Department of Economics, Delhi School of Economics, University of Delhi

THE PROBLEM OF FINANCING OF ECONOMIC DEVELOPMENT

Author(s): M. Kalecki
Source: Indian Economic Review, Vol. 2, No. 3 (February 1955), pp. 1-22
Published by: Department of Economics, Delhi School of Economics, University of Delhi
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THE

PROBLEM OF FINANCING OF
ECONOMIC DEVELOPMENT
By M.

Kalecki

The present article is a summary, revised by the author,

the
lectures which he gave in the Centro de Estudios Moneta*
of
rios Latinoamericanos, Mexico
1953. The
City, in August,
author was at that time an official of theDepartment of Econo?
mic Affairs of theUnited Nations ; the points of view expressed
in the article should, however, be considered as his own, without
The article
in any way.
committing the above organization
was published in Spanish
in the October-December
issue of
El Trimestre Economico, Mexico.
I
the first stage of our analysis we shall deal with a
We
shall assume
that the economic
system
simplified model.
revenue is
that government
and
and
is closed
expenditure
not correspond
to the real
does
This
obviously
negligible.
At

situation
depend

in under-developed
to a great extent on

and

ture

revenue

are

not

Such

countries.

foreign trade,
less

important

countries

and public
than

in

usually
expendi?

developed

that from the considera?

however,
model
conclusions
be derived
tion of such
may
simplified
of financing of investment in the
the mechanism
elucidating
countries.

It will

be

seen,

It will be seen, moreover,

of economic
development.
that it is rather easy to amend these conclusions when simpli?
fied assumptions are dropped by stages.
in our model
the following
shall distinguish
We
social
course

and small proprietors.

The
last
capitalists, workers
small
includes
etc.
poorer
peasants,
artisans,
group
shopkeepers,
that both small proprietors and workers dp
It will be assumed
not save, and that their consumption is equal to their income.
the assumption of no saving is realistic for this group,
While
classes:

This
happen frequently that some dis-saving takes place.
true
of poorer peasants.
For the sake of
may be especially
we
abstract
this
from
factor and thus
however,
shall,
simplicity
it may

we

shall

assume

that workers

and

small

proprietors

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consume

KALECKI

M.

and no more.1 Under

this assumption
the total
out
to
of
is
of
the saving
the capitalists.
saving
equal
profits
shall sub-divide the economy into two sectors produc?
We
In each
ing investment and
consumption
respectively.
goods

all their income

sector we
modities

from

materials

and

the

lowest

fuel will

to the

II.
Department
Investment

be

stage.
allocated

that are made

uses

according
tion of final products.
sector as Department

of the respective com?

of raw
Thus,
production

the production

include

shall

We
I

of

shall denote

and

the

between

two sectors

in the produc?
investment goods

them
the

the consumption

goods

sector

as

of
here not only for the production
the
sake
of
and
for
replacement
goods
expansion of
of invento?
equipment,, but also for the accumulation

investment
plant and
ries. We

shall

stands

the production
to the
corresponding
even
of consumption
in
inventories,
goods,
This somewhat artificial classification is introduced
include

of

accumulation

I.
Department
coincide
to make
I

Department

investment and consumption with the output of

II respectively which simplifies
and Department

considerably the subsequent

shall now derive
We

argument.
the basic exchange
interrelation bet?
us
Let
consider these departments
ween
the two departments.
In both depart?
in a given unit period (e.g. in a given year).
ments a part of the value of product will be consumed
and

shall also include in saving deprecia?

part will be saved. We
our
so
that
tion funds,
gross saving just as our
saving means
In
this way the value of
investment means
gross investment.

production of each sector will be split between consumption,

which we denote by Cx or C2 and saving which we denote by
I will
the value of production of Department
Sj or S2. Thus,
sum
the
of
to
and
i.e.
+
be equal
consumption
Cj
Sj,
saving
in Department
II
of Department

derived out of incomes received

I.

And

similarly^
be equal
to
production
is of course sup-'
in Department
I, Clt
Consumption
C24-S2.
II.
of
This
out
the
of
Department
production
happens
plied
the

value

as follows.
Department

of

will

of the production of consumption

goods in
is consumed
in that department
by workers,

Part
I

an assumption
not
that the indebtedness
does
involve
of
an increase may
occur
does not increase,
because
such
proprietors
result ol investment financed by credit.

r. This

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small
as a

THE

PROBLEM

OF

FINANCING

OF

ECONOMIC

DEVELOPMENT

small

But as the latter do not

proprietors and also capitalists.
consume all their profits, there is produced
a surplus of con?

sumption goods in that department corresponding to the unconsumed

part of profits, that is, to the saving in this department, S2.
It is obvious,
I is
in Department
therefore, that consumption
II :
equal to the saving in Department
Cx?Sz

ment

In other words, the surplus of consumption

II is sold to the workers and capitalists

goods inDepart?
I.
in Department
in Department
II cannot

of unsold goods
(The accumulation
interfere with this equation
because
by definition
lation of inventories is included in Department
I.)

the accumu?

can be
found in the discussion
of
equation
It
Marx.
also
schemes
be
shown
may
expanded reproduction
by
that this equation is equivalent to the equality between
savings
This

and

basic

investment.

if to both

sides of the equation we

we
have:
I, Slt
savings
S i
Cj 4-S\=Sg -fthe left-hand side is nothing else but the value of
Now,
of Department
I or investment I.
The
production
right-hand
add

