4 0064Topic 12- Growth and development

What is the difference between Growth and Development?

Economic growth measures an increase in Real GDP (Real Output). GDP is a measure of the national income /
national output and national expenditure. It basically measures the total volume of goods and services produced
in an economy.

Development looks at a wider range of statistics than just GDP per capita. Development is concerned with how
people are actually affected. It looks at their actual living standards

Economic growth can be measured and therefore any statement regarding the levels of growth can be a positive
statement. However, economic development is a normative concept dependent on the value judgment of the
person who is stating the opinion. In order to provide a measure of development, various composite measures
are used. For example: Human Development Index (HDI) is the most commonly used measure. However this is
said to be a very narrow indicator of development because it ignores several other concepts that had been listed
below.

Measures of economic Development will look at:

Real income per head GDP per capita
Levels of literacy and education standards
Levels of health care e.g. number of doctors per 1000 population
Quality and availability of housing
Levels of environmental standards
Levels of political freedoms
Energy consumption per person
Mobile users per thousand of the population
Proportion of people working in agricultural sector.

Do high levels of GDP necessarily correspond with high levels of development? Not necessarily. It is not
aggregate GDP that is important, but GDP per capita. Countries like China and India have much higher levels of
GDP than, say, Singapore, New Zealand or Belgium, but few would suggest that the latter are economically less
developed than the former.




Economic Growth without Development

It is possible to have economic growth without development. i.e. an increase in GDP, but most people dont see
any actual improvements in living standards.

Economic growth may only benefit a small % of the population. For example, if a country produces more oil, it
will see an increase in GDP. However, it is possible, that this oil is only owned by one firm, and therefore, the
average worker doesnt really benefit.
Corruption. A country may see higher GDP, but the benefits of growth may be siphoned into the bank
accounts of politicians
Environmental problems. Producing toxic chemicals will lead to an increase in real GDP. However,
without proper regulation it can also lead to environmental and health problems. This is an example of
where growth leads to a decline in living standards for many.
Congestion. Economic growth can cause an increase in congestion. This means people will spend longer
in traffic jams. GDP may increase but they have lower living standards because they spend more time in
traffic jams.
Military Spending. A country may increase GDP through spending more on military goods. However, if
this is at the expense of health care and education it can lead to lower living standards.


Reasons for the different levels of development /low rate of development in
developing countries.

Different availability of natural Resources:
Countries such as Nigeria have significant oil wealth if used wisely, this could improve growth and
development. Other natural resources would include precious metals/ minerals. However, control of these is
often fought over in civil war and much of it is wasted financing such wars instead of being used for
development projects.

Many LDCs have subsistence or primary-sector economies, which produce low-value-added goods and therefore
generate low income in trade. Consequently, people cannot save any excess income as they do not earn much,
and funds for investing in the secondary sector are not available and this reduces further investment levels and
reduce the possibility of creating better sources of income for the people.

However it should be noted that there had been situations where countries, which are dependent on primary
products have been able to raise themselves out of the poverty trap and make their conditions better for
themselves. This is specially noted in countries which specialize in products like petroleum, gold and such
valuable resources. Furthermore, agricultural had been rising, albeit slowly, over the years. Therefore this had
led to increased export revenues for these nations as well.

Differing geographical terrain:
Highly mountainous regions may struggle to develop transport infrastructure and primary/secondary sector
economies, e.g. Himalayan communities.

However, Switzerland is a counter-example of a country which had been able to successfully develop excellent
transport infrastructure despite the difficult terrain. However, it should be noted that countries need to have
more capital for them to invest in such transport facilities and often developing countries may not have the
capital needed to spend on elaborate transport facilities when other uses are there for the scarce capital.

Climate:
Many sub-Saharan economies are severely affected by droughts followed by flooding, making it difficult to
establish any industry and attract any investment. The natural disasters often destroy human capital along with
infrastructure and this can be costly to rebuild and even harder to replace socially in countries where capital is
scarce. Therefore this can become a large factor that prevents development in these countries. Bangladesh is
one of the better examples of this.

