IB Economics/Development Economics

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Contents 1 Sources of Economic Growth and/or Development 2 Consequences of Growth 3 Barriers to Economic growth and/or Development 4 Growth and Development Strategies 5 Evaluation of Growth and Development Strategies

[edit] Sources of Economic Growth and/or Development

Natural factors: the quantity and/or quality of land or raw materials: many LEDCs have abundant natural resources - agriculture is especially important as an export sector, and is an area for initial mechanisation, productivity gains and growth

• Agricultural (arable) land is finite and therefore the law of diminishing returns applies as more labour is added to the land - many LEDCs have had problems with severe weather, low agricultural productivity, worsening terms of trade and rising prices for crucial pesticides and fertilisers
• It is estimated that more than half the renewable natural resources are being utilized in the world - this includes arable land, fisheries, forests, and water
• There are still significant amounts of non-utilized arable land in some African and Latin American countries

Human factors (labour): the quantity and/or quality of human resources - relatively high population growth rates in LEDCs reduce growth in per capita GDP

Physical capital and technological factors: the quantity and/or quality of physical capital

• Investment in machinery and equipment add directly to productivity
• Investment in infrastructure such as roads, bridges, dams, sanitation and electricity are indirectly productive, but equally as essential
• The opportunity cost of capital investment is the lower levels of current consumption which result from saving

• Savings present a great hardship for people who may already be living below the poverty line

• Technology developed in MEDCs is appropriate for labour scarce, rich countries - because it is labour saving, it is inappropriate in labour abundant countries where it is more efficient to use more labour and less capital
• Capital intensive development often displaces workers and does little to reduce unemployment
• Factor rewards go to capitalists or investors from foreign countries - it does little to relieve poverty

Institutional factors that contribute to development:

• banking system
• education system
• health care
• infrastructure
• political stability

Economic development: occurs if there is a reduction in poverty, inequality, and unemployment. Having more choices for the population is essential. This will include increasing the access to and the means to obtain improved food, shelter, health and protection under law

• If growth occurs with no improvement in living standard for most of the population, then economic development has not taken place
  • Trickle down theory (market economy): an early theory which assumed that economic growth, leading to greater prosperity, would diffuse from the rich to the poor raising overall living standards
  • Development plan (central planning): must include targets and policies for reducing poverty, inequality and unemployment

There are 144 developing economies (LEDCs) in the world, of which 83 have fewer than 5 million people

• LEDCs tend to have low standards of living, and low GNP per capita
  • Low income countries receive $700 per capita, middle income countries receive from $700 to $8,000 per capita
  • They tend to have a high population growth rate
• More than 50% of the population is involved in primary production:

• Primary goods are the most prominent exports
• Mining tends to be dominated by MNCs (multinational corporations)/TNCs (transnational corporations)
• Infrastructure, often built by colonial powers, is designed to move primary goods to the coast for shipment overseas

• All sectors are characterised by low productivity and high unemployment:

• Capital equipment and technology is likely to have been imported
• Processing and manufacturing for export is discouraged because MEDCs tend to raise trade barriers against higher value added goods

• Economic power is unequally distributed both internally and externally
• Latin American and Asian countries tend to have more private enterprise, African countries tend to have greater state ownership of enterprises

Measuring Growth

• The share of a sector or component of GDP such as manufacturing or agriculture is measured by the value added contributed by that sector
• Value added: the addition to value of a product during a stage of production

• Value added in the cotton textile industry: the value of the textiles when they leave the factory minus the value of raw cotton used in their manufacture
• This is equal to payments to the factors of production: wages paid to labour plus profits, interest, depreciation of capital, and rents for buildings and land

• If economic growth is 1%, it will take approximately 72 years for the value of the economy to double
• If the growth rate is 10% it will only take 7.2 years for the economy to double

Growth Theories

• The trickle down theory has failed to happen in most LEDCs. While the emphasis on growth has switched more toward development, growth is still of great concern as it is a necessary foundation for economic development
• Growth occurs:

