5.

4 Growth and Development Strategies

[edit] Harrod-Domar growth model

 1930s concept that explains why economies do not grow as fast their potential growth rates

 Assumes fixed capital-labour ratios and low savings ratios due to poverty cycle

 LEDCs have abundant supply of labour and the lack of physical capital holds back economic
growth/development

 More physical capital will generate economic growth

 Actual income determines the savings ratio, which determines the disposable income for
investment, which then affects the rate of economic growth

 Savings rate, plus capital productivity, minus capital depreciation, equals rate of economic
growth

 Potential growth rate is not achieved automatically (needs Keynesian intervention) if saving is
not enough (or not enough confidence in the banking system to offered commercial loans)

 Change in savings ratio or increased productivity will lead to an economy realizing more of their
potential (more efficient)

Problems of the H-D model

 Economic growth and economic development are not the same; growth is a necessary (but not
sufficient) condition for development

 Difficult to stimulate the level of domestic savings, particularly in the case of LEDCs where
incomes and confidence in the banking system are low

 Borrowing from overseas to fill the gap caused by insufficient savings causes debt repayment
problems later

 Law of diminishing returns suggests that as investment increases the productivity of the capital
will decrease and the capital to output ratio rise

[edit] Lewis' Structural change/dual sector model

  1954 idea: assumed many LEDCs had dual economies with both a traditional agricultural sector
(subsistence nature, characterized by low productivity, low incomes, low savings and much
unemployment) and a modern industrial sector (technologically advanced with high levels of
investment operating near an urban environment)

 Development was held back by lack of savings and investment; key to development was to
increase savings and investment

 Theorized that 'pull factors' from the modern industrial sector would attract workers from the
rural areas (these firms, whether private or public, could offer wages that would offer a higher
quality of life than remaining in the rural areas)

 As the level of labour productivity was so low in traditional agricultural areas, people leaving the
rural areas would have virtually no impact on output (amount of food available to the remaining
villagers would increase as the same amount of food could be shared amongst fewer people;
possibly offering a surplus which could be sold)

 Those in the urban areas wold earn increased incomes, generating more savings and providing
funds for entrepreneurs for investment; the growing industrial sector required labour and
provided incomes that could be spent and saved, generating demand and providing funds for
investment

 Income generated would trickle down through the economy

Problems of the Lewis Model

 Productivity of labour in rural areas is almost zero may be true for certain times of the year;
however, during planting and harvesting the need for labour is critical to the needs of the village

 Constant demand for labour from the secondary industrial sector is questionable. Increasing
technology may result in labour saving and actually reducing the need for labour. Additionally, if
the industry declines, demand for labour will fall

 Trickle down has been criticised; higher incomes earned in the industrial sector will not
necessarily be saved and invested. If the entrepreneurs and labour spend their new incomes
rather than save (preferably in banks), funds for investment and growth will not be available

 Rural-urban migration in many LEDCs has been far larger than the secondary industrial sector
can provide jobs; urban poverty has replaced rural poverty

[edit] Types of aid

OFFICIAL AID
Official Development Assistance (ODA) is transferred either as bilateral aid between governments or as
multilateral aid through agencies such as the World Bank or the UN

OECD's Development Assistance Committee (DAC) defines ODA as: flows to developing countries and
multilateral institutions provided by official agencies, including state and local governments, or by their
executive agencies, each transaction of which meets the following tests:

 it is administered with the promotion of the economic development and welfare of developing
countries as its main objective, and

 it is concessional in character (lower rate/perhaps none interest, easier credit terms and
repayment schedule, sometimes repayable in local currency; targeted toward a certain 'theme',
i.e., poverty reduction or trade expansion) and contains a grant element (not expected to be
paid back: food, medical and emergency aid) of at least 25%

 ODA has grown from $22 billion to $60 billion between 1960 and 1990

 Aid has fallen from 0.5% of donor GNP in 1960 to 0.3% in 1990

 The US is the largest donor (in nominal/real terms) with $11.3 billion in 1991

 Represents ~0.2% of GNP

 Japan is the second largest with $10.9 billion in 1991

 UN aqreement of 0.7% of GNP (1970)

Sweden gives ~1% of GNP

 The World Bank lent $6 billion in 1990

 UN agencies gave $4 billion, and provided the largest amount of technical assistance through
the United Nations Development Program (UNDP), United Nations Environmental Program
(UNEP), United Nations Industrial Development Organization (UNIDO), International Labour
Organization (ILO), World Health Organization (WHO)

 Unofficial aid is transferred through non-governmental organizations (NGOs):

 NGOs gave $6 billion in 1990, the same amount as the World Bank

 NGOs tend to attack poverty directly by working with local groups to achieve LOCAL AGENDAS
rather than imposing their own agenda

 LEDCs with large populations have received less because donors have a greater impact by
donating to smaller countries which then become more dependent
  It is estimated that less than 10% of overall aid goes directly to programs to help the poor such
as health care/health education, basic literacy education, AIDS prevention, agricultural
extension, microcredit schemes, immunization and vocational training, and clean water and
sanitation (these are all project typically taken on through NGO aid)

BILATERAL & MULTILATERAL FOREIGN AID

Bilateral Foreign Aid

 Bilateral aid tends to be distributed directly between two countries according to political
interests:

 The US mainly directed its aid toward containing communism

 The EU helps former colonies, especially African countries

 Islamic members of OPEC concentrate on Islamic countries, but this source of funding has faded
rapidly with the sharp declines in oil revenues

 Communist bloc countries used to give to communist countries such as Cuba, Mongolia, and
Vietnam, but aid from this source has disappeared

Multilateral Foreign Aid

 Most LEDCs have a current account deficit created by the import of high value added capital
goods which cannot be matched by the low value added exports - aid provides an alternative to
FDI as a way to create a capital account surplus

 The first aid plan was the Marshall Plan (no longer available) provided by the US which was
motivated by a combination of national security fears, economic interests and humanitarian
concerns

 This aid was available to European countries with acceptable development plans for physical
capital investment

