Consequences of Economic Growth and Development

In this chapter we consider some of the costs and benefits from expanding levels of production and consumption. In particular we focus on the idea of sustainability. Benefits of Economic Growth Growth has a number of economic and social benefits:
UK Economic Growth and Unemployment
Annual percentage change in GDP at constant prices, percentage unemployed

12.5
Unemployment (LFS measure)

12.5

10.0

10.0

7.5

7.5

Percent

5.0

5.0

2.5

2.5

0.0

0.0

-2.5
Real GDP (Annual % Change)

-2.5

-5.0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

-5.0

Source: UK Statistics Commission

Improvements in living standards: Growth is an important avenue through which per capita incomes can rise and absolute poverty can be reduced in developing nations. More jobs: Growth creates new jobs e.g. a sustained growth lead to a halving of the rate of unemployment in the UK from 1993 through to 2007. Recession has reversed this trend. The accelerator effect of growth on capital investment: Rising demand and output encourages investment in capital this helps to sustain GDP growth by increasing LRAS. Greater business confidence: Growth has a positive impact on profits & business confidence The fiscal dividend: A growing economy boosts the tax revenues flowing into the government and generates the money to finance spending on public and merit goods and services without having to raise tax rates. Potential environmental benefits as countries grow richer, they have more resources available to invest in cleaner technologies. And, as nations move to later stages of development, energy intensity levels fall.

Disadvantages of Growth Economic growth does not come risk-free. Although our material progress can be measured in part by the growth of national output, income and spending, if the economy grows too quickly, it can bring about many short and long-term problems. Inflation risks: There is the danger of demand-pull and cost-push inflation if AD grows faster than productive potential Rising inflation can be destabilizing because it puts pressure on interest rates to rise and businesses lose competitiveness in international markets The environment: Growth cannot be separated from its environmental impact not least the connection to man-made climate change. A rapid growth of production and consumption can create negative externalities such as waste, CO2 emissions and increased noise and air pollution and road congestion. Inequality: Not all of the benefits of growth are evenly distributed. A rise in real GDP can often be accompanied by widening income and wealth inequality in society that is reflected in an increase in relative poverty. The Gini coefficient is one way to measure the inequalities in the distribution of income and wealth in different countries. The higher the value for the Gini co-efficient (the maximum value is 1), then greater the inequality. Countries such as Japan, Denmark and Sweden typically have low values for the Gini coefficients whereas African and South American countries have an enormous gulf between the incomes of the richest and the poorest elements of the population. A good example of the uneven spread of the benefits from growth is the enormous wealth gap in China. Regional disparities: Growth is rarely balanced between regions and across industries and sectors. A recent report from the Centre for Cities highlighted the divide between economic growth rates in cities and regions of the UK.

Developing Countries Consumer Price Inflation

Annual % change in consumer prices, source: IMF data
110 100 90 80 70 110 100 90 80 70 60 50 40 30 20 10 0 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 ar 1 year
Source: Reuters EcoWin

Percent

60 50 40 30 20 10 0

Population Policies
Indian Population (top pane) and Population Growth (bottom pane)
1.175 1.150 1.175 1.150 1.125

Person (billions)

1.125 1.100 1.075 1.050 1.025 1.000 2.1 2.0 1.9

1.075 1.050 1.025 1.000 2.1 2.0 1.9 1.8 1.7 1.6 1.5 1.4 00 01 02 03 04 05 06 07 08

Percent

1.8 1.7 1.6 1.5 1.4

Population, all India

Population, Chg Y/Y

Source: Reuters EcoWin

Governments can attempt to slow down population growth to match economic growth thus raising standard of living. Possible policies include: 1. Education programmes 2. Family planning clinics offering contraception and advice 3. Disincentives to have lots of children. China has legislated against having too many children fines are equal to ten times the average per capita income whilst Singapore only offers free education and healthcare to the first two children. 4. Introduce state pensions, so people dont feel they need to have lots of children to support them in their retirement. But this requires taxation a dilemma facing developed and developing economies alike. 5. Change the status of women. Improving womens education and job prospects will mean that they assign a higher opportunity cost to having children. Rural-Urban Migration Issues Rural-urban migration was originally viewed as beneficial, since it aided structural change (as argued in the Lewis model). The process accelerated in the second half of the twentieth century and into the first ten years of the twenty-first century. Rural people migrate into the cities in search of better wages, the chance of a better education and healthcare, and because of other social attractions. The results, though, are often far from beneficial; cities simply cannot absorb floods of rural migrants without a substantial reduction in standard of living.

billions

1.100

The Challenge of Population Shift for China

Mid year population, billions of people 1.4 1.3 1.2 1.1 1.0 1.4 1.3 1.2 1.1 1.0 Rural population 0.9 0.8 0.7 0.6 0.5 Urban population 0.4 0.3 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 0.4 0.3