• Through increases in the factors natural resources and capital
• It also occurs by increasing the productivity of existing factors through investment in education (labour) and technology (capital)

Stages of Growth

• Countries appear to go through distinct stages of growth, and are arrayed along the following spectrum:

• Low income LEDCs (HIPCs=Highly Indebted Poor Countries) are characterized by subsistence agriculture with a manufacturing and service sector producing goods and services using simple technologies to service the rural sector (food processing, textiles), perhaps exporting basic commodities
• Middle income LEDCs are further up the escalator and are involved in processing raw materials for export and producing basic chemicals, steels, some farm machinery, clothes for export, and perhaps some tourism
• The NICs, newly industrialized countries are involved in manufacturing clothes, cars, some simple electronics for export
• MEDCs are heavily involved in manufacturing higher value added products, e.g., luxury cars, sophisticated electronics and simple services such as tourism
• High income MEDCs are at the top of the escalator such as the US and Switzerland which put greater emphasis on the production of highly sophisticated services such as research, development, design, marketing, financing, computer software, and management consulting

Transitioning economies (from command to market) have similar characteristics: inflation rate, unemployment rate, difficulty attracting FDI, nonconvertible currency

• The position of each country on the spectrum is determined by the endowment of natural resources, the historical heritage of experience with commerce, finance, and trade, the size of the country which can lead to economies of scale, and the level of investment in human capital both in terms of education and training and in terms of learning by doing

Analysing Economic Growth

• If we call real output Y, and the stock of capital K, then output can be related to the capital stock:Y=K/k, where k=the capital output ratio (the amount of capital required to produce a unit of output), and is simply a measure of the productivity of capital
• Growth, g, is simply the rate of change in Y and is related to the investment in the capital stock K, where investment measures the rate of change in K
• If we designate S/Y as the percent saving rate in the nation and call it s, then: g=s/k
• Capital created by investment is one of the main determinants of growth and it is savings by people and corporations that pays for that investment

Planning

• Given the formula, planners can decide on the rate of growth, g, and the equation tells them the savings and investment necessary to achieve that growth level

• Alternatively, planners can decide on the rate of savings and investment that is feasible, and the equation tells them the rate of growth that can be achieved. Often referred to as the savings gap, the ‘s’ tells planners how much they need to borrow internationally after deducting what the nation saves domestically

• Poor countries with low savings rates and unemployed labour can achieve higher growth rates by economizing on capital and utilizing as much labour as possible

• As economies grow and per capita income rises:

• Savings rates tend to increase and the labour surplus diminishes
• Savings become relatively more abundant and hence the price of capital falls while employment and wages rise

• Producers increasingly economize on labour and use more capital
• Technological change and learning by doing can play important roles; both can contribute to increased productivity of all factors of production

• Richer nations like the US, Japan and Norway tend to have higher capital output ratios because capital is less expensive relative to labour than in LEDCs
• Studies indicate that increases in productivity or efficiency account for a much higher proportion of growth than was believed to be the case
• Between 50% and 70% of growth can be attributed to increases in factor productivity, including mobilization and improvement in the quality of labour
• Increases in the capital stock frequently account for much less than half of the increase in output, particularly in rapidly growing countries; however, capital tends to play a larger role in growth in today's developing countries, and some of the increases in efficiency or productivity involve advances in technology that is embodied in capital equipment

Productivity and Growth

Policies to Stimulate Growth

According to the World Bank, rapid growth in Asia is a direct result of policy guidance rather than just a free market - these policies include:

• Making income distribution more equitable: measured by Lorenz Curve and Gini coefficient
• Encouraging savings and making banks more reliable
• Improving primary and secondary education
• Improving agricultural productivity
• Facilitating technology transfer and encouraging FDI
• Streamlining legal and regulatory structures to create a positive business environment
• Setting industry wide standards and monitoring quality facilitates marketing.
• Targeting key industries for development:

• Protecting infant industries in the early stages
• Managing resource allocation
• Facilitating exports through government-assisted marketing

