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Handbook of Development Economics Volume 5 1st
Edition Dani Rodrik Digital Instant Download
Author(s): Dani Rodrik, M.R. Rosenzweig
ISBN(s): 9780444529442, 0444529446
Edition: 1
File Details: PDF, 6.55 MB
Year: 2010
Language: english

HANDBOOKOF
DEVELOPMENTECONOMICS
VOLUME
5
Edited by
DANI RODRIK
John F. Kennedy School of Government,
Harvard University,
Cambridge, MA 02138, USA
MARK R. ROSENZWEIG
Department of Economics,
Yale University,
New Haven, CT 06520-8269, USA
AMSTERDAM BOSTON HEIDELBERG LONDON
NEW YORK OXFORD PARIS SAN DIEGO
SAN FRANCISCO SINGAPORE SYDNEY TOKYO
North-Holland is an imprint of Elsevier

HANDBOOKS IN
ECONOMICS
Series Editors
KENNETH J. ARROW
MICHAEL D. INTRILIGATOR
AMSTERDAM BOSTON HEIDELBERG LONDON
NEW YORK OXFORD PARIS SAN DIEGO
SAN FRANCISCO SINGAPORE SYDNEY TOKYO
North-Holland is an imprint of Elsevier

HANDBOOKOF
DEVELOPMENTECONOMICS
VOLUME
5

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INTRODUCTION TO THE SERIES
The aim of theHandbooks in Economicsseries is to produce Handbooks for various
branches of economics, each of which is a definitive source, reference, and teaching
supplement for use by professional researchers and advanced graduate students. Each
Handbook provides self-contained surveys of the current state of a branch of econom-
ics in the form of chapters prepared by leading specialists on various aspects of this
branch of economics. These surveys summarize not only received results but also
newer developments, from recent journal articles and discussion papers. Some original
material is also included, but the main goal is to provide comprehensive and accessible
surveys. The Handbooks are intended to provide not only useful reference volumes for
professional collections but also possible supplementary readings for advanced courses
for graduate students in economics.
Kenneth J. Arrow
Michael D. Intriligator
v

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CONTENTS OF THE HANDBOOK
VOLUME 1
PART 1 ECONOMIC DEVELOPMENT —CONCEPTS AND APPROACHES
Introduction
T.N. Srinivasan
CHAPTER 1 The Concept of Development
Amartya Sen
CHAPTER 2 The Roots of Development Theory
W. Arthur Lewis
CHAPTER 3 Alternative Approaches to Development Economics
Pranab Bardhan
CHAPTER 4 Analytics of Development: Dualism
Gustav Ranis
CHAPTER 5 Economic Organization, Information, and Development
Joseph E. Stiglitz
CHAPTER 6 Long-run Income Distribution and Growth
Lance TaylorandPersio Arida
PART 2 STRUCTURAL TRANSFORMATION
Introduction
Hollis Chenery
CHAPTER 7 Patterns of Structural Change
Moshe Syrquin
vii

CHAPTER 8 The Agricultural Transformation
C. Peter Timmer
CHAPTER 9 Industrialization and Trade
Howard Pack
CHAPTER 10 Saving and Development
Mark Gersovitz
CHAPTER 11 Migration and Urbanization
Jeffrey G. Williamson
PART 3 HUMAN RESOURCES AND LABOR MARKETS
Introduction
T.N. Srinivasan
CHAPTER 12 Economic Approaches to Population Growth
Nancy Birdsall
CHAPTER 13 Education Investments and Returns
T. Paul Schultz
CHAPTER 14 Health and Nutrition
Jere R. BehrmanandAnil B. Deolalikar
CHAPTER 15 Labor Markets in Low-Income Countries
Mark R. Rosenzweig
CHAPTER 16 Credit Markets and Interlinked Transactions
Clive Bell
Volume 2
PART 4 PLANNING AND RESOURCE ALLOCATION
Introduction
Hollis Chenery
viii
Contents of the Handbook

CHAPTER 17 Short-Run Macroeconomics
Persio AridaandLance Taylor
CHAPTER 18 Multisectoral Models
Sherman Robinson
CHAPTER 19 Income Distribution and Development
Irma AdelmanandSherman Robinson
CHAPTER 20 Taxation for Developing Countries
Nicholas SternandEhtisham Ahmad
CHAPTER 21 Project Evaluation in Theory and Practice
Lyn Squire
PART 5 INTERNATIONAL ASPECTS
Introduction
T.N. Srinivasan
CHAPTER 22 International Cooperation
Paul Streeten
CHAPTER 23 Trade and Development
Christopher Bliss
CHAPTER 24 Alternative Perspectives on Trade and Development
David Evans
CHAPTER 25 Foreign Public Capital Flows
Jonathan Eaton
CHAPTER 26 Foreign Private Capital Flows
Eliana A. CardosoandRudiger Dornbusch
CHAPTER 27 Transitional Corporations and Direct Foreign Investment
Gerald Helleiner
ix
Contents of the Handbook

CHAPTER 28 Disequilibrium and Structural Adjustment
Sebastian EdwardsandSweder van Wijnbergen
PART 6 COUNTRY EXPERIENCE WITH DEVELOPMENT
Introduction
Hollis Chenery
CHAPTER 29 Primary Exporting Countries
Stephen R. Lewis, Jr.
CHAPTER 30 Import Substitution
Henry Bruton
CHAPTER 31 Outward Orientation
Bela Balassa
CHAPTER 32 Large Countries: The Influence of Size
Dwight H. PerkinsandMoshe Syrquin
VOLUME 3A
PART 7 ANALYTICAL TOOLS
Introduction
Jere BehrmanandT.N. Srinivasan
CHAPTER 33 Data and Econometric Tools for Development Analysis
Angus Deaton
CHAPTER 34 Human Resources: Empirical Modeling of Household and Family
Decisions
John StraussandDuncan Thomas
CHAPTER 35 Applied General Equilibrium Models for Policy Analysis
Jan Willem GunningandMichiel Keyzer
x
Contents of the Handbook

PART 8 RESOURCES, TECHNOLOGY, AND INSTITUTIONS
Introduction
Jere BehrmanandT.N. Srinivasan
CHAPTER 36 Savings, Credit and Insurance
Timothy Besley
CHAPTER 37 Technological Change and Technology Strategy
Robert E. EvensonandLarry E. Westphal
CHAPTER 38 Institutions and Economic Development
Justin Yifu LinandJeffrey B. Nugent
CHAPTER 39 Poverty, Institutions, and the Environmental-Resource Base
Partha DasguptaandKarl-Goran Mäler
VOLUME 3B
PART 9 POLICY REFORM, STABILIZATION, STRUCTURAL ADJUSTMENT AND
GROWTH
Introduction
Jere BehrmanandT.N. Srinivasan
CHAPTER 40 Policy Lessons from Development Experience Since the Second
World War
Anne Krueger
CHAPTER 41 Poverty and Policy
Michael LiptonandMartin Ravallion
CHAPTER 42 Power, Distortions, Revolt and Reform in Agricultural Land Relations
Hans P. Binswanger, Klaus DeiningerandGershon Feder
CHAPTER 43 Human and Physical Infrastructure: Investment and Pricing Policies in
Developing Countries
Emmanuel Jimenez
xi
Contents of the Handbook

CHAPTER 44 Structural Adjustment, Stabilization and Policy Reform: Domestic and
International Finance
Viti'orio CorboandStanley Fischer
CHAPTER 45 Trade and Industrial Policy Reform
Dani Rodrik
CHAPTER 46 The Contributions of Endogenous Growth Theory to the Analysis of
Development Problems: An Assessment
Pranab Bardhan
VOLUME 4
PART 10 NEW INSIGHTS INTO RURAL AND AGRICULTURAL DEVELOPMENT
Introduction
T. Paul SchultzandJohn Strauss
CHAPTER 47 Economic Development and the Decline of Agricultural Employment
Andrew D. FosterandMark R. Rosenzweig
CHAPTER 48 Information Networks in Dynamic Agrarian Economics
Kaivan Munshi
PART 11 PUBLIC GOODS AND POLITICAL ECONOMY: THEORY AND EVIDENCE
CHAPTER 49 Public Action for Public Goods
Abhijit Banerjee, Lakshmi IyerandRohini Somanathan
CHAPTER 50 Understanding Political Corruption in Low Income Countries
Rohini Pande
PART 12 HUMAN RESOURCES AND HOUSEHOLD RESPONSES TO MARKET
INCENTIVES AND PUBLIC GOODS
CHAPTER 51 Household Formation and Marriage Markets in Rural Areas
Marcel FafchampsandAgnes R. Quisumbing
CHAPTER 52 Population Policies, Fertility, Women's Human Capital, and Child Quality
T. Paul Schultz
xii
Contents of the Handbook

CHAPTER 53 Health Economics for Low-Income Countries
Germano Mwabu
CHAPTER 54 Health over the Life Course
John StraussandDuncan Thomas
CHAPTER 55 Schooling in Developing Countries: The Roles of Supply, Demand and
Government Policy
Peter F. OrazemandElizabeth M. King
CHAPTER 56 The Impact of Child Health and Nutrition on Education in Less Developed
Countries
Paul GlewweandEdward A. Miguel
CHAPTER 57 Child Labor
Eric V. Edmonds
CHAPTER 58 Extended Family and Kinship Networks: Economic Insights and
Evolutionary Directions
Donald CoxandMarcel Fafchamps
PART 13 PROGRAM EVALUATION: METHODS AND APPLICATIONS
CHAPTER 59 Evaluating Anti-Poverty Programs
Martin Ravallion
CHAPTER 60 Evaluating Social Programs with Endogenous Program Placement and
Selection of the Treated
Petra E. Todd
CHAPTER 61 Using Randomization in Development Economics Research: A Toolkit
Esther Duflo, Rachel GlennersterandMichael Kremer
CHAPTER 62 Evaluating Conditional Schooling and Health Programs
Susan W. Parker, Luis RubalcavaandGraciela Teruel
xiii
Contents of the Handbook

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PREFACE
Development Policy and
Development Economics: An
Introduction

