ECONOMICS 56

ECONOMIC DEVELOPMENT
Session 7
September 02, 2017
Ms. Ammielou Gaduena
 Entrepreneurship, Organization,
and Innovation
• Entrepreneurship- activities essential to creating an enterprise in ill-defined
markets or with ill-specified production function.
• Entrepreneur as a coordinating instrument- organizes the firm through
command and hierarchy
• Makes up for market deficiencies or fills gaps
• Develops more productive techniques to make up for the lack of marketable inputs
 Entrepreneurship, Organization,
and Innovation
• An entrepreneur acts as:
• Coordinator of other production resources
• Decision maker under uncertainty
• Innovator
• Gap filler and input completer
• Innovation- the embodiment in commercial practice of some new idea or
invention
 Schumpeterian Model
• The source of private profits is successful innovation, and innovation brings
about economic growth.
• Introducing new products
• Opening of new markets
• Introducing new production functions that decrease inputs needed to produce a given
output
• Exploiting new sources of materials
• Reorganizing an industry
 Schumpeterian Model
• Perfect competition
• Full employment
• No savings
• No technical change
• Economy in a stationary (steady) state- an unchanging economic process that
merely reproduces itself
• No entrepreneurial profits
 Schumpeterian Model
• Suppose an entrepreneur innovates.
• Leads to the creation of new firms and the establishment of new leadership
• Profits are earned off innovations (no other source of profit).
• Imitation wipes out the profits from innovation, which forces the entrepreneur to come up
with new innovations.
• Innovations arise in clusters.
• The waves of entrepreneurial activity forces out old firms (creative destruction).
• Economic growth is explained by the cycle of creative destruction.
• Innovation-saving-credit creation-imitation
 Schumpeterian Model
• Stages of innovation • Interaction between science and
• Development of pure science technical innovation
• Invention • Basic scientific advances create
opportunities for innovation.
• Innovation
• Economic incentives and technical
• Financing progress can affect the agenda of and
• Acceptance payoffs from scientific research
 International Trade Theory
• Globalization- integration of national economies into international markets
• Presents new possibilities for broad-based economic development through
international trade and finance, and cultural, social, scientific and
technological exchanges.
• Can also create a pattern of dependence, exacerbate dualism and fail to make
gains inclusive
• Primary product export dependence- country reliance on exports of products and
commodities from extractive industries (farming, lumbering, mining)
 International Trade Theory
• Free trade- international flow of goods without barriers in the form of
tariffs, quotas and other trade restrictions
• Exports earnings can be unstable due to the low income and price elasticities
of demand for primary products.
• Results to wide fluctuations in developing-country earnings on commodity exports
• Falling export prices relative to import prices increases the real cost of a unit of import
• Commodity terms of trade is believed to worsen over time (Prebisch-Singer hypothesis)
 International Trade Theory on
Comparative Advantage
• Comparative advantage as the motivator for trade.
• Production of a commodity at a lower opportunity cost than any of the alternative
commodities that could be produced.
• Different individuals have different abilities, resources and consumption preferences.
• Individuals trade the things they possess in large quantities relative to their
tastes or needs in return for things they want more urgently.
• Specialization- concentration of resources in the production of commodities that the
economic agent has comparative advantage on.
• A country specializes in the export of the products that it can produce at the lowest
relative cost.
Hecksher - Ohlin Model of International Trade

Assumptions:
• All countries have the same technological possibilities.
• Countries are endowed with different, fixed factor supplies that are perfectly
mobile between different production activities.
• Different products require inputs in different relative proportions.
 Labor (capital) abundant countries can produce labor (capital) intensive
products more efficiently.
Hecksher - Ohlin Model of International Trade

Assumptions:
• Different domestic commodity price ratios.
• Government plays no role in international economic relations and
international prices reflect supply and demand.
• Trade balance
• The gains from trade that accrue to any country benefit the nationals of that
country.
Hecksher - Ohlin Model of International Trade

• All countries gain from trade and world output is increased.

