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LECTURE 1 (BLOCK RELEASE)
CHAPTER 1 INTRODUCTION
Introduction
Macroeconomics
is
concerned
with
the
study
of
the
whole
economy.
Macroeconomics is concerned with the study of economy wide aggregates, such as
the analysis of total output and employment, total consumption, total investment and
national product. (Vaish,1995). It is concerned with the behaviour of the economy as
a whole- with booms and recessions, the economy’s total output of goods and services
and growth of out[put, the rates of inflation and unemployment, balance of payments,
exchange rates etc. Because it is closely related to real world issues, macroeconomics
also involves many non-economic factors such as political, historic, cultural and
sociological factors. (Dornbusch et al, 1998).
Macroeconomics and Microeconomics
The line between macroeconomics and microeconomics is less sharp than it used to
be, but it is still there.
What makes this module different is that we focus on the economy as a whole.

Instead of talking about the demand and supply of (say) pizza
(microeconomics), we talk about the aggregate demand and aggregate
supply of output in the whole economy (macroeconomics).

Instead of talking about what determines the demand for workers in the
pizza industry (microeconomics), we talk about what determines the total
demand for workers (macroeconomics).
Policy objectives of all economies
The macroeconomic problems arise when the economy suffers from high
unemployment, inflation, or a balance of payments deficit or a decline in economic
activity. All governments like to achieve the following 4 major macroeconomic policy
objectives:(Low unemployment , Low inflation or more or less stable price level, A
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balance of payments equilibrium especially a surplus, A satisfactory rate of economic
growth ).
1. Full employment (or low unemployment)- available factors of production in the
economy must be fully employed to avoid losing potential production for good.
There is also moral degradation of those who were formerly employed and now
can no longer support their families. On full employment of labour force it is not
possible to achieve this in the strictest sense. The use of official unemployment
statistics as basis for setting policy objectives is also suspect. The list by
government includes those defined as being unemployed by government rather
than those who would be willing to take up paid employment should it become
available. Some people on the register may be unemployable-aged, disabled,
criminals and those not intending to work.
2. Stability of prices (or low inflation rate)- this is less pressing than the full
employment objective. Effects of inflation on certain sectors and groups of the
economy are regarded as undesirable (negative effects include redistribution off
income, BOP problems and the possibility of a misallocation of factors of
production.
3. External stability (or balance of payments equilibrium)- a balance should exist
between the value of exports and imports in order to ensure that the country will
be able to pay for its essential imports. Policy must ensure that the balance of
payments (a statement of all transactions with foreign countries) is stable and that
the rate of exchange consequently remains relatively stable.
4. Economic growth (or a satisfactory rate of economic growth). Since a positive
ratio exists between economic growth and employment this objective is often set
as a goal together with full employment. Economic growth is largely
complementary to greater employment.
Problems of Policy Timing
The timing of policy events may be crucial to the efficiency and effectiveness of
policies. There are basically three forms of time lag to consider in relation to the
behaviour of policy makers and operation of the economy.
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(a) Recognition lag- authorities perceive problems after some time.
(b) Administration lag- it takes time to set up the necessary administrative machinery
in motion. For example Parliament approves income tax measures after debate but
monetary policy options take days or hours to implement.
(c) Implementation lag- by the time the policy is implemented, new issues have arisen
hence new policies have to be implemented/formulated or adapt the policy
instruments introduced.
Chief Instruments of Economic Policy
The two important subdivisions of economic policy are the monetary policy and the
fiscal policy. These two policies are applied as mutually complementary policies to
serve as instruments of government’s economic policy which is applied to achieve
certain social goals. Often the two overlap, because it is almost impossible to envisage
any major fiscal or monetary measure which does not affect the other.
A. Fiscal Policy. This is the policy of government with regard to level of government
spending and tax structure. Government expenditure includes transfer payments,
government current expenditures and budgetary balance (extent of borrowing).
Taxation (i) provides the funds to finance expenditure. (ii) Can also be used for
income redistribution. Taxes are subdivided into direct and indirect.
o Direct taxes – these are levied directly on persons / corporates and
include income tax, corporate tax, poll tax and inheritance taxes,
import duties. Typical uses for this instrument are a reduction in
income inequalities, regulate aggregate demand, protection of domestic
producers, reduce poverty, and provision of infrastructure and to adjust
balance between aggregate demand and supply. Import duties are
important sources of revenue in many African countries. Countries
impose import tariffs for some or all of the following reasons: (a)
Revenue, protection to local producers, (b) discriminate between
essential and non-essential goods and (c) B.O.P purposes.
o (ii)Indirect tax is levied on a thing and is paid by an individual by
virtue of association with that thing, e.g. local rates on property, sales
taxes and excise duties. Tax structure can be regressive proportional or
progressive. Tax incentives may be given - investment allowances, tax
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holidays, accelerated depreciation allowances, duty-free imports; notax concessions may be given by government for e.g. provision of
roads, water and power. In some African countries rural taxation- was
used e.g. Cameroon, Mali and Sudan.
Problems of Fiscal Administration
(a) Tax evasion
(b) Shortage of trained and experienced staff.
(c) Corruption.
(d) Attitudes towards payment of taxes.
(e) Poor co-ordination of budgets with development plans.
B. Monetary Policy- the manipulation of the volume of credit, interest rates and
other monetary variables. Monetary policy is a policy which employs central
bank’s control over the supply, cost and use of money as an instrument for
achieving certain given objectives of economic policy. The policy is used to
improve credit and saving facilities and to regulate macroeconomic balance of the
economy. All governments run deficits in that their total spending exceeds the
value of their tax and other current receipts. The deficit is financed by long-term
borrowing from abroad and from local residents. Sometimes the long-term
borrowings will not cover the gap which means it has to be financed by other
means. Government usually fills the gap by short-term borrowing from the central
and commercial banks. This borrowing from the banking system (deficit
financing) usually has highly expansionary effects on money supply. In other
words it increases the money supply by the amount of the deficit but is likely also
to result in secondary increases in money supply by increasing the cash base of the
banking system and hence its ability to lend more to private borrowers. (N.B.
Expansionary does not mean inflationary). Monetary policy can be used for antiinflationary purposes. Much industrial and commercial expansion is financed by
bank credit (especially for working capital) so to restrict bank lending is liable to
place a brake on new investment and economic expansion. It is possible for credit
restrictions to be pushed to the extent of forcing a deflation on the economy, with
serious avoidable losses of output and employment. Some economists have argued
in favour of the use of high interest rates to curb aggregate demand. The effect of
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a move along these lines is to encourage the holding of larger money balances,
reducing the pressure of demand for commodities.
Critique of the interest rate Reservations to the interest rate issue have been raised:
 Higher interest rates may discourage investment and thus impede the development
of the economy. It can be counter argued that higher interest rates will raise the
productivity of new investments because now only projects which promise large
returns will be undertaken. Hence it may be possible to sustain the overall rate of
economy growth even from a reduced volume of investment.
 A successful induction of people to substantially increase their money holdings
may due to the withdrawal of purchasing power from commodity markets, be
deflationary.
 Several studies have found the elasticity of demand for money with respect to the
cost of holding it to be rather small. If this is the case, it would take a very large
rise in interest rates to affect a significant increase in the demand for money.
Limitations of the state in achieving Macroeconomic Policy Objectives
The following are typical limitations of the state in achieving macroeconomic policy
objectives especially in developing countries:
 Too many ministries, often with competing interests, too many public
corporations and too many boards of one kind or another.
 Too much corruption of civil service, civil servants badly motivated.
 Too much red tape.
 Too much political instability with governments often changed by military coups
and other unconstitutional means. Governments are therefore preoccupied with
tasks of maintaining their own popularity, authority and power.
BUSINESS CYCLES
Business Cycles (or trade cycle)
A business cycle is the more or less regular pattern of expansion (recovery) and
contraction (recession) in economic activity around a growth trend (Dornbusch et al,
1998). Business cycles can also be described as the periodic booms and slumps in
economic activities. The ups and downs in the economy are reflected by the
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fluctuations in aggregate economic magnitudes, such as, production, investment,
employment, prices, wages, bank credits etc.
Fig. 1.1 Trade Cycles or business cycles- simplified diagram
The upward and downward movements in these magnitudes show different phases of
a business cycle (Dwivedi, 1996). Basically there are only two phases in a cycle,
namely prosperity (boom) and depression (recession). Considering the intermediate
stages between prosperity and depression, the various phases of trade cycle may be
enumerated as follows:
1)
2)
3)
4)
5)
Expansion
Peak
Recession;
Trough
Recovery and expansion
Fig. 1.2 Phases of Business Cycles
line of cycle
Peak
Growth
Rates
prosperity
expansion
peak
recovery
trough
Time
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steady growth line
depression
trough
Expansion or prosperity (or boom)
This boom is characterised by increase in output, employment, investment, aggregate
demand, sales, profits, bank credits, wholesale and retail prices per capita output and a
rise in standard of living. The growth rate eventually slows down and reaches the
peak. However:

A boom increases spending on imports, causing balance of payments
problems.

