Development

GLOBALISATION

The practice of free trade in all factors of production

(land, labour, capital, entrepreneurship) and all final

goods/services (think of the globe as one single market)

 Factors of production move according to where rate of returns for

given risk are highest (taking comparative advantage to its limits)

 Barriers: protection of markets, tariffs/quotas, etc.



Why is globalisation good?

 (Taiwan) Land reform: gov’t buys land to give to the poor to give

incentive to use the land to make money → growth of SME

(small and medium enterprises) → creation of jobs for

individuals, expansion leads to ↑ employment

o Let land be used in the free market so returns are highest.

Factories sprang up, demand for labour increased →

higher wages → more competition for labour (only firms

that are successful will survive because wages are high) →

more innovation/productivity/efficiency → improvement

in standard of living (e.g. education)

o Globalisation → economic growth → democracy

 (Vietnam) Multinationals bring improvement in business

practices, bring in FDI (foreign direct investment)

o FDI leads to jobs, higher wages, better work conditions

(hygiene and ethics), better training (multiplier effect in

local area) → sets apace local companies to improve their

quality of products and treatment of workers

o Top 5 multinationals control significant portion of the

(global) market → 5 firm concentration ratio

 (Kenya) No development because no globalisation

o No property rights: no incentive/motivation to

build/expand businesses because returns must be given to

gov’t

o Gov’t behaviour: corruption and favouritism affect production,

standard of living, etc

o Clothes: second-hand clothes dumping → decline in textile

industry because demand for second-hand clothes is high,

prices are cheap and there is consumer choice

o Access to foreign markets: aid vs. trade from farm subsidies

trading blocks (i.e. EU) use tariffs on African goods and

subsidises their farmers



Africa’s comparative advantage

o Primary commodities: owned by gov’t or foreign

multinationals

o Cheap labour: not being hired because industries can’t

compete with dumping, imports, etc

o Agriculture: subsidies and tariffs are harmful – no money is

made

Global recession: the rich want to sell their manufactured

goods/services to the poor; the poor don’t have any money to buy

foreign goods because they have no access to (developed

countries’) markets to sell their goods/services



ECONOMIC GROWTH VS. GLOBALISATION

What is the difference?

Economic growth

 Rise in GDP per capita (value of output of goods/services at a

specific time)

 Measured by income and wealth

Development

 Measured by the Human Development Index (HDI)

o Income and wealth

o Education

o Health

 Measured by quality and quantity of life indicators

o No single indicator for development – the more the better

o Addition of all indicators = HDI

*Note: In most cases but not all, high GDP per capita, high

growth rate, implies high quality of life



BARRIERS TO DEVELOPMENT

The reasons why poor countries stay poor

 Lack of resources

 Lack of technology

 Corrupt practices

 Lack of incentives to innovate

 Lack of access to foreign markets

 Lack of property rights

 Lack of savings to invest

 Debts to foreigners (gov’ts and banks)

 Lack of free trade in the global economy (unfair trade practices)

 Inefficiency in production/distribution

 Lack of infrastructure

 Lack of management skills

 Replacement of raw materials (primaries) with synthetic materials

 Too high a spending on “regrettables”

o E.g. military hardware which have high opportunity costs

 Capital flight

o Repatriation of profits

 Hyperinflation; uncertainty of currency value

 Worsening terms of trade

o Exports become increasingly cheaper, imports become

increasing higher in value

 Institutional barriers

o I.e. attitudes, resistance to change (some players lose while

some players gain)

o E.g. power shifts from landowner to tenants, civil servants,

industrialists → loss of monopoly

o E.g. legal system cannot be trusted; not fair/efficient



MEASURING DEVELOPMENT

Two approaches: basic needs approach, GNP statistics

approach



Basic Needs Approach

Basic needs (minimum requirements) for an individual to live and

grow:

 Adequate food, shelter, warmth, clothing

 Access to basic education

 Access to adequate health care

 Opportunity to work at a decent wage

 Sufficient leisure time

 Freedom to make one’s own economic decisions (what to buy)

 Freedom to participate in the decisions of the gov’t and

community

 Protection of basic human rights



Advantages:

 “Holistic” approach – taking into account all aspects of human life

 Reflects the human condition (well-being)

 Implies that everyone must at least satisfy these requirements

before development can take off

Disadvantages:

 Measuring each item objectively may be difficult

o Qualitative approach = subjective, hard to quantify

 Deciding what to include in the list may be limitless/debatable

o E.g. freedom of religion, self-esteem

 Coming up with one measure that is the sum of each item on a

long list may be inaccurate

o E.g. cannot add calories per capita with individual years of

education in any sense – different units

 Distribution of the various items may not be equal among all

citizens

o E.g. if average calories per capita rises, it may not be

distributed equally, i.e. there may still be people living

well below poverty levels



GNP Statistics Approach

A higher GNP generally implies a higher standard of living



Advantages:

