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Economic growth and development Objectives: Identify the main factors influencing the economic growth of a country. Outline the major benefits and costs that results from economic growth. Describe the key indicators of developing countries. Explain the main theories of economic development. Appreciate the role of population in economic development. Economic growth and development (Cont.) Economic growth can be defined as an increase in a country’s productive capacity, identifiable by sustained rise in real national income over a period of years. A country is enjoying economic development when it is experiencing economic growth and at the same time is undergoing major structural changes in its economy, like a shift from agriculture to manufacturing. Economic growth and development (Cont.) A less developed country is the one with low real national income per capita, a large agricultural sector, high population growth, a low capitallabour ratio and a poor infrastructure. A developed country – A country in which real national income per capita is relatively high and which enjoys a relatively high standard of living. What do you think of Namibia? Economic growth and development (Cont.) Main determinants of economic growth: 1. Growth of the labour force 2. Growth of the capital stock 3. Technical progress Growth in labour force 1. Growth of the labour force A growing labour supply may enable a community to produce bigger combinations of goods and services and so bring about an outward shift in its production possibility frontier. This, in turn, can lead to an increase in output per head and hence a potential improvement is social welfare. Growth in labour force (Cont.) Growth of the labour force depends on the following main factors: The natural increase in population size. For this to happen, birth rate should exceed death rate. If a country’s population is below its optimum size, then a natural increase in population will eventually lead to a rise in output of goods and services per head. If a country’s population is above its optimum size, then a natural increase in population will lead to a fall in output of goods and services per head. Growth in labour force (Cont.) Growth of the labour force depends on the following main factors: Since population growth causes an increase in the number of consumers as well as an expansion of the labour force, the rate of economic growth caused by population growth must exceed the rate of population growth if output per head is to increase. GDP per capita = GDP / Population Growth in labour force (Cont.) Growth of the labour force depends on the following main factors: International migration which is the flow of people between countries and is largely determined by the degree of international labour mobility. Net immigration will tend to add to a country’s labour force while net emigration will tend to reduce it. The participation rate which is the proportion of the economically active population to the total population. A rise in participation rate would amount to an increase in the size of the labour force. Growth in capital stock 2. Growth of the capital stock An expansion of a country’s capital stock through net investment increases the country’s stock of productive resources and so represents another possible source of economic growth. Growth in capital stock (Cont.) Harrod-Domar growth model: Named after English economist, Sir Roy Harrod and the American, E. Domar. Assumptions: o Assumed a closed economy and no government activity. i.e. no imports, exports, government expenditures or taxes and the condition for equilibrium is that planned investment equal planned savings. o There are only two factors of production, Labour (L) and capital (K). No technical progress. o Labour is homogeneous, measured in its units and grows at the constant natural rate of growth, n. Growth in capital stock (Cont.) Assumptions (Cont.) o There are constant return to scale. If labour and capital are increased by given proportion, output will also increase by that proportion. o Saving (S) is a fixed proportion of income (Y). i.e. S=sY where s is both the average and marginal propensity to save. Investment (I) is autonomous and there is no depreciation. o The potential level of national income (Yp) is proportional to the quantity of capital and to the quantity of labour. Thus we can write K=vYp and L= uYp, where v is a constant capital-output ratio and u is a constant labour-output ratio. This type of production function is called a fixed proportions production function. B L2 Q2 A L1 0 K1 C K2 Saving, Investment Labour Growth in capital stock (Cont.) B I2 A Q1 Capital S=sY I1 0 Y1 Y2 Income In Panel (a) The isoquant illustrating such a function are L-shaped. Both labour and capital have to be employed in fixed combinations: in the graph, increase in labour and capital from 0L1 and 0K1 to 0L2 and 0K2 increase output from Q1 to Q2 (from point A to B). increase in only one of the factors, say capital from 0K1 to 0K2 keeping labour unchanged, leaves output unchanged at Q1 ( from point A to C). Growth in capital stock (Cont.) Now consider Panel (b). Starting at equilibrium point A, the initial level of investment is I1 which equals saving (s) at the income level 0Y1. Over time, however the investment adds to the capital stock and so increases the economy’s level of potential output, say to 0Y2. The following analysis shows what the increase in potential output (ΔY) will be: K= vYp, Therefore, ΔK = vΔYp But ΔK = I1, so we have Therefore ΔYp = 𝐼1 𝑣 𝑣Δ𝑌𝑝 𝑣 = 𝐼1 𝑣 Growth in capital stock (Cont.) The new level of income, 0Y2, will only be in equilibrium level of income if aggregate demand increases. Assuming that the consumption and saving functions are stable, this increase in demand must come from an increase in investment. In fact investment must rise to I2 as shown in panel (b). Now I2 intersects the saving line at point B, where 0Y2 is in equilibrium level of income. As soon as the new capital from this extra investment comes into operation, potential output will rise yet again, say to 0Y3. for this equilibrium, investment must rise again-and so on as the growth process take place. Growth in capital stock (Cont.) The Harrod model stated that the rate of growth of outputs which maintains equilibrium and keeps the capital stock fully employed, is the warranted rate of growth (gw). This rate can be derived as follows: ΔY = In equilibrium, we have I=S=sY By substituting, ΔY = Rearranging; 𝐼 𝑣 ∆𝑌 𝑌 = 𝑠 𝑣 𝑠𝑌 𝑣 = gw Growth in capital stock (Cont.) Suppose the capital-output ratio, v, is equal to 4 and the saving proportion, s, equal to 0.2. what is the warranted rate of growth? Answer: Gw = This means 5% growth per time period would be necessary in this economy to keep the potential and equilibrium output levels equal. 