Topic pack - Development economics - introduction
Welcome to this Triple A Learning topic pack for Development economics. The pack has a wide range of materials including notes, questions, activities and simulations.
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Terms and definitions
One of the key things you need to be sure to know are the definitions of all key macroeconomics terms. In this section we give you explanations and definitions as well as some flash cards, crosswords and word searches to help you practice them.
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Development economics - key terms
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Games and activities
In this section are some games and activities to help you get to grip with terms and definitions in macroeconomics. You could try some crosswords, or perhaps a word search or, if you are revising, you might like to try going through the flashcards for each section.
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Flash cards - development economics
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Crosswords & wordsearches
Why not try some economics crosswords to see how well you know your terms and definitions? Follow the links below to access interactive versions of the crosswords.
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If you prefer, you could alternatively download pdf versions of the crosswords and print them out to complete them. Follow the links below to download the equivalent pdf files.
In this section we take a look at the various different international organisations that regulate, monitor and support world trade. We also look at organisations that support development in less developed countries.
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Section 5.1 Sources of economic growth and/or development - notes
The four elements of economic growth
The sources of growth in a developing economy are no different from those in the advanced industrialised countries. There are four basic requirements, which are:
- Natural resources - land, minerals, fuels, climate; their quantity and quality
- Human resources - the supply of labour and the quality of labour.
- Physical capital and technological factors - machines, factories, roads; their quantity and quality
- Institutional factors - these may include the banking system, the legal system and important factors like a good health care system. We look at this in more detail in Section 5.1.4.
Economic growth is caused by improvements in the quantity and quality of the factors of production that a country has available, i.e. land, labour, capital and enterprise. Conversely economic decline may occur if the quantity and quality of any of the factors of production falls. In this section we look at approaches that developing countries could take to improve the quantity and quality of factors of production.
In this section we consider the following topics in detail:
- Natural factors
- Human factors
- Physical capital and technological factors
- Institutional factors
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Improving the quantity and quality of land resources
Increases in the quantity of land available for agriculture will increase economic growth. However, the extent to which this happens is limited by the extent to which bush land can be converted to agricultural land (and this process may have negative effects on soil erosion and quality, and contribute to deforestation globally). All economic resources are scarce and have an opportunity cost. As bush land is increasingly used for agricultural purposes, it is no longer a habitat for wildlife.
The relative scarcity of land in the face of a growing population means that the law of diminishing returns might also become relevant. This law predicts that, if an increasing amount of labour is applied to a fixed quantity of land, the marginal productivity of the labour will fall. This was the basis of the argument put forward by the Reverend Thomas Malthus. To prevent this loss in productivity, the quality of the land must be improved. This can be done through the application of better technology through improved irrigation, fertilisers and pest control.
Importance of agriculture
For most developing economies, agriculture is the largest single sector in the economy. We can see this clearly in chart 1 below.
There is also a static version of this chart available.
So why are natural resources such an important issue in developing countries and what can be done to improve the situation? Summarise what we have considered above and then follow the natural resources link below to see the major issues.
Improving the quantity and quality of human resources
The quantity of labour is important. Increases in the population can increase the number of young people entering the labour force and these increases in the supply of labour can increase economic growth. Increases in the population can also lead to an increase in market demand thus stimulating production. However, if the population grows at a faster rate than the level of GDP, the GDP per capita will fall. This can be seen from the two charts below.
There is also a static version of this chart available.
There is also a static version of this chart available.
Note the difference between these last two graphs. The first shows average GDP growth over the last two decades and the second shows the same figure, but adjusted to show how much GDP per capita (per person) has changed. This effectively adjusts for changes in the population. Where there is little or no change in population the difference is small (e.g. the UK), but where population is growing fast (e.g. Bangladesh or Zambia) the difference is greater.
However, it is not simply the amount of labour that will lead to economic growth. It is also the quality of that labour. This will depend on the educational provision in countries. Improving the skills of the work force is seen as being a key factor in promoting economic growth. Many LDCs have made enormous efforts to provide universal primary education. As more and more capital is used, labour has to be better trained in the skills to use the capital, such as servicing tractors and water pumps, running hotels and installing electricity. It should always be remembered that education spending involves an opportunity cost in terms of current consumption and thus it is often referred to as investment spending on human capital.
So what we can be done to improve the quality of labour and boost economic growth? Think through some ideas and then follow the link below to see how your answers compare.
The enrolment in education and illiteracy levels in selected countries can be seen in charts 3 and 4 below.
There is also a static version of this chart available.
There is also a static version of this chart available.
The quantity of labour is affected by the labour supply and, as we have seen in the previous section, this will depend on changes in the population. In this section we look at some background to population and the factors that will affect it.
Population will be an important part of the development of many of the economies we are looking at.
For further information on population and world population data, population pyramids and a world population clock, it may be worth looking at the World Population Information site provided by the US Census Bureau. For population data, look at the International Database section of the site.
The net population increase figure (births - deaths + migration) will be an important factor as it is this that determines the growth rate of the population - the quantity of labour as a resource. In some developing economies, population growth is still around 4% per annum. In the short run, this will put pressure on education and employment but eventually social provision for the elderly will have to be financed. Population growth also impacts on the:
- Supply of food - although little starvation exists in the developing world, malnutrition (see chart 1 below) is a major problem in many countries. It adds to the size of infant mortality.
- Environment - food pressure puts pressure on land and takes valuable resources away from other sectors. Intensive methods require inputs that might damage the environment. GM crops are thought by some to be a major reducer of poverty whilst for others they threaten our very survival.
Age is also an important consideration when looking at the population and its structure. We need to consider the dependency ratio - the proportion of those of working age to those who are dependent. The dependent population will include those of school age and those over the age of retirement. The dependent population will, by definition, need to be supported by those who are actively working but, in the longer term, economic development will be crucially determined by the quality of education and training received by the younger element of the dependent population. Often, however, in developing countries, children do not receive an appropriate education on account of the following:
(a) Inadequate education systems
(b) The need to keep children away from school to work on the land
(c) A lack of adequate jobs for those who have received a more formal education. The lack of jobs may lead to crime and increasing drug abuse, and an unwillingness to attend school in the first place.
For many young women, the only way to guarantee some form of security is to accept early marriage and child bearing.
Government and the birth rate - development implies better health, education etc and a fast growing population makes this more difficult. So, should government try to influence the size of families? China tried this with its one child policy. Some of the problems associated with this form of population manipulation are not attractive.
Whatever the government decides to do, one fact is agreed upon by most, namely, that as an economy develops, so the number of conceptions per female declines. It therefore follows that policies designed to raise the living standards of the poor, e.g. redistributive fiscal policy, are likely to be the most effective way to reduce the rate of population increase - certainly more effective than just handing out contraceptives!
Education - health care and family planning can feature in government-sponsored programmes. As mentioned earlier fiscal (tax) incentives can be used to promote fewer children.
The role of women in society - if women can earn some money - say by a female only micro loan and then save this in a women-only bank, then they can gain some financial independence. This seems to be a successful way of reducing family sizes.
Migration - the pull of cities continues to cause large numbers to move to urban areas. Some argue that agricultural workers have low productivity and that they should be encouraged to move to cities and to take the higher productivity jobs to be found there. However, they create little, if anything, if all they drift into is unemployment, underemployment, poverty, crime and often prostitution.
Many of those who migrate to the cities do so on the expectation that eventually they will earn more than in the rural areas. Perhaps it might be best if some government funding went to the rural areas, so making life in those regions more closely resemble what the rural dwellers perceive urban life to be? This would take both money and time, as schools, hospitals, roads etc would be needed to offer a similar lifestyle to that which the urban dweller supposedly has access to.
The question of land ownership is also likely to be a crucial factor in preventing rural-urban migration, and policies which redistribute land from absentee landlords to landless peasants, although politically controversial, are likely to be a key factor in reducing the 'push' off the land and the 'pull' of the city.
Physical capital and technological factors
Improving the quantity and quality of capital resources
When looking at capital resources (machinery, equipment and so on), it is important to distinguish between:
- Directly productive capital - plant and equipment, e.g. factories
- Indirectly productive capital - infrastructure or facilitating capital, e.g. roads and railways.
The process of acquiring capital is called investment. However, like many economic decisions, there is an opportunity cost involved in any investment decision. The opportunity cost of capital investment is the current consumption foregone. This makes it tempting not to invest, but the level of investment and the quality of investment will directly affect the level of economic growth - particularly in the long term. The efficiency of the labour force and the other factors of production will depend upon the amount and quality of capital they have. In LDCs, some investment comes from abroad in the form of foreign direct investment. This is usually through multinational enterprises locating in a country. There has been criticism of some investment in LDCs as to whether it is appropriate, but this is an issue we ill look at later. If production moves from being labour intensive to capital intensive, unemployment and poverty may increase, so there may be a difficult transition process for an economy aiming to develop through investment which is not geared towards the needs of the population.
The need to invest in improved infrastructure becomes clear when we look at the provision of basic roads, telecommunications systems and other vital infrastructure requirements in developing countries. See section - differences between developing economies for more detail on this.
For more detail on capital formation and the issues associated with raising money for this investment follow the link below.
Technology and its use is another important aspect of development and countries have to try to keep up with technological change wherever possible. Have a careful think about the issues that are associated with this technological change and then follow the link below to compare the issues that you have identified with ours.
As we saw in the introduction to this section, it is no good just improving the factors of production. A country also needs a good quality infrastructure to support them. This means having a suitable financial, legal and social institutional framework. Important institutional factors are therefore:
- The banking system - a good banking system provides the financial infrastructure that enables businesses to flourish and grow. This makes it an important driver of economic growth. Often such a system is lacking in developing countries.
- The educational system - this could also be included under the human resources heading above. Growth requires a high quality, well educated workforce. This in turn needs a good educational system to provide for as many people as possible.
- Health care - a healthy workforce and population is just as important as a well educated one. This means a good health care system.