 Takes into account virtually all goods/services and converts them

into a single measure

o E.g. $ per capita

 Rules of measurement universally agreed → easy to compare

between countries

 Nearly all countries compile GNP statistics so data already exists

o No significantly new resources required

 It is also accepted that ↑ GNP is a necessary condition for

sustained rise in welfare

 There is a close correlation between the level of GNP per capita

and other indicators such as: mortality rates, literacy rates,

calorific intake, life expectancy

Disadvantages:

 Approach ignores income distribution

 Exchange rates may not reflect local purchasing power

o Use PPP (purchasing power parity) approach

 GNP approach may exclude many items, such as: subsistence

farming, do-it-yourself (DIY) work, bartering

 Market prices may be highly distorted due to monopoly behaviour

or gov’t fixing prices or high sales taxes and subsidies →

distortion of GNP figures

 Higher expenditure on “regrettables” in some countries, compared

to others

 GNP statistics do not give an indication on the “spiritual” aspect

of life

o E.g. freedom to practice religion, freedom to vote



CHARACTERISTICS OF LDCS AND MDCS

What are the differences between rich and poor

nations?

Less Developed Countries (LDCs)

 Lower real income per capita

 Income distribution is more uneven

 Higher population growth

 Higher birth rates than death rates

 Lower life expectancy

 Young population

o Not enough experience

o Gov’t resources diverted to their needs: day-care, etc

 Low(er) literacy rate

 High infant mortality (deaths of under 5’s per 1000)

 Greater supply of untapped resources

 Greater level of labour-intensive production methods

 Greater rural → urban migration

 More agrarian based economies slowly industrialising

 Lower quality infrastructure

 Legal system more inefficient

 Lower labour productivity

Value of output

Productivity =

Input

o Value of output for each worker is low → lack of

efficiency

o Low value on the world market due to unskilled labour

 Market value is different for different

goods/services

 Low value added ($) on product

 Lack of job opportunities paying a decent wage

 Poorly developed financial system (shark lending)

 Lack of funds available for capital investments due to low level of

saving in banks due to lower incomes

 Much higher interest rates to reflect scarcity of funds, higher

levels of risk and inflation

 Poorly developed insurance system

o Invest in foreign market = high risk – small, private

businesses cannot afford risk or marketing costs



More Developed Countries (MDCs)

 Higher real income per capita

 Income distribution is more even

o Now: more and more inequalities because of

discrimination for opportunity to learn/work/etc → free

market, must support oneself

 Lower population growth

 Lower birth rates than death rates

 Higher life expectancy

 Aging population

o Gov’t resources diverted to their needs: wheelchair,

hospitals, etc

 High(er) literacy rate

 Low infant mortality

 Most of natural resources already being used

 Greater level of capital-intensive production methods

 Lower rural → urban migration

o Even urban → rural migration

 More tertiary based economies

 Higher quality infrastructure

 Legal system more efficient

 Higher labour productivity

 High value added ($) on product

o Add transportation costs, packaging costs, brand name

costs under “extras” (e.g. Starbucks $7, amount of coffee

7¢ - add syrup, sugar, whipped cream, etc)

o Large companies in MDCs being bought up by companies

in LDCs that have money for investment (cheaper costs of

production)

 Greater level of job opportunities paying a decent wage

 Better developed financial system

 Funds available for lending are plentiful due to high level of

saving and collateral

 Lower interest rates reflecting abundance of funds, lower levels of

risk and inflation

 Better insurance system

o By allowing LDCs to sell products in market will ↑ MDC

incomes (because there is demand and foreigners gain

percentage of profit) → ↑ LDC incomes (because products

can be sold) → ↑ consumer choice, ↑ employment,

multiplier effect







Determination of Income Distribution

Income Distribution Graph

100%



Line of perfect equality









% of GNP

Lorenz curve



a



b







0 100%

% of population

a

Gini Coefficient =

a+b



Gini coefficient

 Measurement of income distribution

o The higher the ratio (closer to 1), the larger the inequality

o The lower the ratio (closer to 0), the smaller the inequality

 The smaller a is, the more equal the distribution

Trade cycle

MDC Trade Cycle

Potential growth



Boom

Real GDP Peaking out





Recovery





Recession







Time



 Developed countries go through trade cycle: recession, recovery,

boom, peaking out

o Cannot always be in boom because of limiting factors

 E.g. number of works, inflation, etc

 Less developed countries do not experience trade cycle because

they have large amount of under-developed resources

o Can go through boom for several years



INTERNATIONAL TRADE AND DEVELOPMENT

Role of international trade in economic development, is

there a connection?



Importance of Trade

 Growth in the relative size of the export sector

o International trade is becoming more and more important

→ export sector getting bigger and bigger

o E.g. HK’s exports: 97% of GDP (1970) → 149% of GDP

(1995)

 Growth rates and export performances of selected secondary

outward looking countries

o Secondary = manufactured goods/services; Outward

looking = exporting

o Real GDP has increased more rapidly for these countries

who focus more on exports (this is in favour of

globalisation)

o Export-oriented countries → greater growth



Trade Strategies

As countries develop, their policy towards trade goes

through various stages

1. Primary Outward-Looking Stage

 Export primaries (e.g. coffee, cotton, copper)

 Use export earnings to import manufactured consumer goods

 Little or no industrial base

 Justification:

o Using comparative advantage (production according to

lowest opportunity cost)

o Vent for surplus (method of selling excess products – not

dumping unless selling below cost)

o Engine for growth (injection of purchasing power into the

economy)

 Weakness of traditional trade theory:

o Comparative advantage/opportunity cost can change over time

 With the acquisition of new skills and technology, a

LDC can change its comparative advantage from

primary to certain manufactured products. These

manufacturers tend to be labour-intensive and use

abundant raw materials (e.g.: Morris Minor Car

production in Sri Lanka)

o Concentration on primaries may hinder growth.

