Assignment no #1 (economic )

Submitted by: jehanzeb khan

Submitted to: sir laeeq ur rehman
Date of submission : 21 april, 2020.

Bs applied psychology GCUF

QNO#1:Discuss economic growth and economic development ?
ANS:

Gross domestic product is the best way to measure economic growth. It takes into
account the country's entire economic output. It includes all goods and services that
businesses in the country produce for sale. It doesn't matter whether they are sold
domestically or overseas.

GDP measures final production. It doesn't include the parts that are manufactured to
make a product. It includes exports because they are produced in the
country. Imports are subtracted from economic growth.

Most countries measure economic growth each quarter.

The most accurate measurement of growth is real GDP. It removes the effects of

inflation. The GDP growth rate uses real GDP.

The World Bank uses gross national income instead of GDP to measure growth. It

includes income sent back by citizens who are working overseas. It's a critical source of
income for many emerging market countries like Mexico. Comparisons of GDP by
country will understate the size of these countries' economies.

GDP doesn't include unpaid services. It leaves out child care, unpaid volunteer work, or
illegal black-market activities. It doesn't count the environmental costs. For example, the
price of plastic is cheap because it doesn't include the cost of disposal. As a result, GDP
doesn't measure how these costs impact the well-being of society. A country will
improve its standard of living when it factors in environmental costs. A society only
measures what it values. 

Similarly, societies only value what they measure. For example, Nordic countries rank
high in the World Economic Forum's Global Competitiveness Report.1  Their budgets
focus on the drivers of economic growth. These are world-class education, social
programs, and a high standard of living. These factors create a skilled and
motivated workforce.

These countries have a high tax rate. But they use the revenues to invest in the long-
term building blocks of economic growth. Riane Eisler's book, “The Real Wealth of
Nations,” proposes changes to the U.S. economic system by giving value to activities at
the individual, societal, and environmental levels.

This economic policy contrasts with that of the United States. It uses debt to finance
short-term growth through boosting consumer and military spending. That's because
these activities do show up in GDP. 

The Phases of Economic Growth

Analysts watch economic growth to discover what stage of the bussiness cycle  the
economy is in. The best phase is expansion . This is when the economy is growing in a
sustainable fashion. If growth is too far beyond a healthy growth rate, it overheats. That
creates an asset bubble . This is what happened to the housing sector in 2005-2006. As
too much money chases too few goods and services, inflation  kicks in. This is the
"peak" phase in the business cycle.

At some point, confidence in economic growth dissipates. When more people sell than
buy, the economy contracts. When that phase of the business cycle continues, it
becomes a recession . An economic depression is a recession that lasts for a decade.
The only time this happened was during the Great Depression of 1929.

The chart below shows the different phases of the U.S. economy since Q4 of 2005 up til
Q4 of 2018. You might have heard the term in an introductory class to economics,
or maybe you’ve seen it in passing on the doors of offices around town: economic
development.

It sounds like an area of economics meant for business people or investors, related
to growing profits. But economic development is actually something more,
requiring input from social workers just as much as business leaders.
 Economic Development :
Economic and social development, as a public sector term, is the process by which
the economic well-being and quality of life of a nation, region or local community
are improved according to targeted goals and objectives.

The term has been used frequently in the 20th and 21st centuries, but the concept
has existed in the West for centuries. "Modernization", "Westernization", and
especially "industrialization" are other terms often used while discussing economic
development.

Whereas economic development is a policy intervention endeavor aiming to

improve the well-being of people, economic growth is a phenomenon of market
productivity and rise in GDP. Consequently, as economist Amartya Sen points out,
"economic growth is one aspect of the process of economic development". But
what do practitioners say about this term? Economists study the broader economy
or the commercial economy, they do not study the practice of economic
development as carried out by practitioners such as those in the Community
Economic Development field, who focus on socio-economic development as well.

The precise definition of economic development has been contested: while

economists in the 20th century viewed development primarily in terms of
economic growth, sociologists instead emphasized broader processes of change
and modernization. Development and urban studies scholar Karl Seidman
summarizes economic development as "a process of creating and utilizing
physical, human, financial, and social assets to generate improved and broadly
shared economic well-being and quality of life for a community or region”.
Daphne Greenwood and Richard Holt distinguish economic development from
economic growth on the basis that economic development is a "broadly based and
sustainable increase in the overall standard of living for individuals within a
community", and measures of growth such as per capita income do not necessarily
correlate with improvements in quality of life.Economic development is a wider
concept and has qualitative dimensions. Economic development implies economic
growth plus progressive changes in certain important variables which determine
well-being of the people, e.g: health, education. The University of Iowa's Center
for International Finance and Development states that:

'Economic development' is a term that practitioners, economists, politicians, and

others have used frequently in the 20th century. The concept, however, has been in
existence in the West for centuries. Modernization, Westernization, and especially
Industrialization are other terms people have used while discussing economic
development. Economic development has a direct relationship with the
environment.