0.2 4 =5% Technical progress Technical progress 3. Take a form of improved techniques of production, improved machinery, invention or improvements in education. i.e. anything which improves the quality of capital stock or labour force. The effect of technological progress is to raise the productivity of the stock of capital and labour. Note: the effect of technical progress on a country’s equilibrium growth path depends on: o Whether it raises in the same proportion the productivity of all labour and capital, both old and new; o Whether it raises the productivity of only new labour and capital; Technical progress (Cont.) o Whether it affects only the productivity of capital (capital-biased technical progress) and o Whether it affects only the productivity of labour (labour-biased technical progress). Technological unemployment: The loss of jobs caused by technological change, such as introduction of machinery that make some labour skills obsolete. Examples: o Computer controlled equipment. o Products can be transported into stores and even loaded semi-automatically. Economic growth and development Benefits of economic growth: 1. It leads to an increases standard of living. 2. It can eliminate poverty. 3. It can redistribute income without making anyone worse of.f Costs of economic growth: 1. Growth involves change which benefits many but may harm some. 2. Growth has an opportunity costs. 3. Continued growth may not be possible for much longer. 4. Growth causes negative externalities. Examples? Economic growth and development (Cont.) Economic development: A process in which an economy not only experiences an increase in its real output per head, but also undergoes major structural changes, such as infrastructure development and reallocation of resources between agricultural, industrial and service sectors. Indicators of a developing country: 1. Low GNP per capita 2. Large agricultural sector 3. High population growth rate 4. Low capital – labour ratio 5. Poor infrastructure and social services Developing vs. developed? Economic growth and development (Cont.) Theories of economic development: 1. Classical theory of development- asserts that major economic development is caused by the rate of investment which in turns, depends on the share of profits in the national income. The higher the rate of profits, the faster will be the rate of investment and the rate of economic development. Economic growth and development (Cont.) 2. Marxian theory: Karl Marx’s theory combine economics and sociology and view the economic development as a continuous change in the social, cultural and political life of a society. Such a change is brought about by changes in methods of production and in property rights by a class of people in the society seeking economic power and prestige. According to this theory, the major factor in economic development is the rate of accumulation of labour surplus value – i.e. the rate of profit appropriated by capitalists from workers. Such surplus value arises in every society irrespective of its stage of development because labour, the sole producer of value, is capable of producing more than necessary for payment of subsistence wages. Labour surplus value is the difference between the value of what is produced and the amount paid in wages. Economic growth and development (Cont.) 3. Rostow’s stage theory of development: Asserts that, the transition of an economy from being less developed to being developed is possible through a series of steps or stages. The most important of these is the take-off stage when resistance to change in traditional values and in the social, political and economic institution of a less developed country is finally overcome and modern industries begin to expand. The theory can be criticised for viewing development as simply a matter of higher saving and investment ratios. Many LDCs did achieve remarkable growth rate (5-6%) in the 1950s and 1960s, but poverty and unemployment and income inequalities worsened. Economic growth and development (Cont.) 3. Rostow’s stage theory of development: Economic growth and development (Cont.) 4. Harrod-Domar growth theory: Has a special analytical appeal to development planners. The planners have to make appropriate assumptions about Capital-output and labour- output ratios, the sources of saving and rate of population growth when formulating their development plans. The Modern view of economic development Views economic development in terms of reduction in poverty, income inequalities and high unemployment through a carefully selected strategy of development projects. The per capita income retention of economic development is relegated to secondary place of importance. In order that such strategies succeed in realising the goals of development, emphasis is placed on removing the structural rigidities in LDC through such measures as land reform, better farming practices and improvement of access of farmers, craftspeople and traders to marketing and credit facilities of modern sector. The Modern view of economic development (Cont.) Structural rigidity - refers to Factors, such as the lack of skills and the lack of a modern infrastructure, that hinder the process of economic development. The modern view of development perceives the problem of poverty and income inequality in an international setting- i.e. between the rich and poor nations of the world. Focuses on the need to reform of the United Nations’ agencies, such as World Bank, the International Development Association and other bodies such as EU, to improve the access of the LDCs to the commodity and capital markets of industrialised economies to effect large scale transfer of technology and financial resources to poor nations. Population