Section 4: Development economics (Review Notes) Be familiar with at least 3 of these goals:

The Millennium Development Goals

1. Eradicate extreme poverty and hunger w Halve the proportion of people living in extreme poverty by 2015. w Halve the proportion of people who suffer from hunger by 2015. 2. Achieve universal primary education w Ensure that by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary school education. 3. Promote gender equality and empower women w Eliminate gender disparity in primary and secondary education, preferably by 2005, and in all levels of education no later than 2015. 4. Reduce child mortality. w Reduce by two-thirds the under-5 mortality rate by 2015 (health). 5. Improve maternal health w Reduce by three-quarters the maternal mortality ratio by 2015 (health). 6. Combat HIV/AIDS, malaria and other diseases w By 2015 halt and begin to reverse the spread of HIV/AIDS w By 2015 halt and begin to reverse the incidence of malaria and other major diseases. 7. Ensure environmental sustainability w Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. w Halve by 2015 the proportion of people without sustainable access to safe drinking water and basic sanitation w By 2015 achieve a significant improvement in the lives of at least 100 million slum dwellers. 8. Create a global partnership for development with targets for aid, trade and debt relief w Develop further an open, rule-based, predictable non discriminatory trading and financial system w Address the special needs both of the least developed countries and of landlocked and small island developing countries. w Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable w In cooperation with developing countries, develop and implement strategies for decent and productive work for youth w In cooperation with pharmaceutical companies, provide access to affordable essential drugs in developing countries w In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.

4.1 Economic Development Definitions: Differentiate between economic growth and economic development: Economic growth: This occurs where there is an increase in the productive potential of the economy and is best measured by the increase in a country's real level of output over a period of time i.e. the increase in real Gross Domestic Product (real means adjusted for inflation). Economic development: Economic development, on the other hand is a process where there is improvement in the lives of all people in the country. This involves not only living standards, such as greater availability of goods and services (and also the ability to purchase them) but also the promotion of attributes such as self-esteem, dignity and respect, and the enlarging of people's freedom to choose and to take control of their own lives. While a country may grow richer therefore, through the growth of its real output, it does not necessarily mean that it will experience development.

Is it possible to develop without growth?

• If growth occurs with no improvement in living standard for most of the population, then economic development has not taken place.

• Growth occurs:

• Through increases in the factors natural resources and capital. • It also occurs by increasing the productivity of existing factors through investment in

education (labor) and technology (capital).

A. Increasing or improving Factors of Production

Natural resources: • It is estimated that more than half the renewable natural resources are being utilized in

the world. This includes arable land, fisheries, forests, and water. • There are still significant amounts of non-utilized arable land in some African and Latin

American countries.

Labor: population growth rates in LDCs reduce growth in per capita GDP.

Capital: • Investment in machinery and equipment add directly to productivity. • Investment in infrastructure such as roads, bridges, dams, sanitation and electricity are

indirectly productive, but equally as essential. • The opportunity cost of capital investment is the lower levels of current consumption,

which result from saving. Savings present a great hardship for people who may already be living below the poverty line.

• Technology developed in MDCs is appropriate for labor scarce, rich countries. Because it is labor saving, it is inappropriate in labor abundant countries where it is more efficient to use more labor and less capital.

• Capital-intensive development often displaces workers and does little to reduce unemployment.

• Factor rewards go to capitalists or investors from foreign countries. It does little to relieve poverty.

B. Improvements in the Institutional Environment - Rule of law or at least property rights can support local populations in growing the economy and distributing income more equitably. This requires a functioning political system that does not have to be democratic to achieve development aims (i.e. PRC). • Key institutions: property ownership or land tenure, domestic markets (free or controlled),

labor markets, education, financial sector (savings and investment, capital markets), international trade (import substitution or export oriented), govt. (structures and experience), and the colonial creation of artificial countries.

• Countries with a history of stable govt. and a developed commercial sector including merchants, financiers, and businesses familiar with international trade tend to have fewer problems with development.

• Countries with govts. previously dominated by colonial powers and with commerce

controlled by minorities, find it difficult to compete in international trade and finance.