Low Productivity Leads to Slow Growth

Diminishing returns is the major cause of low productivity in LEDCs

• There is a scarcity of capital and trained management, ever increasing supplies of labour combine with relatively fixed supplies of land, capital and management
• Also people need to be healthy and educated in order to be productive; some studies have shown that a third of the working population in very poor countries are afflicted with internal parasites which drain energy rapidly
• Savings are needed for investment in both physical and human capital, but savings requires a higher income, and higher income requires greater productivity. This is often referred to as the poverty trap.
• Higher productivity does not require high tech solutions:

• Billions of dollars in aid for large scale, high tech projects has only increased dependency for the poor rather than increasing productivity.
• What is needed is technology appropriate for the poor which will allow them to help themselves.
• Appropriate technology uses local materials, and local labour skills, and capital that can easily be repaired locally:

• Simple clay stoves, pipe wells, pipe latrines, micro hydro power transformers, better harnesses for oxen etc.

Growth Through Enhancing Factor Productivity

Natural resources

• While there is still land to be developed, the bulk of land available to most populations is limited in size
• Irrigation, drainage, the use of chemicals for fertilizing, pest and weed control, and the use of machinery can increase productivity dramatically
• The green revolution is an example of this

• The problem is that the damage to the soil can be so extensive, that the increase in productivity may only last 70 years before the soil is destroyed
• Already India is starting to seriously question the use of irrigation, machinery and chemicals as soil degradation is very serious

Labour

• If 50% to 70% of economic growth arises from improvements in the productivity of factors, there is a need for better education, greater efficiency in management, and better training in technology
• LEDCs have made large investments in primary and secondary education
• Increase in worker skills is essential in order to make use of capital equipment and new technology, and to provide the services needed for growth in the future

Capital

• 85% of the scientists working in research and development live in the US, Japan, and Germany. The new ideas and inventions which are applied through the new technology and capital are dominated by MEDC thinking
• Only modest amounts are invested in research and development in LEDCs

Growth & Multi-National/Trans-National Corporations

• 50 of the top 100 ‘national incomes’ in the world are earned by MNCs/TNCs
• MNCs/TNCs have no loyalty and are happy to produce and sell anywhere, they are economically powerful and often more influential than the govts. they deal with
• Industrial orientation: 40% of FDI by MNCs/TNCs is for manufacturing, and 60% is for extraction and processing of natural resources:
• 500 MNCs control 80% of the FDI, 40% of them are US based, and 30% are based in the UK, Germany and Japan
• Most European and US based MNC/TNCs tend to invest in other MEDCs
• US owned: US MNCs/TNCs still account for 50% of total FDI in LEDCs - much of the FDI from US based MNCs/TNCs is directed toward the oil industry
• Japanese owned: 60% of Japanese MNCs/TNCs investment has been in LEDCs
• LEDC owned: MNCs/TNCs which are LEDC based and invest exclusively in other LEDCs have the fastest growth rate

Growth Through Industrialization

• Manufacturing has been growing faster than GDP in most LDCs, but can only absorb 30% of the growing workforce
• In the early stages of development, manufacturing growth often occurs through backward integration from consumer to producer goods
• Primary sector growth usually occurs through forward linkages rather than backward linkages
• Cities have grown rapidly because:

• There are agglomeration economies (face to face contact with bankers, govt. decision makers, lawyers, marketing, and suppliers)
• There are external economies (railroads, ports, airports, communications utilities, roads, water and sewage)
• Businesses prefer large cities, infrastructure costs can be 15% higher in smaller cities

Benefits of Industrialization

• Industrialization allows economies of scale to be reached in production:

• Exports: access to larger markets allows minimum efficient scale to be reached more rapidly
• Research and development: costs are more spread out
• Heavy industries: economies of scale are important for steels and chemicals
• Cost savings: size confers concessions and discounts through bulk buying, and lower interest rates when borrowing money.