Once high levels of employment have been reached, output cannot be
increased any further and the boom causes inflation.
Peak

This is characterized by slacking in the expansion rate, the highest level of
prosperity, and downward slide in the economic activities from the peak.
Recession
The phase begins when the downward slide in the growth rate becomes rapid and
steady. Output, employment, prices, etc. register a rapid decline, though the realised
growth rate may still remain above the steady growth line. So long as growth rate
exceeds or equals the expected steady growth rate, the economy enjoys the period of
prosperity, high and low. When the growth rate goes below the steady growth rate, it
marks the beginning of depression in the economy. Total output, employment, prices,
bank advances etc. decline during the subsequent periods. In other words there is a
slump in the economy. [A slump reduces spending on imports, thus improving the
balance of payments. Reduced total spending lowers inflationary pressure.] The span
of depression spreads over the period growth rate stays below the secular growth rate
(or zero growth rate) in a stagnated economy.
Trough
This is the phase during which the downtrend in the economy slows down and
eventually stops and the economic activities once again register an upward movement.
Trough is the period of most severe strain on the economy.
Recovery
When the economy registers a continuous and rapid upward trend in output,
employment, etc, it enters the phase of recovery though the growth rate. When it
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exceeds this rate, the economy once again enters the phase of expansion and
prosperity. If economic fluctuations are not controlled by the government, the
business cycles continue to recur as stated above.
Why worry about business cycles?
Business cycles, cause not only harm to business but also misery to human beings by
creating unemployment and poverty. Governments in many countries assume the role
of a key player in employment and stabilization. Stabilization broadly means
preventing the extremes of ups and downs or booms and depression in the economy
without preventing factors of economic growth to operate.
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LECTURES 2 AND 3 (BLOCK RELEASE)
CHAPTER 6 UNEMPLOYMENT AND LABOUR FORCE
PLANNING
What is unemployment?
Definition
Unemployment is the pool of people above a specified age who are without work, are
currently available for work and are seeking work during a period of reference.
Unemployment results when the available workplaces cannot adapt to the job seekers.
When the number of persons, who offer their working capacities, exceeds the number
of available workplaces, this leads to a lack in workplaces.
Unemployment is an overwhelming concern of policymakers and the general public.
Unemployment often implies a waste of human resources that could otherwise be
producing goods and services to satisfy the needs of society. At the same time, it can
mean extreme personal hardship for the Unemployed, and therefore it is an important
social concern. Unemployment rate fluctuates widely over time within a given
country, in line with the business cycle. Unemployment increases during recession
and declines during booms.
Why unemployment is studied
1. The income aspect- income can mostly be earned if one is employed. Most
economies gain from employment of their nationals.
2. The production aspect of employment- concern is on the labour utilisation. If
labour is unemployed there is a waste of productive resources.
3. Recognition aspect- the type of employment determines social status and selfesteem. Studies found that people who had been unemployed for two or more years
had self-esteem.
Consequences of unemployment /Costs of Unemployment
1. Lost Output
The opportunity cost of each unemployed person is their foregone output.
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2. Increased Benefit Payments
Each extra person who becomes unemployed stops paying tax ( perhaps $4000)
and starts receiving benefit (upwards of $5000). The government therefore has to
raise a additional funds to finance unemployment benefits for unemployed. As the
figure falls the government pays out less unemployment benefits and receives
more in tax. The savings to the exchequer from this will be considerable.
3. Lost Tax Revenue
Growing unemployment means less direct and indirect tax revenue. When people
lose their jobs they will stop paying income tax, and their spending will fall
considerably reducing government receipts from VAT and other indirect taxes.
4. Human Costs of Unemployment
The long-term and youth unemployed feel increasingly isolated and removed
(alienated) from society. There will also be increased national health service costs
as people's health often suffers when they are unemployed, and there will be
increased costs to society in terms of crime.
In a society where money means success the unemployed feel useless and
consider themselves a failure. Studies have shown that people who have been
unemployed for some time develop a low self esteem.They are dissatisfied and
depressed and this may lead to alcoholism drug problems and homelessness and
even to crime.Especially for families it’s difficult because they do not have
enough money to afford their basics of life. Because of that that government has
to help financially, but this causes high costs for working people who have to
support the unemployed.
High risk groups
There are some high-risk groups, for example youths, women with little children after
their maternity leave or elderly people aged 50 and over. Lots of those people cannot
find a (good) job.
 Young people are part of the high-risk group because in most cases they do
not have any practical experience and there are lots of young people searching
for the same few jobs. That is why there is a high selection rate on the job
market. Firms want to employ young people with lots of experience who want
to work almost 24 hours a day and earn just a little pocket money.
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 Women in general, but especially women with little children who want to
work again after their maternity leave are another high-risk group. Their
problem is that the probability of their needing time off to nurse sick children
is very high, especially if they have little kids. Another problem is that those
women have not worked for the time of their child nursing and there might be
new trends, new developments or things like that.
 The last high-risk group is the large group of over 50 year old people. Their
problem is that they cost too much. If a firm employs younger workers they do
not have to pay as much as they would for an older person. That is why they
are fired. And it is almost impossible for those people to find a new work
place.
Measurement of Unemployment
When calculating the level of unemployment many governments only count those
people who register as unemployed and claim benefit(where available). A large
number of people seeking work either do not register or do not claim benefit and are
now excluded from official figures. Unemployment rate is the number of unemployed
people as a proportion of the labour force. The labour force is the total of all those
with work and all those seeking work. The unemployment rate is the percentage of the
labour force officially jobless.
Unemployment rate=
Unemployed
 100%
Economically Active Population
The unemployment rate in Zimbabwe is calculated by dividing the number of
unemployed persons aged 15 years and above by the economically active population
in that age range in Zimbabwe. The table below shows the unemployment rate in
Zimbabwe for some given provinces in 1997
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Table 6.1 Unemployment rates in selected Provinces (1997)
Province
Economically
Unemployed
Active Persons
Manicaland
757009
27152
Unemployment
Rate (%)
3.6
Mashonaland West
511354
35219
6.9
Matebeleland South
255670
4011
1.6
Midlands
624445
28693
4.6
Masvingo
500341
17432
3.5
Harare
831333
134105
16.1
Bulawayo
267200
51782
19.4
Source :CSO Compendium of Statistics, 2001
Unemployment Trends
Unemployment is a flow and not a stock. There are always inflows onto the
unemployment register, and there are outflows off the register as people get jobs or
join training schemes. If all inflows rise and all outflows except training fall then
overall unemployment will rise. Young people, women, the over-fifties and ethnic
minorities tend to be the hardest hit. Inner cities and manufacturing areas also tend to
have above-average unemployment.
Natural rate of unemployment
The natural rate of unemployment is the rate of unemployment associated with the
output level at which the aggregate supply curve becomes vertical, that is the full
employment level of output. The natural rate of unemployment is sometimes called
the “the full employment” rate of unemployment conveying the sense that
unemployment is excessive only when actual unemployment exceeds the natural
level. Full employment occurs when the number of notified job vacancies exceeds the
number of registered people unemployed. A more recent term for the natural rate of
unemployment is the Non-Accelerating –Inflation Rate of Unemployment or NAIRU.
The gap between actual unemployment and the natural rate is normally referred to as
cyclical unemployment. In other words, cyclical unemployment is the amount of
unemployment that can be reduced by expansionary macroeconomic policies without
setting off an endless rise in the rate of inflation.
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Types of unemployment
We have to differentiate between a few types of unemployment:
1. Cyclical unemployment: if a country has an economical boom then people have
jobs, if there is an economic recession people lose jobs. Cyclical unemployment is
unemployment above the natural rate.
2. Frictional unemployment: This arises because people are always flowing into and
out of unemployment. New workers are constantly entering the labour force, and
existing workers frequently leave one job and look for another. During these
transitions they spend time on their job searches e.g. you stop working in December
and start your new work in March, these period between these months is called
frictional unemployment
3. Structural unemployment: Structural unemployment can occur in factories when
too old machines, cannot produce enough, sell less products, cannot pay their staff,
and result in more unemployed people. This occurs when economic readjustments are
not fast enough during economic growth, so that severe pockets of unemployment
occur in areas, industries and occupations in which the demand for factors of
production is falling faster than is the supply. Policies that discourage movement
among regions, industries and occupations can raise structural unemployment.
4. Technological Unemployment- this comes about as a result of technological
change.
5. Seasonal unemployment: e.g. tourism-areas, construction sector, and agricultural
sector. In the rural areas or farming areas, everyone is fully employed during the rain
season and harvesting periods but thereafter demand for labour is very low. The
unemployment is mostly where there is single cropping
6. Hidden unemployment: dismissed people don’t ask for a new job, they also don’t
register for unemployment benefits, e.g. women after their maternity leave often stay
at home with their children. It can also include the discouraged, those nominally
having jobs for which they are paid but in fact doing nothing; and those who can be
withdrawn from rural areas because of their zero marginal product.
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Causes of Unemployment
1. Rapid growth of labour forces due to high population growth rate in developing
countries. Fast growth of labour force places a strain on the ability of the economy to
generate new work opportunities on a sufficient scale to absorb rising numbers
(economic dualism and rural- urban migration). In the Lewis model, an unlimited
supply of surplus farm labor migrates to urban areas for wages in excess of rural,
