Strategies to promote growth and development

A range of strategies may be used to promote growth and development but there is no one simple prescription: each country is individual, having a different history, geography and natural resources. Consequently, policies which may appear to have worked in one country may not be successful in another. In practice, it is likely that a combination of strategies may be required, with the particular blend being dependant on the characteristics needs of the country in question. Various strategies are outline below. As with the previous section, the emphasis is on developing countries, but some of these strategies may be relevant to developed economies.

Aid

The term ‘aid’ is used to describe the voluntary transfer of resources from one country to another or to loans given on concessionary terms i.e. below the market level of interest. Official development assistance relates specifically to aid provided by governments and it excludes aid given by voluntary agencies. Aid may also be given for emergency relief, such as in the case of the recent Japanese earthquake and following tsunami. This kind of aid is usually not contentious and so the focus here is on aid given for more general purposes.

The UN goal for the amount of aid offered by developed countries (agreed in 1970) is 0.7% of GDP.

There are various types of aid:

  • tied aid: this is aid with conditions attached. For example, there might be a requirement to buy goods from the donor country or the aid might be given on the condition that there are economic or political reforms
  • bilateral aid: aid given directly from one country to another
  • multilateral aid: this occurs when countries pay money to an international agency who then distributes it to countries based on certain criteria.

The arguments for aid

These include:

  • the reduction in absolute poverty
  • filling the savings gap
  • providing funds for infrastructure – essential if the country is to industrialise. Aid, therefore will increase AD and investment will have a multiplier effect on GDP. In thern, this will help promote sectoral investment
  • improving human capital through promotion of healthcare, education, training and expertise (e.g. the training of teachers and doctors). In some countries, aid might be used to help the prevention and treatment of aids.
  • aid might contribute to increased globalisation and trade, both of which are frequently associated with growth and development
  • the reduction of world inequality

The arguments against aid

There are powerful arguments against the use of aid, expect in the case of emergency aid, some of which are given below:

  • It results in a dependency culture (i.e the recipients of aid become dependant on it and therefore do not pursue appropriate macroeconomic policies to achieve independent growth and development
  • Aid might not benefit those for whom it is intended (e.g. it could be diverted into military expenditure or it could be lost as a result of corruption)
  • There is no clear evidence that aid contributes to the reduction of absolute poverty or to growth and development
  • Right-wing economists argue that aid distorts marker forces and results in an inefficient allocation of resources, while left-wing economists regard aid as a form of economic imperialism by which donor countries aim to secure political influence over the countries to which they give aid.
  • Aid in the form of concessional loans involves the payment of interest, in which case there will be an opportunity cost for the developing countries.

Debt cancellation

The burden of debt bears heavily on some countries, e.g. the Gambia, Mali, Nicaragua, Bolivia and Malawi.

The debt is usually owed to all or some of the following: the IMF, the World Bank, governments and banks in developed countries.

The problem is that servicing the debt may account for a disproportionate amount of public expenditure, to the extent that resources available for expenditure on health and education are severely limited. As a result, pressure to cancel the debts of the poorest countries has increased. Under the Heavily Indebted Poor Countries (HIPC) initiative and the Multilateral Debt Relief Initiative (MDRI), the World Bank provides debt relief to these countries. The HIPC initiative was started with the aim of reducing the external debts of the poorest and most heavily indebted countries in the world to sustainable levels. Changes were made in 1999 to make the process quicker and deeper and to strengthen the links between debt relief, poverty reduction and social policies. In 2005, the HIPC initiative was enhanced by the MDRI in order to speed up progress in meeting the Millennium Development Goals (MDGs).

The MDRI allows for 100% relief on eligible debts by three international instituations – the World Bank, the IMF and the African Development Fund (AfDF) for countries completing the HIPC initiative process. In addition, in 2007 the Inter-American Development Bank (IaDB) also decided to provide additional (beyond HIPC) relief to the five HIPC in the Western Hemisphere.

