Development Economics: A Layman’s Primer

It’s really short on the theory, but that’s what makes this World Bank blog post a good primer for development issues:

Pathways to Development: What We Know and Don’t Know
Raj Nallari

Development is about welfare enhancing transformation through economic, social, political, and technological progress. Transformation is predicated on per capita income growth but development is also about progress in reduction of poverty and inequality, individual capabilities, access to social services, and quality of life. Both growth and development are also predicated on distributive politics of how a society is able to deal with vested interests and social conflicts.

During past sixty years, growth spurts have occurred in most countries but generally outcomes have fallen short of expectations. Developed economies have averaged growth rates of 2.4 percent during 1990 and 2008 while developing economies have collectively increased their GDP by an average of 4.7 percent over the same period. For low and middle income countries, physical capital is the principal determinant of growth, while for upper middle income and higher income economies total factor productivity was the most important driver. TFP is a catchall for other factors, which are human capital variously measured, and its quality; technological capability and innovation; managerial skills; organizational effectiveness; institutions affecting incentives, competition, allocative efficiency and governance; and the characteristics of urbanization.

This post puts the NEM in the right context – for Malaysia to achieve high income status, the mechanism needed is higher growth in TFP. In a growth accounting framework, it will look something like this:

ΔY = ΔTFP + ΔK*(rK/Y) + ΔL*(wL/Y)

where Y is national income, K is the stock of capital, r is the return to capital, L is the labour force, and w is the return to labour (wages).

The NEM assumes capital growth (i.e. investment) of around 11% p.a. and a labour force growth of 1.3% – the shares of capital and labour are typically 1/3rd and 2/3rds respectively. For a 6.5% real growth target, that requires an increase in productivity of about 2.0% per annum – which sounds ambitious when in the past ten years we’ve only managed an average 1.6%, and just 1.7% in the ten years preceding the 1997 crisis.

I happen to think that labour force growth will exceed population growth  - double in fact – which changes the calculation considerably. If in fact Malaysia’s demographic transition is fully taken into account, then we only need an average productivity increase of just 1.2% over the next decade. Not so hard after all, but that of course assumes that we continue to upgrade our skills and reform the education system. Even that low productivity target has to be worked for.