- Infrastructure - economic activity needs an infrastructure to support it. Roads, ports, telecommunications networks - all these are vital elements to support economic development.
- Political stability - without political stability there will not be certainty and businesses require certainty to enable them to plan for the future. A stable political environment is likely to be a key factor in determining whether or not businesses are prepared to undertake major investment projects.
Section 5.1 Sources of economic growth and/or development - questions
In this section are a series of questions on the topic - Sources of economic growth and/or development.
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Development - short answer (1)
Explain why the savings gap is considered to be important when analysing development.
What are the advantages for developing countries of adopting an export-led form of development?
Is tourism always a good area for a developing economy to exploit?
Development - short answer (2)
What types of capital flows are available to a developing economy?
How might the developed world help resolve the debt crisis faced by many of the developing economies?
Explain the concept of sustainable development and why it may be threatened by economic growth.
Development - case study 1
It now seems unlikely that the targets set for poverty reduction will be met. It was hoped to halve the number living in absolute poverty by 2015. To achieve this figure most sub-Saharan economies would need to grow by more than 5% each year. Current estimates suggest that few will reach this figure. Too many lack the basics needed to build the ingredients of economic development.
The HDR for 2003 shows clearly that the division between the rich and poor in the world opened up further during the 1990s, despite rapid growth. Some brief facts from the HDR for 2003:
The richest 1% of the world's population (around 60 million) now receive as much income as the poorest 57%.
The income of the richest 25 million Americans is equivalent to that of almost 2 billion of the world's poorest.
2147 will be the year when, on current trends, sub-saharan Africa can hope to halve the number of people in poverty.
13m children were killed by diarrhoea in the 1990s - more than all the people lost to armed conflict since the second world war.
363 children in 1,000 in Sierra Leone do not reach their fifth birthday. In Norway, only 4 in 1,000 do not survive.
54 countries saw their average income decline in the 1990s.
500,000 women a year, one for each minute, die in pregnancy or childbirth.
33.1 years is the life expectancy in Zimbabwe, down from 56 in the early 70s. In the UK average life expectancy is 77 years.
30,000 children die daily of preventable illness.
21 countries went backwards in the 1990s in terms of human development.
Will domestic savings and funds be enough to lift these countries out of poverty by the date set?
How else may these poorest of African countries seek financial assistance?
Will the developed economies have to change their attitudes towards the poorest people on earth? If so, how?
Development - case study 2
As the 1970s evolved, so Nigeria was seen as one of the great hopes of the developing world. It had oil, a population that was being educated to international standards and bankers liked lending to such a prosperous nation. Then the oil price started to fall and lenders wanted their money back. Today, Africa's largest country is riddled with debt, poverty and corruption.
Key data - Nigeria
|Life expectancy (years)||50.1||46.8||46.1|
|Infant mortality rate (per 1,000 live births)||111.2||110.0||110.0|
|Under 5 mortality rate (per 1,000 children)||...||184.0||183.0|
|GDP growth (annual %)||2.7||3.8||3.9|
|Exports of goods and services (% of GDP)||45.0||52.3||48.3|
|Imports of goods and services (% of GDP)||37.8||41.1||49.0|
|Total debt service (% of exports of goods and services)||7.8||7.9||12.0|
|Short-term debt outstanding (current US$)||5.5 billion||1.1 billion||1.7 billion|
What might have caused the fall in the economic potential of a country as rich as Nigeria?
How might this oil-rich nation recreate its development potential?
Development - essay questions
(a) Describe the features of a market economy.
(b) Discuss the view that economic development will be most effectively achieved through a freely operating market economy.
Econ. growth/development - short answer
Sources of economic growth and/or development
Explain the importance of human capital in contributing to human development.
Explain two reasons why growth rates may differ between countries.
Discuss the view that the achievement of higher economic growth rates should be the priority of developing economies.
Briefly explain the causes of economic growth and discuss the extent to which governments are able to influence the long term growth rate of the economy.
Section 5.1 Sources of economic growth and/or development- in the news
In this section are a series of questions on the topical news items in relation to the topic - Sources of economic growth and/or development.
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Death by water
Read the article Where death by water is part of daily life (you can do this in the window below or follow the previous link to read the article in a separate window) and then consider answers to the questions below.
Explain the difference between the concepts (a) economic growth and (b) economic development.
Analyse the extent to which improved water infrastructure will help to contribute to economic growth.
Discuss whether an increase in overseas aid will be an effective method of improving water infrastructure in developing countries.
Section 5.2 Consequences of growth - notes
'Growth is good'. This is the standard view of economic growth, and it tends to be treated as the 'Holy Grail' of economic policy for both developed and developing countries. However, it may not always be good. Possible costs of growth include:
- Inequality of income - growth rarely delivers its benefits evenly. It often rewards the strong, but gives little to the economically weak. This will widen the income distribution in the economy. In developing economies income distribution can already tend to be unequal and many of the benefits of growth may go to the better-off in society and flow overseas as increased profit for multinational corporations.
- Pollution (and other negative externalities) - the drive for increased output tends to put more and more pressure on the environment and the result will often be increased pollution. This may be water or air pollution, but growth also creates significantly increased noise pollution. Deforestation and environmental degradation are likely to result from growth. This is particularly true in developing countries as they tend to have little legal protection of the environment.
- Loss of non-renewable resources - the more we want to produce, the more resources we need to do that. The faster we use these resources, the less time they will last.
- Loss of land - increased output puts further pressure on the available land. This may gradually erode the available countryside. In many developing economies there will also be additional problems resulting from the movement of people from country to urban areas.
- Lifestyle changes - the push for growth has in many areas put a great deal of pressure on individuals. This may have costs in terms of family and community life in many economies.
In this section we consider the following topics in detail:
- Income distribution
This section links with the discussion of externalities in Section 2.4 (reasons for market failure). It would be useful if you thoroughly revised this part of the course before proceeding with this section. Can you, for example, accurately define the term 'negative externality' and distinguish negative externalities from social cost?
All of us have recently become aware of the real cost of resource usage. We now need to be conscious of externalities. How will the developing world control air pollution, or the risk of deforestation? Will they simply become the dumping ground for rich nations' waste?
Another negative externality from growth might be soil erosion and degradation. There are also the issues of water scarcity, pollution and waste disposal. All of these challenges face countries in the developed world but those experiencing the challenges of economic development have to 'balance' their desire to grow against the possible problems that might arise. The reduction in their biodiversity might also need to be addressed, as will atmospheric changes. Do the developing countries:
- Ban certain activities or impose strict rules and controls?
- Extend property rights and force private enterprise to pay more for the problems they cause?
- Impose taxes on pollution and other externalities?
- Subsidise non-pollution methods of production?
- Award permits to pollute?
To achieve their goals, the developing countries will also need to address problems of:
- Land ownership and reform
- Involving local communities in their own development
- Engaging the poor and making them feel that opportunities will come their way
- Pricing in ways that include the real costs of development
So externalities need to be taken into account when considering development but, for many developing countries, there will be a significant opportunity cost if they try to grow while minimising externalities, because this requires investment and perhaps reform - both of these can be expensive.
As economies grow and develop, income distribution is likely to widen. As economies grow, they tend to reward the economically strong rather than the weak. The rich get richer while the poor get poorer. In most developed economies, progressive tax systems and social security systems exist to help those at the bottom of the economic pile to varying degrees. However, many developing economies do not have the institutional framework they need to do this. They may not have a sufficient tax base to collect enough tax to help the least well off and so income distribution will often worsen considerably during the process of growth.
Have a look in the data section to see clear evidence for this (click on the 'home' icon to find this section or use the table of contents on the left).
Go to the World Bank 'data query' section (http://devdata.worldbank.org/data-query/) - this section will allow you to select in detail the data you want. Select a developing country, then select some data that help to show the income distribution in the economy and, finally, the years you would like the data for. Once you get the data, you can view it on screen, but you can also download it as an Excel file.
How has income distribution changed in recent years?
Many economies now aim for sustainable economic growth. This means that they are attempting to grow today without damaging the prospects for development for future generations. Some doubt if this is really possible, but to achieve it means investing more in such ventures as:
- Using alternative methods and resources to generate power
- Watching our biodiversity
- Admitting to both social costs and benefits and accepting that someone has to pay the true cost of resource allocation.
Achieving this may mean developing ways of:
- Extending property rights - this means extending ownership of resources to allow people to protect the environment and other resources more effectively.
- Taxing the polluter - if a tax is imposed that is equal to the external cost of an activity, this should ensure that resources are allocated in the interests of society.
- Issuing permits to pollute (tradable permits) - these allow a company to pollute a certain amount, but if they exceed their limit, they have to buy more permits. Companies who under-use their permits can sell them. This effectively taxes poorly performing companies and subsidises companies using best practice.
- Introducing congestion charges and other road pricing policies to combat traffic congestion.
- Using direct controls and regulations on certain types of economic activity.
Section 5.2 Consequences of growth - questions
In this section are a series of questions on the topic - Consequences of growth.
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Consequences of growth - short answer
Discuss the view that economic growth will inevitably conflict with sustainable development.
Section 5.2 Consequences of growth- in the news
In this section are a series of questions on the topical news items in relation to the topic - Consequences of growth.
Click on the right arrow at the top or bottom of the page to move on to the next page.
Winners and losers in Kolkata
Read the article Rising Kolkata's winners and losers (you can do this in the window below or follow the previous link to read the article in a separate window) and then consider answers to the questions below.
Discuss the impact that development in cities like Kolkata is likely to have on the distribution of income.
Assess possible policies that the Indian government could adopt to minimise the impact of development in Kolkata on the most disadvantages communities.
Discuss the costs and benefits for Kolkata of rising foreign direct investment into the area.
Section 5.3 Barriers to economic growth and/or development - notes
We have already seen that a high quality institutional framework is an essential pre-requisite for development. This means that institutional weaknesses will be a significant factor restraining growth and development.
