Development

Economics
Links to each chapter in this document:

4.1 Economic Development

4.2 Measuring Development

4.3 The Role of Domestic Factors

4.4 The Role of International Trade

4.5 The Role of International Trade

4.6 The roles of foreign aid and multilateral development

assistance

4.7 The role of international debt

4.8 The balance between markets and intervention

4.1 Economic Development
Economic growth and economic development

1. Distinguish between economic growth and economic development.

Economic growth refers to increases in output and
incomes over time, often measured on a per capita
basis.

Economic development refers to a process

where increases in real per capita output lead
to improved standards of living for a population as a
whole

OR
Economic development can be defined as a process
where increases in real per capita output and
incomes are accompanied by:
- improvements in standards of living of the population
- reductions in poverty
- increased access to goods and services that satisfy basic needs (including food,
shelter, health care, education, sanitation),
- increasing employment opportunities
- reduction of unemployment
- reductions of serious inequalities in incomes and wealth.

2. Explain the multidimensional nature of economic development in terms of reducing

widespread poverty, raising living standards, reducing income inequalities and
increasing employment opportunities.

Economic development can be defined as a process

where increases in real per capita output and
incomes are accompanied by:
- improvements in standards of living of the population
- reductions in poverty
- increased access to basic goods and services (including food, shelter, health care,
education, sanitation),
- reduction of unemployment through increased employments
- reductions of inequalities in incomes/wealth.

Economists used to believe that economic growth over long

periods would automatically provide economic
and social benefits for the entire population, however
they found out that this was not the case. Economists began to understand that
governments should intervene to help bring about human development.

Human development
Human development is a process of expanding
human freedoms - the freedom:
- to satisfy hunger
- to be adequately fed
- to be free of preventable illnesses;
- to have adequate clothing and shelter
- to have access to clean water and sanitation
- to be able to receive an appropriate education
- to be knowledgeable
- to be able to find work
- to enjoy legal protection
- to participate in social and political life
- to have the freedom to develop one’s potential and lead a full and productive life.

Income poverty occurs when

income falls below a nationally or internationally
determined poverty line.

Human poverty involves deprivations and the lack

of opportunities that allow individuals ‘to lead a long,
healthy, creative life and to enjoy a decent standard
of living, freedom, dignity, self-esteem and the
respect of others

Income poverty is reduced

through higher income, but human poverty cannot
be lowered without measures to provide a broad
range of social services to the entire population. On
the other hand, if people on low incomes have access
to education, health services, improved sanitation,
improved water supplies, etc., human poverty can be
reduced even while income poverty remains.

3. Explain the 4 most important sources of economic growth in economically less

developed countries
1. Increases in the quantity of physical
capital
Physical capital is an important source of growth
because it makes possible increases in labour
productivity (output per unit of labour input). It is
especially important in developing countries, which
tend to have relatively limited amounts of capital in
relation to their large supplies of labour.

2. Increases in the quantity of human capital

Increase in Human capital contributes to increasing the
productivity of labour. In developing countries people have
low levels of educational attainment, and
also low levels of health, so there is huge potential for increasing HC,
and this can make a very significant difference
to productivity, employment opportunities, and output
growth

3. Development and use of new appropriate

technologies
New technology contributes to improving the quality
of physical capital. - However,
technology need to be appropriate to conditions of LEDCs,
as what might be well-suited to MEDCs
might not be well-suited to LEDCs

4. Institutional changes
In many economically less
developed countries, there is a need to develop:
- institutions relating to property rights (laws and regulations that define rights to
ownership, use and transfer of property)
- a well-functioning legal system that provides effective enforcement of laws,
contracts and mechanisms for settling conflicts
- an efficient, fair and transparent tax system
- banking and credit institutions that provide effective links between savers and
investors, and broad access by the population (including the poor) to credit
- institutions that protect against corruption

A market system cannot function well without well-developed institutions such as

these

4. Discuss the relationship between economic growth and economic development

Economic growth may not lead to economic development

Some limited economic development is possible in the

absence of rapid growth, if appropriate policies are
followed to provide access to basic social services for
the poor.

Over the long term economic growth is usually necessary for economic development

More depth:

An economy that does not experience

growth can still achieve some economic development,
by reallocating its resources such that it cuts back
on industrial production and increases merit goods
production; this would entail a movement along PPC1
from point A to a point like B.

Over long periods of time, the possibilities for

improving the population’s well-being by moving
along the same PPC will be exhausted, and further
improvements will depend on outward PPC shifts -> Growing output per capita
translates into
higher incomes and an improved ability to provide
the goods and services needed by the population.

However, economic growth (outward shift) does not guarantee that

economic development will occur. If an economy moves
from point A to point C, for example, there is little if
any increase in merit good provision.
Possible question idea: To what extent do you agree with this statement: An
increase in economic growth always results in an increase in economic
development?

Increasing levels of output and incomes resulting from economic

growth mean that societies can better satisfy the needs
and wants of their populations and secure improvements
in their standards of living.

However, while economic

growth can make improved levels of living possible, it
does not by itself guarantee that this will occur.

Persisting poverty and the failure of many countries to secure

long-lasting improvements in the well-being of their
populations, even if they have achieved respectable rates
of growth over extended periods of time, have shown
that economic development is a highly complex and
sometimes elusive process.

+talk about stuff above

Common characteristics of economically less developed countries

5. Explain, using examples, that economically less developed countries share certain
common characteristics (noting that it is dangerous to generalize as there are many
exceptions in each case) (5 characteristics)

1)low levels of GDP per capita

2) high levels of poverty
3) relatively large agricultural sectors
Relatively low
income elasticities of demand for agricultural products
play a role in reducing the relative size of the agriculture
sector as countries grow and develop, while agriculture
increasingly becomes replaced by industry and services.

4) large urban informal sectors

The large size and growth of the urban informal
sector is due to several factors. One has to do with
policy failures of the 1950s, 1960s and beyond, that
focused on industrialisation and completely neglected
the agricultural sector. If rural incomes and rural
employment possibilities had increased, the massive
departure of the rural poor towards urban areas might
have been avoided. Secondly, it is related to rapid
population growth (see below). Thirdly, cities still
attract people from rural areas who are poor, landless
and destitute, looking for work that will enable them
to make a better living or simply to survive. However,
employment opportunities in the urban formal sector
are limited, and the formal sector demands skills that
rural migrants lack.

5) high birth rates.

6. Explain that in some countries there may be communities caught in a poverty trap
(poverty cycle) where poor communities are unable to invest in physical, human and
natural capital due to low or no savings; poverty is therefore transmitted from
generation to generation, and there is a need for intervention to break out of the cycle.
P1: Definition=Explanation of poverty cycle diagram,
P2: Draw poverty cycle diagram
P3: Explain 4 ways poverty is transmitted across generations
P4: An easy solution to prevent poverty cycle that is prevented from occurring naturally
P5: How to break out of the poverty cycle (2 solutions + 1 limitation and the solution to that
limitation)

Definition/Explanation of poverty cycle diagram:

A poverty cycle (poverty trap) arises when low
incomes result in low (or zero) savings, permitting
only low (or zero) investments in physical, human
and natural capital, and therefore low productivity
of labour and of land. This gives rise to low, if
any, growth in income (sometimes growth may be
negative), and hence low incomes once again. A
poverty cycle may occur in a family, a community,
a part of an economy, or in an economy as a
whole. An important feature of the poverty cycle
is that poverty is transmitted from generation to
Generation.
How poverty is transmitted across
generations:
1)cannot afford to send their children
to school, either because the children work to
supplement the family income, or because the
parents cannot afford transport costs, this results in their children lacking skills for
higher income job opportunities
2) cannot afford the necessary medical care
for themselves or for their children, and sometimes
cannot provide enough food for the family, leading
to malnourished and physically disadvantaged
children.
3) often have large families, which increases
the level of poverty, as the income of the
parents must be stretched to cover the needs of
more people.
4) Moreover, poor people who are unable to buy
or invest in modern agricultural inputs (fertilisers,
irrigation facilities, improved seeds) because their
incomes are too low are forced to overuse their land,
thus depleting the soil of essential nutrients, with the
result that their children will be forced to work on soils
of poorer quality that have lower yields (lower output
per unit of land).

P4: Since poor people cannot make investments because

they do not have enough savings, it would help if they
could borrow to finance the necessary investments
in human, physical and natural capital, all of which
would raise their productivity and increase their
incomes. However, banks do not usually lend to poor
people, who lack the necessary collateral. Therefore,
the poor remain without access to the credit that
could help raise them out of their poverty, and poverty
is carried into the next generation.

P5: Breaking out of the poverty cycle (2 solutions + 1 limitation and the solution to
that limitation)

Sol 1) Breaking out of the poverty cycle requires the intervention of the government,
which must undertake investments in human capital
(health services, education,), physical
capital in the form of infrastructure (sanitation, water
supplies, roads, power supplies and irrigation), and
natural capital (conservation and regulation of the
environment to preserve environmental quality).

Sol 2) Further, the government must take the necessary

steps to ensure that poor people can participate in
private sector activities, such as ensuring access to
credit so that the poor can borrow to finance private
investments.

Limitation: However, the public investments

needed to break out of the poverty trap depend on
the availability of government revenues. If the
country is so poor that the
government does not have the revenues required to
undertake the necessary investments, then an entire
country is trapped in a poverty cycle.

Solution to this: Resources that are provided through foreign aid

Diversity among economically less developed nations

7. Explain, using examples, that economically less developed countries differ

enormously from each other in terms of a variety of factors, including resource
endowments, climate, history (colonial or otherwise), political systems and degree of
political stability

1) Difference in natural resource endowments and quality of human and capital resources

2) Difference in climate
Climate differences are a factor determining types and methods
of agricultural production, animal husbandry, and even
labour productivity. For example, heat and humidity may
reduce labour productivity, while tropical and subtropical
climates are known to reduce soil quality and negatively
affect the health of both humans and animals.

