The Causes of Economic Growth
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Economic Growth is caused by improvements in the quantity and quality of the factors of
production that a country has available i.e. land, labour, capital and enterprise. Conversely
economic decline may occur if the quantity and quality of any of the factors of production falls.
Improving the Quantity and Quality of Land Resources
Increases in the quantity of land available for agriculture will increase economic growth.
However, the extent to which this happens is limited to the extent to which bush land can be
converted to agricultural land. All economic resources are scarce and have an opportunity cost.
As bush land is increasingly used for agricultural purposes it is no longer a habitat for wildlife.
The relative scarcity of land in the face of a growing population means that the law of
diminishing returns might also become relevant. The law predicts that an increasing amount of
labour applied to a fixed quantity of land the marginal productivity of the labour will fall. This
was the basis of the argument put forward by the Reverend Thomas Malthus. To prevent this
loss in productivity the quality of the land must be improved. This can be done through the
application of better technology through improved irrigation, fertilisers and pest control
Improving the Quantity and Quality of Human Resources
Increases in the supply of labour can increase economic growth. Increases in the population can
increase the number of young people entering the labour force. Increases in the population can
also lead to an increase in market demand thus stimulating production. However, if the
population grows at a faster rate than the level of GDP the GDP per capita will fall.
It is not simply the amount of labour that will lead to economic growth. It is often the quality of
that labour. This will depend on the educational provision in countries. Improving the skills of the
work force is seen as being an important key to economic growth. Many LDCs have made
enormous efforts to provide universal primary education. As more and more capital is used,
labour has to be better trained in the skills to use them, such as servicing tractors and water
pumps, running hotels and installing electricity. It should always be remembered that education
spending involves an opportunity cost in terms of current consumption and thus it is often
referred to as investment spending on human capital.
Improving the Quantity and Quality of Capital Resources
One can distinguish between:
1. Directly productive capital - plant and equipment e.g. factories
2. Indirectly productive capital - infrastructure or facilitating capital e.g. roads and railways.
The process of acquiring capital is called investment. The opportunity cost of capital investment
is the current consumption foregone. The level of investment and the quality of investment will
directly affect the level of economic growth. The efficiency of the labour force and the other
factors of production will depend upon the amount and quality of capital they have. In LDCs
some investment comes from abroad in the form of foreign direct investment. This is usually
through multinational enterprises locating in a country. There has been criticism of some
investment in LDCs as to whether it is appropriate. If production moves from being labour
intensive to capital intensive, unemployment and poverty increases.
The Quantity and Quality of Enterprise resources
The level of economic growth may be slowed down if there is a lack of entrepreneurial and risk
taking managers. For growth to take place inventions and innovations must be encouraged.
Again the role of education is seen as being essential here. Multinational enterprises also can
provide training in management skills.
In countries like Zambia where for many years the government has taken a considerable role in
production through parastatals there might be a lack of enterprise culture. In addition, where
traditional agriculture has been communally organised then the move towards a private sector
profit making culture is likely to be slow.
Thus there are many potential economic, cultural and social barriers to economic growth.
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The Causes of Inflation
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This area of economics has probably given rise to one of the most significant macroeconomic
debates in recent history. There are essentially two causes of inflation.
Inflation bought about by an increase in demand (called Demand Pull Inflation)
Inflation bought about by an increase in the costs of the factors of production (called
Cost Push Inflation)
The debate has been over which particular one of the above predominates. In addition there is
also argument over how demand pull inflation is actually caused. These arguments exist because
each protagonist in the debate has different ideas about the policy measures that can be used to
tackle inflation. In the last two decades the prevailing view in most countries has tended to be
predominantly the neo-classical view of inflation. The multilateral donor organisations such as
the IMF and World Banks have supported this view and this has had an impact on the economy
of Zambia through the macroeconomic stabilisation (including anti- inflation policies) that have
been made conditions of loans and foreign aid.
Let us consider the debate.
Demand Pull Inflation
Increases in aggregate demand brought about by an increase in any of its component parts will
cause the aggregate demand curve to shift to the right.