subsistence wages. Also inadequate capital, lack of technology, low educational and
skill levels, the brain drain to urban areas, food price policies, below market foreign
exchange rates, and governmental urban bias contribute to low incomes in rural areas.
2. Education system also contributes – the size of the educated labour force is
growing more rapidly than the economy can absorb. The LDC unemployment is
higher among the educated than the uneducated because the educated may have
unrealistic earnings expectations or job preferences and because wages paid to
educated workers are often inflexible. Although education can increase the
entrepreneurial supply by making available skills needed for business, it can decrease
this supply by increasing a person's job options. Cultural norms in LDCs defining
how women should behave at work limit female entrepreneurial activity.
3. Shortage of saving and investment- investment per worker in developing countries
is often less than that in developed countries. Some countries substantial savings and
income from widespread rent seeking, acquiring private benefits from public
resources.
4. Inefficient land tenure systems in many developing countries cause them not to be
able to utilise their expanding labour resources.
5. Inappropriate developmemnt strategies they pursued and technologies adopted.
They engaged in import substitution strategies hence limited jobs. Technology
designed for the industrialized countries, which have a relative abundance of capital
and scarcity of labor, is often not suitable for LDCs, with their abundant labor and
scarce capital. This inappropriate technology increases unemployment.
6. Engineering bias, minimum wage laws, government salary structures, influence of
trade unions, pay policies of multinational corporations all help to raise the urban
wages well above competitive market clearing levels.
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7. Laws and conventions holding down interest rates, tax concessions for foreign
investors similarly hold the price of capital well below levels which would reflect
their scarcity in the economy.
Solutions to unemployment
Possible solutions:
 Job-sharing and Early retirement- Job-sharing cannot be the best of solutions
because if you share your job you won't earn enough money to afford the
basics of life for your family.
 Early retirement sounds nice but it means a huge amount of costs for all the
other working people who have to pay for that. This can therefore not be the
best of ways.
 A good solution would be the attendance of further training courses, so that
unemployed people are trained to find a new job and learn new skills. The
only problem about that are the costs, which are very high and the question is
who is going to pay them.
 Population control- if there is population restraint the growth of developing
country labour force will be in check.
 Overhaul of the education systems to change from their present academic,
elitist, white-collar job orientation to vocational and technical training systems
to produce artisans and technicians the countries desperately need. Stress
scientific and technical education. Resist pressures for a too rapid expansion of
upper level education and refuse to subsidize this level of education.
 Sectoral priorities which particularly favour the development of small-scale
agriculture and the informal sector. Small-scale agriculture and the informal
sector are labour intensive, so their development will both generate more
employment and raise productivities of those already working in them.
Increase official purchases from small scale, labour intensive firms.
 Incomes policies designed to prevent formal sector wage levels from being
raised by institutional factors to levels well above the true economic value of
unskilled labour. This involves attention to the government‘s own pay
policies, its policies towards the trade unions, towards multinational firms and
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towards minimum wage legislation. Curtail wages in the organized (formal)
sector.
 Rural development and decentralisation- this involves coordination of
programmes for the improvement of agriculture, water, transport; access to
goods and services and appropriate land tenure- aim is to reduce rural- urban
migration. Encourage rural development and amenities.
 Informal Sector:The development of the sector is attractive because it does
not require complex and expensive infrastructure and has high potential for
creating jobs. It uses mostly locally produced resources or raw materials. It
can be a major source of income generation both for rural and nonagricultural
informal sections of the economy. It creates a platform for the exchange of
locally produced goods and services. It provides strong base for local
entrepreneurs. It is also a source of government revenue when these sectors
grow and become registered.
Informal sector in Zimbabwe
The following problems have been cited in respect of informal sector in Zimbabwe:
 Procedures to be followed in obtaining licences and project approval are
discouraging and they (operatives in the sector) pay high rentals to landlords.
 Because of the high corporate tax, they would rather remain unregistered. If
they are taxed they face financial problems and hence cannot pay minimum
wages.
 Lack of adequate transport and infrastructure to facilitate delivery of produce
to the target market.
 Lack of technological support and managerial, technical and marketing skills.
 Lack of project planning and implementation.
 Inability to obtain loan and credit facilities hence due to lack of collateral
security, 90% of microenterprises are automatically eliminated from getting
financial assistance.
However it must be pointed out that the development path whereby there is heavy
emphasis on informal sector enterprise and small business development has
limitations, although it provides employment and income. The disadvantage of
informal enterprise is it does not lead to development of high technology non
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traditional export.It does not invest in new technique, generate new skills and develop
new products.
Types, Causes, and Remedies for Unemployment – a summary
The table below summarises the main causes and remedies for different types of
unemployment.
Table 6.2Causes and remedies of some unemployment
Type
Description
Cause
Workers temporarily
Delays in applying
Frictional
between jobs
interviewing and
accepting jobs
Workers have the
wrong skills in the
wrong place
All firms need fewer
Cyclical
workers
Technological Firms replace workers
with machines
Structural
Regional
Seasonal
Declining industries
and the immobility of
labour
Low total demand in
the economy
Automation and
information
technology
High unemployment in Local concentration of
one area
declining industries
Unemployment for part Seasonal variation in
of the year
demand
Remedy
Improve job
information, eg
computerised job
centres
Subsidies and improve
the mobility of labour
Increased government
spending or lower taxes
Retraining
Regional aid, eg
relocation grants
Retraining
LABOUR FORCE PLANNING
Why planning?
1. Growing need for skilled labour force for economic growth and technological
progress.
2. Response to employment difficulties and elimination of unemployment.
Basically all economies aim at ensuring full employment and training the
growing number of highly skilled personnel.
Realistic Manpower planning
-depends on extensive knowledge of the inherent relationships and tendencies
underlying the objective processes in labour force. The processes are
determined by dominant relations of production, given amount level and
structure.
-must consider major continuous movements affecting the labour force
(external and internal). External include retirement and new engagements.
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Internal-within active labour force e.g. place and kind of employment. These
can be partly controlled through size, direction and structure may be
accurately estimated.
-must allocate and use the available labour force efficiently both qualitatively
and quantitatively.
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CHAPTER 7 INTERNATIONAL TRADE
Introduction
Basic condition of the world community is one of mutual interdependence. All
countries of the world rely for their national well being on international trade and
payments. Foreign currency or foreign exchange is used for effecting payments. The
rate at which one country’s currency is exchanged for another. for example Z$44 000
/ 1Rand is the exchange rate.
International trade is the exchange of goods and services between countries. An
import is the Zimbabwean purchase of a good or service made overseas. An export is
the sale of a Zimbabwean-made good or service abroad.
Benefits of Trade
Participation in the international economy can improve living standards and the rate
of economic development. This is in 3 ways:
1. Trade provides countries with an escape from confines of their national
economies. It creates more profitable investment opportunities and this leads
to accelerated growth.
2. By giving access to the products of other nations, it avoids the need to strive
for self sufficiency within national boundaries- technology developed
elsewhere is available.
3. Capital flows, an integral feature of world trade and payments give
developing countries access to the savings of richer nations, to augment their
own. Capital is obtainable from private sources as well as from ‘aid’ from
foreign governments and agencies eg. World Bank.
Reasons for Trade
Domestic Non-availability -A nation trades because it lacks the raw materials,
climate, specialist labour, capital or technology needed to manufacture a particular
good. Trade allows a greater variety of goods and services.
Theories of International Trade
A number of theories were put forward to explain the basis of international trade:
(1) Theory of Absolute Advantage
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(2) Theory of Comparative Advantage or Comparative Costs
(3) Factor Endowment Theory
1. Theory of Absolute Advantage
Advanced by Adam Smith- Absolute advantage exists when one nation can produce a
good more cheaply and efficiently than another. For example Kenya has an absolute
advantage over the US in producing tea because of its climate and natural resources
and labour force while the US has an absolute advantage over Kenya in computer
production.
2. Principle of Comparative Advantage
Initially developed by David Ricardo, the principle of comparative advantage states
that countries will benefit by concentrating on the production of those goods in which
they have a relative advantage.
For instance, France has the climate and the expertise to produce better wine than
Brazil. Brazil is better able to produce coffee than France. Each country benefits by
specializing in the good it is most suited to making. France then creates a surplus of
wine which it can trade for surplus Brazilian coffee.
Exchange in international trade is more efficient if each country offers that particular
good of which it has advantage in production relative to the good it receives in
exchange. A country has comparative advantage in producing a good if the
opportunity cost of producing the good is lower at home than in the other country.
Even when one nation is absolutely more efficient in the production of every good, as
long as there are differences in the relative costs of producing the various goods in the
two potential trading nations the foreign trade is mutually beneficial.
Numerical Example:
The following is a breakdown of labour costs in the production of 1 unit of wine and 1
unit of cloth in Portugal and England.
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Table.7.1 Production costs in England and Portugal
Labour Cost of Production
1 unit wine
1 unit cloth
Portugal
80
90
England
120
100
Portugal has an advantage in the production of both goods.
The opportunity costs can be worked out for both goods in both countries.
Table. 7.2 Opportunity costs
Opportunity Cost for
wine
cloth
Portugal
80 8
  0.89
90 9
90 9
  1.125
80 8
England
120 12

