Development Economics

4.1 Economic Development

Economic Growth and Economic Development

• Economic Growth is the increase in the real value of a country’s output overtime, measured by GDP/GNI.
  • Increase in ability to produce goods and services
  • Increase in economic output
  • May result in a small portion of increase of living standards
  • Inflation rate not taken into account
  • Objective, measurable
  • Quantitative

• Economic Development is the increase in the living standards of citizens of a country over time (usually more wide-spread) measured by HDI/MPI.
  • Reducing widespread poverty
  • Raising living standards
  • Reducing income inequality
  • Increasing employment opportunities
  • Increasing freedom to choose
  • Includes non-monetary factors
  • Subjective, harder to measure
  • Qualitative

• Economic growth is necessary but not sufficient condition for economic development.

• To achieve economic growth developing countries need:
  • Increase or improvement of quantity of physical capital:
    • Improves productivity, lower production costs and price
  • Increase or improvement of quality of human capital:
    • Improve productivity, lower production costs and price, usually by increasing health care and education
  • Development of new technologies that are appropriate for the conditions present in the nation:
    • Improve quality of physical capital and productivity, but needs to be appropriate
    • e.g. scientific revolution
  • Institutional change: rules, organisations and systems which govern economic interaction
    • Develop property rights, legal systems and enforcement, regulation, fair and transparent tax systems, tackle corruption, access to credits, savings and bank institutions.

• Relationship of growth and development:
  • Growth without development

• Increase in output are concentrated in the hands of a few
• Worsen income distribution
• e.g. mineral extraction of MNCs, increase output but no employment

• Growth with development

• Increased output leading to increased incomes, thus living standards increasing
• Receive more tax revenue, fund programs to help improve health and education, provide progressive benefits

• Development without growth

• Less realistic: in LR impossible to have development without growth
• Output is redistributed away from industrial goods or activities which profit the rich
• To development aims such as education, health and improved technologies

Common Characteristics of Economically Less Developed Countries

• Low levels of GDP per capita: average person produces low output

• because: lack of education, health care, technology → unproductive

• High levels of poverty: many citizens have a poor standard of living

• because: lack of skills to secure high levels of income
• Little to no welfare provision
• Low tax revenue
• Corruption

• Relatively large agricultural sectors: citizens rely on volatile agricultural products

• because: little formal education received, lack of improved technology

• Large urban informal sectors: little formal monitoring of small ‘cottage industries’ where cash is used but unaccounted, e.g. street vendors

• because: lack of proper institution, tax systems, regulations

• High birth rates:

• because: lack of education and health care, need children for agriculture production

• Dualism: two different and opposing sets of circumstances exist simultaneously

• because: income inequality
• corruption
• unable to invest in infrastructure due to low tax revenue

• Low productivity: low levels of output for per hour of work

• because: low levels of health and education
• low levels of technology, human and physical capital

• Low levels of health and education: health system not good enough, lead to simple work, high birth rate, low income

• because: low income, low tax revenue, unable to invest

• Poverty Trap: poor communities unable to invest in physical, human and natural capital due to low or no savings, poverty is therefore transmitted from generation to generation, an injection must be present to break out of the cycle.

• e.g. low income → low savings → low investment → low human capital → low productivity → low growth in income → low income
• Possible injections: subsidies, investment in education, develop financial institutions, investment in health and infrastructure
• If tax revenue is limited, govt. spending also limited → need of foreign aid

Diversity Among Economically Less Developed Nations

• Resource Endowments: countries differ with respect to the natural resources endowments

• LEDC has more labour capital, MEDC has physical capital → price difference
• Different quality of capital resources → form comparative advantage and pattern of specialisation

• Climate: Determines the nature of economic activities

• Usually tropical countries are less developed

• History: colonies, their experiences influence their development

• e.g. colonisers extract resources or encourage development

• Political Systems: a set of legal institutions that defines how a govt. is structured and functions

• Determines relationship with society, degree of power in hand
• Its hard to carry out development without out support of elites

• Degree of political stability: able to withstand forcible removal from power

• Stability:

• High rates of growth
• Effective decision making and implementation
• Instability creates uncertainty towards policies → reduce investments
• Inflow of financial capital, keep their money safe
• Decreases vulnerability to hunger and famine

