Question

Institutional Development

1. Understand the basic framework for evaluating an investment project and the determinants of costs and benefits of the investment. Understand how government policies/institutions may affect the incentives of investments by affecting these costs and benefits.

2. Understand why it is institutions/policies rather than geography or culture that explain substantial cross-country differences in investment rates and economic development (through examples).

3. Understand what misallocation is and why misallocation may lower total factor productivity (using examples of China and India).

Answer 1

Ans 3) Misallocation is a potential factor in accounting for aggregate productivity. Policies and institutions generating misallocation are prevalent in poor and developing countries and may also be responsible for differences in the selection of producers and technology used, contributing substantially to aggregate productivity differences across countries. We find that misallocation of human capital reduces China’s productivity significantly. Most of the channels through which misallocation of human capital affects productivity are industrial structure upgrading, technological innovation and labour productivity. The counterfactual experiments show that terminating the labour mismatch between industries completely the result of increase in productivity of around 41% for the whole sample in China. The results suggest that correcting the current shortcoming of incentives in non-productive sectors, where encouraging more human capital to work in high-tech enterprises may be an essential measure to stimulate the development of emerging economies.