Dani Rodrik
John F. Kennedy School of Government, Harvard University, Cambridge, MA 02138, USA
Mark R. Rosenzweig
Department of Economics, Yale University, P.O. Box 208269, New Haven, CT 06520-8269, USA
Anyone who undertakes to produce a volume of surveys in economic development
must confront the question: Does the world really need another one? There have been
four volumes in the present series alone, going back to 1988 (Chenery & Srinivasan,
1988), with the latest collection published in 2008 (Schultz & Strauss, 2008). The field
changes over time and, one hopes, knowledge accumulates. So, one motive is the
desire to cover the more recent advances. And indeed, economic development has
been one of the most dynamic and innovative fields within economics in recent years.
But we had another motive as well. We envisaged this Handbook to have a some-
what different focus from earlier ones. In particular, rather than just surveying the
“state of the literature” in various subfields, what we sought to accomplish is to present
critical and analytical surveys of what we know (and do not know) in differentpolicy
areas. We asked the authors of each chapter to answer the questions: “What kind of
policy guidance does the literature offer in this particular area of development? Where
are the gaps? What can we say with certainty that we know? What are the weaknesses
of the literature from a policy perspective? What kind of research do we need to
undertake to answer burning policy questions of the day? To what extent does actual
policy practice correspond to the prescriptions that follow from solid research?” We
thus envisioned that the audience for this volume would not only be graduate students
and other academics, but well-trained policy makers in developing countries or inter-
national financial institutions as well.
While one primary goal is to inform policy makers, we also hope that the volume
will assist scholars in designing research agendas that are informed by policy questions,
in particular, by the gaps in knowledge that would speak to major policy issues. The
xv

development field has always been one in which the worlds of research and practice are
in close relationship with each other and move in tandem. The large number of PhD
economists who work in international organizations such as the World Bank and the
influence of academia among developing-country officialdom ensure that ideas ema-
nating from the ivory tower often find quick application. But equally important, in
principle, is the reverse feedback—the need to tilt researchers’ attention on the ques-
tions that are, or should be, on the policy agenda. The organization of the present vol-
ume around policy issues is designed to make a contribution toward both of these
goals.
1. KEY THEMES
Before briefly summarizing the individual chapters, it is worthwhile to highlight some
of the main cross-cutting themes that emerge from the material that follows.
1.The policies that impact development are wide-ranging, all the way from broad macroeconomic
policies such as monetary and exchange-rate policies to interventions in microfinance.This is
perhaps one of the differences between the economics of development and other
fields within economics. Poverty reduction, economic growth, and development
most broadly are the outcomes of a complex set of interactions across the entire
range of economic policies and institutions. From this perspective, “development
policies” must have a very broad meaning indeed. As the chapters in this Handbook
illustrate, one cannot associate the field of development with policies in just a
narrow set of domains—such as education or growth. Nor do these effects and
interactions neatly separate along methodological dividing lines such as microeco-
nomics versus macroeconomics. To cite just a few examples: A couple of years’
bout with high inflation can undo the effects on poverty reduction of decades of
effective antipoverty programs. In the absence of effective social programs, high
growth may not deliver much real development. The returns to schooling may
be affected by health interventions that affect life expectancy or cognitive capacity.
Improving credit markets may affect schooling. And the analysis of institutions,
human capital effects on growth, or environmental policy span across micro- and
macroperspectives.
2.The efficacy of policy is rarely a question of “does it work”; instead it is a question of “when
does it work and when not and why?”Economic theory is rich and flexible enough to
justify many different policies, depending on the constraints and opportunities
defined by the context. Nowhere is this general point better illustrated than in
the area of development policies. The chapters that follow elucidate the point
amply. Whether it is in trade, macroeconomics, labor markets, property-rights, edu-
cation, or microfinance, there is no unique correspondence, as the Washington
xviDani Rodrik and Mark R. Rosenzweig

Consensus and other general recipes suppose, between policies and outcomes. Ear-
lier attempts to establish universal linkages (such as the impact of tariffs or foreign
aid on growth) do not survive the most recent generation of work.
As the newer literature surveyed here makes clear, the trick is to know enough
about context and the universe of applicable models to be able to apply the right
framework. There are no simplistic rules of thumb and no alternative to the hard
work of applying economic reasoning and evidence to the context. Even in such
an area as property-rights, around which current orthodoxy has coalesced, there
are no clear-cut and immediate policy implications one can drawin general.As
Besley and Ghatak note, “The creation of effective property rights is heterogeneous
in its impact and there are many potential mechanisms that can sustain property
rights. This suggests that there should not be a ‘one size fits all’ mantra of extension
of private property rights, nor a blind faith that this is a magic bullet that will cure all
economic ills.” All of this suggests the need for far greater modesty when general-
izing about the role of policy and for studies that evaluate polices or interventions
in different contexts.
Relatedly, details of policy implementation matter. The specifics of how a policy
or intervention is designed can have a substantial impact on its success. Decentrali-
zation of schooling may in principle lead to improved outcomes because educa-
tional resource allocations better reflect their suitability to differing local
environments, but as studies reviewed by Behrman show, the implicit incentives
built in to actual decentralization programs can undermine their achievements. Sim-
ilarly, Karlan and Morduch emphasize in their chapters that the specific delivery
mechanisms for financial products can have substantial effects on outcomes such
as repayment rates for similar-sounding financial products (e.g., microloans).
3.Appropriate development policies typically exhibit high degrees of complementarity.One rea-
son behind context-specificity is the presence of prerequisites for policies to work
appropriately. Policy can work or fail depending on the presence of those prerequi-
sites and the feasibility of implementing the entire package. For example, Kose et al.
list a long list of macroeconomic and structural policies that need to be in place for
countries to reap the benefits of financial globalization, and emphasize how policies
toward the capital account need to be seen as part of a much broader set of policies.
Similarly, Harrison and Rodriguez-Clare emphasize the relevance of complemen-
tary aspects of the policy regime—such as labor-market policies or the ease of entry
and exit for firms—to the success of the trade policy. As Temple points out, we
cannot analyze the economics of aid without combining it with the economics of
growth, trade, and political economy. As Baland et al. argue, governance is best
thought of as a bundle or cluster of institutions and not just a single thing. Hanson
points to the interactions between trade in goods, domestic schooling polices, and
xviiDevelopment Economics and Policy

international labor flows. Schultz points to the ineffectiveness of schooling interven-
tions where the health environment is such that life expectancy is low. And
Dasgupta emphasizes the incompleteness of any account of development that leaves
natural capital out of the picture.
4.Even though developing countries have become significantly more integrated into the world
economy in recent decades, their integration remains skewed, has been full of surprises, and
has failed to provide many of the expected benefits.Many of the chapters in this Hand-
book (those on trade, aid, international labor mobility, monetary and currency poli-
cies, financial integration) focus on the linkages between the world economy and
development outcomes, and on how domestic policies in both developed and
developing countries affect the quality and consequences of those linkages. This is
entirely appropriate, as the integration of developing economies in the world
economy has been one of the major trends of the last quarter century. Yet, as the
chapters demonstrate, this has been a far from smooth process: trade liberalization
has not always paid off the anticipated dividends and financial globalization has
brought frequent and painful crises. International labor mobility, which could be
a great boon, remains mostly restricted, by high-income countries. As the authors
document, however, we are now in a far better position to understand these
processes and to avoid the blind spots of the past.
5.Actual experience with development policy has increasingly led economists to broaden and
deepen the scope of the analysis into the areas of institutions, governance, and politics.Scratch
any economic issue of consequence, and you are likely to find politics lurking
underneath. The chapters that follow demonstrate that this is all the more true of
development economics. Economists increasingly acknowledge the importance of
institutions—the rules of the game in a society—and the nature of political and
power struggles that lie behind them. Encouragingly, they are also increasingly
applying their empirical and conceptual tools to analyze those deeper determinants.
Issues of governance, politics, and power are no longer a sideshow; they constitute a
central element in the field. However, while there has been increased attention to
generic issues such as corruption and politician competence, there are few studies
that examine the political economy aspects of specific policies, although Behrman’s
chapter discusses some research that focuses on how elites suppress public schooling
in their own interest. As Dasgupta notes in his chapter, the institutions of gover-
nance with respect to natural capital—domestic and international—is also beginning
to receive some belated attention.
6.Getting cause-and-effect right is extremely important in designing development policy, and has
become a central focus of research in development.But there are dangers. There is consensus
that associations between variables cannot be used as a sound basis for policy. For
example, Shultz’s chapter on health and population documents the strong positive
xviiiDani Rodrik and Mark R. Rosenzweig

historical relationships across countries and over time between income and health
measures (e.g., life expectancy). Some have argued that indeed, based on these asso-
ciations, ill health is a major barrier to development. What is unclear is to what
extent these associations reflect the effects of income on health demand and/or
jointly reflect differences in both governmental capacities to simultaneously deliver
health services and promote income growth. Existing microstudies, which deal with
the issue of causation, however, all indicate only modest effects of improvements in
nutrition or health on productivity even among the poorest households relative to
the aggregate correlations observed in cross-country data.
While to some extent policies should be skewed toward interventions for which
evidence is more persuasive, the limitations of empirical methods and of data (see
below) mean that only a limited set of interventions will be well-supported by
causal evidence. And, indeed, empirical studies will focus on those topics for which
obtaining credible, causal estimates is least costly. Thus, the danger is that some
interventions that may have large payoffs for generating growth and for which there
is little empirical support, because of the absence of evidence, may be neglected. Of
course, one aim of this Handbook is to point researchers to areas of potential policy
relevance where evidence is weak.
7.Distinguishing symptoms of underdevelopment from root causes of underdevelopment is key to
setting the right policies.This is distinct from identifying cause and effect. One may
find a true causal remedy for a symptom, but remedying the symptom may not lead
to economic growth or development. Distributing a certain pill efficiently may
cost-effectively and causally reduce the incidence of a particular disease that is prev-
alent in low-income countries, but even eradicating the disease may not lead to sub-
stantial economic growth. Finding which “pills” work for which symptoms thus
may not go a long way toward solving problems of underdevelopment. A program
redistributing income to the poor alleviates poverty to some extent, but it does not
address the root cause of poverty and thus may not be sustainable in the long run. In
most low-income countries, school attendance and school inputs are also at low
levels. There may be many ways in which schooling can be increased, and there
is now increased evidence on the “effectiveness” of various mechanisms (see
Chapter 73), through cash transfers that condition on schooling, via polices that
relieve credit constraints, or through improvements in school availability or school
quality. But if schooling demand is low, principally because payoffs to schooling are
low, such interventions will have little effect on poverty reduction and growth.
Alternatively, a policy change that accelerated the pace of technical change and
raised the demand for skilled workers might both alleviate all of the symptoms of
low schooling and enhance economic growth. An understanding of the contexts
in which schooling and health contribute to long-term growth is needed along with
xixDevelopment Economics and Policy

evidence on the effectiveness of polices that induce increased schooling demand or
increase healthiness. Evidence on the former may be more difficult to obtain com-
pared with evaluating specific interventions that raise the quality of schooling,
attract students and teachers to school, or eradicate disease.
8.We learn from many different types of evidence. Development policy progresses through
the updating of priors on what works, how, and where. These chapters demonstrate
that there are multitudes of ways in which our priors can be updated. For example,
economists have exploited historical events—for example, colonization and techno-
logical inventions; natural events—for example, twinning and disease spikes; and
policy variation to assess the impacts of institutions and population and health
policies on income growth. Economists are also directly inducing intervention ran-
domness, rather than achieving it through imposing structure on existing data. Ran-
domized controlled trials (RCTs), in which randomly selected subpopulations are
selected for an intervention and then outcomes are compared across the treated
and untreated populations, have been used to evaluate the causal effects of specific
programs (e.g., cash transfers, subsidies to medical inputs), delivery mechanisms
(e.g., kinds of financial products), and, less pervasively, to obtain evidence on fun-
damental behavioral assumptions that underlie models used to justify policy—for
example, adverse selection.
As we learn from the chapters on aid, microfinance, health, and education,
RCTs are extremely useful in some settings, because, unlike many other empirical
techniques, they leave little room for questioning the internal validity of the results.
But this method has a number of important limitations. First, in common with
other empirical methods, the findings obtained from one population may not be
generalizable to others (problems of external validity). This, of course, is just the
same principle that applies to development policies—we need to know where inter-
ventions work, and why. Second, in common with RCTs applied to medicines but
not to other methods, if an intervention is deemed successful in the short run it is
almost always then provided to the control population, and if the intervention is
deemed ineffective in the short run it is abandoned, thus making it difficult to assess
long-term effects of any randomized trial. For example, the original MexicanPro-
gresaprogram, which restricted cash transfers to a randomly chosen subpopulation,
was deemed to be a success and then immediately extended to all eligible house-
holds. Third, in common with the medical use of RCTs and many other methods,
interventions are evaluated one at a time—there are few comparisons of alternative
interventions that could achieve the same outcome within a given experiment.
Some of these limitations are remediable—multiple interventions can be rando-
mized, treated and nontreated populations can be followed over time, and the same
set of interventions can be tried in different populations to assess external validity.
xx Dani Rodrik and Mark R. Rosenzweig

