Development Economics Summary Summary PDF

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Development Economics - Summary - Summary
Development Economics (Vrije Universiteit Amsterdam)
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Week 1: Poverty and inequality 03/17/2015
POVERTY
Most visible characteristic of economic underdevelopment.
Poverty means different things in different societies  most accepted definition: level of
welfare deemed unacceptable by society.
Poverty is a multi-dimensional concept (affects health, income and living environment), it is
therefore hard to find a single indicator for it. Most accepted measure is consumption:
 Household consumption: doesn’t value public goods nor take into account distribution w/in
household
o Household poverty  individual poverty
o Must account for household size
 Consumption vs income: would it be better to measure using income? More accurate measure
in developing countries.
o Self employment income hard to measure
o Covers self-produced goods
o Consumption smoothing  less fluctuations.
 Per capita consumption:
o Doesn’t take account of public goods in household
o Assumes equal needs – costs for children may be lower
o Assumes equal distribution
Capabilities approach to poverty: ability to:
 Live to old age
 Engage in economic transactions
 Participate in society
Poverty line: critical threshold of income, consumption, or access to goods and services
below which individuals are declared to be poor. Represents the min lvl of “acceptable” econ
participation in a given society at a given point in time.

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Concerns:
 Absolute vs relative notion:
o Declare a person to be poor when her actual, observed consumption basket falls
below prespecifed threshold or when her expenditure falls below the min. required 
ABSOLUTE
Ppl of diff incomes don’t all spend on same things  income represents capacity to
consume, not consumption itself
o Can the phrase “acceptable levels of participation in society” be given absolute
meaning? What you see as necessary depends from country to country. Must therefore
evaluate these standards relative to the prevailing socioeconomic standards  poverty lines
may vary greatly between countries.  RELATIVE
 Chronic vs transitive: Are people temporarily or chronically in poverty?
 Usually only household information is available, but this takes away from the evaluation of
individuals. In some households distribution of income can be greatly skewed.
Poverty lines are always approximations to a fuzzy threshold.
Can be set using 20th percentile income distrib, price of min food basket, or decreed min
wage.
Showing poverty statistics:
Measuring the poverty line

Food energy intake method
Different poverty lines can be due to
price, taste and relative price of food/non-food
differences.
1) Calculate MRS between food and
non-food
2) y = PFQF + PNFQNF
3) Substitute in MRS
4) Solve for quantity food and output
and plot line.
Cost of basic needs method
 Calorie intake 2100 cal

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 Food poverty line =q*p

sum(qc)=2100, c: cal val
PL = Food PL + Non-food PL
Use MRS between food and non-food.
QFPFPNF = PFF + PNFNF
QFPFPNF = PF(MRS) + PNFNF
NF = x
Total poverty line = NF + F (found using FEIM)
Laspeyres index: using weights as provided by basket to correct poverty line for inflation.
∑ PF Q F + P NF Q NF
∑ PF Q F + P NF Q NF
Using area stated in reference as the quantity of both for both areas.
Poverty measures
Head count(HC): count number of people below poverty line
Head count ratio(HCR): headcount as a fraction of population = HC/n
Insensitive to how far below poverty line people are  thus systematically biases policy in
favor of indiv very close to poverty line. Can lead to the people who need the help the most not
getting it.
Poverty gap ratio (PGR): measure of average income shortfall from poverty line.
∑ x (p− y i )
yi < p
PGR= , ¿
p
Divide by avg for society bc gives an idea of gap size relative to resources available in society  not
a measure of poverty itself, but of resources required to eradicate it.
Might have a misleading interpretation of poverty in econ w/ large income gaps.

Foster-Greer-Throbecke (1984): 1  z  yi 
P    
z: poverty line n yi  z  z 
HC ratio (P0), alpha = 0, PGR (P1), alpha = 1, Squared PGR (P2), alpha = 2
Income gap ratio (IGR): measure of shortfall of poor from poverty line, but calc differently (divide
by income required to bring all poor ppl to poverty line)  captures more directly acuteness of
poverty.
∑ ( p− y i )
y i< p
IGR= , HC : headcount of poor
pHC
PGR and IGR avoid bang for buck prob by neglecting # ppl below poverty line, but capture per
capita intensity of poverty.
HC and HCR have the bang for buck prob but not the per capita intensity problem.

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Therefore, should use them jointly if possible.

However, none of the measures above take account of relative deprivation (inequality) among poor.
Demographic features of poverty
 Household size: families below poverty line tend to be larger.
 Gender: female headed households
 Location: poverty is largely rural  regional inequalities
 Lack productive assets
o Rural poor: (Near) landless laborers
o Urban poor: informal sector
o Lack of human capital
INEQUALITY
Does inequality matter?
 Ethical grounds: is it really fair? Wealth is inherited – don’t we all have the same birth
rights?  NORMATIVE ANGLE
 Functional reasons: POSITIVE ANGLE: how inequality affects functioning of society as a
whole (criminality, work incentive +++)
o More inequality: more savings – more incentive to work
o More equality: more opportunities for the poor – less conflict.
What is inequality?
 A function of distributions: I  I ( y1 , y2 ,..., yn )
 Generally defined over the distribution of income (y)

 Also distribution of assets (land, health, education ++)
Measuring inequality – Lorenz curve
Says nothing about elements being analyzed, only about the
distribution of it among/within countries
The further the Lorenz curve moves from the 45* line, the more
unequal the economy is.
An inequality measure is consistent w/ Lorenz criteria  it
satisfies 4 principles
 Anonymity: no names: if you mix up y1 and y2 (ex) it should not
change inequality results: no one counts more than others
 Population: cloning: if you clone population and put it together
w/ current population, inequality should not change, bc. twice as many people but same income
distrib.
I ( y1 , y2 ,.., yn ) I ( y1 , y2 ,.., yn ; y1 , y2 ,.., yn )

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 Relative income: absolute income levels have no meaning: average income doesn’t matter – it
is the distribution that matters. If you make everyone k* rich, inequality should stay the same
I ( y1 , y2 ,.., yn ) I (ky1 , ky2 ,.., ky n )

 Dalton: robin hood: if you take from the rich, and give to the poor, you reduce inequality.
Same vise versa. Therefore, transfers from poorer to richer households are regressive transfers
and result in a more unequal distribution. Regressive transfer:
I ( y1 ,.., yi , y j ,.., yn )  I ( y1,.., yi   , y j   ,.., yn ) yi  y j

when
Problems:
 Lorenz ranking of income distributions is incomplete – curves may cross
 Policy makers want a single number
Alternative measures: range, kuznets ratio, mean absolute deviation, coefficient of variation,
Cumulative
Gini coefficient. proportion
in total
income
Gini coefficient: A/(A+B)
Line of Absolute Equality
Surface between 45* line and Lorenz curve,
Lorenz Curve
divided by total area under 45*
A B
GC = 1  1 person has total income
45o
GC = 0  No inequality
Cumulative proportion of population
CHECK!!!!
POVERTY TRAPS – BARRETT AND SWALLOW (2006)

Poor and try as hard as they can but are stuck in poverty  chronic poverty

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Poverty traps counter general economic theories, because to allow for poverty traps we must
distress some of the characteristics of the neoclassical model.
Capacity curve
- Work capacity generates income
- income is used for food
You first need a lot of energy to live, once you have

enough of that, you can get energy to work.
If you income is low (blue) you iterate down to a low
equilibrium where you move towards a worse welfare
If you have high income, you iterate upwards to better
welfare.
Nutrition poverty gap: health seen as an asset  incr marginal returns to health in the
beginning.
Poverty traps can also result from poor not having access to improved technology; even if
technologies have decr returns to assets.
Imagine there are 2 technologies in agriculture and they depend on L1/L2. On horizontal
function are assets. Both technologies have decreasing marginal returns to assets. They really help,
but at some time they work less and less. L2 is more advanced than L1.