3) Difference in History - colonization can have lasting impact

4) Difference in Political stability - some stable, some not

A stable government is necessary for effective
government decision-making and for implementing
economic and other policies

Political instability creates an environment of

uncertainty related to economic policy, property
rights, possibility of expropriation, and taxation
rules, all of which make both domestic and
foreign investments far riskier, thereby reducing
investments.

Political instability often leads to an outflow of

financial capital as people seek safety for their
financial assets, depriving the country of its
scarce financial resources and contributing to
balance of payments deficits.

Political instability increases vulnerability to

hunger and famine, as it deprives governments of
the capacity to provide relief

RWE: The 1984–85

famine in Ethiopia resulting in over 1 million
deaths (with another 7 million people severely
affected) was caused as much by political instability,
internal war and violence as by drought.

International development goals

8. Outline the current status of international development goals, including the

Millennium Development Goals.
Skip
4.2 Measuring Development
Single indicators

1. Distinguish between GDP per capita figures and GNI per capita figures.

GDP per capita is an indicator of the total value of output produced

within a country divided by the number of people in the country

GNI per capita is an indicator of the

total income (or value of output) received by the residents
of a country, usually within a year, divided by the number of people in the country

For some countries the difference in the sizes of

GDP per capita and GNI per capita is not very large.
This happens when inflows of income into a country
are roughly balanced by income outflows, or if most of
the production in a country is by factors of production
owned by its residents.

Otherwise, the difference can

be quite significant. The factors of production that
mainly account for differences are labour and capital.

When a country has many workers from other

countries (labour) who send part of their wages back
home, or foreign corporations (capital) that send their
profi ts back home, this works to decrease GNI relative
to GDP, because the wages and profits of the foreigners
are excluded from the country’s GNI though they are
included in GDP. In such cases, domestic incomes
received on average (GNI per capita) are lower than the
value of output produced in the country (GDP per capita).

On the other hand, inflows of money into a country

from workers abroad or from corporations located
abroad increase the size of GNI relative to GDP,
making domestic incomes on average (GNI per capita)
higher than the value of output produced in the
country (GDP per capita).

GNI per capita is a better indicator of the

standards of living of a country, because it represents
income per person received by the residents. GDP
per capita is a better indicator of the level of
output per person produced in a country.

2. Compare and contrast the GDP per capita figures and the GNI per capita figures for
economically more developed countries and economically less developed countries.

in more developed countries, the inflows

and outflows tend to cancel out to some extent
(though not entirely in many cases). In most high-income countries,
the difference between the two measures is roughly
plus or minus 10%.
RWE: USA - 1% difference

In less developed
countries, we often see greater differences between the
two measures. Usually, these are due to multinational
corporations sending their profits back home (‘profi t
repatriation’), thus making GNI smaller than GDP; or
they are due to workers living abroad who send some
of their income back home (‘worker remittances’),
thus making GNI larger than GDP.

RWE Exception: A major exception is Ireland, whose GNI is

about 81% of its GDP per capita (it is much smaller).
Ireland has many multinational corporations, as well
as foreign workers, who send profits and wage incomes
back to their home countries. Therefore, Ireland’s very
high GDP per capita gives a misleading impression of
average standards of living in Ireland.

RWE: Lesotho (LEDC)

Lesotho has its very large GNI compared
to GDP (almost 50% larger), which is due to a very
large amount of workers wages
sent home by workers who live outside of Lesotho).
Therefore, Lesotho’s average standards of living are
much higher than its GDP per capita indicates.

3. Distinguish between GDP per capita figures and GDP per capita figures at
purchasing power parity (PPP) exchange rates.
If we wanted to compare GDP per capita
(or GNI per capita) across countries, it would give us misleading results. The
reason is that different countries have different price
levels. This means that the same amount of money
in a low-price country has greater purchasing power
(can buy more things) than in a high-price country.

Purchasing power parity is defined as the

amount of a country’s currency that is needed to
buy the same quantity of local goods and services
that can be bought with US$1 in the United States.

Thus, Comparisons of GDP per capita (or GNI per capita)

across countries require measures of per capita
output or income based on conversions of national
currencies into US$ by use of purchasing power
parities (PPPs), to eliminate the influence of price
differences on the value of output or income.

4. Compare and contrast GDP per capita figures and GDP per capita figures at
purchasing power parity (PPP) exchange rates for economically more developed
countries and economically less developed countries.

For the poorer countries

GDP figures based on PPPs are
higher than those based on exchange rates

For the wealthier countries, GDP

figures based on PPPs are lower than those based on
exchange rates.

The reason for this is that prices of goods and

services on average tend to be lower in countries with
low per capita GDPs, and higher in countries with
high per capita GDPs.

5. Compare and contrast two health indicators for economically more developed
countries and economically less developed countries.
Three commonly used health
indicators are life expectancy at birth, infant mortality
and maternal mortality.

Life expectancy at birth refers to the number of

years one can expect to live, calculated as the average
number of years of life in a population.

Infant mortality refers to the number of infant deaths

from the time of birth until the age of one, per 1000
live births.

Maternal mortality refers to the number of women who

die per year as a result of pregnancy-related causes, per
100,000 live births.

Table of Data shows that higher levels of GDP per

capita (US$ PPP) tend to be linked with higher
life expectancies, and lower infant and maternal
mortalities. This is what we would expect, since higher
income countries have more resources to provide the
necessary services and appropriate living conditions
for their populations. However, there are very wide
departures from this broad pattern, so GNI per capita (or any other income or output
measure) is an insufficient indicator of health
Outcomes.

How is it possible that some countries have

managed to achieve far better health outcomes than
others with similar or even lower incomes per capita?

The answer is that for any given level of income per

capita, health indicators are better when there are:
1) adequate public health services (such as
immunisation, provision of health information
and education), and prevention of communicable
diseases (such as malaria, tuberculosis, HIV/AIDS)
2) adequate health care services with broad access by
the entire population
3) a healthy environment, including safe drinking
water, sewerage and sanitation, and low levels of
pollution
4) an adequate diet and avoidance of malnutrition
5) a high level of education of the entire population
6) absence of serious income inequalities and poverty.

RWE Exception: the United States

stands out for its lower life expectancy and higher
infant and maternal mortalities compared to other
developed countries, with lower GNI per capita.
Health outcomes in the United States may be due
to inequalities in income and education resulting in
pockets of poverty, connected to poor housing and
living conditions, poor nutrition and health, and
insufficient access to medical care (due to lack of
medical coverage). Such factors result in worse health
outcomes among low-income groups

RWE Exception: Among less developed countries, we find some very

surprising health outcomes. For example, Sri Lanka,
with GNI per capita less than one-third of Russia’s,
surpasses Russia in life expectancy by six years.

Health outcomes in Sri Lanka

are due to government
policies placing a high priority on public health and
the provision of health care services for low-income
groups, as well as on education.

Summary:

GNI per capita (or any other income or output

measure) is an insufficient indicator of health
outcomes.

Limited resources, due to low GNI per capita, are

not always the most important cause of poor
health outcomes. Most (if not all) countries, both
more and less developed, can do more with their
available resources to meet economic development
goals. They can reallocate resources towards
provision of more social services and merit goods,
improving the institutions through which these
services are delivered, as well as reducing poverty.

Some development issues apply not only to

developing, but to developed countries as well,
because of the presence of poverty in wealthy
societies that make people on low incomes
subject to similar deprivations as poor people in
developing economies.
6. Compare and contrast two/three education indicators for economically more
developed countries and economically less developed countries.

The first education indicator is the adult literacy

rate, which measures the percentage of people aged
15 or more in the population who can read and write.

The second indicator, primary school enrolment,

measures the percentage of school-age children who
are enrolled in primary school

The third
indicator, secondary school enrolment, measures the
percentage of children enrolled in secondary school

Table of data shows that as income per capita increases,

education indicators tend to increase. However, as in the
case of health indicators, there are many exceptions,
involving countries with relatively low incomes that
have high levels of educational attainment, especially
in adult literacy and primary school enrolment.

Two reasons for these exceptions

1) Countries of the former Soviet Union and
other former communist countries have very good
education outcomes because historically, communist
governments placed a high priority on education.
This explains the high achievements of Azerbaijan,
Georgia, Moldova, Kyrgyzstan and Tajikistan. (RWE)

2) Some governments have made

a special effort to provide education services to their
populations. We therefore see countries like Swaziland,
Bolivia, Indonesia and Mongolia with very good
education outcomes compared to countries with
comparable or higher incomes per capita. Perhaps most
striking is the primary enrolment ratios of Zambia,
Uganda and Burundi, among the poorest countries
in the world, which match and even surpass those of
some very high-income countries. (RWE)

The case of secondary enrolment is different.

Countries that are economically less developed
must use their scarce resources to provide primary
education to achieve universal literacy, which is an
important precondition for economic growth and
development. Secondary
education is less of a priority for low-income
countries. Therefore, it is not surprising that
countries with very good achievements in primary
enrolment lag behind in secondary enrolment.

Conclusion:
Countries can achieve universal literacy and universal
primary education even if they have relatively low per
capita incomes, provided their governments allocate
enough resources to education services, and ensure
that all children have access to these.

Composite indicators

7. What do composite indicators include and why are they considered to be better
indicators of economic development.

Composite indicators include more than one

measure.

Thus, they are considered to be better indicators of

economic development, as economic
development cannot be adequately measured by
any single indicator.

8. Explain the measures that make up the Human Development Index (HDI).

HDI has three dimensions:

1)a long and healthy life - measured by life expectancy at birth
2) access to knowledge - measured by mean years of schooling and expected years
of schooling
3) a decent standard of living - measured by GNI per capita

Each dimension is expressed as a value between 0

and 1, with 0 being the lowest possible value for the
dimension, and 1 being the highest.