But, at this point in time we have almost no evidence of long-term effects based on
RCTs and few systematic comparisons of the outcomes of RCTs across different
populations to improve our understanding of the conditions in which particular
interventions are most effective.
The limitations of cross-country empirical work have been increasingly recog-
nized in recent years, but as the chapters in this Handbook demonstrate, there is still
much that can be learned from these exercises if appropriate judgment is exercised.
First, aggregate cross-country associations can be used to establish important regula-
rities (as in Freeman’s chapter on labor markets and Hanson’s on international labor
flows) or to cast doubt on policy presumptions based on incorrect assumptions
about cross-country relationships. The chapters by Harrison and Rodriguez-Clare
and by Kose provide important illustrations of the latter. As these authors discuss,
strongly held professional priors about the impact of trade and financial opening
on growth have been considerably weakened by the latest generation of cross-
country regressions. These cases represent learning—or perhaps more appropriately,
unlearning. History and case studies can also be useful, and many of our chapters
make strategic use of them. Schultz, for example, examines the historical demo-
graphic transition. He also shows that the existing macroevidence on the relation-
ship between fertility decline, which ages a population, and savings is weak or
nonexistent, even though the life-cycle model of savings predicts that savings should
rise as a consequence of aging. The impact of fertility decline on savings has been
one key motivation for population control polices. A second potential benefit of
using relationships among aggregate statistic is that they permit inferences about
externalities. For example, the microevidence on the causal effects of, say, health
or fertility change on individual wages captures private but ignores social gains from
polices that improve health or reduce family size. As Schultz and Behrman point out
in their respective chapters, there has in fact been little evidence on the externalities
of fertility, schooling, or health that help justify public interventions in these areas.
In the field of environment and natural capital, Dasgupta notes that it is possible to
learn from about household and village behaviour governing local ecosystems from
studies that differ greatly in style, ranging from narratives on individual lives to
econometric studies that cover many villages.
9.The experience of developing countries with diverse policies and institutions provides a rich lab-
oratory for learning about the effect of policies and institutional arrangements—so has made
important contribution to economics as an applied science.Policies and institutions in the
advanced nations tend to be stable and relatively uniform. Policies in the developing
nations tend to be in a flux, and both policies and institutions vary considerably
across time and space. This is both a blessing and a curse. You want to test the idea
that nominal variable can have no real effects? What better environment to look at
than developing countries with high inflation? Want to scrutinize the diverse ways
xxiDevelopment Economics and Policy

in which property rights affect economic incentives or how firms and households
cope with absent markets? Why not look across developing countries—where there
is huge variance—or indeed within African countries where there can be significant
variation in property-right protection even across households? Want to understand
the implications of diverse labor-market policies? Again, the developing countries
with a range of institutions provide a great laboratory. Of course, it is precisely this
heterogeneity in institutional settings and policies that makes it difficult to draw
general conclusions about a policy from individual studies confined to particular set-
tings, or from cross-country regressions that assume that policy-response coefficients
are identical across countries. Nevertheless, the combination of economic theoriz-
ing along with careful and thoughtful empirical work applied to new data has led
to an increased understanding of the effectiveness of policies across a wide spectrum
of environments, as the chapters in this Handbook demonstrate.
2. AN OVERVIEW OF THE VOLUME
We now provide a brief summary of the chapters that follow.
Harrison and Rodriguez-Clare ask the question: When should the government
depart from policy neutrality in trade and foreign investment—employing industrial
policies or tilting in favor of (or against) inward foreign investment—and what does
the empirical literature say about the record of such policies? The authors draw atten-
tion to two important empirical regularities in recent decades: first, there is no signifi-
cant relationship between average protection levels and growth; and second, there is a
positive association between trade volumes and growth. They interpret these regulari-
ties to suggest that any successful industrial policy strategy must ultimately raise the
share of international trade in GDP. The authors are also skeptical that promotion of
FDI is warranted by the existing evidence. They find little support for what they call
“hard” interventions (those that distort prices to deal with Marshallian externalities,
learning-by-exporting, and knowledge spillovers from FDI). But they believe there is
room for “soft” industrial policy, wherein the goal is to develop a process whereby
government, industry, and cluster-level private organizations collaborate on interven-
tions to increase productivity. They suggest programs to help particular clusters “by
improving the formation of skilled workers, regulation, and infrastructure.”
As Levy Yeyati and Sturzenegger underscore, few things can have as quick and
dramatic effect on poverty as mismanaged monetary policy that ends up in a bal-
ance-of-payments crisis and high (or hyper-) inflation. Their chapter focuses on the
role of “sound monetary policy,” and on the evolving understanding of how that idea
is practiced. It emphasizes the role of both economic theory and economic history in
shaping governments’ choices with respect to monetary and exchange rate policies.
A central argument in the chapter is that these policies not only affect key nominal
xxiiDani Rodrik and Mark R. Rosenzweig

variables, but, also as a result, real outcomes such as output volatility, economic
growth, and income distribution. In addition, they affect many other variables that
are only loosely related to monetary issues. For example, currency stability may foster
trade, or augment financial fragility as it undermines the incentives of agents to hedge
against currency risk. As Levy Yeyati and Sturzenegger note, the pros and cons of alter-
native policies depend both on the country context and the changing global context.
So the debate on appropriate monetary and exchange rate policies is far from closed.
Kose et al. survey the extent of financial globalization and the nature of the policies
that help developing nations put it to better use. They conclude that financial sector
development, institutional quality, and trade openness help to derive the benefits of
globalization. Low levels of public debt and the avoidance of fixed exchange rate
regimes are also important prerequisites. But this chapter also emphasizes that “the rela-
tionship between financial integration and economic policies is a complex one and that
there are unavoidable tensions inherent in evaluating the risks and benefits associated
with financial globalization.” Consequently, the risk-benefit ratio has to be evaluated
in a country-specific manner. One of the main contributions of this chapter is the idea
that financial integration’s benefits may come not directly in the form of greater invest-
ment and better risk sharing, but indirectly in the form of “collateral” benefits:
improved macroeconomic discipline, development of the domestic financial sector,
competitive discipline, and so on.
Temple reviews the rich and contentious literature on foreign aid and its effective-
ness. His chapter’s focus, appropriately, is not on whether aid works, but on when it
works. The first half of the chapter takes a general equilibrium perspective, and dis-
cusses aggregate models, the Dutch Disease, and the political economy of aid. This part
also discusses the cross-country evidence that underpins much of the academic litera-
ture on foreign aid. The second half of the chapter is organized more concretely
around current debates among donors. Here Temple reviews recent changes in donor
policies, against the background of the emergence of a new “partnership” model for
donors and aid recipients. He focuses on the shift toward greater targeting of aid, gov-
ernance and institutions, local ownership of reforms, the streamlining of conditionality,
and direct budgeting support for recipient governments. Temple ends on a hopeful
note: “Although much remains unknown, arguably enough has been learnt that aid
and conditionality can be more effective in the next few decades than in the past. By
assigning a central role to governance and institutions, academics and policy-makers
may have finally identified the most important binding constraint on growth, develop-
ment, and aid effectiveness. Donor policies are responding to this, and evolving toward
greater flexibility in approach... ”
It has become trite to say that markets depend on well-defined property rights. But
how exactly do these matter, and what is the evidence that they matter in the develop-
ment process? Besley and Ghatak devote their chapter to these questions. They develop
xxiiiDevelopment Economics and Policy

a unified analytical framework for studying the role of property rights in economic
development. The model aims to address two fundamental questions: (i) What are
the mechanisms through which property rights affect economic activity? Property
rights may work through reduced expropriation, through facilitating gains from trade,
or by acting as collateral. (ii) What are the determinants of property rights? Using the
analytical framework as an organizing device, Besley and Ghatak survey some of the
main empirical and theoretical ideas in the literature. They caution about not fetishiz-
ing property rights reform (as it may have diverse effects in different settings), and warn
that there may not be a single, uniform manner in which it can be implemented.
Baland, Moene, and Robinson address the broader issue of governance. Their
chapter yields four main conclusions. First, governance remains a vague notion which
is difficult to unbundled in practice. Nevertheless, the emphasis on governance is quite
consistent with the results of the recent academic literature emphasizing the importance
of institutions. Second, governance is the outcome of a political process, and as such,
the analysis of governance is closely related to the literature on the political economy
of development. Third, reformers who want to improve governance need to under-
stand the nature of the underlying political equilibrium which determined prevailing
arrangements of governance. Finally, little is understood about the forces that create
or impede endogenous improvements in governance, and this remains an important
frontier for future research.
Freeman provides a survey of the institutional landscape of labor markets in devel-
oping nations, and looks at the effects of labor market practices such as employment-
protection laws, minimum wages, and unions on economic outcomes. Developing
nations are characterized by labor market dualism. But Freeman’s evaluation greatly
qualifies the simple Harris-Todaro picture of labor markets where rigidities in urban
formal sectors have adverse implications both for efficiency and equity, and in which
there are easy benefits to be had from weakening labor regulations. He concludes that
“regulations and unions are not the bugbear to development that many believed them
to be years ago.” Where policies have adverse effects on employment, the magnitudes
are generally modest. Freeman emphasizes that practices in formal labor markets have
important spillovers on informal labor markets. For example, minimum wages produce
spikes in wage distribution in informal labor markets as well. He provides capsule sum-
maries of the Chinese and Argentinean experiences, which suggest that labor market
institutions can play a positive role in promoting development and preserving social
stability. The chapter calls for more research on the informal sector, about which Free-
man says we still know far too little.
One sign of the growing integration between developed and developing countries
is the increase in labor flows from low- to high-income countries. The associated
phenomenon of remittances has also caught the attention of development economists,
as these financial flows from high- to low-income countries exceed in magnitude
xxivDani Rodrik and Mark R. Rosenzweig