Indeed,

in Department

side of the equation

is the sum of the savings in both depart?
ments or the total saving S. Thus, the last equation is equivalent to
I=S
This equation shows that in a sense investment finances itself.
Indeed,

imagine

that investment

in the course of its execution

is

by banking credit or out of liquid reserves of firms ; it

seen
be
will
that investment as it is carried out creates its counter?
financed

I.
part in saving. A part of saving arises directly in Department
second part of saving is the equivalent of the selling of the
II to workers and
surplus of consumption goods of Department

The

in Department
I. These
savings which accrue to entre?
preneurs who profited from the demand
generated
by higher
as deposits.
investment accumulate
If investment is financed out
capitalists

of liquid reserves of the entrepreneurs concerned

the process will
result in a shift of deposits from these entrepreneurs
to other
If investment is financed by short term bank credit,
the savings accruing in the form of deposits will be available for
absorption of the issue of debentures and shares by the investing
Thus the latter are able to repay in this way the
entrepreneurs.
capitalists.

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M.

KALECKI

bank

credits involved. Finally, if investment is financed by long

term bank credit, the saving being
the counterpart of the higher
investment will swell the deposits or will be used for repayment of

bank credits.
are no financial limits in the formal sense to the volume

There
of

investment.

investment

does

real problem
this financing of
is whether
not create inflationary pressures.
For
of this problem the most convenient is our first

The

or does

the consideration
=
equation, C?
S2.
It is easy to show that the crucial point in the problem of
whether a certain level of investment creates or does not create

inflationary pressures are the possibilities of expansion of supply

of consumer goods in response to demand.
To
elucidate
this
us
two
us
cases.
let
consider
extreme
Let
assume,
first,
problem
that while

is increased, output of consumption goods

the productive
cannot be stepped up because
capacities are fully
utilised at the beginning of the period considered and no expansion
In such a case
in these capacities has taken place in this period.
investment

I
for consumption
in demand
goods inDepartment
an
cause
in
these
of
The
increase
will
would
goods.
prices
prices
rise up to the point where the saved profits, S2, will be equal to Cx
the increase

in Department
II
real wages will fall.
(Small proprietors
the
in
not
rise
because
the
also
from
will
necessarily profit
prices
on whom
accrue
to
the
i.e.,
may
they depend,
capitalists
profits
case
some?
This
is
the
which
is
etc.).
merchants, money-lenders,
and

in economic writings "forced savings".

The
reaction
to the reduction of real wages will be a demand for
money wages, and thus a price-wage spiral will be initiated.

times called
of workers

higher
Let us now consider

another

extreme

case.

Let

us

assume

that sufficient capacities are available tomeet the increased demand

I. This may be the case
for consumption goods from Department
at the beginning of the period in which the increase
in investment takes place there were adequate productive capacities

either because

II1 or because in the course of this period

inDepartment
there had
to these capacities
additions
from
the
been adequate
resulting
a
case
In
itwill be not
such
process of economic development.
the prices but production
I.

that will be pushed

up to the point where'

the small volume of capital equipment

It should
be noted
that despite
such equipment
relation to labour force in under-developed
countries,
exists is frequently under-utilized.

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in
as

THE

PROBLEM

OF

FINANCING

OF

ECONOMIC

DEVELOPMENT

II
is equal to Cv
In other words,
the output of Department
increase to such an extent that the surplus in this department
corresponding to the part of profits that is not consumed, S2, will

will

be equal to the increased Ct at constant prices.

:
In the next section we shall consider

in more

detail

the

problem of inflationary pressures generated by investment. Prior

to this, however, we shall generalize somewhat the above argument
have assum?
by dropping one of the simplifying assumptions. We
and revenue is negligible.
ed so far that government expenditure
shall allow now for public investment. Since we shall assume,

We

however, for the time being that it is fully financed by government

loans we shall continue to abstract from government revenue as
well as from government administrative expenditure.

shall allow for loan-financed public investment by modi?

In what follows it will stand not only
the
fying
meaning of L
and the
investment
for private investment but also for public
We

respective production will be assumed to be included in Department

I. It is easy to see that despite thismodification of the meaning of /,
the preceding equations and in particular the equality between invest?

ment and saving, will hold good ifpublic investment is fully finance
by loans. The process of such financing will indeed not differ from
increase in production of Depart?
that of private investment. The
I on account

of public
investment, will push production or
to
in
II
the
up
point where the increase in con?
Department
prices
will
in
I
be equal to the increase in saving
Department
sumption Cj
II. Public
investment, if financed by loans,
Sz in Department
will thus generate just as private investment its counterpart in
ment

us

assume

that the government finances investment

from
the
banking system. The disbursement of
initially by
sums
will
the respective
generate an equal amount of liquid saving
which will then be available for taking up government securities
saving.

Let

loans

and thus will make possible the founding of the loan. If, however,
such securities are not issued, this saving will swell the deposits
or will be used for repayment of private bank credits. Here
again
the problem of inflationary pressure will depend merely on the
conditions of supply of consumption goods.
results are of considerable
These
importance.
trated above on the subject of repercussions upon

We

concen?

the economy

of an

increase in private investment, especially on the problem

under what conditions this increase does or does not
give rise to

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MP

KALECKI

It should be noted,
however, that the
inflationary pressures.
problem of the "danger of inflation" may not arise at all because
the entrepreneurs may for various reasons tend to keep
their
investment at a low level.
Investment may be limited not because
of the difficulties

to finance its increase without causing inflation

of entrepreneurs
to expand
their capital
hy unwillingness
a
In
situation
such
investment
expenditures.
public
acquires a
crucial importance for the process of rapid economic development

but

and the fact that its repercussions even when financed by loans
do not generate higher inflationary pressures
than private invest?
ment is highly significant.1
II

We
considered above the two extreme cases of the elasticity
of supply of consumption goods, which are rather simple. Actually
the situation is more complicated
in some sectors of
because
II the supply of consumption goods may be elastic and
Department

in some it is usually rigid. An important instance of this situation

in under-developed
the supply of
countries is the case where
is
industrial consumption
elastic
considerable
because
goods
reserves of productive capacity are in existence or because
itmay

not require a very large investment to increase those capacities.