 1.2
100 10
100 10

 0.83
120 12
From this, Portugal has a comparative advantage in wine production while England
has comparative advantage in cloth production. These countries can specialize in the
production of the good for which each has a comparative advantage over the other.
Portugal will specialize in the production of wine while England will specialize in the
production of cloth.
Therefore foreign trade is mutually beneficial, even when one nation is absolutely
more efficient in the production of every good as long as there are differences in the
relative costs of producing the various goods in the two potential trading nations.
3. Factor Endowment Theory
-also called the Heckscher –Ohlin theory of international Trade. Assuming all
countries have access to the same technological possibilities for all commodities,
factors are immobile and the countries have different factor endowments, countries
would trade in goods produced by the factor of production which is more abundant.
Countries with more labour relative to capital would thus sell to other countries those
goods produced using labour intensive technology. Those with more capital relative to
labour will sell goods produced using capital intensive technology.
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Protectionism
Protectionism occurs when one country reduces the level of its imports.
Arguments for Protectionism
Reasons for protectionism include the following:

Infant industries. If sunrise firms producing new-technology goods (eg
computers) are to survive against established foreign producers then temporary
tariffs or quotas may be needed.

Unfair competition. Foreign firms may receive subsidies or other government
benefits. They may be dumping (selling goods abroad at below cost price to
capture a market).

Balance of payments. Reducing imports improves the balance of trade.

Strategic industries. To protect the manufacture of essential goods produced
by strategic industries such as defence.

Declining industries. To protect declining industries from creating further
structural unemployment.

Protecting consumers- e.g banning the sale and importation of hormone
treated beef to protect consumers from the possible health consequences of meat
treated with growth hormones.
Arguments against Protectionism

Prevents countries enjoying the full benefits of international specialization and
trade.


Invites retaliation from foreign governments.
Protects inefficient home industries from foreign competition. Consumers pay
more for inferior produce.
Methods of trade restriction/ protectionism
Tariffs
Tariffs are a tax on goods produced abroad and sold domestically. In other words
Tariffs (import duties) are surcharges on the price of imports. A tariff can be specific
or advalorem. A specific tariff is a fixed amount for every amount of imports. For
every unit of import a charge is put and this fixed amount for every unit of import is
the tariff. An advalorem tariff is the charge per value of import.
The principal objective of most tariffs is to protect domestic producers and employees
against foreign competition; they also raise revenue for the state. The government
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gains with increase in tariffs because tariff increases government revenues. Domestic
producers also gain because tariff gives them some protection against foreign
competitors by increasing the cost of imported foreign goods.
The impact of a tariff
 raises the price of the import;
 moves a market closer to the equilibrium that would exist without trade.
 reduces the demand for imports;
 encourages demand for home-produced substitutes;
 raises revenue for the government MNKL
The diagram below uses a supply-and-demand graph to illustrate the effect of a tariff.
Fig. 7.1 The impact of a tariff on prices
Equilibrium without trade
Price with tariff
P
Govt Revenue
P
Price without tariff
Imports with tariff
Imports without tariff
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Quotas
An import quota is a limit on the quantity of a good that can be produced abroad and
sold domestically. Put in other words Quotas restrict the actual quantity of an import
allowed into a country.
From the diagram below the world price is shifted to the right by exactly the amount
of the quota. The supply curve below the world price does not shift because in this
case importing is not profitable for the licence holders. A variant on the import quota
is the Voluntary Export Restraint (VER). A VER is a quota on trade imposed by the
exporting country, typically at the request of the importing country’s government.
Fig. 7.2 The impact of quotas on domestic prices
Domestic Supply
Price
Domestic Supply
+ import supply
Equilibrium without trade
Quota
Price with quota
Pq
I Surplus for J
Licence holders
Pw
H
G
K
F
Price without quota= world price
Equilibrium with quota
E
World Price
Domestic Demand
Imports with quota
A
B
C
D
Quantity
Imports without quota
Impact of a quota:
 raises the price of imports;
 reduces the volume of imports and moves a market closer to the equilibrium
that would exist without trade;
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 encourages demand for domestically made substitutes;
 raises surplus for the licence holders equal to IGFJ.
A quota is a non tariff restriction. Another example of a non tariff restriction is an
embargo. An embargo is a complete ban on imports.
Other Protection Techniques
1. Administrative practices can discriminate against imports through customs delays
or setting specifications met by domestic, but not foreign, producers.
Governments use a range of informal or administrative policies to restrict imports
and boost exports. Administrative trade policies are bureaucratic rules designed to
make it difficult for imports to enter a country. For example France required that
all imported video tape recorders arrive through a small customs entry point which
was both remote and poorly staffed. The resulting delays kept Japanese VCRs out
of the French market.
2. Exchange controls (currency restrictions) prevent domestic residents from
acquiring sufficient foreign currency to pay for imports.
3. Prior to imports deposits. Before you import you are supposed to put aside an
import value. This reduces the amount of import.
4. Technical specifications on imported goods. The government put standards on the
goods imported causing rejection of some. For example the local content
requirements call for some specific fraction of a good to be produced
domestically. For example 75% of component parts for this product must be
produced locally.
5. Subsidies. A subsidy is a government payment to a domestic producer. The
subsidies take many forms including cash grants, low interest loans, tax breaks,
and government participation in domestic firms. By lowering costs, subsidies help
domestic producers in two ways: they help compete against low cost foreign
imports and they help them gain export markets.
6. Antidumping Policies. Antidumping policies are policies designed to punish
foreign firms that engage in dumping. The ultimate objective is to protect
domestic producers from “unfair” foreign competition.
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Zimbabwe’s External Trade position
The major destinations for Zimbabwean exports are South Africa, United Kingdom,
Germany and lately China. The exports and imports statistics are shown in the table
below. The major sources for Zimbabwean imports are again South Africa, United
Kingdom, United State, Botswana and Germany. The main trading partner is South
Africa.
Table 7.3 Zimbabwe’s exports 1995-2000
Year
Export Value ($000)
1995
29757834
1996
23169907
1997
28967449
1998
46317037
1999
73844947
2000
81258506
Source CSO Compendium , 2001 p 198
Table 7.4 Zimbabwe’s imports (1995-2000)
Year
Import Value ($000)
1995
37 900 116
1996
38 156 392
1997
37 646 358
1998
66 155 618
1999
83 407 195
2000
80 245 320
Source CSO Compendium , 2001 p 199
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CHAPTER 8 BALANCE OF PAYMENTS AND THE
FOREIGN EXCHANGE MARKET
Definition of the Balance of Payments
In order to know the position as regards international payments, governments compile
records of transactions. This record of transactions is thus called the Balance of
Payments (BOP). The balance of payments:
o Is a systematic record of the economic transactions between residents
of the exporting country and residents of the foreign countries during a
certain period of time or
o Is the difference between the total earnings on both invisible and
visible items and total expenses or
o Is a record of one country's trade dealings or transactions with the rest
of the world. Any transaction involving Zimbabwean and foreign
citizens is calculated in dollars
Dealings which result in money entering the country are credit (plus) items while
transactions which lead to money leaving the country are debit (minus) items.
Components of the Balance Of Payments
It consists of three parts:
(1) Current Account- this records the current purchases and sales of goods and
services to the rest of the world.
(2) Capital Account- this records the financial or capital transactions, including the
borrowing and lending of funds. Deals with overseas flows of money from
international investments and loans.
(3) Monetary Account- also called official financing account. It deals with foreign
currency reserves and transactions with multilateral bodies. deals with overseas
flows of money from international investments and loans;
Current Account
The current account consists of international dealings in goods (visible trade) and
services (invisible trade). It records all transactions in goods and services, i.e. visibles
and invisibles. Invisible exports and imports consist of factor plus noon-factor
services. Receipt of interest, profits and dividends on loans and investments in foreign
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countries; earnings from tourism and transportation and remittances home of income
earned by nationals working abroad are included in this account as invisibles.
Table 8.1 Example of Current Account 1985
Debits
$m
Credits
$m
Balance $m
Visible imports
80 140
Visible exports
78 072
-2 068
Invisible imports
75 007
Invisible exports 80 027
5 020
By referring to above table you can see that in 1985:
 Zimbabwe bought $80 140 million worth of goods made overseas.
 Zimbabwe sold $78 072 million worth of goods overseas.
 The difference between visible exports and imports is known as the balance of
trade or trade balance or visible balance. This amounted to -$2 068 million.