Though the concept's origin is uncertain, some scholars argue that development is
closely bound up with the evolution of capitalism and the demise of feudalism.
Others link it to the postcolonial state.

Mansell and Wehn also state that economic development has been understood by
non-practitioners since the World War II to involve economic growth, namely the
increases in per capita income, and (if currently absent) the attainment of a
standard of living equivalent to that of industrialized countries. Economic
development can also be considered as a static theory that documents the state of
an economy at a certain time. According to Schumpeter and Backhaus (2003), the
changes in this equilibrium state to document in economic theory can only be
caused by intervening factors coming from the outside.

QNO#2 What are are developing economies . discuss in detail characteristic of

developing economies ?

ANS:

Developing Economy:
I have running water and access
to electricity in my house. Does
that make my own economy developed? How about if I have several major industries
working within twenty miles of me? No one really has a definition for what a developing
economy is. The United Nations, for instance, has stated there is no objective way of
defining the term.
As a rule, though, a developing economy is one where people have a lower standard
of living and less developed industries than other countries. However, it's all relative.
Nineteenth-century Britain was the most developed country in the world, but if you put it
into the modern world it might be considered a developing economy .
ECONOMIC DEVELOPMENT IS NOT ECONOMIC GROWTH

It’s easy to confuse development with growth, considering they have similar
meanings and are often used interchangeably. Add the fact that economic growth is
an important part of economic development, and you might feel like the room is
spinning trying to understand it all.

Economic growth is all about numbers. As the aptly named Keydifferences.com

points out: “Economic Growth is the positive change in the real output of the
country in a particular span of time.”

Economic growth is a straightforward measurement of actual economic output —

things like gross domestic product (GDP) fall into this measurement. It’s a pure
numbers game.

But economic development is much broader in scope and includes elements that
you might not normally associate with economics, like social welfare, early
childhood education, and criminal justice reform.

THE GOAL OF ECONOMIC DEVELOPMENT

Economic development is defined by Wikipedia as “the process by which a nation

improves the economic, political, and social well-being of its people.” Like we
said, it’s a broad scope.

But this definition doesn’t tell us much about the nuts and bolts of economic
development and how it can effect change in a positive way on a big scale.

Because the scope is so broad, it can be difficult to discern what the tangible goals
of economic development are. Amy Liu, writing for the Brookings Institute, argues
that the goal for economic development should be “to put a region on a path to
higher growth by improving the productivity of firms and people in ways that leads
to better incomes and living standards for all.”

The end game of economic development is not just growing the economy, but
growing it in a way that improves the quality of life for everyone in the region.
Rather than projects benefitting a few investors, a successful economic
development project would benefit investors, companies and people in need of
economic relief. By doing so, there is also a positive effect on the region and
indirectly business and citizens who live there.

This means a focus on innovation, skills and infrastructure, as well as overall

economic growth.

HOW ECONOMIC DEVELOPMENT WORKS

Now we know that the goal of economic development is to improve the well-being
of everyone, regardless of race, background or class, but how does it actually
work?

As Britannica.com points out, there is no single definition of what constitutes the

process of economic development. But there are key indicators and learnings that
have shown success.

It might sound like a pretty big project to try to improve the social and political
well-being of a country through economic strategies, and it is. That’s why it’s
important to not try to solve it all at a national or international level, but at the local
and regional levels.

As Michael Porter, a professor at the Harvard Business School, puts it: “While
macro policies and regulatory reforms set important conditions for growth and
access to opportunity, it is ultimately the role of local and regional actors and
institutions to address the unique market failures and opportunities in their
community.”

This is why local and regional economic development organizations are so vital.
Every metropolitan area has its own unique set of circumstances, and there’s no
blanket approach that will work across the diverse economic landscape of a
country like the United States (or anywhere else, for that matter).

