Unit 4.

10: Economic growth and economic development

strategies
What you should know by the end of this chapter:
• Trade strategies for growth and development
• Import Substitution
• Export promotion
• Trade liberalisation
• Economic integration
• Market-based and interventionist supply-side
approaches to economic development
• Foreign direct investment
• Foreign aid
• Multilateral development assistance
• Institutional change

Introduction
Governments in ELDCs have an important role to play in developing a strategy to support and
facilitate economic growth and development in their country. The focus of government strategy
often tends to be on increasing economic growth and using the benefits of growth to enhance
economic development.

Trade strategies for growth and development

We know from unit 4.1 in this book that international trade can bring significant economic benefits
to a country which can increase economic growth and provide an environment for economic
development. This means international trade can be used by a country as an approach to economic
growth and development.

Import Substitution
This is a development strategy where an ELDC country switches away from imported manufactured
goods and develops an industrial base to produce these products in their own country. The
approach involves the extensive use of trade barriers to protect domestic manufacturing businesses
and government support to develop industries centred on manufacturing. Import substitution is
sometimes referred to as an inward-orientated development strategy. Import-substitution has in the
past been used as a growth and development strategy by countries such as Chile, Brazil and India.

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Evaluation of the strategy
Strengths

• Import substitution means an ELDC can diversify away from producing and exporting
primary commodities and the unstable incomes that result from specialising in them.

• Diversifying into manufactured goods means an ELDC can start to access growth markets in
goods such as cars, clothing and consumer electronics which are more likely to bring
economic growth.

• The trade barrier element of import substitution means domestic industries are protected
from competition from MEDCs which allows the ‘infant’ industry to develop and create
employment.

• Trade barriers can help to reduce a balance of payments current account deficit and protect
foreign exchange reserves.

Weaknesses

• Import substitution using extensive trade barriers can lead to retaliation from MEDCs. This
can make it difficult for ELDC exporters to access overseas markets.

• Tariffs and quotas used to protect domestic industries can increase import prices making
imported goods more expensive for consumers and increasing the cost of imported inputs to
businesses.

• Import substitution relies on businesses in ELDCs being able to access labour, capital and raw
materials to support this industrial strategy. For example, a car manufacturer might not be
able to access the labour, machinery and components needed to produce their cars
efficiently.

• The trade barriers associated with import substitution are counter to the benefits of free
trade and bring with them the welfare losses associated with tariffs and quotas.

Export promotion or export-led growth

Export promotion is an economic development strategy that
involves a country concentrating resources in the production
of manufactured goods primarily for export. Export
promotion is sometimes referred to as an outward-
orientated development strategy where the government
focuses on developing overseas markets to facilitate
economic growth through increased exports.

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The export promotion approach was seen as a foundation for economic development in countries
such as China, Singapore, South Korea, Taiwan and Indonesia.

Although the policy of export promotion varies between countries the overall themes of the
approach involve:

• Using trade agreements to reduce trade barriers such as tariffs and quotas to decrease the
cost of imported inputs. This also makes export markets more accessible as other countries
reduce their trade barriers in a trade agreement.

• Government support for export industries through grants, subsidies, tax incentives and
cheap loans to help them establish a level of output that gives them the economies of scale
needed to compete effectively on international markets.

• ELDCs often encouraged Foreign Direct Investment by multinationals to give them the
knowledge and capital needed to compete in global markets.

• Developing a financial market through the banking system and stock market where firms can
raise funds for investment.

• Achieving a high rate of investment in the economy is a key part of the export promotion
approach because new, advanced capital allows the LDC to achieve a high level of labour
productivity and low unit cost of production.

Evaluation of the strategy

Strengths

• Export promotion allows an ELDC to

enter a growth cycle which is shown
in diagram 4.29. The key benefit of
the exports is the way they provide
funds for new investment as firms
make more profits from exports. The
profits can then be used to buy new
capital and improve productivity
leading to long-run economic growth.