Total

People (billions)

0.8 0.7 0.6 0.5

Source: Reuters EcoWin

Problems: Overcrowding and homelessness in the cities The emergence of shanty towns Increased crime Increased pollution Increased congestion Qualification inflation with such a large pool of unemployed workers to choose from, employers often set absurdly high requirements for menial jobs in order to reduce the number of applications. Significant expansion of the informal economy

Essentially, the main cities in developing economies have simply not been prepared for the huge influx of rural migrants over the past decade or so. Governments were unprepared for the huge strain on urban water supplies and sanitation. Existing property laws in some countries mean that much urban housing is illegal, rendering occupants ineligible for government services. Pollution, overcrowding, dirty water and inadequate sanitation facilities are serious health hazards for the millions of people exposed to them. Conditions in large cities throughout the developing world are often ripe for disease, epidemics and health crises. Congestion and pollution emissions are also bad news for the environment. The most effective way to combat excessive migration is to pursue policies aimed at developing the rural areas. Making life better in rural areas should help to remove the incentive to migrate to the cities. 1. Encourage the use of labour-intensive production methods in rural areas using appropriate intermediate technology. This should increase both employment and output in rural areas.

billions

0.9

2. Improve the social and physical infrastructure in rural areas schools, hospitals, roads, electricity. Such provisions go a long way to making peoples lives easier. 3. Awareness. Make rural people aware of the problems associated with living in the cities. People are less likely to move if they recognise that life in the city may in fact be worse than rural life.
China's Urban Population and Unemployment
Population (top pane) and Unemployment (bottom pane) 600 575 550 525 500 475 450 425 400 375 350 4.50 4.25 4.00 600 575 550 525 500 475 450 425 400 375 350

Person (millions)

4.50 4.25 4.00 3.75 3.50 3.25 3.00 2.75 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Percent

3.75 3.50 3.25 3.00 2.75

Population, urban, total

Unemployment, Urban area, rate

Source: Reuters EcoWin

Aid Issues Aid essentially involves international financial institutions or rich countries giving or loaning resources to developing countries. It sounds like a good idea on the face of it but there are some important drawbacks to take into consideration in an exam answer. Types of aid: 1. Bilateral: an agreement between 2 countries 2. Multi-lateral: joint assistance, for example from the EU or the United Nations 3. Tied aid: specific conditions attached, such as an obligation for the recipient to buy goods from the donor 4. Untied aid: no strings attached! Unfortunately, this doesnt happen often. 5. Loans: must be repaid 6. Grants: no repayment necessary Should rich (advanced) countries give aid to poorer ones? Yes if: Its used to increase the countrys productive capacity (e.g. buying capital); the benefits of extra production are likely to be widely spread, thus decreasing poverty, inequality and unemployment It represents an injection of resources, which can facilitate investment and therefore growth [see the Harrod-Domar model]

millions

 No if:

It helps the transmission of new ideas and promotes innovation and invention

Its frittered away on current consumption Its spent on inappropriate, labour-saving capital which does not create employment or increase wages It is spent on showcase infrastructure projects for which there is no real demand, such as international airports It leads to dependency It is in the form of free or cheap food, which lowers prices for local farmers The right social, political, institutional and cultural conditions are not in place The funds are intercepted by corrupt politicians The aid flows are unsustainable

Debt cancellation Most developing countries are saddled with large amounts of debt which they have huge difficulty repaying. There are some very strong moral arguments for cancelling such debts; but again, there is another side to the argument. Debt cancellation diverts funds from future investment in less developed countries Decreasing debt does not necessarily decrease poverty. The extra funds may well be misused by government, and the benefits may not be evenly distributed amongst the population Loans impose discipline on developing countries; cancellation could encourage reckless borrowing

Different types of capitalism Free market economies come in different shades. Different societies and economies have developed their own brands of capitalism. The Swedish model is different to the American. The German one is distinct from the Korean type. What are they key differences between them? One simple way to differentiate economies is by the degree of government intervention in the economy. One way to measure this might be through the proportion of GDP taken as tax revenues by the state. With the figure in Britain around 40% (and the rich world average typically between 30% and 50%) you might describe Britain as a mixed economy, suggesting that resource allocation decisions are made by a blend of government intervention and free markets. But this would also describe just about everyone else too. Using the label mixed economy to describe almost every economy suggests that it isnt really a very good label. The problem gets bigger when you consider the dramatic changes in the world economy since the collapse of command or planned economies such as the Soviet Union in 1991. What of these economies, and the emerging giants of Brazil, India and China?

