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1930s concept that explains why economies do not grow as fast their potential growth rates
Assumes fixed capital-labour ratios and low savings ratios due to poverty cycle
LEDCs have abundant supply of labour and the lack of physical capital holds back economic
growth/development
Actual income determines the savings ratio, which determines the disposable income for
investment, which then affects the rate of economic growth
Savings rate, plus capital productivity, minus capital depreciation, equals rate of economic
growth
Potential growth rate is not achieved automatically (needs Keynesian intervention) if saving is
not enough (or not enough confidence in the banking system to offered commercial loans)
Change in savings ratio or increased productivity will lead to an economy realizing more of their
potential (more efficient)
Economic growth and economic development are not the same; growth is a necessary (but not
sufficient) condition for development
Difficult to stimulate the level of domestic savings, particularly in the case of LEDCs where
incomes and confidence in the banking system are low
Borrowing from overseas to fill the gap caused by insufficient savings causes debt repayment
problems later
Law of diminishing returns suggests that as investment increases the productivity of the capital
will decrease and the capital to output ratio rise
Development was held back by lack of savings and investment; key to development was to
increase savings and investment
Theorized that 'pull factors' from the modern industrial sector would attract workers from the
rural areas (these firms, whether private or public, could offer wages that would offer a higher
quality of life than remaining in the rural areas)
As the level of labour productivity was so low in traditional agricultural areas, people leaving the
rural areas would have virtually no impact on output (amount of food available to the remaining
villagers would increase as the same amount of food could be shared amongst fewer people;
possibly offering a surplus which could be sold)
Those in the urban areas wold earn increased incomes, generating more savings and providing
funds for entrepreneurs for investment; the growing industrial sector required labour and
provided incomes that could be spent and saved, generating demand and providing funds for
investment
Productivity of labour in rural areas is almost zero may be true for certain times of the year;
however, during planting and harvesting the need for labour is critical to the needs of the village
Constant demand for labour from the secondary industrial sector is questionable. Increasing
technology may result in labour saving and actually reducing the need for labour. Additionally, if
the industry declines, demand for labour will fall
Trickle down has been criticised; higher incomes earned in the industrial sector will not
necessarily be saved and invested. If the entrepreneurs and labour spend their new incomes
rather than save (preferably in banks), funds for investment and growth will not be available
Rural-urban migration in many LEDCs has been far larger than the secondary industrial sector
can provide jobs; urban poverty has replaced rural poverty
OFFICIAL AID
Official Development Assistance (ODA) is transferred either as bilateral aid between governments or as
multilateral aid through agencies such as the World Bank or the UN
OECD's Development Assistance Committee (DAC) defines ODA as: flows to developing countries and
multilateral institutions provided by official agencies, including state and local governments, or by their
executive agencies, each transaction of which meets the following tests:
it is administered with the promotion of the economic development and welfare of developing
countries as its main objective, and
it is concessional in character (lower rate/perhaps none interest, easier credit terms and
repayment schedule, sometimes repayable in local currency; targeted toward a certain 'theme',
i.e., poverty reduction or trade expansion) and contains a grant element (not expected to be
paid back: food, medical and emergency aid) of at least 25%
ODA has grown from $22 billion to $60 billion between 1960 and 1990
Aid has fallen from 0.5% of donor GNP in 1960 to 0.3% in 1990
The US is the largest donor (in nominal/real terms) with $11.3 billion in 1991
UN agencies gave $4 billion, and provided the largest amount of technical assistance through
the United Nations Development Program (UNDP), United Nations Environmental Program
(UNEP), United Nations Industrial Development Organization (UNIDO), International Labour
Organization (ILO), World Health Organization (WHO)
NGOs gave $6 billion in 1990, the same amount as the World Bank
NGOs tend to attack poverty directly by working with local groups to achieve LOCAL AGENDAS
rather than imposing their own agenda
LEDCs with large populations have received less because donors have a greater impact by
donating to smaller countries which then become more dependent
It is estimated that less than 10% of overall aid goes directly to programs to help the poor such
as health care/health education, basic literacy education, AIDS prevention, agricultural
extension, microcredit schemes, immunization and vocational training, and clean water and
sanitation (these are all project typically taken on through NGO aid)
Bilateral aid tends to be distributed directly between two countries according to political
interests:
Islamic members of OPEC concentrate on Islamic countries, but this source of funding has faded
rapidly with the sharp declines in oil revenues
Communist bloc countries used to give to communist countries such as Cuba, Mongolia, and
Vietnam, but aid from this source has disappeared
Most LEDCs have a current account deficit created by the import of high value added capital
goods which cannot be matched by the low value added exports - aid provides an alternative to
FDI as a way to create a capital account surplus
The first aid plan was the Marshall Plan (no longer available) provided by the US which was
motivated by a combination of national security fears, economic interests and humanitarian
concerns
This aid was available to European countries with acceptable development plans for physical
capital investment
It expanded to include new technical assistance programs: available to invest in human capital
Plans and projects were generally excellent making the Marshall plan so successful that private
capital was attracted
The success of the Marshall Plan led to the formation of the development assistance committee
of the OECD (25% US) which provided money for:
World Bank
Large donor countries such as the US or Japan or EU tend to dominate multilateral aid agencies
such as the World Bank (created at the Bretton Woods conference in 1944)
The World Bank does not give grants (gifts of money) but borrows at the prime rate from MEDCs
and relends at a slightly higher rate to LEDCs and must be repaid:
90% of loans are for projects (physical capital); 10% for programmes
IMF
Large donor countries also tend to dominate the IMF (also created at the Bretton Woods
conference in 1944)
The loans are conditional on the imposition of a structural adjustment programme (SAP) which
often requires: reductions in government budget deficits, a slower rate of money expansion
(lower inflation) and devaluation
Soft loans: loans with a lower interest rate (perhaps none), easier credit terms and repayment
schedule, sometimes repayable in local currency; targeted toward a certain 'theme', i.e., poverty
reduction or trade expansion
TIED AID
Bilateral aid is often tied: aid money can only be used to purchase goods and services from the
donor countries
Historically, the proportions were: France 60%, Britain 75%, Italy 90% - while Japan does not
officially tie aid, it often reaches unofficial agreements which do tie aid
The proportions which are tied have dropped steadily and average 25% for many countries
Services are tied in the form of technical assistants being sent out from the donor country:
They are designed to provide the technical and managerial skills which may be missing in the
LEDCs
An estimated 100,000 consultants from MDCs are working in African countries, many are doing
jobs which could be done by local people
Conditionality
Loans and aid from large agencies is often conditional on changes in government policy in the
recipient country
IMF's SAP is a good example of this, encouraging: less protectionism/lifting restrictions in trade;
currency devaluation; exports of primary agricultural commodities ("cash crops"), metals and
minerals; increased FDI; privitization of nationalized businesses; removing subsidies and price
controls; reducing social expenditures and government expenditures in general to have a
balanced budget; charging for education and health services; reducing corruption; and making
government more responsive to the people (Washington Consensus)
One condition is often that funds are used to buy goods and services from the donor country
Resulting in aid money actually flowing back into the donating country
Domestic production is displaced and unemployment rises in domestic industries that compete
with imports
Costs for intermediate goods fall leading to an increase in exports and a fall in unemployment in
the external sector
There is more rapid growth in both GDP and GDP per capita
Even if growth is more uneven, the huge increase in productive capacity will lead to rapid
investment and linkage adjustment in other sectors (backward and forward integration)
MEDC tariffs and quotas block imports of labour intense manufacturing goods where LEDCs
have a comparative advantage
Vertical integration is lost, workers may be confined to assembly and some fabrication
There may be an overemphasis on natural resource exports which could lead to deteriorating
terms of trade
The first to be protected are final stage assembly and simple consumer goods
Capital and intermediate goods become more expensive, otherwise why would tariff barriers be
needed to promote sales of domestic equivalents?
Costs rise for exports, exports fall, and unemployment rises in the export sector
There is greater vertical integration within industries (both upstream and downstream)
There is less dependence on other countries, therefore less specialization and more evenly
distributed development in the economy
Infant industries never grow up because the lack of international competition leads to higher
costs
Balance of payments problems lead to a reduction in imported capital which is often needed for
industrialization to proceed:
The poor gain little, the major beneficiaries are the wealthy and the MNCs operating behind
tariff walls
Government tends to subsidize capital, and currencies are held artificially high to encourage the
use of imported capital and intermediate goods:
Exporters of primary goods (the poor) are hurt: because LEDCs face perfectly elastic demand,
they have to lower their prices to compensate for the higher currency value.