Political stability:
Democratically-elected, non-military governments tend to have less corrupt economies that are more able to
develop. They are able to raise taxes and spend on public services without a backlash from the community and
on the whole such governments do spend on the growth and development projects within the country. This is
because democratically elected leaders will wish to be elected again the following year; hence they will do more
for the nation than dictators who will know that they may not be in power later. Dictators often lead to more
corrupt governments as they wish to hoard as much as possible before they are ousted from power. Thus
development projects may be given a backseat under such regimes. Politically hostile governments do not
attract foreign investments and local investors will also be cautious when investing in such an environment.
Most of them will be hoarding money abroad. This reduces the employment opportunities and hinders growth
and development of the country.

Education:
Countries which place an emphasis on education and provide some state funding are more likely to grow and
develop e.g. Tiger economies and China take education seriously. This improves human capital leading to
increased productivity and shifts the PPF outwards. However in many of the developing nations, education is not
given much emphasis, especially in rural areas where children are supposed to work to earn for their family or
where most people are too poor to afford the fees needed to join schools, colleges and universities.
Furthermore, even if these facilities are available social restrictions may limit the availability of education to
certain members of society, such as the female population or the lower casts and class members. Hence these
groups of people become deprived from the chance to change their lives for the better.

Investment:
Low investment means that economic growth is unlikely. Low investment could be due to lack of confidence by
businesses/consumers/MNCs, low savings rates leading to lack of finance (Harrod Domar model), poor
availability and trustworthiness of financial institutions (this may be heightened by poor transport
infrastructure, reducing access to banking). Low public sector investment in education, healthcare, transport or
communications could be due to corruption or inability to raise taxes (due to low incomes and poor
infrastructure). This is true of many African economies.

Population:
Many LDCs are characterized by high birth and death rates families aim to have many children in order to
increase family income, but often these children are underemployed in the informal sector in low value-added
jobs result: low development.

There is also significant urbanization in many LDCs as people search for better jobs in the cities; however,
healthcare and sanitation is severely reduced in the resulting slums, and unemployment increases (Lewis two-
sector model). Some of the biggest slums in the world are Kibera (in Nairobi, Kenya) and Dharavi in India. These
slum cities often become the hub of all criminal and antisocial activities as the people here are often underpaid,
under employed and in bad circumstances. Often people find themselves sinking lower in living conditions as
opposed to improving them.

Finance:
Many LDCs are laden with international debt, on terms that they cannot afford to repay. Many people blame the
IMF for making poor lending decisions; others blame incompetence on the part of the borrowing government.

Due to corruption in some LDCs, loans have been used to fuel extravagant lifestyles of those in office rather than
to improve their country. Pressure groups such as Jubilee 2000 are trying to persuade governments and the IMF
to cancel third world debt.

Another problem is capital flight. The owners of any extra income that could be saved and therefore used for
investment often leave the country in search of higher return for their money; this reduces the growth of capital
and therefore economic growth.

Unfair trade:
High subsidies and protective tariffs for agriculture in the developed world (example, the Common Agricultural
Policies implemented by the EU countries) drains the taxed money which is used to pay for the subsidies given
and increases prices for consumers in the developed world. This also leads to decreasing competition and
efficiency in the developing countries as these tariffs and export subsidies given by the rich prevents the exports
of agricultural goods by the more competitive agricultural in developing countries. This undermines the
comparative advantage that the developing countries have in agricultural sectors and make it harder for them to
gain a foothold in the international market in these products.

The export subsidies given by the developed world to their farmers make the prices of primary products lower in
the international markets, lowering the already low incomes that developing nations get from their exports. This
problem is made even worse as developing countries have to use the low incomes to purchase the high priced
capital goods from the developed world.

Savings gap:
Many developing countries have a low GDP and consequently many hold inadequate savings to finance the
investment which is necessary for the growth of the economy. The lower incomes and the higher dependency
rate of the population mean that there is very little to save in these countries. Hence banks have low lending
capacity and thus the low savings gap contribute to lowered GDP and low capital accumulation which contribute
to lower incomes once more.

Capital flight:
This occurs when individuals or companies decide to place cash deposits in foreign countries, or buy assets in
foreign countries rather than in domestic country. This can be due to many reasons, such as evading the taxes in
the domestic country, the returns from investment are higher in other countries rather than home country, its
much more safer to invest abroad than at home because of political instability and bad governance and so on.
Whatever the reason given for investing abroad, it has serious implications for the country as a whole.
Namely:
o It contributes to the domestic savings gap and consequently it restricts growth and domestic
investments
o Reduces tax revenues that the government can earn on these assets and hence restricts the
government spending in development projects in the country.

