Economics 2003-04: Economic Development Page 1

SECTION 5: DEVELOPMENT ECONOMICS

5.1: SOURCES OF ECONOMIC GROWTH &
DEVELOPMENT
• Economic development occurs if there is a reduction in poverty,
inequality, and unemployment. 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 (LDCs) in the world, of which 83

have fewer than 5 million people.
• LDCs 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).
• 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 MDCs 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.
Economics 2003-04: Economic Development Page 2

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 LDCs. 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).

Factors of Production
• Natural resources:
• 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.
• Labour: population growth rates in LDCs reduce growth in per capita
GDP.
• 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.
 Economics 2003-04: Economic Development Page 3

• Technology developed in MDCs 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.

Stages of Growth
• Countries appear to go through distinct stages of growth, and are
arrayed along the following spectrum:
• Low income LDCs 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 LDCs 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,
• MDCs are heavily involved in manufacturing luxury cars,
sophisticated electronics and simple services such as tourism,
• High income MDCs 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.

• 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.
Economics 2003-04: Economic Development Page 4

Analysing Economic Growth

• If we call real output Y, and the stock of capital K, then output can be
related to the capital stock:
K
Y=
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:
s
g=
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
LDCs.
• Studies indicate that increases in productivity or efficiency account for a
much higher proportion of growth than was believed to be the case.
 Economics 2003-04: Economic Development Page 5

• 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.
Economics 2003-04: Economic Development Page 6

E C O N O M IC G R O W T H

F in a n c e
In d u s tr ia liz a tio n
B a n k in g
M o b iliz e S a v in g s
E n tre p re n e u rs - S a f e ty o f c a p i ta l
S m a ll s ta y in c o m m u n ity - P a y i n te r e s t o n s a v in g s
- P r o j e c t e v a lu a ti o n
- A c c e p t ris k F a c il ita te L e n d i n g :
-E c o n o m ie s o f s c a le -P ro j e c t e v a lu a tio n
- L e a rn in g b y d o in g - K e e p l e n d i n g r a te l o w
- M a n a g e m e n t tr a i n i n g - R e d u c e r i s k b y d i v e r s i fy i n g
- B a c k w a r d & fo r w a r d l in k s -G e o g ra p h ic , s e c to ra l, in d u s tria l

In te r m e d i a te m o v e to la r g e r c e n tr e s
- A c c e s s to s k i l le d l a b o u r
F o re ig n A id
- S u b c o n tr a c t to l a r g e fi r m s E c o n o m ic G r o w th (G ro w th o rie n te d )
- S m a l l m o d e r n fa c to r i e s M u ltila te ra l
- A g g lo m e r a ti o n & e x te r n a l e c o n o m i e s D e v e lo p m e n t P o s itio n -W o rld B a n k lo a n s ($ 6 b illio n )
- L D C 1 : p r im a r y ( i r o n o r e , c o tto n )
L a r g e te n d to i n v e s t i n c a p ita l - L D C 2 : p r im a r y & p r o c e s s i n g ( s te e l , te x ti l e s ) B ila te r a l ($ 5 0 b illio n )
- P r o d u c ti v i ty r i s e s w ith m o r e K b u t: - N IC 1 : m a n u fa c tu r i n g ( to y s , s h i r ts ) - T ie d g r a n ts
- L a b o u r o fte n d is p l a c e d b y K - N IC 2 : a d v a n c e d m a n u f. ( c a r s , c o m p u te r s ) -P o litic a l & m ilita ry
-J o b s a re o fte n p a rt tim e o n ly - IC 1 : m a n u fa c tu r i n g & s e r v i c e s - IC s d i c ta te d e v e l o p m e n t p r i o r itie s
- In v e s t in R & D : Q /K r i s e s - IC 2 : m o s t ly s e r v ic e s ( s o ftw a r e , fin a n c ia l) -L a c k o f c o m p le m e n ta r y in p u ts
- T r a in e d m a n a g e r s te n d to e m m ig r a te
G o a ls
-In c re a s e G D P p e r c a p ita
-A c c e le ra te e c o n o m ic g ro w th (g = s /k ) b y :
-M o b iliz in g s a v in g s
M u ltin a tio n a l F irm s - A ttr a c tin g F D I
B e n e fi ts : T ra d e
-L e a rn in g b y d o in g P ro b le m E x a m p le : L D C D e b t
-M a n a g e m e n t tra in in g - 1 9 7 3 - 7 9 L o w i n te r e s t r a te s : G o v t. T r a d e P o lic y
- T e c h n o lo g y tr a n s fe r -E x c e s s O P E C m o n e y fro m h ig h e r o il p ric e s B e n e fits :
- A c c e s s to m a r k e ts -IC s ta rte d in fla tin g - G a i n s fr o m tr a d e
-E m p lo y m e n t c re a tio n -1 9 7 9 -8 6 H ig h in te re s t ra te s : -E c o n o m ie s o f s c a le
-IC s to p p e d in fla tin g - T e c h n o lo g y tr a n s fe r
C o s ts : -P o o r re tu rn o n L D C in v e s tm e n ts -L e a rn in g b y d o in g
-L D C in a b ility to a p p l y te c h n o l o g y -H ig h e r o il p ric e s ra is e d e n e rg y c o s ts
-L a b o u r s a v in g c a p ita l d is p la c e s jo b s -IC re c e s s io n le d to d ro p in im p o rts fro m L D C C o s ts :
- P o o r ta x c o l l e c ti o n d u e to : - P o o r p r o je c t e v a l u a tio n m e a n t l o w r e tu r n s -F o re ig n e n c la v e
- T r a n s fe r p r ic i n g - IM F s tr u c tu r a l a d ju s tm e n t p r o g r a m h a s fa i le d - S p e c ia liz a tio n tra p
-T a x c o n c e s s io n s - U n b a la n c e d g ro w th
-C r e a tio n o f fo re ig n e n c la v e - IC b a r r i e r s to i m p o r ts