 It expanded to include new technical assistance programs: available to invest in human capital

 Plans and projects were generally excellent making the Marshall plan so successful that private
capital was attracted

 The success of the Marshall Plan led to the formation of the development assistance committee
of the OECD (25% US) which provided money for:

 Capital and human capital investment (education)

 Improving health and sanitation

  Relieving poverty through rural regeneration, and assistance to women

World Bank

 Large donor countries such as the US or Japan or EU tend to dominate multilateral aid agencies
such as the World Bank (created at the Bretton Woods conference in 1944)

 The World Bank does not give grants (gifts of money) but borrows at the prime rate from MEDCs
and relends at a slightly higher rate to LEDCs and must be repaid:

 90% of loans are for projects (physical capital); 10% for programmes

 US traditionally selects leader

IMF

 Large donor countries also tend to dominate the IMF (also created at the Bretton Woods
conference in 1944)

 The IMF is designed to support the system of international currencies

 It only gives loans to countries experiencing balance of payments difficulties

 The loans are conditional on the imposition of a structural adjustment programme (SAP) which
often requires: reductions in government budget deficits, a slower rate of money expansion
(lower inflation) and devaluation

 European governments traditionally select leader

GRANT AID, SOFT LOANS

 Grant aid:money not expected to be returned

 Used primarily for food, medical and emergency aid

 Soft loans: loans with a lower interest rate (perhaps none), easier credit terms and repayment
schedule, sometimes repayable in local currency; targeted toward a certain 'theme', i.e., poverty
reduction or trade expansion

 Relatively easy to renegotiate a different repayment schedule if a country is having difficulty

with debt service

TIED AID

 Bilateral aid is often tied: aid money can only be used to purchase goods and services from the
donor countries
  Historically, the proportions were: France 60%, Britain 75%, Italy 90% - while Japan does not
officially tie aid, it often reaches unofficial agreements which do tie aid

 The proportions which are tied have dropped steadily and average 25% for many countries

 Services are tied in the form of technical assistants being sent out from the donor country:

 They are designed to provide the technical and managerial skills which may be missing in the
LEDCs

 An estimated 100,000 consultants from MDCs are working in African countries, many are doing
jobs which could be done by local people

Conditionality

 Loans and aid from large agencies is often conditional on changes in government policy in the
recipient country

 IMF's SAP is a good example of this, encouraging: less protectionism/lifting restrictions in trade;
currency devaluation; exports of primary agricultural commodities ("cash crops"), metals and
minerals; increased FDI; privitization of nationalized businesses; removing subsidies and price
controls; reducing social expenditures and government expenditures in general to have a
balanced budget; charging for education and health services; reducing corruption; and making
government more responsive to the people (Washington Consensus)

 One condition is often that funds are used to buy goods and services from the donor country

 Resulting in aid money actually flowing back into the donating country

[edit] Export-led growth/outward oriented strategies

 Tariffs are reduced or eliminated, and imports rise

 Domestic production is displaced and unemployment rises in domestic industries that compete
with imports

 Costs for intermediate goods fall leading to an increase in exports and a fall in unemployment in
the external sector

 Countries specialize in the sectors in which they have a comparative advantage

 Export promotion benefits

 There is more rapid growth in both GDP and GDP per capita

 Technology transfer takes place through imports of capital goods

  Exports of manufactured goods rise compared to primary sector exports

 Gains from trade: lead to a higher standard of living

 Specialization allows economies of scale and rapid learning by doing

 Even if growth is more uneven, the huge increase in productive capacity will lead to rapid
investment and linkage adjustment in other sectors (backward and forward integration)

 Export promotion costs:

 MEDC tariffs and quotas block imports of labour intense manufacturing goods where LEDCs
have a comparative advantage

 Growth is more uneven

 Vertical integration is lost, workers may be confined to assembly and some fabrication

 There is a risk that new technology may render a sector obsolete

 There may be an overemphasis on natural resource exports which could lead to deteriorating
terms of trade

[edit] Import substitution/inward-oriented strategies/protectionism

 Tariffs are imposed and imports fall

 The first to be protected are final stage assembly and simple consumer goods

 Over time, parts fabrication and more sophisticated manufacturing is protected

 Domestic production increases and unemployment falls

 Capital and intermediate goods become more expensive, otherwise why would tariff barriers be
needed to promote sales of domestic equivalents?

 Costs rise for exports, exports fall, and unemployment rises in the export sector

 Benefits from import substitution

 There is greater vertical integration within industries (both upstream and downstream)

 Research, development, engineering, design, fabrication, assembly, marketing, and financing

provide a richer variety of jobs
  There is greater integration amongst industries (both backward and forward linkages)

 Learning by doing takes place

 There is less dependence on other countries, therefore less specialization and more evenly
distributed development in the economy

 Costs of import substitution

 Infant industries never grow up because the lack of international competition leads to higher
costs

 With few imports of capital goods, there is virtually no technology transfer

 The export sector collapses so there are no gains from trade

 Economies of scale cannot be achieved because the market is too small

 Balance of payments problems lead to a reduction in imported capital which is often needed for
industrialization to proceed:

 Producers are cut off from new technology in international markets.

 The poor gain little, the major beneficiaries are the wealthy and the MNCs operating behind
tariff walls

 Government tends to subsidize capital, and currencies are held artificially high to encourage the
use of imported capital and intermediate goods:

 Industry becomes less labour intense, leading to unemployment.

 Exporters of primary goods (the poor) are hurt: because LEDCs face perfectly elastic demand,
they have to lower their prices to compensate for the higher currency value.

Import Substitution vs Export Promotion

Is it better for industrialization to proceed through replacing imported goods with domestically
produced goods, or is export promotion more likely to lead to faster growth because of the gains from
trade through specialization?