Is it better for industrialization to proceed through replacing imported goods with domestically
produced goods, or is export promotion more likely to lead to faster growth because of the gains from
trade through specialization?
Small loan amounts for a small time period often with weekly/bi-weekly payments due at a low
percentage interest, often tied with entrepreneurial education (used to purchase a sewing
machine, a handloom, a cow), taken out by consumers deemed uncreditworthy by commercial
banks
Access to credit is a human right and one way to break the poverty cycle
FDI by MNC/TNCs usually comes in a bundle including: equity and debt financing, management
expertise, technology transfer, technical skills training, and access to overseas markets:
Product life cycles have reinforced the need to maintain technical superiority in order to
advance, thus MNCs are extremely reluctant to un-bundle the package: they fear the technology
will be exposed to a competitor who will reach the life cycle window faster
Learning by doing: is accelerated which can enable the country to cope with a technologically
advanced future
Technology transfer: while embodied in a process, also includes information and the technical
skills needed to adapt, install, operate and maintain capital equipment systems
Managerial shortage: LEDC govts understand the acute shortage of local managers capable of
organizing and operating large scale industrial projects
Intra firm exclusion: LEDC govts realize that access to international markets is severely limited
because markets are dominated by intra and inter firm transactions (50% of Canada's imports
and exports are intra firm sales), MNC/TNCs are needed to gain access to this system
Marketing expertise: MNC/TNCs have preferential agreements with customers due to volume,
length of time in the business, the use of standardized contracts and standardized products, it
may take years for LDC producers to understand let alone break into international markets
Supply side bottlenecks: can be reduced through FDI by MNC/TNCs
National gaps in savings, foreign exchange, taxes, technology and human skills can all be filled by
MNCs:
Labour: they can create jobs, develop managerial skills, and provide technical education of
labour,
Capital: they can transfer technology and provide much needed physical capital
Tax revenue can be earned on the exports of natural resources which can be used to fund
construction of much needed infrastructure
Foreign currency flows in from the MNC/TNC investments, and from the private earnings on the
exports
The process which maximizes the net benefits of economic development while maintaining the services
and quality of environmental and natural resources forever
This involves:
Using natural resources at rates less than or equal to the natural rate of regeneration
Economic development and resource usage are complementary but after a certain point
development will reduce one or more of the functions of certain resources resulting in a
tradeoff
Or the trees can be left uncut so the forest can act as a waste assimilation system or a region to
absorb rain to prevent flooding
Or the trees can be left and the area used as a park for recreation
We need to develop environmentally friendly technologies and ensure they are made available
to developing countries.
The elimination of burning fires for cooking: they cause smoke pollution both within buildings
and around urban areas and contribute to deforestation
We must remove subsidies that encourage excessive use of forests, fossil fuels, irrigation water,
and chemical sprays
IB Economics/Development
Economics/Barriers to Economic Growth
From Wikibooks, the open-content textbooks collection
Contents
[hide]
Low incomes --> Low savings --> Low investment --> Low income
Absolute poverty: inability to just meet basic physical human necessities/needs of food/nutrition,
clothing, health and shelter in order to survive
Because this is so difficult to measure accurately, many researchers simply estimate that
20% of the world’s population falls below this line
UNDP reports that most live in 10 countries, with the proportions falling below the
poverty line in brackets: Bangladesh (80%), Ethiopia (60%), Vietnam (55%), Philippines
(54%), Brazil (49%), India (40%), Nigeria (40%), Pakistan (29%), Indonesia (24%) and
China (10%)
A characteristic of most LEDCs is the unequal distribution of income
What is interesting is the middle income LEDCs appear to have greater income
inequality than very poor or high income countries
Income inequality is greatest in Latin American countries
Relative poverty: a poverty measure based on a poor standard of living/low income compared to
the rest of society
Suggests that the lack of ACCESS to many goods and services expected by the rest of the
respective society leads to social exclusion and damaging results for the individuals and
families mired in relative poverty
Rural Poverty
Most poor people are found in rural areas: farmers with small holdings, landless
peasants, artisans, fishermen, nomads and indigenous people - the poor are not idle,
they work hard
Those with a traditional way of life are not necessarily poor - for thousands of years they