• Export promotion targets growing markets with positive income elasticities of demand such
as consumer electronics, cars and telecommunications. As world incomes rise, these are the
products that people want to buy and this gives exporting countries sustained economic
growth.

• Export promotion allows a country to develop and exploit its efficiency advantages in areas
such as low-cost skilled labour and high rates of investment.

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 • Export promotion means a country can diversify away from an over-reliance on commodities
which means the country spreads its risk across a number of markets. This means if one
market declines other markets can be targeted to take its place.

• Export promotion often brings high rates of economic growth which creates employment,
increases household incomes and increases tax revenues to improve government services

Weaknesses

• Governments in MEDCs may use protectionism against exported goods from developing
countries. Protectionism from the US has been a particular problem for China over the last
four years.

• The market for a manufactured good can become saturated with products and this slows the
growth of exporting countries. This has been the case in the market for cars where there is
currently over-capacity in the industry.

• Export promotion can lead to unsustainable growth if, for example, high demand for raw
materials leads to a big rise in input prices which pushes up production costs. The current
growth of China and India has led to the rise in the price of commodities used to produce
mobile phones, batteries and computers.

• Export promotion can conflict with sustainable development. As manufacturing industries

expand it brings with it significant negative externalities and environmental costs. These
problems can be localised (pollution in growing cities in China) or more global in the form of
climate change.

• The high economic growth rates that often come with export promotion lead to rising
income inequality.

Trade liberalisation
Trade liberalisation is closely linked to the policy of export promotion, but it can also be seen in the
wider context of using the benefits of free trade to facilitate economic development. The benefits of
trade are covered in detail in Unit 4.1 of this book.

Trade liberalisation involves countries reducing or removing the trade barriers such as tariffs, quotas
and subsidies. Trade liberalisation also involves World Trade Organisation (WTO) taking an active
role in setting up and enforcing a framework that ensures countries reduce trade barriers.

Economic integration
Bilateral, regional and multilateral free trade agreements are an important part of an economic
development strategy based on international trade. An example of a bilateral trade agreement
would be the free trade agreement between China and Pakistan which was first signed in 2012 and
is currently in its second phase.

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Regional and multilateral free trade agreements have been completed between groups of
developing countries in different parts of the world. For example, Mercosur is a common market in
South America that includes Argentina, Brazil, Paraguay and Uruguay.

Trading blocs can support economic development through trade because ELDCs that work together
as a group of countries are more likely to have more negotiating power against established MEDCs
and trading blocs like the EU.

Supply-side policies
Market-based supply-side policy as an economic development strategy
Detailed coverage of market-based supply-
side policies is covered in Unit 3.7(1). A
market-based supply-side policy can be
used as a development strategy when the
government allows the market to facilitate
economic development in an ELDC. By
creating greater efficiency on the supply
side the potential output of the ELDC is
increased and this leads to long-term
economic growth and economic
development. Diagram 4.30 illustrates the
impact of market-based supply-side policies
on potential output.

The approach involves:

• Encouraging an export promotion strategy through liberalised free trade involving the
reduction and elimination of trade barriers.

• Reducing the restrictions on capital (money) flows in and out of the country so that ELDCs
have access to more finance to fund increased investment.

• Decreasing direct taxation on individuals and businesses increases employee motivation,

investment and enterprise. It can also encourage foreign direct investment (FDI).

• Privatisation of key domestic industries such as energy, transport and communications to

improve productive efficiency in important parts of the economy.

• Deregulation of markets encourages competition and reduces constraints on business

decision-making. Deregulation can also reduce business costs.

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Evaluation of the strategy
Strengths

• Creating greater efficiency on the supply side can increase long-run aggregate supply leading
to long-run economic growth and development.

• Encouraging free trade leads to lower prices in the domestic economy and the
accompanying welfare gains for consumers.

• Less regulated markets and lower rates of tax increases domestic investment and
enterprise.