foreign aid flows. Hanson’s chapter documents the rise in international labor mobility
and in remittances. In this area, it is the policies of developed countries that appear to
have the greatest impact on these phenomena and thus on the development of poor
countries experiencing emigration—high-income countries severely restrict both the
quantity and types of immigration, but few countries control labor outflows, although
some actively support labor emigration (e.g., the Philippines). Hanson’s review of the
existing literature suggests that we do not yet know the primary causes of the still rela-
tively low levels of interborder labor movements given the substantial disparities in
world wages. We do know that most emigrants are positively selective with respect
to human capital and that remittances do not appear to have any special effects on send-
ing-country domestic investment. Hanson asks the policy question of whether
increased outflows that would be enabled by less restrictive high-income country
immigration policies would aid development in low-income countries, and finds that
the evidence is still too weak to provide a reliable answer, but does point to mechan-
isms to study—effects on wages (generally positive), effects on domestic returns to
schooling (unclear), effects on income distribution (depends on the selectivity of
receiving-country restrictions). Areas of interaction across topics highlighted in this
chapter include domestic schooling policy—schooling abroad is an alternative to
domestic investment in education but has implications for the permanent outflow of
workers as well—and trade and aid, although the literature on whether trade, aid,
and migration are complements or substitutes is not yet clear.
Chapter 72 documents the declines in fertility and improvements in health across
the world generally and examines the evidence on the impact of health on productivity
and on the effects of fertility reduction on human capital development. He presents
evidence that policy-makers in low-income countries wish to lower fertility while
those in high-income countries tend to favor polices that are pro-natalist. However,
the amount of public domestic or international-donor funds devoted to affecting fertil-
ity decisions is relatively modest and has declined over time. Existing microstudies that
examine the impact of family size on human capital also point to only relatively small
effects. Such microstudies, however, do not capture externalities that may exist from
population growth reduction. The aggregate effects of fertility reduction on age-
composition also do not appear to have major effects on growth. Emerging evidence
does suggest that early interventions in health, including when a child is in the womb,
have potentially the largest impacts on adult productivity. Because a child’s health is
proximately affected by parental decisions, the chapter highlights these and points to
how an effective health policy that seeks to promote economic growth must focus
on early interventions and thus on the role of parents.
Behrman focuses on schooling policy issues pertaining to the effectiveness of
improvements in school inputs such as smaller classes, or textbooks, and the efficacy
of decentralization of schooling. There is now a growing literature, using RCTs, that
xxvDevelopment Economics and Policy

has examined schooling input effects and incentive schemes to improve both the qual-
ity and quantity of schooling resources, but Behrman notes the paucity of evidence of
long-term effects of schooling improvements and findings across multiple settings. An
emerging theme is that preschool interventions may be especially effective in the
majority of low-income countries where primary schooling is now the norm. These
findings complement those of the health literature, which, as reviewed in Schultz’s
chapter, also show stronger effects of early interventions. The set of RCTs is still too
limited to draw generalizable conclusions; however, there is a relative absence of stud-
ies that look at the general issue of schooling incentives. Behrman also points to a lack
of study of the markets in which schooling inputs are supplied, most especially on what
determines the quantity and quality of teachers and other education providers.
Many economists believe that poverty itself is a barrier to development, given the
limitations of credit and insurance markets—the poor are too poor to save or invest
in either human capital or businesses that spur growth. Such a view takes as given
financial institutions, however. And it is true that existing formal institutions such as
banks find it unprofitable to offer financial services to the poor, and the poor also
appear not to be interested in insurance products and to have low savings rates. Karlan
and Morduch’s chapter takes the point of view that the principal barrier to providing
the poor with financial resources is the absence of delivery mechanisms that appropri-
ately take into account market imperfections, informal institutions, and behavior. One
well-known institutional innovation in finance is “microcredit,” but evidence of its
success is mixed and an understanding of why and whether the specific features of
microcredit mechanisms contribute to solving the fundamental problems of credit mar-
kets is incomplete. Designing the appropriate financial institutions and delivery
mechanisms, of course, requires a deep understanding of behavior and informal sources
of finance. The chapter reviews these with respect to how they contribute to designing
financial delivery mechanisms. They then review recent RCTs that look at how differ-
ing mechanisms of delivery for savings, insurance, and loan products affect both take-
up rates and sustainability (e.g., repayment rates in the case of loans), as well as how
such products affect savings, contribute to consumption smoothing, and spur business
investment.
Of all the issues discussed in this volume, none has the potential to do as much last-
ing damage to the prospects for development, if mismanaged, as climate change and
other sources of degradation in “natural capital.” As Partha Dasgupta notes, policy dis-
cussion on these issues vacillates between two perspectives, one pessimistic and held
mostly by ecologists and the other optimistic and held mostly by economists. The for-
mer points with alarm to the current pattern of apparently unsustainably use of natural
resources, while the latter takes comfort in the fact that any potential scarcity is not
(yet) reflected in rising prices for marketed resources. The complex interactions
xxviDani Rodrik and Mark R. Rosenzweig

between the environment and economic development is the subject of Dasgupta’s
chapter.
Dasgupta begins by emphasizing the huge importance of natural capital in the lives
of the poor, which he argues is often neglected in economic analyses. He then discusses
the externalities involved and the kinds of institutions, particularly community-based
ones, most likely to be effective in removing them. Common property resources
(CPRs) have both their pros and cons, but have been diminishing in importance for
a variety of reasons that Dasgupta identifies. The rest of his paper focuses on ways to
value natural capital and proposes a method for evaluating economic programs. He
draws a distinction between project evaluation and identifying sustainable develop-
ment. He shows that GDP is a misleading indicator in the presence of natural capital,
as it measures the well-being of only the current generation, and should not be used as
a welfare index in either type of exercise. He proposes a comprehensive measure of
wealth as an alternative, and discusses the relevance of his preferred index for both
identifying sustainable development and undertaking project evaluation. Dasgupta
argues that determining the shadow prices of ecological capital assets should be central
to the future research agenda in development economics.
3. CONCLUDING NOTE
As these contributions amply demonstrate, development remains a vibrant field, with
lively interplay among theory, empirics, and policy. We hope these chapters will give
a good account of where the field stands. We also hope their suggestions on important
new policy-relevant research will eventually contribute to this Handbook’s own
obsolescence.
End Notes
This is the introduction toHandbook of Development Economics,vol. 5, Dani Rodrik and Mark R.
Rosenzweig (Eds.), North-Holland, 2009, forthcoming.
References
Chenery, H., & Srinivasan, T. N. (Eds.). (1988).Handbook of development economics(Vol. 1). Amsterdam:
Elsevier Science.
Schultz, T. P., & Strauss, J. (Eds.). (2008).Handbook of development economics(Vol. 4). Amsterdam: Elsevier
Science.
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CONTENTS OF VOLUME 5
Introduction to the Series v
Contents of the Handbook vii
Preface xv
PART Fourteen The Economics of Development policy
CHAPTER 63 Trade, Foreign Investment, and Industrial Policy for Developing
Countries 4039
Ann HarrisonandAndrés Rodríguez-Clare
Abstract 4040
Keywords 4040
1. Introduction 4040
2. The Theoretical Justification for Industrial Policy 4043
2.1Multiple equilibria and latent comparative advantage 4045
2.2Industrial policy without latent comparative advantage 4052
2.3Industrial policy as sector-specific collective action 4054
2.4Self-discovery and diversification 4059
2.5National and global gains from IP 4060
3. Empirical Evidence on Infant-Industry Protection and Other Forms of IP 4062
3.1Single-industry studies 4063
3.2Cross-industry studies 4065
3.3Cross-country studies 4067
3.4Export subsidies and other forms of IP 4070
4. Trade and Economic Development 4071
4.1Stylized facts on trade policies, 1980– 2004 4072
4.2Cross-country evidence on trade policies, trade volumes, productivity,
and growth 4080
4.3What can the different effects of trade volumes versus trade policy tell
us about the success of IP? 4091
4.4Identifying the mechanisms for gains from trade 4095
5. Foreign Direct Investment 4099
5.1FDI and productivity 4103
5.2FDI and host-country factor markets 4108
6. Concluding Comments 4110
Appendix 4114
End Notes 4196
References 4198
xxix

CHAPTER 64 Monetary and Exchange Rate Policies 4215
Eduardo Levy YeyatiandFederico Sturzenegger
Abstract 4215
Keywords 4216
1. Introduction 4216
1.1Do nominal variables matter for development? 4217
2. What Do We Talk About When We Talk About MERP? 4220
2.1Classifying exchange rate policies 4224
2.2Exchange rate policy trends in the post-Bretton Woods era: A casual
glance at the distribution of regime choices 4230
2.3Inside the nonfloat group 4233
2.4Monetary policy: From exchange rate anchors to inflation targeting 4236
3. Why Do We Talk About MERP? 4240
3.1The link between exchange rates and growth revisited 4241
3.2ERR and output volatility 4246
3.3MERP on price stability 4247
3.4MERP on income distribution 4248
3.5Indirect links: The integration channel 4249
3.6Indirect links: The financial channel 4251
3.7Summing up 4254
4. The Making of a Policy 4254
4.1Exchange rate anchors in the 1980s 4254
4.2Financial integration and financial crises in the 1990s 4258
4.3Float cum inflation targeting (FIT) 4260
4.4The comeback of exchange rate regimes: Leaning against the
appreciation wind 4263
5. Where Do We Stand? 4267
End Notes 4269
References 4273
CHAPTER 65 Financial Globalization and Economic Policies 4283
M. Ayhan Kose, Eswar Prasad, Kenneth RogoffandShang-Jin Wei
Abstract 4284
Keywords 4284
1. Introduction 4284
2. Financial Globalization: Measurement and Trends 4288
2.1How to measure financial integration? 4288
2.2Evolution of financial globalization: Some basic stylized facts4289
2.3Factors driving financial globalization 4292
xxx
Contents of Volume 5

3. Macroeconomic Implications of Financial Globalization 4292
3.1Economic growth 4294
3.2Macroeconomic volatility and patterns of international risk-sharing 4303
4. Economic Policies and Growth Outcomes 4306
5. Structural Characteristics and Economic Policies 4310
5.1Financial sector development 4310
5.2Institutional quality 4316
5.3Trade openness 4323
6. Macroeconomic Policies 4330
6.1Theory 4330
6.2Evidence 4330
7. Direction of Capital Flows and Economic Growth 4332
7.1Empirical evidence 4332
7.2How to interpret these findings? 4334
7.3Are developing countries savings-constrained? 4336
7.4Policy implications 4337
8. Capital Controls as a Policy Tool 4337
8.1Implementation and measurement issues 4337
8.2Macroeconomic implications of capital controls 4338
8.3Microeconomic implications of capital controls 4339
9. How to Approach Financial Integration? 4341
10. Conclusion 4343
End Notes 4345
References 4350
Postscript to“Financial Globalization and Economic Policies” 4360
1. Openness, Structural Features and Policies 4360
2. Policies Regulating Capital Account 4361
End Notes 4361
References 4362
CHAPTER 66 International Migration and the Developing World 4363
Gordon H. Hanson
Abstract 4363
Keywords 4364
1. Introduction 4364
2. The Dimensions of International Migration 4366
2.1Data sources 4367
2.2International migration patterns 4368
2.3Skilled emigration 4375
2.4Networks and migration costs 4383
2.5Discussion 4385
xxxi
Contents of Volume 5