In this section, we consider these issues in more detail and also look at the poverty cycle - a trap that prevents many economies from developing and growing. We also consider the following topics in detail:
- Poverty cycle
- Institutional and political factors
- International trade barriers
- International financial barriers - indebtedness
- Social and cultural factors
Earlier we noted that poverty and inequality are major factors holding back the development of many of the poorest countries on earth. Poverty is a grinding fact of life. Often, people receive little education, hope or access to any of the normal features of life. What value can be added to these people? They may be intelligent and gifted individuals but they will receive little, if any education. Health care will be non-existent. The inequalities apparent within their economy will breed resentment. This can lead to hatred, ethnic violence, corruption and the undermining of the democratic process. Those thinking of investing in such an economy will probably decide not to. If you earn little, say just a few dollars a day, what chance do you have of saving any money, or owning a bank account? The acquiring of capital is impossible and that precludes you from passing wealth to your direct descendants.
This poverty is clearly shown in Chart 1 below which shows the Human Poverty Index (HPI). The HPI is a composite index measuring deprivations in the three basic dimensions captured in the human development index-a long and healthy life, knowledge and a decent standard of living.
This poverty can be very difficult to reduce as many economies struggle to develop. They often find themselves in what is known as the poverty cycle. This can be seen as a spiral that prevents them from developing. To develop, we know that they need to invest. Investment needs funding and this requires savings. However, if they have low income levels, then they have low savings levels. This means a lack of funds for investment, which in turn leads to lower incomes. It is in essence a downward spiral of cumulative causation. Low incomes means low investment levels which means even lower incomes. They need to break the cycle to develop, but how? This cycle is shown in diagrammatic form in Figure 1 below.
Institutional and political factors
As we have seen many developing countries have a poor institutional framework. They may face a range of barriers to growth. These may include:
- Ineffective taxation structure - in many developing economies, governments face enormous problems in collecting tax. These may be physical problems (actually accessing the communities in rural areas) or simply data information problems - poor records of the population. This makes it very difficult to collect tax revenue and low tax revenue makes it difficult to develop the required institutions.
- Lack of property rights - many developed economies lack a well developed system of property rights. Property is allocated on traditional or tribal grounds or ownership is perhaps even unknown. This can prevent economic development which is often based on ownership of the factors of production so that they can be traded.
- Political instability - if there is political instability then it is very difficult for economic activity to develop and grow. If businesses are to grow, then they need stability and a reasonably consistent or predictable political structure. Without this, development becomes a lot more difficult as there will be an unwillingness to engage in capital investment.
- Corruption - this almost speaks for itself. Corruption makes development difficult and can certainly act as a barrier for overseas firms investing in an economy.
- Unequal distribution of income - as we saw in Section 5.2.2, income distribution will tend to widen as economies grow. This can act as a barrier to growth. Those on the lowest income levels will often have the highest marginal propensity to consume and therefore if they get an increase in their incomes, they are likely to spend it. This will help drive demand growth. However, if growth simply means that the rich get richer (and perhaps even move their money overseas) this will act as a constraint on development.
- Formal and informal markets - in the developed world most activity takes place in formal markets - that is organised markets where money is exchanged. However, in the developing world much of the economic activity takes place in informal markets. No money is exchanged and economic activity goes unrecorded.
- Lack of infrastructure - a good quality social infrastructure is vital for economic development, but in the developing world the infrastructure is often very poor. This is a significant barrier to growth and development and we look at this in more detail below.
We can see the differences in the infrastructure of developing and developed countries from the data below.
(c) They lack human capital in sufficient supply to be able to develop their resources and add value to these.
(d) The high population growth mentioned above puts enormous strain on facilities and in many of these countries people's life styles are actually getting worse. The 'dependency rates' are getting larger as those in work become responsible for more who are not directly contributing to the economy.
(e) Again high population growth places enormous burdens on the health facilities and infant deaths remain very high in most of these countries.
(e) With so many people living in these countries, finding a job is difficult. This leads to high unemployment and also underemployment (when people have a job, say selling single cigarettes but which does not constitute a formal full-time form of employment).
International trade barriers
World trade is very uneven and different countries rely more on it than others. The vast majority of trade coming from the developed world is destined for fellow developed economies. Developing countries trade mainly with developed economies.
Trade coming from developing countries has been growing faster than that from developed economies but the individual, country-by-country growth rates have differed considerably. Despite the financial crisis of the late 1990s, many of the Tiger economies have continued to grow, while in most of Africa less successful growth rates have been recorded.
Overdependence on primary products
Developing economies mainly trade in primary exports. The money raised from their sale pays for manufactured imports. Diversification has been a slow process and again it has a strong geographic bias. The Far Eastern economies have been able to move up through the categories of exports to command increased market shares of low and medium technology goods. Alas, for many of their poorer African cousins, the reliance on low-valued primary exports has not fallen by a significant amount in the sources of foreign exchange earnings.
To see all the data relating to the type of exports and type of imports to and from developing countries, click on 'Data' from the table of contents on the left.
In 1970 primary exports constituted 72% of total developing country exports. By 1999 this had fallen to 48% for low-income countries and 32% for middle-income countries. However, this contrasts with 18% for advanced economies and so is still very high. However, the ratio is still very high for many of the poorest African countries - over 90%.
There are several problems involved in being overdependent on primary products (you should also look at section 4.8 on the terms of trade when considering this issue):
The terms of trade have deteriorated over a long period of time for the developing countries. This has been because of the long term downward trend in the prices of primary goods that the developing countries export prices relative to the prices of the manufactured goods that they import. The result has been that the developing countries have had to export ever greater quantities of primary products to be able to import the same quantity of imported goods.
Low income elasticity of demand for primary products. As real world incomes have grown, the demand for primary products has increased less than proportionately. This is in sharp contrast to the high income elasticity of demand for manufactured goods.
Violently fluctuating prices of primary goods. The demand for primary products tends to be price inelastic as does supply. This combination leads to large price fluctuations when either the demand or supply curves shift. In the case of primary products, it is usually supply that shifts most due to factors beyond the control of producers such as droughts, pests, diseases, floods, weather changes etc. The problem is illustrated in Figure 1 below.
The steepness of both the demand and supply curves leads to a relatively large decrease in price as the supply increases from S to S1.
Compare this with the relatively smaller decrease in price in Figure 2 below where the demand and supply curves are relatively more price elastic.
Increased trade between developed countries. As the more developed countries have grown, they have tended to trade increasingly with one another, rather than with the poorer countries. Thus the advanced countries are becoming increasingly more self-sufficient in the primary goods (foodstuffs, raw materials etc.) which they have traditionally imported from the developing countries. This has been achieved through the development of synthetic substitutes and the formation of powerful trading blocs from which the developing countries may be excluded.
Consequences of an adverse terms of trade
One major problem facing a number of developing economies is the volatility of the commodity markets. Over a significant period of time, commodities, both of hard and soft varieties, fell in real terms. This drag-down on the terms of trade figures of many of the poorest countries on earth meant that they needed to sell more just to earn the same amount as they did in previous years and that does not take into account any decline in the value of their domestic currency. Such trends also had an impact on their balance of payments figures and their ability to generate economic growth.
Consequences of a narrow range of exports
Many developing economies produce mainly primary exports and tend to specialise in a relatively small range of these products. This leaves them heavily reliant on the world prices of relatively few products, and this can be a real barrier to further development. Many of the exported commodities are relatively inelastic in supply in the short run and once the crop has begun its development, there, is little else to do but accept whatever the world price is at the time of harvest. With unreliable flows of earnings, it is difficult to put aside monies for investment in diversification - so the problem is compounded. Some economists have advised the creation of sellers' agreements, which would be an effective cartel in all but name. However, problems seem to arise when trying to keep individual countries loyal to such agreements. They seem to have difficulties regarding:
- Overproduction, which puts pressure on that country to accept whatever price they can get
- Failure to get all producers to join the 'club'
- Storage of some commodities is difficult and expensive, so fluctuations cannot be evened out
- Floor prices are too high and encourage overproduction. This then requires precious funds to buy up surpluses and so the investment funds begin to disappear.
The heavy reliance on primary exports which, as we have noted, can lead to considerable changes in revenues, means that current account balances can vary at alarming speed. Import costs can quickly exceed export revenues. This can lead to increased borrowing, or a run down of slender foreign exchange holdings. If such deficits persist, the country may have to adopt deflationary policies, which will result in higher unemployment and cuts in, what are at best, small-scale public services. The domestic currency will probably suffer a depreciation, which in turn can make imports even more expensive and destroy the chances of achieving a period of sustained economic growth. The consequences of all this normally hit the poorest members of society. If the deficit persists then major structural changes may have to be introduced. Imports are normally essential to growth planning and a failure to acquire the essentials of diversification further hamper the development process.
Protectionism in international trade
Many of the developed economies have strict protection policies in place to stop cheaper imports coming in from developing economies. In general, developing economies have a comparative advantage in many agricultural markets. Increasingly, they are also gaining similar advantages in a number of low and middle group manufactures. Regarding agriculture, the developed world has such policies as the Common Agricultural Policy (CAP), which protects EU-based farmers. It also allows for EU farmers to export food crops to developing countries. The US protects its farming community and demands that the WTO adopt policies that safeguard its agricultural sector. Textiles face a similar battle to gain entry to most of the major developed economies. However, as some of the Far East economies have proven, the right product at the right price can break through into the lucrative markets of North America and Europe, e.g. electronics.
International financial barriers - indebtedness
The developing world and debt
As well as aid, most developing countries have borrowed on the international markets. In the period immediately after independence, many countries borrowed quite large amounts from commercial banks. Then came the fist oil-crisis in 1973-74. As many developing countries are non-oil producers, their debts suddenly rose. Those developing countries that had oil became the owners of large inflows of revenue. They could not spend the money they were receiving. Many of the petro-dollars that appeared in the world banking system had come from new, oil rich countries. Banks could find few takers for loans amongst developed economies as they were trying to deflate to reduce inflationary pressures. So, they turned to the developing world and offered them competitive terms to borrow money.