 The export of primaries is highly dependent on the

demand for them in rich countries. They also have very

low added-value (lack of demand).

o The citizens of the exporting country may not gain from trade.

 Mines/plants may be under foreign ownership. The

foreign country tends to bring in its own skilled

workers and machinery. Locals receive only a few low-

paid jobs, since the company may be a monopsony

(i.e.: single buyer of labour allows them to dictate rules

and conditions)

o Trade can also lead to greater inequality of income

 Workers in the export sectors and owners of factors of

production (land owners, mine owners) may be the

only beneficiaries (e.g.: Nike worker salaries rise, but

local/non-exporting industry worker salaries don’t)

o Balance of payment problems may result from trade.

 E.g.: With a free trade policy, imports may exceed

exports. This trade deficit will create various

adjustment costs (e.g.: devaluation/ depreciation of

currency may affect locals who are not working in

export sectors).

o Trade may adversely influence tastes

o Trade may raise people’s standards for a ‘better life’, which

cannot be fulfilled. This can lead to frustration, insecurity and

unhappiness (unrealistic aspirations)

 Problems for primary exporters:

o Long term:

 Slow growth of exports, because of low YED and low

PED for primary exports:

 Primary products have low YED. (low income

elasticity of demand) As the rich countries

grow, the extra income earned is spent on

luxuries, services rather than on more salt,

coffee wheat (i.e.: extra money stays in

MDC’s)

 With higher incomes, consumers buy more

sophisticated products (most profit not from

primaries, but from end products).

 Agriculture protection in advanced countries is

detrimental to LDC’s.

 Technological developments mean greater

replacement of raw materials with synthetic

substitutes.

 Terms of Trade (ToT)

o Low ToT for primaries although overall PED in the global

economy is low, the PED for coffee from any one country is

very high since there are very many coffee producing

countries



2. Secondary Inward-Looking Stage (Import

Substitution Industrialisation – ISI)

 Protect your industry by closing markers to foreigners (less X, M)

o Only export to import essentials (buy capital goods).

 Make your own goods

o Only works if big country → have necessary raw

materials/enough resources + have enough domestic

consumers/population/demand

 Justification:

o The problems of primary-outward looking policies

o Greater dynamic potential with industrial production

o Infant industries

 Adverse effects:

o Against comparative advantage

o Cushions inefficiency (e.g.: In India, government issued Ray

License to certain favoured domestic industrialists →

protectionism → no innovation → later will be bad (no

competitiveness).

o Urban bias

o Damages exports

o Wide variations in effective protection

o Social/cultural problems

o Environment costs

o Exporting manufactures:

 Transition form inward-looking to outward-looking

industrialization

 Benefits from a secondary outward-looking policy

 Drawbacks of a secondary outward-looking policy

3. Secondary Outward-Looking Stage

 Secondary = manufactured goods/services; Outward looking =

exporting

 Real GDP has increased more rapidly for these countries who

focus more on exports (this is in favour of globalisation)

 Export-oriented countries → greater growth



STRUCTURAL PROBLEMS IN LDCS

The neglect of agriculture

 Problems of urban bias

 Policies to promote agriculture

 Problems with these policies



Inappropriate technology

 Capital-intensity biases

 Arguments for capital intensive technology

 Arguments for labour-intensive technology



Unemployment

 Rapid population growth

 Capital-intensity bias

 Rural-urban migration

 External influences



Inflation

 Problems of hyper-inflation

 Monetarist explanations

 Structuralist explanations



AID VS. TRADE

Foreign aid

Official aid

 Bilateral aid: given by individual gov’ts to another

 Multilateral aid: given by multilateral agencies

o E.g. World Bank, IMF, Asian Development Bank, UN

agencies



Unofficial aid

 Aid given by non-governmental organisations (NGOs)

 E.g. Red Cross, Oxfam, churches, and other indigenous NGOs

Amount of aid

Official – figures likely to worsen over time

 1960 – $4.6 billion

o 0.51% of GDP

 1991 – $55.5 billion ($8 billion if adjusted for inflation)

o 0.33% 0f GDP

 USA = largest donor in terms of absolute amount, lowest in terms

of % of GDP

o Most US aid → Israel and Egypt (politics)

 As % of GDP, highest donors = Saudi Arabia, United Arab

Emirates (UAE), and Nordic countries

o Religious aid



Direction of aid

 Less than 50% of all official aid goes to the poorest countries

 After 1990, funds directed to former soviet countries (politics)