The increase in aggregate demand causes excess demand and prices are raised from r0 to r1.
The cause of demand pull inflation
The debate exists about what actually brings about these changes. The two schools of thought
Monetarists ( the neo-classical)
Non-monetarists (the neo-Keynesians)
The Monetarists essentially believe that the increase in aggregate demand is influenced almost
entirely by the amount of money in the economy, namely the money supply. They argue that
inflation is caused by the amount of money in the economy and hence the spending power of the
population exceeding the capacity of the country to produce goods and services.
The monetarists argue that policies that result in increases in the money supply such as attempts
to stimulate the national income of a country will only have short-term effect on real output but
generate inflation. Increased money supply will lead to increases in spending through
transmission mechanisms and this will invariably create a situation where aggregate demand for
goods and services exceeds the aggregate supply resulting in demand pull inflation. This is
shown by the shift of the short-run aggregate demand curve in the diagram below.
The role of the budget deficit
The Monetarists identify the budget deficit as one of the main culprits in inflation. If government
spending exceeds government revenue printing more money or borrowing are inevitable. Both
result in increases in the amount of money supplied. In Zambia the IMF argued that the high
levels of government spending on supporting a large and bureaucratic civil service contributed to
the inflationary pressures in the economy.
Instead they argue that policies should address the supply side. By complementing strict control
of the money supply with supply side policies aimed at providing incentive for firms and workers
to become more efficient situations of excess aggregate demand are unlikely to happen. The
higher level of aggregate supply that results from the supply side policies can support a higher
level of demand without inflation. This is shown in the diagram below.
Finally they also stress the need for a market determined exchange rate. Fixed exchange rate
systems take the control of the money out of the hands of the government.
The Non Monetarist or Keynesian Argument
These economists dispute the link between increases in the money supply and inflation. They do
so on a number of counts. They argue that keeping a tight control over money supply so as to
control spending is highly questionable. Spending they say is not only dependant on the amount
of money in the system but also how rapidly it is used. This velocity of circulation will vary. So
controlling money supply will not necessarily control spending as the velocity of circulation can
They argue that increases in money supply will lead to increases in spending and providing there
are unemployed resources firms will increase output in response.
They also worry about the line of causality of the Monetarists assertion that increases in money
supply lead to prices increase. Perhaps the amount of money in the economy responds to
changes in the price level?
Finally they argue that basing economic problems on controlling money supply is fraught with
practical problems. How do you define the money supply? What is included in the measure of
money? Cash? Cheque Accounts? Savings Accounts? How do you actually go about controlling
the amount of money. In a world where there many ways in which people can borrow money,
can monetary policy successfully control the amount available for spending?
The Non- Monetarist View of Inflation
The non-monetarists put forward two possible explanations of inflation. Firstly they recognise
that increases in aggregate demand may lead to demand pull inflation. Increases in spending in
excess of the full employment level of output will create shortages (overheating) and firms will
raise their prices. This can be shown by a shift of the aggregate demand curve to the right. Real
GDP will increase but with higher prices. Given the diagram below with the distinctive aggregate
supply curve the price level will increase once the economy has passed the full employment level
Cost Push Inflation
Increases in costs of production cause the aggregate supply curve to shift to the left. This may
occur if there are increases in the costs of the factor inputs or if there is a supply shock such as a
The non- monetarists also suggest that one of the main causal factors of inflation is an increase
in the costs of the factors of production. When firms' costs increase they will raise their prices in
order to maintain the real value of their profits. This will result in the real incomes of the owners
of the factors of production e.g. wages, falling. In an attempt to maintain their real income
labour will demand higher money wages and this will in turn raise costs. This is often referred to
as cost push inflation and may be caused by:
Increases in factor prices e.g. oil price increase.
An increase in wage settlements in excess of any increase in productivity.
A devaluation or depreciation of currency leading to an increase in import prices.
Interest rate increases will increase the cost of borrowing.
Indirect taxation or the removal of subsidies.
Cosh push inflation can be shown using the aggregate demand and aggregate supply curves. In
this case it is not the aggregate demand that increases, it is the aggregate supply curve that
shifts to the left, as in the diagram below.