Then came the 1980s, and a new era of economics in the USA. Taxes were cut but government spending was kept at previous levels. The shortfall was financed by a large increase in US government deficits and borrowing. Interest rates moved significantly upwards and the poorer nations found that their debt had risen in real value. They were faced with:
- Increased interest rates
- Increased value of the dollar, so they had to sell more exports in order to pay back debt valued in dollars
- The recession in the developed world meant that they imported less from developing economies. A long-term decline started in the real value of most commodities.
Within a few months a debt crisis was hitting the developing world and it is still with us today. The crisis hit the developing world in a number of ways. These included:
- Net capital inflows reduced dramatically
- Many of the developing countries experiencing net outflows of money, in that they actually paid more to the developed economies than they received from them. So, the poorest nations were sending a substantial part of their income to the richer countries (the poor aiding the rich!).
- Their total debt increased 25 fold during the two decades of the 1980s and 90s.
- Their debt-export ratio rose and they had to earn more money from the sale of exports just to pay their debts.
- Their debt to GDP ratio rose and so a larger proportion of their national income was owed in debt.
- Their debt-service ratio rose. This shows the percentage of export revenue that has to be used to repay debt plus interest. This need not be a problem if exports are rising faster in real terms, but they were not.
So, many countries had borrowed in the hope that their economies would grow and they could easily pay-off debts. Alas, the opposite took place. Such debts are of course a loan and not a gift. Interest as well as the capital sum has to be repaid. Failure to repay debts causes a loss of financial status and this can have an adverse effect on future foreign investment flows. It also means that slender financial resources are being used to pay debts and not to build schools, hospitals etc. so there is a substantial opportunity cost involved. The 'debt-crisis' is most serious in sub-Sahara Africa, though some Latin and Southern American countries also owe large sums of money. At present every child born in Mozambique owes several hundred dollars from the moment it arrives on this planet! Attempts have been made to reduce debt but those loans removed tend to be in the 'unlikely to ever be repaid' category, and so the real impact on the developing economy is minimal.
How then can these countries solve their debt crisis?
- They can attempt to expand GDP faster than their debt ratio. This is quite easy to write but difficult to achieve in reality.
- The richer nations could write-off debts. Supporters of this action argue that, once released from a burden they cannot afford to pay, developing economies would import more and so boost developed world trade. Such imports could raise living standards and allow for more investment. Opponents, and the US is amongst these, point to irresponsible borrowing being promoted if old debt is wiped off. Such arguments have very much less force since the advent of the 'credit crunch' which largely arose from the irresponsible lending of the financial institutions of the richest countries. The Highly Indebted Poor countries initiative of the EU and others has borne some fruit but, in reality, many of the debts cancelled would never have been repaid. Most countries attempt to re-schedule debt, or seek a moratorium while they adjust to the increased sums needed to be allocated to debt.
- Structural adjustment programmes can be accepted as part of an IMF loan to clear debts. This scheme tends to impose heavy costs on economies. These are discussed in more detail elsewhere.
These mainly apply to developing countries whose exchange rates are fixed (usually against the dollar), rather than floating, and whose currencies are not therefore freely convertible through the financial markets.
As the fixed rate is usually one that would be greater than the free market equilibrium rate, the exchange rates have tended to be overvalued. This may act as a barrier to development as it makes exports more expensive, causing yet another problem for exporters of primary commodities, while at the same time making imports cheaper.
Usually a pre-condition of the IMF when it gives loans to heavily indebted developing countries is that they devalue their currencies and allow them to float.
Capital flight is an aspect of the debt crisis of developing countries. Indebted countries have often borrowed more money to simply finance their debts but, rather than being used to repay these debts, much of this money has been put on deposit in foreign banks by firms and individuals, or has been put into stocks and shares and property.
Capital flight occurs when firms or individuals speculate on the prospect of earning a higher return abroad. This will particularly occur when there is:
- Fear of devaluation / a belief that the exchange rate is overvalued
- High rates of inflation
- A low real rate of interest
- A need to 'launder' money abroad
- A poor domestic investment prospect.
Developing countries generally suffer from a shortage of foreign exchange, so capital flight may be a serious financial barrier to development. It is likely to:
- Adversely affect the growth potential of the economy as domestic investment will be reduced by money flowing overseas.
- Reduce government revenues as money held overseas is not subject to tax by the developing country; this will make it more difficult to service debt and will increase the tax burden on people within the economy.
- Cause balance of payments problems on the capital account due to the money outflows.
- Make international agencies less well disposed to provide further financing to service the debts.
- Worsen the distribution of income as the poor will be the group most affected by the measures put in place to meet the country's debt servicing requirements, while the rich will receive interest from the foreign banks to whom they have switched their money.
So how can capital flight be tackled?
One way would be for developing countries to impose strict exchange controls, but this would fly in the face of the world-wide movement towards liberalisation of capital markets.
Another approach would be to take measures, through sound economic management, to build investors confidence, but this may be more easily said than done as people in a position to move money around the globe are often more influenced by 'herd instinct' than anything of a more rational and socially responsible nature.
Social and cultural factors
Social and cultural factors acting as barriers to growth and development might include:
- Gender issues
Your author, in order to establish some universal truths here, thought long and hard about this one, scoured his own not inconsiderable library of books, surfed the Internet and even 'tapped the brains' of an eminent social anthropologist friend. Such efforts were, however, to prove fruitless. At the end of his research, he felt unable to provide you, IB students, with an all embracing definitive answer. Are there specific factors relating to religion, culture, tradition and gender which universally do or do not contribute to growth and development? Is it possible to stereotype particular religions / cultures as being conducive / non-conducive to development? The radical perspective on this holds that the wealth of the developed countries and the poverty of the developing countries cannot be attributed to the persistence of an unchanging, traditional society, but is due to the historical and on-going large drain of resources towards the advanced countries and the creation of neo-imperialist structures (e.g. specialisation in primary commodities, structural adjustment programmes, foreign direct investment) to serve the needs of the rich countries.
What's your view on this? (Yes, this is the teacher's old trick of throwing the question back to the student when s/he is unsure of the answer?).
Perhaps it would be helpful to think of the society in which you live and to consider how its specific social and cultural factors have or have not contributed to growth / development.
- Religion - what is the dominant religion in your society? Does it promote a work ethic or does it lead its followers away from work, or is it neutral in this respect?
- Culture / tradition - what is the recognisable culture / tradition of your society? Is it one that could be classified as 'modern' or does its foundations spread back many years? Is it growth orientated, has it acted as a barrier to growth, or are other factors more significant?
- Gender issues - what is the role of women in your society? Are women fully involved in the formal economy or do women mainly perform tasks in the informal economy such as housework? Is there equality of opportunity? Has the particular role of women in your society promoted or retarded growth and development?
Finally, apologies for just posing some questions and not providing all the answers here!
Section 5.3 Barriers to economic growth and/or development - questions
In this section are a series of questions on the topic - Barriers to economic growth and/or development.
Econ. growth / development - short answer
Barriers to economic growth and/or development
Explain briefly why in the short term the supply of manufactured goods is likely to be more elastic than that of manufactured commodities.
Explain the problems which developing countries may face if their economies are mainly dependent on the export of primary products.
How might the government of a developing country make the distribution of income and wealth more equal?
In the short run the price elasticity of demand and the price elasticity of supply of primary products tends to be inelastic. Explain why this is the case.
Explain two reasons why it may be more beneficial for a country to specialise in the production of manufactured goods rather than primary products.
Over the past twenty years, developing countries have faced a situation of even greater indebtedness. Discuss the problems which this poses for them.
Section 5.4 Growth and development strategies - notes
When thinking about this serious issue, we need to be honest and ask ourselves if Africa and other parts of the world should simply follow the same path as the now developed countries. Would this solve all their problems? Should they switch from the lower productivity based traditional sectors of their economies and compete with us in the modern, industrialised world? Should they be forced to adopt the ways of the rich nations, or is a more enlightened way forward the blending of what is good in both ways of life, so as to allow a better final result to emerge?
In this section, we look at the different theoretical models that have been developed to try to explain the process of development and therefore help construct suitable policies. As you are working through the section, always try to think critically about the models. When might they be appropriate and when might they be inappropriate?
In this section we consider the following topics in detail:
- Harrod-Domar growth model
- Structural change/dual sector model
- Types of aid
- Export-led growth / outward-oriented strategies
- Import substitution / inward-oriented growth strategies / protectionism
- Commercial loans
- Fair trade organisations
- Micro-credit schemes
- Foreign direct investment
- Sustainable development
Harrod-Domar growth model
The Harrod-Domar model is unsurprisingly named after two economists, RF Harrod and ED Domar, who were working in the l930s. The model suggests that the economy's rate of growth depends on:
- The level of saving
- The productivity of investment, i.e. the capital output ratio
They therefore placed considerable emphasis on investment, savings and technology as the main agents of economic growth. Increased investment would, in turn, force the production possibility curve outwards and create more wealth. The impact of this increased investment on the production possibility frontier is shown in Figure 1 below.
The model concludes that:
- Increasing the savings ratio, or the amount of investment or the rate of technological progress are vital for the growth process
- Economic growth depends on the amount of labour and capital.
- As developing countries often have an abundant supply of labour it is a lack of physical capital that holds back economic growth and development.
- More physical capital generates economic growth.
- Net investment leads to more capital accumulation, which generates higher output and income.
- Higher income allows higher levels of saving.
The key to economic growth is therefore to expand the level of investment both in terms of fixed capital and human capital. To do this, policies are needed that encourage saving and/or generate technological advances which enable firms to produce more output with less capital, i.e. lower their capital output ratio.