The Need for Stable Govt. • Stable govt. reduces risks for local investors, encourages investment, and reduces capital

flight • Stable govt. is more willing to make tough decisions such as devaluation, reducing urban

subsidies, reducing overstaffed bureaucracies, reducing tariffs to promote competition, and perhaps redistributing income to poorer people

• Stable govt. is more able to encourage small scale entrepreneurs to: • Take initiative, develop managerial ability, and undertake risks. • Train to overcome weaknesses in marketing, finance, and managerial ability.

C. Increasing Productivity – Higher productivity does not require high tech solutions:

• Billions of dollars in aid for large scale, high tech projects has only increased

dependency for the poor rather than increasing productivity. • What is needed is technology appropriate for the poor, which will allow them to help

themselves. • Appropriate technology uses local materials, and local labor skills, and capital that can

easily be repaired locally: Simple clay stoves, pipe wells, pipe latrines, micro hydro power transformers, better harnesses for oxen etc.

Improving natural resources productivity in agriculture • While there is still land to be developed, the bulk of land available to most populations is

limited in size. • Irrigation, drainage, the use of chemicals for fertilizing, pest and weed control, and the use of

machinery can increase productivity dramatically. • The green revolution is an example of this.

• The problem is that the damage to the soil can be so extensive, that the increase in productivity may only last 70 years before the soil is destroyed.

• Already India is starting to seriously question the use of irrigation, machinery and chemicals as soil degradation is very serious.

• Both India and Egypt have severe water crisis due to overexploitation of ground water resources.

Increasing productivity of labor • If 50% to 70% of economic growth arises from improvements in the productivity of factors,

there is a need for better education, greater efficiency in management, and better training in technology.

• LDCs have made large investments in primary and secondary education. • Increase in worker skills is essential in order to make use of capital equipment and new

technology, and to provide the services needed for growth in the future.

Common Characteristics of LDC’s

Todaro

1. Low levels of living characterized by low Y, poor health and inadequate education. 2. Low levels of productivity. 3. High rates of population growth and dependency burdens. 4. High and rising levels of unemployment and underemployment. 5. Substantial dependence on agricultural production and primary product exports. 6. Prevalence of imperfect markets and limited information. 7. Dominance and dependence and vulnerability on International relations. This is made evident by technological transfer, aid and trade patterns dominated by MDC’s in addition to brain drain and the transfer of values and attributes. Yet all are different: All have different histories, cultures and resource endowments. Therefore, there is no one size fits all solution nor is there a single path to development!

• Singapore’s path differs greatly from India’s due to different geographic locations and populations.

• Even though India and Pakistan used to be one colony of the UK, different cultural aspects influence their path to development.

• Zambia has an abundance of copper with no access to the coast yet Somalia does have coastal access but little in the way of natural resources to offer.

• Brazil’s colonization was at the hands of the Portuguese with a long history of slavery and Argentina’s colonization was by the Spanish with many fewer slaves.

Vicious Cycles of Poverty: Many LDC’s are afflicted by an inability to get out of the cycle of poverty that is perpetuated by the inability to save. Individual - For an individual education plays a critical role in improving productivity and incomes.

Source: World Bank

Nation States – In essence this played out on a larger stage due to population pressures in many LDC’s

Combined Cycle of Poverty

4.2 Measuring development Single indicators – GDP per capita v. GNI per capita GDP = GDP at purchaser's prices is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. GNI = GNI is the sum of value added by all resident producers plus any product taxes (less subsidies) not included in the valuation of output plus net receipts of primary income (compensation of employees and property income) from abroad. This may mean that less stays in the country! GDP p.c. in 2010 Afghanistan USD 457 Cameroon USD 1444 Sweden USD 57,114 GNI p.c. in 2010 Afghanistan USD 420 Cameroon USD 1190 Sweden USD 50,780 Health indicators Malnutrition prevalence, weight for age (% of children under 5) 2010 Cambodia 29% Greece 1.1%

Mortality rate, under-5 (per 1,000 live births) 2010 Chad 171 Belgium 4

Births attended by skilled health staff (% of total) 2010 Laos 37% Norway 100%

Education indicators Literacy rate, adult total (% of people ages 15 and above) 2010 Sierra Leone 42% Denmark 100%

School enrollment, secondary (% net) 2010 Burundi 16% Japan 100%

Composite Indicators: Most common is the Human Development Index (HDI). The breakthrough for the HDI was the creation of a single statistic, which was to serve as a frame of reference for both social and economic development. The HDI combines three dimensions:

• A long and healthy life: Life expectancy at birth • Education index: Mean years of schooling and Expected years of schooling • A decent standard of living: GNI per capita (PPP US$)

Some sample HDI’s

Is it possible to have a higher GDP/GNI ranking and a lower HDI measure?