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The combined slope does not show any more decreasing marginal returns to assets  could
give rise to poverty trap (don’t have assets to get more technology).
Critical threshold: determinant of whether ppl initiate upwards or downwards as a result of
market.
Empirical work  not yet proven
Advanced technology required at minimum asset level. If high to that level, temporary high savings
may be possible to switch to advanced technology. If low equilibrium, point is hard to reach.
Poor came make a much higher income if they get access to loans.
Regional poverty traps:
 Regional assets: local public goods – some regions are conflict regions and require big initial
investments in safety before assets have any returns.
 Poor extra vulnerable as they tend to rely more on pooled resources as a risk sharing strat
Policy implications of poverty traps:
 Need revolutions? Drastic redistributions towards poor – make entire econ better of
 Safety nets: avoid poor fall into poverty traps
 Improve access to credit – microfinance institutions

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Week 2: Land and Labor 03/17/2015
LAND AND TENURE CONTRACTS

The emergence of property rights
Low population densities: Before there where less people and so land was more abundant 
was always land available, and so labor was the determining factor ownership not required (labor
is the constraining factor).
Rising population densities: When population incr it started w/ communities defining what
their communal land was. Therefore, land was cultivated by inhabitants in village, and inhabitants
would build up right to be on land by working on it.
 Land used by members of communities but not by outsiders (strangers)
 W/ abundant land (fallow): general cultivation right but not spec right to cultivate
 w/ scarce land: spec cultivation rights & right to pledging
 Land cannot be sold (except maybe with approval of whole community)
Higher population densities: land rights move towards ownership. But since they do not own
it it cannot be used as collateral.
 Specific rights to cultivate
Land right  Right to inheritance
movement
 Right to rent out/use as collateral
 Right to sell w/in community
 Ultimately: right to sell outside community (complete private property)
Scale and productivity factors:
Expect larger farms to be more productive bc:
Technology – economies of scale
 Indivisibilities in production
 Large farms should be able to do as well as small farms or better
 However, many crops are scale neutral (coffee, tea ++)
Risk – Imperfect insurance markets

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Larger farms more productive bc:

 Fewer incentives will be offered to hired labor relative to owner-cultivation if labor is risk
averse – low wages on large farms, high productivity
 Owner-cultivator may try to self-insure by choosing low-risk low-yield crops - ppl risk averse
Poor people have a much harder time managing risk, because bad yield one year can have
fatal consequences, whilst rich people are self-insured through personal savings.
Expect smaller farms to be more productive because:
Incentive problems: Labor supervision favor small scale family production bc. productivity of
large scale production with hired labor lower than on small family farms.
Imperfect labor markets: unemployment: opportunity costs of family labor is lower than
market price  small farms employ more labor/m^2 higher productivity
Overall, productivity decreases with farm size. Smaller farms more productive if in ownership, larger
farms in sharecropping. Productivity on owned land is higher.
Pooling land – can smallholders exploit econ of scale by cooperating? Depends on source of
scale econ:
 Marketing: share fixed costs equally among farmers – easily supervised
 Production: effort not easily observed, incentives to free ride  lower productivity
Effect on econ of scale argument can lead to achieving econ of scale you wouldn’t w/out
cooperation – do things together to get benefits hard to attain on your own.
Some risks of pooling can be controlled by a
contract
Cultivation types:
 Owner cultivation: no contract
Optimized where marg costs = marg rev

o High in Asia and Latin America
o Low in africa
 Tenancy: rental contract
o Great regional variation
o General contract form: R  Y  F
Degree of yield you can achieve plays a large role in determining interest. R: revenue of
owner, f: rent to owner for renting out land, alpha: share of land owner has, y: yiled
owner gets from land

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o Fixed rent in Latin America  alpha = 0; F>0

Production on land remains the exact Same, so no Inefficiency results from this type of
contract, but owners revenues are smaller
 Share-cropping in Asia: yield shared among worker and owner of land  Alpha between 0
and 1; F=0
Smith & Marshall state that sharecropping is inefficient bc it’s like a tax on output/labor (tenant
doesn’t receive entire marg prod  disincentive to work)
Nothing has changed to production function, but now farmer is not maximizing production
function, but the net return, which is what remains after they have shared with the other. Because
marginal costs reduce labor inputs from L1 to L3, production reduced.
 Pure wage contract: get entire yield, but must pay for land. Alpha = 1; F<0
 Conclusion: sharecropping is not Pareto efficient: by moving to a fixed rent contract it is
possible to make the tenant better off while the owner is indifferent between the two contracts.
So why is there still sharecropping? Risk aversion!
 Squatting/tribal/commune tenure
Risk aversion
Measure risk aversion by use of the utility function.
Your utility increases more for lower incomes.
Maximize expected utility at C’
Expected utility to ensure function =
0.5(2000)+0.5(10000)=u(6000)
Person is risk averse?: divide deviation of unsure expected u by deviated expected utility
function.
Comparing two risky
projects------------------------------------ 
Risk in agricultural production

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Agriculture: size of harvest depends on “nature” with prob

Assume landlord is risk-neutral – tenant is risk-averse.
Therefore, must design a share contract that leaves owner indifferent but farmer better off
than under a fixed R.
p: prob outcome is good, (1-p): prob outcome is not good
Sharecropping: Expected return is equal between contracts –
spread (risk) of returns is reduced – share risk w/ others
Share production risks – risk adverse farmer prefers sharecropping. Landlord can write
contract that leaves farmer & himself better off than under fixed rent.
Reduce risks, and still make sure production is done efficiency: tradeoffs of the different ways
of doing it: look at underlying causes outside control of farmer in which you can insure. Insure against
nature.
This is efficient because it doesn’t affect the incentives of the farmers  they will still put in
as much effort because they want to make returns when weather is bad, BUT they can get help when
weather is bad  DOESN’T WORK – farmers don’t want to buy insurance (too poor to see the
benefits of paying for something that doesn’t give you anything back  financial literacy)
Constraint: Need to have money to pay for insurance  don’t outside of harvest period
Alternative view: Eswaran & Kotwal (1985) – share cropping exists bc there isn’t a mkt
for managers and supervisors
Markets for some inputs needed for agricultural production are absent (particularly mkt for
managers and land supervisors).
Supervisors supervise workers. Managers decide on production levels etc.
Fixed rent: tenant is manager and supervisor
Fixed wage: owner is manager and supervisor
Sharecropping: tasks are split
 Tenant is supervisor
 Owner is manager
Theory of contracts: owner had comparative advg in mgt, the tenant in supervision
Owner chooses:
 Fixed wage contract if difference in supervision capacities is small
 Fixed rent if difference in management capacities is s,all
 Sharecropping: otherwise: pool unmarketed resources.
LABOR MARKETS