 Most aid linked with military and political interest of donors

o Usually tied – with strings attached

 NGOs are the ones delivering pecuniary/non monetary aid to

villages



Types of foreign aid



Grants: money for development projects

 For free technical places, free university education

Loans: loan may be at commercial interest rates, or may be a soft

loan

 Soft loan: discount/subsidised/below market price

Tied aid: grants and loans tied to buying from the donor country,

supporting the donor country



Aid arguments



For

 Aid can fill resources gap, foreign exchange gap,

capital/machinery gap

o ↑ aid → ↑ capital → ↑ economic growth → ↑ savings → ↑

investment → ↑ growth

 Via multiplier

 Aid = injection

o Counts in GNP



Against

 In reality, aid is often tied

o E.g. a poor country is given aid on the condition that it buys

machinery from the donor country

 Aid is criticised for maintaining inequalities in LDCs since aid

projects are biased toward the richer urbanites, biased towards

capital intensive development

 Aid can allow a country to postpone necessary reform

o Food aid → countries depress local food prices → reduced

investment in rural sectors

 Aid, especially military aid, increases the powers of dictators and

despots

 Poor substitute for trade

o Trade requires removing many restrictions on manufacturers

(e.g. textiles)

 Defence spending in MDCs = $800 billion a year

Aid ‘given’ to LDCs = $56 billion

Debt repayment from LDCs → MDCs = $200 billion



Trade arguments (injecting capital through

multinational/transnational trading)

 Transnational (TNC): income generating assets e.g. mines,

plantations, factories, and sales offices in different nation states

Types of foreign direct investment (FDI)

 Joint venture

o Foreign TNC working with local companies to produce goods

 Licensing

o Company with exclusive license to produce products

 Franchising

o Producing products under a certain (well-known) brand name

by buying a franchise

o Lower risk → lower returns

 Mergers and acquisitions

o Buying up local companies (major/minority shareholders)

o E.g. Coca Cola buying up Thumbs Up (local Indian company)

 Setting up own operations

o E.g. microchip company Intel in Malaysia



Characteristics of MNCs

 Large size

o In terms of capital investment, value of assets, number of

affiliates, number of employees/workers, size of

turnover/revenues/profits

 Foreign ownership

 Large size + foreign ownership leads to the debate over the

desirability of MNCs in LDCs

Pros of MNCs

 Increases GNP through multiplier effect

 Increases investment (I), technology transfer

 Increases savings

 Increases manufacturing and employment

 Creates new markets

 Can ease bottleneck supply-side problems in LDCs – helps get

processes startes

 Can help close resource gap, pay taxes, and boost exports

o LDCs typically have shortages in savings, foreign exchange,

tax revenue, technology, skills, etc

 On B/P: MNCs often sell/make spare parts in one of their

factories to sell as an input in another of their foreign factories

o Intra-corporate/transfer prices can differ from market prices

o MNCs set global objectives in profit maximisation, tax

minimisation, risk minimisation, etc



Cons of MNCs

 Inequality between the urban high wage sector and the rural low

wage sector widens

 Inappropriate, overly sophisticated products marketed to the rich

elite causing unrealistic aspiration amongst the poor

 Location in the cities encourage rural → urban migration – strains

cities’ infrastructure

 Capital-intensive technologies introduced, benefit the poor very

little

 Size and power to influence local, national gov’ts

o E.g. Shell in Nigeria

 May intimidate local enterprises into selling

Conclusion: remember to weigh up costs and benefits of MNCs



DEBT CRISIS (– due to oil shocks)

Servicing the debt:

 Paying interest

 Paying amortisation (actual size of the debt)

Import bill = (price of oil) x (amount of oil imported)



Oil shock

 Recession → ↓ exports because consumers don’t buy as much

 Banks flooded with oil money – must lend (to make money) with

as little risk as possible

o MDCs in recession

o LDCs need to borrow to pay off oil imported

 Inflation → ↓ real value

o Stagflation: economy stagnant but with inflation due to high

oil prices

o Wage-price spiral: ↑ wages (demand from workers) → ↑

prices (to pay ↑ labour costs) → ↑ wage demanded, etc.



Consequences of increasing debt

 Further lending restricted → lack of capital for investment

 High debt levels ← IMF may step in and offer loans – but severe

conditions which may affect gov’ts social programmes

o No returns on social programmes

 Loss of international credibility – end up at mercy of world

markets

 Continuous repayment of the debt implies continuous outflows of

funds and this may lead to a fall in the exchange rate thus

reducing purchasing power for foreign goods, standards of living

are likely to fall

o Owe money → keep paying back → ↓ funds, ↓ exchange rate,

↓ standard of living

 Domestic supply of goods fall relative to demand → inflation

o E.g. Brazil/Bolivia had inflation rates as high as 1600%

 Difficulties will arise in accumulating domestic capital since any

surplus will be used to pay back the debt → will reduce domestic

investment and cause an eventual fall in national income and

consequently unemployment

o Debt = massive leakage



IMF

 1945 used to be linked to gold standard

 All countries are members

o Bigger country → bigger payment



IMF and World Bank

 Pro-free market; monetarists; facilitator

o Create conditions for free market to work out

 Will ask for structural reforms

o → State has to specialise in merit goods only

 E.g. healthcare: vaccination, basic hygiene, infant

healthcare

E.g. education: primary and secondary

E.g. infrastructure: basic roads, irrigation, electricity

o Want private sectors to build auto routes, ports, etc (which are

tolled)

