The Fundamental Problem of Development (Part 1)

Economics concerns itself with one fundamental problem, that of allocating scarce resources efficiently and optimally.

(Vocabulary Digression: Efficient means that there is no waste. If we divide a cookie between the two of us, and some of it falls into the trash, the division is not efficient. Thus efficiency requires lack of waste of resources. Optimality is defined with reference to some criterion and subject to some constraint. In the case of the cookie, the division could be said to be optimal if we achieve a division that maximizes our combined utility subject to the constraint that neither of us recieves less than, say, 25% of the cookie. An efficient division need not be optimal.)

The most succinct definition of the economic problem is therefore a constrained maximization problem.

(Random Digression: Succinct definitions are fun. For instance, a computer programs can be succinctly described as a state to state mapping where a state is defined as a name to value mapping. So also, the Tao is negatively defined by The Tao That Can Be Named Is Not The Eternal Tao.)

Constraints are all over the place. Physical resources are limited. It is interesting to ask if there is one single physical resource which if not constrained would release all other constraints. There are some basic limited resources such as land, labor, energy, water, etc. Of these, energy is that resource which if it were unconstrained, all the other basic resources constraints will be released.

If you had sufficient energy, you could transform whatever you had into whatever you wanted and recycle old stuff into new stuff. For instance, water. Using energy, clean the water; use the water; and then clean and reuse the water. You can use energy to desalinate sea water (lots of that around) and grow food hydroponically (don’t need too much land). You need basic minerals and metals? Use energy to get it by the millions of tons from the sea. Bottom line: if you had unlimited energy, you don’t have any real scarcity.

Consider the problem of economic development. There are constraints that bind an economy and keep it from developing. I asked myself if there is one fundamental constraint that if released, will free an underdeveloped economy. The answer I arrive at is yes, it is the credit constraint.

Let’s discuss the credit constraint tomorrow.