On
the other hand the supply of food may be fairly rigid. This will
in under?
depend on the fact that under conditions prevailing

developed countries food production expands in response to demand

less than in developed countries.2
One
factor seems to make for a relief in the demand pressure
on limited food supplies as a result of increase in industrial
employment

effect proves to be at least in part only

labour
In under-developed
countries the additional
but

this

apparent.
In many
instances
force will frequently come from rural districts.
as
a
not
fall
will
result
of
the
of
existence
agricultural production
in agriculture.
It may be thus surmised that no
labour"
"surplus
the migration
from the
difficulties in supply will arise because
country-side
find its way
1.

It

2.

This

will

leave behind

an extra surplus of food which will

however, is not correct
This,

to the urban markets.

not be concluded
investment by loans is
that financing
should
public
at a later stage
that financing of
We
shall argue
desirable.
particularly
it helps to
because
investment
by taxes on profits is preferable
public
reduce inflationary pressures.
does

not

under-developed

of agriculture
the possibility
of a quick
exclude
expansion
are eliminated.
obstacles
if the institutional
countries

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in

THE

PROBLEM

OF

FINANCING

OF

ECONOMIC

DEVELOPMENT

a large proportion of this extra surplus will frequently be

In
for the increase in food consumption
of the peasants.
an
worker
will
be
industrial
the
of
of
standard
addition,
living

because
used

than that of a poor peasant.. Thus the demand

generated by higher employment will only in part be met by the
extra surplus created in the course of migration.
frequently higher

It follows

from the above that the rise in investment may

a strong pressure on the available supplies of food while at
the same time it is possible to increase the production offindustrial
It may be shown that in
consumption goods in line with demand.
some instances the rigidity of the supply of food may
lead to the
create

under-utilization

of productive facilities in non-food consumption

will not be the case if the peasants profit from the

This
goods.
increases in food prices, because then they buy more industrial con?
if the benefits of
sumption goods out of higher incomes. However,
higher food prices accrue to landlords, merchants or money-lenders,
then the reduction in real wages due to the increase in food prices
will not have as a counterpart the increased demand for mass
consumption
goods on the part of the countryside; for increased
In
profits will not be spent at all or will be spent on luxuries.
a
this case the high demand
generated by
rapid development
a market
not create
for
involving large-scale investment will
industrial mass consumption goods.
As
is clearly seen from the
above, two factors will be involved here: (a) the inelastic supply of
food leading to a fall in real wages, (b) the benefit of food price
increases accruing not to small proprietors but to capitalists.
It is of some interest to put this case into a more general

It should be noted that it is the lack of adequate

perspective.
markets
that was
of
the main obstacle
frequently considered
rather than the dangers of inflation. The
development
problem
was usually formulated as follows.
In view of the small internal
demand

there will

be no

outlet for the products of the newly built

thus industrialisation will prove impossible unless it is
factories;
oriented towards external markets.
The answer to this problem is
section.
If investment
provided by the argument in the previous
is sufficiently high, it pushes
the demad for consumption goods up
to the point where the surplus of these goods
in Department
II

meets
ment

the higher demand of workers and capitalists

inDepart?
I. In this way it is the high level of investment itself that

generates demand

for consumption

goods.

It still remains true that

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M.

KALECKI

the initial impetus for investment comes frequently from external

or from government
intervention and that even in the
demand
later stages private investment may be supplemented
by public
a
level
and
however,
rising
capital expenditure.
Assuming,
high
is solved and there arises,
of investment, the problem of the market
of
even on
the
inflation if the pace of
the contrary
problem
industrialization is rapid. But closer analysis indicates in turn that

the "danger of inflation" is by no means

incompatible with the
market problem : the latter is apt to reappear if the supply of food
of the distribution of income in;
is rigid and the conditions
as
are
described above.
such
agriculture
under
can conclude
that the increase in investment
We
conditions of inelastic food supply will cause a fall in real wages and
this type
will generate an inflationary price-wage spiral. Moreover,

with any considerable

rise in
it is clear from
Thus
for industrial consumption
demand
goods.
the
of
food production, paralleling the
the above that
expansion
inflation may not be

of

associated

is of paramount
importance for avoiding
in
Investment
industry,
transportation;
inflationary pressures.
public utilities and even long-run development projects in agriculture
industrial

should

development,

by measures which would

expand agri?
accompanied
measures
the
These
in
short
range
period.
production
to
for
land reform and cheap bank credit
peasants
improve?
be

cultural
from
ments

in the method

of cultivation, small-scale

irrigation, and cheap

fertilizers.1
an adequate
While
supply of food is of basic importance
in
the course of economic development
for preventing
inflation,
the increases in industrial productivity work in the same direc?
increase
tion. There
is, however, an important difference. An
in the supply of food

tends, to raise

real wages

at a given ,level

the other hand, an increase

On
employment.
tends to increase real wages
in productivity
through a reducn
to a given level
tion of the level of employment corresponding

of non-agricultural

I.

the problem of rigidity of the supply of food

be noted
that after
It should
consumer goods
of sunply of industrial
the problem
has been
overcome,
acute.
if the rise in food prices involves a
becomes
Indeed,
usually more
lenders or'
of income
towards big landowners, money
shift in distribution
rise will
tend to increase
of such a price
the prevention
mtrchants,
the,;
This
is a special case of an
for industrial mass consumption
demand
goods
in one sector, through a ?
of scarcity prices
law : the elimination
economic
of scarcity prices in
of appearance
the probability
supply, increases
higher
another

sector.