4.3 Domestic Factors in Development Population is the elephant in the room…this is a distinct difference from the experience of MDC’s economic history. • Populations are much larger, population densities greater, and education levels lower than

they were for MDCs during their period of industrialization. • Crowding in cities usually leads to pollution, health and sanitation problems, crime and

vandalism, and a breakdown in infrastructure (New Delhi, Sao Paulo, Jakarta) • Reinforces the rural-urban divide

A. Education and Health – Improvements in health increase productivity and standards of living.

1. As countries develop the death rate drops very quickly due to:

• Sanitation: there is a reduction in infant mortality due to better sanitation, cleaner water and basic health knowledge,

• Health care: there is a reduction in mortality from disease because of better health care systems and access to health care providers

• Agricultural production: as food production increases deaths resulting directly or indirectly from malnutrition fall

2. As countries develop the survival rate for children increases and there is a rapid increase in children as a proportion of the population, savings and investment rates fall:

• This increases dependency rates within families, per capita income falls as

unproductive children are housed and fed, • Children under 15 form 25% of MDC population and 50% of the LDC

population, which leads to a high dependency ratio of non-workers to workers. • Because of the young population, fertility rates are very high and birth rates

increase yet again: healthier, better fed women have a greater capacity to give birth to a healthy child.

B. Use of Appropriate Technology

Very straightforward – a country misallocates resources to infrastructure or glamour projects if they focus on the latest cutting edge technology instead of that which is necessary to get the job done. Examples:

a. 8 lane bridges in community where there are 1000 cars.

b. Scanning technology for toll collection in a community with high unemployment and unpredictable electrical power.

c. Encouraging the use of physical capital in agriculture when areas of cultivation are too small.

C. Access to credit and micro-credit –

Lack of capital is a serious problem in the developing world for entrepreneurs and established businesses. Problem of access to credit - Most LDC citizens do not use banks for several reasons

1. Do not make enough money to need a bank 2. Banks do not locate in slums or in rural areas due to lack of profit incentive 3. Banks will not lend to the poor 4. Bank services cost too much (loan origination and other services) 5. Moneylenders are more readily available 6. Lack of trust in the banking system

Micro-credit can help – Popularized by Mohammed Yunus in the book Banker to the Poor and

the group Kiva. Grameen Bank in Bangladesh the first one. Microlenders lend small amounts of money to groups of poor people, mainly to help foster entrepreneurship and trade. For example, in India $2.5 billion in micro loans in 2009 to 22.6 million borrowers. Benefits

1. Small loans that are paid back daily 2. Focus on lending to women 3. Minimize administration costs 4. Lower interest rates than banks and moneylenders 5. Usually the community knows the administrator.

Problems:

1. Not every poor person is an entrepreneur waiting to be discovered. 2. Peer pressure in remote villages can be immense and break down the social fabric 3. Profit incentive has drawn in loan sharks (Nigeria & Mexico) 4. Big banks are now involved in India and other countries to

D. The empowerment of women –

We know that educating women is the best way to improve health and education of children and long run productivity.

* In rural areas, women are often the poorest of the poor. Men control most of the land, capital and technology, and receive a better education in most countries. This can have a major impact on population control.

* Education allows for women to be able to better access family planning, understand the need for pre-natal care and good nutrition for children.

* Educated women are more likely to keep their children in school thereby improving the education level of successive generations.

* * With greater wealth and income in the hands of women, the child mortality rate is low,

and spending on health, nutrition and education for children has been very high: the illiteracy rate is very low.

* E. Income distribution

 

If the most important cause of inequality is an unequal distribution of land, natural resources and capital, attempts must be made to redistribute at least some natural resources such as land.

