Economic Development
what you need to know about development
Economic development is more difficult to define than economic growth. Whereas economic growth only takes into account output produced/income earned, development takes into account other variables that affect the quality of life/standard of living.
What variables may affect the development of a country? Here are some examples:
Income earned
Levels and quality of education
Population’s overall health
Levels of technology
Quantity and quality of infrastructure
Environmental degradation
Government spending
Levels of crime
Levels of inequality
So, economic development is much broader than economic growth, and it can be argued, it is a more important indicator in general.
HOW ECONOMIC DEVELOPMENT IS MEASURED
There are a few broad ways we can try and measure development:
· GDP per capita (GDP per head)
· GPI (Genuine Progress Indicator)
· HDI (Human Development Index)
GDP per capita – easy to calculate, however is fundamentally flawed because it doesn’t take into account other development factors like education, health and inequality.
GPI – uses GDP but also tries to take into account other factors that may benefit development e.g. pollution levels, volunteer work etc.
HDI – the UN’s standard indicator of development. It is calculated by assessing 3 main factors.
· Income per head (measured by GNI per capita PPP adjusted)
· Education (measured by the average years of schooling)
· Health (measured by life expectancy)
HDI is ranked between 0 and 1 – 1 being the highest rank for a developed country, and 0 being the lowest. A figure above 0.8 implies a country has a high level of development. Below 0.5 indicates low levels of human development.
The HDI is probably considered to be the leading indicator of development. However, it is not perfect because it does not take into account all factors that contribute to a country’s standard of living (as listed above).
One of the things not taken into account by the HDI is inequality. Inequality is a particular problem in a developed and a developing country.
INEQUALITY
In a developing country, levels of absolute poverty are relatively high. Absolute poverty is when somebody can not afford the necessities of life. For example, when you cannot afford food or shelter.
In a developed country, levels of relative poverty can be high. Relative poverty is when somebody is unable to fully participate in society, due to relatively lower income. This can lead to social exclusion, where all the opportunities needed to fully participate are not available. For example, growing up in a low-income area and as a result “mixing with the wrong crowd”. This can lead to less opportunities for you in the future.
Inequality can slow down development because:
· Potential entrepreneurs do not have the opportunities to invest. They find it harder to save or borrow money
· Higher income earners will likely spend their money on luxury imports – therefore, this demand doesn’t contribute to the domestic economy
· Inequality is directly linked with social exclusion and crime
HOW CAN INEQUALITY BE IMPROVED?
Inequality is directly affected by:
· Levels of welfare benefits
· Education levels
· Unemployment levels
· Wages
· Taxes
· Property ownership
Policies can be made to improve these inequality factors. For example, the government could spend more on education, and provide more funding to low-income families. The government could also raise the level of welfare benefits.
HOW CAN INEQUALITY BE MEASURED?
Inequality is measured using the Gini Coefficient, calculated using the Lorenz Curve (see below).
To calculate the Gini coefficient, we use the following equation:
Gini coefficient = Area A / Area (A+B)
A Gini coefficient equal to 1 indicates the most extreme inequality. A Gini coefficient equal to 0 indicates perfect equality.
LORENZ CURVE DIAGRAM
CONSTRAINTS ON GROWTH AND DEVELOPMENT
There are many factors that can make it difficult for a country to grow and develop. Narrowed down, the following would be the main constraints:
· Poor infrastructure e.g. roads, schools, water supplies, hospitals, sewerage, telecommunications.