How can these different brands of capitalism be compared? Then there are the other emerging or (submerging) economies that vie for our attention, ranging from Nigeria to Nepal. They come in so many stripes that many economists have been looking for more powerful ways to compare similarities and differences between them In their 2007 book, Good Capitalism, Bad Capitalism and the Economics of Prosperity and Growth, Baumol, Litan and Schramm try to crack the puzzle by describing economies as falling in to four broad groupings. They observe that most economies show characteristics of at least two of four different flavours of capitalism. They then make observations of which types of economy tend to generate the fastest and most effective routes to prosperity. What were their main conclusions? Prosperity and growth were best promoted in those economies with the strongest blend of entrepreneurial and big firm capitalism. These are the forms seen least often in the developing world. What are the implications of this research in our fast changing world? Will globalisation and capitalism march onwards and those economies that remain open, competitive and entrepreneurial grow the fastest? Or is the tide turning from free trade towards more inward focussed, even protectionist economies with strongly interventionist governments? Although most world leaders at global summits pledge a commitment to remain open, tough times at home often make it politically desirable to close ranks around powerful domestic interest groups oligarchies and use the powers of the state to direct investment. Source: Tom White, EconoMax Free market approaches to economic development: This approach is often epitomised by the so-called Washington Consensus (subject to many criticisms!) 1. Strong focus on cutting the size of the government sector and keeping household and business taxes low as a share of GDP 2. Emphasises importance of incentives to work, invest and employ people 3. Key role for the state and legal system to protect private property rights importance of strong and good governance to attract inflows of foreign capital 4. Underlying belief in the power of free market forces and the profit motive to drive the allocation of scarce resourced among competing 5. Belief in the trickle down effect whereby rising national wealth filters down in the form of higher per capital incomes and household spending. Free market approach believes that freely functioning markets offer the best hope for economic efficiency and rising competition, productivity, profits and investment. Criticisms of the free market approach: 1. Extensive market failures resulting from unfettered competition 2. Unsustainable nature of fast growth driven by rising investment and consumption 3. Inequities of the world financial and global trading system resulting in a widening scale of relative poverty within the world economy and increasing relative poverty within many developing nations

4. Rising inequality threatens social cohesion and creates enormous economic and social costs 5. The process of establishing a market system often involves radical reform that produces both winners and losers. Often the burden of adjustment falls unequally on society. For example: 6. Destabilising effects of privatisation, deregulation and liberalisation of global finance reflected with the global credit crunch which has caused net capital flows to some of the worlds most vulnerable countries to dry up / be reversed 7. Threats to the global commons from permanent environmental damage failure of free markets and their agents to respond to this 8. Exploitation and discrimination of workers e.g. employed for MNCs in sweatshop conditions 9. Erosion of national culture and identity Overview of development strategies
Developing Countries Trade
Annual value of exports and imports, US $ trillion 7 7

US Dollars (thousand billions)

0 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Export, EXPORTS,F.O.B.

Imports, IMPORTS,C.I.F.
Source: Reuters EcoWin

Domestic policies to promote development 1. Resource improvement and management: I.e. improve the productivity of the agricultural sector, by using modern products and techniques. Fertilisers, pesticides, GM crops, irrigation and crop rotation schemes will all make the primary sector more efficient. But this is easier said than done a. Agricultural prices should be allowed to rise, to act as an incentive for farmers to be more efficient. This means withdrawing subsidies which is politically unpopular. b. Increased food prices will lead workers to demand higher wages. This will increase firms costs, reduce competitiveness and perhaps also contribute to inflation. c. Pursuing exports might cause domestic food shortages

thousand billions

d. Taxing farmers as agricultural incomes increase may provide a wider tax base for the government, but it will also be a disincentive for farmers. 2. Policies to improve the functioning of financial markets: a. If a country lacks a good financial infrastructure (i.e. banks, savings organisations, a stock exchange and the like), it is difficult to channel savings into investment b. Informal financial markets may appear. Informal money lenders can charge extortionate interest rates to vulnerable borrowers. c. There are often no credit facilities available in rural areas. d. The expansion of micro-finance programmes has helped to resolve some of these issues. 3. Import substitution: a. In order for an economy to established and develop infant industries, it is generally accepted that these industries initially need to be protected by import tariffs. Infant industries provide the capability for a developing economy to adopt a policy of import substitution. The idea is to domestically produce what was previously imported from elsewhere. b. There are some economically sound reasons for doing this; producing rather than importing will save valuable foreign exchange and ease the balance of payments deficit that most poor countries have. Moreover, there is obviously a ready-made market for the product, because people are already buying it from abroad. In theory, new firms would start by importing investment goods [machinery], intermediate goods [raw materials], and expertise. c. Once off the ground, the industry would be able to import capital goods to make all the necessary machinery themselves. The government would remove the tariffs once the industry was ready to compete with producers from around the world. d. Import substitution has usually failed because: i. Governments have interfered too much ii. Firms have suffered from a shortage of foreign exchange (needed to buy raw materials) iii. Firms have tried to use inappropriate technology that needed foreign expertise; remember that developing countries often have a comparative advantage in labour-intensive production. iv. Tariffs have allowed the industries to carry on producing at high costs, with no incentive to strive for greater efficiency and productivity.