A. Land reform can often lead to a dramatic increase in farm productivity and incomes for the rural poor.

B. Children of the elite have greater access to education and to the best jobs: Policies to open access to education for the poor, to reduce absenteeism and improve the quality of education can lead to great increases in productivity.

C. Growth needs to be targeted at those sectors, which will reduce poverty. D. Raising the income of the poor will lead to increased consumption of necessities, which

are produced within the country.

E. Local production stimulates investment, incomes and jobs and leads to improved health and education, which, in turn, increases productivity.

4.4 International Factors in Development Problems with international trade for LDC’s

• Overspecialization in a narrow range of products – Usually very little diversity so the economy is dependent upon foreign demand for income.

• Price volatility of primary products

a. In farming: supply shocks due to weather and disease combined with inelastic demand means farm revenues are very unstable.

b. Low-income elasticity of demand for primary goods, the substitution of synthetic materials and the dramatic reduction in the weight and bulk of manufactured goods have all led to virtually no growth in demand.

c. World demand: tends to be inelastic: there are no substitutes for primary goods: d. World supply: intense competition amongst LDCs lowers price and total revenue. e. Supply price elasticity problems:

In mining: shifts in demand for minerals due to MDC economic cycles combined with inelastic supply means mineral revenues are very unstable

• Inability to access international markets – due to MDC protectionism. I. Strategies for economic growth and development

A. Import Substitution (Inward Oriented) • Tariffs are imposed and imports fall: • The first to be protected are final stage assembly and simple consumer goods. • Over time, parts fabrication and more sophisticated manufacturing is protected. • Domestic production increases and unemployment falls. • Capital and intermediate goods become more expensive, otherwise why would tariff barriers be

needed to promote sales of domestic equivalents? • Costs rise for exports, exports fall, and unemployment rises in the export sector.

1. The benefits from import substitution: • There is greater vertical integration within industries (both upstream and downstream):

• Research, development, engineering, design, fabrication, assembly, marketing, and financing provide a richer variety of jobs

• There is greater integration amongst industries (both backward and forward linkages) • Learning by doing takes place. • There is less dependence on other countries, therefore less specialization and more

evenly distributed development in the economy.

2. The costs of import substitution: • Infant industries never grow up because the lack of international competition leads to

higher costs. • With few imports of capital goods, there is virtually no technology transfer.

• The export sector collapses so there are no gains from trade • Economies of scale cannot be achieved because the market is too small. • Balance of payments problems lead to a reduction in imported capital which is often

needed for industrialization to proceed: • Producers are cut off from new technology in international markets.

• The poor gain little; the major beneficiaries are the wealthy and the MNCs operating behind tariff walls.

• Govt. tends to subsidize capital, and currencies are held artificially high to encourage the use of imported capital and intermediate goods:

• Industry becomes less labor intense, leading to unemployment. • Exporters of primary goods (the poor) are hurt: because LDCs face perfectly elastic

demand, they have to lower their prices to compensate for the higher currency value. • The elite benefit from importing luxury goods more cheaply.

B. Export Promotion (Outward Oriented) • Tariffs are reduced or eliminated, and imports rise. • Domestic production is displaced and unemployment rises in domestic industries that

compete with imports. • Costs for intermediate goods fall leading to an increase in exports and a fall in

unemployment in the external sector. • Countries specialize in the sectors in which they have a comparative advantage.

1. Export promotion benefits:

• There is more rapid growth in both GDP and GDP per capita • Technology transfer takes place through imports of capital goods. • Exports of manufactured goods rise compared to primary sector exports. • Gains from trade: lead to a higher standard of living. • Specialization allows economies of scale and rapid learning by doing. • Even if growth is more uneven, the huge increase in productive capacity will lead

to rapid investment and linkage adjustment in other sectors (backward and forward integration).

2. Export promotion costs:

• MDC tariffs and quotas block imports of labor intense manufacturing goods

where LDCs have a comparative advantage. • Growth is more uneven • Vertical integration is lost; workers may be confined to assembly and some

fabrication. • There is a risk that new technology may render a sector obsolete. • There may be an overemphasis on natural resource exports, which could lead to

deteriorating terms of trade.