Debt:
Many of the developing countries have borrowed money in the past when interest rates where lower only to
find that they are struggling to service the debts some years later. Debts have become a problem for a variety of
reasons. Large debts mean that the country will be using the hard earned cash it has to service these debts
rather than use it for development purposes and often countries will raise taxation to repay these loans and this
leads to worsening of economic growth as increased taxes discourage investment and had people scrambling to
hide their assets from the government.


Other reasons include poor governance, corruption, human capital inadequacies, infrastructure provision, wars
and political unrest and so on.

What is the role of the state in promoting growth and development?

1. Fiscal policy any policy concerned with government spending, taxation or government borrowing.
If government spending = taxation, there is a balanced budget. An increase in government spending/ a fall in tax
cause an increase in AD (expansionary fiscal policy). In the short-run, this can be inflationary, reduce
unemployment and increase GDP. In the long run, depending on what the government spends its money on, it
can be anti-inflationary, raise employment and cause sustained economic growth (if the LRAS increases due to
spending on education for example). The opposite is true of a restrictions or deflationary fiscal policy.

2. Models/theories of growth and development

Harrod-Domar Now considered an old theory that focuses on the role of investment for growth
This theory states that the rate of growth equals the marginal propensity to save (which provides funds for
investment) divided by the capital-output ratio. Low savings means low investment and therefore low
development according to this theory. A problem with this theory is that it doesnt help LDCs to establish a
financial system in which savings and investment are possible in the first place.

Lewis 2-sector
This is a structural change model. Lewis said that growth would be achieved by the migration of workers from
the rural primary sector to the modern industrial urban sector this would occur through higher wage
incentives. However, despite evidence from current developed economies, this model often seems
inappropriate for LDCs, where the population in the urban slums is often unemployed, and would have been
more productive in the rural sector. This theory also assumes that secondary sector production would be labor-
intensive and hence provide many employment opportunities, whereas it is often capital-intensive and requires
less labour.


2. Role of tourism
Many LDCs are increasingly highly dependent on tourism from the developed world as incomes rise. Most LDCs
positively encourage tourism because it allows foreign currency to be earned and it is not capital-intensive
(therefore not reliant on high investment). However, there may be significant negative externalities resulting
from tourism growth, eg use of clean water for tourists not locals, expansion of airports causing pollution and
loss of farmland etc. The Kingdom of Bhutan, in the Himalayas, aims to tackle this problem by taxing tourists
heavily for every night they spend in the country.

3. Microfi nance
The lack of extensive fi nancial infrastructure in many LDCs is an inhibitor to development. Microfinance allows
people in LDCs to borrow small amounts of money from local lenders much of this business is now conducted
using mobile telephones, which have leapfrogged landlines in many LDCs. The idea is that local but poor
entrepreneurs will be able to set up small businesses, and go on to employ other local people a sort of
grassroots approach to development. Debtors must be sure, however, that their micro-creditor does not
charge extortionate interest given a lack of education in many LDCs, this may prove difficult.

4. Debt relief
Many LDCs hit a debt crisis in the 1980s and 1990s, as they could not afford to pay the interest on their large
debts to international financial institutions. This was a combination of interest rates rising and the value of the
dollar rising (and most loans were agreed in terms of US dollars). Latin American countries and many African
countries were amongst the worst hit Mexico defaulted on its loans first, and others followed suit. This meant
that these countries were then unable to borrow.

The massive debts that they had to repay meant that governments of these countries were unable to invest in
human capital or other infrastructure necessary for growth and development. Initially, the IMF set up Structural
Adjustment Programmes, where it would lend the debtors money to pay off their original debts, but on strict
conditions with respect to fiscal policy and trade policy. These were very unpopular. One solution is debt
forgiveness, where the loans are essentially cancelled many lenders do not want to do this. An alternative is
debt rescheduling, where the repayment terms are altered. Jubilee 2000, a pressure group, actively campaigns
for debt cancellation

2. Foreign aid
This is increasingly multilateral (between many countries), rather than bilateral (between two countries), which
reduces the restrictions under which aid is provided. There are different types of aid, ranging from humanitarian
aid (such as food and shelter, in times of emergency), to grants (sums of money that do not need to be repaid)
and loans (money that should be repaid). Whilst many in the developed world see aid as a positive thing, much
of the aid is squandered on projects that will not contribute to development, or are duplicated by different aid
agencies who do not communicate with each other, or even spent by corrupt governments on themselves in the
LDCS. If humanitarian aid is continued for a long period, then people become overly dependent on it, and forget
their own skills this has happened in Ethiopia. Many of the neediest do not get any aid; much of it is
channeled into those projects which have captured the global media interest.

