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# Macroeconomics Study Set 45

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## Quiz 22 : Macro Policies in Developing Countries

Seven problems facing developing countries that make their path to development difficult are: (a) Political instability, (b) Corruption, (c) Lack of appropriate institutions, (d) Lack of investment, (e) Inappropriate education, (f) Overpopulation, (g) Poor health and diseases.Briefly explain two of these problems, indicating how they make development difficult.
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(Any two of the following)
(a) Political instability.Successful development under any strategy requires political stability as a necessary condition.The framework of rules (law, property rights, commercial legal institutions) established by government provides the foundation for development.When there is no political stability, this framework keeps changing (or is never established).Development requires investment, and investment looks to the future for its payoff.Political instability discourages foreign investment, as well as internal investment (those few citizens of an unstable country who might have resources to invest may, in particular, fear the consequences of a change in government, and keep their wealth outside the country).
(b) Corruption.Some form of what would be regarded as bribery in developed countries is deeply ingrained in the culture of many developing countries.This is very difficult to eradicate, both because cultural attitudes and expectations are different, and because it has become established in the economy.People make calculations on the basis of the expectation of giving and receiving bribes.Low pay of many jobs (particularly in the public sector) is offset by the opportunity to receive bribes.But this is a great obstacle for development.Much of the costs of any business investment will be in this form.It is very difficult to calculate or estimate these costs.A great deal depends on familiarity with local conditions, and local contacts.For an outsider, such as a foreign investor, this is unfamiliar and risky terrain.
(c) Lack of appropriate institutions.Successful functioning of markets requires institutions that are appropriate to them.For example, property rights must be established, and legal institutions must exist to enforce them.Cultural aspects of human behavior, such as the value of punctuality and responsibility, are critical to how well a market economy can function.If "deadlines" are seen as demeaning, and "it happens when it happens" is a cultural norm, this will inhibit the effectiveness of a market economy.
(d) Lack of investment.The most critical ingredient for development is investment.Investors, both within and without the country, will weigh their investment opportunities carefully.Developing countries must compete with the rest of the world for investment.With the threat of political instability and the lack of developed financial institutions, they are often at a severe disadvantage.Of course, they may have some offsetting advantages, such as inexpensive labor and untapped natural resources.But competition among developing nations often produces "focal points," where a slight lead in the competition for investment allows a country to exploit its gains, and become still more attractive for further investment.This results in a sharp bifurcation between winners and losers in the competition for investment.
(e) Inappropriate education.Inappropriate education is often an obstacle to development.The education most important for development is widespread basic skills.In developing countries, education is often skewed toward the education of small elites, whose education is comparable to that of educated persons in developed nations.This contributes to the "dual economy" problem, skews income distributions, and leaves persons making up the potential work force without basic skills.
(f) Overpopulation.This has proven to be a particularly difficult obstacle to development.Public health measures have reduced infant mortality, and in many rural agricultural economies, an extra child is a useful source of labor.When population is growing rapidly, it is very difficult for real output to grow fast enough to keep up; so per capita income may stagnate or even fall.
(g) Poor health and diseases.In many developing countries, large portions of the population are undernourished or sick with diseases.These diseases make it difficult for people there to work, or even care for their kids, thus creating a vicious circle.

What is the balance of payments constraint? What international financial institutions can countries turn to when facing this constraint?
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The balance of payments constraint consists of limitations on expansionary domestic macro policy due to a shortage of international reserves.To meet both domestic goals and international balance of payments constraints, many developing countries turn to the International Monetary Fund (IMF).

How does the existence of a dual economy affect a country's strategy of converting a developing economy to a market economy?
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The traditional sector is often outside the market economy.Policy makers want to be sure that the entire economy moves toward a market economy.This would mean, however, different policies for each sector.In the traditional sector, policy makers would want to push toward privatization and use of a market (away from barter) from within.The internationally oriented modern market sector could be used to attract foreign investment.

What is a dual economy?
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Because of the structure of government in many developing countries, many economists who, in Western developed countries, favor activist government policies may well favor Classical laissez-faire policies for the same reasons that early Classical economists did-because they have a profound distrust of the governments.Why do these economists often distrust government officials in countries with developing and transitional economies?
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On the basis of exchange rates, per capita income in developing countries is around $500 per year; in the United States per capita income is about$61,000.Why does this overstate the difference in living standards? How does the purchasing power parity method of comparing income in different countries deal with that problem?
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What is the purchasing power parity method of comparing income in different countries? What are the results of using this method?
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Many developing countries have "dual economies".What is a dual economy and how does it affect a country's strategy of converting a developing economy to a market economy?
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How are the economic institutions of developed economies different from those of developing countries? How does this affect the implementation of fiscal and monetary policy?
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What are some of the institutional barriers facing developing countries in terms of implementing fiscal policy?
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The immediate cause of inflations in most developing countries is that the central bank is issuing too much money.What is the underlying cause of those inflations?
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Developed and developing countries have very different normative goals.What are these goals?
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What three ways do developed countries differ from developing countries? Briefly explain your answer.
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List five problems facing developing countries that make their path to development difficult.
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What is an inflation tax, and who receives the revenues from such a tax?
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The economic problems of developing countries may seem impossible to solve through the application of standard monetary and fiscal policy; but they sometimes can be solved by "regime change".How is regime change different from a policy change? Give an example where regime change was successful in turning around the economy of a developing country.
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