adequately sustained themselves - it is only recently that they have become poor due to
policies which have deprived them of the means of earning a living (land, fisheries,
hunting ranges, forests)
Poverty in city slums is highly correlated with poverty in the countryside and is linked
through migration
Women are often the poorest of the poor, as men control most of the land, capital and
technology, and receive a better education in most countries - this can have a major
impact on population control
Investments in infrastructure, social services, and technology in rural areas can go a long
way to helping those mired in the poverty cycle
Human Suffering Index (HSI) has been developed which looks beyond HDI
Case study: Kerala State in India This is a region with low income and yet a reasonably high
standard of living because of the emphasis on human development:
The society is very international in its approach, and is not afraid of new ideas and
methods of doing things
Women have a high status in the society due to the matrilineal system of passing
property from mother to daughter rather than from father to son
With greater wealth and income in the hands of women, the child mortality rate is low,
and spending on health, nutrition and education for children has been very high: the
illiteracy rate is very low
There is a strong interest in community economic development and the institutions
which promote community welfare such as cooperatives and community associations
The result is strong representation for labour in the workplace, excellent health
standards and low prices on food which result in very little malnutrition
Reducing Poverty
The trickle down theory is associated with the concept that inequity is inevitably a part
of economic growth, but after a period of rapid growth, greater equity and poverty
reduction will occur
Studies have shown that income distribution does appear to worsen at first
However, the evidence indicates that rapid growth does not appear to have eradicated
poverty which is surely the aim of growth in the first place
Furthermore, as income rises for the few who are lucky, their consumption pattern
tends to dominate the location on the production possibility curve, more luxury goods
rather than necessities are produced
In many countries very little tax revenue is collected and government is forced to raise
revenue by printing money or imposing export tariffs which inevitably reduces the
incomes of rural people because most LEDCs export raw materials and agricultural
products
A proper income tax system can provide the revenue for govt. and reduce inequality by
making the wealthy pay a fair share for running the country
Greater tax revenue also allows the government to provide basic infrastructure for the
poor such as better health care, better schools, provision of clean water, sanitation, and
electricity and more reliable road systems (infrastructure)
Laffer Curve
Price Distortions
Prices are often distorted due to subsidies or a strong union sector which is able to
extract high wages from foreign multi-nationals
A return to market prices is essential so that correct signals can be sent to allocate
resources according to true scarcity: for example, lower wages would lead to greater
employment
Government subsidizes capital through tax breaks, grants and low foreign exchange -
this lowers the price of capital artificially and leads to substitution of capital for labour
Political instability
Corruption
Redistribution of assets often does not happen or does not happen fairly (transparently)
If the most important cause of inequality is an unequal distribution of land, natural
resources and capital, attempts must be made to redistribute at least some natural
resources such as land
Land reform can often lead to a dramatic increase in farm productivity and incomes for
the rural poor
Children of the elite have greater access to education and to the best jobs:
Policies to open access to education for the poor, to reduce absenteeism and improve
the quality of education can lead to great increases in productivity
Gini coefficient/Lorenz Curve
Lack of infrastructure
Economic development has been promoted since 1960 as the best route for LEDCs to
follow, justifying borrowing from banks to spend on projects:
The risky nature of lending to LEDCs requires: higher interest rates, much more
expensive than the rate charged by the World Bank or aid agencies
Stock of debt: the ratio of debts to exports has averaged 125% to 150%
Debt servicing flow: includes interest payments and repayments of principal, and often
exceeds 40% of exports for certain poorer LEDCs
Oil rich countries looked for the highest rate of return on investments
The international banking community started lending this money to LEDCs
While the nominal interest rates charged were high, once inflation had been taken into
account, the real interest rates were very low leading to an explosion in LEDC borrowing
Those LEDCs which did not have oil, were now faced with vastly higher costs for fuel,
input costs rose dramatically hurting exports
Since 1935 most industrialized countries have been off the gold standard