C. Trade liberalization – Lowering of trade barriers by MDC’s to allow market access to LDC’s.

i. LDCs may find that MDC's have already achieved economies of scale, and protect their home industries through tariffs and quotas thus effectively blocking imports from LDCs.

ii. Campaign against MDC’s to lower trade barriers to generate income in LDC’s and create jobs in growing sector of the economy.

iii. Many LDCs have turned to other LDCs for trade opportunities. Yet they often make similar products so not much to gain from trade.

iv. Gains from trade may benefit foreign owned plants and factories and the profits repatriated to home countries.

D. Role of the WTO – Is to be a non-partisan force for the reduction of trade barriers and increase free trade.

i. Multilateral negotiations that are meant to reduce tariffs and NTB’s

globally. ii. Provides a venue for settling trade disputes

1. EU complaint against China on dumping solar panels 2. Brazil’s complaint against U.S. cotton subsidies.

iii. Progress has been hung up in the Doha Round due to MDC intransigence on protecting their agricultural markets.

E. Bilateral and regional preferential trade agreements By negotiating bilateral free trade areas, LDC’s can get around protectionist walls and expand market for their goods.

i. Costa Rica – Singapore preferential free trade area in 2013. ii. NAFTA

iii. Increases access to more consumers by setting up a regional arrangement. There are a number of smaller trading blocks including: • LAFTA: the Latin American free trade area • CARICOM: the Caribbean community • Mercosur: involving Argentina, Brazil, Paraguay and Uruguay as full

members.

4.5 The role of foreign direct investment (FDI) According to UNCTAD in 2009 there are 85,000 MNCs of which a majority was controlled by US, Japanese, German and Swiss investors. Next biggest were Hong Kong, China, Korea, and India.

• In 2000 53 MNC’s were wealthier than 120 countries. • 100 companies produced 50% of all industrial production. • These 100 companies control more than 50% of world trade.

A. MNCs have grown for the following reasons:

• They need to secure their supply lines of raw materials. • The need to sell to ever-larger markets where new products are fully developed and

competition increases the price elasticity. • Tax regimes are advantageous and allow for low taxes and easy repatriation of

profits. • Rapid globalization and containerized shipping has reduced transportation costs. • Spread of technology has reduced information costs. • • Location advantages are important: •

• They need to locate within restrictive trade barriers • Low wages, low taxes and high education levels are important • They like to locate near markets to reduce transport costs.

B. What LDC characteristics attract MNC’s?

• Low cost factor inputs • Easy repatriation of profits • Favorable tax rules

I. Advantages of FDI

A. Objective is to fill in the various capital, financial, technological, managerial skills gaps in LDCs.

B. MNC’s can increase economic growth by breaking down supply-side bottlenecks in an LDC.

C. MNC’s can break the growth restraints by providing investment, foreign exchange, management skills, technology and access to markets.

D. FDI activities can generate jobs, tax revenue and exports, which lead to increases in income and can result in increased saving for future domestic capital formation.

II. Disadvantages of FDI

1. Studies have indicated that MNCs are not good at providing jobs:

3. Local firms are displaced by the MNC and the displaced firms often have much higher labor/capital ratios,

4. LDC govts may force the MNCs to operate in a highly capital intense sector of the economy such as natural resource extraction and processing requiring massive investments in sophisticated equipment and machinery: 5. The labor that is hired is very highly skilled

6. Either local labor must be given extensive training 7. Or skilled workers must be imported.

2. Labor protection laws: introduced by the govt. to appease the labor sector may increase labor costs significantly leading to the substitution of K for L

3. MNCs may prefer to take advantage of cheaper labor by using more appropriate technology but LDC govts anxious for technology transfer insist on the latest technology being used, once again this lowers the labor capital ratio.

4. Technology transfer is severely limited by the country's ability to absorb and utilize the

new technology: • Workers lack the technical skills • The LDC govts' system of information dissemination may be non-existent, • The MNC may be extremely reluctant to accommodate technology transfer for

fear of losing trade secrets.