o This makes it difficult for countries to become internationally competitive. It also makes it difficult for countries to attract FDI (foreign direct investment)
· Poor standards of national health – e.g. disease can result in lowered levels of national productivity (and therefore low human capital)
· Poor education – e.g. low educational standards lead to lowered skill sets among the workforce. This leads to low levels of human capital
· Low levels of investment – there are many reasons for this
o One reason is due to the “savings gap”. Poorer countries have less disposable income and therefore less savings in banks. This means banks receive less cash deposits which means there is less money to lend to new businesses via loans. A scarce supply of liquid money increases the interest rate (cost of loans), which many people cannot afford to pay back. This limits overall investment
o Another reason is due to “capital flight” – political instability and a poor economy can lead to people holding their assets abroad in other countries to avoid risk. This makes economic growth more difficult to achieve which means less tax for the government
o A “foreign exchange gap” can also lead to constraints on development. This occurs when there is more money leaving the country than entering it (capital outflows outweigh capital inflows). This can be due to a country being too reliant on imports and only producing primary products which are of low value
o Absence of property rights – in some countries people cannot be sure their land is really theirs. This could be due to instability in the country and it leads to lower levels of investment due to fear
· Primary product dependency e.g. when a country is too reliant on exporting primary products (commodities), it can lead to a lowered terms of trade (average price of exports compared to average price of imports). The average price of goods being imported into the country (manufactured goods) are higher than the goods being exported by the country (commodities). This can lead to increases in world inequality. This is suggested by the Prebisch-Singer hypothesis.
o The idea is that developing countries produce goods that are income inelastic (necessities). Developed countries, on the other hand, produce goods that are income elastic (luxuries), which means as world GDP rises, there is more demand for luxury products relative to necessities. So, developed countries get richer and developing countries stay relatively poor.
· Corruption – e.g. when power is abused for personal gain, such as government officials accepting bribes. This can lead to the needs of the many being ignored in favour of the few. The government may therefore not prioritise the needs of the country. It can lead to limited investment into important things like education, infrastructure and national healthcare. It can also lead to civil wars which creates even more instability
HOW TO PROMOTE GROWTH AND DEVELOPMENT
There are some ways that growth & development can be promoted.
Harrod-Domar Model
This economic growth and development model suggests that the growth rate of the economy is dependent on:
1) Level of saving – because saved funds can be used for the purchase of capital
2) Efficiency with which capital can be used – investment into capital has to produce a return
If these two factors can be improved, economic growth can also increase.
Aid
Aid means transferring resources (e.g. money) from one country to another. Bilateral aid is when the aid is being sent directly to the recipient country. Multilateral aid when the donor country donates to a middle-man (e.g. World Bank), which distributes the money to other countries. Tied aid is when aid is given with a condition attached (e.g. money is to be used for purchasing of imports from the donor country)
Aid is good because it can reduce levels of absolute poverty. It can also improve health, education and therefore human capital. It can help fill the savings gap in the country and trigger off the multiplier effect.
Aid is bad because it can lead to developing countries becoming dependent on foreign aid. It can also be misused by corrupt governments. Aid can also be used as a bribe by developed countries to secure favours from developing countries.
Debt Relief
Debt relief means cancelling some debts owed by developing countries.
It can be a good thing because money can be freed up to spend on public services, health care and education. So, it can be used to increase levels of human capital. It is also good because the extra money can be used to invest into capital and help grow the economy.
Debt relief might be bad because low-income countries can become dependent on the good nature of creditors. More money may be misused by corrupt governments. Debt relief might also be used as a weapon by wealthier countries e.g. to secure favours with poorer countries.
Developing the Agricultural Sector
Products produced from the agricultural sector are generally seen as income elastic. Therefore, it is difficult for countries to add value to their resources and sell for a reasonable profit. However, investment into agriculture can be seen as a stepping stone for a developing country and a way to generate necessary income which can be used to invest into other industries in the future. It is especially crucial if the country has a comparative advantage in a particular commodity.
Developing the Industrial Sector
This is outlined by the Lewis model. The Lewis model says that excess labour in the agricultural sector should be used to transfer to other industries in order to earn higher wages. This ensures that the country still has enough workers in the agricultural sector, and the country also gains workers in other sectors like manufacturing. It doesn’t necessarily lead to inflation either, because only “excess” workers should transfer into other industries, so it shouldn’t lead to a drastic increase in wage rates. Moreover, profits from manufacturing can now be reinvested into the purchase of more capital goods, which leads to higher productivity and GDP.