3. Impact of Emigration on Sending Countries 4386
3.1Labor markets and fiscal accounts 4386
3.2Remittances and return migration 4390
3.3Information and the flow of ideas 4394
3.4Discussion 4395
4. Immigration Policy Regimes 4396
4.1Political economy of immigration policy 4396
4.2The design of immigration policy regimes 4398
4.3Discussion 4402
5. Final Discussion 4403
End Notes 4405
References 4408
CHAPTER 67 Aid and Conditionality 4415
Jonathan R. W. Temple
Abstract 4416
Keywords 4417
1. Introduction 4417
2. Key Concepts and Stylized Facts 4423
2.1The Millennium Development Goals 4423
2.2Recent trends in aid 4425
2.3The forms of aid 4431
2.4Fungibility 4432
2.5Debt relief 4433
3. Aid and Growth in Theory 4435
3.1Capital shortage and neoclassical growth models 4435
3.2Poverty-trap models 4437
3.3Virtuous circles and amplification effects 4439
3.4Binding constraints 4439
3.5Complementary inputs 4441
3.6Growth versus basic needs 4442
3.7Summary 4442
4. Has Aid Worked? 4443
4.1Project evaluations 4443
4.2Case studies 4444
4.3Cross-country evidence 4445
4.4Aid and social indicators 4447
4.5Summary 4448
5. The View From Trade Theory 4449
5.1The transfer problem 4449
5.2The Dutch Disease 4450
5.3Evidence on the Dutch Disease 4451
xxxii
Contents of Volume 5

6. Aid, Fiscal Policy, and Volatility 4452
7. Aid and Governance 4454
7.1History and the state 4456
7.2Aid and political leadership 4457
7.3Aid and the common-pool problem 4458
7.4Aid and corruption 4459
7.5Aid, political instability, and war 4461
7.6Aid to fragile states 4462
8. A New Partnership Model? 4463
8.1Should democracies get the most aid? 4464
8.2Democracy as a necessary condition 4465
8.3Democracy as a sufficient condition 4466
8.4Summary 4467
9. Conditionality in Theory and Practice 4468
9.1Policy conditionality 4469
9.2Commitment problems 4470
9.3Heroes and villains 4471
9.4Conditionality versus ownership 4472
9.5Governance conditionality 4474
10. Selective Aid Allocation 4475
10.1Developing rules for aid allocation 4477
10.2Dynamic aid allocation 4477
11. The New Conditionality 4478
11.1The meaning of ownership 4479
11.2Poverty Reduction Strategy Papers 4479
11.3Social participation 4480
11.4New forms of conditionality 4481
11.5The future of conditionality 4483
12. Donor Policies 4483
12.1Proliferation of projects and programs 4484
12.2Learning and accountability 4485
12.3Randomized trials and evidence-based aid policies 4486
12.4Evaluate, evaluate, evaluate 4489
13. Meeting Basic Needs 4490
13.1Public service delivery 4491
13.2Agriculture and rural development 4492
14. Aid for the Twenty-First Century 4493
14.1New directions for foreign aid 4495
15. Conclusions 4499
xxxiii
Contents of Volume 5

Appendix 4501
Data 4501
Endogeneity and control variables 4501
Panel data and dynamic responses 4502
Error dependence 4503
Heterogeneity 4503
Publication bias 4505
End Notes 4506
References 4511
CHAPTER 68 Property Rights and Economic Development 4525
Timothy BesleyandMaitreesh Ghatak
Abstract 4525
Keywords 4525
1. Introduction 4526
2. Resource Allocation and Property Rights 4528
2.1The role of property rights in limiting expropriation 4529
2.2Insecure property rights as a barrier to trade 4534
2.3Optimal assignment of property rights 4545
2.4Evidence 4552
3. Endogenous Property Rights 4559
3.1Expropriation 4559
3.2Improving state effectiveness 4583
4. Concluding Comments 4588
End Notes 4589
References 4592
CHAPTER 69 Governance and Development 4597
Jean-Marie Baland, Karl Ove MoeneandJames A. Robinson
Abstract 4597
Keywords 4598
1. Introduction 4598
2. What is Governance 4602
3. Measurement 4603
3.1Political institutions 4603
3.2State capacity and effectiveness 4603
4. Theoretical Mechanisms 4608
4.1The Political economy of governance in Sierra Leone 4610
xxxiv
Contents of Volume 5

5. Consequences and Causes of Variation in Governance 4615
5.1Correlates of governance 4615
5.2The first stage 4620
5.3Origins of bad governance in Sierra Leone 4625
6. Improving Governance 4629
6.1Persistence of power and incentives—The See-Saw Effect 4631
6.2Persistence ofde factopower 4633
6.3The Iron Law of Oligarchy 4637
6.4Successful reform 4640
6.5Governance and equity—The Scandinavian model 4641
6.6Promoting reform 4647
7. Conclusions 4648
End Notes 4649
References 4650
CHAPTER 70 Labor Regulations, Unions, and Social Protection in Developing
Countries: Market Distortions or Efficient Institutions?4657
Richard B. Freeman
Abstract 4657
Keywords 4658
1. The Debate Over Labor Institutions 4661
1.1Theoretical perspectives 4664
2. Microevidence on Minimum Wages 4667
3. Wage Curve 4670
4. Employment Regulations 4672
5. Mandated Benefits 4674
6. Union Effects 4674
7. Cross-Country Evidence 4680
8. Country Cases 4682
8.1China 4683
8.2Argentina 4684
9. The Informal Sector 4684
10. Conclusions 4687
Appendix A 4688
Appendix B: Regression 4693
End Notes 4693
References 4695
xxxv
Contents of Volume 5

CHAPTER 71 Access to Finance 4703
Dean KarlanandJonathan Morduch
Abstract 4704
Keywords 4704
1. Introduction 4704
1.1Mechanisms matter 4706
1.2Testing what works 4707
2. Global Financial Access 4710
3. Financial Intermediation and Economic Growth 4712
4. Returns to Capital 4715
4.1Framing the question 4717
4.2Evidence from estimating profit functions 4717
4.3Evidence from field experiments 4719
4.4What do average returns tell us? 4720
4.5Sensitivity to interest rates 4721
4.6A final caveat 4722
5. Credit Market Innovations 4723
5.1Nature of frictions and policy examples 4724
5.2Interventions and mechanisms 4729
5.3Impacts from solving credit market failures 4736
6. The Economics of Saving 4739
6.1Basic models of saving 4742
6.2Constraints to saving 4745
6.3Impacts of saving 4757
7. Risk Management and Insurance 4759
7.1Why insurance markets fail 4762
7.2Partnership models and index-based insurance 4766
7.3Health insurance 4769
8. Governments, Businesses, and Nonprofit Institutions 4770
9. Concluding Comments 4774
End Notes 4775
References 4777
CHAPTER 72 Population and Health Policies 4785
T. Paul Schultz
Abstract 4785
Keywords 4786
1. Introduction 4786
xxxvi
Contents of Volume 5

2. Historical Transition of Death and Birth Rates and Population Policies 4789
2.1International population policy assistance: Levels and trends4792
3. Stylized Facts Related to Health, Fertility, and Development4797
4. Framework for Studying the Determinants and Consequences of Health 4800
4.1Estimating without bias health production functions with endogenous
inputs 4802
4.2Estimating the marginal product of health human capital 4804
4.3Parent investment in children in response to their children's initial
endowments 4805
4.4Spillovers from health human capital beyond the individual and family 4810
4.5Phases of the mortality transition and implications for health inequality 4812
5. Macroeconomics Evidence on Health Determinants and Economic Growth 4813
5.1Macroeconomic evidence of the impact of income on health 4816
5.2Alternative indicators of health status and their economic consequences 4818
6. Microeconomics of Health and Development: Individuals and Households 4820
6.1Height, weight, body mass index, and birth weight as indicators
of health stocks 4822
6.2Heterogeneity of height as a measure of the stock of health
human capital 4828
6.3Pathways from fetal and early child development to adult productive
life span 4840
7. Macroeconomics of Fertility and Development: Diminishing Returns to Labor,
Human Capital and Savings, and Changing Age Composition 4844
8. Microevidence of Determinants of Fertility and Consequences of
Policy on Fertility 4847
8.1Income and price effects affecting the quantity and quality of children 4848
8.2Family planning policies and fertility: Cross-country relationships 4850
8.3Estimating the cross-effects of fertility variation on family lifetime
outcomes 4853
8.4A social experiment in family planning and reproductive health:
Bangladesh 4855
9. Internal Migration, Demographic Transition, and Evaluation of Policy 4857
10. Conclusions and Policy Directions 4861
End Notes 4865
References 4871
CHAPTER 73 Investment in Education—Inputs and Incentives 4883
Jere R. Behrman
Abstract 4883
Keywords 4884
1. Introduction 4884
xxxvii
Contents of Volume 5

2. Framework for Analysis and What We Know and Do Not Know 4886
2.1Demand side—Models, estimates, and policy implications 4886
3. Supply Side—Models, Estimates, and Policy Implications 4914
3.1Supply-side modeling 4915
3.2Estimates and policy implications 4920
4. Markets for Products and Inputs—Models, Estimates, and Policy Implications 4943
4.1Sorting in educational markets 4943
4.2Supplies and sectoral choices of childcare workers, teachers, trainers,
and other educational service sector staff 4944
4.3Educational expenditures and age distributions 4945
5. Conclusions 4946
Appendix: Estimation Issues, Possible Methodological Resolutions, and Data 4947
A.1. Econometric Approaches to Dealing with Estimation Problems4947
A.2. Strengths and Limitations of Analysis of Various Types of Data and
Related Methods 4952
A.2.1Some major characteristics pertaining to data quality 4953
A.2.2Some major types of data for investigating education and
development 4955
End Notes 4959
References 4965
CHAPTER 74 The Place of Nature in Economic Development 4977
Partha Dasgupta
Abstract 4978
Keywords 4978
1. Nature in Economics 4978
2. Natural Capital and Economic Development 4980
3. Natural Capital and Development Economics 4982
4. Types of Natural Capital 4985
5. Contents 4987
5.1Externalities 4988
6. Unidirectional Externalities: Exports and Wealth Transfers 4989
6.1Quantifying externalities 4990
6.2Internalizing externalities 4990
7. Reciprocal Externalities: Common Property Resources 4992
7.1Why CPRs? 4992
7.2The importance of CPRs 4994
7.3The good news about CPRs 4995
7.4The bad news about CPRs 4996
7.5Valuation, evaluation, and sustainable development 5001
xxxviii
Contents of Volume 5

8. Inadequacies in GDP 5001
9. Valuing Goods and Services 5002
9.1Defining shadow prices 5003
9.2Estimating shadow prices 5003
10. Social Well-Being and Comprehensive Wealth 5006
10.1A unifying model 5007
10.2The welfare significance of net domestic product 5008
11. Comprehensive Investment and Sustainable Development 5009
11.1The basic theory 5009
11.2Global public goods 5011
11.3An application 5012
12. Evaluating Policy Reforms 5016
12.1Social cost-benefit analysis 5016
12.2Evaluating projects in practice 5017
13. Discounting Climate Change 5021
13.1Global activism now or later? 5021
13.2Negative discount rates 5022
13.3The welfare economics of climate change 5022
13.4Social aversions to inequality and risk 5024
13.5Climate treaties 5025
14. Conclusions 5026
Appendix 5029
A.1. Economic Perturbation as Movement Through Time:
Sustainable Development 5029
A.1.1The formal analysis 5029
A.1.2Accounting for population growth 5031
A.2. Policy Evaluation 5033
End Notes 5034
References 5036
Index 5047
xxxix
Contents of Volume 5