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Classical model
Assumptions
 One period model (causal = permanent workers)
 No distinction between labor power & laborers
 No involuntary unemployment
 No uncertainty
 Work capacity of workers is given & labor supply determined by relative
benefits and costs of (labor) income and leisure.
Capacity curve ------------------------------------------------------------------------
W*: equilibrium wage: reach income you need for ok nutrition.
Labor supply curve:
Income affects work capacity and work capacity affects income.
Suppose individual maximizes income – labor supply jumps
discontinuously at a wage that can support required work capacity.
V angle denotes a wage. V4 is low as it only supports D. You can
only jump to C by V3.
As wage increases from V4 to V1, at V3 you gt a discontinuous
jump in labor supply. Same at the aggregate level if all are the same.
Labor market equilibrium

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Standard situation – everyone is healthy Market clears wage at v3, but demand
and labor supply is determined by is not enough to make everyone be at
leisure income trade off. the healthy side.
Degree to where society stands is determined by
non-labor assets and labor market.
If some people have other sources of income
which can help them achieve their healthy state,
they can achieve more income with lower work
capacity
Since rich person has non-labor income R2, they
work hard at v2. R1 has less NL income, and
therefore requires higher income for same
capacity
Minimum piece rate for work

Giving people more land, shifts work capacity supply
(demand curve) to the left because they have more non-labor
income (and giving more land incr their NL income).
People in supply curve, thus giving the land to others, causes
supply curve to shift to the right (bc they need to compensate
for non-labor income).
CHILD LABOR – UDRY (2003)

What is child labor?
 Laborer: 5-11 years: economically active (> 1 hrs)
 12-14 years: < 14 hrs (non-hazardous work; >1 hr hazardous)
 Child works on a regular basis for which he/she is paid
Where do most child laborers work? Agriculture
Industry with most injuries per 100 children: Construction
What can be done about child labor?
Most child labor in Africa. Then comes Oceania, Asia, and Latin America.

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Child labor and poverty

 Participation rates of children in the workforce are decreasing
 Child labor is related to poverty – but mostly to econ opportunities
 Child labor is largely an econ decision of the household
 Child labor sacrifices future welfare of child in exchange for current benefit for household
Dynastic trap: vicious circle (Udry) – not socially efficient
Financial markets imperfect: people underinvest in education  trade off between sending
children to school vs letting them work  capital market is not working bc they don’t have enough
money to invest and so would have to borrow. But banks are not willing to lend against future income
of children. Contradicts vs society benefit of investing in education
Allocation of benefits between generations: agency consideration: parents take decision, not
children themselves. Parents love children but think of their own household situation. Value their own
welfare more than that of their children. They benefit from income from child labor, but may not
benefit form the income the child will generate in the future due to the education.
Positive externalities education: collaboration. More productive when more people work
together than doing it on your own. Education doesn’t only benefit person with educaiton, but his/her
environment. Undervalue education because only see how it benefits you and not how it benefits
society as a whole.
Policies:
 Increase adult incomes – particularly in agriculture  may also incr demand for child labor
 Reduce cost of education
 Ban child labor
o Difficult to implement
o Immediate effect is less opportunities for poor families
Basu and Tzannatos: Parents will only send their children to work if their income falls
below minimum levels  adult and child labor are substitutes
Multiple equilibrium model: Adult and child labor are substitutes – both can do work 
adults don’t like to make their children work, so only do it to get the min income they need. After this
send their children to school.
E2: both work, bc a lot of labor is
supplied at low wage
E1: children don’t work: wage incr,
and less labor needed.
E3: is not a stable equilibrium, you
can iterate in both ways. Both children
and parents work.

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Week 4 03/17/2015
FOREIGN AID
Foreign aid can be either:
 Multilateral: goes through an institution
 Bilateral: from rich countries’ gov
Effective Development Assistance: grants from donor nation or institution
Official Development Assistance: grants and concessional loans net of repayment of previous
aid loans
Although inflows to poor countries are rising sharply, official inflows have been falling.
However, remittances have increased, and so the increase in inflows is due to capital from private
sources.
Grants are taking over for loans – to prevent countries from getting more debt. If they would
get loans their debt would incr.
Categories of official development assistance (ODA)
 Social: education, healthcare, sanitation, drinking water, ++
 Economic:
o Production (agriculture, manufacturing, mining, construction, trade, tourism)
o Economic infrastructure (energy, (rail)roads, communication equipment, electronic
networks, financial infrastructure)
 Other: consumption in emergency situations (emergency and food aid)
Dutch aid:
 2012: 6.5 billion dollars
 6.8% decr
 50% bilateral, 25%multilateral (WB), 25% through NGOs/private firms.
 Size and effectiveness hotly debated
Why aid?
 Traditional argument:

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o Financial: project finance for countries with poor access to world capital markets
o Technical/knowledge: raising returns through donor’s role in project selection and
design
o BUT many developing countries now have access to world capital mkts
o Fungibility: what you see is not what you get
 Policy argument:
o Use aid to change policies (structural adjustment lending)  conditionality
(especially with IMF loans there is a conditionality condition for aids).
o BUT overwhelming evidence that ex ante conditionality does not work – donors keep
on distributing aid when conditions are not met
o Recipient has no incentive to maintain reforms if aid is temporary and donor reluctant
to punish reversals
o 4 possible outcomes if donor attempts to “buy” policy reforms
 Desired policy changes not implemented
 Implemented, bur also in the no-aid counterfactual
 Policy change is due to donor pressure, but reversed
 Policy change effected by donor and sustained
 Selective argument: Regarding good behavior – ex post better than ex ante
o Ex post conditionality: donors don’t try to change policies but they are selective in
awarding aid
o Roles of aid under selectivity
 Signaling: if aid tied to success then private agents can economies on
monitoring. Rationale for donor role: underinvestment of private agents
in info about small, recently reformed economics
 Restraint: easier to resist pressures for policy reversal if aid allocation
rule perceived as credible
 Realistic argument: bureaucracy
o Easterly: focus on political economy of aid industry
o Goal: aid volume rather than outcomes?

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o Principal-agency problems: Principal (tax payer), agent (aid bureaucracy) 

beneficiaries invisible, lack information – hard to get info from those who it should have
helped to assess effectiveness. Therefore, info is asymmetric
Micro Macro Paradox
Mosley (1987): the seeming lack of a positive macroeconomic impact of aid in combination
with the many favorable micro-based project evaluations is a puzzle
 Aid is not a large input at macro level
 Project outcome variables are intermediate
 Macro evidence is questionable (robustness)
 Micro evidence is questionable (externalities, selective reporting)
New aid allocation:
 Decr marginal returns to aid  growth
 Aid more effective in good policy countries
 Estimate poverty reduction growth relationship
 New recommended distrib – more to india
CORRUPTION
The misuse of public office for private gain – typically involves a legal standard
Ex:
 Sale of gov property by gov officials
 Kickbacks in public procurement
 Bribery
 Embezzlement of government funds
Is corruption like a tax or fee?