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OF

PROBLEM

THE

FINANCING

OF

ECONOMIC

DEVELOPMENT

of non-agricultural
Let us now consider the latter
production.
more
in
detail.
process
that there is a significant increase in productivity
Imagine
I and
sector both in Department
throughout the non-agricultural
a
to a
II.
As
Department
result, employment
corresponding
level

of production
in that sector will fall in inverse
This will cause a proportionate
fall of the wage bill
proportion.
at given wage rates. The demand for food will thus be reduced
given

and food prices will decline.

If the distribution
proportionately
of income between capitalists and workers in industry will remain
unchanged, prices of industrial products will also decline
roughly
to productivity.
The final result will thus be a
proportionately
fall both

in industrial

rates

thus a rise

and agricultural prices with given wage

in real wages.
It is of course clear from
at
the above that
the same time the process of transfer of labour
from agricultural to industrial sector will be slowed down.
In order to put the effect of changes in productivity into
and

? proper

perspective
us
Let

it may

to consider

be useful

two extreme

first assume

that agricultural
production
examples.
remains stationary and that all increases in industrial production
are achieved by using more capital per worker which results in
In such an economy
a rise in productivity.
the problem
of
not

The
industrial goods will
prices of
?f the rise in productivity.
conse?
The
will
increase
in
real
rise
the
demand
for
wages
food, and
quent
that will cause some rise in food prices. But this rise cannot
be so high as to eliminate the increase in real wages, since then
inflation will

tend

arise.

to fall because

the very cause of the higher demand for food would disappear.
the real wages will rise to some extent ; so will peasants'
of higher prices of agricultural products1 and
incomes, because

Thus,

lower prices of industrial commodities.

as would
so favourable
from
appear
there would

But

shift of population
is one of the main causes
in the course

is not

this description,
because
from the countryside to

be no

the town, which

the standard of living

the situation

of

the increase

in

of economic

development.
Disguised
unemployment would not be reduced, and the country
would be
split into two sectors of primitive
agriculture and
modern
other extreme is the case where produc?
industry. The
tivity does
i.

Unless

not
this will

increase
benefit

only

at all and
rural

the increase

in industrial

capitalists.

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10

M.

KALECKI

is achieved merely
production
through a shift of population
from the rural to the urban districts.
In such a case, disgui?
sed unemployment
would
be diminishing
radically, but at the
same time considerable
inflationary pressures are likely to develop,
it may be difficult to expand agricultural production
because

so as to satisfy the rapidly rising urban demand.

The optimum
the increase
these two extremes:
pattern falls usually between

should be based on the rise both in

production
and
in
productivity
employment.
an assumption
that the
In the above argument we made
distribution of income between workers and capitalists in industry
will remain unchanged while productivity
increases. This need?
in industrial

not of course be the case if there will be a rise in the degree

of monopoly which would cause a shift to profits. Such pheno?
menon may, of course, occur quite independently of the increase
in productivity.
Since in the course of economic development

in industry,
there will be a tendency of increased concentration
a rise in the degree of monopoly may easily take place. More-s
direct investment by,
involves considerable
over, if development

or quasi
foreign capitalists, the practices of industrial monopolies
are
to
from
monopolies'
under-developed
brought
developed
countries. What
will be the repercussions of an increase in the
rise of prices in relation to wages
degree of monopoly ? The
will

reduce

industrial
will

effective demand

facilities.

It

and prevent the full utilization of

that this decline
in real wages,
on
but the
agricultural
supplies;

is true

diminish

the pressure
in
food prices cannot be so great as to restore the
ensuing
real wages
because
otherwise
its very cause would disappear.
a shift in the distribution of income
The
final result will be
and agricultural incomes to industrial profits. The
from wages
fall

case

some

above where real

analogy to that considered
fell because of the increases in food prices while bene?
wages
fits of these increases accrued to merchants,
landlords or money
shows

lenders.
demand
a

In both
for

the process
tends to keep down the
industrial mass
'as a result of
consumption
goods

shift to profits
the present case

cases,

in the distribution

of

it is the monopolistic

income.

However,

industrialists

in

that will

reap the benefit.

In the above
ture and

analysis
the monopolistic

the inelasticity of supply in agricul?

in industry emerge as
tendencies

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THE

OF

PROBLEM

OF

FINANCING

important factors underlying

rapid economic development.

ECONOMIC

DEVELOPMENT

inflationary effects in the course of

The
rise in productivity mitigates
at the same time it slows down the

but
inflationary pressures,
rate at which surplus rural labour

is absorbed

into industry.