Arguments for the cancellation of debt

These arguments include the following:

  • Developing countries would have more foreign currency with which to buy imported capital and goods from developed countries.
  • To the extent that the money release from debt cancellation is used for the purchase of capital goods, then there is the prospect of higher economic growth in the future.
  • In turn, this means that developing countries would be able to buy more goods from richer countries.
  • It would help reduce absolute poverty
  • It would help reduce both the savings gap and the foreign exchange gap
  • It might help to conserve the environment (debt for nature swaps)

Arguments against the cancellation of debt

These arguments include the following:

  • In comparison with aid, it is likely to take much longer to agree a debt cancellation programme.
  • Unless conditions are attached to debt cancellation, there is no guarantee that the government of these countries will peruse sound macroeconomic policies (i.e. there is a moral hazard problem)
  • Corruption might mean that the benefits of debt cancellation are channelled to government officials rather than the poor.
  • Shareholders of banks in the developed world may bear some of the burden of debt cancellation
  • It may be much less effective than the introduction of policies to reduce protectionism in developed countries.

Investment in growth and development

Human capital

Human capital can play a significant role in growth and development. However, evidence suggests that investment in primary education in developing countries yields a higher return than other forms of education

Agriculture

The problem associated with primary product dependency and agriculture in particular, as discussed in a previous article. However, some developing countries have achieved growth and development based on investing in agriculture. The case for focusing on agriculture is that the country may have a comparative advantage in the production of agricultural goods and so resources are more efficiently allocated to that use. Such a comparative advantage should be viewed in a dynamic context (i.e. as the country experiences growth, the government may use its tax revenues to spend on education. As a result of such a dynamic, the country may gain a comparative advantage in other products.

Some countries have specialised in producing agricultural products with a high income elasticity of demand. e.g. Peru produces asparagus, Chile produces blueberries, wine and papaya. Consequently, during periods of economic growth they have benefited from significant increases in demand.

Manufacturing industry 

It has traditionally been assumed that development is synonymous with industrialisation, i.e. that developed requires an increasingly large manufacturing sector. The structural change/dual sector model requires a move away from traditional agriculture (characterised by subsistence, low productivity and barter) to more productive manufacturing (characterised by high productivity and monetary exchange)

Key features of the Lewis model

  • This model describes the transfer of surplus labour from a low productivity (subsistence) agricultural sector to a high productivity industrial sector.
  • Lewis thought that, because of the excess supply of workers, the marginal productivity of agricultural workers might be close to, or at, zero. This is based on the law of diminishing returns.
  • With MP zero, then the opportunity cost of transferring workers from the agricultural to the industrial sector would be zero
  • Industrialisation will be associated with investment (possible from transnational companies), which will increase productivity and profitability. If profits are reinvested, further growth will occur
  • The share of profits as a percentage of GDP will increase, as will the savings ratio, providing more funds for investment and continued economic growth

Criticisms of the Lewis model

  • Profits made in the industrial sector might not be invested locally, especially if  firms are owned by transnational countries.
  • Reinvestment might be made in capital equipment, with the result that extra labour is not required.
  • Empirical evidence suggests that the assumption of surplus labour in the agricultural sector  and full employment of the industrial sector is invalid.
Tourism

Some countries have developed on the basis of investment in tourism. Clearly there are advantages to this strategy over primary product dependency, not least that demand is likely to be income elastic. The expansion of tourism has strong attractions for developing countries.

Advantages of tourism

  • It is a valuable source of foreign currency as tourists spend money on goods and services provided within the local economy.
  • Tourism is likely to attract investment by transnational hotel chains
  • In turn, this will increase GDP via the multiplier
  • Jobs will be created, both as a result of investment in the tourist and leisure industries and also as a result of the multiplier effects in the economy
  • All of the above will help to increase the tax revenues of the government, which may be used to improve public services
  • It can help to preserve the national heritage of the country
  • Improvements in infrastructure may be made, for example, road links to hotels, new airports

Drawbacks of tourism

There are some serious drawbacks associated with tourism:

It may be associated with a significant increase in imports, not only for the capital equipment required to build hotels and facilities but also to meet the demands of tourists for specialised goods, such as food. Further, the balance of payments might be adversely affected by the reparation of profits to shareholders of TNCs.