Zimbabwe bought $75 007 million worth of foreign-produced services.

Zimbabwe sold $80 027 million worth of services overseas.

The difference between invisible exports and imports is called the invisible
balance. This amounted to $5 020 million.
Adding the balance of trade and balance on invisibles together gives the balance on
the current account. This is an important concept with a view to economic policy
because it indicates whether or not a country has been living within its current means.
A deficit on the current account means that more goods and services have been
imported into the country than have been sold abroad. A surplus on the current
account means more goods and services have been exported than imported.
Capital account
It deals with transactions in Assets and liabilities. The transactions in assets and
liabilities section of the balance of payments shows all movements of money in and
out of the country for investment. This may be direct investment - investment in
productive capacity (when firms invest in other countries to increase capital in these
countries), or portfolio investment - investment in shares ,bonds or other assets in
foreign countries. Changes in assets will be outflows from Zimbabwe, as
Zimbabwean investors invest money overseas. These flows will be debits to the
Zimbabwe’s Balance of Payments. Changes in liabilities will be credits to the
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Zimbabwean Balance of Payments as overseas investors invest money into the
country (Zimbabwe)
The capital account is divided into 2 sections, that is long-term capital movements and
short-term capital movements.
(i)
Long term capital movements. These include public authorities, public
corporations, banking sector and non-bank private sector.
(ii)
Short-term capital movements- these consist of import and export credit
granted by banks in Zimbabwe and in other countries.
Monetary Account
This is also called the official financing account. It records changes in the country’s
official foreign currency/exchange reserves (consisting usually of a mixture of gold
and foreign currencies) plus transactions with the IMF and other financial institutions.
Gold and foreign reserves
The reserves must be kept at a reasonable level for 3 reasons:

Foreign reserves are needed to finance transactions with foreign countries
especially as month to month payments and receipts do not necessarily
coincide.

Foreign reserves are also needed to even out undesirable fluctuations in the
exchange rate.