Ill
were

considerations

above

The

simplifying assumptions:
and (b) from government

we

abstracted

based

on

(a) from

administrative

the

following

foreign trade
and revenue;

expenditure
financed
by loans. We
public
now shall introduce in our model
foreign trade but we shall
assume for the time being that it is balanced,
i.e., that exports
to imports. We
are equal
shall also
allow for government
investment was

assumed

to be

but we shall again assume that it is

administrative expenditure
so that public
revenue
investment will
balanced
by government
continue to be loan-financed.
this
For
Let us allow first for balanced
foreign trade.
sake we

shall modify

industries

proportionately

and

consumption
exports ; we next
Department
in addition

our model

goods
allocate

as follows. We

to

the imports of
which are obtained

split all export

investment goods
for
in exchange

I and
these two parts to Department
II respectively. Thus Department
I will now include,
to the industries producing
investment goods, also

exports of the value equal to

export industries which produce
II will
the imports of investment goods.
Similarly, Department
the
include the production of consumption
produc?
goods plus
tion of export goods for providing for imports of consumption

there will hold good

It is clear that also in this model
goods.
in Department
I and saving
the equality between consumption
II:
in Department

Ql = S2

and

thus the equality

It will

be

of investment and saving

I= S

seen

that the relation

between
employ*
I
and the volume of
in Department
investment will
now not only on the productivity of labour but also
depend
on the terms of trade The better are the terms of trade the
easily

ment

higher will be ceteris paribus the volume of investment in rela?

I. And
tion to employment in Department
similarly, the supply
of consumption,

goods

in relation to employment

in Department

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II

12

M.

KALECKI

to
be the higher the better are the terms of trade. Thus
there corresponds a higher invest?
the same level of employment
ment and a lower pressure of demand.
It follows directly that
will

an improvement in the terms of trade will

reduce inflationary
pressures corresponding to a giveft level of investment.
It _should be noted that an even more important aspect of
the better terms of trade is their contribution

to the equilibrium
economic
Indeed
imports and exports.
develop?
rapid
ment is apt to create a strain in foreign balance.
will
tend
Imports
to increase for various reasons:
in
will
the
rise
investment
(a)
between

require considerably higher imports of capital goods which cannot

at home;
be produced
(b) the increase in total industrial produc?
and semi?
tion will involve higher imports of foreign raw materials
the difficulty of increasing food production
; (c)
with
demand
may also necessitate importation of food.
pari passu
An offsetting factor is the increased self-sufficiency with regard
manufactures

consumption
goods but this will hardly com?
the
for
demand
due to the above factors especially
higher
pensate
At the same time
in the first stage of the accelerated
development.
to industrial mass

itmay be difficult to increase exports in step with imports. First,

such an expansion may require considerable capital resources and
the
thus with a given level of investment would
slow down
it
oriented toward the internal market.
Second,
development
a
means
no
on
to
enter
scale
easy
may by
larger
foreign markets
of the
without causing a deterioration in terms of trade. Because
of payments resulting from all these factors,
to minimize
restrictions
designed
import
importation of non
essentials are almost inevitably a concomitant of vigorous econo?
strain

in the balance

mic development.
shall next
We
ture and revenue.
which we assume

introduce in our model government expendi?

Let us introduce first the administrative budget
to be balanced,
i. e., we assume that administra?

tive expenditure is, equal to revenue. We

shall, moreover, assume
for the sake of simplicity that all the administrative expenditure
is
on

the salaries

of officials and

that there consumption

the total tax revenue

that these officials do not save, so

to their salaries.
is equal
Let us denote
T
the
and
both
direct
and indirect,
taxes,
by
I (i.e. by capitalists, small proprietors and

paid by Department
workers of this department) by T2 and all taxes paid byDepart?
ment II by T8. Total consumption of the officials will be, according

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THE

PROBLEM

OF

FINANCING

OF

ECONOMIC

DEVELOPMENT

13

to the total amount

of tax revenue
the above, equal
77
*
for
out?
the
from
consumption
demand
Therefore,
goods coming
side of Department
II, is equal to Cj
(consumption in Depart-^
On the other hand, the surplus
ment I) plus T (total tax revenue).
to

of consumption goods over the consumption

in Department
II is:
to T2 + S2, because now this surplus corresponds not
now equal
II but also to taxes
only to savings of capitalists of Department
a
our
As
result,
previous equation Cl=S2
paid by this department.
is now modified into an equation

+ T=

T2 + S2

If we deduct T2 from both sides of the equation, we shall obtain

Cl + Tt= S2

we shall add to both

the saving.in Department
sides- of the equation
I, we shall obtain
=.
+
+
S2
-St
7Y+ S,
Cx
is nothing else but the total
left hand side of this equation
The
or
I
investment J. The right
value of production of Deparment
is equal to the total saving S. We
hand side of the equation
because

is equal

to T, +

T2t

If,moreover,

therefore obtain again the equality between

I= S

investment and saving :

in this case again the process of investment creates auto?

in saving.
a counterpart
Production
of consumption
matically
a
to
be
will
or
where
their
up
the sur?
pushed
point
prices
goods
in
of
II, equivalent to taxes
Department
goods
consumption
plus
of
of
that
and
capitalists
savings
department, will equal
paid there
for
the demand
consumption
goods
coming from Department
Thus,

I and from Government officials.

It is clear that the higher the government expenditure and
revenue, the lower will be ceteris paribus the real wages
after taxa?
case
in
the
is
clear
the
where
taxes
are
This
tion.
paid directly
case of indirect taxation. But this will be
or
the
in
workers
by
true even in the case of direct taxes paid by capitalists. These"

taxes will partly come out of capitalists' saving, and to this extent
for consumption
the demand
goods will not be reduced, and an
additional pressure on the available
supply of consumption
goods,
will be generated.
Thus

lower

administrative
government
and
expenditure
revenue will mitigate inflationary repercussions of rapid economic
and consequently
the reduction of the administrative
development
budget

will tend to benefit the process

of

developments

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It should

M.