5. Transfer pricing: the setting of internal prices between branches of an MNC such that goods can be exported at artificially low prices:

• The MNC raises price in the next country to the market level and takes the profit there if the taxes are very low, thereby saving on income taxes.

• This reduces the ability of the host govt. to collect taxes and defrauds them of taxes on work done in their own country.

• 25% of all trade is between branches of the same MNC company. • The highest value added work is done in the countries with the lowest taxes. • It is a powerful tool in labor negotiations to demonstrate that the company is

losing money.

6. Competing LDC govts may offer concessions on: • Reducing taxes while providing subsidies, and tariff or quota protection. • Allowing monopoly power • Reducing environmental regulations • However, concessions are often useless: • Repatriated profits are simply taxed by home govts • Tax relief may lead to confiscation of MNC property if the host govt. changes in

the future

7. Foreign enclave: the MNC can increase the inequality between the rich and the poor by

developing a modern high wage sector. • Misallocation of resources away from host country citizens (think power grid). • This sector imports luxury goods for expat workers, which prevents the

development of local providers. • Inappropriate goods are marketed in the LDC • It widens the rural-urban wage gap leading to increased migration • MNC supporters may influence the govt. to undertake projects or adopt policies,

which are growth rather than development oriented.

Successful MNC Policies • Over time, nations and institutions such as labor unions have developed laws and agreements

to control or balance the excess of private companies. • The problem with MNCs is that there is no global govt. or global union to oppose or

reduce the worst excesses.

• To achieve their ends LDC govts. may: • Impose a schedule for local value added to be increased and for greater utilization of

local personnel • Impose bans on the import of used capital equipment with an insistence that only the

latest technology be used • Insist on joint ventures with local firms, and ceilings on the repatriation of profits to

encourage or force reinvestment of profits in the local economy • Insist on market pricing rather than transfer pricing on intra firm transactions: • Many MNC now insist on proper tax payments right from the start:

• To provide enough tax revenue for the govt. to build the infrastructure needed to service the MNC

• To prevent resentment and potential nationalization which can lead to risk and uncertainty that threaten the long-term viability of a project.

4.6 The Role of Foreign Aid

I. Types of Aid

A. Bilateral - Bilateral aid tends to be distributed according to political interests:

• Official Development Assistance (ODA) is transferred either as bilateral aid between govts. or as multilateral aid through agencies such as the World Bank or the UN.

• ODA has grown from $22 billion in 1960 to $135 billion in 2011. • Aid has fallen from 0.5% of donor GNP in 1960 to 0.3% in 2011. • The US is the largest donor with $30.7 billion in 2011 • Germany is the second largest with $14.5 billion in 2011

B. Multilateral Foreign Aid Multilateral aid is delivered though international institutions such as the various agencies in the United Nations, World Bank and Asian Development Bank.

• Multilateral - The World Bank lent $57.4 billion in FY 2011 (down from $72 billion in FY 2010).

• Multilateral - UN agencies gave $5.5 billion, and provided the largest amount of technical assistance through the United Nations Development Program (UNDP), United Nations Environmental Program (UNEP), United Nations Industrial Development Organization (UNIDO), International Labor Organization (ILO), World Health Organization (WHO)….and the Global Fund to fight AIDS, Malaria and TB.

C. Unofficial Aid - is transferred through non-governmental organizations (NGOs):

• These are private groups like Mercy Corps, Feed the Children, Oxfam and other that

have specific objectives. • NGOs gave $6 billion in 1990, the same amount as the World Bank • NGOs tend to attack poverty directly by working with local groups to achieve their

agenda rather than imposing their own agenda.

D. Humanitarian Aid – is temporary and usually focused on natural disasters or man-made events such as conflict. Usually this is grant aid and not to be repaid

i. Food aid ii. Medical aid

iii. Emergency aid

E. Development Aid – is meant to alleviate poverty and improve the welfare of individuals. i. Long term loans – 10 – 20 years at low rates of interest usually repayable

in foreign currency. ii. Tied aid – Grants or loans that are conditional on sourcing all goods and

services for the aid from the donor country.

iii. Project aid – Usually given for a specific project in the form of a grant to improve infrastructure. The World Bank is a big player in this area.