• Industrialization leads to better firm management:

• In many industries this is more important than economies of scale
• Firms become more efficient through the introduction of: subcontracting systems, re sequencing of production systems, and just in time delivery; while the product life cycle can confer temporary monopoly profits
• The introduction of flexible computer integrated manufacturing has made low cost labour less important for assembly operations

• Increased productivity enhances the possibilities for import substitution as well as for export promotion

• Industrialization can ensure that inputs needed to enhance productivity in the primary sector are available

• Industrialization can enhance job creation:

• K/L ratios can be as low as 4 to 1 in textiles in LEDCs which contrasts with 80 to 1 in MEDCs, thus providing 20 times as much employment

Balanced Industrial Growth

• Balanced growth requires countries to develop a wide range of industries simultaneously to achieve sustained growth: on the demand side to absorb the output, on the supply side to prevent bottlenecks
• Balanced growth is very important for centrally planned economies, without price adjustment, all sectors must be developed simultaneously:

• Information about shortages in one sector cannot be transmitted properly as prices are not permitted to rise
• Even if prices were permitted to rise and rates of return were to rise in those industries in response, there are no entrepreneurs to respond to the profit opportunities by investing to reduce the shortages

• Unbalanced growth typically occurs for a developing country which cannot start up a wide range of industries simultaneously:

• Import substitution can be followed as a way to ensure a ready market for the output of a domestic industry
• Alternatively export promotion can be pursued: access to larger markets, economies of scale are quickly reached, and workers learn by doing

Backward and Forward Linkages

• With unbalanced growth, imports provide what cannot be produced locally
• Backward linkages can be created as follows:

• Fabrication: as the imported goods are repaired, domestic industries are set up to supply the parts required rather than importing parts

• Forward linkages are also created as follows:

• Adding value: rather than exporting raw materials, processing industries are created to add value to the output, for example iron ore is smelted into steel
• Once processing is viable, there are opportunities to invest in machinery, metal processing and eventually car part fabrication and assembly plants

• Both forward and backward linkages set up pressures that lead to the creation of new industries, all operating through the profit driven investment process
• Governments build the infrastructure necessary to service the expanding industry: roads, railways, harbours, airports, electricity, water and sewage
• Linkage pressures will eventually lead to balanced growth, provided:

• Free market pricing is permitted to allow the proper signalling to occur to reflect enhanced profit opportunities
• A stable banking system is instituted to allow the process of saving and investing to proceed with low risk
• An entrepreneurial sector is fostered through training to allow individuals to respond to the profit signals by investing in areas of the economy where shortages and profit opportunities are the greatest
• Super-normal profits can be earned

Entrepreneurship

• Unemployment is not a result of demand deficient cyclical unemployment:

• In most LEDCs it is supply bottlenecks that create constraints on employment creation
• There are insufficient savings and investment to create the expensive workplaces needed to create urban jobs
• Where there has been technology transfer from MEDCs, investment is labour saving and does not create jobs
• Capital is often subsidized by a government intent on accelerating growth. Firms use the cheap capital as a substitute for labour
• Wages may be too high due to minimum wage laws or MNCs/TNCs permitting unions to bid up wages and forcing firms to replace labour with capital

Small Scale Industry

• There needs to be investment in small scale, labour intense industries in both urban and rural areas to provide alternatives to low paid farm jobs, and the competition for scarce industrial jobs in cities
• Small scale businesses in both urban and rural areas have certain characteristics

• People perform all sorts of services and fashion all sorts of products from recycled materials
• Capital and materials are scarce but human labour is abundant, production is labour intensive
• Usually employs 5 workers or less, and yet can account for 30% of the work force
• Are a wonderful way to flush out entrepreneurial talent

• Governments favour large firms through price distortions, output controls, regulations, export licenses, and credit rationing
• To foster small scale businesses, government needs to:

• Remove controls and regulations to reduce the bias against small firms
• Provide a technology extension system to assist in the process of technology transfer to small entrepreneurs

• Small, modern factories grow out of small scale businesses:

• They generally employ 50 or less, and yet can account for 50% of the industrial labour force
• If they stay in the rural economy, they can provide technology transfer
• However, they are often forced to move to cities to gain: agglomeration and external economies, access to pools of skilled workers, cheap transport and marketing; and access to subcontract work for large firms

Growth & Financial Institutions

• A good banking system is essential for economic growth:

• Savers: deposit money in the bank and expect to receive a steady interest rate (e.g., 5%); savers know that there is no risk attached and do not mind earning such a low rate of return
• Lenders: banks then take the money and lend it out to entrepreneurs; they charge 10% on the loans for several reasons:

• The bank assesses the investment proposals of various businesses looking for those which are feasible (can be done) and viable (can support themselves and repay the loan), and rates them according to risk and return
• Low risk investors pay 10% and higher risk investors pay up to 18%
• The rate differential between savers and borrowers covers the paperwork, earns a return on invested capital, and covers the loans which may fail
• By diversifying across various sectors in the economy and geographic regions in the country, banks are able to reduce risk
• They can also reduce risk through securitization:

• Banks grade loans by risk (grade A, B etc.), and group the loans into standard sized packages/tranches, such as $5 million)
• The packages of loans are sold to domestic and foreign investors

• Before investing, entrepreneurs analyse the various opportunities available and rank projects according to the expected rates of return.

• They borrow at the bank as long as the project rate of return at least covers the bank charges
• They can often earn considerably more, but need it to cover the risks of failure which can be very high for certain projects:

• Primary sector projects may find no oil or minerals, manufacturing projects may face competition from new products or lower cost imports
• The product life cycle may be near exhaustion, or new technology may render a project obsolete

• Entrepreneurs earn more because they are prepared to accept the risk of failure and the consequences of going bankrupt

• They are willing to take new technology and apply it to a new product, or to invest in innovative locations or new product areas - their reward is a relatively high rate of return

Institutional Structures

• Key institutions: property ownership or land tenure, domestic markets (free or controlled), labour markets, education, financial sector (savings and investment, capital markets), international trade (import substitution or export oriented), government (structures and experience), and the colonial creation of artificial countries
• Countries with a history of stable government and a developed commercial sector including merchants, financiers, and businesses familiar with international trade tend to have fewer problems with development
• Countries with governments previously dominated by colonial powers and with commerce controlled by minorities, find it difficult to compete in international trade and finance

Substituting for Missing Institutions

Is it necessary to substitute for missing institutions in order to enhance the development process in LEDCs?

• Many countries have managed to develop without the need for accumulated wealth or developed financial sectors (Germany, Russia, Japan)
• Importing foreign experts with knowledge and experience is not as effective as training and utilizing local talent
• There is a need to transfer power from old ruling classes with no interest in promoting development for poorer people:

• Landowners block small farm development to prevent competition, and block growth of industrialists to prevent loss of influence and power
• Rich industrialists try to block small businesses to prevent competition
• 'Corporate' unions lobby the govt. for high minimum wages and labour protection laws (making it difficult for business to be competitive), in order to stop erosion of artificially high wages
• Problem: down trodden peasants of one generation become materialistic consumers of the next generation who prefer imported goods

The Need for Stable Government

• Stable government reduces risks for local investors, encourages investment, and reduces capital flight
• Stable government is more willing to make tough decisions such as devaluation, reducing urban subsidies, reducing overstaffed bureaucracies, reducing tariffs to promote competition, and perhaps redistributing income to poorer people
• Stable government is more able to encourage small scale entrepreneurs to:

• Take initiative, develop managerial ability, and undertake risks.
• Train to overcome weaknesses in marketing, finance, and managerial ability

[edit] Consequences of Growth

Externalities

• Positive: more efficient production methods that are better for the environment, results in larger tax base which may be spent on environment
• Negative: pollution, overuse of land

• The market is not responsive to certain externalities and so fails to account for entropy and potentially catastrophic environmental damage
• Even with government regulation replacing the market, some ecologically relevant externalities may involve damage to the ecosystem itself, and yet the signals going to the regulators may be false and sustainability may not be attainable

• Environmental Degradation & Pollution

• Population pressures have led to degradation of the environment:

• Soil erosion is a serious problem in several countries
• Forest cover is lost by cutting for fuel
• Desertification occurs from domestic animals over-grazing land
• There has been overfishing of lakes and rivers, and now the oceans

• Most pollution such as depletion of the ozone layer and the greenhouse gasses which are causing global warming are a result of industrialization
• The question becomes: how can we develop indicators which can be used to adjust national income accounting to alert us when there is a problem and provide a way of evaluating attempts to reverse the degradation?