G o v t In d u s tr ia liz a tio n P o lic y Im p o r t R e p la c e m e n t

- R e d u c e p r ic e d is to r tio n s G o a ls :
-E lim in a te u rb a n s u b s id ie s - V e r ti c a l i n te g r a ti o n
- E n s u re s ta b le g o v e rn m e n t -L e a rn in g b y d o in g
- S tre a m lin e le g a l & re g u la to ry s y s te m
- S e t u p p ro p e r ta x s y s te m P ro b le m s :
- B u il d p u b l i c in fr a s tr u c tu r e -P ric e o f in te rm e d ia te g o o d s ris e s
- S e t i n d u s tr y s ta n d a r d s - E x p o r ts fa l l
- F a c il ita te te c h n o l o g y tr a n s fe r -U n e m p lo y m e n t ris e s
- S u p p l y b o ttl e n e c k s
- N o te c h n o l o g y tr a n s fe r
-S lo w g r o w th

E x p o rt P ro m o tio n
- T a r iffs fa l l, e x p o r ts r i s e
- B a c k w a r d & fo r w a r d l in k s
-R a p id g ro w th
- G o v e r n m e n t fa c il i ta te s :
- I n fr a s tr u c tu r e & m a r k e ti n g
- S tr a te g i c tr a d e p o l i c y
 Economics 2003-04: Economic Development Page 7

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.
• 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 govt. assisted marketing

Low Productivity Leads to Slow Growth

Diminishing returns is the major cause of low productivity in LDCs.
• 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.
Economics 2003-04: Economic Development Page 8

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.
• LDCs 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 MDC thinking.
• Only modest amounts are invested in research and development in LDCs.

Growth & Multi National Corporations

• 50 of the top 100 ‘national incomes’ in the world are earned by MNCs.
• MNCs 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 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 MNCs tend to invest in other MDCs.
• US owned: US MNCs still account for 50% of total FDI in LDCs. Much of
the FDI from US based MNCs is directed toward the oil industry.
• Japanese owned: 60% of Japanese MNCs investment has been in LDCs,
• LDC owned: MNCs which are LDC based and invest exclusively in other
LDCs have the fastest growth rate.
 Economics 2003-04: Economic Development Page 9

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 LDCs which
contrasts with 80 to 1 in MDCs, thus providing 20 times as much
employment.
Economics 2003-04: Economic Development Page 10

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.
• Govts. 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.
 Economics 2003-04: Economic Development Page 11

• Super-normal profits can be earned.

Economics 2003-04: Economic Development Page 12

Entrepreneurship
• Unemployment is not a result of demand deficient cyclical
unemployment:
• In most LDCs 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 MDCs,
investment is labour saving and does not create jobs.
• Capital is often subsidized by a govt. 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
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,

• Govts. favour large firms through price distortions, output controls,

regulations, export licenses, and credit rationing
• To foster small scale businesses, govt. 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.
 Economics 2003-04: Economic Development Page 13

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 of, for example, 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 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 the high rate of return.
Economics 2003-04: Economic Development Page 14

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), govt. (structures and experience), and the colonial
creation of artificial countries.
• Countries with a history of stable govt. and a developed commercial
sector including merchants, financiers, and businesses familiar with
international trade tend to have fewer problems with development.
• Countries with govts. 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 LDCs?
• 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 Govt.