In times of recession, the fall in demand may be more than proportionate, assuming that demand is income elastic

Employment may only be seasonal in nature. Further, jobs created may be low skilled and low paid if the TNCs provide their own managers and professional staff

Tourism is subject to changes in fashion. In the developed world, Spain has suffered from a significant downturn in tourism in recent years, as Europeans now prefer more exotic locations

There may be significant external costs (e.g. increase in waste, pollution of beaches, water shortages for local people, as the needs of tourists are prioritised. The damage to the environment cause by tourists might result in restrictions (e.g the restrictions on the number of tourists allowed each day to the Galapogos, visitors to Machi Picchu are limited by the requirement to have a guide)

Inward-looking/outward-looking strategies

Te strategies adopted by countries to construct a path towards diversification and industrialisation have taken a variety of forms.

Inward looking strategies are characterised by:

  • import substitution (i.e. replacement of imports with domestically produced manufactured goods)
  • protectionism

The aim of inward-looking strategies is to enable a country to diversify in a controlled way until it has built a strong domestic base. Clearly, this approach will be most effective where a country’s domestic market is large enough to enable industries to benefit from economies of scale. Once achieved, industry will be strong enough to cope with foreign competition.

However, there are some drawbacks to this approach:

  • comparative advantage is distorted and so resources will not be allocated effectively
  • the lack of competition could result in inefficiency

In contrast, outward looking strategies are characterised by:

  • free trade
  • deregulation of capital markets
  • promotion of foreign direct investment
  • devaluation of exchange rates

The disadvantages of these policies have been considered in previous articles. In practice, many countries have used a combination of strategies.

Interventionist approaches

For at least 30 years after the Second World War, most developing countries experienced significant degrees of government intervention. This approach was characterised by the following:

  • import substitution policies
  • nationalisation
  • farmers forced to sell their produce to state controlled boards at low prices
  • price subsidies on many goods regarded as necessities
  • over-valued exchange rates (aimed at keeping down the cost of imports)

By the end of the 1970s, there was increasing disillusion with such interventionist policies, which were associated with:

  • low rates of economic growth
  • resource and allocative inefficiency because of the absence of the profit motive
  • government failure
  • corruption by civil servants associated with increased government intervention
  • increasing fiscal deficits (associated with subsidies and nationalised industries)
  • increasing balance of payments deficits on current account (associated with over-valued currencies)

Free-market approaches

The perceived failure of interventionist strategies and the election of right-wing governments in the USA and the UK resulted in the adoption of free-market and outward-looking strategies. The key components of these strategies are:

free market analysis: assumes markets are efficient and therefore the best way to allocate resources

public choice theory: based on the assumption that politicians, civil servants and governments use their power for their own self-interest

In particular the free market approach is characterised by:

  • trade liberalisation
  • market liberalisation
  • supply-side policies
  • structural adjustment programmes

Since the turn of the decade, there has been some modification of this approach in recognition of the fact that imperfections exist in product and labour markets, for example:

  • asymmetric information
  • externalities
  • absence of property rights
  • investment decisions

There is therefore a need for governments to intervene in a market-friendly way (e.g. by developing in infrastructure, education, health) and to provide a favourable climate for enterprise.

Microfinance

Microfinance is a means of providing extremely poor families with small loans (microcredit) to help them engage in productive activites or grow their tiny businesses. In particular, it can help the poor to increase income, build business and therefore save more, and reduce vulnerability to external shocks.

The pioneer of microfinance was Mohammed Yunus, who established Grameen Bank in Bangladesh.

  • The key features of microfinance schemes are as follows:
  • In contrast to developed lending, microcredit inisits on repayment
  • Interest is charged to cover the costs involved
  • The focus is on groups whose alternative source of finance are limited to the informal sector, where the interest charged would be prohibitively high

The main clients of microfinance are:

  • women, who form 97% of the clients
  • the self-employed, often household based entrepreneurs
  • small farmers in rural areas
  • small shopkeepers, street vendors ans service providers in urban areas

Criticisms of microfinance

Concerns have been raised about the repayment rate, collection methods and questionable accounting practices.

On a larger scale, some argue that an overemphasis on microfinance to combat poverty will lead to a reduction of other assistance to the poor, such as official development assistance  or aid from NGOs.

Fair trade

The aim of fair trade schemes is to address ‘the injustice of low prices’ by guaranteeing that producers receive a fair price. It means paying producers an above-market price for their produce, provided they meet particular labour and productive standards. This premium is passed back to the producers to spend on development programmes.