International Development Goals

• Millennium goals by 2015:

• Produced the most successful anti-poverty movement in history: people living in poverty declined by more than half
• Number of children receiving education increased
• Undernourished number of people dropped by more than half
• Gender parity achieved in most countries
• Maternal mortality fell by 45 percent
• More people gained access to improved sanitation

• Further improvements that could be done include:

• Decrease the number of people suffering from poverty
• Promote women participation and leadership
• Child survival
• More women to receive antenatal care

4.2 Measuring Development

Single Indicators

• Gross Domestic Product (GDP) per capita

• The average dollar value of all goods and services produced by a person in a country over a specific period of time.

• Gross Domestic Product (GDP) per capita in terms of PPP

• GDP per capita that is corrected/adjusted by the exchange rate changes between different countries in order for it to be equivalent to each country’s value
• It is better than just using GDP per capita as it accounts the changes and difference in price levels

• In MEDCs, GDP per capita at PPP will be lower than GDP per capita as the exchange rate also rises when an economic growth occurs

• Gross National Income (GNI) per capita

• The average amount of domestic and foreign output claimed by a resident of a country
• It is the average “repatriated income” of a citizen from his or her originated country
• Since it includes money from abroad, the GNI is usually automatically corrected by the PPP
• It is better than using GDP per capita as it specifically represents the citizens/residents of a country while GDP doesn’t

• In MEDCs the GDP per capita may be higher than the GNI per capita as MEDCs higher cheaper foreign labour forces into the country for manufacture.
• In LEDCs such as Philippines, where a large percentage of workers are sent abroad, its GNI is a much better indicator than GDP as it includes all the money sent back

• In 2013, Philippines has a GDP of 272.1 billion USD and a GNI of 771.3 billion USD

• Health Indicators

• Life Expectancy at Birth

• Number of years a citizen is expected to live calculated by the average within the country

• Infant Mortality Rate

• Number of infant deaths before the age of 1

• Maternal Mortality

• Number of women died due to pregnancy-related causes

• Correlation with country’s income and spending

• It shows the amount of investments into health care researches

• A longer life expectancy usually means more effort are put into health care

• It shows the amount of health education

• Better education leads to more consciousness of self-protection which may lead to a longer life expectancy and less mortality as a whole

• It shows the living standards in this country
• HOWEVER, it depends on whether the government prioritises health as their spending

• Education Indicators

• Adult Literacy Rate

• The number of people who are older than 15 and can read and write

• Primary School Enrolment

• Percentage of people enrolled in primary school

• Secondary School Enrolment

• Percentage of people enrolled in secondary school

• Exceptions where this indicator is not as correlated with income

• Some low income countries still place more emphasis on education than other low income countries
• Some governments does not prioritise education as their main goals

Composite Indicators

• Composite indicators include more than one indicator and so they are considered to be better indicators of economic development

• Human Development Index

• A measure of economic development and economic welfare

• 1 indicates a high level of economic development
• 0 indicates a very low level of economic development

• Examines three important criteria of economic development

• Life expectancy Index
• Education Index

• Mean years of schooling
• Expected years of schooling

• Income Index (GNI at PPP)

• The HDI is usually the mainly used Index for showing economic development as it has the ability to make comparisons on issues of economic welfare

• Single indicators such as GDP and GNI only shows economic growth

• Limitations of HDI

• Wide divergence within a country

• Big countries will have wide differences in different regions

• North China poorer than south east China

• HDI only responds to long term changes

• Short term changes will not affect life expectancy rapidly

• By using Gross National Income it doesn’t necessarily show the economic welfare, as it really depends on where the money is spent
• Income inequality not shown, as it is an average taken and the rich may add on to the poor
• Economic welfare may also be depended on several other factors

• Threat of war
• Level of pollution
• Access to clean drinking water

• Comparison of HDI in more developed countries and less developed countries

• Economically more developed countries will usually hold a higher HDI

• More GDP/GNI per capita
• More government spending, possibly on health care or education
• More investments into health care and education

• Economically less developed countries will therefore hold a lower HDI due to the low income and generally less spending on health and education

• Sometimes the global ranking of HDI is very different from the global ranking of GDP per capita or GNI per capita