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PARTFourteenFourteen
The Economics of Development Policy

CHAPTER6363
Trade, Foreign Investment, and
Industrial Policy for Developing
Countries

Ann Harrison
University of California at Berkeley and NBER
Andrés Rodríguez-Clare
Pennsylvania State University and NBER
Contents
1.Introduction 4040
2.The Theoretical Justification for Industrial Policy 4043
2.1Multiple equilibria and latent comparative advantage 4045
2.2Industrial policy without latent comparative advantage 4052
2.3Industrial policy as sector-specific collective action 4054
2.4Self-discovery and diversification 4059
2.5National and global gains from IP 4060
3.Empirical Evidence on Infant-Industry Protection and Other Forms of IP4062
3.1Single-industry studies 4063
3.2Cross-industry studies 4065
3.3Cross-country studies 4067
3.4Export subsidies and other forms of IP 4070
4.Trade and Economic Development 4071
4.1Stylized facts on trade policies, 1980–2004 4072
4.2Cross-country evidence on trade policies, trade volumes, productivity,
and growth 4080
4.3What can the different effects of trade volumes versus trade policy tell
us about the success of IP? 4091
4.4Identifying the mechanisms for gains from trade 4095
5.Foreign Direct Investment 4099
5.1FDI and productivity 4103
5.2FDI and host-country factor markets 4108
6.Concluding Comments 4110
Appendix 4114
End Notes 4196
References 4198
Handbook of Development Economics,Volume 5 Doi 10.1016/B978-0-444-52944-2.00001-X
#2010 Elsevier B.V. All rights reserved.
4039

Abstract
In this chapter we explore the popular but controversial idea that developing countries benefit
from abandoning policy neutralityvis-a-vistrade, FDI and resource allocation across industries.
Are developing countries justified in imposing tariffs, subsidies, and tax breaks that imply distor-
tions beyond the ones associated with optimal taxes or revenue constraints? We refer to this set
of government interventions as“industrial policy.”We explore the theoretical foundation for
industrial policy and then review the related empirical literature. We follow this with a broader
look at the empirical work on the relationship between trade and FDI and growth. In this review
we find no support for“hard”interventions that distort prices to deal with Marshallian external-
ities, learning by exporting, and knowledge spillovers from FDI. Nevertheless, we still envision an
important role for what we refer to as“soft”industrial policy. The goal is to develop a process
whereby government, industry and cluster-level private organizations can collaborate on inter-
ventions to increase productivity. We suggest programs and grants to help particular clusters by
improving the formation of skilled workers, technology adoption, regulation and infrastructure.
JEL classifications: L50, L51, O12, O13
Keywords
trade
foreign investment
industrial policy
agglomeration
1. INTRODUCTION
...growth was not a passive, trickle-down strategy for helping the poor. It was
an active, pull-up strategy instead. It required a government that would
energetically take steps to accelerate growth, through a variety of policies
including building infrastructure such as roads and ports and attracting
foreign funds.
Jagdish Bhagwati, In Defense of Globalization(2004)
During the last three decades, developing countries have made enormous strides in
opening up their protected domestic markets to international trade and foreign invest-
ment. Yet most countries have not simply opened up their markets. They have also
instituted a range of policies to encourage exports, attract foreign direct investment
(FDI), promote innovation, and favor some industries over others. This leads to the
following question: is openness to trade and FDI alone sufficient to achieve high
growth rates in developing countries? If harnessing the gains from globalization
requires additional policies, can we identify them? While some types of complementary
policies, such as building roads and ports, are not controversial, others are. Bhagwati’s
suggestion to “attract foreign funds” implies tilting incentives in favor of foreign
4040Ann Harrison and Andrés Rodríguez-Clare

Another Random Scribd Document
with Unrelated Content

12
The Grattan and Harney Massacres, 1854-55
Until August 18, summer emigration in 1854 appears to have been
unaffected by trouble with the Indians. On that day a Mormon
caravan passed a village of Brule Sioux 8 miles east of Fort
Laramie, and a cow ran into the village where it was
appropriated by a visiting Miniconjou brave. This matter was reported
at the fort by both the Mormons and the chief of the Brules. Lt. John
Grattan, Sixth Infantry, with 29 soldiers, 2 cannon, and an interpreter,
was dispatched to the village to arrest the offending Indian.
Unfortunately, the interpreter was drunk and the young officer was
arrogant. The Indian offender refused to give himself up and a fight
was precipitated in the Indian village, resulting in the annihilation of
the military party.
The enraged Indians then pillaged Bordeaux’s nearby trading post
and helped themselves to both annuity goods and company property
at the American Fur Co.’s post 3 miles up the river. Fortunately, no
attack was made on the small remaining garrison of Fort Laramie to
which neighboring traders and others rushed for protection. All Sioux
immediately left the vicinity of the fort, and the Cheyennes and
Arapahoes waited only for the distribution of treaty goods before
moving away.
During the following year, Indians committed many small-scale
depredations along the Oregon Trail. However, despite greatly
exaggerated alarms, the emigrants of 1855 were for the most part
unmolested. Meanwhile, the Army had become convinced that the
Indians must be punished, and a force of 600 men under Gen. W. S.
Harney marched westward from Fort Leavenworth. The Indian agent
at Fort Laramie warned all friendly Indians to come to the south side
of the Platte—a warning heeded by many bands. On September 2,

General Harney arrived at Ash Hollow, 150 miles below Fort Laramie,
and located Little Thunder’s band of Brule Sioux some 6 miles north
on the Blue Water. Early the next morning, after rejecting
protestations of friendship by Little Thunder, his troops attacked the
village from two sides, killing 86 Indians and capturing an almost
equal number of women and children. At Fort Laramie, General
Harney issued a stern warning to other Sioux bands, then proceeded
overland through Sioux territory to establish a military post at Fort
Pierre on the upper Missouri River.

13
Handcart to Pony Express, 1856-61
In 1856, in an effort to reduce the cost of emigration to Utah, the
Mormons introduced the handcart plan. Two-wheeled handcarts,
similar to those once used by street sweepers, were constructed of
Iowa hickory and oak. One cart was assigned to each four or five
converts who walked and pushed or pulled their carts over the long
trek from the railhead at Iowa City to the Salt Lake Valley. Livestock
was driven with the parties and at times 1 ox-drawn wagon to each
100 emigrants was provided to carry additional baggage and
supplies. The first handcart parties were very successful, but
the last two, in 1856, started too late in the summer and were
snowed in near Devil’s Gate. There, more than 200 of the 1,000 or
more in the two parties perished from cold and hunger before the
survivors could be rescued by wagon trains sent out from Utah. From
1856 to 1860 some 3,000 Mormons made the journey to Utah in 10
handcart companies, and to these footsore travelers Fort Laramie was
indeed a haven in the wilderness.
Early in 1857, the War Department decided to abandon Fort Laramie,
but events forced the cancellation of the order before it could be
carried out, and the fort again demonstrated its strategic importance.
First, it served as a supply base for a punitive expedition led by Col.
E. V. Sumner against the Cheyennes between the Platte and Arkansas
Rivers. Then, as that campaign drew to an inconclusive end, the fort
became a vital base for the Army which marched toward Utah that
fall to subdue the reportedly rebellious Mormons.
By the next year, the Utah Campaign involved some 6,000 troops,
half of whom were in or near Utah, with Fort Laramie their nearest
sure source of supply.

14
In spite of this warlike activity, thousands of emigrants continued to
roll westward by covered wagon, the great travel medium of the
plains. To these the fort was a vital way station, as it was to the great
firm of Russell, Majors, and Waddell, freighting contractors who
carried supplies to the Army in Utah. In 1858, this enterprise alone
involved 3,500 wagons, 40,000 oxen, 1,000 mules, and 4,000 men.
Beginning in 1850, mail service of varying frequency and reliability
linked Fort Laramie with the States to the east and Salt Lake City to
the west. Interrupted in the summer of 1857 by the Utah Campaign,
a new and improved weekly mail service was organized in 1858
bringing news only 12 days old from the Missouri River to the fort.
In 1858, the discovery of gold at Cherry Creek, 200 miles south of
Fort Laramie, precipitated the Colorado gold rush. That winter Fort
Laramie was the nearest link between the gold miners clustered
about the site of Denver, Colo., and the outside world. An informal
mail express to the fort was organized and carried by old trappers.
These developments were soon overshadowed by the spectacular
pony express. The first westbound rider galloped into Fort Laramie on
April 6, 1860, just 3 days out from St. Joseph, Mo. This remarkable
system of relays of riders and ponies carried up to 10 pounds of mail
from St. Joseph to San Francisco in 13 days, at the rate of $5 in gold
for a half-ounce letter. Later, a Government subsidy, begun on July 1,
1861, reduced the rate to $1 for one-half ounce. On that same date
daily overland mail coaches began operating from St. Joseph to San
Francisco, via Fort Laramie, on an 18-day schedule.
Meanwhile, the poles and wires of the first transcontinental telegraph
were stretching out across the plains and mountains. Reaching
Fort Laramie in September, the telegraph was completed to Salt
Lake City and connected with the line from the west coast on October
24, 1861. That date also marked the end of the pony express which,
although a financial failure that cost W. H. Russell his fortune, had
proved the practicability of the central route to California for year-
round travel.

The Civil War and the Uprising of the Plains
Indians
The outbreak of the Civil War led to the reduction of garrisons at all
outposts. This, coupled with a bloody uprising of the Sioux in
Minnesota in 1862, inspired the Plains Indians, nursing many
grievances, to go on the warpath. In the spring of 1862, many stage
stations along the Platte route were raided and burned. To meet this
threat, volunteer cavalry from Utah rushed east to the South Pass
area, and the Eleventh Ohio Volunteer Cavalry under Col. Wm. O.
Collins was ordered west to Fort Laramie. These raids also prompted
the moving of the overland mail and stage route south to the
Overland Trail and the establishment of Fort Halleck 120 miles to the
southwest. During this period, troops at Fort Laramie continued to
protect the vital telegraph line through South Pass and a still
considerable volume of travelers, principally to Utah.
The next winter was fairly peaceful at Fort Laramie, and of social life
at the post young Caspar Collins wrote to his mother: “They make
the soldiers wear white gloves at this post, and they cut around very
fashionably. A good many of the regulars are married and have their
wives and families with them.” He also indicated that they had a
circulating library, a band, amateur theatricals, and an occasional ball.
However, the dangers of the frontier were ever present, and, later
that winter, troops en route from Fort Laramie to Fort Halleck
encountered weather so severe that several were frozen to death.
Indians continued to steal horses from the overland mail stations,
freighters, and ranchers, and incidents provoked by both whites and
Indians piled up until the whole region was in a state of alarm. Efforts
were made to call the Indians into the forts to treat for peace, but
with little success.