9. Compare and contrast the HDI figures for economically more developed countries
and economically less developed countries.
Data shows that it is possible
to achieve similar levels of human development with
very different levels of GNI per capita.

RWE: Norway and Australia have

similar HDIs, indicating that they have attained
approximately the same level of human development,
yet Australia has accomplished this with a lower GNI
per capita.
RWE: Tajikistan’s GNI per capita is roughly one-fifth of South Africa's but they have
similar HDI

RWE: Kuwait and Latvia have similar HDI even though Kuwait has a much higher
GNI per capita

Summary:

GNI (or GDP) per capita used alone can be a

poor measure of the different dimensions of
development.

Many countries, even with their given levels

of GNI per capita, are capable of making
significant improvements in the well-being of
their populations by making different choices
regarding the resources allocated to health,
education and other services or merit goods.

Limitation of HDI:

However, the HDI, too, has its shortcomings. This

is because economic and human development are
much broader concepts with more dimensions
than are reflected in the HDI. The HDI does
not provide us with information about income
distribution, malnutrition, demographic trends,
unemployment, gender inequalities, political
participation

10. Explain why a country’s GDP/ GNI per capita global ranking may be lower, or
higher, than its HDI global ranking.
Many countries, even with their given levels
of GNI per capita, are capable of making
significant improvements in the well-being of
their populations by making different choices
regarding the resources allocated to health,
education and other services or merit goods
4.3 The Role of Domestic Factors
1. With reference to a specific developing economy, and using appropriate diagrams
where relevant, examine how the following factors contribute to economic development:
a. Education and health
b. The use of appropriate technology
c. Access to credit and micro-credit
d. The empowerment of women
e. Income distribution

a. Education and Health

Basically greater human capital -> greater productivity -> greater output

education leads to improved employment opportunities

and higher levels of income.

Improved health reduces

illness and physical disability, increases life expectancy,
improves quality of life and reduces poverty.

Positive externalities of education

1) Increased labour productivity and greater output

2) Education contributes to improvements in the

quality of physical capital (i.e. technological
advances), because knowledge can be applied to R&D

3) Education results in lower unemployment, lower

absenteeism from work and increased international
competitiveness; and it attracts foreign direct
investment.

4) Education leads to increased political stability (important)

5) Lower crime rate and a better quality of life.

6) The education of women promotes

their increased participation in the labour force,
lower birth rates, leading to lower
rates of population growth and reduction of poverty
Education externalities that spill over into -> health
7) The education of women leads to improvements
in maternal health and reductions in maternal
mortality (deaths)

8) The education of mothers results in healthier

children through improved health care and better
nutrition and lower child mortality

9) Schools teach children basic principles of hygiene

and sanitation

Positive externalities of health

1) greater worker productivity and

therefore greater output and economic growth.

2) Healthy people do not transmit diseases, thus

lowering the risk of spreading diseases to the
community.

3) Immunisation benefits the whole community

4) Healthier people provide more benefits to the

community through more active and productive
participation.

Health -> education

5) Increased levels of health and good nutrition
improve school attendance and performance in
school, and lead to longer periods of time spent
in school.

6) Healthier individuals make better use of the

knowledge and skills they possess.

7) Better health means a longer lifespan, and so

a longer time during which the benefits of
education can affect the economy and society

b. The use of appropriate technology

Appropriate technology is technology that is well-suited to

the particular economic, geographical, ecological and
climate conditions of a country.

Part 1: Different factor supplies (labour and

physical capital)

Developing countries are characterised by relatively

large quantities of labour,
while physical capital
is relatively scarce and costly to acquire.

In developed countries, labour is relatively

scarce in relation to more abundant physical capital,
and there is a large capacity for producing and
maintaining technologically advanced machines and
equipment.

Therefore, developing and developed

countries have different needs with respect to the
kinds of capital goods/technologies that are best
suited to their conditions.

Example: farm in a developing country should upgrade to animals with ploughs

instead of tractors, because tractors are too expensive and will increase
unemployment on the farm as less people will be needed

Labour-using (labour-intensive) technologies use

more labour in relation to capital. They result
in increases in local employment and the use of
local skills and materials, increases in incomes
and poverty alleviation, and save on the use of
scarce foreign exchange.

Capital-using (capital-intensive) technologies use

more capital in relation to labour. In developing
countries with large supplies of labour they
displace workers and increase unemployment,
reduce incomes and throw people into poverty,
and require skill levels that may be costly and
difficult to acquire, as well as the use of foreign
exchange for imports.

Most technological advances tend to be of the capital-using

type, because most research and technological
developments occur in developed countries that focus
on their own priorities and needs. This poses serious
problems for developing countries that mostly require
labour-using technologies and have limited resources
for developing technologies well suited to their own
economic and physical environments.

Part 2: Difficulties in the development of

appropriate technologies

Many developing countries

have very few resources to devote to R&D and
new technology development

The private sector in

developing countries faces few incentives to engage
in R&D.

c. Access to credit and microcredit

Part 1: The importance of banking and credit in

economic growth and development

If funds of savers
could not be borrowed by investors, people would
have to rely on individual savings for investment, and
these would hardly be enough to finance the needed
levels of new capital formation.

Credit -> increased investment -> greater output

Banking and credit institutions contribute to

growth and development in the following ways:

• They provide an incentive for people to save,

because they offer a return on savings. The greater
the savings in an economy, the greater are the funds
available to be invested.

• They provide businesses and farmers with credit to

open, run and expand their businesses and farms.
Increased borrowing permits greater investment,
resulting in increased output and therefore growth.
• They provide consumers with credit that can be
used for investments in human capital (education
for their children as well as essential medical
care), increasing the productivity of labour and
contributing to growth and development.

The commercial banking system in developing

countries is not well developed. The total amount of
funds in bank deposited is much less than in
developed countries. The number of bank branches per capita
in developing countries is far
smaller than in developed ones, so that businesses and
consumers may not have easy access.

Part 2: Exclusion of the poor from access to credit

• Access to credit is very important for poverty

alleviation because poor people are least able to save
any part of their income, since they are forced to
spend most of it on essentials.
Making credit available to very low income
earners can therefore allow them to make
necessary investments in physical, human and
natural capital. It can also contribute to improving
the distribution of income as the investments that
credit makes possible increase the incomes of the
poor and allow them to participate in economic
growth.

However, Commercial banks are

interested in large loans that are safe (are secured with
collateral). Poor and small-scale producers, farmers
and traders need very small loans, and very often lack
collateral to secure their loans.

The result is that the majority of

people in developing countries have to go to loan sharks.

Lack of access to credit by the poor and farmers is therefore

a major deterrent to growth and broad-based development.

Part 3: Solution - Microcredit Schemes

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

Micro-credit is delivered to poor people through

microfinance institutions

Benefits
The evidence on micro-credit schemes indicates that
these have a positive impact on poverty reduction.
They result in higher incomes, in more stable incomes,
as well as improvements in health, nutrition and
primary school attendance. They also result in an
improved social and economic status of women.

Limitation
Micro-credit schemes reach only a very small
proportion of poor people because there are as yet not enough
micro-credit schemes and microfinance institutions.

Disadvantages
1) Micro-credit schemes may become a
substitute for urgently needed government
anti-poverty policies. The alleviation
of poverty cannot be achieved by reliance on
micro-credit schemes alone.

2) Micro-credit schemes contribute to the

growth of the informal sector - The microenterprises
that are created through micro-credit
operate for the most part in the informal sector,
which is unregulated by the government, where
workers have no social protection, and where
exploitative conditions often prevail

3) Microcredit may end

up burdening some extremely poor people with
payments on loans that have not produced a
stable source of income.

4) Interest rates in micro-credit schemes

tend to be higher than market rates of interest on
commercial bank loans (However, they are lower than
interest rates given by loan sharks)
d. The empowerment of women

Part 1: Gender Inequalities

Gender inequalities in health

Women and girls face higher mortality (death) rates
in many developing countries compared with men
and boys. This is due to the neglect of girls during
infancy and childhood with respect to their health and
nutrition. When incomes are low and necessities like
food and health care are scarce, boys are more likely to
receive adequate amounts of food and the health care
they require.

Gender inequalities in education and

training

Gender inequalities in the labour market

Lower levels of education and skills place women at

a great disadvantage relative to men, as they do not
have qualifications to take on jobs requiring skills.

Discrimination can also prevent her from securing a high-level

job.
Women are more likely to work in the informal
sector, which means that, apart from receiving lower
incomes, they cannot receive the benefits offered
to workers in the formal sector (job security, legal
protection of workers’ rights, pensions

women are far more likely than men to have unpaid

responsibilities (child-rearing, household chores

Gender inequalities in inheritance rights

and property rights

Gender inequalities in access to credit

Over and above the problem of discrimination, lack
of property rights means that women have little if
anything they can use as collateral. Moreover, their
low earning power makes them far less attractive
candidates to receive credit

Gender inequalities in income, wealth and

poverty
due to lower levels of education and skills,
discrimination against women in the labour market
so that women are paid less for the same work,
and the preponderance of women’s work in the
informal sector

lack of inheritance and

property rights of women mean that most wealth goes to men

Part 2: Positive Externalities of Women empowerment

1) Improvements in child health and nutrition

and lower child mortality due to increased education of women and increases in
women’s income levels.

2)Improvements in educational attainment of

children
The more educated the mom, the more educated the children
Also higher income means better quality of education

3) Increased Quality of human resources

4) Because women are working due to increased education, lower birth rates ->
lower population growth -> reduces poverty
e. Income distribution

Highly unequal distributions of income are

actually a barrier to growth and development BECAUSE:

1) High income inequality may lead to lower overall

savings because the groups with the highest savings
rates are the middle classes and not the most
wealthy. Also, savings of higher
income groups often leave the country as financial
investments abroad, thus reducing resources
available for domestic investments.