3. Fairer trade
The WTO works towards reducing protectionist policies. Many LDCs argue that they need to protect their
economies however, as they cannot afford to compete with the subsidies provided to the agricultural sectors in
developed economies, such as the CAP in the EU. Many LDCs are unable to sell their mainly primary sector
products abroad because of protectionism in the developed world. The Fair Trade movement is one way in
which farmers in LDCs are supposed to benefit, thus improving development. This guarantees farmers a certain
income, so that they are not subject to monopsony purchasing power from developed countries, particularly
with respect to coffee, cocoa and cotton. However, there are often a significant number of middle men
involved, reducing the benefits that fair trade farmers receive. Additionally, not every farmer in every LDC
benefits many are unaware of the scheme, and many are not able to afford the membership fees that are
required. Some cynical people argue that the Fair Trade movement is just a means of making people in the
developed world feel better about their position in relation to those in LDCs.

Poverty is the state of being extremely poor and has been described by Mahatma Gandhi as the worst form of
violence. This week, Cristiano Ronaldo signed a new $120,000-per-week contract to play football for
Manchester United whilst the average yearly wage for the 3.5 billion people living in low income countries such
as Uganda is $313. Such a rich-poor divide is down to a variety of factors highlighted in this essay, and there are
many potential methods for reducing poverty available to rich countries such as the UK.

The World Bank suggests that boosting economic growth (GDP per capita) in developing countries is intrinsically
linked to the aim of reducing poverty. Two principal ways in which such growth can be achieved are through
provision of aid (through a variety of different forms) and fair trade arrangements by developed countries.
However, for developing countries to catch up with their developed counterparts they will need to maintain a
substantially higher growth rate; the 2006 World Development Report indicates that a 2% annual growth rate
for the next 25 years would yield an increase of $10,000 per capita in Luxembourg, compared to a figure of $375
in Nicaragua, hence would only succeed in widening the gap still further.

Historically, the provision of financial aid has been a hugely popular way to fight poverty; international events
such as the 1985 Live Aid appeal to relieve famine in Ethiopia illustrate the enormous public willingness to
donate to such causes; over 150 million was raised from this event alone. However, financial aid has its
problems. Injection of extra money into the economy of a developing country can lead to exchange rate
appreciation, rendering their goods less competitive on the international market.

Efficiency arguments against financial aid may also put be put forward; firstly a risk exists that not all the money
will not reach its intended destination (for reasons of internal corruption and lack of transparency) or that, in
response to the aid, governments of developing nations will alter their fiscal policies, reducing taxation and
place too great a reliance on the donations. For these reasons, loans are frequently coupled with conditions that
the developing country will spend the money in a certain way, of that they will undergo supply-side, monetary
and fiscal reforms to help reduce poverty, for instance through the creation of a minimum wage

A problem with loans is that debts can spiral, as was the case after the 1980s oil shocks; debt in sub-Saharan
African countries increased from 29% of GNP in 1980 to 77% in 1996. From 1970 to 1997, Kenyas debt service
as a percentage of its net export has more than tripled; from 6% to 21%. Such debts make economic growth very
difficult, as it detracts from investment in physical and human capital. An alternative to direct financial aid
therefore is to write off debt, as the G8 committed to doing at in respect of 18 of the worlds poorest countries
at the Gleneagles conference in 2005.

