Winter Reading Notes on Industrial Development (1)

This winter break I am reading some classic articles about trade and development, fields that I am likely to specialize in. If you are interested, the materials come from this industrial development course taught by Professor Eric Verhoogen at Columbia. This is the first in a series of posts documenting my thoughts on these readings.

In The Fall and Rise of Development Economics, Paul Krugman writes about how the “high development theory” perished because of its inability to express its key ideas in structured economic models. There is a lot to be learned just from Krugman’s writing.

Mookherjee (1999) argues that contractual constraints are the major impediments to firm performance in developing countries. In developing countries, moral hazard problems can hardly be solved through formal channels because of financial constraints and weaker contract enforcement institutions. He proposes three alternative solutions:

1. Designing contracts that reward abstinence from dysfunctional behavior (when performance is contractible);

2. Joint ownership by agents with conflicting interests (when performance is non-contractible);

3. Relying on reputational constraints, when neither 1 nor 2 works.

Clearly, weaker institutions and greater information barriers will shift people from external monitoring (formal contracts) to internal monitoring (reputation and networks).

Another interesting and insightful point made in the article is that entrepreneurs with higher wealth have a bigger chance to secure investment in risky projects, because they have high stakes and bigger collaterals.

Tybout (2000) outlines several key observations about manufacturing firms in developing countries: the proliferation of very small plants (under 5 workers), the large market shares of big plants, and high turnover rates of plants and jobs. However, linking these phenomena to productivity level and growth requires clearer measures of efficiency and productivity, better data tracking firms across long enough time periods, and better models of firm behavior in macroeconomic uncertainty.

References:

Krugman, P. 1994. “The fall and rise of development economics.” Rethinking the development experience: Essays provoked by the work of Albert O. Hirschman: 39-58.

Mookherjee, D. 1999. “Contractual constraints on firm performance in developing countries”. Working Paper. Boston University, Institute for Economic Development.

Tybout, J. R. 2000. “Manufacturing firms in developing countries: How well do they do, and why?.” Journal of Economic literature 38(1): 11-44.

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