 World Bank will lend money to private firms

 Policy controlled by World Bank (very free market)

 Rates of returns must be high enough to justify projects

 Risk vs. reward is weighed

 If risky → ↑ rates of return

o Exchange rates – gov’t should create stability so exchange rate

doesn’t fluctuate

 No budget deficits – spend no more than it has

 If high budget deficit and want to borrow money → ↑

taxes or ↓ G

 ↓ G through shelving projects, can’t/difficult to

lay off people, reduce capital costs, cut back on

social programmes (poor affected)

 ↓ G → ↑ prices of food → ↑ supply – but poor

can’t afford to buy

o Taxation – improve/expand the tax base, lower the tax rate

 Reduce taxes but widen the number of taxpayers such

that tax revenues remain constant or even increase

 Formalise the underground/Black/parallel/informal

economy

 Money received not always declared

 Greater gov’t accountability on spending of tax

revenues

o Inflation problem

 Control money supply (MS linked with real growth of

production)

 Reduce gov’t deficit

 Remove bottlenecks in production

 E.g. power cuts in industry

 Low labour costs may not mean other costs are

not high

 Increase aggregate supply to alleviate shortages



SUSTAINABLE DEVELOPMENT

Type of development where future generations have at

least the same level of/access to resources as the current

generation

 Ideally have the same/greater amount of choice



What sort of development is considered sustainable?

 Farming at the rate of depletion

o Rate of depletion = rate at which stocks are replaced in the

natural world

 E.g. teak wood requires 40 years to produce a full-

grown tree. The rate of depletion is 2.5 (1/40 x 100) –

cut down 100 trees, must grow 4,000 in replacement

 Collecting and recycling material such as paper, metals

(aluminium, tin), and glass

o Generally done in poor countries – material can be sold again

 Using synthetic substitutes provided they use sustainable material

 Investing in human skills (education, training), primary

healthcare, basic hygiene, and infrastructure

o Multinationals provide training for local labour



Is sustainable growth incompatible with economic

growth?

 Higher sustainable growth may mean greater use of appropriate

technology, which may spur on greater long term economic

growth

 Sustainability can be incompatible with higher economic growth

since more sustainable projects can end up using resources for

very low returns

o E.g. solar panels

o Rate of return (similar to profit) = [(Revenue – Cost)/(number

of years)] x 100

 Cost = private cost + external costs

o Standard ways of calculating rate of return

 Often only include private cost

 External costs ignored

o Sustainable development ← all costs valued and included

 Economic growth and its measurement could be, and perhaps

should be, redefined – not sustainable

o E.g. tobacco companies make large amounts of profit on their

products which is considered economic growth. The resulting

increase in hospital and healthcare spending also shows

economic growth but is hardly a benefit to society

o Related to materialism

o The more, the better

 Economic growth “should” include the environmental aspect in

order to make economic growth compatible with sustainable

growth



DEVELOPMENT THEORIES AND MODELS

(mysite.freeserve.com/devtheories/theomod.htm)



Economic development theories and models seek to

explain and predict how

 Economies develop over time

 Barriers to growth can be identified and overcome

 Gov’ts can induce, sustain and accelerate growth with appropriate

development policies

Theories are generalisations

 While LDCs share similarities, every country’s unique economic,

social, cultural and historical experiences means the implications

of a given theory vary widely from country to country

There is no agreed ‘model of development’

 Each theory, like Rostow, gives an insight into one or two

dimensions of the complex process of development

o E.g. Rostow helps us to think about the stages of development

LDCs might take and the Harrod Domar model explains the

importance of adequate savings in that process

The main models of development fall into two categories:

 Stage (or linear)

o Stress similarities between the now underdeveloped economies

and the now developed economies during their early phases of

industrialisation

 Non-linear

o Stress the differences between the conditions faced by the now

undeveloped countries and the conditions faced by the now

developed countries in their early phases of development



The main models (outline)



Comparative advantage (linear)

 Economic theory predicts all countries gain if they specialise and

trade the goods in which they have a comparative advantage

o Lowest opportunity cost

 This is even true if one country has an absolute advantage over

another country



Rostow (linear)

 Linear theory of development

 Economies can be divided into primary, secondary and tertiary

sectors

 The history of developed countries suggests a common pattern of

structural change



Harrod Domar (linear)