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 Yes: creates a wedge between marginal product of effort and private marginal gain.
 No:
o no transfer to government budget,
o bribes involve higher transaction costs than taxes because of uncertainty and secrecy
(bribe-taker may renege on agreement and ask for additional bribe).
Is corruption like lobbying?
 Yes: influencing another party.
 No:
o private gain versus collective gain
o temporary versus (more) permanent gain
o individual government officials versus government decision-making.
For example a firm can pay a bribe to a government official to privately avoid a tariff or a
license today or it can (collectively) lobby the government to remove the tariff or license for all
current and future firms. Hence, lobbying involves collective action problems.
No definition of corruption is clear-cut. Corruption can also involve private actors, such as
firms misusing corporate assets or colluding. Also corruption may be borderline legal, such as legal
offers of postretirement jobs in private sector firms to officials and politicians or legal campaign
contributions.
English dictionary gives a broader definition: to change from good to bad in morals,
manners, or actions / to degrade with unsound principles or moral values / to rot, spoil / to become
morally debased / impairment of integrity / inducement to wrong by improper or unlawful means
(bribery) / a departure from the original or from what is pure or correct
note: corruption depends on a standard of propriety and therefore is context-specific.
Which countries are the most corrupt? (Svensson 2005)
Two types of common corruption measures:
 Subjective/perception (ordinal): likelihood that gov official expects a bribe
 Objective (cardinal): share of sales paid in unofficial payments to officials
Perception measures:
 Control of corruption (Kaufmann et al)
 Transparency International: Corruption perception index

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 International Country risk guide: risk assessment by private firm: likelihood officials will
demand bribe (Mauro 1995)
Characteristics of high corruption countries
 Developing or transition countries
 Corruption is correlated with
o GDP/capita: corruption tends to decr w/ incr GDP per capita, but there is a lot of
variation
o Schooling
o Openness
o Regulations
o Freedom of media
How to fight corruption
 Higher wages: only useful if there’s an honest third party that can monitor the official. Incr
wages w/out monitoring only incr official’s bargaining power
 Additional resources to strengthen enforcement
 Delegation (hiring integrity)
 Reward refusal of bribes
 Reduce personal contact between potential bribe-takers and givers
 Simplified and transparent rules
 Improving citizen access to info
 Whistle blower protection
 Induce competition
Corruption case: School funds in Uganda (Reinikka and Svensson, 2004)
Public expenditure tracking survey in 250 Ugandan schools.

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Corruption grant based on number of children (ca 2$ per child)

Cross checking study of corruption (theft): grants vs actual receipts
Policy: transfer of non-wage funds form central level to schools but through intermediate
bureaucratic level.
Info asymmetric: in rural areas parents lack info
Grass-root monitoring: Reinikka and Svenssson (2005)
Focus on % grants received at school
Reducing asymmetric info can decr capture (corruption)
Possibly more effective for reducing capture private goods than public goods
Incr. grass root monitoring nowadays viewed as important input for efficient serv del.
POPULATION GROWTH AND ECONOMIC DEVELOPMENT

Birth rate: # newborn children per 1000 population per year
Death rate: # ppl who die per 1000 population per year
Population growth rate(%): Birth rate – Death rate
Countries by birth rate Countries by death rate
Demographic structure:
 Aggregate growth hides significant info
 2 countries can have same population rate:
o A: high birth rate and high death rate
o B: low birth rate and low death rate
 A and B will have different age distributions  large consequences on future growth rates

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World age distributions
Developing world is very “young”

Impact of age distribution on birth and death rates:
 Birth rate is determined by age-specific fertility rates and the age distribution
 Age specific fertility rates = average # children per year born to women in a particular age group
 Total fertility rate = total expected # children (summed over lifetime)
 Birth rate is determined by age-specific fertility rates and the age distribution
Age specific fertility rate = avg # children per year born to women in particular age group
 Death rate is determined by age-specific mortality rates and the age distribution
Age specific mortality rate = avg # ppl per yr who die in particular age group
Birth rate inertia: at a young age distribution, birth rates (and population growth) will remain
high for years even if total fertility rate goes down.
Echo-effect: high birth rates  population growth  younger-population  high birth rates
& low death rates
Mortality rates differ between countries bc of different:
 Standards of living
 Public health policies – sanitation
 Medical treatments
3 phases in demographic history:
 high birth rate – high death rate (18th century)
 high birth rate – low death rate: population explosion (18th – 19th century)
 Low birth rate – low death rate (late 20th century)
Demographic transition

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Population growth inertia: Given fast mortality transition, population growth depends on
what happens to birth rates.
Birth rate inertia at macro level: aggregate:
 Age distribution
 Echo effect
Birth rate inertia at micro level: household:
 Age-specific fertility rates
 Total fertility level
 Children are seen as consumption goods and as an investment (old age security, insurance
against shocks)
 Missing institutions and/or markets:
o Social security and retirement plans
o Other insurance: health, life, disability, unemployment, theft, fire, etc.
 Are children a perfect asset?
 Inadequate info on death rates
 Lack of employment opportunities
 Social norms
 Hoarding/targeting?
Investment calculus children

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An economic analysis of fertility (Becker, 1960)

Utility maximizing framework: maximize utility for given budget & time constraints
Benefits:
 Consumption good
 Production good: child labor, insurance, old-age security
 Tastes (and risk aversion)
 Quality – quantity trade-off
Costs of children:
 Direct costs (food, education, health)
 Indirect costs (opportunity cost of foregone labor and time)

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Criticisms of study:
 Access to birth control (knowledge, availability, affordability, acceptability)
 Social norms and identity
 Intra-household decision making
Mozambique
Are fertility choices socially optimal?
 Incomplete info on death rates: better info might change decisions
 Uncertainty: ex-ante versus ex-post preferences
 Limited access to contraception: availability, affordability, acceptability
 Social norms (inertia)
o Appropriate age of marriage, strength of family ties
o Ideal # children, importance of education
o Images of masculinity/femininity, role of women in labor market
o Contraceptive, breastfeeding practices
o Acceptability of family ties
 Externalities: full (social) costs/benefits of children not internalized
o Across families:
 External cost of using services (schools, health)
 Congestion, environmental pressures
o Intra-family: negative if baby mining shared by extended family

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RURAL AND URBAN

Nigeria: most populous country of Africa (175 million) & largest economy of Africa since
2014. Share of urban population has steadily increased from 25% in 1984 to 32% in 1994 to 46% in
2014. Lagos: Since 2012 largest city of Africa with 21 million inhabitants (it surpassed Cairo);
produces a quarter of Nigeria’s GDP; notorious traffic jams; 2/3 of its population are slum dwellers.
General
 Economic development is uneven and leads to structural transformation of the economy.
 Most important structural feature of developing countries is distinction between rural and urban
sector
 Rural development and urban development are strongly linked because rural areas provide labor
and food. Urban access to international markets for labor and food is often limited because of
market restrictions (e.g. because of desire for ‘self-sufficiency’).
Time trend vs population
 Urban areas:
o Population increased in less developed regions
o Population increased slightly, but almost stayed constant, in more developed regions
 Rural areas:
o Population grew but is constant (slightly declining atm) in less developed regions
o Population constant over years in more developed regions (slight decr)

