5.4 Growth and development strategies

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5.4 Growth and development strategies

• INTERNATIONAL BACCALAUREATE

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5.4 Growth and development strategies

• As a general rule, growth models describe how
  growth has occurred and so suggest that this may
  be replicated. Growth strategies are economic
  policies and measures designed to gain growth,
  and development strategies are economic policies
  and measures designed to achieve human
  development.

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Harrod-Domar growth model

• In the 1940's Roy Harrod (1948) and Evsey Domar
  (1946) separately developed a macro-dynamic model
  through an extension of Keyns's theory. The
  model's original intent was to identify the
  source of instability in the growth of developed
  economies where effective demand is normally
  exceeded by supply capacity. In the 1950's and
  1960's this model was applied to economic
  planning in developed economies.

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Harrod-Domar growth model

• The model states that the rate of growth of GDP
  is determined by the national savings ratio and
  the ratio of capital to output in the economy.
• Rate of growth of GDP savings ratio/ Capital
  output ratio
• So if the savings ratio in the country is 5 and
  the capital/output ratio is 2.5, then the country
  can grow at a rate of 2 per annum.

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Harrod-Domar growth model

• If the model is correct then we can say that the
  rate of growth of an economy may be increased by
  one of two things.
• Increasing the level of saving in the economy
• Reducing the capital/output ratio in the economy
  (capital use becomes more efficient)

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Harrod-Domar growth model
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Harrod-Domar growth model

• The main criticism of the model is the level of
  assumption, one being that there is no reason for
  growth to be sufficient to maintain full
  employment this is based on the belief that the
  relative price of labor and capital is fixed, and
  that they are used in equal proportions. The
  model explains economic boom and bust by the
  assumption that investors are only influenced by
  output (known as the accelerator principle) this
  is now widely believed to be false.

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Harrod-Domar growth model

• In terms of development, critics claim that the
  model sees economic growth and development as the
  same in reality, economic growth is only a
  subset of development.
• Another criticism is that the model implies poor
  countries should borrow to finance investment in
  capital to trigger economic growth however,
  history has shown that this often causes
  repayment problems later.

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Harrod-Domar growth model

• Perhaps the most important parameter in the
  HarrodDomar model is the rate of savings. Can it
  be treated as a parameter that can be manipulated
  easily by policy? That depends on how much
  control the policy maker has over the economy. In
  fact, there are several reasons to believe that
  the rate of savings may itself be influenced by
  the overall lever of per capita income in the
  society , not to mention the distribution of that
  income among the population.
• LDCs savings rates are low due to poverty, poor
  financial infrastructure, and capital flight.

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Harrod-Domar growth model

• growth rate in the Harrod-Domar model is given by
  the ratio between the savings (S) ratio and the
  capital-output (K) ratio G S/K
• on the very basic assumptions of no foreign
  sector and no government sector the Harrod-Domar
  model states that the rate of economic growth G
  is positively dependent on the savings ratio S
  and negatively dependent on the capital output
  ratio K where k is the productivity of capital
  in the economy

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dual sector model

• Lewis's Dual Sector Model of Development The
  theory of trickle down
• Lewis proposed his dual sector development model
  in 1954. It was based on the assumption that many
  LDCs had dual economies with both a traditional
  agricultural sector and a modern industrial
  sector.
• The traditional agricultural sector was assumed
  to be of a subsistence nature characterized by
  low productivity, low incomes, low savings and
  considerable underemployment.
• The industrial sector was assumed to be
  technologically advanced with high levels of
  investment operating in an urban environment.

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dual sector model

• Lewis suggested that the modern industrial sector
  would attract workers from the rural areas.
  Industrial firms, whether private or publicly
  owned could offer wages that would guarantee a
  higher quality of life than remaining in the
  rural areas could provide.
• Furthermore, as the level of labor productivity
  was so low in traditional agricultural areas
  people leaving the rural areas would have
  virtually no impact on output. Indeed, the amount
  of food available to the remaining villagers
  would increase as the same amount of food could
  be shared amongst fewer people. This might
  generate a surplus which could them be sold
  generating income.