Foreign reserves indicate what the maximum foreign deficit is if no further
loans are forthcoming
Balance of Payments ProblemsA. Balance of payments deficit
This is of concern especially in developing countries because it affects the ability of
those countries to trade with other countries. A balance of payments deficit is a major
problem if it is persistent. This can be the result of excessive purchases of foreign
goods and services or excessive Zimbabwean investment overseas. Faced with
existing or projected balance of payments deficits on the combined current and capital
accounts a variety of policy options are available:
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Balance of Payments Deficit
This can be corrected through:
1. Long term capital from the rest of the world. This has the disadvantage of external
indebtedness.
2. Using foreign currency reserves- this is a short term measure because most non-oil
producing developing countries have very few months in which to exhaust this.
3. Attracting additional inflows of short-term capital by raising interest rates. Lack of
stability in developing countries means that there is no guarantee funds will remain in
the countries, i.e. there is capital flight.
4. Import substitution- this is the local production of previously imported goods. This
requires the importation of capital equipment and protection of the infant industry by
imposing tariffs or bans on imported goods.
5. Exchange control – this is designed to control foreign currency reserves. The
foreign currency is rationed so that the most pressing needs of the country will be
given top priority when the funds are allocated., eg. capital goods and essential raw
materials. Measures also include import licensing as well as creating a state monopoly
tasked to import essentials.
6. Use of multiple exchange rates- different rates for currencies/ transactions.
Essentials such as exports, tourism and essential inputs for industry would have a
separate rate(s) of exchange to encourage them while for nonessentials they would be
discriminatory . In other words there is a multi-tiered market for foreign exchange.
The Central Bank can discriminate between different types of transactions,
encouraging some and discouraging others. There can also be a dual exchange rate
system whereby two sets of exchange rates are used. One rate may be overvalued and
may be much lower especially for luxury consumption goods imports. These however
present serious problems of administration corruption and evasion.
7. Disguised depreciation- this is a policy whereby there is a deliberate effort by
government to make imports more expensive. This includes raising import duties,
taxing invisibles, and taxing remittances abroad; subsidize exports, charging high fees
on sales of foreign currency. This policy is deflationary and also has loopholes.
8. Devaluation- reducing the external value of a currency. This increases the volume
of sales abroad.
9. Promoting export expansion- drawbacks of duty, export incentive schemes.
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10. Encouraging more private investment and seeking more foreign assistance. Much
of the foreign aid comes in the form of loans which have to serviced. Interest has to be
paid on the loans. The principal has also to be repaid in future.
B. Balance of Payments Surplus
This is also a cause for concern because if it is persistent, partners may retaliate by
introducing import controls etc. A surplus implies an overvaluation of currency and
this leads to exports becoming less competitive on the world market. It could also be
inflationary because, it is argued by monetarists that it leads to an increase in money
supply. A persistent surplus could mean a depression of domestic living standards.
Correcting a Balance of Payments Surplus
An unwanted balance of payments surplus can be the result of excessive foreign
investment in Zimbabwe. This will place a future strain on the invisible balance. A
reduction in interest rates ( an outflow of funds on the capital account) or the
scrapping of protectionist measures (restrictive exchange controls) will correct the
surplus.
FOREIGN EXCHANGE MARKET
Foreign trade involves payment in foreign currencies .eg. Br pound, US$, SAR.
Zimbabweans have to pay in these currencies for the goods they buy and are therefore
obliged to exchange Z$ for these currencies; i.e. there is demand on the part of
Zimbabwean importers for DM, Pounds, US$, ZAR. On the other hand importers in
other countries have to pay Z$ for Zimbabwean exports and must therefore offer DM,
pounds in exchange for Z$. The rate of exchange therefore represents a ratio or
proportion, but it is also a price. (Price of one monetary unit in terms of another
monetary unit.) An increase in the value or price of one currency (also known as
appreciation) automatically implies a decrease (depreciation) in the price of another
currency.
Players in the foreign currency market
The foreign currency market is conducted by banks, foreign exchange brokers,
foreign currency dealers, etc. through extensive international telephones, cables and
communication networks.
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Functions of the foreign exchange market
1. Provide some insurance against the risks that arise from changes in
exchange rates (also called exchange risk)
2. Currency conversion- the market presents a medium by which amounts
of money denominated in one currency can be converted into another
currency. Each country has a currency in which the prices of goods and
services are quoted.
3. International businesses use foreign exchange markets when they have
spare cash that they wish to invest for short- terms in money markets.
4. Currency speculation- this typically involves the short-term movement
of funds from one currency to another in the hopes of profiteering from
shifts in exchange rates.
Uses of the Exchange Rate
 As a price in a market or mixed economy it provides information and
incentives to guide decisions about what to produce and what to consume.
 As a policy instrument it should provide sufficient incentive to export and
produce local substitutes for inputs to keep balance of payments in
equilibrium.
 As a price it affects all other prices.
 It links together the general level of prices in the national economy with prices
in other countries. Countries with higher inflation than their exchange rates
make their imports cheaper than locally produced goods. This implies balance
of payments problems for these countries. This can however be overcome by
depreciation.
The rate of exchange
An exchange rate is the price of one currency in terms of another. Foreign exchange
refers to the actual foreign currency, or various claims on it such as cheques and
promises to pay, that are traded for each other.
Uses of the Exchange Rate
 As a price in a market or mixed economy it provides information and
incentives to guide decisions about what to produce and what to consume.
114
 As a policy instrument it should provide sufficient incentive to export and
produce local substitutes for inputs to keep balance of payments in
equilibrium.
 As a price it affects all other prices. It links together the general level of prices
in the national economy with prices in other countries. Countries with higher
inflation than their exchange rates make their imports cheaper than locally
produced goods. This implies balance of payments problems for these
countries. (This can however be overcome by depreciation).
Quoting of exchange rates
Because exchange rates actually represent a ratio the price of one currency in terms of
another can always be quoted in two ways. These are the direct method and the
indirect method.
Direct Method - Most countries use the direct method whereby the exchange rate is
expressed in terms of local currency, i.e. how much of local monetary unit (Z$) can be
exchanged for one unit of a foreign monetary unit.
The indirect method - With the indirect method on the other hand, the exchange rate is
expressed as a certain amount of the foreign currency that would be equal to Z$1.
This method of quotation is useful to a Zimbabwean tourist who can immediately
ascertain how much of a foreign currency he can obtain for his Z$. If however the
exchange rate is regarded as a price, it is more logical to quote the price directly in
terms of the Z$ (i.e. direct method).
Determination of Equilibrium Exchange rates
In the diagram below the amount in Rands is measured on the horizontal axis, while
the price of Rands in Z$ is measured on the vertical axis. This is the direct method of
quotation. The demand for South African Rands is determined by the price and
quantity of products and services that Zimbabweans wish to import from South Africa
and to lend or invest in South Africa. Since Zimbabweans have to pay for these
products and services in Rands, the price of these products will mainly be determined
by the exchange rate between the two currencies. We assume that the price of
products remains constant in South Africa for the time being. The higher the exchange
rate on the vertical axis, the more expensive do South Africa products become for
Zimbabweans and the less they can afford to import from ZA Any depreciation of the
Z$ in terms of the rand (.i.e. a rise on the vertical scale from the current to a higher
115
rate on the axis) will give rise to a decrease in the amount of Rands demanded.
Imports decline. Similarly, an appreciation of the Z$ in terms of the rand (i.e. a drop
in the exchange rate on the vertical axis would lead to an increase in the amount of
Rands demanded.
Fig. 8.1 Determination of Exchange rate
Z$/R
D
S
A Excessive Supply
B
Exchange
Z$*
E
Rate
C
D
Excessive Demand
S
D
R million
Amount of Rands
The supply curve of the Rand, is actually based on a demand phenomenon: the South
African demand for Zimbabwean goods or to lend or invest in Zimbabwe The
background to the supply of Rands (on the Zimbabwean foreign exchange market) is
therefore the demand of South Africans for Zimbabwean goods. The supply curve
will have a positive trend from bottom left to top right. The lower the exchange rate
on the vertical axis, the more expensive it is for South Africans to buy Zimbabwean
products.
Should the position of the Z$ deteriorate (depreciate) to an exchange rate above Z$*,
Zimbabwean goods would become so cheap to South Africans that the supply of
Rands would increase to point B in the diagram. The exchange rate is therefore
determined by the supply and demand for rands and is $ per rand
Fluctuations in the Exchange Rate (flexible exchange rate)
A fall in the value of the dollar (depreciation) means one dollar now buys fewer rands
or more dollars have to be paid for a unit of the rand. The dollar depreciates if South
Africans demand fewer dollars (hence fewer Zimbabwean goods) or if Zimbabweans
offer more dollars for a rand (shown in the diagram below). Zimbabwean exports
116
become cheaper and its imports become dearer. Hence, a dollar depreciation improves
the balance of payments.
Fig. 8.2 Fluctuations in exchange rates
D2
Exchange
Rate
Z$/R
ER2
S
D1
Depreciation
ER1
Appreciation
D2
S
D1
Q1
Q2
Quantity of Rands
A rise in the value of the dollar (appreciation) means one dollar now buys more rands
(expressed differently less dollars are required now to purchase a rand.). The
exchange rate changes from ER2 to ER1 while the corresponding demand shifts from
D2D2 to D1D1). Zimbabwean exports become dearer and its imports become cheaper.
Hence a dollar appreciation worsens the balance of payments.
Foreign Exchange Rate Regimes
The rate at which the currency of one country can be exchanged for that of another
depends primarily upon the system of foreign exchange in operation at the time. The
choice of the systems is between (1) Fixed exchange rate (2) Fully flexible exchange
rate system and (3) Floating exchange rate system.
1. Pegged of Fixed Exchange rate system
This is the system whereby exchange rates are pegged. The country aims to maintain
a more or less fixed rate for its own currency in relation to the currencies of other
countries. The exchange rate is however subject to occasional discontinuous change,
i.e. changes in exchange are only permitted by respective authorities e.g. Z$ 30 000
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/US$ from Z$250/ US$1. Exchange rates movements are controlled through fixing or
pegging a soft currency against a more stable currency.
Advantages- provides security to traders. Buyers and sellers can compare prices
immediately and arrange by contract for goods to be delivered months ahead,
knowing prices and costs are stable.
Disadvantages- when a country is experiencing inflation concurrent with long term
deficits (an indication of disequilibria) its currency becomes inflated and there is
pressure for exchange value of its currency to fall i.e. to devalue or depreciate its
currency. The rates therefore change in jumps instead of smoothly and this involves
national pride. With short term disequilibria, fixed rates are alright but not with long
term.
2. Free Floating Exchange Rates/ Fully flexible Exchange rates
This is an alternative to devaluation. It allows foreign exchange rates to fluctuate
freely in accordance with changing conditions of international demand and supply of