Governments started inflating in the early 1960s until 1976 when inflation rates reached
high levels in the MEDCs:
Loanable funds were available at low interest rates to lend around the world
LEDCs were accustomed to ‘soft’ loans from international agencies such as the World
Bank which lent at low rates of interest
Commercial banks charged full market rates on 'hard' loans
It is estimated that 30% of all borrowed funds, usually in a hard currency, ended up in
bank accounts outside the borrowing country
MEDC banks were only interested in securing loans through government guarantees,
there was little checking of the projects the money was to be used for
Much of the borrowed money had been wasted on military arms or projects which did
not have any hope of paying interest on the debt or ever repaying the principal
Many LEDCs printed money to cover the deficits which led to extremely high rates of
inflation in some countries
LEDCs were unable to service their debts and were forced to reschedule
Loans were renegotiated with lenders, extending the terms of repayment
LEDC governments have been forced to make major structural reforms under instruction
from the IMF in order to qualify for rescheduling:
LEDCs which are able to lower their debt servicing experience some benefits:
Lower inflation which stabilizes the exchange rate and creates enough confidence that
the elite repatriate money lost through capital flight
Domestic interest rates fall leading to greater domestic investment and an improvement
in the economy
Restructuring simply extends the length of the repayment problem, it does not
eliminate the debt:
LEDCs simply lack the exports needed to earn the foreign exchange required to service
the debt
The only hope of getting out of debt is for MEDC economies to expand rapidly leading to
major increases in imports from LEDCs
Most of the debtor nations are faced with years of economic deprivation in order to
meet their debt obligations
Domestic policies that lead to overvalued currencies encourage imports and discourage
exports creating strong pressures to seek more loans to support the country until the
next crisis
If the money had been invested in projects which earned a rate of return which could
have paid the interest plus repaid the principal, there would have been few problems
Non-convertible currencies
religion
culture
tradition
gender issues
Periods of economic growth are associated with structural transformation and social
and ideological changes. In the past, 1/3 of growth came from population increases and
2/3s from productivity increases
Productivity increased due to technological change in terms of capital and human skills,
encouraging research and development which led to further growth
The rise in income led to increased consumption:
Many LEDCs are not truly nations, they are artificial creations of former colonial powers
Have not had enough time to adapt to modern concepts such as science, individualism,
economic mobility, and the work ethic
Technological transfer is controlled by MNCs and trade and finance are dominated by
MEDCs
Many LEDC natural resource endowments require western capital and knowledge to
exploit them
Populations are much larger, population densities greater, and education levels lower
than they were for MDCs during their period of industrialization
The terms of trade have moved steadily against the LDCs because they export mainly
raw materials with little value added
LEDCs have little scope to develop new products or techniques of production, the
expertise in the MEDCs is overwhelming:
Where LEDCs try to add value to raw materials they are faced with high tariff barriers in
the MEDCs which are trying to preserve jobs
Growth does not necessarily proceed without interruption. It requires social legitimacy:
When Argentina took off, Juan Peron carried out measures that were popular with his
constituents, such as price control of food grains and enlarged military expenditures,
but that stifled growth and divided society into sharply contending classes
Iran's oil wealth, far from being a source of stability, increased the alienation of the
great majority of the people who felt that the nation's wealth was being monopolized by
a corrupt few
The natural increase in population is the birth rate minus the death rate
The pre-industrial era was characterized by high birth and high death rates leading to a
slow growing population
Birth rates in LEDCs are much higher than in MEDCs during the comparable period of
development: a larger proportion of women marry and do so at a younger age (leads to
larger families)
For many developing countries the birth rate remains high while the death rate falls -
studies suggest that developing countries today are moving through this phase more
rapidly than MEDCs
Eventually the birth rate also declines, until low birth and death rates lead to low and
stable population growth again
For MEDCs population growth rate is 0.5% and for LEDCs it is 2% (2003)
Studies indicate that more even income distribution contributes to a more rapid fall in
the birth rate
In those LEDCs with high poverty levels, birth rates have remained much higher than for