F. Structural adjustment – usually financial in nature and brokered by the IMF to help

LDC’s with balance of payments problems or foreign exchange shortages. This is often used in conjunction with domestic restructuring of fiscal and monetary policies of the recipient country.

II. Purpose of Aid

A. Fills in resource or K gaps - Fills the foreign exchange gap to allow LDC’s to import capital to combine with abundant labor and natural resources to increase productivity and economic growth. This can lead to higher incomes and more savings.

B. Technical assistance – can fill in human capital gaps in technical areas such as health

care, education and engineering. This is to improve quality of labor in LDC’s.

C. Increase access to technology – this is to increase access to technology that the LDC might not be able to afford otherwise (Medical or

D. To fund specific projects – in the case of NGO’s usually a cause driven purpose such as educating women or, in the case of Bill Gates and polio in India, to eliminate a specific disease.

III. Problems with Foreign Aid

A. Aid is a poor substitute for trade: opening up MDC markets to LDC exports can enhance the ability of the poor to earn a living and reduce poverty.

B. It is estimated that less than half the aid goes to poor countries, instead it is based on the military, political and business interests of the donors, a reward to those in power.

C. The LDC govt. may be forced to change development policies to suit the donor's ideas:

• Loans and grants may be contingent on changes in tax laws, wage and price systems, food subsidy programs, and whether the money is used for rural or urban development.

• These ideas may be out of touch with reality and do little to contribute to development in the country

D. Aid contributes in direct proportion to the increase in capital investment, but aid does not

appear to have accelerated the growth rates of recipient countries: • There is a lack of complementary inputs: human technical skills, administrative

capacity, infrastructure, financial institutions, and political stability, • The introduction of hard currency inflows may also lead to increases in

consumption rather than just investment: • Supply bottlenecks may discourage investment in physical capital

• Rising incomes for the poor may lead to increased consumption rather than increased saving.

E. Aid may displace LDC govt. spending:

• There is less pressure to provide infrastructure, and necessary reforms particularly in rural areas

• Resources are then free for consumption instead of investment and may be used to acquire military hardware

F. Famine is often not a result of a lack of food but of the inability to earn enough to pay for

the food: • Distributing cash instead of food can stimulate the local market:

a. Local traders know best how to transport supplies b. They are often able to reach inaccessible places to provide food

• Long-term food production and employment can increase through investment.

4.7 The role of international debt

Sources of Finance & LDC Debt • Economic development has been promoted since 1960 as the best route for LDCs to follow,

justifying borrowing from banks to spend on projects: • The risky nature of lending to LDCs requires: higher interest rates, much more

expensive than the rate charged by the World Bank or aid agencies • Stock of debt: the ratio of debts to exports has averaged 125% to 150%. • Debt servicing flow: includes interest payments and repayments of principal, and often

exceed 40% of exports for certain poorer LDCs.

Causes of the Debt Crisis 1970’s In 1973 and 1979 OPEC increased the price of oil dramatically: • Oil rich countries looked for the highest rate of return on investments • The international banking community started lending this money to LDCs,

• While the nominal interest rates charged were high, once inflation had been taken into account, the real interest rates were very low leading to an explosion in LDC borrowing,

• Those LDCs that did not have oil, were now faced with vastly higher costs for fuel, input costs rose dramatically hurting exports.

1980’s

• LDCs were accustomed to ‘soft’ loans from international agencies such as the World Bank, which lent at low rates of interest. • Commercial banks charged full market rates on ‘hard’ loans

• By 1979 most OECD countries decided to stop inflating: • Interest rates rose dramatically, particularly on short term paper, • More than 50% of LDC debt is short term in nature, the interest rates being charged

to LDCs reached crisis proportion, • With the shortage of money, oil rich countries started taking their cash out of the

bank to be used in their own countries, • No more loans were available for anyone including LDCs. • As incomes in MDCs fell so did imports from LDCs worsening their balance of

payments difficulties. • Elite groups in LDCs panicked and there was capital flight:

• It is estimated that 30% of all borrowed funds, usually in a hard currency, ended up in bank accounts outside the borrowing country.

