Topic 11- economics

8/12/2019 Topic 11- economics

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It is possible to have economic growth without development. i.e. an increase in GDP, but most people dont see

any actual improvements in living standards.

Economic growth may only benefit a small % of the population. For example, if a country produces more oil, it

will see an increase in GDP. However, it is possible, that this oil is only owned by one firm, and therefore, the

average worker doesnt really benefit.

Corruption. A country may see higher GDP, but the benefits of growth may be siphoned into the bank

accounts of politicians

Environmental problems. Producing toxic chemicals will lead to an increase in real GDP. However,

without proper regulation it can also lead to environmental and health problems. This is an example of

where growth leads to a decline in living standards for many.

Congestion. Economic growth can cause an increase in congestion. This means people will spend longer

in traffic jams. GDP may increase but they have lower living standards because they spend more time in

traffic jams.

Military Spending. A country may increase GDP through spending more on military goods. However, if

this is at the expense of health care and education it can lead to lower living standards.

Reasons for the different levels of development /low rate of development in

developing countries.

Different availability of natural Resources:

Countries such as Nigeria have significant oil wealth if used wisely, this could improve growth and

development. Other natural resources would include precious metals/ minerals. However, control of these is

often fought over in civil war and much of it is wasted financing such wars instead of being used fordevelopment projects.

Many LDCs have subsistence or primary-sector economies, which produce low-value-added goods and therefore

generate low income in trade. Consequently, people cannot save any excess income as they do not earn much,

and funds for investing in the secondary sector are not available and this reduces further investment levels and

reduce the possibility of creating better sources of income for the people.

However it should be noted that there had been situations where countries, which are dependent on primary

products have been able to raise themselves out of the poverty trap and make their conditions better for

themselves. This is specially noted in countries which specialize in products like petroleum, gold and such

valuable resources. Furthermore, agricultural had been rising, albeit slowly, over the years. Therefore this hadled to increased export revenues for these nations as well.

Differing geographical terrain:

Highly mountainous regions may struggle to develop transport infrastructure and primary/secondary sector

economies, e.g. Himalayan communities.


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However, Switzerland is a counter-example of a country which had been able to successfully develop excellent

transport infrastructure despite the difficult terrain. However, it should be noted that countries need to have

more capital for them to invest in such transport facilities and often developing countries may not have the

capital needed to spend on elaborate transport facilities when other uses are there for the scarce capital.

Climate:

Many sub-Saharan economies are severely affected by droughts followed by flooding, making it difficult to

establish any industry and attract any investment. The natural disasters often destroy human capital along with

infrastructure and this can be costly to rebuild and even harder to replace socially in countries where capital is

scarce. Therefore this can become a large factor that prevents development in these countries. Bangladesh is

one of the better examples of this.

Political stability:

Democratically-elected, non-military governments tend to have less corrupt economies that are more able to

develop. They are able to raise taxes and spend on public services without a backlash from the community and

on the whole such governments do spend on the growth and development projects within the country. This is

because democratically elected leaders will wish to be elected again the following year; hence they will do more

for the nation than dictators who will know that they may not be in power later. Dictators often lead to morecorrupt governments as they wish to hoard as much as possible before they are ousted from power. Thus

development projects may be given a backseat under such regimes. Politically hostile governments do not

attract foreign investments and local investors will also be cautious when investing in such an environment.

Most of them will be hoarding money abroad. This reduces the employment opportunities and hinders growth

and development of the country.

Education:

Countries which place an emphasis on education and provide some state funding are more likely to grow and

develop e.g. Tiger economies and China take education seriously. This improves human capital leading to

increased productivity and shifts the PPF outwards. However in many of the developing nations, education is not

given much emphasis, especially in rural areas where children are supposed to work to earn for their family orwhere most people are too poor to afford the fees needed to join schools, colleges and universities.

Furthermore, even if these facilities are available social restrictions may limit the availability of education to

certain members of society, such as the female population or the lower casts and class members. Hence these

groups of people become deprived from the chance to change their lives for the better.