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 More people living in urban areas in Latin America and more developed regions, BUT the
amount in African and Asia is increasing EXTREMELY much
No country has grown to middle-income status without urbanizing – a lot of econ
development & growth produced w/in urban areas!!
Rapid urbanization around the world
 Positive association between urbanization and per capita income
 Urbanization is happening everywhere, also for countries with negative income growth
 Countries that are the least developed are the least urbanized, and vise-versa
 Shift from agriculture to industry and services with economic development
 The poorest countries in 1980 had most of their population working in agriculture.
 The richest countries were most industrialized & had the most services.
Urban and rural: development context
 Structural info form agriculture to industry and services w/ econ development
 Population flows from agriculture to industry
o Large rural-urban migration flows
o Migrant labor in industrialization process
 Food surplus from agriculture to industry
 Flows from industry to agriculture: industrial inputs in agriculture, agriculture as a major source
of demand for industrial consumption goods
 Industrialization pulls people from rural to urban areas  ppl who migrate from rural to
urban areas are called migrant labor
The Lewis Model
Growth can only happened in the extent to which food and labor are moving from rural to
urban areas
Distinction between ‘traditional’ and ‘modern’ is not always perfect. Agriculture can be
highly commercial, highly capital-intensive, and employ wage labor as well.
Low Marginal product of
labor (MPL) in agriculture implies
that:
 Pulling labor out of
agriculture has negligible
social costs
 Wages in agriculture low
Wages in agriculture are not
equal to MPL  income sharing
w/in family &/or community:
insurance,
social prestige, altruism

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As capitalist sector expands, resources are pulled out of traditional sector

Industrial expansion is fuelled by low-wage labor and food form rural areas, until loss of
agricultural labor starts to ‘bite’.
Process cont due to development of industrial sector (Saving and investment)  finally
agriculture commercializes  limited international food-gain trade
Assumption of surplus labor realistic?
Assumption of zero marginal productivity is not necessary:
 Important is lower productivity in agriculture and even if the marginal product of labor is not
zero, there might be a surplus of laborers given that family members can work more if they
have a constant marginal cost of labor (leisure)
How realistic is it?
Whole concept of labor surplus is not essential for model to work.
 Even in disguised unemployment it is easy to attract workers to urban
 All ppl contrib a bit to output, but taking them away won’t decr output bc others incr their Y
Constant wages:
 Policies implemented by gov so that income won’t be increased (tax to prevent ppl left in rural
from incr their pricing)
Policy issues:
Agricultural taxation: Keeps agricultural wages down and labor supply elastic (+ urban food
availability)
Problem:
 Lack necessary information to tax smoothly – costly to find out
 Political: industrial elite in favor, workers & farmers against – elite want to tax hard
 Economic: if farmers know all their extra income will be taxed, they won’t want to incr total
production
Agricultural pricing policy:
 Higher output prices are costly to industrial capitalist bc opportunity cost of workers (i.e. farm
income) incr & food prices incr. Therefore in practice higher output prices are combined with a
food subsidy. The cost is paid from the government budget
 Overvalued exchange rate benefits especially urban consumers: discourages exports of food &
encourages consumption of import goods. Farmers may not be aware that exchange rate is
overvalued. However overvalued exchange rates creates inefficiencies & possible balance of
payment problems
Agricultural reform to improve incentives: ex. China & Vietnam
Intro of household responsibility sys: farmers are allowed to sell on the market &
deregulation of prices). Other barriers are imperfect credit markets, insurance markets, land markets,
& removing barriers will boost production  will keep food prices low (although still incr
opportunity cost of workers)

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China is the country w/ the largest migration from rural to urban

Most important price in world: Chinese wages bc translates into global process which
translates into global inflation.
Large informal sectors and slums in LCD urban areas
Harris-Todaro model
View of Levis:
Pull factors:
 Higher wages (+)
 Better facilities in urban areas (+)
Push factors:
 Lack of employment in rural areas (+)
! Higher than equilibrium wages are institutionally determined, not by market clearing!
Assume: high turnover: each period new round of ‘lottery’ for the formal sector jobs
Condition gives ex ante condition of being indifferent between migrating & not migrating. Ex
post the migrant is not indifferent.
The model assumes risk neutrality. With risk-aversion there would be less migration
 Probability of finding a formal sector job in urban area:
 Expected urban wage:
 Equilibrium with risk neutrality:
HT predicts:
 How much migration
 Employment lvls in both formal & informal urban sectors
Classic formulation:
 Would-be migrant compares agricultural wage to expected urban wage
 Prob of formal sector job = formal sector share in urban employment
Policy issues:

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Formal sector job creation may increase urban unemployment if “migration effect”
dominates the “soak-up effect”
Paradox applicable to other situations: urban congestion after building more roads, increasing
waiting lines in hospitals after increasing health services, +++
MODEL IS TOO SIMPLE TO TAKE LITTERALLY BUT HIGHLIGHTS IMPORT
MECHANISM

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Week 5 03/17/2015
CREDIT
Wellbeing: material resources (regular income, sufficient food), mental peace, good health,
being part of a community, safety, freedom
Poverty: lack – of employment, money, shelter, clothing; being powerless, voiceless,
excluded; risk and uncertainty, fear for what tomorrow will bring – MULTIDIMENSIONAL
Financial lives of the poor:
 Low average income
 Large fluctuations in income (seasonal)
 Necessity for saving/borrowing for large expenses and investments (ex. education)
 Many & large uninsured risks (drought, health +++)
Currently 2.5 billion adults in the world don’t have access to formal financial services (credit,
savings, insurance, money transfer)
Lending is risky
 Limited liability: limited enforcement, lack of collateral
 Info asymmetries (Adverse selection, moral hazard)
Credit important bc:
 Poor face combo of high income fluctuations, time consuming agricultural production
(business), and high (uninsured) risk
 Poor have low income and low savings/assets  short-term liquidity prob (hurts consumption
and production)
 Credit needed to ‘smooth’ consumption, invest in production and offer protection against shocks
Demand for credit:
Fixed capital: land, machinery, buildings, equipment, cattle
Working capital: cash needed for financing inputs, e.g. seeds, fertilizer, pesticides, inventory
Consumption credit: often needed for survival after shocks (bad harvest, illness, death),
seasonal effects, weddings
In Thailand average income of business owners is three times higher than non-business
owners in their sample. Cannot be explained by differential entrepreneurial ability.

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Who provides rural capital:

 Formal (institutional) lenders:
o Commercial banks: prob of limited liability bc no collateral & high transaction costs.
o Development banks: heavy subsidies to compensate for risk and high transaction costs,
and in order to keep interest rates down. Led to a surge in demand for credit, channeling
funds to the politically favored instead of the poor. Issues that made the poor worse off
on average:
 Pushed out informal lending mechanisms
 Break down rationing mechanism of interest rates
 Saving deposits were less necessary
 State banks: pressure to forgive loans before elections and remove
incentive to build efficient institutes.
o Microfinance institutions
 Informal: Moneylenders – loan sharks; extremely high interest rates; exploitative; local
monopoly, can keep the poor for ever in debt. However, banning moneylenders could actually
make the poor worse off: apparently some are willing to pay the high rates; moreover, the
interest may be necessary to cover transaction/screening/monitoring/enforcement costs.
Other informal: family, friends, landlords, employers, traders
Linkage formal-informal sector
---------------------------------------------------- 
Unclear between formal and informal  integrated,
Farmer gets credit form trader who borrows money form formal banks
since they have more collateral
Administrative costs, premium for default risk, monopoly rents resulting from high value of
information. Costly to expand business
Low levels of default: even without legal systems enough enforcement mechanisms
Collateral expands options for borrowing/ Default rate is less so interest rate can be lowered
There are profitable enterprises available but default risk stops lenders from providing loans

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Efficiency: cost of
capital r is the minimum
interest rate i.

