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Acemoglu (2010) emphasizes that theory has a central role to play in empirical economic research. He argues that the role of theory is particularly significant in the areas of general equilibrium analysis and external validity. Economic theory, according to him, should be employed to formulate and define ‘structural parameters,’ and should be used as a motivating force for empirical work.
He further adds that without theory, economic estimates would not have a proper external validity, without which we would not able to find out whether a particular model or theory is an accurate estimate of reality. They also cannot explain what would be the effects of the model when implemented across different circumstances or scales. However, he also adds that the usefulness of ‘structural parameters’ in policy analysis depends on the specific environment and sample from which they were formulated.
Acemoglu (2010) argues that it is very challenging to establish external validity when political and economic considerations and general equilibrium are to be taken into account. The primary role of economic theory is to enable us to tackle these constraints, and provide an accurate external validity despite the presence of these parameters. He further states that factors such as composition effects and price changes should be considered while analyzing a policy. This highlights the significance of interpersonal dimension while measuring the impact of intervention development. Thus, as Aguirre (2013) opines any intervention carried out to induce development should aim to build human, moral and social capital.
He tries to explain the concept of endogenous technology responses with the help of the labor supply scenario that existed in the 1960s United States. During this period, there was a massive increase in the number of college-educated workers in the labor market. Ideally, this supply change should have brought down the college premium. Instead, the reverse scenario took place, and from the late 1970s, college premium increased at an accelerated rate.
This phenomenon, according to Acemoglu, was a result of endogenous technology response to the increase in the supply of skilled workers. Trade opening can be evaluated based on the same principle. Acemoglu (2010) says, “One cannot simply rely on partial equilibrium estimates derived from firm-level variation in access to foreign markets.” Because trade opening is a general equilibrium change, it will also have an impact on technology choices and in determining the way in which technological changes occur.
However, his arguments are not without limitations. As explained by Aguirre (2013), his findings are based on factors that have an immediate impact, such as skilled workers supply in the labor market, and ignored certain factors that play a major role in determining external equilibrium effect. One such major factor is the effect interpersonal dimensions have on economic agents’ decisions.
Alesina and Rodrick (1994) explain the relationship between income distribution and economic growth by drawing upon the median voter theorem. They argue that if the income is distributed equitably it contributes to a better median voter capital, lower capital taxation equilibrium, and better economic growth. They elucidate that the specific assumptions made by them in their model is a depiction of a more general idea.
For example, in their model they have employed the term capital, which encompasses all growth-producing assets, such as proprietary technology, physical capital and human capital. The crux of their argument is that uneven distribution of wealth is harmful for economic growth. The land ownership pattern and income levels are taken as the parameters, based on which the wealth of the population is calculated. Thus, steep income differences and uneven land ownership patterns are considered to be detrimental for economic growth.
Banarjee and Duflo (2007 and 2008) take a similar stand, when they demonstrated that poverty and inequality in the society leads to negative economic growth. They highlight how the poor of the society are forced to lead a life out of limited resources. They also argue that the middle class values are vital inputs to entrepreneurial classes, as they empathize on the importance of savings and accumulation of human capital.
However, there is a huge disparity in the way income is distributed among the middle class across various countries. Thus, assumptions that middle class families have the same values irrespective of their regional differences are not substantiated. However, some values remain constant among the middle class irrespective of the countries they belong to, significantly, the ability to remain the backbone of the economic growth.
Banarjee and Duflo argue that the middle class share a love for well-paying and steady jobs more than entrepreneurial ventures. Even though there are middle class entrepreneurs, they do not place much emphasis on expanding their business are becoming capitalists. They run businesses only because of their economic pressures, and if they find a good job, they are more than willing to put an end to their business ventures. They argue that, “If the middle class matters for growth, it is probably not because of its entrepreneurial spirit.”
Their argument relate to the theory of Alesina and Rodrick, which also proposes that wealth should be equally distributed among the majority faction of the society, the middle class. If a large section of the society does not have access to productive resources, it will take the economy backward. They also elucidate that the pressure of redistributing wealth among the majority is experienced not only by democratically elected governments, but also in autocratic regimes.