Investment:

Low investment means that economic growth is unlikely. Low investment could be due to lack of confidence by

businesses/consumers/MNCs, low savings rates leading to lack of finance (Harrod Domar model), poor

availability and trustworthiness of financial institutions (this may be heightened by poor transport

infrastructure, reducing access to banking). Low public sector investment in education, healthcare, transport or

communications could be due to corruption or inability to raise taxes (due to low incomes and poor

infrastructure). This is true of many African economies.

Population:

Many LDCs are characterized by high birth and death rates families aim to have many children in order to

increase family income, but often these children are underemployed in the informal sector in low value-added

jobs result: low development.


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There is also significant urbanization in many LDCs as people search for better jobs in the cities; however,

healthcare and sanitation is severely reduced in the resulting slums, and unemployment increases (Lewis two-

sector model). Some of the biggest slums in the world are Kibera (in Nairobi, Kenya) and Dharavi in India. These

slum cities often become the hub of all criminal and antisocial activities as the people here are often underpaid,

under employed and in bad circumstances. Often people find themselves sinking lower in living conditions as

opposed to improving them.

Finance:

Many LDCs are laden with international debt, on terms that they cannot afford to repay. Many people blame the

IMF for making poor lending decisions; others blame incompetence on the part of the borrowing government.

Due to corruption in some LDCs, loans have been used to fuel extravagant lifestyles of those in office rather than

to improve their country. Pressure groups such as Jubilee 2000 are trying to persuade governments and the IMF

to cancel third world debt.

Another problem is capital flight. The owners of any extra income that could be saved and therefore used for

investment often leave the country in search of higher return for their money; this reduces the growth of capital

and therefore economic growth.

Unfair trade:

High subsidies and protective tariffs for agriculture in the developed world (example, the Common Agricultural

Policies implemented by the EU countries) drains the taxed money which is used to pay for the subsidies given

and increases prices for consumers in the developed world. This also leads to decreasing competition and

efficiency in the developing countries as these tariffs and export subsidies given by the rich prevents the exports

of agricultural goods by the more competitive agricultural in developing countries. This undermines the

comparative advantage that the developing countries have in agricultural sectors and make it harder for them to

gain a foothold in the international market in these products.

The export subsidies given by the developed world to their farmers make the prices of primary products lower inthe international markets, lowering the already low incomes that developing nations get from their exports. This

problem is made even worse as developing countries have to use the low incomes to purchase the high priced

capital goods from the developed world.

Savings gap:

Many developing countries have a low GDP and consequently many hold inadequate savings to finance the

investment which is necessary for the growth of the economy. The lower incomes and the higher dependency

rate of the population mean that there is very little to save in these countries. Hence banks have low lending

capacity and thus the low savings gap contribute to lowered GDP and low capital accumulation which contribute

to lower incomes once more.

Capital flight:

This occurs when individuals or companies decide to place cash deposits in foreign countries, or buy assets in

foreign countries rather than in domestic country. This can be due to many reasons, such as evading the taxes in

the domestic country, the returns from investment are higher in other countries rather than home country, its

much more safer to invest abroad than at home because of political instability and bad governance and so on.

Whatever the reason given for investing abroad, it has serious implications for the country as a whole.

Namely:


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o It contributes to the domestic savings gap and consequently it restricts growth and domestic

investments

o Reduces tax revenues that the government can earn on these assets and hence restricts the

government spending in development projects in the country.

Debt:

Many of the developing countries have borrowed money in the past when interest rates where lower only to

find that they are struggling to service the debts some years later. Debts have become a problem for a variety of

reasons. Large debts mean that the country will be using the hard earned cash it has to service these debts

rather than use it for development purposes and often countries will raise taxation to repay these loans and this

leads to worsening of economic growth as increased taxes discourage investment and had people scrambling to

hide their assets from the government.

Other reasons include poor governance, corruption, human capital inadequacies, infrastructure provision, wars

and political unrest and so on.

What is the role of the state in promoting growth and development?

1.

