Growth policy

Question 1

Explain why monopolistic competition in the intermediate goods market is an inefficiency and give policy suggestion

Answer 1

• Intermediate good firms need to make profits to cover R&D costs.
• Quantity supplied too low, price is too high relative to social optimum
  Policy: Subsidize purchase of intermediate goods

Question 2

Explain why knowledge spillovers an inefficiency and give policy suggestion

Answer 2

Knowledge evolves according to At+1 = G(At, LtA, Kta), which means that the positive externality caused by research is not properly compensated by the market. This results in too little R&D being done.
Policy: Subsidize research

Question 3

Explain why the appropriability effect is an inefficiency and give policy suggestion

Answer 3

Innovators cannot cash in on the consumer surplus created by their innovation, meaning the full benefits of research cannot be appropriately distributed by the market.
Policy: Subsidize R&D

Question 4

Explain why the business stealing effect is an inefficiency and give policy suggestion

Answer 4

New innovative product takes market share of existing substitutes, or drives them out of the market all together. Innovator captures rents of previous innovators, not just the added social benefit that the innovation provided. Therefore the incentives for innovation are too high.
Policy: Tax R&D

Question 5

Why are lump sum transfers suggested for policy?

Answer 5

Does not distort household/firm decisions.

Question 6

If a lump sum is not used how can negative effects be minimized?

Answer 6

• Use proportional tax on consumption
• Avoid using capital taxation.

Question 7

Give the 4 sources of market failures

Answer 7

• Public goods
• Externalities
• (Natural monopolies)
  -Coordination failure

Question 8

Give 4 reasons why Governments enact policies that are bad for growth

Answer 8

• Motives may be different from maximising growth (pander to constituency)
• Staff in Government may act in own self interest (corruption)
• Redistribution effects of growth may threaten economic power of ruling elite
  -Reforms for growth may be burdensome for many in SR (may harm re-election motives if voters short sighted.)

Question 9

What is Government failure

Answer 9

• Government’s attempt to correct market failures leads to even larger inefficiency
• Government intervenes in well-functioning market stronger than necessary to foster social welfare.

Question 10

Give 4 examples Government failure

Answer 10

1) Lack of incentives for nationalized firms
2) High Government wages distorting functioning labor market
3) Corruption
4) Large tax burden

Question 11

Give 4 suggestions from the Washington consensus

Answer 11

1) Fiscal policy discipline
2) Deregulation
3) Privatization of state enterprises
4) legal security of property rights

Question 12

Has the Washington consensus work?

Answer 12

Latin America followed during 1990s
Most Asian countries deviated significantly from it
Asia had more growth

Question 13

What does the evidence from the Washington consensus tell us?

Answer 13

Washington consensus factors are necessary for growth but do not map into specific growth policies of institutional arrangements (every country is different)

Question 14

What do results show about the effect of institutions vs policy?

Answer 14

Once institutions are accounted for, macro-policies are insignificant in explaining the level of development and growth rate volatility.

Question 15

What are the 3 objectives that good institutions should aim for?

Answer 15

1) Productive efficiency
2) Macroeconomic and Financial stability
3) Distributive justice and poverty alleviation

Question 16

What are the 3 universal principles that lead to productive efficiency?

Answer 16

• Property rights (Ensure investors can retain returns)
• Incentives (align producer incentives with social costs/benefits)
• Rule of law (provide transparent, stable, and predictable set of rules)

Question 17

What are the 3 universal principles that lead to Macro and financial stability?

Answer 17

• Sound money (don’t generate liquidity beyond nominal money demand at reasonable inflation)
• Fiscal sustainability (limit debt)
• Prudential regulation (prevent excessive banking risk)

Question 18

What are the 2 universal principles that lead to Distributive justice and poverty alleviation?

Answer 18

• Targeting (redistributive programs should be targeted as closely as possible.)
• Incentive compatibility (minimize incentive distortions with redistribution.)