• Poor project evaluation: • MDC banks were only interested in securing loans through govt. guarantees; there was

little checking of the projects the money was to be used for. • Much of the borrowed money had been wasted on military arms or projects that did not

have any hope of paying interest on the debt or ever repaying the principal. • Many LDCs printed money to cover the deficits, which led to extremely high rates of

inflation in some countries.

Rescheduling & Restructuring (1990’s and 2000’s) • LDCs were unable to service their debts and were forced to reschedule (Argentina) • Loans were renegotiated with lenders, extending the terms of repayment. • LDC govts have been forced to make major structural reforms under instruction from the

IMF in order to qualify for rescheduling: • Market mechanisms: supply side measures increase output and investment • Devaluation of the currency: devaluation should lead to greater exports and fewer

imports unless both domestic demand for imports and external demand for exports are inelastic.

• Deflation: tight monetary and fiscal policy reduce govt. deficits, inflation and eventually interest rates.

• LDCs which are able to lower their debt servicing experience some benefits:

• Lower inflation, which stabilizes the exchange rate and creates enough confidence that the elite repatriate money lost through capital flight.

• Domestic interest rates fall leading to greater domestic investment and an improvement in the economy.

• Restructuring simply extends the length of the repayment problem, it does not eliminate the

debt: • LDCs simply lack the exports needed to earn the foreign exchange required to service

the debt. • The only hope of getting out of debt is for MDC economies to expand rapidly leading to

major increases in imports from LDCs. • Most of the debtor nations are faced with years of economic deprivation in order to meet

their debt obligations, • Domestic policies that lead to overvalued currencies encourage imports and discourage

exports creating strong pressures to seek more loans to support the country until the next crisis

• If the money had been invested in projects which earned a rate of return that could have paid the interest plus repaid the principal, there would have been few problems.

Massive reallocation of resources to servicing the debt away from domestic programs focused on improvements in education, health care, improvements in agricultural productivity and strengthening political institutions that could improve the general welfare of society…promoting economic development!

4.8 Market-oriented v. Interventionist Strategies See Pages 372 - 375 in B & D. Market led strategies are defined as policies that are designed to minimize the role of government and maximize the free operation of supply and demand in the private sector. Interventionist strategies are policies involving an active role by the government and the manipulation of the workings of markets in the economy. Market-oriented Strategies

Advantages Disadvantages Overall strategy leads to increased efficiency and economic growth due to market mechanism.

Potential for a dual economy to develop as the urban area wages increase motivating more migrants from the countryside to the city.

Liberalization of trade allows for markets to work efficiently and send clear signals to both consumers and producers.

Deregulation can lead to market failure and lack of mitigation due to weak government institutions. (Example: China)

Free flow of capital from outside the country as well as inside can increase access to scarce resources to increase productivity and incomes.

Income inequality increases rapidly as those with access to capital, skills and market take a majority of the income.

Privatization of state owned Enterprises (SOE) prevents misallocation of resources and increases efficiency.

Deregulation allows for lower costs of factors of production as well as manufacturing processes that increase economic growth and incomes.

Interventionist Strategies

Advantages Disadvantages Provides for more widely distributed infrastructure thereby loosening supply-side bottlenecks.

Excessive bureaucracy can slow or eliminate government responsiveness to change in society.

Government directed focus on human capital via education and skills training increases skill set for all instead of few who can afford it.

Poor planning can result in misallocation of resources and government failure in the case of subsidies, price floors, price ceilings and quotas.

Planned pathway for macroeconomic stability ensures predictability for society.

Temptation of corruption is too great in a planned economy.

Provides a social safety net to ensure that all have basic human needs met.

Neither one is better...a mix of both are necessary for development!

Policies to Stimulate Growth According to the World Bank, rapid growth in Asia is a direct result of policy guidance rather than just a free market. These policies include:

• Making income distribution more equitable. • Encouraging savings and making banks more reliable • Improving primary and secondary education • Improving agricultural productivity • Facilitating technology transfer and encouraging FDI • Streamlining legal and regulatory structures to create a positive business

environment • Setting industry wide standards and monitoring quality facilitates marketing. • Targeting key industries for development: • Protecting infant industries in the early stages • Managing resource allocation • Facilitating exports through govt. assisted marketing