Alternative Approaches to Development Economics Econ 239 September - PowerPoint PPT Presentation

Alternative Approaches to Development Economics Econ 239 September 2008 Econ 239 () Alternative Approaches September 2008 1 / 22

Development Planning View (dominant until mid 1970s) Development viewed as a sequence of stages Government intervention justified by standard market failures : → Market Power ֒ → Externalities ֒ → Missing Markets ֒ → Coordination Problems ֒ Econ 239 () Alternative Approaches September 2008 2 / 22

Criticisms of Development Planning Approach Little account taken of response of indigenous (private sector) institutions to market failures Government may have less information than private citizens. Public sector often has less incentive to cut costs than private sector Vested interests and corruption Diversion of talent from private sector Planned economies fared no better and often worse than others. Econ 239 () Alternative Approaches September 2008 3 / 22

Chicago School View (dominant from mid–1970s to mid-1990s) Although “non–market institutions” often replace pure markets, they achieve the same efficient outcomes as predicted by the neoclassical model (at least in the long run) Private–sector creates institutions to minimize transactions costs : → costs associated with risk ֒ → coordination costs ֒ → motivation costs ֒ Intellectual basis for pure laissez faire → implies that policy-makers can largely ignore institutional details ֒ → but need well–defined property rights ֒ Econ 239 () Alternative Approaches September 2008 4 / 22

Criticisms of Chicago School View Does not explain absence of many markets, esp. risk markets Many transactions are affected by more than just the price Does not explain the variety and nature of non–market institutions Predicted behaviour is often wrong Econ 239 () Alternative Approaches September 2008 5 / 22

New Institutional View (dominant since mid 1990s) Emphasizes the role and endogeneity of non–market institutions → develops a positive theory of economic institutions ֒ Asymmetric information results in fundamental market failures → private sector creates “institutions” to deal with them, but still ֒ inefficient → standard forms of government intervention may fail ֒ Outcomes depend on institutional arrangements and the distribution of wealth Econ 239 () Alternative Approaches September 2008 6 / 22

The Institution of Sharecropping Ray, p. 420–436 Example: Tenancy in the ICRISAT Villages Sharecropping is dominant as a form of tenancy Wide variety of tenancy arrangements → 50–50 output shares, plus input cost sharing (Dokur) ֒ → 75% shares, plus tenant pays for all inputs (Shirapur) ֒ “Reverse tenancy” is common → 32% of leasings are from small to large farmers ֒ → 47% between farmers that own similar sized plots ֒ Econ 239 () Alternative Approaches September 2008 7 / 22

Is sharecropping associated with lower yields? Ray p. 430-1 Village surveys from ICRISAT → can compare owned and sharecropped land for same farmer ֒ Results: → sharecropped land 16% less productive (controlling for other factors) ֒ → no systematic differences between fixed rental and owned land ֒ Policy question: should the government ban sharecropping ? Econ 239 () Alternative Approaches September 2008 8 / 22

A Simple Analytical Framework Value of output: Y = g ( L ) → L = labour effort ֒ → decreasing marginal product, MP ֒ Cost of effort to Tenant: C ( L ) → increasing marginal cost, MC ֒ Econ 239 () Alternative Approaches September 2008 9 / 22

Output, Production Function, g(L) Cost Labour L** MC MP Labour L** Figure: Production, Cost and Economic Surplus Econ 239 () Alternative Approaches September 2008 10 / 22

Linear compensation schemes: I = ( 1 − α ) Y − F − C ( L ) Tenant’s income : Landlord’s income : R = α Y + F → pure wage contract : F < 0 and α = 1 ֒ → pure rental contract : F > 0 and α = 0 ֒ → sharecropping contract : F ≥ 0 and 0 < α < 1 ֒ Econ 239 () Alternative Approaches September 2008 11 / 22

The Negative Incentive Effects of Sharecropping Development Planning View Assume both parties are risk neutral Under sharecropping Tenant exerts effort until: ( 1 − α ) MP = MC ⇒ undersupply of effort and low output relative to fixed rental Policy implication: remove sharecropping and replace with fixed rents Econ 239 () Alternative Approaches September 2008 12 / 22

Output, g(L) Cost (1- α )g(L) C(L) Labour L** L MC Efficiency Loss MP (1- α )MP Labour L L** Figure: Ine¢ciency of Sharecropping Econ 239 () Alternative Approaches September 2008 13 / 22

Sharecropping as an Efficient Response to Risk Chicago School View Risky production: � g ( L ) + x with probability 1 Y = 2 with probability 1 g ( L ) − x 2 → average output: ֒ Y = g ( L ) . ¯ Tenant and Landlord are risk–averse → cost of risk is a transactions cost that varies with α ֒ Econ 239 () Alternative Approaches September 2008 14 / 22

Total Cost of Risk Exposure MCR Exposure Figure: Marginal Cost of Risk Econ 239 () Alternative Approaches September 2008 15 / 22

Landlord and Tenant can agree on efficient level of effort, L ∗∗ → if Tenant does not provide this effort, Landlord does not pay him ֒ Then choose value of α to minimize the total cost of risk to the two parties → since 0 < α < 1, sharecropping results as an efficient response to risk ֒ Policy implication: no need for government intervention Econ 239 () Alternative Approaches September 2008 16 / 22

Cost of Risk Tenant Landlord α Cost of Risk Total Cost α α ∗∗ 1 0 Figure: Cost-Minimizing Sharecropping Contract Econ 239 () Alternative Approaches September 2008 17 / 22

Problems Assumes away negative incentives of sharing 1 cost of monitoring effort 2 Does not explain 50–50 splits when Landlord is wealthy (risk–neutral) Econ 239 () Alternative Approaches September 2008 18 / 22

Sharecropping as an Incentive Scheme New Institutional View Assume → Landlord is risk–neutral, but Tenant is risk–averse ֒ ⇒ wage contract is optimal according to Chicago school → costly monitoring ֒ → cannot infer effort due to risk ֒ ⇒ trade–off between risk and incentives Econ 239 () Alternative Approaches September 2008 19 / 22

MC A E B MP ∗ ) MP (1−α Labour L* MCR C D 1−α 1−α ∗ Figure: Constrained-e¢cient Sharecropping Contract Econ 239 () Alternative Approaches September 2008 20 / 22

The incentive–constrained or second–best efficient value of α ∗ is → decreasing in MP ֒ → increasing in MC ֒ → increasing in cost of risk ֒ Sharecropping is a rational response to risk and incentive problems BUT outcome not same as predicted by neoclassical model (not efficient) Policy implication: should not ban sharecropping, but should encourage institutional changes that reduce risk. How ? Econ 239 () Alternative Approaches September 2008 21 / 22

The Culturalist Position Economist’s view: variation in socio–economic outcomes due to variation in incentives ⇒ change underlying institutions → change individual behaviour → better oucomes Culturalist’s view: variation in socio–economic outcomes due to social conditioning ⇒ change underlying culture of society → achieve better outcomes for given institutions Example: “trustworthiness” in a lending contract Econ 239 () Alternative Approaches September 2008 22 / 22