• Stable govt. reduces risks for local investors, encourages investment, and
reduces capital flight
• Stable govt. 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 govt. 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.
 Economics 2003-04: Economic Development Page 15

5.2 CONSEQUENCES OF GROWTH

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 govt. 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 govt. restricted rural urban migration, the resulting migration
which did occur was not enough to eliminate the rural labour surplus,
the govt. 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: Some African Countries

• 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.
Economics 2003-04: Economic Development Page 16

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.
• The market is not responsive to certain externalities and so fails
to account for entropy and potentially catastrophic environmental
damage.
• Even with govt. 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 over-fishing 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.
 Economics 2003-04: Economic Development Page 17

• 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?

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.
Economics 2003-04: Economic Development Page 18

S U S T A IN A B L E D E V E L O P M E N T
H u m a n D e v e lo p m e n t

G o a ls
S u s ta in a b le D e v e lo p m e n t
G o a ls
-R edu ce p o v e rty
- M a x im i z e e c o n o m i c g r o w th
-R edu ce u n e m p lo y m e n t
- S h a r e s g a in s th r o u g h h u m a n d e v e l o p m e n t
-R edu ce i n c o m e i n e q u a lity
- M a in ta i n s e r v ic e s & q u a lity o f e n v i r o n m e n t
-M o re eq u i ta b l e in c o m e d is tr i b u ti o n E n v ir o n m e n ta l C o n s e r v a tio n
A lt e r n a ti v e C h o i c e s
- E c o n o m i c g r o w th i n c r e a s e s th e s i z e o f t h e p ie P r o b le m s
G o v t. P o lic y - H u m a n d e v e lo p m e n t m a k e s p ie c e s s a m e s iz e C u r r e n t S i tu a t io n
E d u c a tio n - E n v i r o n m e n t a l c o n s e r v a ti o n m a k e s p i e s m a lle r - W o r l d 's r e s o u r c e s a r e s u f f i c i e n t
- In v e s t in h u m a n c a p i ta l: Q /L r i s e s - G r e a te s t l i m i t is w a s te p r o c e s s i n g c a p a c ity
- B a s ic lite ra c y
- P rim a ry & s e c o n d a ry s c h o o ls P ro b le m s
- U n e v e n s p a tia l d is trib u tio n p ro b le m :
H e a lth E c o n o m ic G r o w th - N a tu r a l c a r r y i n g c a p a c i ty i s o v e r ta x e d
- C le a n w a te r E n tre p re n e u rs - E n tr o p y p r o b l e m :
- S a fe s a n i ta tio n S m a ll s ta y i n c o m m u n i ty G o a ls - S c a le a n d r a te o f e n e r g y th r o u g h p u t
- B a s ic m e d ic a l c a re - P r o j e c t e v a lu a tio n , a c c e p t - In c re a s e G D P p e r c a p ita - T h r e s h o ld p r o b le m d u e to u n c e r ta i n ty
- A d e q u a te n u t r it io n - A c c e le r a te e c o n o m ic g ro w th
T ra d e - M a r k e t fa i lu re p ro b l e m
ris k
-M o b iliz in g s a v in g s B e n e fi ts :
-L e a rn b y d o in g - N o s y s t e m to v a l u e o r m e a s u r e
P o p u la ti o n G r o w th R a te - A tt r a c ti n g F D I -G a in s fro m tr a d e
-M a n a g e m e n t tra in in g - E c o n o m ic g r o w th fo r p o o r l e a d s t o :
- M e a n in g f u l w o r k fo r w o m e n -E c o n o m ie s o f s c a le
- B a c k w a r d a n d fo r w a r d li n k s -H ig h c o n s u m p tio n o f r e s o u r c e s
- S o c ia l s e c u r i ty - T e c h n o lo g y t r a n s fe r
- S e r io u s p o l l u ti o n & w a s te p r o b l e m
- E c o lo g i c a l fo o tp r in t -L e a rn in g b y d o in g
M e d iu m m o v e to c i tie s P o lic y - F u tu r e g e n e r a ti o n s