• A business environment that is more attractive to firms can increase foreign direct
investment.

Weaknesses

• Deregulated markets are associated with market failures such as negative externalities and
monopolies. The environmental costs of deregulation can be significant, and this can conflict
with the objective of sustainable development.

• A market-based approach can lead to the widening of income inequalities in ELDCs. For
example, reducing taxes on individuals and businesses is likely to favour households on
higher incomes relative to those on lower incomes.

• Increasing rates of FDI can mean ELDCs lose some of their independence and control over
their economy.

• By reducing trade barriers and entering into a trade agreement with MEDCs, ELDCs can leave
their domestic producers exposed to foreign competition which leads to business failure and
unemployment.

• Inflows of financial capital because of liberalised financial market mean there could be
greater outflows of funds on the current account balance of payment. Increase foreign
portfolio investment may also destabilise the ELDC's currency and its financial markets.

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Interventionist policies supply-side policy as an economic development
strategy
Detailed coverage of interventionist supply-side policies is covered in Unit 3.7(2). An interventionist
development strategy is where the government is actively involved in the economy through its own
expenditure and activities to facilitate economic development in an ELDC.

The approach involves:

• Government investment in infrastructure projects such as roads, water and energy supply,
ports and airports, and telecommunications. Infrastructure improvements provide the
framework for businesses to function efficiently.

• Improving human capital through effective education and training. By doing this the
government increases labour productivity in the economy.

• Interventionist policies to manage the distribution of income and take people out of poverty
makes sure economic development benefits the whole population and is sustainable.

• State provision of merit and public goods means the output of these goods is at the socially
efficient level and increase welfare. For example, widening the provision of state-provided
healthcare is likely to support sustainable development.

Evaluation of the strategy

Strengths

• Direct government intervention on the supply side can increase potential output and
increase long-run aggregate supply which allows the economy to achieve long-run economic
growth and development. This is shown in diagram 4.30.

• An interventionist approach is important in achieving a socially efficient output in the

provision of public goods (infrastructure) and merit goods (education) which are crucial to
development.

• State intervention is more effective in managing the distribution of income compared to a

market-based approach.

Weaknesses

• Government-funded and managed projects are sometimes associated with excessive

bureaucracy, corruption and inefficient management.

• Direct intervention needs finance either through taxation, government borrowing or the
opportunity cost of reduced expenditure in other areas.

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 • Sometimes LEDCs can get into financial difficulties if the policy is funded by borrowing and
this increases interest and repayment costs. This is a particular problem if a debt is external
and funds flow out of the ELDC economy.

• Interventionist policies involve political influence in government-funded and managed

projects. This can involve political decision-making and corruption which can conflict with
economic development objectives.

Inward foreign direct investment (FDI)

FDI is investment in production in one country by a business from another country. It can take the
following forms:

• One firm buys another firm in a different country. For example, Volkswagen buys a Chinese
car manufacturer in China.

• When a firm opens a new production plant or outlet in another country. For example,
McDonald’s opens new outlets in Vietnam.

• When a firm expands its operations of an existing business in that country. Samsung
increases the size of its plant in Brazil.

Multinational corporations (MNCs)

MNCs are businesses that have significant production operations in at least two countries and are
responsible for a high proportion of FDI in ELDCs.

Evaluation of the strategy

Strengths

• FDI increases investment in an ELDC which raises its potential output shifting the long-run
aggregate supply curve outwards.

• The MNCs that are responsible for FDI, export their output from an ELDC they produce in
which increases the ELDC's export income. This improves the ELDC's current account balance
of payments and earns them foreign exchange.

• FDI through MNCs can create significant amounts of direct employment and this reduces
unemployment in an ELDC.

• Working in MNCs can also increase the skills of workers in ELDCs.

• Employment and income can be created in the supply chains of the MNCs located in the
ELDC.