Denver’s challenges in providing affordable housing, for example, are going to be

much different than in New York City. Construction costs are different, timelines
will vary based on weather, and managing relationships between private and public
sectors will be subject to unique regional policies.
 Characteristic:
1. Low per capita real income:
Low per capita real income is one of the most defining characteristics of
developing economies. They suffer from low per capita real income level,
which results in low savings and low investments.
It means the average person doesn’t earn enough money to invest or save
money. They spend whatever they make. Thus, it creates a cycle of
poverty that most of the population struggles to escape. The percentage of
people in absolute poverty (the minimum income level) is high in
developing countries.
2. High population growth rate/size:
Another common characteristic of developing countries is that they either
have high population growth rates or large populations. Often, this is
because of a lack of family planning options, lack of sex education and the
belief that more children could result in a higher labor force for the family to
earn income. This increase in recent decades could be because of higher
birth rates and reduced death rates through improved health care.
3. High rates of unemployment:
In rural areas, unemployment suffers from large seasonal variations.
However, unemployment is a more complex problem requiring policies
beyond traditional fixes.
4. Dependence on primary sector:
Almost 75% of the population of low-income countries is rurally based. As
income levels rise, the structure of demand changes, which leads to a rise
in the manufacturing sector and then the services sector.

5. Dependence on exports of primary commodities:

Since a significant portion of output originates from the primary sector, a
large portion of exports is also from the primary sector. For
example, copper accounts for two-thirds of Zambia’s exports.

QNO#3:Discuss economic and non economic obstacles to economic

development of Pakistan suggest remedial measure ?

ANS:
 Pakistan inherited an extremely narrow economic base at the time of Partition
in 1947 Since then, the Government of Pakistan is making rigorous efforts to build up
infrastructure and productive potential of the economy through the process of
development planning. The start for preparing the country for future advancement was
made by launching a Six Year Development Programmer (1951-57) named as
Colombo Plan. The Plan was suspended two years before its completion due to the
repercussions of Korea War. In addition to the Colombo Plan, Five other Five Year
Development Plans were drawn up and implemented. The Sixth and Seventh Five
Year Plan are complete. The 8th Five Year Plan (1993-98) has been implemented.

If the economic performance since 1947 is evaluated, the overall results are not very
encouraging. The per capita income at market price is only 925 dollars per year
in 2007 in Pakistan. The major portion of the population is just above the poverty line
(poverty line 23.9%) The disturbing feature of the economy is that whatever economic
growth has been achieved, it is accompanied by unequal distribution of wealth. |This
has created social tension in the country and has slowed down the rate of economic
growth. Pakistan has devised various strategies to quicken the tempo of economic
development but it has not been able to break the vicious circle of poverty and enter
into take off stage. The main obstacles which have affected the rate of growth in
Pakistan are grouped under following heads.

(1) Economic obstacles (2) Social and cultural obstacles (3) Administrative obstacles.
These obstacles are now discussed in brief:

1 Economic Obstacles
(1) External debt: There was a rising trend in external debt which posed a serious
threat to the economic future of the country. During the last five years, serious efforts
are being made to reduce the external liabilities as far as possible. The external debt
even now stands at $ 38.8 billion in 2007.

(2) Fiscal deficit. Another serious constraint in economic development is the higher

levels of budget deficits. The overall budget deficit was 8% of GDP in 1990-91. It
was brought down to 5.4% in 1999-2000. The present government has succeeded in
bringing its down to 4.2% in 2006-07. The large fiscal deficits reduces the capacity of
the government to spend on key development activates.

On the revenue side, the tax GDP ratio stands at around 9.5% during the last several
years. It is mainly attributable to narrow tax base, inelastic tax system, complex tax
laws, heavy reliance on foreign trade taxes, large tax exemptions and incentives, tax
evasions, weak tax administration etc. On the expenditure side, defense and bebt
serving are taking a very major share of the current revenue.

(3) Banking and Financial Sector in Crisis. The second major economic

impediment to economic development was that the public sector banks and
development financial institutions (DFI's) were mainly in crisis. Excessive bank
credits, large scale defaults in payment of loans were great fault lines of the economy.
The poor performance of the financial sector had adversely affected development in
various sectors of the economy till 2000. However, due to rapid economic growth
from 2000 onward, the banking sector is earning profits. The investment of the banks
is mostly on consumer products.

(4) Persistent deficit in balance of payments. Another important obstacle to

economic development is the persistent deficit in the balance of payments over the
years.