2) Highly unequal income distributions mean that

the poor are unable to obtain credit, as they have
no collateral, meaning fewer investments for
people on lower incomes, leading to lower growth
and development. Also, opportunities to pay for
education and health care through borrowing are
reduced, leading to lower human capital and lower
growth and development.

3) An improved income distribution increases the

demand for locally produced goods and services,
thus encouraging local production and promoting
local employment and investment

4) Rich and powerful groups may be able to influence government

policies for their own benefit, even though these
policies may go against growth and development
objectives favouring the interests of the whole
population.

5. A more equal distribution of income leads to greater

political stability
4.4 The Role of International Trade
Trade problems facing many LEDCs

1. State the three barriers to development for economically less developed countries
(answer below)

2. With reference to specific examples, explain how the following factors are barriers to
development for economically less developed countries. a. Over-specialization on a
narrow range of products b. Price volatility of primary products c. Inability to access
international markets

a. Over-specialization on a narrow range of products

Developing countries
tend to specialise in the production and export of only a
few goods (Usually primary commodities)

The exports of any country are determined to a large

extent by the variety of goods it produces. Therefore, if it
specialises in primary products, its exports are likely to be
dominated by primary products. As the country diversified
into manufacturing and services, its exports are likely to
become more varied accordingly.

However, many developing countries are still

heavily dependent on primary products for their
export earnings

Countries that depending heavily on

only a few primary products for most of their export
earnings, face a number of risks and obstacles that work
against growth and development objectives:

Like Missing out on the benefits of

diversification and expansion into higher
value-added production

- The concept of ‘value added’ refers to the value of a good

that is added in each step of a production process

Adding value means:

• engaging in more varied production activities
• creating employment opportunities
• establishing new firms involved with manufactured
goods
• expanding into activities requiring higher skill and
technology levels.

If a country produces primary commodities and exports

these in their ‘raw’ form, it misses the benefits listed
above.

If a country has a comparative advantage

in the production of primary products, the theory of
comparative advantage suggests that it should specialize
and export these commodities. However, if a country
followed this route and did not diversify into new
areas of production, including manufacturing, it would
be seriously limiting its growth and development
prospects, for all of the reasons discussed above.

A country that relies too much on one market, let it be primary commodity or processed
goods, is susceptible. If the demand for that market changes, the country’s revenue will
suddenly drop. Current account deficits might widen as well because revenue from export is
not as much.

b. Price volatility of primary products

The prices of primary products are more volatile

(fluctuate more) than the prices of manufactured
products because they have low price elasticities of
demand and low price elasticities of supply
(Review Explanation and Diagram from Microeconomics)

Thus, farmers’ incomes fluctuate, along with agricultural

investment, employment and wages of agricultural
workers.

When the product is exported, this results in

fluctuating and unstable
export earnings, affecting the country’s balance
of payments and ability to import, as well as the
government’s efforts to engage in development
planning and undertake necessary investments.
c. Inability to access international markets

The inability to access international markets refers to

difficulties encountered by developing countries in
their exports to developed countries.

1) Developed countries impose higher tariffs

on imports from developing countries than
on imports from each other

2) Tariff escalation from developed countries discourage the

development of manufacturing
and diversification into higher
value-added activities

Tariff escalation - Developed countries impose low tariffs on

raw materials and much higher tariffs on processed products

Tariff escalation makes it difficult for

developing countries to expand into manufacturing,
since the greater the degree of manufacturing, the
more difficult it is for the product to be exported to
developed countries.

Thus, tariff escalation works to discourage

developing countries from diversifying their
production into manufacturing with a higher value
added.

3) Developing countries impose high tariff

barriers on trade with each other

4) Agricultural support by rich countries such as price floors and subsidies.

- This protection has
major negative consequences for many developing
country primary product exports and for poverty
alleviation.

3. Evaluation of consequences of agricultural support by rich countries (Added by me)

See Tragakes Textbook page 499
Emphasis needed on balance of payments difficulties
Trade strategies for economic growth and economic development

4. What are the six trade strategies to achieve economic growth and development

5. With reference to specific examples, evaluate each of the following as a means of

achieving economic growth and economic development. a. Import substitution b. Export
promotion c. Trade liberalization d. The role of the WTO e. Bilateral and regional
preferential trade agreements f. Diversification

a. Import Substitution
Import substitution, also known as import substituting
industrialisation, refers to a growth and
trade strategy where a country begins to manufacture
simple consumer goods for the domestic market to
promote its domestic industry
Import
substitution depends on protective measures (tariffs,
quotas, etc.) preventing the entry of imports that
compete with domestic producers.

See page 501 of Tragakes Textbook

b. Export promotion

Export promotion refers to a growth and trade

strategy where a country attempts to achieve
economic growth by expanding its exports.

Typical policies of export promotion

See page 502 of Tragakes textbook

Factors behind the success of export

promotion over import substitution
See page 502 and 503

c. Trade liberalization
trade liberalisation - the elimination of trade barriers to achieve free trade

Many countries found themselves losing their export

shares in world markets
Whereas some countries increased their exports,
on the whole liberalisation policies did not succeed
in helping developing countries diversify their
production into increased manufacturing for
export

The reason is that economic and trade liberalisation

creates both ‘winners’ and ‘losers’. When new export
markets are opened up, those who find employment
in the production of export goods will be better off;
people who find jobs in a growing formal sector (if it
is growing) will also gain; people with some education
and skills may also gain as they are better able to
exploit new opportunities in the more competitive
environment made possible by liberalisation.

However, there will also be those who will become

worse off as a result of the changes introduced by
liberalisation and free (or freer) trade. They include:
• less educated or illiterate people, who are unable to
compete in the new environment
• poor people who lack collateral, and who cannot
get credit to open or expand a business to take
advantage of new opportunities
• people who live in remote geographical areas with
no transport links to markets
• people who have nothing to export, and no
possibilities of producing for export
• people in agriculture who switch to producing
commodities for export, making themselves more
vulnerable to wide fluctuations (volatility) in cash crop
prices
• people who lose their jobs as public employees
due to cutbacks in the size of the public sector (in
Zimbabwe, people in this category are referred to as
the ‘new poor’)
• people who may become unemployed due to
privatisation of public enterprises, which fire
workers to lower costs
• people affected by cuts in government spending on
merit goods, forced by a greater reliance on market
forces
people affected by lower levels of social protection
caused by supply-side policies (such as lower
minimum wages, lower protection against being
fired)
• people who are forced from the formal into the
informal sector, where wages are lower and social
protection is non-existent, due to removal of trade
protection leading to the closure of formal sector
firms that can no longer compete

possibility of benefits from increased exports

• it may lead to greater unemployment
• it may lead to greater income inequality and poverty due to inability to compete with
increases in imports
• loss of tariff revenue.

d. The role of the WTO

Potential benefits

1. Resolves trade disputes

2. Gives consumers more choice

3. Lower trade barriers increase

international trade, which leads to higher incomes

4. Trade leads to increased

growth, and this may mean more employment
(though some jobs are lost).

Evaluating the negative consequences of the Uruguay Round

1) As a
result of the Uruguay Round agreements, developing
countries face tariffs on their exports that are
10% higher than the world average

2) Tariffs on textiles remained much higher

for developing country exports
This is of special importance
to developing countries because textiles are a low
technology industry that can make heavy use of the
abundant supplies of labour in developing countries,
and for these reasons textiles usually make up a large
share of output in countries that are just beginning to
industrialise.

3) The Uruguay
Round did not address the problem of tariff escalation,
which does not permit
developing countries to diversify their
production and exports

4) The Uruguay Round did not address

the fact that Developed countries make increasing use
of non-tariff barriers against developing
country exports

5) Agricultural subsidies of developed

countries were not reduced

6) Uruguay Round resulted in increased protection of

intellectual property which increases
costs of acquiring new technology by
developing countries

7) One of the
provisions of the Uruguay Round agreements was that
MNCs are not obliged to buy materials locally.

e. Bilateral and regional preferential trade agreements

Regional free trade agreements (FTAs):

potential benefits for growth and
development

Economists generally agree that free trade agreements

have the greatest potential to help developing
countries achieve growth and development when they
involve:
• regional agreements
• geographical closeness
• a similar level of development and technological
capabilities
• similar market sizes
• a shared commitment to co-operation.
Regional
groupings allow countries to expand their markets
(and achieve economies of scale) and to diversify
production and exports.

Larger markets increase

domestic and foreign direct investment.

When
countries are at a similar level of development and
have similar technological capabilities as well as
similar market sizes, the new competition created
by increased imports is more ‘fair’ and easier to
deal with

There are several policies that can be pursued jointly

by members so they can further benefit from their
integration. They can invest in transport infrastructure
needed for trade, as well as in energy and water
supplies needed for growth and development.
They can also collaborate on research and development

Bilateral free trade agreements (FTAs):

risks for growth and development

A bilateral agreement has the potential to provide

a developing country with access to the market of
the developed country, and the prospect of gaining
such access (not available to other countries) is the
reason why developing countries enter into such
agreements. However, this potential comes with some
serious risks:

• The developing country must make equal and

matching (or ‘reciprocal’) cuts in tariff and other
barriers, which are often much greater than those
required by WTO agreements. This puts even
efficient developing country firms at a competitive
disadvantage because they are forced to compete
with lower cost developed country firms (which are
larger, with greater technological, managerial and
marketing capabilities). The result may be to destroy
even efficient local firms.
• When many developing countries form FTAs with
the same developed country in order to gain market
access, the advantage they each hope to gain
individually is lost, as they must now all compete
with each other for the developed country market.

• Increased imports and only slightly increasing

exports may result in trade deficits, balance of
payments problems and increasing foreign debt.
They may also result in greater unemployment,
worsening income distribution and increased
poverty.