[edit] Commercial loans

[edit] Fair trade organizations

[edit] Micro-credit schemes

 Small loan amounts for a small time period often with weekly/bi-weekly payments due at a low
percentage interest, often tied with entrepreneurial education (used to purchase a sewing
machine, a handloom, a cow), taken out by consumers deemed uncreditworthy by commercial
banks

 Low default rates

 Access to credit is a human right and one way to break the poverty cycle

 Grameen Bank (Muhammad Yunis) Nobel Prize 2006

[edit] Foreign Direct Investment (FDI)

 FDI by MNC/TNCs usually comes in a bundle including: equity and debt financing, management
expertise, technology transfer, technical skills training, and access to overseas markets:

 Product life cycles have reinforced the need to maintain technical superiority in order to
advance, thus MNCs are extremely reluctant to un-bundle the package: they fear the technology
will be exposed to a competitor who will reach the life cycle window faster

 LEDC governments are attracted by the FDI bundle:

 Learning by doing: is accelerated which can enable the country to cope with a technologically
advanced future

 Technology transfer: while embodied in a process, also includes information and the technical
skills needed to adapt, install, operate and maintain capital equipment systems

 Managerial shortage: LEDC govts understand the acute shortage of local managers capable of
organizing and operating large scale industrial projects

 Intra firm exclusion: LEDC govts realize that access to international markets is severely limited
because markets are dominated by intra and inter firm transactions (50% of Canada's imports
and exports are intra firm sales), MNC/TNCs are needed to gain access to this system

 Marketing expertise: MNC/TNCs have preferential agreements with customers due to volume,
length of time in the business, the use of standardized contracts and standardized products, it
may take years for LDC producers to understand let alone break into international markets
  Supply side bottlenecks: can be reduced through FDI by MNC/TNCs

 National gaps in savings, foreign exchange, taxes, technology and human skills can all be filled by
MNCs:

 Labour: they can create jobs, develop managerial skills, and provide technical education of
labour,

 Capital: they can transfer technology and provide much needed physical capital

 Tax revenue can be earned on the exports of natural resources which can be used to fund
construction of much needed infrastructure

 Foreign currency flows in from the MNC/TNC investments, and from the private earnings on the
exports

[edit] Sustainable Economic Development

The process which maximizes the net benefits of economic development while maintaining the services
and quality of environmental and natural resources forever

 This involves:

 Using natural resources at rates less than or equal to the natural rate of regeneration

 Using non-renewable resources in a manner which permits recycling of materials and

substitutability between natural resources and technological change

 Economic development and resource usage are complementary but after a certain point
development will reduce one or more of the functions of certain resources resulting in a
tradeoff

 Using forestry as an example:

 The wood can be harvested and sold

 Or the trees can be left uncut so the forest can act as a waste assimilation system or a region to
absorb rain to prevent flooding

 Or the trees can be left and the area used as a park for recreation

 How can we make less use of natural and environmental resources:

 Create a low growth, austerity economy?

  Develop a high tech economy in which growth is based on very low resource usage and high
technological progress?

 Use renewable resources on a sustainable basis and recycle non-renewable resources?

 We need to develop environmentally friendly technologies and ensure they are made available
to developing countries.

 Top priority must be given to:

 Adequate sewage disposal and safe water

 The elimination of burning fires for cooking: they cause smoke pollution both within buildings
and around urban areas and contribute to deforestation

 We must remove subsidies that encourage excessive use of forests, fossil fuels, irrigation water,
and chemical sprays

 Clarify rights to own resources

 Help local communities to take ownership of their common resources:

 Local participation in setting and implementing environmental policies

 Teach them how to make long term decisions and investments

 Develop realistic policies and strategies which:

 Permit low cost monitoring and enforcement for developing countries

 Use market systems of punishments and rewards rather than regulation

 Restrict the power of rich resource owners and large institutions

IB Economics/Development
Economics/Barriers to Economic Growth
From Wikibooks, the open-content textbooks collection

< IB Economics | Development Economics

Jump to: navigation, search

Contents
[hide]

 1 5.3 Barriers to Economic growth and/or Development

o 1.1 Poverty cycle
o 1.2 Institutional and political factors
o 1.3 International trade barriers
o 1.4 International financial barriers
o 1.5 Social and cultural factors acting as barriers

[edit] 5.3 Barriers to Economic growth and/or Development

[edit] Poverty cycle

Low incomes --> Low savings --> Low investment --> Low income

Absolute poverty: inability to just meet basic physical human necessities/needs of food/nutrition,
clothing, health and shelter in order to survive

 Because this is so difficult to measure accurately, many researchers simply estimate that
20% of the world’s population falls below this line
 UNDP reports that most live in 10 countries, with the proportions falling below the
poverty line in brackets: Bangladesh (80%), Ethiopia (60%), Vietnam (55%), Philippines
(54%), Brazil (49%), India (40%), Nigeria (40%), Pakistan (29%), Indonesia (24%) and
China (10%)
 A characteristic of most LEDCs is the unequal distribution of income
 What is interesting is the middle income LEDCs appear to have greater income
inequality than very poor or high income countries
 Income inequality is greatest in Latin American countries

Relative poverty: a poverty measure based on a poor standard of living/low income compared to
the rest of society

 Suggests that the lack of ACCESS to many goods and services expected by the rest of the
respective society leads to social exclusion and damaging results for the individuals and
families mired in relative poverty

Rural Poverty

 Most poor people are found in rural areas: farmers with small holdings, landless
peasants, artisans, fishermen, nomads and indigenous people - the poor are not idle,
they work hard
 Those with a traditional way of life are not necessarily poor - for thousands of years they
adequately sustained themselves - it is only recently that they have become poor due to
 policies which have deprived them of the means of earning a living (land, fisheries,
hunting ranges, forests)
 Poverty in city slums is highly correlated with poverty in the countryside and is linked
through migration
 Women are often the poorest of the poor, as men control most of the land, capital and
technology, and receive a better education in most countries - this can have a major
impact on population control

 Investments in infrastructure, social services, and technology in rural areas can go a long
way to helping those mired in the poverty cycle

Human Suffering Index (HSI) has been developed which looks beyond HDI

 Composite indicator, linking ten measures of human welfare - income (GDP/capita),

inflation rate, life expectancy, demand for new jobs/urban population pressures, infant
mortality/infant immunization, nutrition/daily calorie supply, access to clean water,
energy use/telephones/1000 people, adult literacy/secondary school enrollment, and
personal political freedom/civil rights
 HSI numbers are worst in Mozambique (93), followed by Somalia, Afghanistan, Haiti,
and Sudan. Most of these countries also have high population growth. The most
comfortable countries are Denmark (1), the Netherlands, Belgium, Switzerland, and
Canada, which have low population growth. Total scores of 75 or greater (extreme
human suffering) occur in 37 countries (20 in Africa, 16 in Asia, and Haiti) with 8% of the
world's population (432 million people) (2002)
 It is estimated that 75% of the world’s population live in countries where the human
suffering index is over 50%
 It is estimated that 1 billion people live in desperate poverty
 HSI numbers are comparatively worse off now than just five years ago

Case study: Kerala State in India This is a region with low income and yet a reasonably high
standard of living because of the emphasis on human development:

 The society is very international in its approach, and is not afraid of new ideas and
methods of doing things
 Women have a high status in the society due to the matrilineal system of passing
property from mother to daughter rather than from father to son
 With greater wealth and income in the hands of women, the child mortality rate is low,
and spending on health, nutrition and education for children has been very high: the
illiteracy rate is very low
 There is a strong interest in community economic development and the institutions
which promote community welfare such as cooperatives and community associations
 The result is strong representation for labour in the workplace, excellent health
standards and low prices on food which result in very little malnutrition

Reducing Poverty
  The trickle down theory is associated with the concept that inequity is inevitably a part
of economic growth, but after a period of rapid growth, greater equity and poverty
reduction will occur
 Studies have shown that income distribution does appear to worsen at first
 However, the evidence indicates that rapid growth does not appear to have eradicated
poverty which is surely the aim of growth in the first place
 Furthermore, as income rises for the few who are lucky, their consumption pattern
tends to dominate the location on the production possibility curve, more luxury goods
rather than necessities are produced

 The elite may not contribute that much to growth

 They often import luxury goods rather than invest domestically - this is very different
from the historical pattern for the MEDCs
 Often there is capital flight: elites may invest in overseas bank accounts, property or
investment opportunities
 Brain drain occurs when those in skilled positions (e.g., doctors, engineers, architects,
university professors) leave and work abroad for higher pay/increased opportunities

Stimulating Growth while Reducing Poverty

 Growth needs to be targeted at those sectors which will reduce poverty

 Raising the income of the poor will lead to increased consumption of necessities which
are produced within the country
 This stimulates investment, incomes and jobs and leads to improved health and
education which, in turn, increases productivity
 R&D should be directed toward appropriate technology rather than to the transfer of
labour saving technology from MEDCs

[edit] Institutional and political factors

Ineffective taxation structure

 Taxation is often a difficult problem in LEDCs:

 In many countries very little tax revenue is collected and government is forced to raise
revenue by printing money or imposing export tariffs which inevitably reduces the
incomes of rural people because most LEDCs export raw materials and agricultural
products
 A proper income tax system can provide the revenue for govt. and reduce inequality by
making the wealthy pay a fair share for running the country
 Greater tax revenue also allows the government to provide basic infrastructure for the
poor such as better health care, better schools, provision of clean water, sanitation, and
electricity and more reliable road systems (infrastructure)
  Laffer Curve

Price Distortions

 Prices are often distorted due to subsidies or a strong union sector which is able to
extract high wages from foreign multi-nationals
 A return to market prices is essential so that correct signals can be sent to allocate
resources according to true scarcity: for example, lower wages would lead to greater
employment
 Government subsidizes capital through tax breaks, grants and low foreign exchange -
this lowers the price of capital artificially and leads to substitution of capital for labour

Lack of property rights

 And rule of law in general, including reasonable, predictable contract enforcement

 No clear title to real property (land, houses) and high-value assets
 Inheritance of property often cloudy
 Capital gains from sales often subject to negotiation, thus not predictable

Political instability

 Important to attract FDI

 Important that the next government assume the debt obligations of outgoing
government
 Rule by the will of the people OR for the government in power - who is the government
working for?

Corruption

 An issue worldwide; many different forms; some quite subtle in nature

 Most involving bribes for getting imports into a country or in bidding on government
contracts
 Transparency International

Unequal distribution of income

 Redistribution of assets often does not happen or does not happen fairly (transparently)
 If the most important cause of inequality is an unequal distribution of land, natural
resources and capital, attempts must be made to redistribute at least some natural
resources such as land
 Land reform can often lead to a dramatic increase in farm productivity and incomes for
the rural poor
 Children of the elite have greater access to education and to the best jobs:

 Policies to open access to education for the poor, to reduce absenteeism and improve
the quality of education can lead to great increases in productivity
  Gini coefficient/Lorenz Curve

Formal and informal markets

 Percentage of population engaged in a money economy v. subsistence/barter economy

 The less informal markets operating, the more grasp on the macroeconomy the
government has

Lack of infrastructure

 Important to attract FDI

 Key to allow access to markets, schools, hospitals, wider world (even if just the capital
city/urban area)

[edit] International trade barriers

 overdependence on primary products

 consequences of adverse terms of trade
 consequences of a narrow range of exports
 protectionism in international trade

[edit] International financial barriers

International finance & indebtedness

 Economic development has been promoted since 1960 as the best route for LEDCs to
follow, justifying borrowing from banks to spend on projects:

 The risky nature of lending to LEDCs requires: higher interest rates, much more
expensive than the rate charged by the World Bank or aid agencies
 Stock of debt: the ratio of debts to exports has averaged 125% to 150%
 Debt servicing flow: includes interest payments and repayments of principal, and often
exceeds 40% of exports for certain poorer LEDCs

Causes of the Debt Crisis

 In 1973 and 1979 OPEC increased the price of oil dramatically:

 Oil rich countries looked for the highest rate of return on investments
 The international banking community started lending this money to LEDCs
  While the nominal interest rates charged were high, once inflation had been taken into
account, the real interest rates were very low leading to an explosion in LEDC borrowing
 Those LEDCs which did not have oil, were now faced with vastly higher costs for fuel,
input costs rose dramatically hurting exports

 Since 1935 most industrialized countries have been off the gold standard
 Governments started inflating in the early 1960s until 1976 when inflation rates reached
high levels in the MEDCs:

 Loanable funds were available at low interest rates to lend around the world
 LEDCs were accustomed to ‘soft’ loans from international agencies such as the World
Bank which lent at low rates of interest
 Commercial banks charged full market rates on 'hard' loans

 By 1979 most OECD countries decided to stop inflating:

 Interest rates rose dramatically, particularly on short term commercial paper

 More than 50% of LEDC debt is short term in nature, the interest rates being charged to
LEDCs reached crisis proportion
 With the shortage of money, oil rich countries started taking their cash out of the bank
to be used in their own countries
 No more loans were available for anyone including LEDCs
 As incomes in MEDCs fell so did imports from LEDCs worsening their balance of
payments difficulties
 Elite groups in LEDCs panicked and there was capital flight:

 It is estimated that 30% of all borrowed funds, usually in a hard currency, ended up in
bank accounts outside the borrowing country

Poor project evaluation

 MEDC banks were only interested in securing loans through government guarantees,
there was little checking of the projects the money was to be used for
 Much of the borrowed money had been wasted on military arms or projects which did
not have any hope of paying interest on the debt or ever repaying the principal
 Many LEDCs printed money to cover the deficits which led to extremely high rates of
inflation in some countries

Rescheduling & Restructuring

 LEDCs were unable to service their debts and were forced to reschedule
 Loans were renegotiated with lenders, extending the terms of repayment
 LEDC governments have been forced to make major structural reforms under instruction
from the IMF in order to qualify for rescheduling:

 Market mechanisms: supply side measures increase output and investment

  Devaluation of the currency: devaluation should lead to greater exports and fewer
imports unless both domestic demand for imports and external demand for exports are
inelastic
 Deflation: tight monetary and fiscal policy reduce government deficits, inflation and
eventually interest rates

 LEDCs which are able to lower their debt servicing experience some benefits:

 Lower inflation which stabilizes the exchange rate and creates enough confidence that
the elite repatriate money lost through capital flight
 Domestic interest rates fall leading to greater domestic investment and an improvement
in the economy

 Restructuring simply extends the length of the repayment problem, it does not
eliminate the debt:

 LEDCs simply lack the exports needed to earn the foreign exchange required to service
the debt
 The only hope of getting out of debt is for MEDC economies to expand rapidly leading to
major increases in imports from LEDCs
 Most of the debtor nations are faced with years of economic deprivation in order to
meet their debt obligations
 Domestic policies that lead to overvalued currencies encourage imports and discourage
exports creating strong pressures to seek more loans to support the country until the
next crisis
 If the money had been invested in projects which earned a rate of return which could
have paid the interest plus repaid the principal, there would have been few problems

Non-convertible currencies

Capital flight/brain drain

[edit] Social and cultural factors acting as barriers

 religion
 culture
 tradition
 gender issues

 Periods of economic growth are associated with structural transformation and social
and ideological changes. In the past, 1/3 of growth came from population increases and
2/3s from productivity increases
 Productivity increased due to technological change in terms of capital and human skills,
encouraging research and development which led to further growth
  The rise in income led to increased consumption:

 Demand for income elastic industrial products rose quickly

 Demand for income inelastic agricultural goods grew only slowly
 This led to a rapid rural-urban shift which often destroyed traditional values

Current Conditions facing LEDCs

 Many LEDCs are not truly nations, they are artificial creations of former colonial powers

 Have not had enough time to adapt to modern concepts such as science, individualism,
economic mobility, and the work ethic

 Political dependency has been replaced by economic dependency:

 Technological transfer is controlled by MNCs and trade and finance are dominated by
MEDCs
 Many LEDC natural resource endowments require western capital and knowledge to
exploit them
 Populations are much larger, population densities greater, and education levels lower
than they were for MDCs during their period of industrialization
 The terms of trade have moved steadily against the LDCs because they export mainly
raw materials with little value added

 LEDCs have little scope to develop new products or techniques of production, the
expertise in the MEDCs is overwhelming:

 Most R&D is concentrated in MEDCs

 Most technology is labour saving which may not be of great use in countries which have
a large labour force looking for employment

 Where LEDCs try to add value to raw materials they are faced with high tariff barriers in
the MEDCs which are trying to preserve jobs
 Growth does not necessarily proceed without interruption. It requires social legitimacy:

 When Argentina took off, Juan Peron carried out measures that were popular with his
constituents, such as price control of food grains and enlarged military expenditures,
but that stifled growth and divided society into sharply contending classes
 Iran's oil wealth, far from being a source of stability, increased the alienation of the
great majority of the people who felt that the nation's wealth was being monopolized by
a corrupt few

Population Birth and Death Rates

 The natural increase in population is the birth rate minus the death rate
 The pre-industrial era was characterized by high birth and high death rates leading to a
slow growing population
  Birth rates in LEDCs are much higher than in MEDCs during the comparable period of
development: a larger proportion of women marry and do so at a younger age (leads to
larger families)
 For many developing countries the birth rate remains high while the death rate falls -
studies suggest that developing countries today are moving through this phase more
rapidly than MEDCs
 Eventually the birth rate also declines, until low birth and death rates lead to low and
stable population growth again
 For MEDCs population growth rate is 0.5% and for LEDCs it is 2% (2003)
 Studies indicate that more even income distribution contributes to a more rapid fall in
the birth rate
 In those LEDCs with high poverty levels, birth rates have remained much higher than for
MEDCs: there is a correlation between high birth rates and low GDP per capita

 Death rate: as countries develop the death rate drops very quickly due to:

 Sanitation: there is a reduction in infant mortality due to better sanitation, cleaner

water and basic health knowledge
 Health care: there is a reduction in mortality from disease because of better health care
systems
 Agricultural production: as food production increases deaths resulting directly or
indirectly from malnutrition fall

 Survival rate: as the survival rate for children increases there is a rapid increase in
children as a proportion of the population, savings and investment rates fall:

 This increases dependency rates within families, per capita income falls as unproductive
children are housed and fed
 Children under 15 form 25% of MEDC population and 50% of the LEDC population which
leads to a high dependency ratio of non-workers to workers
 Because of the young population, fertility rates are very high and birth rates increase yet
again: healthier, better fed women have a greater capacity to give birth to a healthy
child

Population: Policy Options

 After the last ice age, 13,000 years ago, world population was 100 million
 By 1790 this had increased to 1.7 billion, and current estimates place world population
at 6 billion - the latest findings show a very rapid decrease in population growth rates to
the point where it is now expected that population will stabilize at about 7.5 billion by
2040, much lower than original estimates of 12 billion by the year 2075

Optimal Population Levels

 Sub-optimal levels: there is not enough labour to utilize the available resources to the
maximum potential
 Above optimal levels: diminishing returns set in as there is too much labour
 However, natural resource discoveries and increases in productivity: will increase the
optimal population level
 Preference for additional children depends on the number of surviving children and the
costs and benefits of those extra children
 Costs are dependent on feeding, clothing and education, plus the opportunity cost of
the mother’s time
 Benefits include the need for children to help with the farm or small family business, the
security in old age, and particularly during periods of prolonged sickness

 Slower population growth: can be achieved through family planning by women:

 Social security: if there are pensions and support during illness, there is less need for a
large family
 Effective birth control: whether through chemical or mechanical means or through birth
spacing through extended breast feeding
 Higher female employment and greater schooling for both men and women leads to
lower fertility rates
 Meaningful work for women: women have an alternative way of achieving fulfillment in
addition to having children

 Financial costs of having children:

 There are reduced opportunities for children to earn income in urban settings due to
enforced schooling and fewer less skilled jobs, plus the opportunity costs of the parent's
time rises
 Higher incomes seem to encourage fewer children with more invested in each child
 Mass sterilization: created much hatred and severe backlash

 Slower population growth is better:

 Savings rates rise: families save more and govts. spend less on social services
 People invest more in human capital: it is more worthwhile if there are fewer children
and they are likely to live longer
 There is more investment in infrastructure
 There is less deforestation and erosion of soil

 Ecological Footprint

 The US with 6% of the population in the world uses 40% of the world’s resources, and
India with 17% of the population uses 4% of the world’s resources
 Population densities: Are very low in most African and South American countries, and
are very high in many developed countries
 If MEDC populations are adjusted to include their ecological footprint, the real
populations and population densities are even higher:

 For the US using 6.7 times the world average of resources per person: 1,900 million
people
  For India using 0.25 times the world average of resources per person: 212 million people

 Malthusian approach: the law of diminishing returns suggests that the world will run out
of resources in the face of the rapid increase in population
 Demographers find that the big increase in population is over - while the long term
effects will lead to increased populations in the future, the growth rate has already
started to stabilize and will reach replacement level by the year 2050
 While resources have been fixed, the gains from specialization, economies of scale and
learning by doing have more than outweighed diminishing returns in the last 100 years
 There does not appear to be a clear correlation between birth rates and per capita
income - death rates have fallen quite independently of incomes
 It appears that a more equitable distribution of income, greater literacy for women, and
more job opportunities for women results in a lower population growth rate

Agriculture & Rural Urban Migration

 It is estimated that in MEDCs, 27% of the population lives in the rural sector with
possibly as much as 5% involved in agriculture
 In LEDCs the figure is 66% living in rural areas, with nearly 70% involved in agriculture
 Many of the most severe development problems arise from a weak agricultural sector -
growth through the agriculture sector has not led to increases in per capita income
 On the demand side:

 The growth potential in the agricultural sector is limited because income elasticity of
demand for food is close to zero, growth is much more rapid for industrial goods and
services.
 Primary exports form the major source of foreign exchange earnings for LDCs, and yet
the proportion of primary sector goods in total world trade has fallen from 33% in 1950
to 21% in 1995.

 On the supply side productivity in agriculture is very low:

 Increased use of machinery and new methods of raising crops have made it possible for
an individual farmer in the US to produce enough food to feed 50 families
 Farmers in LEDCs are hard pressed to support one other family beside their own
 Severe droughts and famines occur on a regular basis
 The oil crisis led to a large increase in energy costs raising the cost of food, while poor
people in urban areas spending 80% of their incomes on food could not afford a 100%
increase in price
 Government often imposes price controls which help the urban poor but hurt the
farmers

 The potential for growth through industrialization is much greater, so governments

invest in infrastructure in cities and subsidized capital
 As a result, food processing can be done much more cheaply by shipping unprocessed
food to the cities: even less value added is left in rural areas
Unemployment & Rural Urban Migration

 As government pours money into urban housing, education, food subsidies, health care,
and infrastructure, people migrate to the cities, and then government pours even more
money into the cities to prevent rioting
 The official unemployment rate in LEDCs tends to be higher than for MEDCs; however, if
disguised unemployment and underemployment figures are included, there is a very
serious unemployment problem in LEDCs
 Disguised unemployment: people are working but producing very little (marginal
product is close to zero), each member of the family is trying to share in the total output
but has very little to add to production
 Underemployment occurs where people who would like to work full time only work part
time each week, or for only a few months each year (or work in a job in which they are
overqualified)

Urban Employment

 If investment has been concentrated in industry, enough capacity may be created to

absorb labour which is surplus to the agricultural sector
 Rural wages equal the average product of farm labour in the farm household, this is at
subsistence level because there is a great deal of surplus labour and much
underemployment
 The supply curve of labour to industry is elastic up to the point at which the withdrawal
of labour can no longer be accomplished without a decline in agricultural productivity:
all the surplus labour has been removed
 Industry only has to pay slightly more than subsistence level to attract labour to
manufacturing jobs in the cities
 A large part of the population can leave without any reduction in farm output
 The problem occurs if the urban sector is small relative to the large rural sector and
there is not enough capacity to absorb the surplus labour
 Often investment has been capital intensive (labour saving) which means there are few
jobs available, particularly for the unskilled rural worker
 Even if there is only a 20% chance of getting work, or if there is only part time work
available for 20% of the year, young people are still attracted to the city if the urban
wage is five times the rural wage
 If a rural area suffers from drought every few years, the lifetime income expected from
staying on a farm could be less despite the prospect of many years of being only
partially employed in the city
 Studies indicate that most migrants do find work within 2 months of reaching the city:
most are young with better education which enhances the prospect of finding
employment in the city

5.5 Evaluation of Growth and Development Strategies

[edit] Foreign Aid
Problems with Foreign Aid

 Aid is a poor substitute for trade: opening up MEDC markets to LEDC exports can
enhance the ability of the poor to earn a living and reduce poverty
 It is estimated that less than half the aid goes to poor countries, instead it is based on
the military, political and business interests of the donors, a reward to those in power

 There has been no significant correlation between the level of aid given to an LEDC and
corresponding growth of GDP

 Though humanitarian/emergency aid is considered morally/ethically necessary and an

important contribution at times of short-term suffering

 The LEDC government may be forced to change development policies to suit the donor's
ideas:

 Loans and grants may be contingent on changes in tax laws, wage and price systems,
food subsidy programs, and whether the money is used for rural or urban development
 These ideas may be out of touch with reality and do little to contribute to development
in the country

 Aid contributes in direct proportion to the increase in capital investment, but aid does
not appear to have accelerated the growth rates of recipient countries
 There is a lack of complementary inputs: human technical skills, administrative capacity,
infrastructure, financial institutions, and political stability
 The introduction of hard currency inflows may also lead to increases in consumption
rather than just investment:

 Supply bottlenecks may discourage investment in physical capital

 Rising incomes for the poor may lead to increased consumption rather than increased
saving

 Aid may displace LEDC government spending (crowding out):

 There is less pressure to provide infrastructure, and necessary reforms particularly in

rural areas
 Resources are then free for consumption instead of investment and may be used to
acquire military hardware

 It has been persuasively argued that tied aid is not as effective as untied aid:
  LEDCs are not able to look for the least expensive goods or services but has to purchase
from the donor country (more expensive)
 Creates no employment or extra output in the LEDC, because no expenditure is taking
place there (money is spent on 'foreign experts' and returns to the granting country)
 Imports may also replace domestic products, which may further harm domestic
industries (e.g., agricultural aid increasing supply and lowering prices)
 May be politically motivated and in fact, no more than a subsidy to industries in the
MEDC
 Tied aid has actually been made illegal in some countries (UK 2002)

 Famine is often not a result of a lack of food but of the inability to earn enough to pay
for the food:

 Distributing cash instead of food can stimulate the local market:

 Local traders know best how to transport supplies

 They are often able to reach inaccessible places to provide food
 Long term food production and employment can increase through investment

 Aid weariness: some in MEDCs are beginning to think that problems in their own
economies are more important than problems in LEDCs and flows of aid may be reduced
(current recession?)

 Politically, very popular in light of continuing allegations of corruption and misspent aid
money

 Some evidence that 'targeted' short-term aid can being about limited growth (at least in
a specific sector)

 Cut flowers in Kenya and Zambia exported to Europe

 Heifer Project in Rwanda and India
 HIV/AIDS health education programmes in Botswana and Uganda

[edit] Market-led and Interventionist Strategies

[edit] The Role of International Financial Institutions

  International Monetary Fund aims to ensure international financial stability - they
provide loans under certain conditions

 Interventionist nature and seeming violation of state sovereignty an issue with SAP

 World Bank: aims to promote development to some extent

 Critics view some World Bank projects as being imposed upon countries, and not being
requested locally
 Large-scale population movements (cultural destruction?) are sometimes required for
dam construction (and dams are expensive with an estimated lifespan of about 25
years)
 Construction firms are often from a country that has lobbied for the World Bank loan, so
loan money flows back into an MEDC

 Private sector banks: provide loans in exchange for interest

 Non-governmental organizations (NGOs): foreign aid by NGOs

[edit] MNC/TNCs: Foreign Direct Investment

MNC/TNCs have grown for the following reasons:

 They need to secure their supply lines of raw materials

 The need to sell to ever larger markets where new products are fully developed and
competition increases the price elasticity
 Locational advantages are important:

 They need to locate within restrictive trade barriers

 Low wages, low taxes and high education levels are important
 They like to locate near markets to reduce transport costs

Problems with Foreign Direct Investment

 There are 35,000 MNCs of which 50% were controlled by US, Japanese, German and
Swiss investors
 50% of all industrial production was produced by 100 companies
 These 100 companies control 50% of world trade
 Studies have indicated that MNC/TNCs are not good at providing jobs:

 Local firms are displaced by the MNC/TNC and the displaced firms often have much
higher labour capital ratios
  LEDC govts may force the MNC/TNCs to operate in a highly capital intense sector of the
economy such as natural resource extraction and processing requiring massive
investments in sophisticated equipment and machinery:

 The labour that is hired is very highly skilled

 Either local labour must be given extensive training
 Or skilled workers must be imported

 Labour protection laws: introduced by the government to appease the labour sector
may increase labour costs significantly leading to the substitution of K for L
 MNC/TNCs may prefer to take advantage of cheaper labour by using more appropriate
technology but LEDC governments anxious for technology transfer insist on the latest
technology being used, once again this lowers the labour capital ratio

 Technology/managerial/knowledge transfer is severely limited by the country's ability to

absorb and utilize the new technology:

 Workers lack the technical skills

 The LEDC goveernment's system of information dissemination may be non-existent
 The MNC/TNC may be extremely reluctant to accommodate technology transfer for fear
of losing trade secrets

Transfer pricing: the setting of internal prices between branches of an MNC such that goods can
be exported at artificially low prices:

 The MNC/TNC raises price in the next country to the market level and takes the profit
there if the taxes are very low, thereby saving on income taxes
 This reduces the ability of the host govt. to collect taxes and defrauds them of taxes on
work done in their own country
 25% of all trade is between branches of the same MNC company
 The highest value added work is done in the countries with the lowest taxes
 It is a powerful tool in labour negotiations to demonstrate that the company is losing
money

 Competing LEDC govts may offer concessions on:

 Reducing taxes while providing subsidies, and tariff or quota protection

 Allowing monopoly power
 Reducing environmental regulations
 However, concessions are often useless:

 Repatriated profits are simply taxed by home governments

 Tax relief may lead to confiscation of MNC property if the host government changes in
the future

Foreign enclave: the MNC/TNC can increase the inequality between the rich and the poor by
developing a modern high wage sector
  This sector imports luxury goods
 Inappropriate goods are marketed in the LEDC
 It widens the rural-urban wage gap leading to increased migration
 MNC/TNC supporters may influence the government to undertake projects or adopt
policies which are growth rather than development oriented

MNC/TNC Policy

 Over time, nations and institutions such as labour unions have developed laws and
agreements to control or balance the excess of private companies
 The problem with MNCs is that there is no global government or global union to oppose
or reduce the worst excesses
 To achieve their ends LEDC governments may:

 Impose a schedule for local value added to be increased and for greater utilization of
local personnel
 Impose bans on the import of used capital equipment with an insistence that only the
latest technology be used
 Insist on joint ventures with local firms, and ceilings on the repatriation of profits to
encourage or force reinvestment of profits in the local economy
 Insist on market pricing rather than transfer pricing on intra firm transactions
 Many MNC/TNCs now insist on proper tax payments right from the start:

 To provide enough tax revenue for the govt. to build the infrastructure needed to
service the MNC/TNC
 To prevent resentment and potential nationalization which can lead to risk and
uncertainty which threaten the long term viability of a project

[edit] International Trade & Economic Development

 About 70% of trade is between MEDCs, with the remaining 20% from LEDCs and 10%
from previously centrally planned economies:

 This situation has not changed significantly for 40 years

 It is the NICs and the oil exporters which are experiencing rapid growth, the remaining
LEDCs have seen their proportion of trade falling steadily

Benefits from Trade

 Comparative advantage: the potential gains from trade resulting from economies of
scale and lower consumption prices can be of great potential benefit:

 Even large LEDCs may have limited domestic markets due to low income
 Small economies can achieve economies of scale through access to larger markets
  Growth: technology transfer can occur through the importing of capital goods: this can
promote the rapid spread of technology
 Learn by doing: best practices in production spread rapidly through trade
 Domestic monopoly power can be reduced through international competition
 Importance of fostering South-South trade

Problems with Trade

 Foreign enclave: with wealth and income concentrated in the hands of the rich, most
imports could be luxury goods
 Countries are assumed to be on their production possibility frontier when in fact most
LEDCs experience high unemployment and underemployment
 Technology transfer may be pointless if it is labour saving in countries with high
unemployment rates. What is needed is appropriate technology
 Risk of permanently slower growth: specialization may lock the LDCs into low skilled,
labour intense production while MDCs benefit from high tech production
 Prices may not reflect opportunity cost but simply manipulation by government and
firms
 Taxes, subsidies and the lack of recognition of true social costs (pollution for example)
can lead to serious price distortions
 All countries CANNOT find an industry/natural resource to specialize and enjoy
comparative advantage
 Markets in MEDCs are not open for exports from LEDCs
 Barriers to trade: LEDCs may find that MEDCs have already achieved economies of scale,
and protect their home industries through tariffs and quotas thus effectively blocking
imports from LEDCs
 Many LEDCs have turned to other LEDCs for trade opportunities
 Displacement of local production: in many LEDCs the production of cheap plastic sandals
can put shoe makers out of work, backward linkages to suppliers of leather, fabric,
glues, polish and packaging materials lead to even more people being put out of work
 Gains from trade will benefit foreign owned plants and factories and the profits
repatriated to home countries
 High income elasticity for manufactured goods and services means that imports rise
with incomes
 Price elasticity of demand for capital goods tends to be low because there are few
substitutes
 Devaluation of the currency can actually lead to a larger import bill

Problems with Primary Goods Exports

 Low income elasticity of demand for primary goods, the substitution of synthetic
materials and the dramatic reduction in the weight and bulk of manufactured goods
have all led to virtually no growth in demand
 World demand: tends to be inelastic: there are no substitutes for primary goods:

 World supply: intense competition amongst LDCs lowers price and total revenue
 Devaluation of the currency can actually lead to lower export revenue
 In farming: supply shocks due to weather and disease combined with inelastic demand
means farm revenues are very unstable

 Attempts to form cartels have met with opposition from MEDCs:

 Cartels that do survive are weak due to cheating amongst members

 Non-member increase supply and reap the benefits of the higher prices

 Alternatives to cartels are buffer stock management:

 When demand falls: the manager provides a price floor, buying and storing the excess
supply
 When demand rises: the manager sells from storage and uses the profit to pay back the
costs of the buffer stocks
 The costs of storage and the interest on the loans to carry the inventory are very
expensive

 Supply price elasticity problems:

 In mining: shifts in demand for minerals due to MEDC economic cycles combined with
inelastic supply means mineral revenues are very unstable

 Trade protection: MEDCs have increased trade protection and subsidies to their own
farmers, effectively blocking imports of food goods from LEDCs
 Worsening terms of trade: prices of primary goods has fallen relative to the price of
manufactured goods and services, lowering the gains from trade for the poorest
countries which do not have the means to produce anything but raw materials

 Commodity agreements: agreements between developing countries in an attempt to

stabilize prices for certain commodities