Question

The causes of underdevelopment highlighted by Hausmann-Rodrik-Velasco growth diagnostics is the low returns to economic activity as evidenced by the low human capital.

what are four policies to boost human capital in developing countries and how they should help developing countries

Answer 1

Underdevelopment highlighted by Hausmann-Rodrik-Velasco growth diagnostics is the low returns to economic activity as evidenced by the low human capital.

The growth diagnostics approach focuses exclusively on economic growth. Hausman et al. (2005) indicate that while development is a broad concept entailing the raising of human capabilities in general, we believe increasing economic growth rates is the central challenge that developing nations face. This is an important statement since as a result of focusing on economic growth, the approach places other important policy objectives of the government—including poverty, income distribution, environmental protection, and basic human needs—outside the approach’s scope.

Although the underlying idea is itself quite clear, in practice, it is not easy to find signals that guide the diagnostics process. The approach requires searching for both price and nonprice signals. Price signals in this context are the shadow prices of resources. If the shadow price of a certain resource is high, it is inferred that growth is constrained by the resource. However, in practice, it is not easy to measure shadow prices. It is thus inevitable for researchers to rely on theoretical grounds and indirect evidence for judging the scarcity of a resource. Moreover, even if we could measure the equilibrium price of a resource, this may not necessarily reflect a constraint on growth. Aghion and Durlauf (2007) explain this problem by discussing low interest rates under credit rationing.7The authors of the growth diagnostics approach also recommend researchers to check nonprice signals, since, when a constraint binds growth, it generally results in activities and arrangements designed to get around the constraint. Strict government controls, for example, can lead to high informality in economic activities. The lack of adequate legal mechanisms can create informal mechanisms of conflict settlement. Application of this approach, therefore, requires in-depth knowledge of the economy being analyzed as well as the ability to rank interventions. This implies that it is possible for two researchers applying the growth diagnostics methodology to reach different conclusions

Four policies to boost human capital in developing countries and how they should help developing countries

The role of the state: Throughout much of the 1960s and 1970s, traditional development thinking had been that government/state control and economic planning, high levels of public investment and protection from the volatility of the world market using protectionism was the best recipe for promoting development.

Self-sufficiency was the main goal including investment in import-substitution industries – overseas trade was seen as a hindrance and therefore a tax opportunity to raise revenues for the government.

In the 1980s and 1990s a new pro-market doctrine gained momentum supported by the work of institutions such as the World Bank and the International Monetary Fund (IMF). This approach advocated market-friendly and open-border policies including cuts in import tariffs and increasing cross-border flows of financial capital and people.

The core idea behind increasing openness in the world economy was that developing countries stronger engagement with the developed world allows them to mimic and develop the technologies of the West, raise productivity and drive per capita incomes higher.

As noted in the Introduction, Lewis (2004) has challenged the view that capital accumulation is the key to growth and development, as well as the public debate around the prescription that what poor countries need is more capital. He makes two crucial points:

(i) capital does not automatically increase labor productivity;

(ii) what capital does is to increase the capacity for growth. This means that developing countries could increase their performance dramatically without any significant increase in capital. To become rich, however, they need additional capital. The problem in most developing countries is in the efficiency with which they use existing capital. To see this, one can think of the role of capital accumulation in a growth accounting exercise. The growth rate of the capital stock ( ̆K) can be written as ̆(/)(/)(/)(/)KKKIKIYYK= == ×, where (I Y/) is the investment share and (Y K/) denotes capital productivity. This means that capital accumulation depends on two factors: one is the amount of investment (as a share of output), and the other one is the productivity with which this capital is used. This implies that two different countries could achieve the same growth rate of the capital stock with different investment shares, depending on the productivity of capital. Lewis’s point is that developing countries’ performance could improve substantially by working on this second factor. Lewis insists that “improving the rules and regulations governing competition would improve not only labor productivity but also capital productivity” (Lewis 2004, 251; emphasis added). Naturally, in the long run, and in order to become a rich country, developing countries with spare labor capability (i.e., labor surplus), need to build offices and manufacturing plants where these workers can work. That is, countries need to increase the capacity to produce goods and services. Lewis remarks: “Of course, the total capital required to increase capacity depends on the efficiency with which the capital is employed” (Lewis 2004, 250). It therefore seems that Lewis reverses the role of capital for purposes of igniting and sustaining growth, i.e., in the short run, developing countries do not need more capital; what they need is to use more efficiently the one they have. To achieve this, reforms of rules and regulations governing competition is the key. However, in the long run, and to become rich countries, developing countries will need more capital.18 This view is in line with that of Easterly (2002), who concluded that in the short run