Academic journal article Journal of Economic Development

Comparative Advantage Defying Development Strategy and Cross Country Poverty Incidence

Academic journal article Journal of Economic Development

Comparative Advantage Defying Development Strategy and Cross Country Poverty Incidence

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1.INTRODUCTION

Poverty is the main social and economic problem in most developing countries. Most economists also agree that economic performance and level of poverty in a country are determined, to a large degree, by the quality of its institutions (Acemoglu, 2007; Acemoglu et al., 2004; Commander and Nikoloski, 2010). A country's chosen development strategy matters in determining the quality of institutions and, hence, the level of poverty (Lin, 2009). Since the end of the Second World War, developing and developed economies around the world have determinedly sought to alleviate, and even eradicate, poverty. With the exception of a few successes in East Asia including Japan, South Korea, Singapore and Taiwan, such efforts have largely failed. Thus, living standards in most developing countries have not improved substantially and particularly for countries in Sub-Saharan Africa, very little have changed (ibid). Now the most important question becomes what was wrong with the development policies in most developing countries and whether it is possible to avoid these mistakes.

Nevertheless, the eradication of poverty remains a high priority for world leaders, as reflected in Millennium Development Goal 1. There is a continuous debate about how to achieve poverty reduction in developing countries, but not enough discussion of why some countries are highly poverty prone and others do not have poverty and what we mean by poverty reduction. It is often understood as shorthand for promoting economic growth that will permanently lift as many people as possible over a poverty line. Thus, many political leaders viewed the development of capital intensive and technologically advanced heavy industries that prevailed in the developed countries as the symbols of modernization and an easy way of reducing poverty. We call this a Comparative Advantage Defying (CAD) strategy because the developing countries have mostly been capital-scarce economies and capital-intensive industries were not to their comparative advantages. Even many economic policymakers were not concerned whether this is really the correct policy measure to reduce poverty. Our motivation is to empirically explore the flawed policy statements taken by the most developing countries and suggest corrections in their development strategies. Thus, the hypothesis that will be tested in this paper is that over an extended period a country adopting a CAD development strategy will have a higher level of poverty.

The most important channel through which the CAD strategy can affect the level of poverty is the channel of finance. Many governments of least developed countries (LDCs) which carry out a CAD strategy subsidize the firms in priority sectors by distorting funds prices, foreign exchange rates, and other inputs or input prices; and use administrative authorities to allocate price-distorted inputs to the firms. For example, immediately after independence in 1949, the Chinese government adopted CAD strategy and made a big push for the nationalization movement by increasing the share in the industrial output of State Owned Enterprises (SOEs) from around 40% in 1952 to 90% in 1958. The government suppressed the price of agricultural products to support priority industry - price premium of agricultural products at informal markets relative to state procurement price went negative at 10 points in the 1950s (Lin et al., 2006). During this time, Chinese government failed to reduce poverty until stopping such deviant behavior in 1978 (Lin, 2009).

The methodology this paper uses is the Ordinary Least Square (OLS) estimation. But because of endogenous problems it uses the instrumental variable (IV) approach as well. We have found IV for both of our interested endogenous variables - CAD and financial development. Nevertheless, our dependent variable, poverty level, contains lots of zeroes due to lack of data on poverty based on our headcount definition of poverty. …

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