MEDCs: there is a correlation between high birth rates and low GDP per capita
Death rate: as countries develop the death rate drops very quickly due to:
Survival rate: as the survival rate for children increases there is a rapid increase in
children as a proportion of the population, savings and investment rates fall:
This increases dependency rates within families, per capita income falls as unproductive
children are housed and fed
Children under 15 form 25% of MEDC population and 50% of the LEDC population which
leads to a high dependency ratio of non-workers to workers
Because of the young population, fertility rates are very high and birth rates increase yet
again: healthier, better fed women have a greater capacity to give birth to a healthy
child
After the last ice age, 13,000 years ago, world population was 100 million
By 1790 this had increased to 1.7 billion, and current estimates place world population
at 6 billion - the latest findings show a very rapid decrease in population growth rates to
the point where it is now expected that population will stabilize at about 7.5 billion by
2040, much lower than original estimates of 12 billion by the year 2075
Sub-optimal levels: there is not enough labour to utilize the available resources to the
maximum potential
Above optimal levels: diminishing returns set in as there is too much labour
However, natural resource discoveries and increases in productivity: will increase the
optimal population level
Preference for additional children depends on the number of surviving children and the
costs and benefits of those extra children
Costs are dependent on feeding, clothing and education, plus the opportunity cost of
the mother’s time
Benefits include the need for children to help with the farm or small family business, the
security in old age, and particularly during periods of prolonged sickness
Social security: if there are pensions and support during illness, there is less need for a
large family
Effective birth control: whether through chemical or mechanical means or through birth
spacing through extended breast feeding
Higher female employment and greater schooling for both men and women leads to
lower fertility rates
Meaningful work for women: women have an alternative way of achieving fulfillment in
addition to having children
There are reduced opportunities for children to earn income in urban settings due to
enforced schooling and fewer less skilled jobs, plus the opportunity costs of the parent's
time rises
Higher incomes seem to encourage fewer children with more invested in each child
Mass sterilization: created much hatred and severe backlash
Savings rates rise: families save more and govts. spend less on social services
People invest more in human capital: it is more worthwhile if there are fewer children
and they are likely to live longer
There is more investment in infrastructure
There is less deforestation and erosion of soil
Ecological Footprint
The US with 6% of the population in the world uses 40% of the world’s resources, and
India with 17% of the population uses 4% of the world’s resources
Population densities: Are very low in most African and South American countries, and
are very high in many developed countries
If MEDC populations are adjusted to include their ecological footprint, the real
populations and population densities are even higher:
For the US using 6.7 times the world average of resources per person: 1,900 million
people
For India using 0.25 times the world average of resources per person: 212 million people
Malthusian approach: the law of diminishing returns suggests that the world will run out
of resources in the face of the rapid increase in population
Demographers find that the big increase in population is over - while the long term
effects will lead to increased populations in the future, the growth rate has already
started to stabilize and will reach replacement level by the year 2050
While resources have been fixed, the gains from specialization, economies of scale and
learning by doing have more than outweighed diminishing returns in the last 100 years
There does not appear to be a clear correlation between birth rates and per capita
income - death rates have fallen quite independently of incomes
It appears that a more equitable distribution of income, greater literacy for women, and
more job opportunities for women results in a lower population growth rate
It is estimated that in MEDCs, 27% of the population lives in the rural sector with
possibly as much as 5% involved in agriculture
In LEDCs the figure is 66% living in rural areas, with nearly 70% involved in agriculture
Many of the most severe development problems arise from a weak agricultural sector -
growth through the agriculture sector has not led to increases in per capita income
On the demand side:
The growth potential in the agricultural sector is limited because income elasticity of
demand for food is close to zero, growth is much more rapid for industrial goods and
services.
Primary exports form the major source of foreign exchange earnings for LDCs, and yet
the proportion of primary sector goods in total world trade has fallen from 33% in 1950
to 21% in 1995.