However, the model has a range of problems as it tends to focus heavily on economic growth. The problems may be:
- Economic growth and economic development are not the same. Economic growth is a necessary but not sufficient condition for development
- Savings and investment are a necessary but not sufficient condition for development
- On a practical level, it is difficult to stimulate the level of domestic savings, particularly in the case of developing countries where incomes are low.
- Borrowing from overseas to fill the gap caused by insufficient savings causes debt repayment problems later.
- The law of diminishing returns would suggest that as investment increases the productivity of capital will diminish and the capital to output ratio will therefore rise.
Structural change/dual sector model
Two economists, Fisher and Clark, put forward the idea that an economy would have three stages of production:
- Primary production is concerned with the extraction of raw materials through agriculture, mining, fishing, and forestry. Low-income countries are assumed to be predominantly dominated by primary production.
- Secondary production concerned with industrial production through manufacturing and construction. Middle income countries are often dominated by their secondary sector.
- Tertiary production concerned with the provision of services such as education and tourism. In high-income countries, the tertiary sector dominates. Indeed having a large tertiary sector is seen as a sign of economic maturity in the development process.
Countries are assumed to first pass through the primary production stage, then the secondary stage and finally the tertiary stage. As economies develop and incomes rise, then the demand for agricultural goods will increase but, due to their low income elasticity of demand, at a proportionately lower rate than income. However, the demand for manufactured goods will have a higher income elasticity of demand. So as incomes grow further, the demand for these goods will grow at a proportionately higher rate. Hence, the secondary sector will grow. As incomes continue to grow, then people will start to consume more services as these have an even higher income elasticity of demand. Thus the tertiary sector will then grow and develop.
However, this may be misleading. Some developing countries may have a large tertiary sector due to a large tourist industry, without having developed a secondary industry. Economists argue that this could be somewhat risky. If the economic base is dominated by an economic activity such as tourism that has a high income elasticity of demand, then a recession in the consuming nations will have a disproportionately large impact on the export earnings of the developing countries. A fall in income will bring about a proportionately greater reduction in demand for the service and this will have a severe impact on the economy. If a developing country does not have a primary or secondary sector to fall back on, then borrowing and debt might be the only prospect.
Lewis dual sector model
This famous West Indian economist felt that productivity was central to the development of an economy. This was best achieved by encouraging migration of workers from the less productive sectors of the economy, for example agriculture, which is traditional, into the newer industries of manufacturing and the tertiary sector. The latter would be more productive and so accumulate greater wealth. In turn, this would generate greater funds for government through taxation, and this would enable them to spend on the essentials of development. Savings would be encouraged as rates of return would increase. Lewis felt that the marginal productivity of a rural worker was low.
However, the Lewis model also has problems and these may include:
- As increasing rural-urban migration takes place, a more unequal distribution of income is caused, as the rural migrants initially join the ranks of the urban poor.
- The idea that the productivity of labour in rural areas is almost zero may be true for certain times of the year. However, during planting and harvesting, the need for labour is critical to the needs of the rural areas.
- The assumption of a constant demand for labour from the industrial sector is questionable. Increasing technology may be labour saving, reducing the need for labour. In addition, if the industry concerned declines, again the demand for labour will fall.
- The idea of trickle down has been criticised. Will higher incomes earned in the industrial sector be saved? If the entrepreneurs and labour spend their new found gains rather than save it, funds for investment and growth will not be made available.
- The rural urban migration has for many LDCs been far larger that the industrial sector can provide jobs for. Urban poverty has replaced rural poverty.
- The model ignores the cost of training and educating the surplus labour from the rural sector who would need to be equipped with new skills to work in the urban sector.
Types of aid
Assistance to developing economies comes in a number of different forms. The largest single source is known as aid. This can be given in three main ways. These are:
- Humanitarian - which can both be by individual country to country or via a major organisation such as one of the UN agencies. This is not a loan and is normally sent to help against a specific problem, e.g. drought.
- Bilateral - which is given by one country to another. It is a loan, though may be subject to a long period prior to re-payment commencing, and granted as soft or below market terms.
- Multilateral - which is when separate countries pay money into one central organisation, say the IMF, and it then determines who receives money and for what. So, multilateral aid is given via one of the large international agencies.
Aid may be official, in which case it is administered by government or government agencies, or it may be unofficial, in which vase it is administered by a non-government body, such as a charity.
Grants might be directed at technical services, or scholarships for some students to study in a particular country, and grants do not have to be repaid. Aid might also be trade related, in that the monies will only be made available if the receiving country agrees to buy goods or services from the donor nation. This is called tied aid - the aid is tied to particular contracts, i.e. it has strings attached.
Successful aid should be an attempt to:
- Overcome the low savings ratios recorded in developing economies. Most poor people consume the vast majority of what they earn.
- Help reduce foreign exchange outflows, so allowing the domestic government to use such monies to build the necessary infrastructure for development.
- Reduce the dependency on private investment, which may not arrive or will only be found at a high price to the country seeking such funding.
Successful aid should also:
- Improve the living standards of the poorest people in the receiving country. This is not always possible, as government is normally based in the capital, which is by definition an urban centre. Like all political regimes, those in developing countries tend to serve those who elected them to office and power. Those who did not tend to receive little. If this persists, it can be a cause of unrest and even coups and military takeovers.
- Move with the times and accept that what was fashionable several years ago may no longer be. Local opinion and knowledge is increasingly used when deciding on what to invest in and why.
- Not simply provide cheap food, except in an emergency, as this undermines the domestic agricultural sector. In some countries a once self-sufficient farming sectors have lost part of their domestic markets to food aid and now have to import part of their staple food crop.
- Allow choice to be exercised by the receiving country. A problem with tied aid is that it reduces choice and the developing economy may not be getting the best deal.
So what are the arguments for and against aid? Have a think about them, jot down some ideas and then follow the links below.
It is possible to take various positions on aid, and those on the left and right of the political spectrum might both oppose it, but for different reasons. Where do you stand? Have a look at the table below and see if you can identify your position.
|Left||Left / Liberal||Liberal / Right||Right|
|No!||Yes, but ...||Yes and||No!|
|Aid is a hypocritical neo-colonialist device to make the rich richer||We have a moral duty to help those who, through unfair terms of trade, for example, have been the victim of economic injustice at our hands||It is in our interest to aid the poor - when they are richer they can buy more from us and help expand world trade.||If a country cannot develop without handouts it will not develop with them. What holds less developed countries back is the people who live there.|
|Aid is used to prop up repressive and reactionary regimes||Aid should be directed towards progressive countries||We should aid friendly countries, or ones of strategic defence importance.||Aid centralises money and power into a few government hands. It makes the possession if political office critical and leads to corruption, instability and coups d'etat.|
|Aid is creamed off by corrupt ruling elites in developing countries and therefore increases inequality||Aid projects should help the redistribution of wealth to the desperately poor. Only the adequately nourished and educated can demand structural changes.||Aid should be given to people who can use it effectively to modernise their society and work more efficiently.||Aid depresses individual initiative and reinforces torpor, fatalism and beggary.|
|Loans and grants tied to the purchase of Western goods distort economic development in poor countries - and increase their dependence on the rich.||Aid should be given as grants only and recipients should be free to import from wherever they like.||Sensible aid can benefit both donor and recipient. Tied aid reduces pressure on the donor's balance of payments and allows more to be given.||No 'lame duck' home industries should be subsidised - by tied aid or any other means. And if tax payers in the rich countries were actually consulted about aid they would refuse to give it.|
|Aid goes largely to governments sympathetic to capitalism. It paves the way for private investment that siphons wealth from poor countries.||Aid should be given solely on the basis of need and the potential for social change. Private investment is not aid and can be damaging.||Private investment is an excellent form of assistance. And aid can help it function properly by providing economic and political stability.||If capital is required, and can be profitably used, it will be available commercially. Grants and interest-free loans only encourage inefficiency and waste.|
Export-led growth / outward-oriented strategies
This section deals with outward-oriented strategies and the next section, 5.4.5, looks at inward-oriented strategies. The debate about which is most appropriate is closely linked with the arguments for and against free trade/protectionism (section 4.2) and the benefits/costs of foreign direct investment by MNCs (section 5.4.9). You should therefore re-read these sections along with 5.4.4 and 5.4.5.
The majority of trade generated by developing economies goes to the developed world. The developing countries seldom trade within themselves. Exporting to the more sophisticated markets of the developed world forces them to produce at the expected standards and that makes their goods more internationally competitive. Information and technology will move between the two types of economy and increases in productivity should follow.
Being involved in export trade also promotes the ending of protectionist policies. Domestic industry must be competitive and not hide behind barriers. Resources will flow to those industries that have a comparative advantage. These tend to be labour intensive and low technology industries. In the early stage of diversification, government can offer incentives to business to switch away from commodity exports and into manufactured goods.
Export-led demand can be an important source of growth for developing countries in the early stages of their development, particularly given their reliance on primary exports (see section 5.3.3). However, countries may also try to export manufactures as a growth strategy. This is often termed an outward-oriented strategy. This may have a number of benefits:
- It conforms more closely to comparative advantage - resources may be used more efficiently as the resources used in earning a unit of foreign exchange from exports will be less than those used in saving a unit of foreign exchange by replacing imports with domestic goods.
- Increased investment - outward-oriented policies may help encourage inward investment and therefore domestic productivity.
- Economies of scale - the increased sale of exports may help raise the domestic level of production and enable the country to gain from economies of scale.
- Increased employment - increased production should help boost the domestic level of employment.
- Greater equality of income distribution - increased demand for labour will help boost wages in a developing economy and this should help to make income distribution more even.
- Increased competition - an outward-oriented strategy will expose the country to the full weight of international competition. They may struggle initially to compete, but productivity will rise much faster than if import substitution policies are followed.
However, many countries will regard these outward-oriented policies as too risky for their own industries and prefer to erect protectionist barriers. Click on the right arrow at the top or bottom of the page to start looking at import substitution.