• Valuing natural and environmental resources is not simple:

• Market values can be subtracted from the flow of income generated by a country; while not ideal this does provide an indicator
• It is usually very difficult to measure changes in quality rather than simple market values of quantities consumed

• If we attempt to measure resources which have no market value:

• People may lie about the true value if they think that lying will benefit them
• Market values usually reflect opportunity costs: the value of substitutes. How do we value a resource for which there is no substitute?

• Problems With Industrialization

• Crowding in cities usually leads to pollution, health and sanitation problems, crime and vandalism, and a breakdown in infrastructure
• The greatest industrial weakness in LDCs is management

• Labour is more difficult to manage than capital, thus firms use labour saving systems to compensate for weak management
• Unionization, minimum wage and labour protection laws motivate firms to buy labour saving capital
• Foreign investors import labour saving capital equipment

• Prestige attached to industrialization leads to government pressuring for capital intense, modern industries and unnecessary infrastructure:

• Paid for with taxes on primary sector exports, impoverishing rural areas
• City infrastructure is heavily subsidized and given priority

• Firms lobby for subsidized food in the cities
• Rural-urban migration explodes

Case Study: China

• China tried to copy the Russian model and put all its investment into industry. Disastrous harvests followed forcing the govt. to change policy:

• Collectivized farms were abandoned and market driven farmers were encouraged to invest in machinery and chemicals
• The government restricted rural urban migration, the resulting migration which did occur was not enough to eliminate the rural labour surplus, the government introduced incentives to lower the birth rate
• Prices to farmers were raised, while input costs were held constant with the result that the terms of trade turned in favour of the agricultural sector
• Mechanization of farms was slowed down to prevent a drop in demand for surplus farm labour

Case Study: Kenya, Zambia

• Investment was devoted primarily to industrialization in the cities:

• Low farm productivity: researchers believed they were a result of diminishing returns because of the limited supply of land, but in fact most African countries had low population densities (many still do)
• New farm lands were opened up, populations grew rapidly because of the increases in agricultural productivity
• Eventually the sharp decline in available arable land and the movement of people to the cities reduced per capita food production
• Resources have been switched back from the cities to the rural areas

Income distribution

• May increase inequality if benefits of growth only seen by a select few, or decrease inequality if benefits seen by entire population.

Fairness of Access

• Traditional economic growth has attempted to maximize the income per person: making the pie grow bigger and hoping that poorer people with only tiny slices will experience some improvement in welfare
• More recently, economic development has emphasized the need to distribute the income more evenly amongst persons. Everyone receives a slice which is more fair in size, even if the pie stays the same size.
• Should growth have priority over the environment?

• Without adequate environmental protection, development is undermined
• Without development, resources will be inadequate for needed investments, and environmental protection will fail

• Poor people have a high marginal propensity to consume compared to rich people who have a high marginal propensity to save

• Should we reduce poverty by spreading limited resources thinly and see them used more rapidly?
• Should we allow the rich to accumulate assets knowing they might invest in and take better care of them?

• People living in poorer countries which are natural resource poor and future generations impoverished by our overused of resources do not have political or economic power to ensure access
• Uncertainty about environmental systems and their role in our very existence make us wary of engaging in traditional economic net benefit maximization. This is especially true for future generations.