Easterly (2001) states that, “A middle class consensus is also associated with more education, better health, better infrastructure, better economic policies, lesser political instability, and less civil war.”He too reiterates that if there is equal distribution of wealth among the middle class and lower ethnic divisions, then there would be better economic growth.
He further states that societies, which are polarized, would have an uneven wealth distribution depending on the people in power, while societies which are not polarized tend to have an inclusive economic development. Their view relate to those expressed by Alesina and Rodrick (1994) and Persson and Tabellini (1994), who opined that low economic growth results when the poor majority impose tax on the rich.
Mauro (1995) presented an approach to analyze corruption by considering the impact the efficiency of government institutions have on economic growth. To achieve this, he took into account the Business international indices on corruption, red tape and judicial efficiency of a country, for a period of three years between 1980 and 1983. He made use of Ethnolinguistic fractionalization as a tool to measure the impact of corruption.
Another method was proposed by Fisman (2007), which appraised the role of cultural values and legal enforcement in checking corruption. He did this by studying the parking violations committed by the UN diplomats in Manhattan. Fisman states that, “The act of parking illegally fits well with a standard definition of corruption, that is, ‘the abuse of entrusted power for private gain’.” He suggests that by analyzing the parking violations of diplomats in different countries, one can garner a picture of the corruption ‘culture’ prevalent in that country.
Along with the above discussed methods, there are other methods used to measure corruption like the one suggested by Olken (2005). He conducted a study in 608 Indonesian villages, following both top-down approach, whereby government auditors were used to monitor level of corruption and bottom-up approach, where monitoring was done at the grass root levels with the help of the villagers. One major roadblock of this controlled experiment is the fact that, sometimes, individuals do not care about the public good.
The paper made some revealing insights into how people care more when private goods are affected, and does not pay much heed when public goods are affected. Thus, grass root monitoring cannot be a viable option on all situations, and can be performed only under circumstances where there is comparatively lesser free riding.
Social capital has an important role in the milieu of corruption. Social capital is a common benefit derived by the society as a whole. While corruption prevails in a society, a particular group of individuals or network gets the benefits, and emerges as the winners in this situation. This network, for example government officials, would shield each other and they would not reveal the corrupt practices of the government institutions to the society. This, in turn, will impede the overall development of the country.
Government institutions are significant for a country’s growth because they structure the environment. The presence or absence of political competition can influence the efficacy of these institutions. Pinto and Simmons (2005) argue that political competition affects the capital and labor accumulation, productivity growth and human capital accumulation.
When there is no political competition and the ruler has a firm hold on the governance of the country, he would implement policies that would maximize the benefits for him and other interest groups. However, in a competitive environment, when the ruler is not sure whether he would be reelected and there is lot of political options available for the people to choose form, the ruler would implement those policies which would benefit the people, so that it increases the chances of his reelection. Thus, political competition benefits the majority of the society.
The consequence of this for an integral economic approach to economic development and for the development of impact measurements with integral approach for a specific development intervention is to take into account the effect social capital can have on these institutions. As Olken (2005) states, the World Bank has called for stringent legal measures to tackle corruption. However, social reformers argue that a change in the civic norms will strengthen the anticorruption efforts rather than legal stipulations.
Social capital, specifically family, is relevant for sustainable economic growth, because family is the building block of a society and is involved in all economic processes. Aguirre (2013) states that family units are a significant determinant of a country’s wealth, progress, savings, and accumulation of social and human capital. He further argues that, when resources are allocated to efforts that weaken family units, development suffers.
The next phase is the exchange of the products produced, which takes place in a market. Markets, along with commercial aspects like lucrative trade terms needed to gain profit, also needs elements such as trust, confidence, communication and a politically conducive environment. Here again social and human capital come into play. For the final phase, consumption, the buyers need purchasing power and fair distribution channels so that the product could reach them, and this would be achieved through income and profits. (Aguirre, 2004)
The other longstanding debate is concerning the property rights of an individual and the question as to can he enjoys the benefits derived out of his property alone. Aguirre opines that, “Private property encourages production and belongs to someone, but the product of this property transcends the owner since he does not work in isolation or for himself alone.” Thus, the members of the community and society at large has a share in the benefit accrued from the property, because no individual can operate in isolation and has to derive his training and education from the society and family.