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Explaining high interest rates:

 Lender monopoly? High rates may not be a sign of monopoly power, may be a result of high
costs of providing capital  if that is the case it makes sense to charge high rates as costs of
lender bust be covered
o Inefficient since good projects may not be funded
o But do high rates imply monopoly / inefficiency?
o Costs for the lender may simply be high:
 Default risk
 Transaction / information costs
 Information asymmetries (agency problems):
o Adverse selection and moral hazard
o Limited liability (due to lack of collateral and enforcement problems):
Borrower will make more risky results if he has limited liability

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Credit rationing
‘At the going rate of interest the borrower would like to borrow more money but is not
permitted to by the lender’  credit constraints, less growth, more poverty
2 types of credit rationing:
 Borrower risk type (adverse selection)
o High-risk versus low-risk borrowers:
 Observable differences (e.g. ill landless laborer versus healthy farmer
with land) – easy to set interest rate accordingly
 Not all ‘risk characteristics’ are observable (asymetric info) – harder
to assess if lender cant observe  bases all on average risk
 Result: contracts based on average risk  may lead to ‘credit rationing’
o Using average risk is not the best way as riskless lenders will also take smaller chances
and thus have smaller returns

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Since R2 higher than R1, risky person is willing to pay higher interest rate
If it is inbetween only risky person will do and so thy he can just as well set it at R2.
Therefore, must set on R1 or R2. therefore, best choice for lender depends on p
So
if
the
risky type is sufficiently risky, and p is

sufficiently low, the lender will not raise interest
rate to i2
 Default-related (moral hazard)
Moneylender wants to maximize the rate of return (interest rate i). The borrower (e.g. farmer)
converts working capital L into output f(L)
The farmer has an outside option yielding A. This implies f(L) – L(1 + i) ≥ A (participation
constraint)  If farmer always repays loan, the optimal solution is given by graph (no credit
rationing)
Production function: the more money he will get his
loan size will increase but at a decreasing rate.
L is where marginal benefits are maximized - loan is
still lower than A, & so lender can increase i

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Chooses i that is relatively low, but as high as possible. Why doesn’t offer higher loan size  bc
then farmer will also want to run away more
Credit rationing in equilibrium
Money lender keeps I below participation constraint, & keeps L low at L1 to meet pay-back
restriction  borrower would want to borrow more  credit rationing in equilibrium!
Interlinked transactions: many loan transactions are linked w/ agreements in other mkts (land,
labor, trade), bc ease of transactions, hidden interest, better info, ease of enforcement +++
Empirical observations
 Extreme variability in the interest rate within the same sub-economy
 Low levels of default
 Rich people borrow more
 Segmentation: Moneylenders serve a fixed clientele on a repeated basis
 Interlinkage: credit and non-credit transactions are often combined
 Rationing: many people want to borrow more at the given interest rate
 Exclusivity: borrowers not allowed to borrow from more than one lender
MICROCREDIT
With limited liability there are two general solutions to the lender: credit rationing (reduces
adverse selection & moral hazard) and interlink age
Microcredit started by Mohammed Yunus  revolutionary
BUT now a lot of critics:
 How does it work, which elements are essential?

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 Effectiveness: has beneficial impact been oversold?

 What about other financial services?
Elements:
 Dynamic incentives
 Joint Liability
 Repayment frequency
 Loan collection in groups
Dynamic incentives: try to incentivize ppl themselves  make them, themselves, want to
payback.
 Access to (increasingly large) future loans is conditional on current loan repayment
 Trade-off:
o Repayment: Cost of loan plus interest now, but generates additional profits in the future
(= future revenues minus loans and interest
o Default: This saves the one-time cost of loan plus interest now, but only generates the
outside option in the future
 Similar to credit rationing!!!
Ppl. will make a personal incentives trade-off  therefore must be properly structured!
- Participation constraint: L better than A
- No default constraint: lender must make sure he’s repaid
therefore, lender must set i lower than from p.c.

If borrower has no mental time horizon frame, lender will never be able to induce borrower to
want to invest as taking & leaving will be most beneficial – incr N = incr likelihood of good loan for
lender
Joint liability: uses social collateral instead of personal collateral.
Screening is done by group members – helps with both adverse selection and moral hazard –
thus easier to enforce.
Group pressure bc group know each other well, & so social sanctions of not repaying makes
people repay. Also about helping each other as there is a lot of informal risk sharing w/in joint liab.
Not observable to bank who is which type, but society does  asks them to come in pairs.

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 Safe pair with safe

 Risk want to pair with safe but no safe will pair with risky  risky pair with risky
 Bank still doesn’t know which pairs are risky and which are safe
 only p & g vary  g > p therefore Return for bank with joint liab > Return without
 Bank can ask lower i  more safe ppl attracted into industry (opposite multiplier effect)
Downsides:
 1 fails  strategic default of partner
 May lead to excessive risk aversion in group
Joint vs. individual liability:
 Gine and Karlan (2009) conducted two field experiments in the Philippines to asess the
importance of joint liability for reducing default
 A) Random assignment of areas to individual or joint liability contract
 B) Among groups who had formed based on joint liability, a random subset received an
individual liability contract instead
 Result: no difference in default rates between the three groups
Repayment frequencies: Field and Pande (2008)
Field and Pande (2008) randomized repayment structure:
 Weekly intervals, starting immediately after loan disbursemen
 Weekly intervals, starting one month after loan disbursement
 Monthly intervals, starting one month after loan disbursement
Results:
 Low defaults, but less risk-taking
 Low defaults, and more profitable business investments. Best performance!
 High defaults from 3rd month onwards  lack of trust/social capital? Or lack of self-control in
setting aside money and saving for repayment?
Ppl in first group invested in less risky & lower return project bc. scared they couldn’t repay
every week in beginning.
Loan collection:
 Even without weekly meetings and without joint liability, default rates are generally very low

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 Low interest rate due to low administrative costs of loan collection:

 Loan agent collects all repayments at the same time
 Repayment amounts are fixed for all members
 Group leader is typically in charge of collecting it for the loan agent
 Social norms (discipline/embarassement) in group meetings?
Does microcredit work?
 Very low default  yes
 Big industry  yes
 Many success stories  yes

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Week 6 03/17/2015
RISK AND INSURANCE

Risk aversion
Utility function is concave bc this is a
charateristic of risk aversion
Can choose 250 certain, or gamle (get 0 or 600).
Expected profic of gamle is 0.5*0 + 0.5*600 = 300. If
you would have got 300 with certainty, you would have
utility c’. But you dont have that option.
Risk premium allows people to have a certainty
that they will never be worse off than x.
Straight line: risk neutral

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Types of risk:
 Regional/country/common: aggregate/systemic/covariant: everyone has prob at same time –
hard for insurance comp & therefore insurance comp must have a very large pool of ppl from
diff areas
o Climatic: rainfall, droughts, floods, tornados, temperature
o Agricultural: pests, rodents, livestock disease
o Social & capital: civil unrest, political changes
 Individual: idiosyncratic: easier to insure as it affects one person at a time – may be limited to
an area
o Accidents and crime: fire, theft, banditry
o Health: illness, disability, death
o Economic: unemployment, price-fluctuations, non-payments
Household risk management
 Access to formal insurance is generally lacking in developing countries
 Income smoothing: Risk-mgt strat: reduce riskiness of income process ex-ante
o Income diversification: combine activities w/ low +’ve covariance
o Income skewing: engage in low-risk (but low-return) activities – choose less risky crops
 Consumption smoothing: Risk-coping strat: deal w/ consequences of income risk ex-post
o Self-insurance (inter-temporal): consumption smoothing: precautionary savings or
buffer stock savings:
 Lack of access to formal saving accounts
 Informal savings, land, jewelry, assets, livestock, grain
 Assets can be risky (price fluctuations correlated w/ stocks, livestock
disease, damage to stored harvest)
 Assets are often lumpy
 Asset sales affect productivity
o Informal credit
o Informal risk-sharing (mutual insurance)