Fiscal policyany policy concerned with government spending, taxation or government borrowing.

If government spending = taxation, there is a balanced budget. An increase in government spending/ a fall in tax

cause an increase in AD (expansionary fiscal policy). In the short-run, this can be inflationary, reduce

unemployment and increase GDP. In the long run, depending on what the government spends its money on, it

can be anti-inflationary, raise employment and cause sustained economic growth (if the LRAS increases due to

spending on education for example). The opposite is true of a restrictions or deflationary fiscal policy.

2.

Models/theories of growth and development

Harrod-DomarNow considered an old theory that focuses on the role of investment for growth

This theory states that the rate of growth equals the marginal propensity to save (which provides funds for

investment) divided by the capital-output ratio. Low savings means low investment and therefore low

development according to this theory. A problem with this theory is that it does nt help LDCs to establish a

financial system in which savings and investment are possible in the first place.

Lewis 2-sector

This is a structural change model. Lewis said that growth would be achieved by the migration of workers from

the rural primary sector to the modern industrial urban sector this would occur through higher wage

incentives. However, despite evidence from current developed economies, this model often seems

inappropriate for LDCs, where the population in the urban slums is often unemployed, and would have been

more productive in the rural sector. This theory also assumes that secondary sector production would be labor-intensive and hence provide many employment opportunities, whereas it is often capital-intensive and requires

less labour.

2. Role of tourism

Many LDCs are increasingly highly dependent on tourism from the developed world as incomes rise. Most LDCs

positively encourage tourism because it allows foreign currency to be earned and it is not capital-intensive


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(therefore not reliant on high investment). However, there may be significant negative externalities resulting

from tourism growth, eg use of clean water for tourists not locals, expansion of airports causing pollution and

loss of farmland etc. The Kingdom of Bhutan, in the Himalayas, aims to tackle this problem by taxing tourists

heavily for every night they spend in the country.

3. Microfi nance

The lack of extensive fi nancial infrastructure in many LDCs is an inhibitor to development. Microfinance allows

people in LDCs to borrow small amounts of money from local lenders much of this business is now conducted

using mobile telephones, which have leapfrogged landlines in many LDCs. The idea is that local but poor

entrepreneurs will be able to set up small businesses, and go on to employ other local people a sort of

grassroots approach to development. Debtors must be sure, however, that their micro-creditor does not

charge extortionate interest given a lack of education in many LDCs, this may prove difficult.

4. Debt relief

Many LDCs hit a debt crisis in the 1980s and 1990s, as they couldnot afford to pay the interest on their large

debts to international financial institutions. This was a combination of interest rates rising and the value of the

dollar rising (and most loans were agreed in terms of US dollars). Latin American countries and many African

countries were amongst the worst hit Mexico defaulted on its loans first, and others followed suit. This meantthat these countries were then unable to borrow.

The massive debts that they had to repay meant that governments of these countries were unable to invest in

human capital or other infrastructure necessary for growth and development. Initially, the IMF set up Structural

Adjustment Programmes, where it would lend the debtors money to pay off their original debts, but on strict

conditions with respect to fiscal policy and trade policy. These were very unpopular. One solution is debt

forgiveness, where the loans are essentially cancelled many lenders do not want to do this. An alternative is

debt rescheduling, where the repayment terms are altered. Jubilee 2000, a pressure group, actively campaigns

for debt cancellation

2.

Foreign aidThis is increasingly multilateral (between many countries), rather than bilateral (between two countries), which

reduces the restrictions under which aid is provided. There are different types of aid, ranging from humanitarian

aid (such as food and shelter, in times of emergency), to grants (sums of money that do not need to be repaid)

and loans (money that should be repaid). Whilst many in the developed world see aid as a positive thing, much

of the aid is squandered on projects that will not contribute to development, or are duplicated by different aid

agencies who do not communicate with each other, or even spent by corrupt governments on themselves in the

LDCS. If humanitarian aid is continued for a long period, then people become overly dependent on it, and forget

their own skills this has happened in Ethiopia. Many of the neediest do not get any aid; much of it is

channeled into those projects which have captured the global media interest.