KALECKI

be noted, however, that the cuts in expenditure

the functioning of economic
agencies which

should
are

not

impair
for

necessary

furthering this process.

is characterized
The model which we have built up gradually
foreign trade, a balanced administrative budget, and
by a balanced
is very
financed fully by loans. This model
investment
by public
as a first approximation.
much closer to reality than that adopted
even the present model may still require modifications.
However,
since imports may exceed
The foreign trade may not be balanced,
tax revenue
of
the
of
because
import
capital. Moreover,
exports
or
a
so
all of public
that
administrative
part
may exceed
expenditure

In both cases the modifica?

expenditure is financed by taxation.
tions in question would tend to relieve inflationary pressures which
shall there?
We
development.
may be caused by rapid economic
fore consider the problems involved in some detail.
IV
shall discuss below the effect of the capital import, which,
above, tends to relieve inflationary pressures corresponding
to a given level of investment.
We

as

said

is equal to the
the import of capital which
F.
the
If
of
deficit in foreign trade by
capital is used for
import
it is clear that the same
investment goods,
abroad
purchasing
Let

us denote

of investment will be achieved by a smaller production of

investment goods at home and thus the pressure on the supply of
Ifwe denote the
goods would be pro tanto relieved.
consumption
we
the
have
shall
total investment by J,
equation
amount

7= S + F

that a smaller amount of saving is now necessary to

a
finance
given amount of investment.
If the import of capital is used for purchasing abroad con?
that the same equation holds good.
sumption goods, it appears
case
trade we had above the equation
balanced
of
the
for
Indeed,

which

shows

d + T = T2 + Sz

Since now there will be available an additional supply of consump?

tion goods equal to the foreign trade deficit F, we shall have :

C, + T = T2 + S2 + F

this follows, taking into consideration

are equal to Tx + T2*

From

that the total

Q + T^Sa+F

Adding

to both sides of the equation, we obtain

Sj

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taxes T

THE

PROBLEM

Cl
Or,

finally,

In

the case

OF

FINANCING

+ Tl +

OF

ECONOMIC

DEVELOPMENT

15

S1-Sr+Sl+.F

I= S + F

abroad
of using the capital
import for purchasing
to
amount
investment
be
of
the
goods
produced
goods,
in order to achieve a given level of total investment is

investment
at home

pro tanto reduced, and the pressure of demand on supply relieved

In the case of using the capital import for
side.
from demand
abroad
consumption goods, the pressure of demand on
purchasing
In both cases, however,
supply is reduced from the supply side.
to
amount
finance
home
of
the
investment is
saving necessary
reduced by the total amount of import of capital and thus infla?
.
tionary pressures are correspondingly relieved
Another function of import of capital is to relieve the shortage
of foreign exchange.
Indeed, as mentioned above, the process of

tends to strain the balance of payments by raising

development
the requirements for imports of capital goods as a result of higher
for imports of industrial raw
the requirements
investment;
of growing industrial production;
for imports of food if home production

materials
ments

because

and the require?

lags behind the

demand.

above shows the advantages of import of capital for the

of a country.
In practice, however, this way
rapid development
of financing econonomic
which
presents problems
development
are frequently insuperable.
From a purely economic point of view,
the interest paid on the imported capital will burden the balance
in the future which means both a loss of resousces
of payments
and also a risk of balance of payments difficulties. This problem
The

is, of course, themore acute, the higher the rate of interest. But
even more important is the question of availability of foreign capi?
talwhich would not involve problems of more basic nature.
3The import of capital may take three forms : grants, loans or
It is clear that from the purely economic point
direct investment.

grants would be the most preferable type because they

not raise the economic difficulties mentioned
How-;
above.

of view
would

ever, some political strings would usually be attached to such grants

?s would be available on a large scale and this may adversely affect
course of development.
consider in turn the problem of direct investment.
It
that such investment is preferable to loans
is sometimes maintained

the whole

Let us

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16

M.

KALECKI

on shares is flexible according to the

the rate of interest on bonds
is not.
It

because

the rate of dividend

business

situation while

should be noticed, however, that this is offset by the fact that the
former rate is usully on the average much higher than the latter.
and political aspects
More
important still are the general economic
of direct investment.

Direct

investment frequently takes place in

the
such as production of raw
certain branches
economy,
for export which may not be in line with a reasonable
materials
of the resources of a country.
the
for
It will
development
plan
a
to
that
one-sided
twist.
But
from
apart
development
that,
give
in this investment will inevitably acquire
the big concerns engaged
of

a considerable

political influence upon the governments concerned,

of this may easily vitiate the process of
the consequences
economic development.
the most suitable type of import of capital for the
Thus,
and

of a country are foreign loans obtained on a purely

development
commercial basis; but such loans may have the economic dis
advantage of a rather high rate of interest and would be hard to
obtain because of the danger of future difficulties in the balance
of
payments which may render the transferability of the interest and
These
amortization
difficulties may
be perhaps,
impossible.
in some instances in the following way. Transactions
remedied
may be imagined where investment goods from abroad are obtained

on loan, the repayment of and the interest on which takes the form
of future exports of specific commodities
in the under?
produced
In this way the future balance-of
developed country in question.

payments
payments

difficulties
on

loans

connected with
amortization
and interest
are eliminated
to some extent because
the

foreign exchange for the respective payments need not be obtained

Such arrangements may be of advantage to
in the world market.
the lending country which on the one hand has an unutilised
of investment goods, and on the other
capacity in the manufacture
hand is keen on securing the future flow of raw materials.
above makes clear the difficulty of securing import of
The
capital
terms.

countries on acceptable
found in preventing the
to developed countries which

from developed to under-developed

Perhaps a partial substitute may be

export of capital from under-developed

Not only visible capital flight must be
is by no means negligible.
but the hidden transfers as well which
here
consideration
taken into
are frequently of even greater importance.