Another strategy is for rich countries to invest directly in health care, physical and human capital in developing
countries, rather than simply throwing money at the problem. Increased physical capital per person would boost
output and incomes, allowing a movement along the Solow curve above. In addition, the Keynesian multiplier
suggests that the increase in output will exceed the sum invested:

A unit increase in investment initially boosts output by the same amount. However the effect does not end
there. Consumption rises by 1 x MPC (the marginal propensity to consume: the fraction of disposable income
spent and not saved), hence firms then increase their output to accommodate this, raising consumption demand
yet further, and so on. Hence, the multiplier suggests that investment will reinvigorate a developing economy to
a much greater value than the initial investment. This should make rich countries willing to invest, given the
likely ability of developing countries to repay the loans with interest. However in practice, such Foreign Direct
Investment is rare, due to disincentives such as political instability and lack of relevant skills in the developing
countrys workforce, but if rich countries could make investment conditional on evidence of political stability, for
instance the implementation of a democratic system of government, FDI may well become more commonplace.

This brings us to another key area where countries such as the UK can benefit developing countries; education.
If investment in physical capital is coupled with teaching the local workforce how to use such machinery, then a
new industry has been created, boosting employment and GDP:

Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.

Increasing awareness of sexual and reproductive education is also essential in tackling the spread of diseases in
developing countries and to curb population growth. This is one of a list of quick wins identified by the UN
Millennium Project to help achieve their Millennium Development Goals by 2015, which also includes other
health care initiative such as provision of mosquito nets to combat malaria.

Arguably, fair trade between developed and developing countries can have the biggest impact on
poverty. Areas of comparative advantage such as (land abundance) should be exploited, for example through
production of land-intensive primary products such as coffee, sugar and agricultural produce. Export promotion
policies should be encouraged; this will enable businesses in developing countries to supply a market size much
larger than if they were simply producing as a means of import substitution. Fixed costs can be spread further,
large-scale machinery can be used to its full effect and workers will be able to specialize on specific roles within
the business. Such economies of scale will enable developing countries to sell goods at competitive prices in the
global market.

Discriminatory trade arrangements, such as unfair import tariffs or quotas, must be abolished to increase
imports of developing countries products into rich countries, as the graph overleaf suggests. The EU has gone
some way to achieving this; quotas on imports were abolished under a WTO agreement in January 2005.
Additionally, the EUs Everything But Arms initiative, entered into in 2001, resulted in duty-free imports into
the Union from the worlds least developed countries. However, such policies need to be less restricted by the
interests of EU producers. The categorisation of certain imported products as sensitive (resulting in a tariff cut
of a mere 3.5% as opposed to tariff-free entry) allows struggling European industries to maintain their
dominance to the expense of more efficient producers in developing countries. Such protectionist policies must
be curtailed to render the EUs efforts towards third world economic growth more credible.

Too great a focus on capitalizing on areas of comparative advantage carries significant risks. Firstly, price
instability is a common problem associated with production of primary goods. Copper production, accounting
for 81% of Zambias exports in 1995, underwent a price variation of almost 400% in a 30 year period. It is
therefore risky to have primary products constitute such a large proportion of a countrys exports. Additionally,
primary goods have demonstrated a tendency to decline in value over time; for instance the value of gold has
almost halved from 1975 to 1999.

This is where, in addition to export promotion, a policy of industrialisation can be implemented with the help of
investment from countries such as the UK. Infant industries, singled out for their promise, can be supported, a
process known as picking winners.' With the sheer scale of exports produced by nations such as India and
China, smaller developing countries will not be able to compete with their economies of scale, and will need to
specialize in particular sectors.

Industrialisation has resulted in a large increase in the share of manufactures in exports of developing countries.
This increase is highlighted in countries such as Malaysia, where the percentage figure has risen from 6% in 1965
to 76% in 1997. Such investment by rich countries can prove to be beneficial to their interests as well as those of
the developing country; the cost of labour tends to be much cheaper in countries with a predominantly unskilled
labour force, and so implementing, for instance, a textiles industry in a developing country would enable the a
country like the UK to benefit from cheap imports, as well as free up their own workforce to focus on their own
areas of comparative advantage. What is more, the positive externality effect of certain initiatives, for instance
the provision of vaccinations and other forms of health care, give developed countries an extra incentive to
alleviate poverty.

Many of the potential methods to reduce poverty and increase economic growth in developing countries can be
implemented with the involvement of rich countries such as the UK. Given the present gulf in prosperity
between the economic haves and the have-nots, the implementation of such ideas should arguably be viewed
more as a matter of moral duty than economic necessity.