• Some countries may hold a high GDP per capita but the government is not spending enough on health care

• This leads to a lower HDI ranking than GDP/GNI per capita ranking

• Some LEDCs spend more money on education and health care than others

• This leads to a higher HDI ranking than GDP/GNI per capita ranking

4.3 The Role of Domestic Factors

Domestic Factors

• Education and Health

• Positive externality of consumption

• Both education and health are merit goods

Positive externality of education:

1. The benefit of education extend to society in the form of increased labour productivity and greater output
2. Knowledge can be applied to research and development
3. Results in lower unemployment
4. Increased political stability
5. Better social benefits such as: lower crime rates, better quality of life
6. Education in women particularly promotes their increased participation in the labour force, lower birthrates, leading to lower population growth and reduce poverty

                Positive externality of health:

1. Greater work productivity and therefore greater output and economic growth
2. Lowering the risk to spread diseases
3. Immunisation
4. Healthy people provides more active and productive participation
5. Which also links to education

1. increase school attendance
2. healthy students provide better efficiency
3. longer lifespan, which means longer the time that education will benefit our society

• Appropriate Technology

The meaning of appropriate technology: To be effective, technologies must be well-suited to particular economic, geographical, ecological and climate conditions.

• Different factor supplies
• Different climate and ecological conditions
• Difficulties in the development of appropriate technologies

Developing countries

• high supply of labour
• labour intensive technology

• increase employment
• use local skills
• safe use of foreign exchange

• Banking, Credit and Micro-Credit

• The importance of banking and credit in economic growth and development
• Exclusion of the poor from access to credit
• Micro-credit schemes

• Micro-credit refers to credit (loans) in small amounts to people who do not ordinarily have access to credit

        Saving -> Credit/loans -> Investment -> Development

                Advantages

• Savings lead to increased loans which lead to increased investment which lead to increased development

                Disadvantages

• The extreme poor cannot participate in savings
• Income distribution
• Inequality

• The empowerment of women

• Education and training

• more available labour force
• increase economic efficiency
• more potential output
• provide better education for children

• Decrease population growth
• Income equality
• Health Care

• Increase life expectancy
• Family planning
• Better hygiene and diet
• Reduced number of orphans / children dependent on state
• Increase quality of workforce
• Many serious health issues in development world are women’s issues
• Gender balance

• Income Distribution

• Definition: High inequality in income distribution hinders economic growth
• Savings

• can lead to less savings
• savings of higher income leave country as foreign investments
• Increase AD

• Social impact

• High inequality can lead to social dissatisfaction and political unrest which can impact growth
• Wealth in the hands of a few can lead to significant political power, which can be exploited in their favor rather than overall growth

• Solutions: Government spending on merit goods such as health and education can improve equity in income and human capital promoting economic growth.

• Infrastructure

• Essential facilities and sources such as roads, sewage, water system and other utilities that are necessary for economic activity
• The availability and broad access infrastructure makes it a major contributor to economic growth
• Provides services that are essential for maintaining a basic standard of living
• These basis of living increases productivity and decreases the cost of production

4.4 The Role of International Trade

Trade Problems facing many Economically Less Developed Countries

• Over-specialisation  on a narrow range of products: missing out on the benefits of diversification

• Tend to specialise in the production  and export only a few goods(primary commodities).
• Dependence on commodity exports

• Many developing countries are heavily dependent on primary products for their export earnings
• Face a number of risks and obstacle

• Missing out on the benefits of diversification and expansion into higher value-added production

• Adding value:

• Engaging in more varied production activities
• Creating employment opportunities
• Establishing new firms involved with manufactured goods
• Expanding into activities requiring higher skill and technology levels

• Price volatility of primary products

• The prices of primary products are more volatile than the prices of manufactured products

• low price elasticities of demand and supply

• Fluctuation affects income, investment, employment, and the wages.
• Fluctuating and unstable export earnings – balance of payments, ability to export

• Inability to access international market: trade protection

• Trade barriers

• Higher on developing countries
• Tariff escalation to discourage manufactured goods and diversification
• High between each other

• Agricultural trade and rich country subsidies

• Agriculture is one of the most protected sectors of developed countries
• European Union Common Agricultural Policy (CAP)

• Price floor and subsidies

• United State Farm Policy

• Price support and subsidies.