The downside of the model is that it is oversimplified. It may not be easy to transfer labour towards industry. During peak harvest seasons, there may not be any excess workers at all. Furthermore, transferring to the industrial sector requires education and training, which needs to be supplied and funded by the government. Profits may also be reinvested in other countries, or they might not be reinvested at all (consumption and imports).
Developing the Tourism Industry
Increases in tourism generates an increase in foreign currency (people bringing money with them on holiday). This can lead to foreign investment too (purchases of hotels for example). This can improve the foreign exchange gap and help growth and development. Employment levels should rise (but it may be seasonal and low-skilled work).
It can also lead to an upset within society, due to tourists’ needs being prioritised over locals e.g. environmental damage, culture change etc. The tourism industry is also very much dependent on external factors like the seasons/weather and the global economic climate.
Protectionism
Protectionism is an “inward looking” strategy. The idea is that goods that were previously being imported are instead purchased from domestic firms. The aim is to create more jobs, reduce poverty and improve the country’s balance of payments.
Over time, domestic firms should be able to grow and benefit from economies of scale, and in turn, compete on an internal scale as its comparative advantage improves.
Free Trade
Free trade on the other hand, is outward-looking. So, less government intervention leading to an improvement in efficiency and a freer market. It is really down to debate whether protectionist policies or free trade policies are most beneficial for growth and development, but it really depends on an individual country’s needs. Today, free-market strategies are more commonly employed.
Microfinance
Microfinance involves providing loans to small businesses and low-income individuals. These people may not be able to get loans from traditional banks, which is a constraint on development. These loans can create more independence for people in developing countries e.g. investment into their business ideas or their education.
While it’s a good initiative, microfinance is not really powerful enough to reduce poverty on a large enough scale.
Fair Trade
Fair trade schemes are in place to improve incomes for farmers and to prevent them from being exploited by large MNCs. It offers them a “guaranteed” minimum income; a fairer price for the goods they produce, essentially. It can mean producers are able to make clearer long-term plans without worrying too much about fluctuations in price.
However, the increased market price can lead to overproduction of crops – they are receiving a better price for their crops so there is an increased incentive to produce more (even when demand is low). This can lead to a misallocation of resources.
Efficiency of the Financial Sector
The financial sector is very important for promoting growth and development. The financial sector supports trade and allows savings to be converted into investment funding. In developing countries, the banking sector is generally underdeveloped, which can reduce economic growth. Investment funds are needed to grow and develop an economy, so it is important that banks are able to provide their services when needed.
The efficiency of the financial sector can be increased by promoting the growth and development of banks and joining international financial markets.
International Institutions and Non-governmental Organisations
IMF
International Monetary Fund – most countries in the world are part of the IMF. Each member makes resources available to the IMF, based on the economy’s size.
The aims of the IMF are to offer loans and give advice to developing countries. The idea is to ensure countries can maintain stability and improve their living standards.
IBRD – part of the World Bank
The International Bank for Reconstruction and Development – the aims of this organisation are to reduce poverty in middle-low income countries, and promote sustainable development. It offers loans, grants and advice to members. Most funds are raised by commercial financial institutions.
IDA – part of the World Bank
International Development Association – aims are to reduce poverty in the world’s poorest countries by offering loans,, grants, debt relief and advice.
It specifically concentrates on areas such as: health care, infrastructure, institutional reforms. These are all big factors of growth and development.
The involvement of these institutions can be a good thing but can also be controversial too.
It can be argued that the conditions placed on loans from the IMF and the World Bank are too limiting. Things like deregulation, privatisation and spending cuts are some of the conditions that can be placed on such loans. It could be argued that these conditions limit development – opening up a developing economy may increase inequality, and spending cuts can mean less spending on healthcare and education.
It can also be argued that senior officials in these institutions most often come from developed countries – so there is a potential for corruption here.
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