• Bilateral negotiations put developing countries at

a disadvantage due to weaker bargaining power
compared to the multilateral negotiations of the
WTO where they can join together and present their
interests as one, thereby gaining a more favourable
treatment.

• The developing country must agree to other

requirements not usually in its best interests (such
as freer rules on foreign direct investment, stricter
rules on intellectual property rights).

f. Diversification

Diversification involves a reallocation of resources

into new activities that broaden the range of
goods or services produced.

We learned that diversification

by adding value to locally produced goods provides
the benefits of more varied production, increased
employment, establishing more firms, and using
higher skill and technology levels.

It permits countries to achieve the

following important objectives:

1) Sustained increases in exports

2) Diversification encourages
technological and skill developments; it provides
incentives to acquire new technologies and
higher training, education and skill levels, which
are very important for economic growth and
development.

3) Reduced vulnerability to short-term price

volatility and long-term price declines - Diversification
protects countries against losses from fluctuating export prices

6. Explain ‘liberalised capital flows’ as one type of market-oriented policy (Added by

me)
Capital liberalisation refers to the free movement
of financial capital in and out of a country.

It occurs
through the elimination of exchange controls
which are government
restrictions on the quantity of foreign exchange that
can be bought by domestic residents of a country

A country that has

exchange controls has a non-convertible currency; the
domestic currency cannot be freely exchanged for (or
‘converted into’) foreign currencies. Non

A fully convertible currency, by contrast, is one that can

be freely exchanged for other foreign currencies.

Read Page 513,514,515 of Tragakes Textbook

4.5 The Role of International Trade
The meaning of FDI and MNCs

1. Describe the nature of foreign direct investment (FDI) and multinational

corporations (MNCs).

Foreign direct investment (FDI) is investment

by firms based in one country (the home country)
in productive activities in another country (the host
country).

Foreign direct investment is by far the most

important source of foreign finance flows to
developing countries. However, for many low-income
developing countries that are almost completely
bypassed by MNCs, foreign aid is the main source of
foreign finance.

A firm that undertakes foreign direct investment

is referred to as a multinational corporation
(MNC), because it operates in more than one country.

2. Explain the 5 reasons why MNCs expand into economically less developed countries.

higher
profits.

Developing countries offer possibilities for

MNCs to:

1) increase sales and revenues (LEDCs have large and fast growing markets)

2) bypass trade barriers.

3) lower costs of production.

developing countries generally have lower
labour costs than in developed countries.

4) use locally produced raw materials.

which, is far less costly on
account of transportation costs.
5) further their activities in natural resource
extraction - Many developing countries are very
rich in natural resources

3. Explain the 8 characteristics (1 part has 6 points) of economically less developed

countries that attract FDI

1) low cost factor inputs - labor and cheaper locally produced raw materials

2) political stability

3) a stable macroeconomic environment (low

inflation, stable currency, acceptable levels of
foreign debt, no major balance of payments
problems)

4) an institutional environment that favours foreign

direct investment, such as
" freedom to repatriate profits (i.e. send profits to
the home country)
" freedom to engage in foreign exchange
transactions (no exchange controls, thus
can import possible needed inputs without
restrictions
" favourable tax rules (to ensure low tax payments)
" lack of restrictions regarding foreign ownership
" well-established property rights
" rules that minimise the risk of nationalisation (a
takeover of private property by the state)

5) a liberalised (free market) economy with limited

government intervention

6) liberal (free market) trade policy with an emphasis

on exports

7)large markets

8) rapid economic growth and expectations of

continued rapid growth
Advantages and disadvantages of FDI for economically less
developed countries

4. Evaluate the impact of foreign direct investment (FDI) for economically less
developed countries.
Potential advantages of MNCs for host developing countries (6)
Potential Disadvantages Part 1 - Why the potential advantages may not work (5)
Potential Disadvantages Part 2 - Further negative consequences (5)

Potential advantages of MNCs for host

developing countries (6)

*1) MNCs can supplement insufficient foreign

exchange earnings. Investment funds flowing
into a country from abroad appear as credits in the
financial account, and can help offset a current
account deficit. Due to MNC, the
country’s exports are expected to increase, which
increases export revenue and is good for BOP.

*2) MNCs bring about technological improvements as well as improvements

in human capital by bringing
technical and managerial expertise and
new production technologies

3) MNCs can supplement insufficient domestic

savings and increase investment and new
capital formation

*4) MNCs can lead to greater tax revenues in the

host country since they are taxed

*5) MNCs can help promote local industry by

buying locally produced goods and services as
inputs into their production.

6) MNCs can decrease local unemployment

7) MNCs can lead to higher economic growth in

the host country due to:
increased levels of investment,
improved technology and increases in human capital,
promotion of local industry,
greater tax revenues,

Potential disadvantages of MNCs for host

developing countries

Part 1: Why the benefits listed above might not

come about

1) MNCs may not always supplement

insufficient foreign exchange earnings.
MNCs usually do bring foreign exchange into
the host country. However, MNCs are also responsible
for foreign exchange outflows due to repatriation
of profits, importing raw materials and other
inputs for use in production; or because they
finance their activities by borrowing from the
parent corporation in the home country, in which
case they must repay the loan plus pay interest.
Thus, the net inflows of foreign exchange may be small.

2) MNCs may not improve on local technical

skills, management skills and technology because
the MNCs’ influence on the
development of local skills may be very small, as in
practice the links between MNC activities and the
local economy are often limited so local
workers do not have the opportunity to learn from
the MNC. Also, MNCs often hire personnel from the
home country

3) MNCs may not lead to greater tax revenues in

the host country. because they enjoy many tax privileges
and benefits, often lowering the amount of tax paid.
Tax benefits are offered as an incentive to attract MNCs
into the host country. Another reason why MNCs pay
less tax involves the practice of transfer pricing, which
allows MNCs to lower their stated profits, which results in
lower taxes
(See Tragakes Textbook if you need more understanding of transfer pricing)

4) MNCs may not help promote local industry as The

operation of MNCs sometimes forces local competing
firms to go out of business, or prevents new local firms to establish themselves in
industries that are directly competitive with the MNC.

5) MNCs may not help lower unemployment

in the host country. If, as noted above, MNCs
prevent the development of local industry, then
their job-creating impact will be limited. In
addition, some MNCs may sometimes import into
the host country capital-intensive technologies
that are inappropriate to local conditions given
large labour supplies, thus contributing to
unemployment and underemployment.

Part 2: Further possible negative effects of MNCs

6) environmental degradation.

7) MNCs create new

consumption needs and promote inappropriate
consumption patterns through advertising.
What makes it more powerful in the case of
developing countries is that populations plagued
by hunger, malnutrition, disease and lack of basic
services can less afford to spend their small incomes
on unnecessary goods while their basic needs
remain unsatisfied.

8) MNCs may use government resources to

build infrastructure needed by MNCs rather
than for poverty alleviation. MNCs sometimes
require infrastructure (road systems, ports,
telecommunications, etc.) which the developing
country must make available if it is to become
attractive as a host country. To build these types of
infrastructure, it may have to shift some of its scarce
resources away from needed merit goods (clean
water, sanitation, schools and health care services)
and toward infrastructure for MNCs.

9) MNCs may use their economic and political

power to bring about policies for their own interest that may work
against economic development.

10) Many developing countries compete with each

other over which will create better conditions to
attract MNCs, which may involve sacrifices of needed
development, lowering government tax revenues,
and use of local resources for infrastructure instead
of merit good provision.
4.6 The roles of foreign aid and multilateral
development assistance
Foreign Aid

Classifications and Types of Aid

1. Explain what aid is, ODA, and the three ways that ODA reaches developing countries

Foreign aid is defined as the transfer of funds or

goods and services to developing countries with the
main objective to bring about improvements in their
economic, social or political conditions.

For such transfers to be considered as foreign aid, they

must satisfy two conditions:
• They must be concessional, which means that the
transfers involve more favourable conditions than
could be achieved in the market. In other words, when
the aid involves loans, interest rates are lower and
repayment periods are longer than borrowers would
get in the commercial banking system. Also, the aid
may involve grants, which are gifts of either money
or goods and services that do not need to be repaid.

• They must be non-commercial, meaning that they

must not involve buying and selling (commerce)
or other activities concerned with making a profit.
Official Development Assistance (ODA), comes from governments of donor countries

ODA funds reach developing countries in three ways:

• through bilateral aid, which is the most important

way – funds go directly from the donor government
to the developing country recipient; examples of
bilateral aid agencies are USAID (US Agency for
Internal Development) in the
United States and DFID (Department for
International Development) in the United Kingdom

• through multilateral aid, going indirectly

from donor governments to international
organisations, which transfer the funds to
developing country governments
• through NGOs – donor governments transfer ODA
funds to NGOs which spend them in developing
countries.

2. Explain what humanitarian aid is and what it consists of (2)

Humanitarian aid involves aid extended in

regions where there are emergencies caused by
violent conflicts or natural disasters such as floods,
earthquakes and tsunamis.

Humanitarian aid consists of food aid, medical aid and emergency relief aid.

3. Explain what development aid is and what it consists of

Development aid is intended to help developing

countries achieve their economic growth and
development objectives. It may take the following forms:

• Project aid involves financial support for specific

projects, such as building schools, hospitals,
irrigation systems or other agricultural infrastructure.

• Programme aid involves financial support

to sectors, such as education, health care,
agriculture, urban development, the financial
sector (credit, banking, insurance), energy, the
environment, or others.

• Technical assistance involves the provision of

technical advice by developed country specialists
such as doctors, teachers, agronomists, etc.

• Debt relief - Very poor countries with high levels

of foreign debt sometimes receive aid involving
some debt forgiveness

4. Explain that, for the most part, the priority of NGOs is to provide aid on a small scale
to achieve development objectives.