Increased use of machinery and new methods of raising crops have made it possible for
an individual farmer in the US to produce enough food to feed 50 families
Farmers in LEDCs are hard pressed to support one other family beside their own
Severe droughts and famines occur on a regular basis
The oil crisis led to a large increase in energy costs raising the cost of food, while poor
people in urban areas spending 80% of their incomes on food could not afford a 100%
increase in price
Government often imposes price controls which help the urban poor but hurt the
farmers
As government pours money into urban housing, education, food subsidies, health care,
and infrastructure, people migrate to the cities, and then government pours even more
money into the cities to prevent rioting
The official unemployment rate in LEDCs tends to be higher than for MEDCs; however, if
disguised unemployment and underemployment figures are included, there is a very
serious unemployment problem in LEDCs
Disguised unemployment: people are working but producing very little (marginal
product is close to zero), each member of the family is trying to share in the total output
but has very little to add to production
Underemployment occurs where people who would like to work full time only work part
time each week, or for only a few months each year (or work in a job in which they are
overqualified)
Urban Employment
Aid is a poor substitute for trade: opening up MEDC markets to LEDC exports can
enhance the ability of the poor to earn a living and reduce poverty
It is estimated that less than half the aid goes to poor countries, instead it is based on
the military, political and business interests of the donors, a reward to those in power
There has been no significant correlation between the level of aid given to an LEDC and
corresponding growth of GDP
The LEDC government may be forced to change development policies to suit the donor's
ideas:
Loans and grants may be contingent on changes in tax laws, wage and price systems,
food subsidy programs, and whether the money is used for rural or urban development
These ideas may be out of touch with reality and do little to contribute to development
in the country
Aid contributes in direct proportion to the increase in capital investment, but aid does
not appear to have accelerated the growth rates of recipient countries
There is a lack of complementary inputs: human technical skills, administrative capacity,
infrastructure, financial institutions, and political stability
The introduction of hard currency inflows may also lead to increases in consumption
rather than just investment:
It has been persuasively argued that tied aid is not as effective as untied aid:
LEDCs are not able to look for the least expensive goods or services but has to purchase
from the donor country (more expensive)
Creates no employment or extra output in the LEDC, because no expenditure is taking
place there (money is spent on 'foreign experts' and returns to the granting country)
Imports may also replace domestic products, which may further harm domestic
industries (e.g., agricultural aid increasing supply and lowering prices)
May be politically motivated and in fact, no more than a subsidy to industries in the
MEDC
Tied aid has actually been made illegal in some countries (UK 2002)
Famine is often not a result of a lack of food but of the inability to earn enough to pay
for the food:
Aid weariness: some in MEDCs are beginning to think that problems in their own
economies are more important than problems in LEDCs and flows of aid may be reduced
(current recession?)
Politically, very popular in light of continuing allegations of corruption and misspent aid
money
Some evidence that 'targeted' short-term aid can being about limited growth (at least in
a specific sector)
Interventionist nature and seeming violation of state sovereignty an issue with SAP
Critics view some World Bank projects as being imposed upon countries, and not being
requested locally
Large-scale population movements (cultural destruction?) are sometimes required for
dam construction (and dams are expensive with an estimated lifespan of about 25
years)
Construction firms are often from a country that has lobbied for the World Bank loan, so
loan money flows back into an MEDC
There are 35,000 MNCs of which 50% were controlled by US, Japanese, German and
Swiss investors
50% of all industrial production was produced by 100 companies
These 100 companies control 50% of world trade
Studies have indicated that MNC/TNCs are not good at providing jobs:
Local firms are displaced by the MNC/TNC and the displaced firms often have much
higher labour capital ratios
LEDC govts may force the MNC/TNCs to operate in a highly capital intense sector of the
economy such as natural resource extraction and processing requiring massive
investments in sophisticated equipment and machinery:
Labour protection laws: introduced by the government to appease the labour sector
may increase labour costs significantly leading to the substitution of K for L
MNC/TNCs may prefer to take advantage of cheaper labour by using more appropriate
technology but LEDC governments anxious for technology transfer insist on the latest
technology being used, once again this lowers the labour capital ratio
Transfer pricing: the setting of internal prices between branches of an MNC such that goods can
be exported at artificially low prices:
The MNC/TNC raises price in the next country to the market level and takes the profit
there if the taxes are very low, thereby saving on income taxes
This reduces the ability of the host govt. to collect taxes and defrauds them of taxes on