3.

Fairer trade

The WTO works towards reducing protectionist policies. Many LDCs argue that they need to protect their

economies however, as they cannot afford to compete with the subsidies provided to the agricultural sectors in

developed economies, such as the CAP in the EU. Many LDCs are unable to sell their mainly primary sector

products abroad because of protectionism in the developed world. The Fair Trade movement is one way in

which farmers in LDCs are supposed to benefit, thus improving development. This guarantees farmers a certain

income, so that they are not subject to monopsony purchasing power from developed countries, particularly

with respect to coffee, cocoa and cotton. However, there are often a significant number of middle men

involved, reducing the benefits that fair trade farmers receive. Additionally, not every farmer in every LDC


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benefits many are unaware of the scheme, and many are not able to afford the membership fees that are

required. Some cynical people argue that the Fair Trade movement is just a means of making people in the

developed world feel better about their position in relation to those in LDCs.

Poverty is the state of being extremely poor and has been described by Mahatma Gandhi as the worst form of

violence. This week, Cristiano Ronaldo signed a new $120,000-per-week contract to play football for

Manchester United whilst the average yearly wage for the 3.5 billion people living in low income countries such

as Uganda is $313. Such a rich-poor divide is down to a variety of factors highlighted in this essay, and there are

many potential methods for reducing poverty available to rich countries such as the UK.

The World Bank suggests that boosting economic growth (GDP per capita) in developing countries is intrinsically

linked to the aim of reducing poverty. Two principal ways in which such growth can be achieved are through

provision of aid (through a variety of different forms) and fair trade arrangements by developed countries.

However, for developing countries to catch up with their developed counterparts they will need to maintain a

substantially higher growth rate; the 2006 World Development Report indicates that a 2% annual growth rate

for the next 25 years would yield an increase of $10,000 per capita in Luxembourg, compared to a figure of $375

in Nicaragua, hence would only succeed in widening the gap still further.

Historically, the provision of financial aid has been a hugely popular way to fight poverty; international events

such as the 1985 Live Aid appeal to relieve famine in Ethiopia illustrate the enormous public willingness to

donate to such causes; over 150 million was raised from this event alone. However, financial aid has its

problems. Injection of extra money into the economy of a developing country can lead to exchange rate

appreciation, rendering their goods less competitive on the international market.

Efficiency arguments against financial aid may also put be put forward; firstly a risk exists that not all the money

will not reach its intended destination (for reasons of internal corruption and lack of transparency) or that, in

response to the aid, governments of developing nations will alter their fiscal policies, reducing taxation and

place too great a reliance on the donations. For these reasons, loans are frequently coupled with conditions that

the developing country will spend the money in a certain way, of that they will undergo supply-side, monetaryand fiscal reforms to help reduce poverty, for instance through the creation of a minimum wage

A problem with loans is that debts can spiral, as was the case after the 1980s oil shocks; debt in sub-Saharan

African countries increased from 29% of GNP in 1980 to 77% in 1996. From 1970 to 1997, Kenyas debt service

as a percentage of its net export has more than tripled; from 6% to 21%. Such debts make economic growth very

difficult, as it detracts from investment in physical and human capital. An alternative to direct financial aid

therefore is to write off debt, as the G8 committed to doing at in respect of 18 of the worlds poorest countries

at the Gleneagles conference in 2005.

Another strategy is for rich countries to invest directly in health care, physical and human capital in developing

countries, rather than simply throwing money at the problem. Increased physical capital per person would boost

output and incomes, allowing a movement along the Solow curve above. In addition, the Keynesian multiplier

suggests that the increase in output will exceed the sum invested:

A unit increase in investment initially boosts output by the same amount. However the effect does not end

there. Consumption rises by 1 x MPC (the marginal propensity to consume: the fraction of disposable income

spent and not saved), hence firms then increase their output to accommodate this, raising consumption demand

yet further, and so on. Hence, the multiplier suggests that investment will reinvigorate a developing economy to

a much greater value than the initial investment. This should make rich countries willing to invest, given the


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likely ability of developing countries to repay the loans with interest. However in practice, such Foreign Direct

Investment is rare, due to disincentives such as political instability and lack of relevant skills in the developing

countrys workforce, butif rich countries could make investment conditional on evidence of political stability, for

instance the implementation of a democratic system of government, FDI may well become more commonplace.