• Negative consequences

• Global misallocation of resources
• Global inefficiency
• Lower export earnings for developing countries
• Increased poverty among affected farmers

• The new trade protection

• Technical regulations
• Standard and requirements
• Testing and certification
• Administrative procedure
• Sanitary measures

Trade Strategies for Economic Growth and Economic Development

• Import Substitution

• Manufacture simple consumer goods for the domestic markets
• Rationale

• Reduces dependence on exports
• Reduces BoP problems
• Infant Industries

• Consequences

• High levels of protection of domestic firms, inefficiency (reduced competition)and resource misallocation
• Overvalued exchange rate
• Government intervention
• Agriculture neglection
• Deterioration of BoP
• Encouragement of capital intensive production method (should be labour intensive)
• Negative impacts on employment and income distribution
• Corruption

• Usually unsuccessful!

• Export Promotion

• Growth and trade strategy where a country attempts to achieve economic growth by expanding its exports.
• Policies

• State ownership and financial institution
• Support for exporting industries
• Domestic producers protection
• Requirements on MNCs
• Large public investments in key areas
• Incentive for R&D for high tech products

• Success factors

• Expansion into foreign markets
• Benefits of diversification
• Major investment in human capital
• Appropriate technologies
• Increased employment
• Reduces BoP problems through exports

• Trade Liberalisation

• The elimination of trade barriers to achieve free trade
• The Washington Consensus

• Policies

• Lowering and eliminating tariffs and other trade barriers
• Interest rate liberalisation
• Floating exchange rate
• Privatisation
• Deregulation
• Restrictions of FDIs
• Limit government lendings

• Effect

• Limited benefits for export growth and diversification

• Trade protection policies from developed to developing

• Limited effect on economic growth

• Increased trade doesn’t equal to growth

• Increasing income inequality and poverty

• Losers

• Less educated
• Poor
• Remote places
• Nothing
• Primary commodities
• Unemployment
• Low level of social protection (Lower minimum wage)

• The New Development Consensus

• Trade liberalisation plus government intervention

• Support education, health and infrastructure development, R&D, techs
• Avoidance of large budget deficit
• Income distribution and poverty alleviation
• Proper framework for markets
• Market-supporting institutions
• Increase foreign aid and access to markets
• Special treatment by international trade agreements under WTO

4.5 The Role of Foreign Direct Investment

The Meaning of FDI and MNCs

• FDI: Foreign Direct Investment

• Investment by firms based in one home country in productive activities in another host country

• MNC: Multi-National Corporations

• A firm that undertakes foreign direct investment (FDI)

• Why MNCs expand into less developed countries (LEDCs)

• Increase sales and revenues

• More easily capture market share
• Speed up delivery of products and save transportation costs

• Bypass trade barriers
• Lower costs of production

• Developing countries generally have lower labor costs

• Use locally produced raw materials

• Far less costly to obtain locally than to import them

• Further activities in natural resource extraction

• Many developing countries are rich in natural resources

• Why are developing countries attractive to MNCs?

• Political stability and political institution that ensure a stable political environment
• A stable macroeconomic environment

• Low inflation, stable currency, acceptable levels of foreign debt, absence of major balance of payment problems

• An institutional environment that favors FDI

• Freedom to repatriate profits and engage in foreign exchange transactions with no exchange controls
• Favorable tax rules
• Lack of restrictions regarding foreign ownership
• Well established property rights
• Rules that minimize risk of nationalization
• Well functioning infrastructure
• Well educated labor force

• A free market economy with limited government intervention
• Free market trade policy with emphasis on exports
• Rapid economic growth and expectations of continued rapid growth

Advantages and Disadvantages of FDI for Economically Less Developed Countries

• Advantages

• Supplement insufficient foreign exchange earnings

• Can help offset current account deficit
• MNCs are usually export oriented

• Supplement and improve upon local technical skills, management skills and technology
• Supplement insufficient domestic savings and increase investment
• Lead to greater tax revenues in the host country
• Help promote local industry
• Increase local employment and help lower unemployment in the host country
• Lead to higher economic growth in the host country
• FDIs would also invest in infrastructure for their own benefits or agreement requirements