In many developing countries, health issues are a major roadblock for sustained economic development, and here too stable familial relationships are the remedy. AIDS is one of the deadliest diseases known to mankind, and huge amount of time and resources are spent in combating this threat. It is placed in seventh position on the various causes of death. AIDS is transferred mainly due to illicit sex and injected-drug-use. Sexual activity through a faithful and stable marriage and the practice of monogamous and faithful marriage relationship are the solutions to prevent this epidemic. (Aguirre, 2004)
The foreign aid access and its effectiveness is a topic that has garnered much attention over the years. There is an extensive amount of literature available on this topic. Boone 1996, Burnside and Dollar 2004, and Easterly 2003 are some of the few examples of the extensive research done in this area. There has been opposing views on the effect foreign aid has on the development of a country’s economy, with some economists arguing that the effect is positive (Burnside and Dollar, 2000), while others disagree (Boone 1996; Easterly 2003; Bourguignon and Sundberg 2007). However, these extensive literatures do not aid us to arrive at any conclusive opinion about the effect of foreign aid on development.
Boone argues that aids are mostly given as a part of a larger political strategy and not often based on need. Aids do not help in achieving growth because a) capital shortages do not give birth to poverty and b) when aid is received politicians do not correct their distortionary policies. Boone (1996) emphatically argues that foreign aid has nil effect on investment. Foreign aid increases consumption and thus, boosts consumption rather than improving investment. He further states that foreign aid minimizes savings and creates a substitution effect.
Boone argues that the effectiveness of the foreign aid should not be calculated by its impact on GDP. He states that even though foreign aid does not have an impact on investment, they help in alleviating poverty by enabling higher consumption by the poor or by impacting the services rendered to them. He corroborates his point through studies conducted on measuring the impact aid had on human indictors, such as infant mortality and life expectancy.
Another phenomenon that is witnessed pertaining to foreign aid is that NGO aids help the poor better than bilateral aids provided by governments of foreign nations. This is because, sometimes governments do not transfer the benefit of the aid to the poor, but channels it to parties who have ties with those in power. Also, giving aid to the poor would foster political activism among the poor, which is a threat to the people in power.
Available literature on this topic points out to the fact that there is often no relationship between foreign aid and growth. There are many occasions where aids are given by donor nations to countries, which do not possess a policy framework or strong institutions. This suggests that the ulterior motive is political strategy rather than humanitarian concern.
Weker (2009) further elucidates on this point by taking the example of foreign aid given by the rich middle-east countries to other Muslim nations. He establishes beyond doubt that such aids never reach the needy. More often than not, this aid is used by the receiving country’s government to increase its expenditure on imports, thus creating trade imbalance. Arab donors have both developmental motives and political motives, and there is no test available to establish their motives.
Easterly (2003) developed a model, which assumes the amount of investment to be a sum total of foreign aid and domestic savings. This model shows that the new investment can promote strong growth, and accelerate development many times more than domestic savings alone could achieve. This model is one of the oft-quoted models for justifying foreign aid. However, if we take the case of sub-Saharan countries, in spite of receiving foreign aids there is little development.
Thus, for foreign aid to make meaningful impact on the economic growth, the receiving country should have good systems and institutions in place to utilize the aid received appropriately. There should also be some improvement in human development factors, such as gender and ethnic equality and violence-free society. Mainly, there should be periodical evaluations done to measure the impact the foreign aid has on the receiving country’s economy.
Microcredit is an innovation that helps reduce the administration costs involved in giving out small loans. Banarjee and Duflo (2010) explain that high interest rates kept the poor away from availing loans, and these high interests were, according to them, because of some inefficiency involved in the process.
De Mel et al. (2008) conducted a study on businesses in Sri Lanka, which revealed that the rate of return on capital was substantially higher than the market interest rate, and this rate varied based on the household liquidity and the gender of the business owner. The aim of the study was to measure the impact of intervention on capital returns of small businesses. The village welfare society, which participated in the study, agreed to conduct monthly meetings in place of the regular weekly meetings. The rescheduling of the meetings did not affect the repayment, and the bank decided to stick to monthly meetings thereafter.