NGOs are ‘private

organizations that pursue activities to relieve
suffering, promote the interests of the poor, protect
the environment, provide basic social services, or
undertake community development

for the most part, the priority of NGOs is to provide aid on a small scale to achieve
development objectives

Most of these are

small local groups pursuing development objectives
within a relatively small community.

NGOs obtain their funds from private voluntary

contributions including private sector corporations
and, increasingly, from bilateral and multilateral ODA
funds. In other words, more and more of ODA funds
are channelled through NGOs, particularly in the case
of humanitarian assistance. The reason for this is that
NGOs can perform functions that are not performed
as effectively by national governments

NGOs are involved in a vast range of activities,

including provision of humanitarian aid in times
of crisis, promotion of sustainable development,
promotion of community development, service
delivery, poverty alleviation, protection of child
health, promotion of women’s rights, promotion
of small-scale entrepreneurs, support of the poor in
the informal sector, provision of technical assistance
to small farmers, provision of credit to poor people
(micro-credit schemes), research activities, political
advocacy, support for people’s movements, and
more.

5. Explain that aid might also come in the form of tied aid. (4p)

Tied aid refers to the practice where donors make

the recipients of aid spend a portion of borrowed
funds to buy goods and services from the donor
country. It occurs only in the context of bilateral
(not multilateral) aid, and gives rise to several serious
disadvantages:

• Recipient countries cannot seek lower price

alternatives for the goods and services they are
forced to buy from the donor country. Tied aid reduces the value of aid
as recipients of tied aid face much higher than necessary costs.

• Having to buy specific goods and services

from the donor country often results in
buying inappropriate, capital-intensive
technologies.

• Those who benefit from tied aid are usually

large firms in developed countries whose goods
and services the recipient countries are forced to
buy. This occurs at the
expense of poor country development
objectives.

6. Examine the motivations of economically more developed countries giving aid.

1) Political and strategic motives.

Often aid has been used to support regimes in developing
countries that are considered to be ‘friendly’ to the
interests of the donor governments.

2) Economic motives.
Developed countries often regard it to be in
their interest to assist countries with which they have
strong economic ties. For example, much of Japan’s
aid is directed towards neighbouring countries with
which it has strong trade and investment links. The
practice of tied aid (to be discussed below), is an
important example of economic motives of donors.
Tied aid forces the recipients of aid to spend a portion
of aid funds to buy goods and services from the donor
country, thus providing significant economic benefits
to donor countries.

3) Humanitarian and moral motives

7. Compare and contrast the extent, nature and sources of ODA to two economically
less developed countries.
Aid financed by ODA can vary widely across recipient countries depending on:
1) the amount of aid (some countries receive much more than others),
2) the type of aid (humanitarian aid, project aid, programme aid),
3) the form it takes (grants and concessional loans),
4) the sectors that are supported,
5) the sources of aid (donor countries offering bilateral aid, international
organisations offering multilateral aid, or NGOs).

6) In addition, it
can vary widely with respect to how effective it is in
helping recipient countries achieve their growth and
development objectives

Evaluation of Foreign Aid

8. Evaluate the effectiveness of foreign aid in contributing to economic development.

Talk about Arguments in favor of ODA (5), Factors that limit the effectiveness of
Official Development Assistance (ODA) (8), Advantages of NGO: why NGOs
are growing in importance (8), Criticisms of NGOs (4)

Arguments in favour of Official

Development Assistance (ODA)

1. Aid and the poverty cycle

To emerge from a poverty
cycle, poor people and poor communities need the
government to intervene by undertaking the necessary
investments in physical, human and natural capital.
However, if the government does not have enough tax
revenues, the only way the country, or community
within a country, can escape the poverty cycle is
through foreign aid that makes up for the lack of
savings.
To be able to finance
these services themselves, poor countries would need
to achieve economic growth that would provide them
with increased economic resources that can be used
to invest in health, education and infrastructure.
However, economic growth is not possible unless there
is first some investment in these areas, which foreign aid helps with.

2. Aid and provision of basic services

Aid can be used to invest in
health, education and infrastructure, which can help
poor people improve their health, employment opportunities,
and improve their incomes.
3. Aid and improved income distribution
By focusing on the most disadvantaged groups in
society, aid can help improve the relative income
positions of the beneficiaries and contribute to
improved income distribution. Highly unequal
income distribution can be a barrier to growth and
development

4. Aid and economic growth

There is strong evidence that aid leads to economic
growth, because it makes possible increased
investment and consumption levels, leading to
increased volumes of output

5. Aid, the debt trap and debt relief

Countries that are heavily indebted (have high levels of
debt) face serious negative consequences for their growth
and development, especially when caught in a ‘debt
trap’, where they must go on borrowing more and more
in order to service old debts (see page 521 of Tragakes Textbook). Aid for
debt relief helps countries reduce their debt burden and
releases resources that can be used for poverty reduction
and economic growth and development.

Factors that limit the effectiveness

of Official Development Assistance
(ODA)

1. Tied aid

2. Conditional aid (conditionality)

Most donors of ODA impose numerous conditions
that must be met by the recipients of aid. Donors
see these conditions as a mechanism for forcing
developing countries to make important policy
changes, as well as for ensuring that aid funds
are used effectively.
Conditional lending has
been found to create disadvantages for developing
countries. Donors do not pay sufficient attention
to the preferences of the government or of the
population groups the project is intended to benefit.
Policy prescriptions by donors may be incorrect; they
may not fit in with the government’s development
strategy and priorities; and they may weaken the
recipient government’s authority and accountability
to its citizens.

3. Aid volatility and unpredictability

The flow of aid funds (particularly bilateral flows)
into developing countries is volatile (unstable) and
unpredictable. This is partly due to changing volumes
of aid in donor budgets, and changing donor priorities
on how to allocate aid funds. This makes it difficult
for recipient governments to implement policies that
depend on aid funds, as they cannot be sure if and
when funds will be available to undertake necessary
investments and activities. Disruptions
in aid flows can have very serious effects on the
welfare of the population groups affected by the
aid cuts.

4. Unco-ordinated donors
In any recipient country there are usually large
numbers of donors (bilateral and multilateral) who
finance unco-ordinated activities, giving rise to
numerous inefficiencies in the use of aid resources.

5. Aid may substitute for rather than

supplement domestic resources
A possible danger is that
governments in recipient countries may use aid funds
to substitute for domestic resources, and not make
enough effort to increase domestic revenues through
taxation.

6. Aid may not reach those most in need

Aid resources are not allocated on the basis of the greatest
need for poverty alleviation. There are two aspects to this
issue: the distribution of aid funds across countries, and
the use of aid funds within recipient countries. We have
already seen in connection with the first that bilateral
donors do not always allocate aid resources according
to country needs. The second, involving the use of aid
funds within countries, is related to a number of factors:
recipient country governments may not be genuinely
committed to poverty alleviation; they may lack the
necessary expertise to design and implement poverty
alleviation policies; tied aid may favour projects that are
not appropriate for poverty alleviation; donors may select
projects that are not the most effective from the point of
view of poverty alleviation.

7. Aid may be associated with corruption

8. The quantity of aid and poverty alleviation

Some rich countries fail to follow through on their commitments,
which results in developing countries being unable to make the
investments in health, education and infrastructure
needed to improve welfare and support the economy.

Advantages of NGO: why NGOs are

growing in importance

More and more bilateral and multilateral donors

of ODA are channelling their funds through NGOs
because of their ability to perform some functions
better than developing country governments. The
reasons for better performance include:

1. Strong anti-poverty orientation of activities

NGO activities are for the most part concerned with
reaching poor people and helping them emerge from
their poverty. Governments often have difficulties in
reaching the very poor; NGOs have an advantage by
working very closely with communities of poor people
and responding to their particular needs as these
arise in their own particular economic, social and
environmental conditions.

2. Working closely with project beneficiaries

One of the strongest advantages of NGOs is that they
work closely with their beneficiaries, involving local
people in the design and implementation of development
projects.

3. Contributing to democratisation
Such participatory practices contribute to a process of
democratisation, which can be important in countries
that do not have democratic institutions.
4. Offering expertise and advice
International NGOs accumulate experience from a
variety of countries and local settings, many of which
may be relevant and transferable to similar settings
in other countries. They recruit experts in a variety
of areas in accordance with need, and the experts are
highly motivated out of a strong commitment to the
objectives of the NGO with which they are affiliated.

5. Ability to be innovative

6. Independent assessment of problems and

pursuit of solutions
Unlike government programmes, which must conform
to general policy guidelines and are subject to
following government agendas, NGOs have a greater
degree of freedom to use their expertise and technical
knowledge to assess problems independently and
arrive at suggestions for solutions.

7. Enjoying the trust of beneficiaries

Poor people are often highly suspicious and
mistrusting of government officials and
administrators, feeling at best neglected and at worst
exploited. NGOs sometimes enjoy greater trust than
governments, because of their close relationship with
project beneficiaries, and their commitment to solving
problems at grassroots level.

8. Advocacy and raising public awareness

and support
Poor people usually lack political voice and
representation, and their concerns are not heard at higher
government levels. NGOs play an important leadership
role in acting as advocates on public policy issues, and
ensuring that poor people’s concerns are heard.

Criticisms of NGOs

Critics charge that NGOs have a number of weaknesses:

1. Small size and weakness of many NGOs

NGOs may be too small and weak to be able to play an
important role as agents of change and development.
They often have limited resources, and may face
difficulties in attracting skilled personnel, so that the
effectiveness of their projects may be limited.

2. Possible loss of independence due to

growing dependence on governments and
aid agencies for funding

3. NGOs may attract the best qualified

personnel away from government
BECAUSE NGOs are often in a
position to offer higher salaries and benefits than
the government.

4. Challenge to state authority

Whereas governments generally welcome NGOs that
complement their activities in poverty alleviation,
they often dislike the advocacy role taken on by many
NGOs, which may conflict with government policy or
question its authority.