work done in their own country
25% of all trade is between branches of the same MNC company
The highest value added work is done in the countries with the lowest taxes
It is a powerful tool in labour negotiations to demonstrate that the company is losing
money
Foreign enclave: the MNC/TNC can increase the inequality between the rich and the poor by
developing a modern high wage sector
This sector imports luxury goods
Inappropriate goods are marketed in the LEDC
It widens the rural-urban wage gap leading to increased migration
MNC/TNC supporters may influence the government to undertake projects or adopt
policies which are growth rather than development oriented
MNC/TNC Policy
Over time, nations and institutions such as labour unions have developed laws and
agreements to control or balance the excess of private companies
The problem with MNCs is that there is no global government or global union to oppose
or reduce the worst excesses
To achieve their ends LEDC governments may:
Impose a schedule for local value added to be increased and for greater utilization of
local personnel
Impose bans on the import of used capital equipment with an insistence that only the
latest technology be used
Insist on joint ventures with local firms, and ceilings on the repatriation of profits to
encourage or force reinvestment of profits in the local economy
Insist on market pricing rather than transfer pricing on intra firm transactions
Many MNC/TNCs now insist on proper tax payments right from the start:
To provide enough tax revenue for the govt. to build the infrastructure needed to
service the MNC/TNC
To prevent resentment and potential nationalization which can lead to risk and
uncertainty which threaten the long term viability of a project
About 70% of trade is between MEDCs, with the remaining 20% from LEDCs and 10%
from previously centrally planned economies:
Comparative advantage: the potential gains from trade resulting from economies of
scale and lower consumption prices can be of great potential benefit:
Even large LEDCs may have limited domestic markets due to low income
Small economies can achieve economies of scale through access to larger markets
Growth: technology transfer can occur through the importing of capital goods: this can
promote the rapid spread of technology
Learn by doing: best practices in production spread rapidly through trade
Domestic monopoly power can be reduced through international competition
Importance of fostering South-South trade
Foreign enclave: with wealth and income concentrated in the hands of the rich, most
imports could be luxury goods
Countries are assumed to be on their production possibility frontier when in fact most
LEDCs experience high unemployment and underemployment
Technology transfer may be pointless if it is labour saving in countries with high
unemployment rates. What is needed is appropriate technology
Risk of permanently slower growth: specialization may lock the LDCs into low skilled,
labour intense production while MDCs benefit from high tech production
Prices may not reflect opportunity cost but simply manipulation by government and
firms
Taxes, subsidies and the lack of recognition of true social costs (pollution for example)
can lead to serious price distortions
All countries CANNOT find an industry/natural resource to specialize and enjoy
comparative advantage
Markets in MEDCs are not open for exports from LEDCs
Barriers to trade: LEDCs may find that MEDCs have already achieved economies of scale,
and protect their home industries through tariffs and quotas thus effectively blocking
imports from LEDCs
Many LEDCs have turned to other LEDCs for trade opportunities
Displacement of local production: in many LEDCs the production of cheap plastic sandals
can put shoe makers out of work, backward linkages to suppliers of leather, fabric,
glues, polish and packaging materials lead to even more people being put out of work
Gains from trade will benefit foreign owned plants and factories and the profits
repatriated to home countries
High income elasticity for manufactured goods and services means that imports rise
with incomes
Price elasticity of demand for capital goods tends to be low because there are few
substitutes
Devaluation of the currency can actually lead to a larger import bill
Low income elasticity of demand for primary goods, the substitution of synthetic
materials and the dramatic reduction in the weight and bulk of manufactured goods
have all led to virtually no growth in demand
World demand: tends to be inelastic: there are no substitutes for primary goods:
World supply: intense competition amongst LDCs lowers price and total revenue
Devaluation of the currency can actually lead to lower export revenue
In farming: supply shocks due to weather and disease combined with inelastic demand
means farm revenues are very unstable
When demand falls: the manager provides a price floor, buying and storing the excess
supply
When demand rises: the manager sells from storage and uses the profit to pay back the
costs of the buffer stocks
The costs of storage and the interest on the loans to carry the inventory are very
expensive
In mining: shifts in demand for minerals due to MEDC economic cycles combined with
inelastic supply means mineral revenues are very unstable
Trade protection: MEDCs have increased trade protection and subsidies to their own
farmers, effectively blocking imports of food goods from LEDCs
Worsening terms of trade: prices of primary goods has fallen relative to the price of
manufactured goods and services, lowering the gains from trade for the poorest
countries which do not have the means to produce anything but raw materials