstraintspermit onlyaselectionofthefinestworkindevelopmenteconomics,spanningtopics, decadesandcontinents,includingtheworkofluminariesaswellassomeseminal papersbyscholarswhoseworkunfortunatelygetslessattentioninthemainstreamof theprofession.Ultimately,thekeycriterioninselectingthesepaperswasnotthatthey
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evincebrilliance,ahighbutfrequentlyattainedstandard.Rather,thekeycriterionwas thefartougherstandardthatthesepapersorthebodyofliteraturetheyrepresent discretelyadvancethestockofeconomicknowledgethatisusefultoimproving standardsoflivingforthoselessfortunatethanmostofuswhohavetheprivilegeofan academicprofession.Myshelvesarechockablockwithbooksandmyfiles overflowingwithpapersthatofferusefulfindingsandinsightsbutonlybearone carefulreading.ThepapersIchoseforthesevolumesIhavereadmultipletimes,each timelearningsomethingnewanduseful.Ihopereadersfindsimilarrichesinthepages thatfollow. Whyshouldonetakeonthetaskofreading,suchabroadranging,immenseand admittedly,sometimesdensecollectionofpapers?Noneofuscanworkalltheseams oftherichintellectualminethatisdevelopmenteconomics,andpreciousfewproduce realgemsregularly.Butbyfamiliarizingourselveswiththecentralthemesandseminal workofthefieldwenotonlyenjoythecollectivebrillianceofmanyscholars noteworthyindividualcontributions,wereapthebenefitsofintellectualarbitragefrom parallelsubliteratureswithinthevastareaofdevelopmenteconomicsand,most importantly,webetterequipourselvestohelpaddressthemanypracticalsocietal challengesthatdevelopmenteconomistsareprivilegedtoresearchanddebate.Because thetaskofhelpingtoreducehumansufferingandtofosterimprovedstandardsof livingissovitallyimportant,wedevelopmenteconomistsmustcontinuouslyinvestin buildingandextendingsoundtheory,rigorousmethodsandaconvincingbodyof empiricalevidence.Wemustregularlychallengepopularbeliefs,eschewideologically purebutempiricallyunsupportablemodels,andhumblyrevisittheforgottenwisdom ofourpredecessors.Butinordertodooriginal,valuableresearch,wemustfirstdoour homework.Learningthetheories,methodsandexistingbodyofempiricalevidence welliscentraltotheevengreatertaskofdoinggood.
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ForthcominginC.B.Barrett,ed.

Whenindividualsmakedecisionsnoncooperatively,multiplemarketfailurescanevenresultinintra householdproductivitygradients,providingstrongevidenceoftheallocativeinefficiencyresultingfrom marketimperfections(Udry1996;chapter17).

thusappeartohavehelpedshapetheoftendisappointinggrowthandpoverty dynamicsofmanylowincomeeconomiestodaythroughasortofinstitutionalpath dependencethatmirrorsthemultipleequilibriumprocessesaroundwhichsomuchof thedevelopmenteconomicshasemerged(SokoloffandEngerman2000,Acemogluetal. 2001). VI. Conclusions

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