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 • FDI can provide production knowledge and innovation that firms in ELDCs can learn from.
When, for example, Nike opened a factory in Vietnam other Vietnamese sports apparel
manufacturers learned from Nike’s production methods.

Weaknesses

• FDI by MNCs can provide competition for domestic producers in ELDCs and drive them out
of business.

• FDI can lead to the repatriation of profits to their host country which is an outflow on the
ELDC's balance of payments current account and reduces their GNI.

• Where FDI leads to the proliferation of MNCs in ELDC markets it can lead to a loss of national
identity. Fast food outlets like Macdonald’s and Starbucks are often accused of
compromising the identity of the restaurant market in ELDCs.

• FDI is often attracted to ELDCs because of lower environmental regulations and this can
have negative effects on the environment in the ELDC and conflict with the aim of
sustainable development.

• FDI is sometimes attracted to ELDCs because of their relatively low labour costs. Many of the
famous brands produced by MNCs such as Gap have been accused of paying low wages and
having poor working conditions.

Foreign aid
Aid is financial and non-financial support given to countries by governments or agencies of other
countries. ELDCs are often the recipients of aid from MEDCs and aid can play a role in an ELDC's
approach to development.

Types of aid
Foreign aid comes in different forms and has different objectives. The main types of foreign aid
include:

Bilateral aid is aid given by one country to another. For example, the UK gave £71m of bilateral aid
to Uganda to fund things such as healthcare, education and governance. If aid was given by a
government of an MEDC to an LEDC it is called Official Development Assistance(ODA).

Multilateral aid is aid given to a country by an agency such as the World Bank, UN or World Health
Organisation. These organisations are generally funded by different governments, individual
donations or business organisations. For example, the UN has released US$15 million to help
vulnerable countries deal with the spread of the coronavirus.

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Unofficial aid is funds given by Non-Governmental
Organisations (NGOs) like Oxfam, the Red Cross and Médecins
Sans Frontières. This is often used in a humanitarian crisis. For
example, Médecins Sans Frontières is currently giving AID to
Yemen to deal with the health crisis resulting from its civil war.
It generally takes the form of food aid, medical aid and
emergency relief funds.

Soft loans are loans made in an aid situation where the recipient country is charged below the
market rate of interest. Angola, for example, has recently received soft loans from China to build
new infrastructure.

Grant or project aid is a form of bilateral aid where a government gives money to another country
to fund a particular project. For example, Norway gave funds to the Guyanan government to fund
the construction of a dam.

Tied aid is where aid is given to a recipient country who in turn agrees to something of benefit to the
donor country. The Malaysian government was given funds by the UK to build a dam and, in return,
the Malaysian government agreed on controversial defence contracts with UK arms manufacturers.

Debt relief occurs when an ELDC has a financial crisis which is often the result of high levels of
external debt. In this situation donor countries, the IMF and the World Bank can offer an ELDC an
extension on a loan, reduced rates of interest or even debt cancellation. The IMF has given debt
relief to 27 countries to support them through the Covid19 crisis.

Evaluation of the strategy

Strengths

• Aid can provide the necessary foreign exchange to ELDCs which enables them to buy
imported goods that can be critical for development. If an ELDC can use foreign aid to import
capital goods it can support an interventionist supply-side approach to economic
development.

• ELDCs often find it difficult to fund investment projects because of low levels of savings and
tax revenues. Aid can be used to fund investment projects and break the poverty cycle. This
can be particularly important for major infrastructure projects.

• Foreign Aid can come with support from an MEDC government on how best to use the aid as
part of a development strategy.

• Aid provides soft loans for development that do not have the high-interest costs associated
with borrowing at normal market interest rates.

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 • Foreign aid is sometimes essential in a humanitarian crisis where an ELDC needs aid to
support them in a natural disaster.

Weaknesses

• The funds given in an aid situation can often be misused and lost through corruption, so the
aid does not reach its intended recipients.