common practice, for

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THE

PROBLEM

OF

OF

FINANCING

ECONOMIC

DEVELOPMENT

17

instance, of circumventing exchange restrictions is to understate the

same
export prices and to overstate the import prices.
(The
practice is frequently used especially by foreign companies in order
tomake the export profits appear lower.) The elimination of such
abuses may indeed yield sizable amounts of ''foreign capital' \
The other similar way of securing foreign capital is to cut down
abroad by existing foreign enterprises.
the transfers of dividends

by taxation of
form; by blocking the transfers of
export profits
abroad partly or fully; and in some cases by nationali?
dividends
The
zation of the enterprises concerned.
argument frequently

This

in fact has

been

done

in many

countries

in this or other

is that it discourages
direct foreign
against such policies
investment.
If, however, a rather sceptical attitude is taken, as
above, with regard to the role of direct foreign investment in
economic development, this argument loses much of itsweight.1

used

The

difficulties of securing foreign capital in a form favourable

the importance which
is attributed in
explains

to development

countries to the improvement in the terms of trade.

underdeveloped
We have already considered briefly its significance for economic
It is interesting to look at it now from the pointos
development.
of comparison with capital import.
terms of trade may be considered equivalent

view

without

the difficulties

Any
improvement in
to the import of capital
the latter. This is obvious

accompanying
to
the
all the
regard
supply of foreign exchange, because
amount
additional
of exchange which is obtained
through the

with

improvement in terms of trade, may be mobilised by a government

to the
As
for additional purchases
essential for development.
with
identical
those of
internal repercussions, they may be rendered
foreign loan by imposing export duties when the improvement in
terms of trade is due to the rise in export prices, or import duties
in
it is due to the fall in import prices.
If the duties
when
question
I.

are exactly

equal

to the change

in foreign prices,

they

or eliminating
It should
be perhaps
of reducing
noted that the policies
as aiming
dividend
cannot
transfers
considered
be always
solely at
immediate
In many instances
of the balance of payments.
improvement
a manifestation
these policies
be mainly
of the fight of an under?
may
The
influences of foreign companies.
developed
country with the political
retaliation
of these companies
to impair the exports of the
by maneuvers
even temporarily
of the
concerned
lead to the weakening
may
products
balance
of payments
the case when one
Such will be especially
position.
or a few companies
role in the foreign trade of the country
play a dominant
involved.

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18

M.

KALECKI

investment
clearly leave the internal situation unaffected, while
increases by the amount of gain in foreign exchange.
The
last stage of the argument leads up to the problem of
the influence of taxation upon the repercussions of investment
undertaken

in the course of economic

development.

shall now

We

deal with this problem.

V.
We

shall now

level of

investment

the subject of taxation as an anti

It has been assumed so far that the adminis?
inflationary measure.
and that public investment was fully
trative budget was balanced
shall now consider the repercussions of
financed by loans. We
It is
financing government investment partly or fully by taxation.
easy to show that the amount of saving corresponding to a given
deal with

(private and public), will be reduced by the

taxation.
Indeed, our equation of the demand
of consumption goods can be written now if we

amount of additional
for and

supply
abstract from capital import, as follows :

+ T = T2 + T'f + S2

where T'2 are the additional

+ T,

taxes raised inDepartment

T\ + S2

II, or

is the total tax covering the administrative expenditure

and Ti and T2 its parts raised in Departments
I and II respectively.
Let us now add on both sides T\ -f-Sx where T\
is part of
additional tax raised in Department
I :
because

Cx + Tx + T\ + SX = T\ +T'a + S1 + S2

left-hand side is nothing but the value of production

of
I or investment (private and public)
I. The right
Department
to Ty, i.e. the total additional
hand side is equal
tax plus 5, the
:
total saving

The

I= T + S

It is easy to show

that if capital imports F

ration this formula will change to :

are taken

It can be

investment will

into conside?

I= V + S 4 F

seen

from this

equation
to finance

generate saving necessary

import of capital.
taxation reduces
Although

that

it in excess

always
of taxation and

the amount

generated by a given level of investment,

mean a reduction in pressure on real wages.

of saving which
is
this will not necessarily
(We have dealt already

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THE

PROBLEM

OF

FINANCING

OF

ECONOMIC

19

DEVELOPMENT

a similar problem when discussing

of an
the consequences
taxation on
Direct
increase in the balanced administrative budget.)
lower income groups, or indirect taxes, will mean
of course a
to taxes on capitalists, they will be
reduction in real wages.
As

with

met only in part by a reduction in their consumption, while in part

In the latter case
they will be paid at the expense of their savings.
there is only a shift from savings to taxes without any change in
prices.

achieved
reduction of capitalists'
Nevertheless,
consumption
It
by taxation of profits will help mitigating inflationary pressures.
is true that no essential commodities will be released in this way.
The

capitalists will not eat less under the impact of taxation. But
as a result, to a given level of investment there will correspond a
lower level of industrial employment, because
less will be produced
for capitalists'
and
this
will
reduce
consumption,
inflationary

in the longer
pressures caused by rapid development.
Moreover,
run this policy will help to shape the development
in the direction
of the expansion of essential industries.
It is true that this can be
achieved
investment plan
through enforcing an appropriate
by

direct means,
e.g.
a parallel

licensing of investment, but it is clear that

tax policy
this might involve considerable
difficulties.
Indeed, prices of non-essential consumer goods would
increase under
and thus create a strong
pressure of demand

without

tendency for investment in the respective

be difficult to control.
The

industries which

itmight

of

reduction

will be
also
capitalists'
consumption
of view of balance of payments
point
it will reduce the demand for imported luxuries.
because
It is
true that import restrictions can cope with
this problem but
bebeneficial

from

the

again the reduction of demand

litate the enforcement of restrictions.