-A c c e s s to s k ille d la b o u r - R e d u c e p r ic e d i s to rt i o n s - D o n o t h a v e p o li ti c a l o r e c o n o m ic p o w e r
R u ra l D e v e lo p m e n t C o s ts :
- S u b c o n tr a c t to la r g e fir m s - E l i m in a te u r b a n s u b s id ie s
- M u s t p r o v id e 7 0 % o f jo b s -F o re ig n e n c la v e
-S m a ll m o d e r n fa c to r ie s - E n s u r e s ta b l e g o v e r n m e n t C u rr e n t E x a m p le s
- L a n d r e fo r m - S p e c i a l iz a tio n tr a p
- In te r n a l, e x te r n a l e c o n o m i e s - S tr e a m l in e le g a l & r e g u l a t o r y - S o i l e r o s io n & d e s e r tifi c a ti o n
- S l o w in tr o d u c ti o n o f b e tte r c r o p s -U n b a la n c e d g r o w th
-S e t u p p r o p e r ta x s y s te m - D e fo r e s ta ti o n & o v e r fis h in g
- M a c h in e r y , irr ig a tio n , c h e m ic a ls - IC b a r r i e r s to im p o r ts
L a rg e in v e s t in c a p ita l -B u ild p u b lic in fra s tru c tu r e - A i r p o l lu ti o n & a tm o s p h e r ic g a s s e s
- F o s te r s m a ll r u r a l e n t e r p r is e s - P r o d u c tiv it y r i s e s b u t: - S e t i n d u s tr y s ta n d a r d s Im p o r t r e p la c e m e n t
- M a c h in e s re p la c e jo b s - F a c il ita te te c h n o lo g y tr a n s fe r - V e r ti c a l i n t e g r a tio n , l e a r n in g
- J o b s a r e o fte n p a r t tim e
P r o b le m s - R & D r a i s e s p r o d u c ti v i ty
b y d o in g G o v e rn m e n t P o lic y
-T e rm s o f tr a d e d e te r io ra te -E x p o rts fa l l, u n e m p lo y m e n t - A p p r o p r i a te te c h n o l o g y
-T ra in e d m a n a g e rs e m m ig ra te F in a n c e
- In c o m e in e la s ti c d e m a n d ris e s - R e s o u r c e s le ft i n th e h a n d s o f th e r ic h
D o m e s tic b a n k in g -S u p p ly b o ttle n e c k s - L e a d s to b e t te r c o n s e rv a ti o n
- R a p id ly g ro w in g w o r ld s u p p ly M u l ti n a ti o n a l F i r m s -M o b iliz e s a v in g s , p a y in te re s t - N o te c h n o l o g y tr a n s f e r -R e s o u rc e s s p re a d th i n ly i f g iv e n to p o o r
- R u r a l - u r b a n m i g r a ti o n -L e a rn in g b y d o in g - K e e p le n d in g ra te lo w - S l o w g r o w th
-A s la b o u r le a v e s : Q /L ris e s -M a n a g e m e n t tra in in g - R e d u c e ri s k b y d i v e rs ify in g S c e n a rio s
-P ric e o f fo o d ris e s - T e c h n o lo g y tr a n s fe r - re g io n a l, s e c to r a l, i n d u s tria l E x p o r t P r o m o ti o n - L o w g r o w th , a u s te r ity
- A c c e s s t o m a r k e ts - P r o j e c t e v a l u a ti o n -E x p o r ts ris e - H i g h te c h , l o w r e s o u r c e u s e
-E m p lo y m e n t c re a tio n
- B a c k w a r d & fo r w a r d lin k s - R e n e w a b le : n a tu r a l r a t e o f r e g e n e r a tio n
F o re ig n A id (H u m a n ita ria n ) -L D C u n a b le to u s e F o re ig n A id - R a p i d g r o w th
- M u l ti la te r a l te c h n o l o g y -N o n -R e n e w a b le : re c y c le re s o u rc e s
- M u lt ila te r a l - G o v t. in fr a s tr u c tu r e &
- U N a g e n c ie s ($ 4 b illio n ) -P o o r ta x c o ll e c tio n d u e to : -W o rld B a n k lo a n s ($ 6 b illio n ) s t r a te g ic tr a d e p o l ic y
-B ila te r a l - T r a n s fe r p r i c i n g - B ila te ra l ( $ 5 0 b i llio n )
- T e r m s d i c ta te d b y I C s -T a x c o n c e s s io n s - T i e d g r a n ts
-N G O s ($ 6 b illio n ) - C r e a tio n o f fo r e ig n e n c la v e - P o l iti c a l & m ili ta r y
- C o m m u n ity le v e l - IC s d ic ta te p r io r i tie s
- S m a l l i m p a c t , n o t w e ll c o o r d in a te d - L a c k c o m p l e m e n ta r y i n p u ts
 Economics 2003-04: Economic Development Page 19