This brings us to another key area where countries such as the UK can benefit developing countries; education.

If investment in physical capital is coupled with teaching the local workforce how to use such machinery, then a

new industry has been created, boosting employment and GDP:

Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.

Increasing awareness of sexual and reproductive education is also essential in tackling the spread of diseases in

developing countries and to curb population growth. This is one of a list of quick wins identified by the UN

Millennium Project to help achieve their Millennium Development Goals by 2015, which also includes other

health care initiative such as provision of mosquito nets to combat malaria.

Arguably, fair trade between developed and developing countries can have the biggest impact on

poverty. Areas of comparative advantage such as (land abundance) should be exploited, for example throughproduction of land-intensive primary products such as coffee, sugar and agricultural produce. Export promotion

policies should be encouraged; this will enable businesses in developing countries to supply a market size much

larger than if they were simply producing as a means of import substitution. Fixed costs can be spread further,

large-scale machinery can be used to its full effect and workers will be able to specialize on specific roles within

the business. Such economies of scale will enable developing countries to sell goods at competitive prices in the

global market.

Discriminatory trade arrangements, such as unfair import tariffs or quotas, must be abolished to increase

imports of developing countries products into rich countries, as the graph overleaf suggests. The EU has gone

some way to achieving this; quotas on imports were abolished under a WTO agreement in January 2005.

Additionally, the EUs Everything But Arms initiative, entered into in 2001, resulted in duty-free imports intothe Union from the worlds least developed countries. However, such policies need to be less restricted by the

interests of EU producers. The categorisation of certain imported products as sensitive (resulting in a tariff cut

of a mere 3.5% as opposed to tariff-free entry) allows struggling European industries to maintain their

dominance to the expense of more efficient producers in developing countries. Such protectionist policies must

be curtailed to render the EUs efforts towards third world economic growth more credible.

Too great a focus on capitalizing on areas of comparative advantage carries significant risks. Firstly, price

instability is a common problem associated with production of primary goods. Copper production, accounting

for 81% of Zambias exports in 1995, underwent a price variation of almost 400% in a 30 year period. It is

therefore risky to have primary products constitute such a large proportion of a countrys exports. Additionally,

primary goods have demonstrated a tendency to decline in value over time; for instance the value of gold has

almost halved from 1975 to 1999.

This is where, in addition to export promotion, a policy of industrialisation can be implemented with the help of

investment from countries such as the UK. Infant industries, singled out for their promise, can be supported, a

process known as picking winners.' With the sheer scale of exports produced by nations such as India and

China, smaller developing countries will not be able to compete with their economies of scale, and will need to

specialize in particular sectors.


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Industrialisation has resulted in a large increase in the share of manufactures in exports of developing countries.

This increase is highlighted in countries such as Malaysia, where the percentage figure has risen from 6% in 1965

to 76% in 1997. Such investment by rich countries can prove to be beneficial to their interests as well as those of

the developing country; the cost of labour tends to be much cheaper in countries with a predominantly unskilled

labour force, and so implementing, for instance, a textiles industry in a developing country would enable the a

country like the UK to benefit from cheap imports, as well as free up their own workforce to focus on their own

areas of comparative advantage. What is more, the positive externality effect of certain initiatives, for instance

the provision of vaccinations and other forms of health care, give developed countries an extra incentive to

alleviate poverty.

Many of the potential methods to reduce poverty and increase economic growth in developing countries can be

implemented with the involvement of rich countries such as the UK. Given the present gulf in prosperity

between the economic haves and the have-nots, the implementation of such ideas should arguably be viewed

more as a matter of moral duty than economic necessity.

Topic 11- economics

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