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The Impact of Multinational Enterprises
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A multinational enterprise is a firm that has productive capacity in a number of countries. The
profit and income flows that they generate are part of the foreign capital flows moving between
As countries adopt more open outward oriented approaches to economic growth and
development the role of multinational enterprises (MNE) or transnational corporations become
more important. As local markets throughout the world are being deregulated and liberalised
foreign firms are looking to locate part of the production process in other countries where there
are cost advantages. These might be cheaper sources of labour, raw materials and components
or have preferential government regulation. Although LDCs may present high levels of risk they
also present the potential for higher levels of profit. Many LDCs with growing economies and
increasing incomes may provide future growth markets.
Many development economists are concerned with role of the MNEs in low income countries and
identify a number of problems associated with foreign direct investment. Equally other
economists and politicians argue that MNE activity can drive growth and development. The true
answer is that probably the arguments put by both sides are applicable in certain countries with
certain MNEs at certain times.
The Benefits of Multinational Corporations
Let us consider the arguments from both sides. Firstly, from those who maintain the importance
of foreign direct investment as part of the engine necessary for growth.
A MNE investing in an area may result in a significant injection into the local economy.
This may provide jobs directly or through the growth of local ancillary businesses such as
banks and insurance. It might initiate a multiplier process generating more income as
newly employed workers spend their wages on consumption.
MNEs may provide training and education for employees thus creating a higher skilled
labour force. These skills may be transferred to other areas of the host country. Often
management and entrepreneurial skills learned from MNEs are an important source of
MNEs will contribute tax revenue to the government and other revenues if they purchase
existing national assets as in the case in Zambia through the privatisation process.
In the light of these benefits what are the problems and concerns associated with MNEs?
The Problems of Multinational Enterprises
The MNE may employ largely expatriate managers ensuring that incomes generated are
maintained within a relatively small group of people. The attraction for the MNE may be
the large supply of cheap manual labour who they can employ at low wages. This may
contribute to a widening of the income distribution. It will also not lead to the transfer of
MNE investment in LDCs often involves the use of capital intensive production methods.
Given that many LDCs are often endowed with potentially large low wage labour forces
and have high level of unemployment this might be considered inappropriate technology.
More labour intensive production methods might be a more appropriate option for
alleviating poverty and aiding development. Any resulting growth might be considered
MNEs engage in transfer pricing where they shift production between countries so as to
benefit from lower tax arrangements in certain countries. By doing this they can minimise
their tax burden and the tax revenue of national governments.
As many MNEs are very large and have considerable power they can exert influence on
governments to gain preferential tax concessions and subsidies and grants.
Outward oriented economists maintain that the cycles of poverty will not be broken from within
the domestic economy. The level of investment needed to raise productivity and incomes is not
possible. Thus foreign direct investment through the MNE activity is essential.
By investing in areas and utilising the factors of production where the LDCs have an absolute and
comparative advantage MNEs will lead to a more efficient allocation of the worlds' resources.
However if this leads to overspecialisation and overdependence in certain sectors of the economy
then the host country will be vulnerable especially if the MNE decides for commercial reasons to
leave the country in the future.
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Externalities: a form of market failure
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Externalities are where the consumption or production of a good impacts on people other than
the producers or consumers that are participating in the market for that good. They are the side
effects borne by third parties. In each case the firms or the individuals will bear some form of
cost known as the external cost. There are a number of types of externality. Some are of
particular relevance to the copper industry.
Producer on producer externalities e.g. a copper smelting firm contributing to acid
rain which affects the crops of surrounding farmers
Producer on consumer externalities e.g. a copper smelting firm causing air pollution
that causes tuberculosis
Consumer on consumer externalities e.g. smokers causing smoking relating ailments
in non- smokers
Consumers on producer externalities e.g. passenger cars causing congestion and
slowing business traffic
The above suggest that these externalities are always negative and result in external costs. In
addition to negative externalities there are positive externalities i.e. benefits accruing to non-
participants in the market place arising from the consumption and production of goods and
services. These are the external benefits.