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 DCs.
• Use market systems of punishments and rewards rather than
regulation
• Restrict the power of rich resource owners and large institutions.
Economics 2003-04: Economic Development Page 20

5.3 BARRIERS TO ECONOMIC GROWTH &

DEVELOPMENT
• Periods of economic growth were associated with structural
transformation and social and ideological changes. 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 LDCs

• Many LDCs are not truly nations, they are creations of former colonial
powers . They 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 MDCs.
• Many LDC 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.
• LDCs have little scope to develop new products or techniques of
production, the expertise in the MDCs is overwhelming: most R&D is
concentrated in MDCs. And most technology is labour saving which may
not be of great use in countries which have a large labour force looking
for employment.
• Where LDCs try to add value to raw materials they are faced with high
tariff barriers in the MDCs 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.
 Economics 2003-04: Economic Development Page 21

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 the LDCs are much higher than they were in the MDCs
during the comparable period of development: a larger proportion of
women marry and they do so at a younger age.
• 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 the MDCs
• Eventually the birth rate also declines, until low birth and death rates
lead to low and stable population growth again.
• For MDCs population growth rate is 0.5% and for LDCs it is 2%.
• Studies indicate that more even income distribution contributes
to a more rapid fall in the birth rate.
• In those LDCs with high poverty levels, birth rates have remained
much higher than for MDCs: 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.
Economics 2003-04: Economic Development Page 22

Population: Policy Options

• After the last ice age, 13,000 years ago, the 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
Optimal Population Levels
• Sub-optimal levels: there is not enough 100

Per Capita Income

labour to utilize the available resources to 80
the maximum potential, 60
• Above optimal levels: diminishing returns 40
set in as there is too much labour. 20
• However, natural resource discoveries and 0
increases in productivity: will increase the P*
optimal population level. Population

• 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.
 Economics 2003-04: Economic Development Page 23

• Slower population growth is better:

• Savings rates rise: families save more and govts. spend less on social
services,
• Poeple 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 MDC 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.
Economics 2003-04: Economic Development Page 24

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
LDCs.

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
LDCs,
• 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 LDC borrowing,
• Those LDCs 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.
• Govts. 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.
• LDCs 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
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 LDCs.
• As incomes in MDCs fell so did imports from LDCs worsening
their balance of payments difficulties.
• Elite groups in LDCs 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.
 Economics 2003-04: Economic Development Page 25

• Poor project evaluation:

• MDC banks were only interested in securing loans through govt.
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 LDCs printed money to cover the deficits which led to
extremely high rates of inflation in some countries.

Rescheduling & Restructuring

• LDCs were unable to service their debts and were forced to reschedule
• Loans were renegotiated with lenders, extending the terms of
repayment.
• LDC govts 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.

• LDCs 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:
• LDCs 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 LDCs.
• 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.
Economics 2003-04: Economic Development Page 26

Poverty
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.
• The 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 LDCs is the unequal distribution of income.
• What is interesting is the middle income LDCs 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. 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 these people.

• A Human Suffering index has been developed which looks beyond the
HDI:
• Life expectancy, daily calorie supply, access to clean water, infant
immunization, secondary school enrollment, per capita GDP, rate of
inflation, telephones per 1000 people, political freedom and civil
rights.
• The five worst include: Mozambique, Somalia, Afghanistan, Haiti,
& Sudan.
• It is estimated that 75% of the world’s population live in countries
where the human suffering index is over 50%.
 Economics 2003-04: Economic Development Page 27

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 MDCs
• Often there is capital flight: elites may invest in overseas bank
accounts, property or investment opportunities.
Economics 2003-04: Economic Development Page 28

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.
• Research and development should be directed toward appropriate
technology rather than to the transfer of labour saving technology from
MDCs.

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.
• Govt. 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 LDCs:
• In many countries very little tax revenue is collected and govt. is forced
to raise revenue by printing money or imposing export tariffs which
inevitably reduces the incomes of rural people because most LDCs 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 govt. 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.
 Economics 2003-04: Economic Development Page 29

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 LDCs 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 LDCs 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.
• Govt. often imposes price controls which help the urban poor but
hurt the farmers.