15
At this time the difficulty of detecting the movements of Indian war
parties was demonstrated at Fort Laramie. Returning from a 3-day
scout, without finding a sign of hostile Indians, a large detachment of
troops unsaddled their horses and let them roll on the parade
grounds. Suddenly, at midday, a daring party of 30 warriors dashed
through the fort, drove the horses off to the north and escaped, with
all but the poorest animals, despite a 48-hour pursuit. The fort’s
commander, Major Wood, was described by his adjutant as “the
maddest man I ever saw.”
Fort Laramie in 1863. Note “Old Bedlam” to the right of the
flagpole. From a sketch in the University of Wyoming
Archives by Bugler C. Moellman, 11th Ohio Volunteer
Cavalry.
Later in 1864, after another attempt to make peace with the northern
Indians had failed, Gen. R. B. Mitchell ordered the strengthening of
the defenses along the road to South Pass. Several former stage and
pony express stations were strengthened and garrisoned. Fort
Sedgwick, near Julesburg, and Fort Mitchell, at Scottsbluff, were

16
among those established. Fort Laramie became headquarters of a
district extending from South Pass east to Mud Springs Station.
Meanwhile, Indian raids along the South Platte River virtually cut off
Denver from the east for 6 weeks.
Continuing efforts to seek peace with the Indians were made
unsuccessful by the Sand Creek Massacre in November 1864, which
united the southern bands of Sioux, Cheyenne, and Arapahoe on the
warpath. Early in January 1865, they raided Julesburg, sacking the
station, carrying off great quantities of foodstuffs, and almost
succeeding in destroying the garrison of Fort Sedgwick. Efforts to
burn out the Indians by setting a 300-mile-wide prairie fire brought
them swarming back to the attack, destroying the South Platte road
stations and miles of telegraph line, sacking and burning Julesburg a
second time, and driving off great herds of livestock. While troops
from Fort Laramie arrived at Mud Springs Station in time to fight off
the Indians there, all efforts by troops from Fort Laramie and the east
failed to prevent the Indians from escaping with their booty across
the North Platte, near Ash Hollow.
Termination of the Civil War in April 1865 released many troops for
service against the Indians, and plans were laid for extensive punitive
expeditions, especially in the country to the north of the North Platte
River.
In May, the fort’s commander, Col. Thomas Moonlight, led 500
cavalrymen on a 450-mile foray into the Wind River Valley, but
failed to find the Indians. Meanwhile, there were several raids on
stations westward to South Pass. An effort to move a village of
friendly Brules from Fort Laramie to Fort Kearny resulted in a fight at
Horse Creek where Captain Fouts and four soldiers were killed as
these Indians escaped to join the hostiles. In pursuing them, all of
Colonel Moonlight’s horses were stolen, and he returned to Fort
Laramie in disgrace.
The major Indian raids of the summer centered on Platte Bridge
Station, 130 miles above Fort Laramie, where late in July a large

force of Indians wiped out a wagon train and killed 26 white men,
including Lt. Caspar Collins who led a small party from the station in
a valiant rescue effort.
Group on the porch of “Old Bedlam” in 1864. Courtesy
Newberry Library.
In the meantime, a great campaign against the Indians, known as
the Powder River Expedition, got under way with 2,500 men, directed
by Gen. R. E. Connor. Of three columns planned to converge on the
Indians in the Powder River country, the first, under Colonel Cole,
started from Omaha, marched up the Loup River Valley, thence east
of the Black Hills and on to the Powder River in Montana. The
second, under Lieutenant Colonel Walker, left Fort Laramie, marched

17
north along the west side of the Black Hills, and joined Colonel Cole’s
column as planned. The third, under General Connor, marched about
100 miles up the Platte from Fort Laramie, then north to the
headwaters of Powder River where a small fort, Camp Connor,
was established; thence, down the Powder River, where he
destroyed the village and supplies of a large band of Arapahoes, but
failed to meet the other two columns. The other commanders,
lacking adequate supplies and proper knowledge of the country, lost
most of their horses and mules in a September storm and, beset by
fast-riding Indians, were forced to destroy the bulk of their heavy
equipment. They were finally found and led to Camp Connor just in
time to prevent heavy losses by starvation and possible destruction
by Indians. The expedition straggled back to Fort Laramie, a failure.

Peace Talk and War on the Bozeman Trail,
1866-68
Officials at Washington now decided to try peaceful measures with
the Indians of the Fort Laramie region, and General Connor was
succeeded in command by General Wheaton. Emissaries were sent to
the tribes, inviting them to a general peace council at Fort Laramie in
June 1866.
In March of that year, Col. Henry Maynadier, then in command at Fort
Laramie, reported, as auguring success of the peace council, that
Spotted Tail, head chief of the Brule Sioux, had brought in the body
of his daughter for burial among the whites at Fort Laramie. Her
name was Ah-ho-ap-pa, which is Sioux for wheat flour, although
modern poets have referred to her as Fallen Leaf. In the summer of
1864, she was a familiar figure at Fort Laramie. While she haughtily
refused the crackers, coffee, and bacon doled out to the Indian
women and children at that time, she spent long hours on a bench by
the sutler’s store watching the white man’s way of life. She was
particularly fond of watching the guard mount and the dress parade,
and the officer in charge was often especially decked out in sash and
plumes for her benefit. She refused to marry one of her own people,
attempted to learn English, and told her people they were fools for
not living in houses and making peace with the whites. When the
Sioux went on the warpath in 1864, however, Spotted Tail and his
daughter were with them and spent the next year in the Powder
River country. There the hard life weakened her, and she sickened
and died during the following cold winter.
Having promised to carry out her express wish to be buried at Fort
Laramie, her father led the funeral procession on a journey of 260
miles. Colonel Maynadier responded gallantly to Spotted Tail’s

18
request. In a ceremony which combined all the pageantry of the
military and the primitive tradition of the Sioux, her body was placed
in a coffin on a raised platform a half mile north of the parade
grounds. Thus, a long step had been taken toward winning the
friendship of a great chief.
The grave of Spotted Tail’s daughter near Fort Laramie,
about 1881. Courtesy Wyoming Historical Department.
Fort Laramie in 1867. From a sketch by Anton Schoenborn.

19
By June, a good representation of Brule and Oglala Sioux being
present, the commissioners set about negotiating a treaty. In the
meantime, unfortunately, the War Department sent out an expedition
instructed to open the Bozeman Trail through the Powder River
country to the Montana gold mines. Colonel Carrington and his troops
arrived at Fort Laramie in the midst of the negotiations and caused
serious unrest among the Indians. One chief commented, “Great
Father send us presents and wants new road, but white chief goes
with soldiers to steal road before Indian say yes or no,” and a
large faction, led by Red Cloud and Man-Afraid-of-His-Horses,
withdrew in open opposition to all peace talk. Nevertheless, the
remaining Indians agreed to a treaty which provided for the opening
of the Bozeman Trail.
In late June the troops under Colonel Carrington marched up the
trail, garrisoned Camp Connor (later moved and named Fort Reno),
and began building Fort Phil Kearny at the foot of the Bighorn
Mountains and Fort C. F. Smith farther north in Montana.
Immediately, it became evident that the peace treaty was
meaningless. Fort Phil Kearny was the scene of almost daily Indian
attacks on traders, wagon trains, wood-cutting parties, and troops.
These attacks were climaxed on December 21 when Capt. William
Fetterman and 80 men were led into an ambush and annihilated by
Indians led by Crazy Horse and Red Cloud. The fort and its remaining
garrison were in danger of being overwhelmed, and the nearest aid
lay at Fort Laramie, 236 miles away. At midnight, John “Portugee”
Phillips, trader and scout, slipped out into a blizzard on the colonel’s
favorite horse and in 4 days made his way across the storm-swept,
Indian-infested plains to Fort Laramie in one of the truly heroic rides
of American history. While his gallant mount lay dying on the parade
ground, Phillips interrupted a gay Christmas night party in “Old
Bedlam” to deliver his message, and a relief expedition was soon on
its way.
The severe weather made an attempted winter campaign against the
Indians unsuccessful, and there was no important fighting until

20
APRIL 1954 NM-LAR-7004
summer. On August 2, 1867, the Indians again attacked a
woodcutting party near Fort Phil Kearny, but the small detachment
led by Captain Powell was armed with the new 1866 Springfield
breech-loading rifles and fought off repeated charges by the Indians
in the famous Wagon Box Fight.
FORT LARAMIE
GENERAL PLAN
(FROM AN OLD MAP)
1867
INDIAN LODGES
OFFICERS’ STABLES
HOSPITAL
GRAVE YARD
CAVALRY STABLES
PROVOST MARSHALL

21
OFFICERS’ QUARTERS
MAGAZINE
CAMP SHOP
SUTLER’S STORE
SUTLER’S RESIDENCE
BAKERY
BARRACKS
ICE HOUSE
BARRACKS
PARADE
COMMANDING OFFICER’S QUARTERS
ADJUTANT’S OFFICE
ICE HOUSE
BAND ROOM
BARRACKS
BARRACKS
GUARD HOUSE
Q.M. STORE HOUSE
POST OFFICE
CARPENTERS’
COMM. OFFICE
COMMISSARY STORE HOUSE
MILL YARD
STORE HOUSE
Q.M. OFFICE
LUMBER, CORN PILE
LAUNDRESSES
SADLERS’
Q.M. QUARTERS
SMITH’S SHOP
HORSE SHED
CORRAL
TEAMSTERS’ QUARTERS
HAY YARD
WOOD YARD
CORRAL
FOOT BRIDGE
BROWN’S HOTEL

The Treaty of 1868
Again, the peace advocates in Washington were in the ascendancy,
and in the summer of 1867 the Congress provided a commission to
treat with the Indians, but authorized recruiting an army of 4,000
men if peace was not attained. Treaties with the southern tribes were
concluded at Fort Larned in October, and the commissioners came to
Fort Laramie in November to treat with the northern tribes. However,
few came in and the hostiles, led by Red Cloud, sent word that no
treaty was possible until the forts on the Bozeman Trail and in the
valley of the Powder River were abandoned to the Indians. They did
agree to cease hostilities and to come to Fort Laramie the next
spring. In April 1868, the commissioners came again to Fort Laramie
and were prepared to grant the Indians’ demands, including
abandonment of the Bozeman Trail. By late May, both the Brule and
Oglala Sioux had signed the treaty, but Red Cloud refused to sign
until the troops had left the Powder River country and his warriors
had burned the abandoned Fort Phil Kearny to the ground.

22
The Peace Commissioners in council with Indians at Fort
Laramie in 1868. From a photograph by Alexander Gardner
in the Newberry Library.

Indians at the North Platte Ferry in 1868. From a
photograph by Alexander Gardner in the Newberry Library.
Dress parade at Fort Laramie in 1868. Note “Old Bedlam” at
the extreme right. From a photograph by Alexander
Gardner in the Newberry Library.
This treaty gave the Indians all of what is now South Dakota west of
the Missouri River as a reservation. It also gave them control and
hunting rights in the great territory north of the North Platte River
and east of the Bighorn Mountains as unceded Indian lands. The

23
Indian agencies were to be built on the Missouri River. Many of the
Indians, however, objected to giving up trading at Fort Laramie as
had been their custom, and, in 1870, a temporary agency for Red
Cloud’s band was established on the North Platte River 30 miles
below the fort, at the present Nebraska-Wyoming line. Finally, in
1873, after he and other chiefs had twice been taken to Washington
and New York to view the numbers and power of the white man, Red
Cloud agreed to having his agency moved north to a site on
White River away from Fort Laramie and the Platte Road.
Indians and whites at Fort Laramie in 1868. From a
photograph by Alexander Gardner in the Newberry Library.
In the meantime, peace prevailed on the high plains, and, in 1872, it
was reported that not a white man was killed in the department of
the Platte.