Sustainability

• Economic growth will put pressure on the environment

Sustainable Development

• Limits to Growth

• In the 1960s and 1970s some scientists predicted the end of the world based on physical limits on resources which would restrain economic growth.
• In the 1980s many prominent studies were published which changed the focus

• The world’s resources are indeed sufficient to meet long term human needs
• The uneven spatial distribution of the human population relative to the natural carrying capacity of the environment is of much greater concern
• There is inefficient and irrational use of natural resources
• The ability to pollute the world to the point where it is unlivable is likely to happen far more quickly than the exhaustion of natural resources

• In the 1990s interest has shifted to applying the knowledge accumulated in the natural sciences to the economic process:

• The scale and rate of throughput, energy and matter passing through economic systems, is subject to entropy, the second law of thermodynamics:

• Entropy: materials that get used in the economy tend to get dissipated and it requires energy inputs to make these materials useful again
• Sometimes it is not worthwhile recycling: the cost of transportation required to bring all the used materials together and the energy required to return them to a useful state may cost more than the original materials

[edit] Barriers to Economic growth and/or Development

Poverty cycle: low incomes --> low savings --> low investment --> low income

• Absolute poverty is defined as the inability to just meet basic physical needs of food, clothing and shelter in order to survive - because this is so hard 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

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 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

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

Institutional and political factors

• ineffective taxation structure
• lack of property rights
• political instability
• corruption
• unequal distribution of income
• formal and informal markets
• lack of infrastructure

International Finance & Third World Debt

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

• The risky nature of lending to LDCs 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 MDCs:

• 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 LDC debt is short term in nature, the interest rates being charged to LDCs 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 LDCs 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 govt. 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 MDC 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

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

Redistribution of Assets

• 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

Taxation

• 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)

International trade barriers

• overdependence on primary products
• consequences of adverse terms of trade
• consequences of a narrow range of exports
• protectionism in international trade

International financial barriers

• indebtedness
• non-convertible currencies
• capital flight

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 MDC population and 50% of the LDC 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 the 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 MDCs, 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

[edit] Growth and Development Strategies

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

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

Types of aid

• bilateral, multilateral
• grant aid, soft loans
• official aid
• tied aid

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.

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.
• The elite benefit from importing luxury goods more cheaply.

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?

Commercial loans

Fair trade organizations

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

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.

Sustainable Economic Development

• Sustainable development is 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

[edit] Evaluation of Growth and Development Strategies

• Evaluation of the following in terms of achieving growth and/or development

• Aid and trade

Foreign Aid: Types & Amounts

• ODA is transferred either as bilateral aid between govts. or as multilateral aid through agencies such as the World Bank or the UN
• 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 with $11.3 billion in 1991
• Japan is the second largest with $10.9 billion in 1991
• 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 their agenda 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 aid goes directly to programs to help the poor such as health care, basic literacy education, clean water and sanitation

Conditionality

• Loans and aid from large agencies is often conditional on changes in govt. policy in the recipient country

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 LDCs and must be repaid:

• 90% of loans are for projects (physical capital); 10% for programs

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 program (SAP) which often requires: reductions in government budget deficits, a slower rate of money expansion (lower inflation) and devaluation

Bilateral & Multilateral Foreign Aid

Bilateral

• Bilateral aid tends to be distributed 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

• Aid from these donor 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

Multilateral Foreign Aid

• Most LDCs 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

Problems with Foreign Aid

• Aid is a poor substitute for trade: opening up MDC markets to LDC 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
• The LDC 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 LDC government spending:

• 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

• 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

Market-led and interventionist strategies

The role of international financial institutions

• International Monetary Fund aims to ensure international financial stability - they provide loans under certain conditions
• World Bank: aims to promote development to some extent
• Private sector banks: provide loans in exchange for interest
• Non-governmental organizations (NGOs): foreign aid by NGOS
• MNC/TNCss: Foreign Direct Investment

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

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

• 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 govt. or global union to oppose or reduce the worst excesses
• To achieve their ends LDC govts. 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

International Trade & Economic Development

• About 70% of trade is between MDCs, with the remaining 20% from LDCs 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 LDCs 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 LDCs 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 LDCs 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

• 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 MDC 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