• Disadvantages

• May not always supplement insufficient foreign exchange earnings
• MNCs can cause outflows by repatriation or import of raw materials
• May not improve local technical skills, management skills and technology
• MNCs influence can be very limited
• May not lead to greater tax revenues in host country

• Transfer pricing: Lie about price of imported materials so reported profit decrease, so tax decrease

• May not lower unemployment due to MNCs limited impact
• May not help promote local industry

• Imported capital intensive technology that are inappropriate to local conditions

• Environmental degradation
• Promote inappropriate consumption patterns in developing countries (e.g. soft drinks, sweets, fast foods)
• Use government resources to build infrastructure needed by MNCs instead of alleviating poverty
• Use economic and political power to bring policies that work against development (e.g. weak labor or environment laws)
• Competition between developing countries to host MNCs and the race to the bottom

• Creating ideal scenarios to attract MNCs

4.6 The Role of Foreign Aid and Multilateral Development Assistance

Classification and Types of Aid

• Humanitarian

• Short-term aid for disaster relief or displaced people due to war and conflict

• Temporary shelter
• Clean drinking water and food provision
• Medical supplies and treatment

• Development

• Long term aid aimed at helping to improve economic growth

• Technical assistance to LEDCs such as engineers, doctors, agricultural experts
• Funding to build/develop educational and health care facilities and infrastructure

• Government:

• Official Development Assistance (ODA)

• Can be bilateral (one country giving to another) or multilateral (giving to an international organization like UN, World Bank, IMF)
• Consists of a combination of grants and low interest, low fee loans
• Use of money is usually general in nature

• Reasons to offer aid:

• Political/Strategic:

• Developing political ties and international influence
• For security reasons, developed countries are concerned about poverty in the developing world as this can cause civil wars, refugee crisis and help breed terrorist (ISIS!!!!!)

• Economic (including tied aid)

• Developed world may want preferential access to developing countries’ raw materials
• Developing countries are potential markets for developed world

• Tied aid: Refers to the practice where donors make the recipients of aid spend a portion of borrowed funds to buy goods and services from the donor country. It occurs only in the context of bilateral aid, and gives rise to several serious disadvantages:

• Recipient countries cannot seek lower price alternative for the goods and services they are forced to buy from the donor country. This means that recipient of tied aid face such higher than necessary import costs
• Having to buy specific goods and services from the donor country often results in buying inappropriate, capital intensive technologies
• Those who benefit from tied aid are usually large firms in developed countries whose goods and services the recipient countries are forced to buy

• Non-Government:

• NGO

• Smaller scale than ODA
• More specific goals/aims
• Usually focuses on helping in areas that ODA doesn’t reach (prenatal care, gender equality)

• Humanitarian reasons: Moral responsibility to reduce human suffering

• Trade and Aid: 3 perspectives

• Trade, not aid (trade liberalisation)

• Development should be based on an expansion of international trade and increasing exports of developing countries, and aid should be limited

• Failures of aid to effectively address the problem of growth and development
• Ability of trade to make major contributions to growth and development, provided rich countries abandon their protectionist policies

• Trade and aid:

• Trade is not enough for low-income countries

• Rich country agricultural subsidies
• Developing country dependence on commodity exports
• The poverty cycle
• Countries may have little to export
• Exclusion of geographically isolated communities and countries

• Aid for trade (export promotion)

• Many poor countries have institutional constraints that prevent them from taking advantage of growing international markets
• A portion of aid is used to support the development of institutions that improve a country’s ability to export

The Roles of International Monetary Fund (IMF) and the World Bank

• World Bank: Development assistance organisation that extends long-term loans to developing governments for the purpose of promoting economic development and structural change. It was established in 1944, at the end of the second world war, as part of an effort to help reconstruct Europe

• International bank for reconstruction and development: lends on non-concessional terms to middle income developing countries
• International Development Association: similar activities to IBRD but extends to low income countries
• Criticisms:

• Governance dominated by rich countries
• Excessive interference in countries’ domestic affairs
• Conditional assistance
• Damaging effect on developing countries

• Structural adjustment lendings have been said to increase income inequalities and poverty within developing countries

• Socially unsound projects

• IMF: Offer loans at commercial rates to help governments facing debt crisis, loans are tied to very demanding conditions that borrowing countries must meet in order to receive the loan, they require these countries to implement very harsh austerity programmes and strict monetary policy which is often harmful in the short run to growth and prosperity in those countries.