 Developed in the 1930s

 Suggests savings provide the funds which are borrowed for

investment purposes

 Rate of savings → rate of investment –determines→ rate of

growth

 To ↑ savings, gov’t can borrow/attract FDI

Lewis

 Structural change model

 Explains how labour transfers in a dual economy

 Growth of the industrial sector drives economic growth

Dependency theory

 Dependency refers to over reliance on another nation

 Dependency theory uses political and economic theory to explain

how the process of international trade and domestic development

makes some LDCs ever more economically dependant on

developed countries

Balanced growth theory

 Argues that as a large number of industries develop

simultaneously, each generates a market for one another

Unbalanced growth theory

 Unbalanced growth theorists argue that sufficient resources

cannot be mobilised by gov’t to promote widespread, coordinated

investments in all industries



Comparative advantage

Different countries have different factor endowments e.g. climate,

skilled labour force, and natural resources vary between nations

 Therefore some countries are better placed in the production of goods

Economic theory suggests all countries gain if they specialise and

trade the goods in which they have a comparative advantage

 This is true even if one country has an absolute advantage over

another country

International trade allows increased specialisation so that higher

output allows economies of scale

 A larger market allows domestic producers greater scope for

economies of scale

 International trade stimulates competition



Absolute advantage

 Occurs when a country or region can create more of a product with

the same factor inputs



Comparative advantage

 Exists when a country has lower opportunity cost in the production of

a good or service

 Do what one is best at

Comparative advantage is used to justify free trade and oppose

protectionism

 Countries benefit if they specialise in the production of a good or

service in which they have a comparative advantage

o I.e. a lower internal opportunity cost

Limits of comparative advantage in development economics

 LDCs tend to specialise in products based on intense labour and/or

land

o The law of comparative advantage demonstrate their standards

of living rise and factor rewards increased given appropriate

exchange rates

o However many LDCs remain poor despite extensive

specialisation

 Overspecialisation in the primary sector has made LDCs susceptible

to the problems of those industries due to:

o Law of Diminishing Returns

o Risk

o Competition

o Difficulty in changing comparative advantage

 Barriers to trade (EU tariffs), unequal bargaining strength and high

transport costs have reduced potential gains from specialization and

trade

 Comparative advantage is a dynamic concept

o A country can lose or acquire comparative advantage overtime

if there is a change in relative efficiency as measured by

opportunity cost ratios

Comparative advantage can be gained or improved through

 Investment in education and training

 Investment in infrastructure

 Research and development to improve competitiveness i.e. lower unit

costs, better product design, and reliability

 Lower inflation rates than competitors

Comparative advantage in the production of some goods has

shifted away from MDCs to LDCs where unit labour costs are

lower

 Some western based firms have started up factories in LDCs where

they can take advantage of cheap labour

 E.g. manufacturing base → China, services → India

International trade requires extensive specialization. This can

have drawbacks including:

 Strategic issues – countries become dependant on imports of

essentials from other countries, a dispute in one country can halt

production in another

 Foreign producers may engage in dumping i.e. selling output below

average cost as part of a predatory pricing strategy (lower prices →

drive out competitors → gain market)

o Such practices are against WTO rules

o Difficult to prove

o The Haitian rice industry was put out of business by dumped

overproduction from the US, courtesy of massive subsidies (→

lower production costs)

 Infant industries may not be able to become established if faced with

competitors from foreign companies with lower costs due to greater

economies of scale

 A country may experience the disadvantage of overspecialisation,

including diseconomies of scale

 Vulnerability to sudden changes in demand

o All products have a life cycle, where a country has specialised

in a product consumers no longer want, structural

unemployment flows



Rostow's 5 stages of growth

American economist WW Rostow suggested that countries passed

through five stages of economic development

 A common pattern of structural change

 A linear process – will happen anyway



Stage 1 – Traditional society (agriculture-based)

 The economy is dominated by subsistence activity where output

is consumed by producers rather than traded

o Produce enough for oneself, not enough to sell in the market

 Any trade is carried out by barter

 Agriculture is the important industry and production is labour

intensive



Stage 2 – Transitional stage (the precondition for take

off – specialisation of primaries)

 Increased specialisation generates surpluses for trading

 There is an emergence of a transport infrastructure to support

trade

 As incomes, savings and investment grow entrepreneurs emerge

 External trade also occurs concentrating on primary products



Stage 3 – Take off (manufacturing e.g. SE Asia, S.

America)

 Industrialisation increases, with workers switching from the

agricultural sector to the manufacturing sector

 Growth is concentrated in a few regions of the country and in

one or two manufacturing industries

 The level of investment reaches over 10% of GNP

 The economic transitions are accompanied by the evolution of

new political and social institutions that support the

industrialisation

o E.g. democracy

 The growth is self sustaining as investment leads to increasing

incomes in turn generating more savings to finance investment



Stage 4 – Drive to maturity (development of industries

→ industrialism)

 The economy is diversifying into new areas

 Technological innovation is providing a diverse range of

investment opportunities

 The economy is producing a wide range of goods and services

and there is less reliance on imports

Stage 5 – High mass production

 The economy is geared towards mass consumption

 The consumer durable industries flourish

 The service sector becomes increasingly dominant

o Agricultural sector becomes increasingly neglected



According to Rostow development requires savings and

substantial investment in capital

 For LDCs to grow the right conditions for investment have to be

created

o If aid is given or foreign direct investment occurs at stage 3,

the economy needs to have reached stage 2

 Savings + investment → capital → mechanisation →

standardisation → mass production/consumption → economies of

scale

Strengths

 Deeply rooted in the economic history of the rich countries

 Highlights the need for investment

o In physical/human capital = machinery/labour

o Capital widening = capital per worker stays constant, more

workers

o Capital deepening = capital per worker rises



Weaknesses

 Assumes that poor countries are poor simply because they 'take

off' later than the rich countries (or because they have not yet

taken off)

