Download Macroeconomics Unit 5

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.