aspects of economic development Growing population and growing labour force, not only pose problems for full employment policies in LDCs, but has a direct effect on living standards and society’s welfare. Population aspects of economic development (Cont.) Malthusian theory on population: Malthus’s basic proposition was that there was a direct relationship between population and the supply of food. A given increase in food supplies and hence living standards would tend to cause an increase in country’s population. He judged society’s welfare by the strict criterion of the amount of food available to the people of the country. He employed the law of diminishing returns to support his view that food production grew more slowly than population. Population aspects of economic development (Cont.) Malthusian theory on population (Cont.): Malthus argued that food shortages would eventually act as a check on the population. He identified two checks: o The Positive check, i.e. famine, disease, epidemics and wars, which increases death rates; and o Preventive checks- i.e. marriages, celibacy and voluntary restraint, which slows down birth rates. He was strong advocate of preventive checks, warning that if people failed to control the birth rate, Nature would apply the more unpleasant positive checks to reduce the population. Population aspects of economic development (Cont.) Criticisms of the Malthusian theory: It underestimates the impact of economic development in general and food production in particular of i) technological advance and ii) international trade. The well-publicised instance of mass starvation in several countries of sub-Sahara Africa, such as the Sudan and Somalia in recent years, was a results of drought and civil wars rather than the result of diminishing returns. Malthus argued that population would not grow without growth in food suppliers or rise in living standards above subsistence level. The population of LDCs, however, have grown without significant rises in food production or income per head. Population aspects of economic development (Cont.) The theory of optimum population: A country’s optimum population- the size of population at which, given the volume of capital and land resources and state of technology, income per head is maximised. As illustrated in the figure next page, income per head is maximised at population OP, which is the Optimum population. A country with population below OP is described as underpopulated, meaning the country does not have sufficient labour resources to exploit all the other resources to the full and increase in population will give rise to an increase in income per head. Population aspects of economic development (Cont.) The theory of optimum population: Income per head Optimum Population 0 P P1 Population Population aspects of economic development (Cont.) The theory of optimum population: If the country population is above OP, it can be described as overpopulated. In this case, the law of diminishing returns is operating and a decrease in population would increase income per head. As a state of technological knowledge improves and the volume of resources increases, so the optimum population shifts upwards to OP1 as illustrated in the figure above. One difficulty confronts the development planners is how to estimate the optimum population. The Role of International Trade in development International Trade: o International trade is a major earner of foreign exchange. o Foreign exchange enables the LDCs to use their export receipts to pay for imports of food, capital goods and technical information. o The emphasis is on reduction of trade barrier to increase trade. Problems: o In the 1980s, third World debt and servicing cost rose faster than the growth in exports to pay for them leading to increase in debt service ratios of low income countries. o The export earnings of very low-income countries declined in real terms in the 1980s and 1990s. o The price of many imports rose during the same period leading to trade deficit. The Role of International Trade in development (Cont.) Factors that contributed to decline in export earnings of LDCs: a) Quotas, tariffs and none-tariff regulations by developed countries. b) The development of substitutes by rich countries for the export of LDCs. c) Financial incentives, such as subsidies and tax rebates, to export industries in developed countries. d) In some Markets, the share of LDCs has fallen because of the low income elasticities of demand for primary products. Foreign direct investment Foreign direct investment in LDCs is undertaken largely by multinational corporations (MNCs) mainly in extractive and manufacturing industries. Problems: o In the 1960s and 1970s, investment by MNCs become less welcome to some countries. o There has been criticism that in many cases the net contribution to foreign exchange earnings and the economic development or the host country has been very small. o The capital inflows, including the transfer of technology, have failed to create anticipated employment opportunities for the local population. o Repatriated profits and interest on loans impose strains on the host country’s balance of payment position. o Host governments have been unable to influence investment decisions of large MNCs. Development Aid Development aid (or assistance) comes directly from individual national government of developed countries, largely in the concessionary loans and grants or technical assistance. Developed countries also provide aid indirectly through international agencies, such as the World Bank, the international Development Association and the Commonwealth Development Corporation. The emergence of surplus Petro-funds of OPEC countries since 1974 opened up new sources of aid to poorer countries of the Third World. Recently a group led by China, Brazil and South Africa called the BRICS try to replicate the model of the World Bank to establish a bank for less developed countries under south-south cooperation. Development Aid (Cont.) Major criticism for development aid: Development Aid is often tied to the exports of donor countries and often results in substantial debt repayment burden. Tied Aid limits the freedom of recipient countries to obtain capital goods and technical know-how at competitive prices in world markets.