 “Wait for take off”



Limitations

 Developed with Western cultures in mind and not applicable to

LDCs

 Its generalised nature makes it somewhat limited

o It does not set down the detailed nature of the preconditions

for growth – vague, there are other considerations for growth

o In reality policy makers are unable to clearly identify stages as

they merge together – hard to pinpoint, some areas developed,

some undeveloped

 It is a growth model and does not address the issue of

development in the wider context

 The determinants of a country's economic development are

usually seen in broader terms, i.e.

o The quantity and quality of factors of production and

technology

o Institutional and social infrastructure

 Doesn’t necessarily state whether development improves or not



Harrod-Domar model

 Developed in 1930s

 Discusses growth, not development

The model suggests that the economy's rate of growth depends on

 The level of saving –leads to→ investment

 The productivity of investment i.e. the capital output ratio

o In machinery

o Want the ratio to be as low as possible



For example, if £10 worth of capital equipment produces each £1

of annual output, a capital-output ratio of 10 to 1 exists



 A 3 to 1 capital-output ratio indicates that only £3 of capital is

required to produce each £1 of output annually

 To increase the output by £2, need £20 as investment

 Smaller the ratio, the better

o Lower ratio by increasing quality of machinery



Harrod-Domar model concludes that:

 Economic growth depends on the amount of labour and capital

 As LDCs often have an abundant supply of labour it is a lack of

physical capital that holds back economic growth and development

 More physical capital generates economic growth

o Depends on amount of machinery/skills

 Net investment leads to more capital accumulation, which generates

higher output and income

o Capital accumulation = total amount of machinery

o Itotal = Ireplacement/depreciation + Inet

o Where Inet = additional/new capital beyond replacement →

increases potential + capacity to serve

 Higher income allows higher levels of saving

 Policies are needed that encourage saving and/or generate

technological advances which enable firms to produce more output

with less capital i.e. lower their capital output ratio

Problems

 Machinery → capital-intensive, but most LDCs are labour-intensive

 Economic growth and development are not the same. Economic

growth is a necessary but not sufficient condition for development

 Practically it is difficult to stimulate the level of domestic savings

particularly in the case of LDCs where incomes are low (FDIs)