Import substitution / inward-oriented strategies / protectionism
The protection of jobs and the promotion of growth might be best served by concentrating on producing import substitutes. Countries need foreign exchange and if they can produce substitutes for imports, this will release foreign exchange. To encourage import substitution, many countries will adopt protectionist policies. (See section 4.2 on the arguments for protectionism).
Critics of this suggest that there will be some short-term gains in job protection but, in the longer term, output will be lower than under a free system of exchanging trade. Comparative advantage allows gains form trade via specialisation. However, domestic producers may have little incentive from foreign competitors forcing them to be dynamic. Countries, which have adopted import substitution policies have tended to record lower growth rates than those who have selected the export-led strategy. (See section on the arguments against protectionism).
Commercial loans are loans from banks and other financial organisations, usually in the developed world. Many developing countries saw borrowing as a way for them to fund development. Between 1970 and 1975 bank loans to developing countries grew from £3bn to $12bn and as their balance of payments position improved later in the 1970s with rising commodity prices, they continued to borrow extensively. However, in the 1980s and 1990s higher interest rates and falling commodity prices meant that many defaulted on their loans and many other loans had to be re-scheduled.
So commercial loans are another possible growth strategy for developing countries, but past experience has revealed the potential problems with this strategy if it is relied on excessively, and the problems of indebtedness that may be caused (see also section 5.3.4 on indebtedness).
In recent years, multinational power has grown and this has put pressure on farmers and other producers in the developing world, resulting in falling incomes. This has led to the growth of fairtrade organisations who guarantee farmers and producers a 'fair' price for the goods they produce. This means a price that covers their production costs and allows a surplus that they can reinvest in their business and that can sustain a 'reasonable' standard of living. This creates a degree of stability of prices and allows development to take place at a more measured and consistent pace.
For more information on fairtrade and examples of fairtrade companies, have a look at some of the web resources below:
- The Fairtrade Foundation - this foundation "exists to ensure a better deal for marginalised and disadvantaged third world producers. The Foundation awards a consumer label, the FAIRTRADE Mark, to products which meet internationally recognised standards of fair trade." (Source: Fairtrade Foundation web site). Have a look particularly at the 'About Fairtrade' section.
- Biz/ed CafeDirect business profile - this is a profile of one of the more successful fair-trade coffee and tea producers. The company has grown significantly and in 2004 floated shares to broaden their ownership.
- Day Chocolate Company business profile on Biz/ed - this company started in 1993 in Ghana and has been very successful. It has expanded from 23 village societies to over 40,000 members in over 900 village societies.
- Fair trade and bananas - a Biz/ed review of the banana wars between the EU and the US in the late 1990s and early part of this century.
Microcredit schemes are schemes that lend small amounts to the poor in a developing country. The loans may be as low as $1, but they are directly targeted at the needs of those people and reflect the circumstances they operate in. These loans are often offered by Non-Governmental Organisations (NGO's) as the commercial financial institutions are not prepared to work in this way. They generally regard the poor as high risk, as they cannot offer any security for the loans.
Many people have argued that these loans are an excellent way to promote growth and development as they are directly targeted at the people who need them the most and help to promote an entrepreneurial culture from the 'bottom-up'. However, whether they are sufficient to boost an economy significantly is very debateable and they are likely to be most effective when combined with other development strategies.
For an excellent summary of microcredit, with examples, why not have a look at the Christian Aid section on this on their web site. You can do this in the window below:
Foreign direct investment
Foreign direct investment is mainly undertaken through multinational corporations (MNCs). An MNC is a firm that has productive capacity in a number of countries. The profit and income flows that they generate are part of the foreign capital flows moving between countries.
The total value of MNC investment worldwide is over $1 trillion ($ 1,000,000,000,000) of which around one third is in the developing world. Given low levels of GDP in the developing world, this foreign direct investment (FDI) can mean that the MNCs can hold a disproportionate amount of power over the countries they operate in.
As countries adopt more open, outward-oriented approaches to economic growth and development, the role of MNCs or transnational corporations becomes more important. As local markets throughout the world are being deregulated and liberalised, foreign firms have looked to locate part of the production process in other countries where there are cost advantages. These might be cheaper sources of labour, raw materials and components or preferential government regulation. Although developing countries may present high levels of risk, they also present the potential for higher levels of profit. Many developing countries with growing economies and increasing incomes may provide future growth markets and they will often offer significant incentives to try to attract the MNCs to locate there.
The benefits of MNCs
- Proponents of outward - oriented economists maintain that the cycle of poverty will not be broken just from within the domestic economy. Developing economies themselves cannot raise enough finance to fund the necessary investment. Thus FDI through MNCs is essential.
- By investing in areas and utilising the factors of production where the LDCs have an absolute and comparative advantage, it is argued that MNCs will lead to a more efficient allocation of the world's resources. However, if this leads to overspecialisation and overdependence in certain sectors of the economy, then the host country will be vulnerable, especially if the MNC decides to leave.
- Investment into an economy will help to boost the rate of economic growth by shifting the economy's long run aggregate supply curve to the right (increasing their productive potential).
- Investment will help inject money into the local economy. This may provide jobs directly or through the growth of local ancillary businesses such as banks and insurance companies. This may contribute to a multiplier process generating more income as newly employed workers spend their wages on consumption.
- MNCs may provide training and education for employees thus creating a higher skilled labour force. These skills may be transferred to other areas of the host country. Often management and entrepreneurial skills learned from MNCs are an important source of improved human capital and, as we have seen in previous sections, this is an important contributory factor to development.
- MNCs will contribute tax revenue to the government and may contribute other funds to local development projects or may perhaps invest in other related assets.
The problems of multinational enterprises
- The MNC may employ largely expatriate managers ensuring that incomes generated are maintained within a relatively small group of people. The attraction for the MNC may be a large and cheap supply of manual labour. This may worsen income distribution. It will also mean that there is no 'skills transfer' to the local people.
- Investment in developing countries often uses capital-intensive production methods. Given that many developing countries are often endowed with potentially large low wage labour forces and have high levels of unemployment, this might be considered inappropriate technology. More labour intensive production methods might help more with alleviating poverty.
- MNCs engage in transfer pricing where they shift production between countries so as to benefit from lower tax arrangements in certain countries. By doing this, they can minimise their tax burden. This means that the host country will not benefit from the higher tax revenues and this in turn limits their ability to spend on infrastructure improvements and improvements in health and education.
- The size of MNCs means that they can exert disproportionate power and influence on governments to get tax breaks, grants and subsidies. This will particularly be the case after they have operated in the country a number of years and are thinking of re-investing. At this point, they can 'threaten' to move elsewhere.
- Growth and development, which are largely dependent on FDI via MNCs, may give rise to a range of other problems, such as a widening of inequalities between rural and urban sectors, the exploitation of local labour through the payment of low wages, the stifling of domestic competition and the establishment of an outward directed pattern of growth in which profits are repatriated to the host country of the MNC rather than being re-invested in the developing country.
Sustainable development is development which will not have a detrimental effect on future generations and which involves measures to limit the use of non-renewable resources.
The developed world has increasingly realised the environmental destruction that results from economic growth. This has led to an increased realisation that we need to move towards more sustainable economic growth. This is also true of development, which will be of little use to developing countries if it results in climate change and a poorer environment to live in.
International agencies like the IMF and World Bank are increasingly being forced to take account of ecological factors when making decisions on appropriate development and aid strategies. In 1992, the United Nations Conference on Environment and Development (UNCED) put forward a programme for environmentally responsible development. In Agenda 21 it set out various policies that could be carried out by the international community. The policies were approved by 178 countries and included:
- Targeting aid to projects that helped improve the environment (the provision of clean water etc.)
- Research into environmentally friendly farming methods
- Programmes to help reduce population growth (e.g. family planning and education)
To try to monitor progress towards these targets a Commission on Sustainable Development was established and in 2002 began a ten-year comprehensive review of progress in meeting the Agenda 21 programme.
Section 5.4 Growth and development strategies - questions
In this section are a series of questions on the topic - Growth and development strategies.
Growth and development strategies - short answer
Explain how a more equal distribution of income might contribute towards economic development.
Explain the different types of aid which a developing country might receive.
Critically evaluate the role of foreign aid in promoting development in the poorer countries.
Section 5.4 Growth and development strategies- in the news
In this section are a series of questions on the topical news items in relation to the topic - Growth and development strategies.
Millennium Development Goals
Read the article Poverty, hunger and disease: so much done yet so much left to do (you can do this in the window below or follow the previous link to read the article in a separate window) and then consider answers to the questions below.
Outline the seven Millennium Development Goals.
Analyse the extent to which the Millennium Development Goals are currently being met.
Discuss whether an increase in overseas development aid would help to achieve the Millennium Development Goals by the target date of 2015.
Upwardly mobile in Africa
Read the article Upwardly mobile Africa: key to development lies in their hands (you can do this in the window below or follow the previous link to read the article in a separate window) and then consider answers to the questions below.
Explain how improving infrastructure, like mobile phone networks, can help to improve the rate of economic growth.
Analyse whether improved mobile phone networks in developing countries in Africa will lead to a reduction in poverty.
Discuss the advantages and disadvantages of foreign direct investment in mobile phone networks for developing countries in Africa.
Bilateral trade deals
Read the article Oxfam slams bilateral trade deals (you can do this in the window below or follow the previous link to read the article in a separate window) and then consider answers to the questions below.
You may also like to read the following articles about the Oxfam paper on bilateral trade deals:
- The state of world trade - Oxfam
- Signing away the future - Oxfam
- Signing away the future - Oxfam Q&A
Explain the difference between a regional trade agreement and a bilateral trade agreement.
Discuss the advantages and disadvantages for developing countries of signing (a) bilateral trade agreements and (b) regional trade agreements.
Choose a specific recent regional trade agreement and assess the impact it has had on the member countries.
West fails aid targets
Read the article West set to fail aid targets, OECD says (you can do this in the window below or follow the previous link to read the article in a separate window) and then consider answers to the questions below.
Explain what is meant by 'official development assistance'.