• Move away from government lead growth to foreign lead growth
• Tight monetary policy, reduce AD, reduce demand of import
• Tight fiscal policy, reduce AD
• Cuts in real wages, Reduce AD
• currency devaluation, encourage export
• Criticism:

• Damaging effects on developing countries
• Dominated by rich countries
• Conditional lending
• Excessive interference in countries’ domestic affairs

4.7 The Role of International Debt

Foreign Debt and its Consequences

• A country’s foreign debt refers to its level of external debt (Public and Private)  incurred by borrowing from foreign creditors.
• Foreign government debt arise from three sources

• government borrowing from multilateral organisation
• government borrowing from foreign commercial bank
• government sales of bond to foreigner                                                

• the debt service payments must be made in foreign exchange, which can come from

• increased exports
• reduced imports
• financing from external sources.

• Under favourable circumstances, debt service payments are made possible by greater economic growth and increased export earnings.

Why countries borrow from foreign sources        

                        

• enters the balance of payments as a credit in the financial account→ helps countries pay for deficits (an excess of debits) in the current account.
• borrow from abroad is to acquire foreign exchange allowing them to pay for trade deficit( import >export).

• A trade deficit allows a country to reach a point outside its production possibilities curve (PPC), meaning it enjoys more goods and services than it can produce itself
•  but this means it must have a method of paying for the extra goods and services eg: borrowing from abroad.                                

• In the long term, is that countries will spend at least a portion of imports made possible by foreign finance on capital goods that are inputs in production, which will accelerate their growth and their exports, so that over the longer term they will be able to pay back their debts plus interest.

Consequences of high levels of foreign debt

• Balance of payment problems        

• When a country borrows from foreign institutions, its debt servicing obligations (repayment of loan plus payment of interest) must be paid in foreign exchange.                                
• If export earnings are not enough to cover its foreign exchange needs for debt servicing → borrow more from abroad to acquire the needed foreign exchange → its debt servicing obligations increase.                         

• Possibility of a debt trap                                                 

•  a situation where a country must keep on taking out new loans in order to pay back the old ones. eg: Latin America and Sub-Saharan Africa, were caught in a debt trap during the 1980s.
• As levels of debt rise, there comes a point where the level of debt cannot be sustained : new debt requires higher debt service payments→ require more foreign borrowing→ leads to more debt servicing payments→  in a self-reinforcing spiral in which the country is trapped.

• Opportunity costs                                         

• government has fewer resources to invest in social services(eg: health, education), infrastructure, all necessary for poverty alleviation and economic growth and development.        
• it has less foreign exchange to pay for imports of needed capital equipment, other production inputs and goods and services generally. The foregone imports are an additional opportunity cost with negative consequences for economic growth.

• Lower private investments        

• fears that a government may be unable to service its debts create uncertainty regarding economic conditions and scare away private investors, both domestic and foreign.        

• Lower economic growth                                                

• lower public investments in merit goods, lower imports of production inputs and lower private investment, work to lower economic growth in highly indebted countries→ a reduced ability to service debts.

4.8 The Balance between Markets and Intervention

Strengths of Market-Oriented Policies

• Increase competition

• benefits consumers (lower prices)
• better / more efficient use of resources
• better innovation

• Increase incentive

• profit incentive when taxes are low
• without a welfare safety net, there is a greater incentive to work

• More employment

• lack of labour market barriers
• allocative productive efficiency

• Trickle down effect

• Increased levels of economic activity overall
• This boosts AD and will be redistributed through increased spending / employment

Weaknesses of Market-Oriented Policies

• Market Failure
• Weak or missing market institutions
• Development of dual economies
• Income inequalities
• Insufficient credit to poor people
• Questionable effects on development and growth

Strengths of Interventionist Policies

• Correct market failure
• Provision of merit and public goods
• Less income inequality
• Basic safety net
• Promote development of domestic industries
• Skilled labour force more adaptive

Weaknesses of Interventionist Policies

• Excessive bureaucracy
• Poor planning
• Corruption