Is the Chinese Export Boom Over?

Monthly value of exports of selected products, $ billion 80 80

70

70

60

60

50

Mechanical and electrical products

50

USD (billions)

40

40

30

30

20

20

10

High and new-tech products

10

0 Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May 09 08 07 06 05 04 03 02 Mechanical and electrical products High-and-new-tech products

Source: Reuters EcoWin

4. Export promotion: a. This was the approach adopted by the Asian Tiger economies in their expansion of hi-tech manufacturing industries. Countries try to find markets in which they can make use of their comparative advantages and sell their products to buyers elsewhere in the world. i. Production centred on labour-intensive technologies (for the comparative advantage!) ii. Industry made up of private-sector firms driven by the profit motive iii. Government provides incentives for firms to export iv. The exchange rate may be manipulated to keep the export sectors competitive in overseas markets
Exports and Imports for Oil Exporting Countries
Annual value of trade, $trillion 1.0 0.9 0.8 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

US Dollars (thousand billions)

0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 70

Export, EXPORTS,F.O.B., OEY

Imports, IMPORTS,C.I.F., USD

Source: Reuters EcoWin

5. Population Control see section on population

thousand billions

billions

6. Macroeconomic stabilisation: Reduce inflation, balance the government budget, and achieve balance of payments equilibrium. See the separate revision note on macroeconomic stabilisation. 7. Policies to attract inward investment: a. Foreign Direct Investment involves a multi-national corporation building a manufacturing plant, or other physical investment, in the economy in question. Such investment will undoubtedly bring benefits for the selected country; but there are also some serious drawbacks which must be taken into account in evaluating the desirability of FDI. b. Benefits: i. FDI can help to plug the savings gap the difference between the level of savings and the amount of investment needed. ii. The MNC will import valuable foreign exchange into the country iii. A large amount of jobs can be created directly iv. But employment will also be created indirectly, through the multipliereffect. v. MNCs can introduce new technology and educate their workers as to its use vi. If profitable, they generate valuable tax revenue for the government c. Drawbacks i. MNCs tend to invest in urban areas. This widens the gap between urban and rural incomes and aggravates the problem of rural-urban migration ii. Many MNCs have been accused of exploiting their workforces. For example, they may force workers to work in unsafe, or simply miserable, conditions; they may employ children, and pay shockingly low wages (by Western standards). iii. MNCs are also accused of exploiting local environments, by polluting air and rivers, cutting down rainforests, or by reducing biodiversity. See revision note on environment and sustainability iv. Finally, MNCs often use inappropriate, capital-intensive production methods, thus preventing countries from exercising their comparative advantages in labour-intensive industries. The World Bank The World Bank ("WB") (or International Bank for Reconstruction and Development (IBRD) was established to promote post-war reconstruction and the flow of capital to developing countries. Its 181 member countries own it. The WB promotes the institutional, structural and social development of LDC's by: (1) Providing low interest loans for domestic investment projects, and (2) Technical assistance The WB comprises several separate institutions; the two main ones are described briefly below:

The International Finance Corporation (IFC) is the private sector arm of the World Bank that: (1) Finances private sector projects in LDC's (2) Helps private companies in the LDC raise finance in international financial markets and (3) Offers advice The International Development Association (IDA) provides long-term loans at zero interest to the poorest LDC's (<$875 per capita income) for projects that address peoples' basic needs e.g. primary education, basic health services; clean water and sanitation. How does the World Bank raise and use its funds? The WB raises most of its funds on the world's financial markets and makes long-term large loans to middle-income and creditworthy poorer countries. Funds are used for large scale development projects. IDA is funded largely by contributions from the governments and lends to the poorest LDCS who lack of creditworthiness to borrow from the WB. Funds are used for basic projects. The WB uses: 1. A Comprehensive Development Framework (CDF) sets out country-driven mechanisms for development stakeholders to reach consensus 2. Poverty Reduction Strategy (PRSP) translates CDF into action. PRS outlines a three-year adjustment programs that include objectives, macroeconomic, structural, and social policy strategies, and loan needs. The WB works jointly with the IMF on PRS 3. Country Assistance Strategy (CAS) sets out the level of WB financial and technical assistance for a country. Civic society must be consulted.