Describe the likely impact on the developing world of a failure to meet the aid targets set by the United Nations.
Discuss the extent to which developing countries are likely to gain from globalisation.
Banker to the poor - microfinancing
Read the articles Profile: world banker to the poor and Small loans to women make big changes (you can do this in the windows below or follow the previous link to read the article in a separate window) and then consider answers to the questions below.
You may also like to read the articles:
Explain what is meant by microfinancing.
Examine the reasons why microfinancing is considered more effective at promoting economic development (as opposed to economic growth).
Assess the extent to which microfinancing could help in other developing countries to promote economic development.
Tobin-lite tax - the answer for aid?
Read the article Tobin-lite could raise £3bn for third world and then consider answers to the questions below. You can either read the article in the window below or you can follow the previous link to read the article in a separate window.
Assess the arguments for and against a 'Tobin tax' on foreign exchange.
Evaluate whether a 'Tobin-lite' foreign exchange tax would be more effective at reducing poverty than debt relief for developing nations.
What problems might be faced if the 'Tobin-lite' tax was adopted unilaterally by the UK government as suggested by the campaign?
Commodity boom for developing countries
Read the article Poor nations ride high on commodity boom but aid agencies worry about the bust (you can do this in the window below or follow the previous link to read the article in a separate window) and then consider answers to the questions below.
What is the likely impact of the rapid rise in metal prices on the terms of trade of developing countries who have significant reserves of metals?
How have developing countries which rely on 'soft commodities' (e.g. sugar) been affected by the rapid rise in metal prices on world markets?
Discuss the most effective ways for developing countries to use these windfall gains from higher commodity prices.
Section 5.5 Evaluation of growth and development strategies - notes
As a grand finale to your IB economics course, the first bullet point in this section does not involve any new body of knowledge (that's the good news!), but draws instead upon all the other sections of the syllabus (not such bad news!). In academic-speak, this is known as 'synoptic' - any assessment in this area in particular will test your understanding of the connections between the different elements of the syllabus content and will require you to demonstrate understanding of the inter-relatedness of different economic issues, theories, concepts and institutions.
To enable you to appreciate this inter-relatedness, we will identify what we believe are the key sections of the syllabus to enable you to evaluate growth and development strategies, and will then direct you to some questions and outline answers, so that you can test your level of understanding.
Aid and trade - this is covered mainly in section 5.4 on growth and development strategies, but would also link with section 4.2 on free trade and protectionism.
Market-led and interventionist strategies - an evaluation of these in terms of achieving growth and/or development really could be all embracing! Some possible sections to look at for this are:
- Section 1 - rationing systems, free market versus mixed versus centrally planned economies (advantages/disadvantages of different forms of resource allocation)
- Section 2.1 - markets/competition, functions of price in resource allocation (the role of markets)
- Section 2.3 - productive and allocative efficiency (benefits of market-led strategies)
- Section 2.4 - market failure and government intervention / response (problems of market-led strategies/need for government intervention)
- Section 3.4 -demand management (interventionist), supply-side policies (market-led)
- Section 3.5 - unemployment/inflation as consequences of market-led/interventionist strategies
- Section 3.6 - income distribution in same context as 3.5 above
- Section 4.2 - free trade (market-led), protectionism (interventionist)
- Section 4.3 - globalisation (market-led), trading blocs (combination of market-led and interventionist)
- Section 4.6, 4.7 and 4.8 - exchange rates, balance of payments problems and terms of trade (impact of market-led/interventionist strategies on these?)
- Section 5.3 - barriers to economic growth and/or development (particularly the sections on international trade and international financial barriers)
- Section 5.4 - growth and development strategies (particularly the sections on types of aid, export-led growth/outward-oriented strategies (market-led), import substitution/inward-oriented strategies (interventionist) and foreign direct investment)
For this section, we suggest that you have a look at the questions on market-led and interventionist strategies in the development. Try in each case to formulate a plan of how you would tackle them using bullet points. If you were writing an essay, or an answer to the final part of a data response question, each bullet should represent a paragraph which you would use to fully expand upon each of the points in your list. Examiners are very keen on structure and the use of paragraphs. These questions are extremely open-ended, there are no right or wrong answers - follow the links in each case for a selection of points you could have raised.
In this section we consider the following topics in detail:
- IMF and World Bank
- Other international organisations
- Private sector banks
- Non-governmental organisations
- Multinational corporations
- Commodity agreements
IMF and World Bank
IMF and World Bank
Large-scale organisations also work in the field of development. Many of these come under the umbrella of the UN and emerged as part of the discussions held towards the end of the Second World War. Amongst the largest are:
The IMF is an international organization of 184 member countries. It was established to: promote international monetary cooperation; exchange rate stability and orderly exchange arrangements; to foster economic growth and high levels of employment; and to provide temporary financial assistance to countries to help ease balance of payments adjustment.
While the IMF was set up to oversee currency values and act as a kind of 'credit union' from which national governments could obtain short term finance to overcome their balance of payments difficulties, it has now developed into an 'international judge' of countries' economic policies - it offers loans conditional on the implementation of a prescribed set of free market policies.
The main purposes of the IMF are given on their web site.
The World Bank is not a bank, but rather a specialized agency. The World Bank is not a "bank" in the common sense. It is one of the United Nations' specialized agencies, and is made up of 184 member countries. These countries are jointly responsible for how the institution is financed and how its money is spent. Along with the rest of the development community, the World Bank centres its efforts on reaching the Millennium Development Goals, agreed to by UN members in 2000 and aimed at sustainable poverty reduction.
Whilst the IMF was concerned with stabilising the international finance system through short term lending to those countries with balance of payments deficits, the World Bank's role was concerned with financing reconstruction and development through the construction of national infrastructure such as roads and dams. By supporting projects through funding, and providing technical assistance, the World Bank considered that it would bring about increases in productivity, output and incomes and self-sustaining economic growth.
The "World Bank" is the name that has come to be used for the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). Together these organizations provide low-interest loans, interest-free credit, and grants to developing countries as follows:
The International Bank for Reconstruction and Development (IBRD)
This IBRD lends money at commercial interest rates to governments or private firms, guaranteed by their governments.
The International Development Association
The IDA lends money, called credits, to the poorest countries on concessionary terms i.e. the repayment periods are longer than the IBRD's loans and the loans are interest free. These are called soft loans.
In addition, the International Finance Corporation (IFC) is closely affiliated to the World Bank. It was started up to enable funds to be lent to, or used to purchase shares in, private firms engaged in activities that would lead to development, but not needing a government guarantee.
Up until the 1970s, much World Bank lending was targeted at projects primarily concerned with building energy and transportation infrastructure in developing economies. Its early history had been concerned with similar projects in reconstructing war torn Europe. The poor economic performance and continued lack of development of many of the countries that had received World Bank assistance resulted in a rethink of the approach of the IBRD and the IDA. The new approach involved identifying specific needs of regions within developing countries, and invariably this meant targeting smaller scale development projects, often of a very diversified nature.
Many of these were concerned with funding agricultural projects, and usually those that stimulated the growth of cash crops. The intention was that such support would raise the incomes of smaller scale farmers and encourage food production. Projects aimed at the tourist industry, education, water supply and health care have also been supported.
Since the 1980s many World Bank loans have, like the IMF, been tied to certain strict conditions laid down in structural adjustment programmes.
Structural adjustment programmes
Structural adjustment programmes
SAP's are programmes of free market and supply side reforms that multilateral agencies such as the IMF lay down as conditions for lending funds.
One major area of contention with the two main 'economic' agencies mentioned above (IMF and World Bank) is their application of Structural Adjustment Programmes. These are part of any 'rescue package' a developing country may ask for. Normally, they require the receiver to accept that:
- They cut, or even drop all subsidies and price controls, even on basic foodstuffs
- They cut public expenditure
- They reduce the quantity of money in circulation
- They reduce those employed in the public sector
- They quickly reduce domestic inflation
- They open up home markets
- They privatise essential utilities such as gas, water and electricity, as well as other industries
There is little doubt that such projects will make any economy 'leaner and fitter' but in the short to medium term the cost in human terms can be considerable. In fact, the 'medicine' has often almost killed the 'patient'! However, it's difficult to gain loans from both the IBRD and IMF without agreeing to the drastic measures outlined above.
There is considerable debate around the policies pursued in recent years by the IMF and the World Bank, particularly in relation to their SAPs for developing countries. There are several useful web sites and articles that you can look at to get a flavour of this debate. A selection are included below, and may be worth looking at:
- Poisoned chalice - George Monbiot (The Guardian 19th August 2003)
- Logic that leads to a plundered world - Herman Daly (The Guardian 1st September 2003)
- IMF's four steps to damnation - Gregory Palast (The Observer 29th April 2001)
- What has the IMF done for you lately? - Christopher Lord (Freezerbox.com 9th May 2000)
- Seven arguments for reforming the world economy - Kevin Danaher (Globalexchange.org 9th June 2003)
- IMF's 'one size' fits few - Nick Mathiason (Guardian 28th April 2002)
More general analysis on the role of the IMF and the World Bank can be found on two useful web sites:
Other international organisations
The Food and Agriculture Organization of the United Nations was founded in 1945 with a mandate to raise levels of nutrition and standards of living, to improve agricultural productivity and to better the condition of rural populations.
Today, FAO is one of the largest specialized agencies in the United Nations system and the lead agency for agriculture, forestry, fisheries and rural development. An intergovernmental organization, FAO has 183 member countries plus one member organization, the European Union.
Since its inception, FAO has worked to alleviate poverty and hunger by promoting agricultural development, improved nutrition and the pursuit of food security - defined as the access of all people at all times to the food they need for an active and healthy life.
Food production has increased at an unprecedented rate since FAO was founded in 1945, outpacing the doubling of the world's population over the same period. Since the early 1960s, the proportion of hungry people in the developing world has been reduced from more than 50 percent to less than 20 percent. Despite these gains, however, more than 790 million people in the developing world - more than the total population of North America and Western Europe combined - still go hungry.