Why do economists consider the impact of these? Economists are always interested in the use of
resources. When externalities result in third parties having to use resources in response to the
external costs and benefits, such as those residents of Copperbelt who need hospital care or
have to take days off work due to pollution related illness, there has been a misallocation of
resources. They recognise that the market for the good has not taken into account all of the
costs and benefits from production and consumption. This is called market failure.
Supply and demand analysis can be used to consider the effect of such negative externalities.
Price can be considered to be a measure of the benefit that a consumer derives from the
consumption of a unit of a good or service. This is called the private benefit. Thus the demand
curve (showing the price that people are prepared to pay for a good or service) can be referred
to as the private benefit curve.
The supply curve represents the costs of the factors of production involved in the production of a
good or service. Thus the supply curve can be referred to as the private cost curve. In the free
market the equilibrium position occurs where the supply equals the demand -where the private
costs and private benefits are equal.
In the diagram below the interaction of the market demand and supply curves result in Q^ being
produced and P^ being charged. This occurs where the private cost is equated with the private
Let's now consider a good or service where there are external costs due to a negative
externality. The production of the good involves private costs and external costs. The full cost to
society or social cost would include both. In considering the full cost to society the external costs
should be added to the private costs. The diagram below illustrates this where the amount of the
external cost is added onto the supply curve. This gives us the social cost curve (MSC) showing
the total cost to society of the production of the good.
Social costs = Private costs + External costs
The supply and demand curves only take into account the private costs and private benefits and
none of the costs or benefits experienced by third parties. The market price and output of P0 and
Q0 do not coincide with the level of output and the price that reflects the full cost to society.
The price that should be paid if all the costs of the negative externalities are taken into account
would be shown in Fig 2 as P1 and the quantity would be Q1. The market failure in this case is
that the free market over-produces and under-prices goods with associated negative
In the case of the copper industry the world price of copper does not take into account the
damage that is being done to those people who are experiencing the effects of environmental
pollution. Indeed as the consumers of copper and the producers of copper are located in different
countries. Some would argue that as long as the environmental impact of production is restricted
to the LDCs the wealthy consumers have little incentive to worry about the negative externalities
associated with it.
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External benefits - These are also known as positive externalities. They are impacts on
`outsiders` that are advantageous to them and for which they do not have to pay.
Externalities occur where the actions of firms and individuals have an effect on people
other than themselves. In the case of positive externalities the external effects are
benefits on other people. There may be external benefits from both production and
consumption. If these are added to the private benefits we get the total social benefits.
An example of positive externalities would be the side effects of production processes.
External costs - They are also known as negative externalities. They are impacts on
`outsiders` that are disadvantageous to them and for which they receive no
compensation. The externalities are occurring where the actions of firms and individuals
have an effect on people other than themselves. In the case of negative externalities the
external effects are costs on other people. There may be external costs from both
production and consumption. If these are added to the private costs we get the total
social costs. An example of negative externalities would be the side effects of production
processes e.g. the pollution (noise, dust, vibration) endured by people living next to a
External debt - the total amount of private and public foreign debt owed by a country
Externalities - The spillover effects of production or consumption for which no payment
is made. Externalities can be positive or negative. For example all fax users gain as new
users become connected (positive); and smoke from factory chimneys (negative).
Negative externalities - Impacts on `outsiders` that are disadvantageous to them and
for which they receive no compensation. The externalities are occurring where the actions
of firms and individuals have an effect on people other than themselves. In the case of
negative externalities the external effects are costs on other people. They are also known
as external costs. There may be external costs from both production and consumption. If
these are added to the private costs we get the total social costs. An example of negative
externalities would be the side effects of production processes e.g. the pollution (noise,
dust, vibration) endured by people living next to a quarry.
Positive externalities - Impacts on 'outsiders' that are advantageous to them and for which
they do not have to pay. Externalities occur where the actions of firms and individuals have an
effect on people other than themselves. In the case of positive externalities the external effects
are benefits on other people. These are also known as external benefits. There may be external
benefits from both production and consumption. If these are added to the private benefits we get
the total social benefits. An example of positive externalities would be the side effects of