• Foreign aid can encourage a dependency culture in an ELDC. It is important for countries to
develop the capital markets, savings culture and tax revenues needed to fund projects
themselves. It is argued that in the long run, this is the only way a country can sustain
economic development.

• Any foreign aid in the form of borrowing adds to an ELDC’s total debt and has to be repaid
along with the interest payments. Because it is borrowed from abroad it will be external
debt and will be an outflow on the balance of payments current account.

• Tied aid can make an ELDC more dependent on an MEDC donor country and this type of aid
can be subject to corruption.

Multilateral development assistance

There are two organisations in the world that exist to support economic development. These are the
World Bank and the International Monetary Fund(IMF)

The World Bank

The role of the World Bank is to provide finance and technical support to developing countries to
achieve sustainable economic development. One of the key objectives the World Bank has set is to:

• End extreme poverty by reducing the percentage of people living on less than US$1.90 a day
to no more than 3%.

• Increasing equality in developing countries by increasing the income of the bottom 40% of
the population.

The world bank provides low-interest loans, credit, and grants to developing countries to support
economic development. This includes funding for education, health, infrastructure and
environmental projects. The World Bank also offers technical assistance, advice and project
management expertise to ELDCs.

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IMF
There are 189 countries that are part of the IMF. The IMF's
main function is to ensure the stability of the international
monetary system through the system of exchange rates
and international payments. This aim helps support
international trade. To achieve its central objective the IMF
also set the following goals:

• Maintain global monetary cooperation between countries

• Ensure financial stability

• Make sure there are funds available to support international trade

• Promote full employment

• Support sustainable economic growth and development

• Reduce poverty world.

Institutional change
One of the barriers to economic development is institutional barriers in ELDCs. The focus on the
institutions that can be improved as part of a strategy to achieve economic development is access to
banking and finance, empowering of women, reducing corruption and increasing property rights.

Access to banking
In order for businesses to start and function efficiently, they need access to finance. Without the
funds to pay for machinery and equipment, it is very difficult for businesses to set up and start
producing. By creating an effective banking system an economy can grow more businesses which
increases potential output and encourages economic development. The banking system needs to
provide systems for payments and receipts, savings, credit and insurance. Governments in LEDCs can
do this with the support of the World Bank. The growth of the internet has made banking much
more accessible to small businesses and individuals in ELDCs where mobile banking has allowed
payments and receipts to be carried out online.

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Microfinance
Microfinance or microcredit offers small loans to people who do not normally qualify for traditional
banking credit, to encourage entrepreneurship. For example, 20 million people in Bangladesh, most
of them women, use microcredit in an effort to lift themselves out of poverty.

Microfinance broadens the base of entrepreneurs in the economy and allows them to build
businesses that can increase the potential output of the economy and increase economic
development. Allowing people on low incomes to access funds also has the benefit of increasing
equality and reducing poverty.

Empowerment of women
Empowerment of women is the process of women gaining power and control over their lives and
increasing their ability to make their own choices. Empowering women is about increasing gender
equality and achieving sustainable economic development.

Increasing the participation rates of women in the labour market and as entrepreneurs will increase
the potential output of the economy and facilitate economic development. For example, Bangladesh
has tried to create an institutional framework that enhances women’s rights and promotes gender
equality by offering:

• Free education for girls up to grade 12.

• Support to small and medium-sized enterprises (SMEs) founded by women.

• Increased participation of women in politics through more representatives in parliament.

Reducing corruption
Reducing corruption is important in removing an important barrier to economic development. Anti-
corruption strategies in LEDCs need the cooperation of all the different stakeholders in the country:
politicians, government officials, businesses and individual citizens. The culture of corruption needs
to be reduced through effective governance and legal process.

Property and land rights

Assigning property and land rights to individuals encourages entrepreneurship because it allows
people to benefit from owning property and building the value of their businesses. Increasing the
number of small businesses widens the productive base of the economy and can increase potential
output. The process of assigning property and land rights by the government is an important part of
the legal process.

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