• Complete specialization does not occur.
• Factor prices among trading partners will equalize.
• The economic return to owners of the abundant resources will rise in relation to
owners of scarce resources as the abundant factor is more intensively used.
• Economic growth is stimulated by enabling countries to move outside their
production possibility frontiers and secure capital as well as consumption goods
from other parts of the world.
 Trade in the Developing Country Experience

North-South trade models

The world economy is characterized by rapid change, and factors of production
are fixed neither in quantity nor in quality.
• Relative factor endowments and comparative costs are not constant, but instead determined
by the pattern of international specialization.
• The comparative advantage of developing countries in unskilled, unproductive activities is
perpetuated by the pattern of global production and trade.
• The domestic growth of needed capital, entrepreneurship, and technical skills can be
inhibited.
 Trade in the Developing Country Experience

Vent-for-surplus theory of international trade

The contention that opening world markets to developing countries
through international trade allows those countries to make better use of
formerly underutilized land and labor resources so as to produce larger
primary-product outputs, the surpluses of which can be exported.
 Trade in the Developing Country Experience

Short run:
Beneficiaries of this process were often colonial and expatriate
entrepreneurs rather than developing-country nationals.
Long run:
The structural orientation of the developing-country economy toward
primary-product exports in many cases created an export “enclave” and
inhibited needed structural transformation in the direction of a more
diversified economy.
 Trade in the Developing Country Experience

Fixed, Freely Available Technology

By first imitating products developed abroad but not on the frontiers of
technological research, certain middle-income countries with sufficient human
capital can follow the product cycle of international trade.
Using their relatively lower wages, they move from low-tech to high-tech
production, filling manufacturing gaps left vacant by the more industrialized
nations.
 Trade in the Developing Country Experience

Increasing Returns, Imperfect Competition and Issues in Specialization

• Monopolistic and oligopolistic market control of internationally traded
commodities.
• Production structures are often rigid and factor movements are largely restricted.
In economies that have gradually become heavily dependent on a few primary-
product exports, the whole economic and social infrastructure may be geared to
facilitate the movement of goods from production locations to shipping and storage
depots for transfer to foreign markets.
 Trade in the Developing Country Experience

Industrial policy
Deliberate effort by governments to guide the market by coordinating and
supporting specific industrial activities.
Involves guiding the market through strategic coordination of business
investments to increase export market shares) are specifically designed to create
a comparative advantage where none existed before but where world demand is
likely to rise in the future.
 Traditional Trade Strategies for Development
Outward-looking development policies
Includes trade policies that encourage free trade but also free movement of
capital, labor, firms and students, encourage the establishment of multinational
enterprises and an open system of communications.

Inward-looking development policies

Policies that stress the need for nations to evolve their own styles of development,
encouraging indigenous learning by doing in manufacturing and the development of
technologies appropriate to a country’s resource endowments.
 Traditional Trade Strategies for Development
Export promotion- governmental efforts to expand the volume of a country’s exports through
increasing export incentives, decreasing disincentives and other similar strategies.
Primary-commodity export expansion faces the following challenges:
• Low income and price elasticities of demand for most primary commodities such as
agricultural foodstuffs and raw materials
• Developed-country population growth rates are now at or near the replacement level
• Development of synthetic substitutes
• Growth of agricultural protection in developed countries
 Traditional Trade Strategies for Development

Import substitution- A deliberate effort to replace consumer imports by

promoting the emergence and expansion of domestic industries, such as those
espoused in the infant-industry argument
 Traditional Trade Strategies for Development

Undesirable outcomes of import substituting strategies:

• Many IS industries (both publicly and privately owned) remain inefficient and costly to operate.
• The main beneficiaries of the import substitution process have been the foreign firms that were
able to locate behind tariff walls and take advantage of liberal tax and investment incentives.
• Most import substitution has been made possible by the heavy and often government-subsidized
importation of capital goods and intermediate products by foreign and domestic companies.
• Overvalued domestic currency raises the price of exports and lowers the price of imports in
terms of the local currency.
• Strategy has inhibited industrialization.
 Traditional Trade Strategies for Development

Industrialization strategy approach A school of thought in trade and

development that emphasizes the importance of overcoming market failures
through government policy to encourage technology transfer and exports of
progressively more advanced products.
Economic integration The merging to various degrees of the economies and
economic policies of two or more countries in a region.
Quiz Time
 Questions
1. The effects of international trade on a country’s development are often related to
four basic economic concepts: efficiency, growth, equity, and stability. Briefly
explain what is meant by each of these concepts as it relates to the theory of
international trade.
2. Briefly summarize the major conclusions of the traditional theory of free trade
with regard to its theoretical effects on world and domestic efficiency, world and
domestic economic growth, world and domestic income distribution, and the
pattern of world production and consumption.