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dual sector model

• Those people that moved away from the villages to
  the towns would earn increased incomes and this
  crucially according to Lewis generates more
  savings. The lack of development was due to a
  lack of savings and investment. The key to
  development was to increase savings and
  investment. Lewis saw the existence of the modern
  industrial sector as essential if this was to
  happen. Urban migration from the poor rural areas
  to the relatively richer industrial urban areas
  gave workers the opportunities to earn higher
  incomes and crucially save more providing funds
  for entrepreneurs to investment.

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dual sector model

• A growing industrial sector requiring labor
  provided the incomes that could be spent and
  saved. This would in itself generate demand and
  also provide funds for investment. Income
  generated by the industrial sector was trickling
  down throughout the economy.

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Problems of the Lewis Model

• The idea that the productivity of labor in rural
  areas is almost zero may be true for certain
  times of the year however during planting and
  harvesting the need for labor is critical to the
  needs of the village.
• The assumption of a constant demand for labor
  from the industrial sector is questionable.
  Increasing technology may be labor saving
  reducing the need for labor. In addition if the
  industry concerned declines again the demand for
  labor will fall.

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Problems of the Lewis Model

• The idea of trickle down has been criticized.
  Will higher incomes earned in the industrial
  sector be saved? If the entrepreneurs and labor
  spend their new found gains rather than save it,
  funds for investment and growth will not be made
  available.
• The rural urban migration has for many LDCs been
  far larger that the industrial sector can provide
  jobs for. Urban poverty has replaced rural
  poverty.

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Structural change model Fisher Clark's Theory of
Structural Change

• Two economists, Fisher and Clark, put forward the
  idea that an economy would have three stages of
  production
• Primary production is concerned with the
  extraction of raw materials through agriculture,
  mining, fishing, and forestry. Low-income
  countries are assumed to be predominantly
  dominated by primary production.
• Secondary production concerned with industrial
  production through manufacturing and
  construction. Middle income countries are often
  dominated by their secondary sector.
• Tertiary production concerned with the provision
  of services such as education and tourism. In
  high-income countries the tertiary sector
  dominates. Indeed having a large tertiary sector
  is seen as a sign of economic maturity in the
  development process.

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Structural change model Fisher Clark's Theory of
Structural Change

• Countries are assumed to first pass through the
  primary production stage then the secondary stage
  and finally the tertiary stage. As economies
  develop and incomes rise then the demand for
  agricultural goods will increase but due to their
  low income elasticity of demand at a
  proportionally lower rate than income. However,
  the demand for manufactured goods will have a
  higher income elasticity of demand. So as incomes
  grow further the demand for these goods will grow
  at a proportionately higher rate. Hence the
  secondary industry will grow. As incomes continue
  to grow then people will start to consume more
  services as these have an even higher income
  elasticity of demand. Thus the tertiary sector
  will then grow and develop.

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Structural change model Fisher Clark's Theory of
Structural Change

• However, this may be misleading. Some LDCs may
  have a large tertiary sector due to a large
  tourist industry without having developed a
  secondary industry. Economists argue that this
  could be somewhat risky. If the economic base is
  dominated by an economic activity such as tourism
  that has a high income elasticity of demand then
  a recession in the consuming nations will have a
  disproportionately large impact on the export
  earnings. A fall income will bring about a
  proportionately greater reduction in demand for
  the service and this will have severe impact on
  the economy. If it does not have a primary or
  secondary production to fall back on then
  borrowing and debt might be the only prospect.

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Structural change model Fisher Clark's Theory of
Structural Change
21
Types of aid

• Aid Assistance given to an individual, firm,
  region or government. Usually used in the context
  of overseas aid where governments give assistance
  to other countries.
• Bilateral aid Official development assistance
  that takes place between a donor country and a
  recipient country.
• Multilateral aid Aid channeled through
  international organizations.