foreign exchange. Because they are unpredictable and are subject to wide
uncontrollable fluctuations the system is susceptible to foreign exchange and domestic
currency speculations. Many developing countries do not like this system because
they are heavily dependent upon imports and exports.
Advantages- it is less cumbersome than the fixed exchange rates. Embarrassing
devaluations are avoided because there is free determination of rates by market forces.
With downward inflexibility of domestic prices and wages, floating or freely
fluctuating rates may be a practical structure to clear away chronic deficits.
Disadvantages- Certainty and stability which are necessary in international trade, are
difficult as import costs or export costs are not known in advance. To avoid
considerable risks, importers/ exporters can to a large extent use the futures market for
foreign exchange. When a currency is weakened and depreciation looming, excess
speculation may be created. Speculators may sell lots of currency before depreciation
thereby lowering the price still further and increasing supply. When it eventually falls
they buy back currency with the stronger currency realizing substantial capital gains.
As currency declines and standards of living decline, government may, to avoid being
blamed for the fall pursue monetary expansion (higher wages, etc.) to accommodate
higher import prices. This worsens inflation and calls for further currency
depreciation.
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3. Managed Floating Exchange Rate system
This is a managed system and is a compromise between a fixed (artificially pegged)
and a fully flexible exchange rate system. Erratic swings are limited through Central
Bank intervention. Some countries however peg their currencies to the movements of
a weighted average of a large number of major currencies of major trading partners.
There are two types of floating exchange rates: (a) Clean floating- market forces are
left entirely free from intervention by the state. (b) Dirty floating- the Central Bank
intervenes to smooth out exchange rate fluctuations to ensure they are not unduly
influenced by purely seasonal or other temporary factors.
A particular exchange rate regime may suit a country’s needs at the time.
Currency Overvaluation
Whenever the official price of foreign exchange is established at a level which in the
absence of any government restriction or controls would result in an excess of local
demand over the available supply of foreign exchange, the domestic currency in
question is said to be overvalued.
Some causes of Fluctuations in Exchange Rates
Fluctuations in quoted rates of exchange may be frequent and considerable,
particularly as a result of speculative dealings and rumour. Fluctuations may be due to
interactions of a number of causes including:
1. Currency conditions. Any changes in a country’s monetary policy tend
to be reflected in the foreign exchange. Inflation due to an increase in
the note issue or to an over-expansion of credit would immediately
lower the external value of the home currency. Low inflation rates
compared with other countries should lead to an appreciating in the
exchange rate.
2. Political conditions- political trends, labour unrest and a country’s
budgetary position all exert a similar influence as above.
119
3. Speculation- Foreign currencies are often bought in anticipation of a
rise or sold in expectation of a fall in the value of currency. The effect
is to raise the value of the currency purchased and to lower the value of
that with which the purchases are made, since it increases the supply
available in the market.
4. Financial factors- resulting from transfers of money in the form of
interest payments on loans and investments, profits, commissions, and
banking and stock exchange operations. Most banks with international
connections maintain a large proportion of their balances in liquid form
in different centres and move them from one to another to take
advantage of improved rates of interest.
5. Trade Conditions- which affect the balance of payments and weaken
the currency of a country whose imports exceed its exports, since it
increases the demand for foreign currencies and so raises their values.
6. Leads and lags- traders who anticipate significant changes in exchange
rates may attempt to manipulate these changes to their own advantage
by bringing forward or postponing currency payments due to them or
from them in respect of their foreign trade. These actions do not affect
the overall balance of payments situation.
7. Interest rates- High rates in country X compared to other countries will
attract investment funds into that country, increasing demand for its
currency. Low rates reduce the international value of the currency.
8. Confidence in the economy- when there is economic decline and poor
prospects for the future, traders and investors will be deterred from
dealings with the country while confidence has the opposite effect.
Exchange Risks- It is often argued that flexible exchange rates would create
uncertainty and instability and this would dampen foreign trade and investment.
Foreign exchange rates which are flexible could increase the risks of foreign trade.
With fluctuations in exchange rates exporters face the risk of loss through the
movements in exchange rates between the date of the sales contract and receipt of
proceeds. Importers also face problems with the exchange rate. Exchange rate can
move before the goods are received and payments have to be made. Exporters can
120
protect themselves from losses due to adverse movements in the rate of exchange.
They can do this in a number of ways:
(1) By exchange clauses in the bills of exchange.
(2) By forward exchange operations-trader can buy or sell foreign
exchange at a fixed date in the future with the rate of exchange being
agreed now.
(3) By maintaining foreign currency accounts with banks in the countries
they have dealings with. This is subject to Exchange Control approval
by the Central Bank.
(4) By maintaining foreign currency accounts with their home bankers.
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CHAPTER 9 ECONOMIC GROWTH
Definition
Economic growth is defined variously as:
(1). the annual rate of increase in real GDP or
(2) the rate of increase in the real GNP or
(3) the increase in the real national product or output over time (During any given
time period it can be expressed as
Y
.) or
t
(4) “a long term rise in capacity to supply increasingly diverse economic goods to its
population, this growing capacity based on advancing technology and the institutional
and ideological adjustments that it demands.” by Professor Kuznets.
(5) an increase in a country's ability to produce goods and services.
Reasons for defining economic growth in terms of data expressed in constant prices
(real values) is because an appreciable difference may exist between the change in
GDP (current prices) and GDP (constant prices). Usually the former rises far more
quickly than the latter especially when there is rising inflation. Growth is considered a
real phenomenon. No economic growth is possible if the change in GDP or the GNP
is simply the result of price rises.
If we consider definitions (4) and (5), when an economy recovers after a period of
slack or depression (with production below full capacity) and the GDP increases as a
result of improved capacity utilisation, i.e. when economy moves from unemployment
to full employment this does not constitute economic growth. (However it is
extremely difficult to determine the real potential GDP from year to year especially
where capacity like full employment is not easily measured). This can be illustrated
using the diagram below.
An increaser in the real GDP from Y1 to Yf1 on the total supply curve AS1 is not
actually growth, because there has been no change in the production potential.
However there is economic growth if the full employment level of the GDP increases
from Yf1 to Yf2 that is when the whole AS curve shifts from AS1 to AS2. Economic
growth (in terms of this interpretation) can therefore be defined as an increase in the
real potential (full employment) income. Another qualification in respect of economic
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growth is that growth always implies improvement of the economic lot or living
standards of those who form part of the economy in question. From this we deduce
that there must be an increase in the (potential) GDP per capita (per head of the
population) before we can talk of economic growth.
Fig 9.1 Economic growth as illustrated by an increase in AS.
AS1
AS2
AS1 and AS2 = total supply curves
General
Price
Level
Y1 Yf1
Yf2
Total Income or GDP
AS1 and AS2 = total supply curves
With the exception of the fact that the GDP has to be measured in real terms, it is
difficult to eliminate the other qualifications in respect of the definition and
description of growth. Population figures can likewise be compared with GDP data
only over relatively long periods.
The advantage of economic growth is that an increase in real national income allows
more goods for consumption or for investment.
Measurement of Economic Growth
It can be measured by the change in real GDP or real GNP (at constant prices) over
time. The best indicator of growth is real GDP per capita.
Factors affecting Economic growth
 Quantity and quality of capital – the manufactured means of production;
further growth will depend largely on whether new capital can be created out
of savings.With Capital accumulation ( accumulation of machinery, equipment
and tools etc). These lead to increased capacity of plants. Capital accumulation
also includes investment in human resources.
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 Population and labour force growth as well as size and quality of the labour
force. - a larger labour force means more productive manpower while a larger
overall population increases the potential size of domestic markets. The
growing supply will have a positive impact if the economic system can absorb
and productively employ these added workers. Labour force’s size is
determined by composition of the population, especially according to age
groups. In this context quality is used in the sense of production. Education
and training are important as are the population’s willingness to work, and its
state of health.
 Technological progress- this is the most important source of economic growth.
In its simplest form technological progress can be said to result from new and
improved ways of accomplishing traditional tasks. The productive resources,
if used efficiently can increase economic growth. A highly developed
technology naturally requires a sophisticated labour force to install, run and
maintain it. It is clear that labour, capital and technology have become integral
to the growth process.
Patents- the right to an investor for exclusive use of an invention (up to 17 years in
some countries). The idea of patents is to encourage inventions.
 Availability of natural resources. Some countries arte rich in natural resources,
this factor is a great advantage in economic development. NB. Raw materials
may also be imported profitably provided the knowledge and means are
available locally to process them further, e.g. Switzerland, Japan, Taiwan and
Singapore.
 Weather (Peculiar to Zimbabwe). Because of the importance of rain-fed
agriculture and agro-industry in certain countries such as Zimbabwe, weather
is also an important determinant of economic growth in the medium term.
When making international comparisons we use the dollar as the common currency
for measuring production in the different countries. The current exchange rates in the
year in question are used for the conversion to dollar values. However this type of
conversion appears reasonable the reliability of comparisons is dubious. Exchange
rate is not necessarily an accurate reflection of the actual purchasing power of the two
currencies. Furthermore in this era of volatile exchange rates sudden exchange rate
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adjustment may cause considerable fluctuations in the dollar values of the different
countries’ domestic product. In order to partly neutralize the worst year to year
exchange rate fluctuations the average per capita GDP over say a five year period is
used. We should also make consideration for such measures as number of hospital
beds, number of telephones or kilometres of tarred roads.
Economic growth describes the process of increases in GDP in developing countries.
Growth is growth in what already exists, i.e. factors such as capital, technology and
labour. Economic development too is a process which results in an increase in the real
potential production (per capita).
But whereas economic growth describes a gradual increase in the means of
production, economic development implies a fundamental change in the community
as a whole and in its economic system, that is, it affects how and where people live
and work. Of particular significance is the physical; displacement from rural to urban
areas, but also adjustments, often radical, in cultural patterns.
Developing Countries
A developing country or less developed country (LDC) is one that is not yet fully
industrialised and tends to have the following features:

Agriculture is more important than manufacturing.

There is limited specialisation and exchange.

There are not enough savings to finance investment.

Population is expanding too rapidly for available resources. Population growth
is equal to or more than the rate of GNP growth in some countries. There are
high and rising levels of unemployment and underemployment.

There are low incomes. In the income distribution, the gap between the rich
and poor is generally greater in less developed than in developed countries.


Inadequate housing.
There are low levels of productivity. This may be due to the absence or severe
lack of complementary factor inputs such as physical capital and or experienced
management.
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
In education there are low levels of literacy, significant school dropout rates,
inadequate and often irrelevant curricula and facilities.

There is poor health. Most LDC people suffer from malnutrition and ill-health
and high infant mortality and have a lower life expectancy than in developed
countries (DCs)

A low standard of living. A large portion of the population is living below the
Poverty Datum Line.
A developed country is more fully industrialised and has a high standard of living.
Barriers to Economic Growth
A country can increase production if it increases the amount of resources used or
makes better use of existing factors. Economic growth is more difficult if:

A country lacks the infrastructure (underlying capital) to produce goods more
efficiently. There are three types of infrastructure:
1.
basic including electricity, road and telephone networks;
2.
social including schools, hospitals and housing;
3.
industrial including factories and offices.

A country lacks the machines or skilled labour needed to manufacture modern
goods or services.

A country lacks the technical knowledge. Technical progress results from a
combination of research, development, invention, and innovation. Technical
knowledge acquired from abroad is costly and usually incomplete.

Workers are not prepared to accept specialisation and the division of labour.

Population growth is too rapid.

A country has too large a foreign debt.

Most LDCs with a large private sector are limited to an indicative plan that
states expectations, aspirations, and intentions but authorizes little public
spending.

Most LDCs have too few resources, skills, and data to benefit from complex
macroeconomic planning models. Yet a simple aggregate model may be useful
as a first step in drawing up policies and projects.

Since they assume that most skills needed for an enterprise can be purchased
in the market, Western economists frequently limit the entrepreneurial
function to perceiving market opportunities and gaining command over
resources. However, LDC entrepreneurs may have to provide some basic skills
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themselves, such as marketing, purchasing, dealing with government, human
relations, supplier relations, customer relations, financial management,
production management, and technological management, which are all skills
in short supply in the market

In most mixed and capitalist LDCs, documents showing how to improve data
collection, raise revenue, recruit personnel, and select and implement projects
are more important for successful planning than planning models.

Why capital does not flow from rich to poor countries is because LDC capital
markets are imperfect and often subject to political risk.

The LDC money markets are often highly oligopolistic and financially
repressive, distorting interest rates, foreign exchange rates, and other financial
prices.

Poor nutrition and health reduce labor productivity.

HIV infection and AIDS-related deaths have had a substantial adverse impact
on economic growth in some developing countries, especially in Africa.
Costs of Economic Growth

Increased noise, congestion and pollution (solid waste, liquid and gaseous
wastes, radioactive materials cause greater danger.

Economic growth is usually associated with urbanisation because modern
means of production are in towns/cities. This leads to overcrowding in cities
Towns and cities may become overcrowded. Overcrowding also results in
noise and litter everywhere.With urbanization, pressure on transport (peak
hour congestion), water supplies, sewage and refuse disposal, urban sprawl
(encroaching productive land) and shortage of space results, necessitating an
expensive road network linking suburbs with the metropolitan area..

Extra machines can be produced only by using resources currently involved in
making consumer goods.

The traditional way of life may be lost.

People may experience increased anxiety and stress.
Roral- Urban Migration
The factors affecting rural-urban migration are as follows:
1. Rural overpopulation.
2. Employment factors.
3. Lure of towns- better life.
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4. Protection –when there is political instability).
5. Education.
ECONOMIC DEVELOPMENT
“is a multidimensional process involving the reorganization and reorientation of the
entire economic and social systems. In addition to improvements in incomes and
output, it typically involves radical changes in institutional, social and administrative
structures as well as in popular attitudes and sometimes even customs and beliefs”
(Michael Todaro1).
Economic development is also defined in terms of the reduction or elimination of
poverty, inequality and unemployment within the context of a growing economy.
Development must have the objectives of -: increasing the availability and wider
distribution of basic- food, shelter, health and protection; raising the levels of living
(higher incomes, higher employment, better education and increased attention to
cultural values).
Indicators of Economic Development.
The traditional view of economic development is GNP is an index of development.
Another common economic index of development is the use of rates of growth of per
capita GNP. Rapid industrialization was viewed as a way of having an increasing
GNP, this often at the expense of agriculture and rural areas – these were to benefit
through the “trickle down effect”.
Obstacles to Economic Development in developing countries
 Overpopulation- high population growth.
 Low savings rate- has hampered industrial development.
 Limited range of exports (droughts and disease). Agricultural subsidies in the
United States, European Union, and Japan are major barriers against LDC farm
exports.
 Urbanization- this compounds population problems through congestion.
Overcrowding promotes pollution, unemployment, disease and food shortages.
1
Michael P Todaro ( ) Economics For A Developing World
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 Lack of an infrastructure. Because LDCs generally do not have infrastructures,
industrial firms will not normally locate plants there. Products manufactured for
mass consumption simply cannot be distributed and used without transportation
and communication facilities- few schools, roads, dams and bridges. In Zimbabwe
the Infrastructural Development Bank was set up in 2005 to revamp
infrastructure.
Solutions for Economic Underdevelopment
 Foreign aid. The problem with this approach is in the debt trap whereby with
increased indebtedness they fail to service their debts yet they require more debt
to repay their debts. The ratio of debt service to GNP is not always a good
indicator of the debt burden.
 Exportation of a major resource e.g. oil, minerals flowers/horticulture. Constraints
include lack of up to date technology, insufficient storage capacity and transport
problems.
 Export promotion is generally more effective than import substitution in
expanding output and employment.
 Industrialization and protective tariffs and quotas. A large share of international
trade is multinational corporations’ intra-firm trade.
 Industrialization and the export of manufactured goods. In Zimbabwe the
Scientific Industrial Research Development Centre (SIRDC) has been mandated
to carry out research into new products and processes. Although Multinational
Corporations (MNCs) in developing countries provide scarce capital and
advanced technology for growth, doing so may increase LDC dependence on
foreign capital and technology. The LDCs need a judicious combination of
MNCs, joint MNC local ventures, licensing, and other technological borrowing
and adaptation.
 Membership of multilateral organizations such as WTO of which they (LDCs) get
assistance in formulating and implementing export promotion programmes as well
as import operations and techniques and training of staff. The International Trade
Centre of the World Trade Organisation (WTO) provides information and advice
on export markets and marketing techniques.
 Foreign Investment-investors do not only look at the specific resource or market
they are targeting but the entire environment of the country they propose to invest
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(for example
tax rates, labour legislation, security situation, poor banking
facilities, insufficient supply of raw materials and spare parts).
They also look at:
(i)
Legal framework (the judicial system that allows for civil disputes to
be settled in an orderly manner.
(ii)
Exchange control Regulations-guarantee to repatriate profits or their
capital.
(iii)
Attitudes of local investors (investors take a close interest in the level
of investment being made by residents of the country of interest).
Conversely if locals are not investing foreigners may see this as a
signal that the country is not attractive enough for them to invest in
either. The argument here is that locals see opportunities first.
(iv)
Political stability.
(v)
Clean government-corruption among government officials takes place
at varying levels in the world. It has the effect of slowing down the
investment process, adding to the costs, and increasing the
uncertainties and risks of an investment project.
(vi)
Economic stability- foreign investors will look to indicators such as
inflation rates, interest rates and currency exchange rates as part of
their overall assessment of the environment in which they operate. The
more stable the exchange rate and lower the inflation rate and interest
rates, the easier it will be for the investor to assess his future prospects.
If government expenditure is excessive this is a significant contributor
to high tax rates, high inflation, high interest rates and weakening
exchange rate.
(vii)
General infrastructure- a good general infrastructure is important to
foreign investors although the degree of importance attached by
different investors will be determined by the nature of their potential
investment. Foreign investment is welcome where it generates
substantial export earnings, leads to transfer of technology skills, and
access to foreign markets.
Cross-border capital movements benefit LDC recipients in the long run but,
because of potential reverse outflows, there is increased vulnerability to
financial and currency crises.
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Some Theories of Economic Development
 The vicious circle theory contends that a country is poor because its income is
too low to encourage potential investors and generate adequate saving.
 Furtado's dependency theory contends that increased productivity and new
consumption patterns resulting from capitalism in the peripheral countries of
Asia, Africa, and Latin America benefit a small ruling class and its allies.
 Frank's
dependency
approach
maintains
that
countries
become
underdeveloped through integration into, not isolation from, the international
capitalist system.
Policies used to reduce poverty and income inequality include credit for the poor,
universal primary education, employment programs, rural development schemes,
progressive income taxes, food subsidies, health programs, family planning, food
research, inducements to migration, income transfers, affirmative action programs,
targeting programs for the poorest groups, and workfare schemes for which only the
poor will qualify.
Taiwan's and South Korea's stress on land reform, education, and labor intensive
manufacturing, and Indonesia's emphasis on rural development have succeeded in
increasing the income shares of the poorest segments of their populations.
Subsistence farming dominated LDC agriculture in the past but with globalization, a
larger proportion of LDC farm output is contracted with multinational corporations.
Africa's food security is low because of substantial fluctuations in domestic
production and foreign-exchange reserves, reductions in food aid, and lack of a Green
Revolution in most of the continent.
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