A specific priority of the Organization is encouraging sustainable agriculture and rural development, a long-term strategy for increasing food production and food security while conserving and managing natural resources. The aim is to meet the needs of both present and future generations by promoting development that does not degrade the environment and is technically appropriate, economically viable and socially acceptable
UNICEF is the United Nations Children's fund and their aim is to work with children and remove all the obstacles like disease, poverty and discrimination that prevent their full and proper development.
For more information on the work of UNICEF, you might like to have a look at the 'Who we are' section of their web site. There is also a history of the organisation and an excellent 'About UNICEF' section to the site giving details of the work they do.
UNESCO is the United Nations Educational, Scientific and Cultural Organisation. According to their web site:
"The main objective of UNESCO is to contribute to peace and security in the world by promoting collaboration among nations through education, science, culture and communication in order to further universal respect for justice, for the rule of law and for the human rights and fundamental freedoms which are affirmed for the peoples of the world, without distinction of race, sex, language or religion, by the Charter of the United Nations."
For more details on them and what they do, why not have a look at the 'About UNESCO' section of their web site.
WHO is the World Health Organisation. They attracted a lot of media attention in 2003 as the lead UN agency dealing with the control of the SARS outbreak in the world. The World Health Organization, the United Nations specialized agency for health, was established on 7 April 1948. WHO's objective, as set out in its Constitution, is the attainment by all peoples of the highest possible level of health. They are governed by 192 Member States through the World Health Assembly.
For more details about the organisation and the work they do, why not have a look at the 'About WHO' section of their web site.
Private sector banks
Private sector banks make loans to developing countries at commercial rates of interest. As such, these loans become part of the debt of the poorer nations and the implications thereof are discussed in section 5.3 (International financial barriers to development). In relation to this, you should also look back at the notes on indebtedness and capital flight and ensure that you fully understand these concepts.
In recent years, one of the biggest growth industries in developing economies has been that of the NGOs - the non-governmental organisations. They undoubtedly do a very fine job (in most cases) but they can become almost a de facto government and exercise huge influence. They are 'guests' in a country and need to think carefully about the projects they select and how they employ nationals. Many are essential to the fabric of the country in whish they operate and as we know many of us contribute via Red Nose Day and other charitable events to the best known of these organisations.
They work best when:
- Allowed to tackle issues at local level
- Encouraged to employ as many local workers as possible
- Specialised in specific and often rural-based project work
- Project monitoring is done very carefully
- Relations with governments are cordial but not too friendly
You may like to have a browse around the web sites of some of these NGOs to see the sort of work and projects they are involved in:
Multinational corporations (MNCs) / Transnational corporations (TNCs)
The advantages and disadvantages of foreign direct investment in developing countries by MNCs have previously been discussed. It might be useful if you referred back to that section now (click on the home icon in the navigation bar to return to the main table of contents, or use the table of contents on the left).
In this section we will consider other aspects of MNCs:
What is an MNC?
An MNC is a company which possesses and controls means of production or services outside the country in which it was established. Although they operate in different countries, most of such corporations are controlled from a national base from which a global system of integrated production, sales, research, marketing and finance is facilitated.
Growth of importance of MNCs in recent decades
Increasingly, giant MNCs have come to dominate markets on a world scale such that they now account for a large proportion of the world's output. This increase in importance may be attributed to various factors, including:
- The growth of international trade
- The trend towards globalisation
- The desire to achieve profit maximisation through economies of scale and strategies such as transfer pricing
- The growth of powerful economic blocs, e.g. the EU, NAFTA
- Advances in communications and information technology
- The marketisation of former communist economies
Multinationals and monopoly power
J K Galbraith on the multinational company
"The two parts of the economy - the world of the few hundred technically dynamic, massively capitalised and highly organised corporations on the one hand and of the thousands of small and traditional proprietors on the other - are very different. It is not a difference of degree but a difference which invades every aspect of economic organisation and behaviour, including the motivation to effort itself. It will be convenient ... to have a name for the part of the economy which is characterised by the large corporations ... I shall refer to it as the Industrial System. The Industrial System ... is the dominant feature of the New Industrial State."
Source: John Kenneth Galbraith, The New Industrial State (1967).
In a world in which giant corporations control over 70% of the world's trade, carry out the bulk of new research and development (R&D), shape international markets through their advertising and exert a great deal of influence over price, it is difficult to find very much evidence of the perfectly competitive market of the economics textbook. The 19th century revolutionary, Karl Marx, was one of the few economists to correctly predict this growth of big business. While mainstream, orthodox economists mainly focused their attentions on markets with large numbers of buyers and sellers, with none large enough to influence price, Marx centred his attention on the likely growth of huge aggregates of capital having significant control over their markets, and with the ability to eliminate many of their smaller rivals: a process in which the stronger and more profitable 'mop up' the weaker, making for giant monopolies with enormous economic, and even political power.
These may take the form of attempts to stabilise prices, through the operation of a buffer stock scheme or attempts to raise prices by forming a producers' cartel and restricting supply through the use of quotas.
Buffer stock schemes
Firstly, we will consider the operation of buffer stock schemes which have existed on and off since the 1920s for a range of commodities including wheat, tin, rubber, coffee, sugar and cocoa. All of these have eventually failed for one reason or another, so there are no prominent examples to consider.
So what is a buffer stock scheme?
Buffer stock schemes are operated by a central authority and aim to stabilise prices and protect producers from sudden shifts in demand and supply (often supply in the case of agriculture). This is done by 'leaning into the wind', i.e. if there is too much supply, forcing the price down, the buffer stock agency will increase demand by buying up stocks. If there is a shortage of supply, forcing the price up, the agency will release stocks onto the market forcing the price down.
A buffer stock makes use of a price band. Figure 1 below shows the effect of setting up a buffer stock scheme for coffee. If the market is within the two boundaries set by the agency, no action is taken. However, if the market price moves outside the boundaries, the buffer stock operators will intervene.
If there is a very good harvest of coffee, the supply curve will shift to the right and the price would fall below the boundary. The buffer stock operators would then step in to increase demand to keep the price within the boundary. This is shown in Figure 2 below.
The bumper harvest causes the supply curve to shift to S1. This would initially cause the price to fall below the lower boundary to OP1. By buying up stocks, the agency shifts the demand curve to D1 and brings price back within the upper and lower boundaries to OP2.
If there is a poor harvest of coffee, the supply curve will shift to the left and the price would increase above the upper boundary. The buffer stock operators would then step in to increase supply by selling stocks and this would push price down below the upper boundary. This is shown in Figure 3 below:
Problems of a buffer stock scheme
There are a number of possible problems related to buffer stock schemes and these may include:
- Problems of storage, storage and administration costs and perishability, particularly if there are too many years of bumper harvests.
- Difficulty of setting appropriate floor and ceiling prices. If buffer stock managers have to consistently intervene at the floor price, they will have to keep buying and may run out of finance. If they have to keep intervening at the ceiling price, they will run out of stocks to put on the market.
- Problems of inadequate supplies if there are too many years of bad harvests.
- Problems of financing the buffer stock if there are too many years of good harvest - funds have to be contributed by the members.
- Problems of keeping prices artificially high if there are close substitutes available, e.g. rubber/rubber substitutes
- Difficulties in maintaining the agreement on prices in that some producers may be underproducing and could improve their individual position by cutting price and raising output. This is particularly the case where producers are scattered in different countries.
Such schemes have been attempted in the case of rubber, tin, coffee and sugar, and involve the formation of a single selling organisation, i.e. a cartel, to restrict output of individual members through the issuing of quotas. Thus, when prices need to be increased, members would be ordered to reduce their output in accordance with their quota allocation. This is illustrated in Figure 3 below.
The supply of primary commodities tends to be perfectly inelastic in the short run, so the cartel requiring a reduction in output would shift the supply curve to the left from S to S1 and raise the price from OP to OP1.
Such schemes have suffered from some of the same problems that have beset buffer stock schemes, i.e. problems of maintaining the cartel and the switch towards substitute goods if prices are kept too high.
Section 5.5 Evaluation of growth and development strategies - questions
In this section are a series of questions on the topic - Growth and development strategies.
Evaluation of growth and development strategies - short answer
Using demand and supply analysis and elasticity, explain the instability of primary commodity prices.
Evaluate the effects of schemes aimed at stabilising the prices of primary commodity on producers and consumers.
Why have MNCs grown in importance over the last half century?
Discuss whether MNCs help of hinder the development of the developing countries.
"The benefits of economic growth will, without any government intervention, trickle down to benefit the poor." Do you agree with this statement? Justify your answer.
Evaluate the advantages and disadvantages of private capital flows for developing countries.
Evaluate the view that policies adopted by the IMF and World Bank in recent years have been disadvantageous for the developing countries.
Evaluation of growth and development strategies - self-test
These questions are an addition to section 5.5 of the notes and consider the success or otherwise of a range of growth and development strategies. Unlike many other areas of the course, there are answers to each question, but these are simply ideas as they are very open-ended questions in each case.
Try in each case to formulate a plan of how you would tackle them using bullet points. If you were writing an essay, or an answer to the final part of a data response question, each bullet should represent a paragraph which you would use to fully expand upon each of the points in your list. Examiners are very keen on structure and the use of paragraphs. These questions are extremely open-ended, there are no right or wrong answers - follow the links in each case for a selection of points you could have raised.
Explain the main features of interventionist and market-led strategies to achieve growth and development.
Outline the various strategies which a country may deploy to achieve economic development.
Explain the likely changes in economic policy that would be necessary if a country moved from an interventionist to a market-led development strategy.
Discuss the arguments for and against completely unrestricted financial capital flows into and out of developing countries.
Discuss the advantages and disadvantages of interventionist growth and development strategies. Define growth and development.
Discuss the advantages and disadvantages of market-led growth and development strategies. Define growth and development.