Development, Economics of

Economic development is the process through which economies are transformed from ones in which most people have very limited resources and choices to ones in which they have much greater resources and choices. Development economics refers to studies of economies with relatively low per capita resources, so-called ‘developing economies.’ What causes economies to move from very low per capita resource levels to high ones is a fundamental question that development economics addresses. In the immediate post-Second World War period development economics branched off from mainstream economics because development economists perceived that development problems were different in kind from those on which mainstream economists were focusing. The conceptualization of development adopted then rested on a set of assumptions about the conditions in developing economies: labor was in surplus so that labor could be removed from traditional agriculture with no loss in product, physical capital such as machinery and equipment was the limiting constraint on development, domestic markets had limited efficacy, industrialization was key, prospects for developing countries in international markets were not promising, and policy makers had good information and could act effectively in disinterested manners. The policy implications that followed were to focus on capital accumulation and industrialization behind barriers to industrial imports and to use quantitative direct policies (not price-related policies such as taxes and subsidies), cost-benefit ratios and planning to direct the changes that had to be made for development, without concern about macroeconomic and foreign sector balance. In the latter decades of the twentieth century, many of the assumptions of this paradigm were studied and questioned. The result was a sea change in the understanding of the development process and the implications for policies. At the start of the twenty-first century the current consensus emphasizes: (a) the basic economic environment must be conducive for investments by having a stable macroeconomic environment with noninflationary monetary policy, fiscal restraint, and international balance and institutions such as private property rights and a just legal system that permit investors to have reasonable expectations of reaping much of the gains from their investments; (b) human capital such as education is important, in additional to physical capital; (c) responsiveness to incentives created by markets and policies are broad and often substantial; (d) information problems are pervasive in a rapidly changing world so institutions and mechanisms are desirable that induce individuals and firms to operate in socially desirable ways even if policy makers cannot closely monitor them; and (e) policies should maintain macroeconomic balance, develop institutions so that investors have reasonable expectations of gaining returns from good investments, encourage competition to induce productivity increases through an unbiased international trade system and through eliminating legal barriers and lessening transportation and communication barriers to greater competition, and use ‘market-friendly’ interventions through prices and subsidies that are transparent, rule-based, general, and nondiscriminatory. Debates continue about how the international financial system should be managed, what are the implications of the demographic transition and aging populations, what are the tradeoffs between poverty reduction vs. growth, what are the roles of social cohesion and social capital, how should one think about changing preferences, what is the association between economic participation and political participation, and what is the extent of externalities—effects beyond those transferred through markets—for human resources such as education and population and economic growth.