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o Adjust labor supply

 Temporal migration
 Incr. activities
 Child labor – linked to uninsured risk
o Last source: Reduced consumption
Ex: Mutual insurance:
2 farmers. Both have 2 possible
outputs
If no insurance they will either get
2000 or 1000 individually. If mutual
insurance, then they split half. The expected
value is same as with no insurance, but the
spread is less. The outcomes are closer together. Therefore, graph from above where utility incr when
spread was smaller applied. Therefore utility higher bc there is less risk  their outputs are
completely independent though
If they were perfectly correlated then the probabilities would be (not bold in central 4) 
shows problem of common/covariant risk – sharing risk doesn’t make sense bc it wont change either’s
output.If they are perfectly negatively related, then it’s a good time for sharing insurance.
Then you have 0 ½ and so they will always get 1500 each
½ 0
Mutual insurance:
 Reduced spread of potential outcomes increases utility if individuals are risk-averse
 Insurance concerns unilateral transfers that are unrelated to past or future transfers (in
contrast to credit!)
 The benefits of mutual insurance depend on the degree of correlation between outputs of
individuals  easier to insure idiosyncratic risk
 With a large number of farmers, independence of outcomes is sufficient to allow for full
consumption smoothing
Perfect insurance model
Epsilon disappears w/ idiosyncratic shock bc it is farmer
specific. Therefore, best farmers can do is getting
insured against epsilon.
Test whether α1 = 0, α2 = 0

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In India: α1 ≠ 0 but small, α2 = 0

Conclusion: consumption smoothing takes place - could be through mutual insurance or other
strategies
 Alpha 1: how much consumption of indiv fluctuates with shocks to individual income: if
insured against personal risks, then alpha 1 should be zero.
 Alpha 2: how much indicidual consumption fluctuates with other shocks
Not always as good a story as in India, but people do seem to be able to insure to some extent
Why is insurance not perfect?
Limited information (about final outcome and what lead to it)
Don’t know how hard farmer works on farm. If you know you’ll always get insured amount, why
would you give farming your all?Start with idea that there are 2 outputs, high or low - Whether or not
you are lucky depends on risks you don’t know and cant control – effort doesn’t affect risk  Effort
incr prob of producing high output.
Viability of insurance if sufficiently large number of farmers participate: Mean inflow = mean outflow
 p(1 – p)(H – L) = (1 – p)p(H – L)
Incentive problem: Pay-off with high effort < Pay-off with low effort:
 u(pH + (1 – p)L) – C < u(pH + (1 – p)L)
Incentive constraint: choose x and y as
close as possible w/out incr incentive
Viability constraint: for famers to be
willing to put in effort prob of having
high outcomes > prob of low

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First best insurance scheme isn’t possible  look for the 2nd best - partial insurance.
Limited enforcement
Ppl put in effort, but will high output farmer remain willing to pay or ditch insurance & leave only the
people who need it there  M maximizes everyone's utility and so would be the first choice.
High output must decide whether to put money in common pot and end up with middle amount M, or
will he keep high individual high amount H?
Utility of M is higher than the risky utility of being on your own - The longer you look ahead the
larger your loss of dropping out of scheme will be.
S: cost of deviating: social sanctions you will have in village
In enforcement constraint must make sure that losses of leaving are larger than one time gain.
Since hard to say if losses are larger than gains, must go for second best insurance scheme.
For enforcement theory X and Y are closer than in previous theory.

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LHS and enforcement constraint
Social capital and mutual insurance

Strong social capital yields information on:
 Actual outcomes (deceit)
 Efforts and behavior (moral hazard)
Strong social capital and enforcement:
 Social sanctions
 Repeated interactions
 Altruism
Downsides:
 Often local: covariance problems
 Exclusion of outsiders: almost by definition if it has strong definitions for who’s in group will
exclude people. These are usually the marginal people
 Decreasing with mobility: break down of current systems
 No privacy (strong social control): social capital will control all aspects off peoples lives 
people feel very pressured.
 Reduced incentives to excel: people who do well feel compelled to share, and so ppl who do
worse dont have incentives to do better bc they just get help from those who are well off

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INTERNATIONAL MIGRATION
Economic migration: Not from perspective of rich countries but on migrants and their home countries
Tertiary educated people are most likely to migrate from developing countries, and also likely to get
high-skilled jobs.
Foreign Direct Investment (FDI) is the largest financial flow.
FDI (decr dramatically) and Official Development Aid (Stopped) responded the most strongly to the
economic crisis, Remittances remained.
A lot of migration between continents BUT most migrants move within their continent!
Main determinants of migration:
 Wage gap between rich and poor countries (+)
 Poverty constraints in sending country (-)
 Size of the young adult share in sending country (+)
 Size of diaspora (foreign-born migrant stock) from sending country currently residing in
receiving country (+)
 Political tensions in sending country (+)
 Income uncertainty (e.g. unemployment) in receiving country (-)
 Immigration regulations (-)
If wage gap is too large people cannot afford to migrate. Poverty constraints are a negative
determinant of migration
Brain Drain: take smart country form one country and take it to their own and so drain the
resources of the poorer countries.
“The migration of engineers, physicians, scientists, and other highly skilled professionals with
university training”
 Lead to negative effects of the poorer countries (?)
 The brain drain has led to grave concerns and heated debates in developing countries
 Skilled (tertiary-educated) individuals are 3.5 times more likely to migrate than the
secondary-educated and 7.3 times more likely than the primary-educated
 Skilled migration has increased in absolute terms over the past decades, but so did education
levels. The brain drain rate has remained stable.
 Skilled migrants are increasingly likely to chose developed countries as their destination
Micro-level drivers:
 Higher income
 Career opportunities
 Lifestyle
 Family reasons
Docquier & Rapoport theoretical model of brain drain

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 Young adults work (for a low-skilled wage) and can choose to invest in higher education at a
cost that depends on ability
 Their consumption cannot drop below subsistence level, i.e. they need to have sufficient money
for the investment in education
 High-skilled wages are above low-skilled wages in their home country
 Wages in rich countries (both low- and high-skilled) are substantially above those in the home
country
 Only high-skilled individuals can migrate - They do so with probability p
 The remaining high-skilled adults work in the home country
 If wages in foreign country are high enough, the best skilled ppl will invest in their
education and try to migrate
Also talk about BRAIN GAIN: more skilled people will get education and so will also be left
with more skilled people in home country. So attractive to try to go abroad, so many invest in
education and therefore, the unlucky who don’t get to move stay at home.
Brain drain or brain gain?
Conditions for a beneficial brain gain in the long-run:
 The differential in wages between host and home country should be large enough to provide an
incentive effect, …
 But not so high that liquidity constraints on educational investment in home country become
binding
 The probability of highly skilled migration should be sufficiently low
Brain gain (the ‘winners’) – a positive net effect:
Countries with low levels of human capital (<5%) and low high-skill emigration rates (<20%), e.g. the
main emerging economies such as Brazil, India, China, Indonesia
Mainly in emerging economies. Started with low level of human capital, but high skilled migration
rates were very low so there was a lot of space for this to happen in.
Brain drain (the ‘losers’) – a negative effect:
Countries with high enrollment rates in higher education and/or large high-skill emigration rates, e.g.
many small and medium-size African and Central American countries
Have either high education enrolment, or have large emigration rates.
Critique:
 Implicit assumption that education in home country can absorb extra demand for education
 Bias in accumulated skills
 Restrictions on migration may not apply to all professions and for the best people
Benefits of high-skilled diaspora:
 Reduces international transaction costs  stimulates trade and FDI: enhanced by diaspora –
make it easier for countries to make business