9. Compare and contrast the roles of aid and trade in economic development.

1) Trade not aid

The arguments centre

on two main points: the failures of aid to effectively
address the problem of growth and development;
and the ability of trade to make major contributions
to growth and development

Regarding the failures of aid, its critics emphasise

the dangers of corruption, the idea that aid replaces
government funds rather than supplementing them,
and that because of corruption and mishandling, aid
does not reach those most in need.

However, it is important that developed

countries eliminate their trade protection
policies, as well as their agriculture subsidies, for this to work.

2) Trade and aid

While trade
and export growth are very important for growth and
development, they are not enough in the case of low income
(very poor) developing countries.

There is strong pressure on donors by aid organisations

to correct these problems, to make aid more effective.
At the same time, there are some situations where
international trade may be unable to help, making aid
necessary:
Rich country agricultural subsidies
Developing country dependence on primary commodity exports with price volatility
The poverty cycle
Countries may have little to export - difficulties moving into new areas of production
Exclusion of geographically isolated communities

3) Aid for Trade

More and more economists believe that to be able to
benefit from international trade, developing countries
must have the institutional capacity to increase their
exports.

Aid and trade should be linked together

so that a portion of aid is used to support the
development of institutions that improve a country’s
abilities to export.

This view is based on the idea that

many poor countries face institutional constraints
that prevent them from taking advantage of growing
international markets.

The constraints faced by developing countries

include everything from high transport costs due to
poor transport networks, limited access to credit, poor
power supplies adding to costs of production, high
administrative costs related to complicated border
procedures, and lack of institutional capacity to meet
technical and sanitary standards required
by importing countries.

Multilateral Development Assistance

The roles of the IMF and World Bank

10. Examine the current roles of the IMF and the World Bank in promoting economic
development.

Multilateral development assistance involves

lending to developing countries on non-concessional
terms, in other words with rates of interest and
repayment periods determined in the market.

The World Bank lends in order

to support economic growth and development

The International Monetary Fund lends in

order to alleviate external payments difficulties.

World Bank Activities

poverty orientation - achieving Millenium Development Goals

aid with institutional development in order to provide

education and health services; ensure availability
of and access to necessary infrastructure (water,
sanitation, transport, etc.); provide an effective and
equitable taxation system; ensure access to credit by
all who need it; secure property rights; minimise the
possibilities for the exercise of corruption; empower
women and other disadvantaged groups; promote
appropriate technology development and innovation;
give a political voice to the economically weak; ensure
and promote competition; and more.

Evaluating the role of the World Bank

Negative consequences (7)

• Social and environmental concerns. The World

Bank has been criticised for implementing socially
unsound projects (such as building hydroelectric
dams that displace indigenous people), as well as
environmentally unsustainable projects.
Now they are aware and do better
• World Bank governance dominated by
rich countries, so decisions are often
made without regard for the needs of
developing countries,

• Excessive interference in countries’ domestic

affairs.

• Conditional assistance (lending).

Conditional assistance (or conditional lending)
refers to the imposition of conditions that must be
met by borrowing countries to qualify for a loan.
Conditional lending is problematic
because it deprives countries of control over their
domestic economic activities.

• Structural adjustment lending has been

criticised for increasing income inequalities and
poverty within developing countries, because of
such factors as increasing unemployment, cuts
in provision of merit goods by governments, cuts
in food subsidies, introduction of payments of fees
for health and education, and limited possibilities
for the poor and the unskilled to take advantage
of opportunities opened up by the freer market
environment. (SALs were a method used by the World Bank in
assisting (and forcing) developing countries to adopt
economic and trade liberalisation policies - it reduces government intervention and
promotes competition and the role of markets)

• Inadequate attention to poverty alleviation - not allocating

enough funds for loans intended to meet the
needed investments in education, health services,
and infrastructure (clean water supplies, sanitation,
etc.).

World Bank not doing

enough in the area of debt relief

IMF

The loans provided by the IMF usually come with

a package of policies that the country must adopt as a
condition for receiving the loan (another example of
conditionality). These policies, known as stabilisation
policies, vary from country to country, but typically
include the following:
• tight monetary policy, through increases in interest
rates, intended to lower aggregate demand, reduce
the level of economic activity and reduce demand for
imports while encouraging inflows of financial capital,
thereby helping the balance of payments position

• tight fiscal policy, also intended to lower aggregate

demand and reduce the level of economic activity,
through cuts in government spending (including
cuts in provision of merit goods, such as health
services, education, infrastructure, etc.) and cuts
in food and other subsidies, as well as increases in
taxation, and the imposition of fees for schooling
and health care services

• currency devaluation or depreciation, intended to

discourage imports and encourage exports and help
the balance of payments position

• cuts in real wages (i.e. wages after taking into

account the impact of price changes), to reduce
aggregate demand and the level of economic activity

• liberalisation policies, such as eliminating or

reducing controls on prices, interest rates, imports
and foreign exchange, to promote a free market and
free trade environment.

Evaluating the role of the IMF

Negative consequences (4)

1. IMF criticized for its highly negative impact on countries that almost always results
from its stabilisation policies.
Positive results tend to be short term, and history shows that BOP
problem of many developing countries does not tend to get resolved
Many developing countries experience increasing poverty
and also low or negative rates of growth
Cuts in real wages
where wages are low to begin with, cuts in
government spending on merit goods and food
subsidies on which many poor people depend for
their physical survival, the imposition of fees for
schooling and health care services among people
who cannot afford them, along with the increases
in poverty that arise from liberalisation policies.

2. IMF governance dominated by rich

countries.

3. Even more excessive interference in countries’ domestic

affairs than World Bank

4. Conditional lending
Countries need to agree to the harsh stabilization policies, and many countries have
to do it because they are desperate
4.7 The role of international debt
Foreign Debt and its Consequences

1. Outline the meaning of foreign debt and explain why countries borrow from foreign
creditors.

A country’s foreign debt refers to its level of external

debt, meaning the total amount of debt (public and
private) incurred by borrowing from foreign creditors
(i.e. lenders).

Foreign government debt (see Figure 18.1) arises

from three sources: (i) government borrowing from
multilateral organisations, (ii) government borrowing
from foreign commercial banks, and (iii) government
sales of bonds to foreigners

Reason

Countries borrow from abroad to acquire

foreign exchange allowing them to pay for an excess
of imports over exports (a trade deficit). A trade
deficit allows a country to reach a point outside its
production possibilities curve (PPC), meaning it enjoys
more goods and services than it can produce itself
(see page 399 of Tragakes textbook), but this means it must have a method
of paying for the extra goods and services; borrowing
from abroad is one method allowing it to do this.
The rationale, over the longer term, is that countries will
spend at least a portion of imports made possible by
foreign finance on capital goods that are inputs in
production, which will accelerate their growth and
their exports

2. Explain that in some cases countries have become heavily indebted, requiring
rescheduling of the debt payments and/or conditional assistance from international
organizations, including the IMF and the World Bank.

The increase in oil price created recessions in developing countries, so they

borrowed money to be able to import oil. Developing
countries, for their part, did not always spend the loan
funds wisely. While a portion of the funds was used
for investments in infrastructure and debt servicing, in
some countries loan funds supported public spending
that should have been financed by government tax
revenues. This allowed governments to enjoy broad
political support by maintaining low tax rates as
well as poor and low tax collection.

Then, A second oil price shock occurred, resulting in

increased import costs and reduced export
revenues. Developing countries were
faced with two options: they could pursue restrictive
monetary and fiscal policies to create a recession that
would cut back on imports, thus saving on the need
for foreign exchange (expenditure reducing policies;
see page 408 of Tragakes textbook); or they could borrow more. As more
borrowing was preferable to recession, levels of debt in
many countries reached massive proportions.

A series of measures to prevent developing country defaults (4)

1. Debt rescheduling
Debt rescheduling involves new loans by commercial
banks to developing country debtors, but on better
terms. It involves granting of new loans that were stretched
out over longer periods of time and at lower interest
rates. The loans were used to pay off some of the old
loans, and therefore ease the pain of having to service
the debts.

2. IMF lending and stabilisation policies

A second measure involved turning to the International
Monetary Fund (IMF) for conditional loans (with stabilization policies)
that would help cover large and growing current account deficits.

3. World Bank lending and structural

adjustment loans
Countries also borrowed from the World Bank, which
also made conditional loans such as structural
adjustment loans (SALs)
which forced the borrowing country government to
pursue economic and trade liberalisation policies to
qualify for receiving a loan.

Other initiatives: debt-for-equity swaps

This occurs when a highly indebted country exchanges
a portion of its debt for equity, which is taken up by
foreign corporations. What this means is that the
foreign corporation takes responsibility for a portion of
a government’s debt, and in exchange the government
gives it ownership of some of its assets (such as a
telephone company or a steel mill).
However, a key problem is that foreign corporations can
be persuaded to engage in a debt-for-equity swap only
if they acquire the state assets at a low price. As a result,
governments lose control of some of their major assets
to foreign-owned corporations at a price that is far lower
than if these assets were sold at market prices.

3. Explain why the servicing of international debt causes balance of payments problems
and has an opportunity cost in terms of foregone spending on development objectives.

Balance of payments problems

When a country borrows from foreign institutions, its debt
servicing obligations (repayment of loan plus interest) must
be paid in foreign exchange. If its export
earnings are not enough to cover its foreign exchange
needs for debt servicing, it can borrow more from abroad
to acquire the needed foreign exchange. However, as it
borrows more, its debt servicing obligations increase.
This means that there will be continuous pressure on the
balance of payments and a constant quest for foreign
exchange with which to service the debt.

Possibility of a debt trap

A situation where a country
must keep on taking out new loans in order to pay
back the old ones with interest.