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Types of aid

• Grant A form of foreign aid that involves a
  direct transfer payment from one country to
  another.
• Soft loan A loan made to a country on a
  concessionary basis such as a lower rate of
  interest.
• Official Development Assistance (ODA)
  Disbursements of loans and grants at
  concessionary rates by governments

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Types of aid

• Tied aid Assistance given on condition that it
  is spent on items produced by the donor country.
• Foreign Aid The international transfer of public
  and private funds in the form of loans or grants
  from donor countries to recipient countries.

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The Benefits of Receiving Aid

• Economic ReasonsClearly the most important
  reason why countries seek and accept aid is for
  the purpose of economic development.
• To improve the investment climate, develop human
  capital, promote entrepreneurship, as well as
  provide direct support in fostering trade
• To enable payment of interest on foreign debt
• To supplement the lack of domestic resources such
  as foreign exchange
• To enable infrastructure changes to be made to
  the economy such as dams and roads

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The Benefits of Receiving Aid

• Political reasonsIn some cases foreign aid is
  seen as being necessary in order to maintain
  power. Often foreign aid in the form of military
  goods provides the power base that suppresses
  opposition and maintains the existing government
  in power. The ending of the Cold War between NATO
  and the Soviet Union has contributed to the fall
  in Official Development Assistance (ODA) to the
  continent of Africa, while Israel and Egypt, for
  example, were the two major recipients of ODA in
  2003.

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The Benefits of Receiving Aid

• Moral reasonsMany people within the Less
  Developed Countries (LDCs) and the More Developed
  Countries (MDCs) consider that the MDCs have a
  moral responsibility to provide development
  assistance for the poorer countries. This may be
  because of basic humanitarian reasons or a
  feeling that the colonial powers such as the UK
  that occupied countries such as Zambia have a
  responsibility to redistribute resources, having
  exploited so many of the resources of the LDCs
  during colonization.

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The Arguments Against Foreign Aid

• Foreign aid often falls into the hands of corrupt
  officials who affect the projects that are chosen
  to be financed.
• Aid money is often misspent, even when handled
  honestly. By imposing solutions from outside, it
  may be used for projects that generate large
  numbers of jobs and are beneficial to the
  government in the short run while providing few
  long-term benefits. Their creation and
  maintenance draw scarce local resources and
  entrepreneurial initiative from other uses,
  crowding out private investment and initiative.
• Transfers of low interest concessionary finance
  or grants to fill the savings or foreign exchange
  gaps will interfere in the market determination
  of interest rates and exchange rates.

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The Arguments Against Foreign Aid

• Aid can create an impression amongst receiving
  countries that More Developed Countries (MDCs)
  are wealthy, free-handed donors which provide
  what seem like huge sums of money by local
  standards. The impression can also be that this
  is given without moral judgment, since many of
  the people who administer aid may be seen as
  authoritarian and corrupt. As well as leading to
  a sense that there is some sort of right to aid,
  it can also distort values of openness, self-help
  and honesty. It encourages many people in
  recipient countries to consider migrating to the
  source of this wealth, since they assume that it
  must be a rich place where all can prosper.

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The Arguments Against Foreign Aid

• The flow of aid is not always dependable, both
  because it is manipulated for political reasons
  and also because in times of recession in
  developed countries, the aid budget makes an easy
  target for a reduction in spending.
• Aid is often seen, like most forms of charity, as
  quite a patronizing concept, one party
  acknowledging its own superiority and aiding the
  other party not on merit but out of a sense of
  wanting to help. Dependency theory argues that
  aid ensures the continuation of the Less
  Developed Countries (LDCs) on the periphery and
  the dominance of the MDCs in the core.