The market for fair-trade products has been growing rapidly, and there are now over 2,500 product lines

Benefits of fair-trade schemes

  • Producers receive a higher price
  • Extra money is available to spend on education, health, infrastructure clean water, conversion to organic farming and other development programmes in the producer’s country
  • There are smaller price fluctuations, allowing producers to be shielded from market forces.
  • The extra money can be used to improve the quality of the products
  • Producers are enabled to diversify their products

Criticisms of fair trade

  • Distortion of market forces: low prices are due to overproduction and producers ought to recognise this a signal to switch to other crops. Further, the artificially high price encourages more producers to enter the market, driving down individual supernormal profits which will limit the money available for investment
  • Certification is based on normative views on the best way to organise labour, for example, in the case of coffee, certification is only available to cooperatives of small producers.
  • Guaranteeing a minimum price provides no incentive to improve quality
  • It is an inefficient way to get money to poor producers: consumers pay a large premium for fair trade goods, but much of this goes to the supermarkets in profits.
  • It may create a dependency trap for producers.

The role of international financial institutions

The International Monetary Fund

The original role of the IMF was to increase liquidity and to provide stability in capital markets through a system of convertible currencies pegged to the dollar. It also lent to countries with temporary balance of payments deficits on current account

In the 1970s, there were significant oil price shocks and many countries – especially developing countries – suffered as a result of rapid inflation, huge balance of payments deficits and deb crises. As a result, most currencies were allowed to float (i.e. the peg to the dollar was broken). The IMF extended its role to include involvement in economic development and poverty reduction. To ensure repayment of loans, the IMF imposed restrictions on conditions on the economic policies to be followed by developing countries – stability programmes – to achieve internal and external balance. In practice, these were similar to structural reduction programmes.

In 2006, the IMF was given a new role – to conduct multilateral surveilance of the global economy and to suggest steps that the leading nations should take to promote it. It was also required to ensure more balanced growth and to reduce global imbalances.

In 2009, the G20 summit authorised the IMF to issue $250bn in new special drawing rights (SDRs). An SDR is sometimes referred to as the IMF’s currency but it is, in fact, the IMF’s unit of account.

The value of an SDR is defined as the value of a fixed amount of yen, dollars, pounds and euros, expressed in dollars at the current foreign exchange. These SDRs represent a potential claim on other country’s reserves, for which they can be exchanged for voluntarily. On the other hand, countries with high foreign currency reserves can buy SDRs from countries that require hard currency.

The International Bank for Reconstruction and Revelopment (IBRD)

More commonly known as the World Bank, its original role was to provide long-term loans for reconstruction and development to nations that has suffered in the Second World War.

In the 1970s, its role changed to setting up agricultural reforms in developing countries, giving loans and providing expertise.

In 1982, Mexico defaulted on its loan repayments. As a result the World Bank now imposes structural adjustment programmes (SAPs), which set out the conditions on which loans are given. The aim is to ensure the debtor countries do not default on the payment of debts.

SAPs were base on free market reforms, (e.g trade liberalisation, removal of state subsidies on food, privatisation and reduction in public expenditure to reduce budget deficits) However, these free market reforms were criticized because they:

  • did little to help the world’s poor
  • failed to promote development
  • increased inequality
  • caused environmental degradation
  • resulte in social and politcal chaos in many countries

The widespread criticism of SAPs and the devastating effect which they had on some developing countries resulted in the World Bank changing its focus to concentrate on poverty reduction strategies, with aid being directed towards:

  • countries following sound economic practices
  • healthcare; broadening education
  • local communities rather than central government

The future of the IMF and the World Bank

The roles of the IMF and the World Bank are currently blurred: both have a role in the developing world and in poverty reduction and it is suggested that they should be reformed to reflect the changing needs of the global economy. Critics of the institutions as they currently operate suggest the following:

  • The IMF should be slimmed down and should undertake short-term lending to crisis-hit countries
  • The World Bank should act as a development agency and undertake credit appraisal of the creditworthiness of recipient countries

The role of non-governmental organisations

The work of NGOs has bought community based development to the forefront of strategies to promote growth and development (i.e. the focus has moved away from state managed schemes). The key characteristics of community-based schemes are:

  • local control of small scale projects
  • self relience
  • emphasis on using the skills avalible
  • environmental sustainablity
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