 Borrowing from overseas to fill the gap caused by insufficient savings

causes debt repayment problems later

 The law of diminishing returns would suggest that as investment

increases the productivity of the capital will diminish and the capital

to output ratio rise

o E.g. computers replaced labour but opened up a new sector



Lewis model

 Driven by industrialism

 Model = structural change model that explains how labour transfers in

a dual economy

30-40 % of people in LDCs live in urban areas

o In MDCs, e.g. France = 80%, Italy = 70-80% live in urban

areas

 Often responsible for a large fraction of national output

o B/c countryside has bad infrastructure, etc

 Cities may employ relatively modern manufacturing techniques

o Due to multinationals

 The level of education, though smaller than in the developed

economies, is typically far higher than in the rural sector

o Rural sector = high illiteracy rates

 Surplus labour in rural areas is sometimes disguised unemployment

o Disguised unemployment = doing jobs where there are others

available/you aren’t needed

 Disparity between rural and urban economies is known as the dual-

economy

o Behaviour of migration from one to another

o Higher wages attract workers from rural areas to urban areas

 Neglect of countryside is supported by infrastructure/subsidies



The Lewis model argues that growth of the industrial

sector drives economic growth

 Economic growth requires structural change in the economy

 Whereby surplus labour in traditional agriculture sector with low or

zero marginal product, migrate to the modern industrial sector where

there is high rising marginal product

o Marginal product = value of what is produced by one worker

o Value of one worker is higher in urban area

Growth means jobs for surplus rural labour

 Additional workers in urban areas increase output hence incomes and

profits

 Extra incomes increase demand for domestic products while increased

profits fund increased investment

 Hence rural urban migration offers self generating growth

The ability of the modern sector to absorb surplus workers

depends on the speed of investment and accumulation of capital

 Where firms invest in new labour saving capital equipment, surplus

workers are not taken on by the formal sector – more machinery per

worker

 Workers go back or work illegally

 Higher wages → more demand → more consumption and savings →

more investment → growth → more jobs

 Higher incomes in urban areas → more demand for agricultural

products →

 incentives for investment



Criticisms

 Recently arrived rural immigrants join the informal economy and live

in shantytowns

 Given urban growth drives economic growth it can lead to neglect of

agriculture by gov’t, yet most people live in rural areas where incomes

are relatively low

 Increased profits maybe invested in labour saving capital rather than

taking on newly arrived workers

 For many LDCs, rural urban migration levels have been far greater

than the formal industrial sector’s ability to provide jobs

 Urban poverty has replaced rural poverty

o Urban poverty is worse

 Trickle down effect does not occur, inequalities still exist/widen

o Benefits don’t flow down

 Urban unemployment has risen to as high as 20% in some LDCs

o Underutilised human resources

o Source of political unrest



Conclusions

 Savings investment

 Free market

 Needs gov’t to direct investment

 In theory surplus workers migrate

o In reality more than the surplus workers leave agriculture

 Too many cash crops may be grown at the expense of food needed for

sustenance – instant cash

 Generated wealth can be leaked out because entrepreneurs may save

in $ instead of local currency to get a better rate of return

 Focus on industrialism



Dependency theory

Dependency refers to over reliance on another nation

 Poor countries depend on rich countries to develop

 Uses political and economic theory to explain how the process of

international trade and domestic development makes some LDCs

ever more economically dependant on developed countries

o E.g. Mexico, Honduras on USA

 Refers to relationships and links to between developed and developing

economies and regions

 Sees underdevelopment as the result of unequal power relationships

between rich developed capitalist countries and poor developing

countries

Powerful developed countries dominate dependent powerless

LDCs via the capitalist system.

 In the dependency model under development is externally induced

o Dominated by outside

o Rich exploits poor so poor remains poor

 Growth can only be achieved in a closed economy and pursue self-

reliance through planning

o Socialist approach, ISI approach

Dominant DCs have such a technological and industrial

advantage that they can ensure the 'rules of the game' (as set out

by the World Bank and IMF) works in their own self-interest

 World Bank + IMF = controlled by Americans/Europeans

In this model only a breakup of the world capitalist system and a

redistribution of assets will 'free' LDCs



Balanced growth theories

Balanced growth involves the simultaneous expansion of a large

number of industries in all sectors and regions of the economy

 Balanced growth theory argues that as a large number of industries

develop simultaneously, each generates a market for another



If a large number of different manufacturing industries are

created simultaneously then markets are created for additional

output

 For example, firms producing final goods can find domestic industries

that can supply them with their inputs

o E.g. car industry → paint/tire/etc industries

 The benefits of growth are spread over all sectors and, ideally, regions



Assumes that industries are interdependent

 The input from one industry is the output from another industry



Predicts that a planned economy rather than a market economy is

more likely to achieve economic development and balanced

growth

 → more gov’t control + direction



It argues that free markets are unable to deliver balanced growth

because entrepreneurs:

 Do not expect a market for additional output – why risk resources

when sales are uncertain?

 Require skilled workers but are not willing to hire and train unskilled

staff who may then leave to work for rival firms

o Assumption that there are qualified/skilled workers

o Employers cannot internalise their positive externalities

 Do not anticipate the positive externalities generated by the

investment of other firms engaged in expansion

 Are unable to raise finance for projects



State planning and intervention is required to:

 Train labour

 Plan and organise large-scale investment programmes

 Mobilise the necessary finance

 Nationalise strategic industries and undertake infrastructure

investment e.g. build roads

 Protect infant industries through tariff and quota policies



Criticisms:

 The strategy of balanced growth is beyond the resources of most poor

countries

 Balanced growth within a closed economy rather than specialisation

and trade contradicts comparative advantage

 Gov’t planning results in gov’t failure

o I.e. gov’t intervention in the market fails to bring about an

efficient allocation of resources e.g. planning process creates a

bureaucracy

o Overmanning

o Misuse of funds

o Baises

 LDC development policies focusing on import substitution,

agricultural self-sufficiency and state control of production yield poor

growth



Economic reform

 Privatisation, liberalisation + deregulation = less state intervention

 State’s role = facilitator to provide conditions so that industries can be

invested in

o Allows for competition

o Allows entrepreneurs to seek finance from anywhere

o Free market prices

o Floating exchange rate/currencies

 SME = responsible for growth



Unbalanced growth theory

Unbalanced growth theorists argue that sufficient

resources cannot be mobilised by gov’t to promote

widespread, coordinated investments in all industries

 Gov’t doesn’t have the ability for growth in all sectors

They share analysis with balanced growth theorists that free

markets, alone cannot generate development but differ in that

gov’t planning or market intervention is required just in strategic

industries

 Strategic industries = e.g. steel, coal mines, energy sources, glass,

copper, plastic, logging of wood, research + development,

infrastructure, irrigation, provision of information, raw materials

o Those with the greatest number of backward and forward links

are prioritised

 Let free markets decide what to do with input

 Aid efficiency of industries/sectors



A country lacks resources to finance balanced growth. Resources

are therefore concentrated on strategic industries with:

 Significant forward linkages

o I.e. firms creating essential inputs for other key firms in the

economy

 Significant backward linkages

o I.e. key firms buy industrial inputs from a large number of

domestic firms

 Import substitution

o Developing domestic industries replaces imports and so

improves the balance of payments



Gov’t identifies strategically important areas with significant

backward and forward linkages to

 Nationalise (planned economy)

 Subsidise (market economy)



Gov’t responsible for:

 Merit goods which benefits the majority of the population

o E.g. education facilities, dam/canal system, etc

 Insuring that materials are safe

 Improving lives

o E.g. legal system

E.g. state owned development banks finance priority investment projects chosen for their

contribution to growth and development