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Types of Foreign Aid

• To be considered foreign aid a flow of funds
  should meet two simple criteria
• It should be non-commercial from the donors point
  of view
• It should be concessional so that the interest
  and repayment is less stringent or softer than
  commercial terms

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Types of Foreign Aid

• Foreign aid can be divided into
• Public Development Assistance and
• Private Development Assistance
• Public or Official Development Assistance
• Individual government assistance, known as
  bilateral aid
• Multilateral donor agencies such as the IMF and
  World Banks offering multilateral aid
• Private Development Assistance
• Private non-governmental organizations (NGOs)
  such as the Red Cross, Oxfam

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Types of Foreign Aid

• A considerable amount of foreign aid is tied aid.
  Here the grants or concessionary loans have
  conditions laid down by the donor country about
  how the money should be used. Tied aid by source
  means that the recipient country receiving the
  aid must spend it on the exports of the donor
  country. Tied aid by project means that the donor
  country requires the recipient country to spend
  it on a specific project such a road or a dam.
  Often this might be to the commercial or economic
  benefit of the firms in the donor country. For
  example their engineers might be the designers of
  the project.

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Export-led growth/outward-oriented strategies

• Export-led growth is an economic strategy used by
  some developing countries. This strategy seeks to
  find a niche in the world economy for a certain
  type of export. Industries producing this export
  may receive governmental subsidies and better
  access to the local markets. By implementing this
  strategy, countries hope to gain enough hard
  currency to import commodities manufactured more
  cheaply somewhere else.

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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

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Export-led growth/outward-oriented strategies

• 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)

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Export-led growth/outward-oriented strategies

• Export promotion costs
• MDC tariffs and quotas block imports of labor
  intense manufacturing goods where LDCs 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

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Import substitution/inward-oriented
strategies/protectionism

• Import substitution industrialization (also
  called ISI) is a trade and economic policy based
  on the premise that a country should attempt to
  reduce its foreign dependency through the local
  production of industrialized products. The term
  primarily refers to 20th century development
  economics policies, though it was advocated since
  the 18th century United States.

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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

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Import substitution/inward-oriented
strategies/protectionism

• 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

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Import substitution/inward-oriented
strategies/protectionism

• 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.

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Import substitution/inward-oriented
strategies/protectionism

• Costs of import substitution
• 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 labor intense, leading to
  unemployment.
• Exporters of primary goods (the poor) are hurt
  because LDCs 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.

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Commercial Loans

• As the government draws its income from much of
  the population, government debt is an indirect
  debt of the taxpayers. Government debt can be
  categorized as internal debt, owed to lenders
  within the country, and external debt, owed to
  foreign lenders. Governments usually borrow by
  issuing securities, government bonds and bills.
  Less creditworthy countries sometimes borrow
  directly from supranational institutions. Some
  consider all government liabilities, including
  future pension payments and payments for goods
  and services the government has contracted but
  not yet paid, as government debt.

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Fair trade organizations

• Fair Trade is an organized social movement and
  market-based approach that aims to help producers
  in developing countries obtain better trading
  conditions and promote sustainability. The
  movement advocates the payment of a higher price
  to producers as well as social and environmental
  standards. It focuses in particular on exports
  from developing countries to developed countries,
  most notably handicrafts, coffee, cocoa, sugar,
  tea, bananas, honey, cotton, wine, fresh fruit,
  chocolate and flowers.

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Fair trade organizations

• Fair Trade is a trading partnership, based on
  dialogue, transparency and respect, that seeks
  greater equity in international trade. It
  contributes to sustainable development by
  offering better trading conditions to, and
  securing the rights of, marginalized producers
  and workers especially in the South. Fair Trade
  Organizations, backed by consumers, are engaged
  actively in supporting producers, awareness
  raising and in campaigning for changes in the
  rules and practice of conventional international
  trade.

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The commodity crisis

• Fair trade advocate also often point out that
  unregulated competition in global commodity
  markets ever since the 1970s and 1980s has
  encouraged a price "race to the bottom". During
  the 1970-2000 period, prices for many of the main
  agricultural exports of developing countries,
  such as sugar, cotton, cocoa, and coffee, fell by
  30 to 60 percent. According to the European
  Commission, the abandonment of international
  intervention policies at the end of the 1980s and
  the commodity market reforms of the 1990s in the
  developing countries left the commodity sectors,
  and in particular small producers, largely to
  themselves in their struggle with the demands of
  the markets. Today, producers live an
  unpredictable existence because the prices for a
  wide range of commodities are very volatile and
  in addition follow a declining long-term trend.
  The total loss for developing countries due to
  falling commodity prices has been estimated by
  the Food and Agricultural Organization (FAO) to
  total almost 250 billion during the 1980-2002
  period.