24
Later in 1873, however, the attitude of many Indians toward their
agents at the Red Cloud and Spotted Tail agencies became so hostile
that the agents requested that troops be stationed at the agencies.
Although the Indians protested this as a violation of their treaty
rights, Camp Robinson and Camp Sheridan were established at these
respective agencies in 1874. At the same time, funds were
obtained for an iron bridge over the North Platte at Fort
Laramie. Its completion, early in 1876, gave the troops there ready
access to the Indian country.
Fort Laramie in 1868. U. S. Geological Survey photograph
by William H. Jackson.

25
The Fight for the Black Hills
Fort Laramie in 1876. Illustration: Courtesy D. S. Mitchell.
Rumors of gold in the Black Hills of South Dakota had persisted for
many years, which induced the Government to send an expedition
under Col. George A. Custer from Fort Abraham Lincoln on the upper
Missouri to investigate the area. Proceeding without opposition from
the Indians, the expedition confirmed the presence of gold in the hills
and sent out word of their discoveries to Fort Laramie in August
1874. The resulting rush of prospecting parties was at first forbidden
by the military, who rounded up several and imprisoned some of their
leaders at Fort Laramie, while other parties were attacked by the
Indians for flagrant violation of the treaty of 1868.
A second expedition, led by Col. R. I. Dodge and Prof. W. P.
Jenney, set out from Fort Laramie the next spring to explore
and evaluate the gold deposits in the Black Hills. Miners also
thronged the hills, and efforts to make them await negotiations with
the Indians were only partly successful. Meanwhile, the Government
did make an effort to buy the Black Hills from the Sioux; but the
Indians, led by Chief Spotted Tail, set a justly high price on the area,
which the Government refused to meet. Moreover, the wild bands of
Sitting Bull and other chiefs refused to sell at any price and warned

26
the whites to stay out. No longer restrained by the Army, the miners
now swarmed into the hills, which became a powder keg.
Ignoring existing treaties, the Government decided to force the wild
Sioux onto their reservation, and when the order for them to come in
was not instantly complied with, the Army prepared for action.
A double enveloping campaign was planned, to be led by Gen.
George Crook with troops based at Fort Laramie and Fort Fetterman,
and by Gen. Alfred H. Terry with Custer’s Seventh Cavalry from Fort
Abraham Lincoln and Col. John Gibbon’s command from Fort Ellis,
Mont. In March, Crook marched north from Fort Fetterman, 80 miles
northwest of Fort Laramie, with 12 companies of soldiers. His cavalry
surprised a large village of Sioux and Cheyenne on the Little Powder
River in Montana, but Crazy Horse rallied the Indians and forced the
troops to retreat. Again in late May, Crook moved north with 20
companies of men plus 300 friendly Shoshones and Crows, and once
more, on June 17, on the Rosebud, he was defeated by a great array
of warriors led by Crazy Horse. Retreating to his supply camp, Crook
again decided to send for reinforcements.
Meanwhile, General Terry’s command had marched west from Fort
Abraham Lincoln and met Colonel Gibbon’s detachment on the
Yellowstone River. Again dividing his forces, Terry sent Custer and the
entire Seventh Cavalry up the Rosebud River, while he and Gibbon,
with 12 companies of infantry and four troops of cavalry, proceeded
up the Bighorn River.
On the morning of June 25, 1876, Custer’s scouts sighted the Indian
village in the valley of the Little Bighorn. He divided his command to
attack the village from three directions. The Indians, however, first
met Maj. Marcus A. Reno’s contingent of three troops in the
afternoon in overwhelming numbers and forced them to retreat to a
defensive position, where they were joined by a similar detachment
under Capt. Frederick W. Benteen and the pack train. Meanwhile, the
great part of the Indians had swung away to meet and wipe out
Custer’s personal command of five troops. Again the warriors

27
attacked Reno, but since he was on favorable ground he was able to
fight them off until the next day when their scouts detected the
approach of General Terry. Firing the grass, the Indians moved off
into the Bighorn Mountain, leaving over 260 soldiers dead on the
battlefield. It was an empty victory, however, as the Indians were
compelled to scatter to hunt for food. By winter, reinforced armies
under General Crook and Colonel Miles had defeated bands led by
Dull Knife and Crazy Horse, forcing them to return to the reservation
and surrender, while Sitting Bull’s band fled north into Canada.
In the meantime, the Government had decreed that no annuities
should be paid to the hostile bands or to any Sioux until they had
ceded the coveted Black Hills to the whites. A commission succeeded
in getting the Sioux to sign an agreement effecting that end when it
became law in February 1877.
The Northern Cheyennes were taken south to the Indian territory in
1877, but they broke away the next year, led by Dull Knife and Little
Wolf, and headed north for their old home in the Dakotas. After
hard campaigning by troops from Fort Laramie and other posts,
many of Dull Knife’s band were killed and all others were captured.
These, however, were permitted to remain on the northern
reservation.

In 1888, officers’ row featured boardwalks, picket fences,
and family gatherings on vine-shaded verandas. Courtesy
Col. Louis Brechemin.
The rush to the Black Hills gave new importance to Fort Laramie, for,
with its bridge across the North Platte, it was the gateway to the
gold-mining region via the trail leading north from Cheyenne, whose
merchants advertised the route as being well guarded. Although the
troops from the fort were virtually all engaged in the effort to combat
Indian depredations and provide escorts, travel to the gold fields was
in fact extremely hazardous. Regular service by the Cheyenne and
Black Hills stage line was impossible, until conditions improved in the
fall of 1876. But no sooner had Indian raids on the trail lessened than
the activities of “road agents” threatened the traveler. Even armored
coaches with shotgun guards failed to deter the bandits seeking gold
shipments.

28
Last Years of the Army Post, 1877-90
Beginning in the late 1870’s, other changes took place around Fort
Laramie. With the Indians removed to reservations, ranchers and
other settlers came in, and great herds of cattle replaced the buffalo
on the Wyoming plains. To many of these settlers the fort on the
Laramie was a supply center, as well as insurance against Indian
outbreaks and lawless white men.

FORT LARAMIE
PLAN OF POST
1888
LEGEND
1 OFFICERS’ QUARTERS
2 ” ”
3 ” ”
4 ” ”
5 ” ”
6 ” ”
7 ” ”
8 ” ”
9 ” ”
10 ” ”
11 ” ”
12 ” ”
13 COMMANDING OFFICER’S QUARTERS
14 OFFICERS’ QUARTERS
15 ” ”
16 ” ”
17 ” ”
18 ” ”
19 ” ”
20 PRINTING OFFICE
21 ADMINISTRATION BUILDING
22 LIBRARY
23 MAGAZINE (OLD GUARD HOUSE)
24 BARRACKS
25 KITCHEN AND MESSHALL
26 GUARD HOUSE
27 GENERAL SINK
28 OIL HOUSE
29 MARRIED MEN’S QUARTERS
30 BARRACKS
31 KITCHEN AND MESSHALL
32 ” ” ”
33 ” ” ”
34 NEW BARRACKS
35 COMMISSARY STORE HOUSE
36 GRANARY

30
37 BAKERY
38 Q.M. STORE HOUSE
39 Q.M. STORE HOUSE AND OFFICE
40 TELEGRAPH OFFICE
41 Q.M. STORE HOUSE
42 ” ” ”
43 Q.M. SHOPS
44 ” ”
45 Q.M. EMPLOYEES’ QUARTERS
46 Q.M. SHOPS
47 ” ”
48 ” ”
49 Q.M. EMPLOYEES’ QUARTERS
50 HARNESS ROOM
51 STABLES
52 ”
53 ”
54 SAW MILL
55 RUSTIC HOTEL
56 STAGE COACH STABLES
57 HOSPITAL
58 HOSPITAL STEWARDS’ QUARTERS
59 N.C. STAFF QUARTERS
60 BATH HOUSES
61 SUTLER’S RESIDENCE
62 SUTLER’S STORE
BUILDINGS STANDING TODAY ARE SHOWN IN BLACK
Officers’ row in the winter of 1889. Courtesy U. S. Signal
Corps.

31
During these same years, Fort Laramie was assuming a false air of
permanence as many of the old buildings of frame, log, and adobe
construction were replaced by sturdy new structures with lime-
concrete walls. A water system changed the parade ground from a
gravelly flat to a tree-shaded greensward. The last cavalry unit to be
stationed at the fort rode away in 1883 with Col. Wesley Merritt. Part
of the Seventh Infantry, commanded by Colonel Gibbon, then
garrisoned the post.
General view of Fort Laramie in 1889. Courtesy U. S. Signal
Corp.
Fort Laramie’s importance had been threatened by construction of
the Union Pacific Railroad 100 miles to the south. Its fate was now
sealed by construction, in the late 1880’s, of the Northwestern Line
50 miles to the north. This made Fort Robinson the logical guardian
of the Indian reservations to the north, and by 1886 Col. Henry
Merriam, then commanding officer of the Seventh Infantry and Fort
Laramie, was ready to agree that further development of the old post
was unwise. Not until August 31, 1889, however, was abandonment
of the proud old fort decreed. At the request of Wyoming’s Governor
Warren, troops remained at the post until March 2, 1890, when the
last two companies of the Seventh Infantry marched away. A few
men were left to ship movable property, while a detachment from
Fort Robinson dismantled some of the structures and on April
9, 1890, auctioned off the buildings and fixtures. At that
auction, Lt. C. M. Taylor of the Ninth Cavalry sold the buildings of
historic Fort Laramie at prices ranging from $2.50 to $100. Thirty-five

lots of buildings and much miscellaneous furniture and fixtures
brought a total of $1,395.

32
The Homesteaders Take Over
In June 1890, the military reservation of some 35,000 acres was
turned over to the Department of the Interior and opened to
homesteading. John Hunton was appointed custodian of the
abandoned military reservation for the General Land Office. He first
came to Fort Laramie in 1867 to work for the sutler. Later, he became
a ranch operator, and in 1888 he succeeded John London as post
trader. Hunton was a major buyer at the final auction and managed
to homestead the northwest side of the old parade grounds of the
fort, continuing to operate the sutler’s store briefly, and living next
door in the former officers’ quarters for nearly 30 years.
Another of the major purchasers at the auction was one Joe Wilde,
who also homesteaded part of the fort grounds, including the
commissary storehouse and the cavalry barracks. He converted the
buildings into a combination hotel, dance hall, and saloon and
operated them as a social center for North Platte Valley residents for
over 25 years. The west end of the parade grounds and the site of
the old adobe trading post which the Army had demolished in 1862
was homesteaded by the widow of Thomas Sandercock, a civilian
engineer at the fort, who made her home in the officers’ quarters
which had been built in 1870.
A dozen or more buildings used by these civilian owners were
preserved with some alterations; but the bulk of the buildings were
soon dismantled for lumber by their purchasers, and the old fort
became a part of many a ranch home, homestead shack, or barn.

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Handbook of Development Economics Volume 5 1st Edition Dani Rodrik

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