The research also throws light on various opportunities for banks and lending organizations to cut administrative costs. For example, banks could offer two months grace period for borrowers struggling to meet the repayment schedule, and compensate the loss by marginal increase in the interest rates. Study also found that the risk of default is minimal in group loans, even those offered without collateral, because it utilizes the existing social capital and also give birth to new social capital among the group members.
Karlan and Zinman (2006) show that default rates among women are lower. Also, women channel their profits more towards their family. Field et al (2009) establish that giving grace period before the repayment begins, results in increased default and delinquency. They argue that a rigid microcredit contract is significant to maintain low default rates.
Gine and Karlan (2009) conducted a study in Philippines, which revealed that individual liability compared to group liability lead to more use of credit, but did not have an impact on repayment. Karlan (2006) argue that individuals who are closer to fellow group members, like living in the same locality or having familial or cultural ties, have more savings and higher repayment rates. Thus, geographical proximity and social connections results in better group lending outcomes.
An integral economic development impact measure to fit the IED should take into account the following:
- Microcredit is an important tool of growth in developing countries because it gives the poor an opportunity to put into practice the crafts they know. It enables them to gain access to capital to make purchases such as livestock, fruits and food grains. Microcredit facilities save them from the clutches unscrupulous lenders. However, the challenge here is that poor people do not often own any kind of property, thus they lack the collateral against which they can secure loans. Also, most of them live in interior rural area and thus, lack access to traditional banks.
- Microfinance institutions play a vital role in facilitating accumulation of social capital in developing countries. Social capital benefits both the lenders and the borrowers. Frequent meetings among group members enable them to assist each other in their investment decisions and increases cooperative behavior. It, in turn, induces group trust and strengthens networks.
- Group lending guarantees the repayment of the individual borrowers. Frequent repayment meetings among the group members will help them form a social network and increase social interactions.
- What are the main theories and policies of economic growth? How does an integral economic approach to economic development defer from these traditional approaches and what gap does it fill in economic development implementation and policy design? Suppose you need to decide whether an intervention in education is justifiable or not. Please explain by means of utilizing one of the growth models the validity for that intervention.
Classical theory is one of the oldest theories available on economical growth. Adam smith published in the year 1776 a book called ‘The Wealth of Nations’ and it deals in detail the principles of classical economic model. The crux of Smith’s argument is that investors are rational observers and there should be no government intervention in regulating market forces. He proposes that unlimited competition will aid economic growth.
Malthusian theory, advocated by Malthus in 1798 through his book An Essay on the Principle of Population, argues that population explosion would provide a major roadblock for economic growth. He argues that the earth’s resources would be put under undue pressure, if the population keeps growing at an accelerated rate.
John Maynard Keynes and his Keynesianism or The General Theory of Employment, Interest and Money, calls for the government to increase its expenditure during depression period, arguing that it would stimulate demand. He disagreed with tenets of classical theory, which assumed investors to be rational observers.
The Neo-classical theory was developed by Robert Solow, who proposes that an increase in labor and capital will stimulate economic growth. The Human Capital Theory argues that capital should always include human capital in addition to physical capital. The Neo-Malthusian theory advocates that people should not be forced to emigrate for economical reasons and also supports the need for conscious birth control.
Maria Sophia Aguirre (2013) argues that for obtaining sustained development, it is not just enough to rely on classical theories, but there is a need to develop a new understanding of the processes involved. She says “This new approach is an integral approach to economic development, that is, an approach that seeks to respect the dignity of the human person, strengthens the family, and foster civic and social responsibility.”
Aguirre argues that the general economic theories have, in the past, failed to give clear solutions to alleviate poverty. She attributes this failure to the generic solutions that failed to address specific social issues and the uniqueness of each community/country. Thus, the economic behavior of a particular country should be scrutinized before developing a policy.
She further argues that “To reach it, opportunities need to be generated, effective initiatives at all levels facilitated, and stability ensured. This requires a better understanding of the socioeconomic dynamics underpinning economic development as well as actions at local, national, and international levels.”
Like her, many other economists suggest that an effective policy would be a combination of time-tested classical theories combined with empirical evidence on the ground reality of the country. Theory helps in understanding the concepts and providing external validity, while data, such as empirical evidence on institutions and statistics, would help fine-tune the policy to suit the needs of the country.