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The commodity crisis

• Millions of poor farmers are dependent on
  commodities and on the price they receive for
  their harvest. In about 50 developing countries,
  three or fewer primary commodity exports
  constitute the bulk of export revenue.
• Many farmers, often without other means of
  subsistence, are obliged to produce more and
  more, no matter how low the prices are. Research
  has shown that those who suffer most from
  declines in commodity prices are the rural poor
  i.e. the majority of people living in developing
  countries. Basic agriculture employs over 50 of
  the people in developing countries, and accounts
  for 33 of their GDP.
• Fair trade supporters believe current market
  prices do not properly reflect the true costs
  associated with production they believe only a
  well-managed stable minimum price system can
  cover environmental and social production costs.

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Micro-credit schemes

• Micro-credit is the extension of very small loans
  (micro-loans) to those in poverty designed to
  spur entrepreneurship. These individuals lack
  collateral, steady employment and a verifiable
  credit history and therefore cannot meet even the
  most minimal qualifications to gain access to
  traditional credit. Micro-credit is a part of
  microfinance, which is the provision of a wider
  range of financial services to the very poor.

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Micro-credit schemes

• Micro-credit is a financial innovation that is
  generally considered to have originated with the
  Grameen Bank in Bangladesh. In that country, it
  has successfully enabled extremely impoverished
  people to engage in self-employment projects that
  allow them to generate an income and, in many
  cases, begin to build wealth and exit poverty.
  Due to the success of micro-credit, many in the
  traditional banking industry have begun to
  realize that these micro-credit borrowers should
  more correctly be categorized as pre-bankable
  thus, micro-credit is increasingly gaining
  credibility in the mainstream finance industry,
  and many traditional large finance organizations
  are contemplating micro-credit projects as a
  source of future growth.

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Foreign direct investment

• Foreign direct investment (FDI) refers to long
  term participation by country A into country B.
  It usually involves participation in management,
  joint-venture, transfer of technology and
  "know-how". There are two types of FDI inward
  foreign direct investment and outward foreign
  direct investment, resulting in a net FDI inflow
  (positive or negative).

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Foreign direct investment

• 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

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Foreign direct investment

• 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
  

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Foreign direct investment

• 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
• Labor they can create jobs, develop managerial
  skills, and provide technical education of labor,
  
• 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

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transfer pricing

• Transfer pricing refers to the pricing of
  contributions (assets, tangible and intangible,
  services, and funds) transferred within an
  organization. For example, goods from the
  production division may be sold to the marketing
  division, or goods from a parent company may be
  sold to a foreign subsidiary. Since the prices
  are set within an organization (i.e.,
  controlled), the typical market mechanisms that
  establish prices for such transactions between
  third parties may not apply. The choice of the
  transfer price will affect the allocation of the
  total profit among the parts of the company.
• This is a major concern for fiscal authorities
  who worry that multi-national entities may set
  transfer prices on cross-border transactions to
  reduce taxable profits in their jurisdiction.
  This has led to the rise of transfer pricing
  regulations and enforcement, making transfer
  pricing a major tax compliance issue for
  multi-national companies.

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Sustainable development

• The process which maximizes the net benefits of
  economic development while maintaining the
  services and quality of environmental and natural
  resources forever
• This involves
• Using natural resources at rates less than or
  equal to the natural rate of regeneration
• Using non-renewable resources in a manner which
  permits recycling of materials and
  substitutability between natural resources and
  technological change
• Economic development and resource usage are
  complementary but after a certain point
  development will reduce one or more of the
  functions of certain resources resulting in a
  tradeoff

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Sustainable development

• 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

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Sustainable development

• 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