• The potential for growth through industrialization is much greater, so

govt. has invested 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.
Economics 2003-04: Economic Development Page 30

Unemployment & Rural Urban Migration

• As govt. pours money into urban housing, education, food subsidies,
health care, and infrastructure, people migrate to the cities, and then
govt. pours even more money into the cities to prevent rioting.
• The official unemployment rate in LDCs tends to be higher than for MDCs.
However, if disguised unemployment and underemployment figures are
included, there is a very serious unemployment problem in LDCs.
• 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.

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.

Urban Unemployment
• 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.
 Economics 2003-04: Economic Development Page 31

5.4: GROWTH & DEVELOPMENT STRATEGIES

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.

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 govt.
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: LDCs may find that MDCs have already achieved
economies of scale, and protect their home industries through tariffs and
quotas thus effectively blocking imports from LDCs.
• Many LDCs have turned to other LDCs for trade opportunities.
•___Displacement of local production: in many LDCs the production of cheap
plastic sandals can put shoe makers out of work, backward linkages to
Economics 2003-04: Economic Development Page 32

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 MDCs:
• 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: MDCs have increased trade protection and subsidies to

their own farmers, effectively blocking imports of food goods from LDCs.
• 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.
 Economics 2003-04: Economic Development Page 33

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?

Import Substitution (Inward Oriented)

• 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.

• The 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.

• The 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.
• Govt . tends to subsidize capital, and currencies are held
artificially high to encourage the use of imported capital and
intermediate goods:
Economics 2003-04: Economic Development Page 34

• Industry becomes less labour 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.
 Economics 2003-04: Economic Development Page 35

Export Promotion (Outward Oriented)

• 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:

Im port Replacem ent vs
• There is more rapid growth in
Export Promotion
both GDP and GDP per capita
• Technology transfer takes
Expansion through linkage adjustment
place through imports of capital
goods.

Domestic Sector
Domestic Investment
• Exports of manufactured goods
rise compared to primary sector Export promotion
exports.
• Gains from trade: lead to a Import replacement
higher standard of living.
• Specialization allows Foreign Direct Investment
economies of scale and rapid Im port/Export Sector
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:
• MDC tariffs and quotas block imports of labour 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.
Economics 2003-04: Economic Development Page 36

Foreign Direct Investment (FDI)

FDI by MNCs 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

• LDC govts. 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: LDC govts understand the acute shortage of
local managers capable of organizing and operating large scale
industrial projects,
• Intra firm exclusion: LDC 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), MNCs are needed to gain access to this system.
• Marketing expertise: MNCs 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 MNCs

• 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 investments, and from
the private earnings on the exports.
 Economics 2003-04: Economic Development Page 37

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.

MNCs 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 MNCs are not good at providing jobs:
• Local firms are displaced by the MNC and the displaced firms
often have much higher labour capital ratios,
• LDC govts may force the MNCs 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 govt. to appease the labour
sector may increase labour costs significantly leading to the substitution
of K for L
• MNCs may prefer to take advantage of cheaper labour by using more
appropriate technology but LDC govts anxious for technology transfer
insist on the latest technology being used, once again this lowers the
labour capital ratio.

• Technology transfer is severely limited by the country's ability to absorb

and utilize the new technology:
• Workers lack the technical skills
• The LDC govts' system of information dissemination may be non-
existent,
• The MNC 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 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.
Economics 2003-04: Economic Development Page 38

• 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 LDC 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 govts.
• Tax relief may lead to confiscation of MNC property if the host govt.
changes in the future

• Foreign enclave: the MNC 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 LDC
• It widens the rural-urban wage gap leading to increased migration
• MNC supporters may influence the govt. to undertake projects or
adopt policies which are growth rather than development oriented.

MNC 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 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
• To prevent resentment and potential nationalization which
can lead to risk and uncertainty which threaten the long term
viability of a project.
 Economics 2003-04: Economic Development Page 39

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.

• LDCs 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.
• 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 MDCs and relends at a slightly higher rate to LDCs and
must be repaid:
• 90% of loans are for projects (physical capital); 10% for programs.

• 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 govt. budget
deficits, a slower rate of money expansion (lower inflation), and
devaluation.
Economics 2003-04: Economic Development Page 40

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 LDCs.
• 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,
 Economics 2003-04: Economic Development Page 41

Relieving poverty through rural regeneration, and assistance to women.

Economics 2003-04: Economic Development Page 42

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 govt. 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 govt. 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.