Opportunity costs
Large debt service payments have major opportunity
costs because the government has fewer resources to
invest in social services (health, education, etc.) and
infrastructure, all necessary for poverty alleviation and
economic growth and development.
In addition, since a highly indebted country is
forced to use a large portion of its export earnings
for debt servicing, it has less foreign exchange to
pay for imports of needed capital equipment, other
production inputs and goods and services generally.

Lower private investment

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

Lower economic growth

The above three factors, lower public investments in
merit goods, lower imports of production inputs and
lower private investment, work to lower economic
growth in highly indebted countries. This in turn
translates into a reduced ability to service debts.

4. Explain that the burden of debt has led to pressure to cancel the debt of heavily
indebted countries
The difficulties caused by high levels of debt
have led to pressure on creditors to cancel debts
of highly indebted countries, because debt puts a lot of pressure on countries and it
becomes increasingly difficult to pay back debts with interest over time
4.8 The balance between markets and intervention
Strengths and Weaknesses of Market-Oriented Policies

Strengths

1. Discuss the 6 positive outcomes of market-oriented policies

Market-oriented Policies
Market-oriented policies, as the term suggests, are
policies based on the market mechanism.

Market-oriented policies we have studied include:

• market-based supply-side policies, including:
policies encouraging competition (deregulation,
privatisation and anti-monopoly regulation), labour market reforms, incentive-related
policies
• trade liberalisation
• freely floating exchange rates
• liberalised capital flows, or the absence of exchange
controls which limit the amount of foreign
exchange that can be purchased with the domestic
currency

Strengths

1. Policies encouraging competition, such as deregulation, privatisation and

anti-monopoly regulation, work by freeing
market forces and making markets more competitive,
are intended to result in greater efficiency in
production, lower prices and improved quality, and
a better allocation of resources, as well as increased
levels of output, or economic growth.

2. Labour market reforms similarly promote free

market forces in labour markets, allowing the
allocation of resources to improve.

3. Incentive-related policies, involving adjustments to various types

of taxes, are intended to work by improving the
incentives to work, innovate and invest, thus making
the signalling and incentive functions of the price
mechanism more effective, again improving the
allocation of resources and also allowing for economic
growth.

4. Trade liberalisation - The elimination of trade

barriers and the opening up of countries to free trade
has the effect of making markets much larger than they
would be with trade barriers. The result of larger free
markets is to increase competition, increase efficiency in
production, lower prices and improve quality, increase
consumer choice, improve the allocation of resources,
and allow for greater economic growth.

5. Freely floating exchange rates reflect

the forces of supply and demand for a currency, and
therefore can effectively carry out the signalling and
incentive function of prices for those carrying out international
transactions of all kinds. A freely
floating exchange rate automatically adjusts to excess
demand or supply of a currency, bringing about a
balance in the balance of payments and offering
greater flexibility to policy-makers to pursue policies
needed domestically (see page 403 of Tragakes textbook).

6. Liberalised capital flows (or absence of exchange

controls) allow domestic residents to purchase any
amount of foreign exchange without restrictions,
whether for imports, or for travel or investment abroad,
etc. This is important for attracting multinational
corporations (MNCs) because it means the MNC is free
to repatriate profits or to purchase inputs from abroad
(import them). In addition, free capital flows mean a
more efficient global allocation of savings, since savers
are free to make financial investments anywhere in
the world without restrictions.

Weaknesses

2. Discuss the negative outcomes of market-oriented strategies.

Weaknesses

1. One of the most important weaknesses of market-oriented

strategies is that they cannot deal with the
issue of market failures.
Market failures we have studied include:
• negative environmental externalities (of production
and consumption)
• the problems of common
access resources
• insufficient provision of merit goods
• failure to provide public goods

There are two additional failures of concern to

developing countries: coordination failures and weak
or missing market institutions.

2. Co-ordination failures
Co-ordination failures
provide a possible explanation for the failure of firms
to be set up and to contribute to growth.
.Co-ordination failures arise when two or more
activities that must begin simultaneously fail to do
so, even though decision-makers make economic
decisions that are in their best self-interest. The
inability of decision-makers to co-ordinate their
behaviours results in an outcome where everyone
is worse off than they would have been had coordination
been possible. These failures lead to
underdevelopment traps, where people are trapped in
a situation from which they cannot escape without
outside help.

3. Does not work if there are Weak or missing market institutions

To be able to function effectively, markets need an institutional
and legal environment that is often missing in less
developed countries in order to enforce
property rights, enforce legal contracts,
effective legal recourse, a stable currency, a well developed
banking and insurance system, an effective
road and utility infrastructure system, and readily
available information on prices, quantities and
quality of goods, services and resources to consumers,
firms and resource owners.

4. Development of dual economies

A dual economy (or dualism) arises when there are
two different and opposing sets of circumstances that
exist simultaneously. Examples include:
• wealthy, highly educated people and poor, illiterate
people
• a formal and informal urban sector
• a high-productivity industrial sector and a low productivity
traditional sector
• a low-productivity agricultural sector and a
high-productivity, urban industrial sector
• a ‘modern’ commercial agricultural sector and a
‘traditional subsistence agricultural sector.

Dual economies may persist even

as a country grows and develops. They are the outcome
of market forces that do not work to the benefit of all
or most people in a country because of the presence
of market failures such as weak market institutions
or co-ordination failures, because of the geographical
isolation of many groups of people, the persistence
or growth of great income inequalities and extreme
poverty, or government policies that support one sector
of the economy at the expense of another.
Thus, dual economies require government policies to resolve them.

5. Income inequalities
The loss of protection of workers resulting from labour-market reforms,
and increases in unemployment resulting from some
policies to increase competition, including trade
liberalisation which often involves the closure of
firms, often result in increases in income inequalities.
Market-oriented policies cannot resolve this problem.

Insufficient credit for poor people (not mentioned in syllabus points)

This results in lower investment possibilities,
greater poverty and poorer income distribution, as
well as the inability to escape the poverty cycle.
Strengths and Weaknesses of Interventionist Policies

Strengths

3. Discuss the strengths of interventionist policies

Interventionist policies are based on government

intervention in markets intended to correct market
deficiencies and create an environment in which
markets can work more effectively.

Strengths

1. Correcting market failures such as negative externalities and overuse of

common access resources

2. Provide public goods and merit goods that

are underprovided by investing in human capital (increases productivity) and
infrastructure (increases productivity and SOL)

3. Assist in the correction of co-ordination failures

4. contribute to the development of market

institutions (enforcement of
property rights, enforcement of legal contracts,
effective legal recourse, a stable currency, a well developed
banking and insurance system, an effective
road and utility infrastructure system, and readily
available information on prices, quantities and
quality of goods, services and resources to consumers,
firms and resource owners) that enable markets to operate more
effectively

5. Provision of a stable macroeconomic environment

A stable macroeconomic environment includes price
stability (the general price level should rise only
gradually); full employment (people willing and able to
work should be able to find a job); a reasonable budget
deficit; and a reasonable balance of trade (avoidance
of large trade or current account deficits), which cannot be achieved without gov.

6. Provision of a social safety net

7. Redistributing Income

8. Industrial policies - Industrial policies are interventionist supply-side

policies that include support for small and medium sized
businesses as well as protection of infant
industries (such as through tariffs or subsidies) in order
to help developing countries in the early stages of
their industrialisation (

Weaknesses

4. Discuss the limitations of interventionist policies

1. Excessive bureaucracy - too many rules

and procedures -> inefficiency

2. Won't work if there is poor planning - planning requires technical knowledge

and expertise on the
part of planners, which they may not possess

3. Corruption - deprives
society of resources that could have been used to pay for
the provision of important merit goods
& can also result in a misallocation of
resources as government officials accept bribes to pursue
uneconomic projects (such as dams and power plants)
instead of socially necessary services like education,
health care

Market with government intervention

5. Explain the importance of good governance in the development process.

Governance is ‘the manner in which power is exercised in the

management of a country’s economic and social
resources for development.

Good governance is important because better

governance is related to more investment and greater
economic growth. The effectiveness of government,
the efficiency of bureaucracy and rule of law are
positively related to economic performance and adult
literacy, and negatively related to infant mortality.

6. Discuss the view that economic development may best be achieved through a
complementary approach, involving a balance of market oriented policies and
government intervention.

• Point 1: A very strong government

intervention leads to misallocation of resources and
inefficiencies in production, and may result in lower
rates of growth. Now, many think that market forces
should be allowed to play an important role, and
that trade, growth and development strategies should
be for the most part market-led, though with varying
degrees and forms of government intervention.

• Point 2: A market-led economic development

strategy with a minimum amount of
government intervention does not take into account the special
set of circumstances faced by developing
countries. If such a policy is pursued over an
extended period, it is likely to lead to only limited
progress in economic growth and economic and
human development, as a result of persisting
and possibly increasing poverty, a likely increase
in unemployment and underemployment,
persisting and probably increasing inequalities in
income distribution, insufficient investments in
education and health (human capital) as well as
in infrastructure, unsustainable development, the
continued use of inappropriate technologies, and
limited opportunities to expand exports.

Point 3: there is broad agreement

among development economists that there should
be government intervention in areas including:
- poverty alleviation;
- reductions in income inequalities and inequalities in economic opportunities;
- investments in health, education, infrastructure, technology transfer
- some support for small and medium-sized businesses;
- protection of the environment and sustainable development.
In addition, many economists support the idea
that developing countries, especially the very
poor ones, may require some protection for their
domestic industries in the initial phases of their
industrialisation in the form of industrial policies,
including protection of infant industries.

Point 4: We cannot take a uniform approach to solve the problems of all developing
countries, as each country has a unique situation, so policies should be tailored
effectively based on the conditions of a country

Point 5: It is likely that countries at lower levels

of economic development can benefit
from strategies that are more strongly
interventionist (because usually lacking in the necessary institutions
and regulatory and legal mechanisms required for successful markets)
Later, government can gradually
withdraw and give greater reign to market
forces as the country grows and develops (as later there will be establishment of
more effective institutions)