here

In addition

for such

imports will

faci?

to

limiting capitalists'
consumption
financing
public
by taxation presents still another advantage.
It reduces the creation of liquid assets. This may be
unimpor?
tant if there is no tendency towards inflation. If, however, as a
investment

result of an inadequate suply of consumption goods an inflationary

sipiral has been for some time in existence, the large amount of
lquid assets will stimulate speculative hoarding and thus will help
to aggravate the primary inflationary process.1
i

The reduction
in the creation of liquid assets will also facilitate
of the structure of investment by direct means,
e.g. licensing.

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the control

20

M.

KALECKI

investment by
In the light of the above, financing public
to be a sound policy.
It should be
taxation of profits appears
noticed that in this way only such profits would be taxed away that
if taxtation in
Indeed,
to public
is
budget
exactly equal
formula will become

are in fact created by public

excess of the administrative
investment, the preceding
= S + F
I?r

investment.

where lPr stands for private investment. For if we substract V

from the previous equation we obtain on the left-hand side private
investment is equal
investment Ipr because we assume that public

that if public investment is fully financed by

taxation, the savings and profits generated are such as would obtain
1 Thus
an increase in
ifpublic investment were not in existence.
a correspondingly higher revenue
public investment accompanied by
from taxation of profits would not have an adverse effect on incen?
to T\

It follows

tive to private investment.

The above puts the role of financing of public investment by
taxation will
This
of profits into proper perspective.
taxation
prevent public
consumption.
investment

upon

investment
There will
the demand

increasing profits and capitalists'

the effect of higher
remain, however,

from

of workers

for

consumption

goods.

investment by taxation
It follows that while balancing public
not fully ''neutralize"
it
will
a
to
sound
be
of profits appears
policy
It
may be shown that
the inflationary impact of such investment.
such monetary measures as banking restrictions are also inadequate
for dealing with the problem of inflation resulting from a high
level of investment.
Let us consider the significance of banking credit restrictions
The main anti-inflationary influence
as anti-inflationary measures.
the
of credit restrictions is exerted obviously
through depressing
in
fixed
the reduction of investment
level of investment. Now
infla?
Thus
capital will obviously upset the pace of development.
cured
be
would
from
rapid development
tionary pressure resulting
it may
If this is deemed necessary, however,
by slowing it down.
investment
be done by more direct means of either reducing public
I.

in a
is increased
investment
considerably
that if public
It should be noted
to finance it is likely to be
short period the rise in taxes on profits necessary
unless other taxes are reduced.
investment,
less than the increment in public
in economic
the resulting upswing
activity will raise the revenue from
Indeed,
'
in a
is not likely to expand much
old" taxes while the administrative
budget
investment will be cover?
a part of the increase in public
Thus
short period.
ed by tax revenue automatically.

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THE

PROBLEM

OF

FINANCING

OF

ECONOMIC

DEVELOPMENT

21

or licensing private investment

latter will help to reduce
The
a
on
To
selective
the same end may
basis.
investment
private
course
be used of
selective restrictions of long-term bank credit
investment.
for financing private
however, would not
This,
exclude unessential investment financed from the firm's profits.
still remains the effect of credit restrictions upon
There
investment in inventories. As long, however, as there is not tend?
ency for hoarding, only limited reductions in investment in inven?
without hampering
the expansion of
achieved
tories can be
production.

that credit restrictions can play an impor?

tant anti-inflationary role only when directed against hoarding of
is a secondary effect of already advanced
in?
commodities which
a
case
must
on
a
it
in
such
be
flation. When
applied
highly
We

may conclude

selective basis

so as not

to impede

the process

of development

itself.
Such a system, however, may be rather difficult to operate. A
credit given for an essential purpose may frequently be used at least
indirectly for speculative hoarding: indeed such a credit may release

for speculative
the firm's own funds and thus make them available
credit
of
selective
restrictions
The
may have to be
system
activity.
run
could
be
that
it
order
in
very complicated
effectively. For
this reason another way may be preferable for combating tend?
encies for hoarding commodities if an inflationary spiral is in exis?
tence.

This

in Chinese

system was applied for the first time, and with success,
People's Republic, for putting a stop to hyper-inflation

inherited from the previous

It consist of
regime.
of
real
the
value
bonds
and bank?
deposits, government
maintaining
ing credits by revaluing them continuously according to established
and
prevents a tendency to convert money
price indices. This
at
same
and
the
time dis?
other liquid assets into commodities,
1
for
purposes.
courages borrowing
speculative
this method nor selective credit restrictions can of
Neither
which

was

inflation. Their
course cope with what we called above "primary"
of
this
the
to
is
aggravation
primary inflation
prevent
only purpose
The
inflationary pressure
primary
hoarding.
by
speculative
I.

cause a fall in
of this measure would
that the application
be noted
the rise
of private securities which would not be ''insured"
against
measures
to all monetary
feature is in fact common
This
against
cause a fall in
In fact5 credit restrictions would
hoarding of commodities.
and private securities.
values of both government

It should
the values
in prices.

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22

M.

KALECKl

experienced in the course of rapid

shown above, the result of basic

is, as
development
in
disproportions
productive

economic

cannot be prevented by purely

these pressures
of
the problem must be based on
The
financial devices.
solution
economic policies embracing the whole process of development.
relations.

Thus

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