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 Facilitates the diffusion of knowledge and ideas  increases productivity in home country
(especially in the high-tech sector): is high skilled migrants get to work in a high tech firm
 May contribute to improved domestic institutions, such as building democracy : if theres a lot of
ppl living abroad it is beneficial for the institutions at home (democracy, government etc). Ppl
change their norms from living abroad and take changed ideas to home country
 Return migration may further increase benefits : ppl don’t need to be permanent migrants 
bring knowledge and contacts home
 But empirical evidence is limited, especially for small countries with largest diasporas
Externalities of brain drain:
Direct fiscal cost: Home countries pay all or part of the tertiary education of high-skilled
migrants. Student loans are difficult to recover.
Indirect fiscal cost: loss of tax income
 estimates suggest these are of the same order of magnitude as the remittances sent by migrants –
not sure they could pay a lot of tax bc might’ve had low income, but would pay tax
 Negative externalities (productivity, health) – productivity decr bc only fewer and low skilled
workers left
 Positive externalities (knowledge diffusion, trade)
 High returns to the migrant (higher income levels)
African doctors: write very negatively about how many doctors leave and so they are not
there to help fight diseases at home. BUT the level of doctors has not decr. Therefore, the braindrain
is in terms of quality, and not quantity. The best doctors have left, but there aren’t less doctors. Much
more subtle and complex issues.
Indian IT specialists: So many IT specialists in India now lead to substantial concerns in
india. The estimations didn’t take the potential brain gains into account.
 India’s diaspora provided foreigners with information on the Indian labor force
 This increased both the demand for Indian IT specialists abroad and the demand for Indian IT
services exported from India
 India’s diaspora helped diffuse knowledge through: Skill upgrading , Return migration, Brain
circulation
 India’s diaspora increased the setting up of sectoral institutions and formal networks in India
Remittances: a transfer of money by a foreign worker to an individual in his or her home country
Uses: consumptive and investing purposes: Saving, Health care, Education, Needs, Invest in
productive resources
 Remittances stayed really high all the time. Didn’t decrease as much as FDI
 FDI fall out if theres a lot of crime in countries etc
Micro-level motives for remittances
 Altruism (increase consumption of recipients)
 Insurance

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 Income diversification
 Repayment of initial migration costs
 Investments by recipients (education, business, farm)
 Investments by migrants
 Old-age support of parents (securing future inheritance)
 Social status
 Productive investments vs. consumption
Micro-level impact
Unexpected and large exchange rate changes due to the 1997 Asian financial crisis in some but not all
host countries:
 Remittances increased significantly
 Significant effect on recipient households’ education , investments in assets, and
entrepreneurship
 No effect on recipient households’ consumption (selective sample? – all households already
had migrants abroad and so amount of remittances might have been set for things outside of
consumption)
Due to exchange rate fluctuations, they could see whether an incr/decr in remittances affected
household behavior.
Changes in local rainfall:
 Strong evidence of insurance motive: Remittances increase when recipient income declines
and decrease when income goes up
 Full consumption-smoothing when faced with income shocks, but only for households with
overseas migrants
Districts had different levels of rainfalls. Do remittances help people smooth their consumption
and work as an informal insurance? YES!!
Macro-economic impact of remittances:
Positive effects: (effect on growth not yet proven!)
 Reduced poverty and increased GDP
 Increased investment, resulting in economic growth ?
 Consumption smoothing, resulting in a more stable macroeconomic environment?
 Higher health and education spending, leading to economic development in the future?
Negative effects:
 Currency appreciation (harmful for exports and LT growth)
 Moral hazard: reduced labor supply of recipients
 ‘Lazy’ home governments
Gains from Emigration

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Model:
 Two countries: one with low wages and one with high wages
 The quantity of labor in the low-wage country is measured from left to right (from O to L), with
labor demand curve D.
 The quantity of labor in the high-wage country is measured from right to left (from O* to L),
with labor demand curve D*.
 World labor supply is OO*. Initial wages are w0 and w0*.
 Free migration would equalize wages in both countries at the intersection of D and D*.
 An increase in migration from L to L’ would lead to:
o A relatively small decrease in wage for high-income country (non-immigrants loose)
o A relatively small increase in wage for low-income country (non-emigrants gain)
o A large increase in income for migrants
o A gain for capital/land owners in the high-income country
o A loss for capital/land owners in the low-income country
 Global welfare effect: shaded area a + e
Assume:
 Elasticity of labor demand in the origin and destination countries
 Highly elastic labor demand curves would increase the slope of the labor supply cuves, and
reduce the gain
 Externalities of (high-skilled) migration on productivity of non-migrants

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 Negative externalities on non-migrants would shift labor curves downwards, and reduce the
gain
 Is productivity about who you are (inherent traits), or where you are (location)?
o If migrants are inherently less productive than workers in rich country, the demand
curve for migrant labor would lie below D*, reducing the gain
o Wages decrease! And so labor supply curve for migrants will fall down (See notes)
 If size of feasible migration is smaller, L’ is closer to L, reducing the gain

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Development Economics (Vrije Universiteit Amsterdam)

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Week 1: Poverty and inequality 03/17/2015

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Measuring the poverty line

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 Food poverty line =q*p

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Therefore, should use them jointly if possible.

 Generally defined over the distribution of income (y)

I ( y1 , y2 ,.., yn ) I ( y1 , y2 ,.., yn ; y1 , y2 ,.., yn )

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I ( y1 , y2 ,.., yn ) I (ky1 , ky2 ,.., ky n )

I ( y1 ,.., yi , y j ,.., yn )  I ( y1,.., yi   , y j   ,.., yn ) yi  y j

POVERTY TRAPS – BARRETT AND SWALLOW (2006)

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You first need a lot of energy to live, once you have

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Week 2: Land and Labor 03/17/2015

LAND AND TENURE CONTRACTS

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Larger farms more productive bc:

Optimized where marg costs = marg rev

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o Fixed rent in Latin America  alpha = 0; F>0

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Agriculture: size of harvest depends on “nature” with prob

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Labor market equilibrium

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Minimum piece rate for work

CHILD LABOR – UDRY (2003)

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Child labor and poverty

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o Principal-agency problems: Principal (tax payer), agent (aid bureaucracy) 

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Corruption grant based on number of children (ca 2$ per child)

POPULATION GROWTH AND ECONOMIC DEVELOPMENT

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World age distributions

Developing world is very “young”

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An economic analysis of fertility (Becker, 1960)

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RURAL AND URBAN

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As capitalist sector expands, resources are pulled out of traditional sector

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China is the country w/ the largest migration from rural to urban

 Probability of finding a formal sector job in urban area:

 Expected urban wage:

 Equilibrium with risk neutrality: