4.
1: The nature of economic growth and economic development
Economic growth: increases in real GDP (real output) and/or real GNI (real income) over time. This is
often measured in per capita terms in order to determine how output or income are changing on average
per person; economic growth may be negative, involving decreases in real GDP or real GNI
Economic development: a process where increases in real GDP/GNI per capita occur alongside
decreases in poverty, increased employment opportunities, lower income inequalities, increased access to
merit goods including education, health care and infrastructure (sanitation and clean water, supplies),
increased gender equality, all generally leading to improvements in a population’s standard of living
(SOL).
Sources of economic growth in LEDCs:
- Increases in quantity of physical capital: helps to increase the productivity of labor
- Increases in quantity of human capital: helps to increase the productivity of labor
- Improvements in appropriate technology: must be appropriate to local conditions (environment,
climate, levels of skill)
- Institutional changes: efficient and fair legal system and tax system, a banking system, protection
of property rights, and protection against widespread corruption
How economic growth relates to economic development:
Economic growth may not lead to economic development if:
- economic growth leads to a worsening distribution of income, often the result of market-based
supply-side policies and trade liberalization
- there are low levels of government investment in human capital, so that large parts of the
population are left without adequate access to education and health care
- there is widespread introduction of capital-intensive technologies leading to unemployment
- improvements in infrastructure (clean water, sanitation) are concentrated in urban areas, with
neglect of rural areas where many of the poor live
- within urban areas improvements in infrastructure are concentrated in the formal sector, with
neglect of the informal sector of urban slums
- there is discrimination against social groups on the grounds of religion, ethnicity, gender, race, etc
- the poor live in remote geographical areas with limited access to growing economic activity
- the poor are caught in a poverty trap/cycle
- the poor have no access to credit
Country groups according to their level of economic development
LEDCs (3 groups): low income, lower middle income, upper middle income
MEDCs (1 group): high income
Human Development Index (HDI): A composite indicator of development which includes indicators that
measure three dimensions of development: income per capita, levels of health and educational attainment
LEDCs differ enormously from each other with respect to their:
- natural resources
- climate
- type of political system
- human and capital resources
- history
- degree of political stability
Common characteristics of economically less developed countries (LEDCs):
- Low levels of GDP and GNI per capita
- High levels of poverty
- High levels of unemployment and underemployment
- Large income inequalities
- Large agricultural (and primary) sector
- High birth rates and population growth
- Low levels of health and education
- Low levels of physical capital and technology
- Low levels of productivity
Dual economies: These involve the simultaneous existence of two different systems that coexist in an
economy, such as:
- a formal (registered and regulated) and informal (unregistered, unregulated) urban sector
- a technologically advanced agricultural sector based on the use of modern and advanced inputs
side-by-side with subsistence agriculture based on labor and simple tools
- very rich, highly educated people side-by-side very poor, illiterate and/or uneducated people
Informal sector: An informal sector is one that is not regulated and not registered. Examples include
hawkers, marketers, vendors, artisans, small businesses and cross border traders.
The poverty trap (poverty cycle): Any circular chain starting and ending in poverty, meaning that
poverty perpetuates itself.
The Millennium Development Goals:
1. Eradicate extreme poverty and hunger
2. Achieve universal primary education
3. Promote gender equality and empower women
4. Reduce child mortality
5. Improve maternal health
6. Combat HIV/AIDS, malaria and other diseases
7. Ensure environmental sustainability
8. Develop a global partnership for development
4.2: Measuring Development
Benefits of indicators:
- Measure a country's performance with respect to reaching a goal
- Compare performance across countries
- Measure progress over time
- Design policies to achieve specific goals
Shortcomings of indicators:
- Varies across countries (cannot compare)
- Lack of data
- Inability to collect it accurately
GDP: measures total output produced in an economy over a year (per capita is per person)
GNI: measures income received by residents of an economy over a year (per capita is per person)
GNI = GDP + income received from abroad - income sent abroad (net income)
GDP per capita= better indicator of output produced per person
GNI per capita: better indicator or standard of living
GNI limitations:
- No indication of distribution of income
- Does not account for achievements in standard of living
- Does not include income earned in underground economy
- No indication of composition of output (capital goods)
- Does not count negative environmental externalities and destruction
- Does not include output not sold in markets
Example of a scenario: same GNI per capita but diff price levels = low PL = greater purchasing power
Health indicators: life expectancy at birth, infant mortality, maternal mortality rate
- Quality of public health services
- Quality of environment
- Level of education in population
- Access of population to healthcare services
- Access to sufficient food
Education indicators: adult literacy rate (above 15 who can read and write), primary school enrollment,
secondary school enrollment, mean years of schooling (25 or more of age who have attended school)
Composite indicator: group of single indicators used together to form a single measure of development
Human Development Index: life expectancy at birth, mean years of schooling, GNI per capita
Measured from 0-1 (process defined in terms of human freedoms including hunger, diseases, poverty etc)
Cons of HDI: does not provide indication of income distribution, employment, gender equality etc
Other indicators: Gender Inequality Index (reproductive health, empowerment, labor market
participation), Inequality, adjusted Human Development, Multidimensional Poverty Index
4.3: Role of Domestic Factors
Education & Health are the building blocks of human capital
- Fundamental Human Rights
- Goals of economic development
- Part of HDI
- Sources of Economic growth
- Positive consumption externalities
External benefits of education:
- Economic growth
- Reduced unemployment
- FDIs
- Technological improvements
- Political stability
- Reduced birth rates, pop growth, poverty
- Healthier female population and children
External benefits of health:
- Economic growth
- Lower risk of diseases
- Improved school attendance and better performance
- Longer life (more contributions to society)
Appropriate technology: technology that is well suited to the FOPs of a country
LEDCs: labor intensive (increased employment, savings on foresign exchange, reduced poverty)
MEDCs: capital intensive (greater unemployment, limits use of local skills, less incomes, scarce of
foreign exchange due to costly imported capital equipment) AS SEEN THROUGH IMPORT
SUBSTITUTION POLICIES IN 1950S AND 1960S
Banking and credit is important because:
- Savings of one household are made available for investors to borrow
- Provides an incentive for households to save due to interest payments on savings
- Funds for investors
- Offer a way out of poverty trap (borrow to create profitable business)
Cons of credit:
- Credit system is not well developed (geographical access is limited)
- Banking sector is dominated by foreign banks lending money to wealthy corporations
- Banks require collateral for making loans (poor people have nothing)
- Poor people borrow from illegal money lenders (high interest rates)
Micro credit: lending of very small amounts of money for short periods to poor people who have no
other access to credit (Muhammad Yunus Bangladesh)
+ Helps poor and unemployed people become self employed in small businesses
+ No collateral necessary to obtain loans
+ Borrowers are often women (highest repayment rates)
+ Social status of women has improved
+ Poverty reduction and stable incomes
- Very few micro credit schemes available (less people benefit)
- Workers are without social protection
- High interest rates
- Excessive borrowing may lead to debt trap
- May become a substitute for badly needed government poverty reduction policies
Empowerment of women: eliminating discrimination faced by gorls and women with respect to access
in education and health care, labor market, right to property, access to credit, so that women have the
same opportunities as bopys to achieve their potential to live a productive life.
- Improved health and nutrition of children
- Improved education of children
- Improved quality of labor force
- Economic growth and development
- Higher participation of women in labor force
- Low birth rates and pop growth
- Greater likelihood of breaking poverty cycle
Cons of high unequal distribution of income:
- Low savings in economy as very low income earners don’t save and very high income people
send a lot on luxury goods
- Larger proportion of population invest less and can’t break out of poverty cycle
- Low income means low demand for goods and services (low employment, econ growth, and
incomes)
- Greater poverty (low human capital)
- Political instability
- Government policies that favor their own interests rather than to combat poverty
Infrastructure: physical capital resulting from investments in socially and economically necessary goods
and services, undertaken by governments (clean water supplies, telecommunications)
Role of infrastructure in LEDCs:
- Reliable transportation systems (low costs, improve international competitiveness, access to
schools and hospitals)
- Clean water supplies include health of population and standard of living
- Energy systems increase range of production methods which increases productivity of workers
- Telecommunications allows faster communication and diversification of economy
Cons of infrastructure in LEDCs:
- Governments run into financing difficulties
- Low revenues means poor quality and maintenance
- Low revenues means lack of access by poor people
- Misallocation of resources
- Inefficient production means high costs
- Environmental degradation and unsustainable development
Additional domestic factors that affect economic growth and development:
1. Ineffective tax systems: corruption, tax exemptions, bureaucracy, low property taxes
2. Legal system & property rights: low investment, less access to credit, no benefits to 3rd parties
3. Lack of political stability: absence of effective policy making, low domestic investment, low
investment by MNCs, outflow of financial capital to other countries
4. Corruption: low economic activity, regressive tax, misallocation, environmental
unsustainability, money goes to private individuals and not govt, trust in govt is weakened
4.4: Role of International Trade
Problems with overspecialization on a narrow range of products:
- Export earnings are vulnerable to changes in conditions of demand and supply
- Lack of diversification of production
Price volatility of products (low PED):
- Unstable export earnings
- Unstable incomes of farmers
- Unstable ability to import
- Negative effects of uncertainty on investment
- Fluctuations in employment
- Inability of government to plan economic development projects
Reasons for LEDCs’ poor access to international markets:
- High income countries providing their farmers with support through subsidies and price floors
(leading to overproduction and low prices)
- High tariff barriers imposed by MEDCs on LEDCs and LEDCs on LEDCs
- Tariff escalation (high tariffs on final goods)
- Hidden trade protection (custom duties, environmental standards)
Consequences of protection of rich country farmers for global economy and LEDC farmers:
- Misallocation on a global scale (overproduction of MED agricultural products dumped into global
markets)
- Forcing LEDC business out of business
- Inefficiency (shift from efficient to inefficient producers)
- LEDC lose export earnings
- Greater poverty amongst LEDC farmers
Trade strategy 1: import substitution (based on strong government intervention involving heavy
protection of domestic industries through tariffs, quotas etc to replace imports with domestic production)
+ Newly independent countries in 1950s used to modernize
+ Use of infant industry argument
+ Protection of domestic employment
+ Avoiding current account deficits and BOP problems
- Inefficiencies and resource misallocation
- Capital intensive production methods lead to unemployment
- Low rates of economic growth
- BOP problems
- Weak agricultural exports due to overvalued currencies
Export promotion: strong government intervention to promote econ growth through export expansion
Included:
- Targeting specific export industries
- Industrial policies
- Large investments by govt
- Some trade protection of industries
- Incentives for private sector r and d
- Imposition of requirements on MNCs (training, technology)
Strengths:
- Labor intensive technologies
- Investment in education and skills improved: economic growth
- Diversification increased skills and employment
- Economies of scale
- Avoided current account deficits and BOP problems
Difficulties:
- Resource misallocation
- Strong dependence of exports (bad if trading partners are in recession)
- WTO are against industrial policies
Trade liberalization: reduction or removal of trade barriers to achieve growth of international trade
+ Specialization because of comparative advantage
+ Economies of scale
+ Greater choice and low prices of imported goods
+ Greater efficiency due to competition
+ More foreign exchange available
+ Economic growth
+ Acquire needed resources
+ Reduce poverty and income inequalities
Based on market based supply side policies (privatization, deregulation)
Pros of WTO:
- Help in trade liberalization globally
- Help resolve disagreements between trading partners
- Forum for participating countries to voice their opinions
- Help in better allocation of resources
- Help achieve lower costs and greater choice
- Achieve economic growth and reduce poverty
Bilateral Trade: one high income country and one low income country
+ Interest to LEDCs to gain access to MEDC market
+ MEDC will provide foreign aid to support projects
- May compete with each other
- Imposition of conditions of agreements
- Unfair competition
- Tariff reductions on imports of LEDCs from MEDCs are greater than those required by TWO
rules (LEDC firms may close down)
- Tariff reductions made by MEDCs for LEDC exports may be greater for primary commodities
Diversification: broadening range of goods and services produced and exported
+ Increasing and maintaining high export levels
+ Avoids problems of excessive specialization in primary commodities
+ Avoids long term deterioration in TOT
+ Creates new jobs
+ Encourages development of skills and technologies
- Loss of benefits of specialization
- Loss of improvements in allocative efficiency due to specialization
- Difficulties in overcoming barriers on manufactured products by MEDCs
4.5: The role of FDI
FDI: investment by a firm originating in one country (home country) in productive facilities in another
country (host country). It is carried out by MNCs. Should be contrasted with portfolio investment which
refers to financial investment (stocks and bonds)
MNC: firm that carries out FDI (having productive investment in more than one country)
Why MNCs expand into LEDCs:
- Greater sales and profits
- Avoidance of trade barriers imposed by LEDCs by producing within their boundaries
- Low costs of labor
- Use of raw materials that are locally produced (reducing transportation costs)
- Extraction of natural resources that LEDCs have
Why LEDCs attract MNCs:
- Larger markets
- Political and macroeconomic stability
- Expectations of rapid economics growth
- Well developed infrastructure and telecommunication systems
- Skilled local labor force
- Weak labor unions
- Free market economy with little govt intervention
- Liberalized trade
- Freedom to repatriate profits
- Weak environmental protection
Pros of FDI for LEDC:
- Increased investment
- Credit in financial account of BOP
- Increased employment opportunities
- Opportunities for training of local labor force
- Bringing new technology (diversification and economic growth)
- Increasing exports and economic growth
- Improving infrastructure for the developing economy
- Promoting local industry/businesses by buying locally produced inputs
Cons of FDI for LEDC:
- Greater outflow than inflow due to profit repatriation as well as imports required for production
- Employment opportunities may not increase as much due to capital intensive technologies and
using labor from the home country
- Production may use unskilled labor only, thus no training of local labor force
- MNCs may have too much power and set inappropriate policies like weak environmental laws,
weak labor protection laws, use of domestic budget funds to build infrastructure
- Environmental degradation and unsustainable development
- MNCs declare highly inflated costs which makes profits seem less than they actually are
4.6: Roles of foreign aid and multilateral development assistance
Foreign aid: transfer of funds in the form of loans and grants, or transfer of goods of goods and services,
as gifts, to LEDCs to help them achieve social or economic objectives. The aid is non-commercial and
concessional.
Tied aid: conditions on the borrowing country imposed by bilateral aid donors requiring that at least a
portion of the borrowed amount must be spent to import goods and services from the donor country.
Governments of donor countries: Official Development Assistance
- Bilateral aid: aid going from one donor to one LEDC recipient country
- Multilateral aid: aid going from donor countries to LEDCs through international organizations
like UN.
- Non-governmental organizations: organizations concerned with promoting objectives that are
in the public interest. They are involved in a very broad variety of development efforts, including
technical assistance for farmers, education and health services, support for urban informal
workers, micr-credit, rights of women, human rights, and sustainable development. They have a
strong anti-poverty perspective that work closely with local people, have a clear understanding of
their problems, and have generally earned the trust of those they try to help.
Humanitarian aid: aid extended in areas which are experiencing emergency situations due to crises
caused by wars or natural disasters and consist of donations of food, medical assistance, and provision of
shelters and supplies.
Development aid: aid extended to LEDCs for the purpose of assisting them in development
Consists of:
- Concessional long term loans (below market interest rates, extended for long periods)
- Grants (gifts that do not need to be repaid)
Takes the form of:
- Project aid: aid for specific projects
- Programme aid: aid in support of whole sectors of economy
Why MEDCs are motivated to provide aid:
Political: support countries that are politically and ideologically friendly to MEDCs
Economic: support LEDCs that have strong economic links with donor country (trade, investment)
Humanitarian: out of feelings of compassion for the plight of poor people living under harsh conditions
Why aid is essential:
- Help poor countries to emerge from the poverty trap
- Impossible to achieve MDGs without aid.
- By increasing investment, aid is linked with higher growth rates.
- Helps in poverty alleviation by: improving education and skills, infrastructure, levels of health,
development of new technologies, helping poor people find employment)
- Helps indebted countries to obtain debt relief
Why aid may be ineffective from the POV of donor countries:
- Tied aid is ineffective because it does not allow recipient countries to search for low price
suppliers, forcing them to use inappropriate technologies.
- Conditional aid forces the countries to use market based supply side policies that may actually not
benefit the donor countries more and be inappropriate for recipient countries.
- Hard to plan effective use of funds due to budget problems
- There may be a large number of donors which is why it can be hard to plan effectively as there
can be a duplication of projects and waste of resources.
Problems for recipient countries:
- Use of aid may weaken government efforts to reform their tax systems .
- Aid may not reach the intended beneficiaries.
- Corruption
Role of aid and trade in economic development:
Trade not aid:
- Focuses on factors that limit the effectiveness of trade
- It is a waste of resources as it does not solve problems of LEDCs
- LEDCs should focus on expanding trade instead of aid
Aid not trade:
- Focuses on the idea that many factors that limit aid effectiveness are the responsibility of donors
- Trade is important but it is not enough.
- There are difficulties expanding trade due to rich country protectionist policies.
- Even if rich countries abandoned these policies, trade would still not be able to achieve growth
and development because poor countries have very little to export and some are even
geographically isolated.
- Therefore aid is necessary to break out of poverty trap and alleviate poverty.
Aid for trade:
- LEDCs must be offered trade to help them build their capacity to export
- Difficulties in export arise due to poor transportation systems, inability to access sufficient credit,
weaknesses in power generation.
Multilateral Development Assistance: lending to LEDCs by international organizations like World
Bank to achieve objectives on non-concessional terms.
World Bank:
- Established after WW2 with the intent of lending Europe for its reconstruction.
- 1950s: lending to LEDCs to support economic growth and development.
- Structural adjustment loans: objective to reduce government intervention and make LEDC
economies market based.
- Lending became conditional on adoption of policies that liberalize trade, remove price controls,
cut govt spending (Washington Concensus_: ambiguous effects on growth, worsening income
distribution, increasing poverty, negative effects on health and education and environment, and
failure to promote development.
IMF: monitors the global financial system that lends to governments that are experiencing difficulties in
making their international payments.
- After WW2 and purpose was to lend to countries facing BOP problems.
- Contractionary policies (high interest rates to lower AD and reduce imports, increase inflows of
financial capital) (contractionary fiscal policy by increasing tax and cutting government spending)
(current devaluation/depreciation to reduce imports and increase exports
- Wage cuts to reduce spending
4.7: Role of international debt
Foreign debt: amount of funds that have been borrowed by the government and private sector from
foresign sources that are owed (problem arises mainly because of govt debt to foreign creditors)
Problem:
- When govt borrows from foreign sources, it must make interest payments in addition to
repayment of borrowed amounts which are made in foreign exchange, which can come from
greater exports, few imports, or more borrowing.
- Governments borrow foreign sources partly in the form of foreign aid or development assistance.
However, current account deficits need to be financed by a financial account surplus.
Debt problem in LEDCs: low export revenues with high import expenditures (oil) led to large current
account deficits
1980s: market based supply side policies (effectively deal with cost push inflation or stagflation better
than demand side policies)
** Con for LEDCs: deepen recession, increase unemployment, worsen poverty and income distribution
Consequences of high level of debt:
- Major opportunity costs as governments have less funds available to invest in social services
needed for poverty alleviation.
- Private investment may be affected due to uncertainty of the future of the economy
- Lower economic growth due to low private investments and low government investment in
human capital
- Debt trap (necessary to go on borrowing to repay prior debts)
- Lower economic growth affects ability to repay debts
- Debt repayments and payment of interest myse be made in foreign exchange, there is less of it
available to import essential goods and services and inputs for production.
Debt rescheduling: extending new loans with longer repayment periods and at lower interest rates which
are then used to pay back the older loans, making it easier for the debtor to make the loan repayments plus
interest.
Debt cancellation: cancelling a portion of debts, so that the amount that must be repaid is reduced; debt
cancellation is a stronger form of debt relief than debt rescheduling
Heavily Indebted Poor Countries Initiative: intended to help very poor countries that are highly
indebted.
+ These programs are an important contribution to providing debt relief.
+ Commendable for anti-poverty approach.
- Level of debt reduction provided for may not be enough.
- Programs take a long time to take effect.
- Some very highly indebted countries do not qualify for assistance.
- Some market liberalization conditions may not be appropriate.
4.8: Balance between markets and intervention
Evaluating market oriented policies:
+ Market allocates resources efficiently, maximizing social surplus through prices and signals and
incentives.
+ Competition between firms forces them to be more efficient, lowering COP & improving quality
+ Lower COP means lower prices which are in the interest of consumers
+ Market increases choice
+ Market provides incentives (higher incomes and profit) that encourage economic activity leading
to greater growth.
+ Policies that encourage competition (privatization, deregulation) allow firms to operate in a more
competitive environment, increasing allocative efficiency.
+ Policies that promote labor market reforms encourage the working of demand and supply in the
labor market, lowering unemployment and COP for firms
+ Incentive related supply side policies provide incentives to work more and invest more
+ Trade liberalization policies allow firms to grow, achieving economies of scale
+ Free floating exchange rates allow market to solve BOP problems automatically
- Market failures do not allow market to achieve allocative efficiency
- Market fails to supply education, healthcare, and infrastructure that are short in supply in LEDCs
- Market fails to provide against environmental degradation and unsustainable development
- Market cannot function well when there are weak market supporting institutions like finance,
legal, and tax systems
- Leads to the development of dual economies
- Leads to large urban informal sectors
- Market leaves very poor people without access to credit
- Does not help communities to break out of poverty trap
- Competition promoting policies increase unemployment
- Labor market reforms lead to greater worker insecurity and lower wages
- Trade liberalization does not encourage diversification
- Trade liberalization would mean many firms will be forced to close down due to their inability to
compete with larger MEDC firms.
- Increasing income inequalities
- Market may not lead to higher economic growth
Evaluation of interventionist supply side policies:
+ Government policies are essential to correct market failures and provide merit goods.
+ Governments can engage in R & D for the development of appropriate technologies.
+ Can pursue macroeconomic policies for a favorable environment.
+ Social safety net = transfer payments of various kinds so that people do not fall below the poverty
line.
+ Income redistribution policies
+ Industrial policies to support firms that need help to grow and become competitive
+ Trade protection for infant industries and assist LEDCs to diversity products
+ Intervene in foreign exchange markets by fixing exchange rates and reducing uncertainty
+ Needed to prevent environmental degradation.
- Require use of government budget funds which are of short supply in LEDCs creating large
opportunity costs.
- Scarcity of budget means governments run the risk of large budget deficits to meet the demands.
- Scarcity of budget funds alsi means that it is difficult to undertake ALL the activities that are
socially desirable in LEDCs.
- Governments are often inefficient as they do not have the incentive to reduce costs and maximize
profits.
- Excessive bureaucracy can lead to inefficiencies.
- Government trade protection policies can protect inefficient producers.
- Excessive government intervention leads to allocative inefficiencies.
- Macroeconomic policy may be imprudent (high inflation, large public debts etc)
- Governments are often susceptible to political pressures by elite groups that influence them.
- Government provided services may be susceptible to corruption and unfair distribution.
Governments should be involved with:
- Correction of market failures
- Provision of merit goods
- Promotion of R&D and technology
- Protection of environment (supporting sustainable development)
- Policies to reduce poverty and income inequalities
- Provision of laws to promote gender equality
- Supporting infant industries and small and medium sized firms