(5) Financing the budgetary gap. One of the serious factor distorting the fiscal
system and obviously economic growth is the huge amount of borrowing to finance
the budgetary gap. The budgetary gap is financed through three sources (i) External
borrowing, (2) Domestic non-bank borrowing, (3) Borrowing from the banking
system. Excessive bank borrowing creates inflationary pressure in the economy.

(6) Deficiency of Capital. Deficiency of capital is an important obstacle in the way of

economic development. If a country is to achieve rapid rate of economic development,
it must save at-least 25% of GDP each year. In Pakistan, the rate of national saving is
very low. It is about 16.1% of GDP which is hardly able to maintain current per
capita level in the country.

(7) Scarcity of Foreign Exchange. Pakistan, like other developing countries, is

foreign trade oriented. It is concentrating mainly on the export of cotton, carpets and
manual labour leather, rice, sport goods. The excessive dependence on export of a few
items has made the economy unstable and is a great obstacle to economic growth,
which are mainly primary commodities. The increase in the prices of imported goods
and their rising flow in the country is a big strain on the foreign exchange resources.

(8) Rapidly Growing Population. The population is growing at the rate of about

1.8% annually in Pakistan. As a result of the rapid increase, the proportion of
dependants below the age of 15 years and above the age of has gone up to 73% which
is a great burden on the meager resources of the country and a big obstacle to
economic development.
(9) Low Level of Technology. One of the obstacles to economic development in
Pakistan is the use of low level of technology in various sectors of the economy. We
do not stress and even do not recommend that Pakistan should adopt most modern and
sophisticated technology. The technology to be applied in Pakistan should be
appropriate to the conditions prevailing in the country. For instance we should
preferably use cheap sources of energy, simple farm equipment, smaller plants and
scale of machinery etc suitable to the local conditions.

(10) Dualistic Economy. Dualism is an another important obstacle to economic

development in Pakistan. There is a vast regional disparity in income. The use of
technology differs from sector to sector and region to region. There are differences in
the social customs, habits and attitudes towards work of the people living i different
provinces of the country. The occurrence of dualism stand in the way of optimum
utilization of factors.

2. Social and Cultural Obstacles:

The socio-cultural attitudes of the people also stand in the way of economic
development of our country. In Pakistan, more than 50% of the people are illiterate.
They are ignorant of the development taking place in their own country as well as in
the world. society. The people are mostly conservative in their habits. They feel pride
in the native culture and are generally not receptive to foreign methods of production.
People lack self confidence and initiative. The joint family system, though on the
decline, has also killed the sense of initiative and the incentive to work. The caste
system functioning mostly in terms of occupation tailors, carpenters, goldsmiths, etc
restrict occupational and geographical mobility. The occupational classification which
is mostly village centered impede the economic development. The religious beliefs of
the people condemning the accumulation of wealth, dependence upon fate and the will
of God only are also obstacles to economic growth. People forget here that God has
also said, ''Your duty is to do and then put the result in the hands of God.''

The unnecessary expenditure on marriages, deaths, births, litigations, class pride etc.
has reduced domestic saving and has adversely affected economic progress. About
half of the population comprises women folk. Our social taboos and customs prevent
them from working and improving the standard of living. The basic needs of the
people remain largely unsatisfied. We do agree here that socio-cultural factors have
impeded economic progress. We should not forget here also that the adoption of
socio-cultural attitudes of the West have brought down the quality of life as well.

3. Political and Administrative Obstacles:

For accelerating the rate of economic development, there should be political stability
in the country. If there is a change in the government set up due to elections, or of
dictatorship, the planning job done by the previous government should not be altered
altogether.

The planning machinery and all others involved in administration should be loyal to
the country. They should be competent sympathetic and honest in the performance of
the duties assigned to them. In Pakistan, since its inception, there are rapid changes in
governments. Each government which came into power condemned the planning
work done by the previous governments. They framed their own plans, formulated
their own strategies of development and left the claim without achieving the targets of
the Plans. The history of planning show that with the exception of the Faith Five Year
Plan, all other Plans have failed to achieve their targets. The overall line of the
planning machinery in Pakistan is bureaucratic rather than professional. The
administration working in various departments is generally weak, incompetent and
unsympathetic. Self-interest is dominating over national interest which is a great
barrier to economic development. Another administrative obstacle line the way of
economic development is that we have not so far been able to decide about the nature
of economic system to be adopted in Pakistan. Mixed economy, Socialistic economy.
Islamic economy all are talked about but nothing concrete has actually been practiced.
There should be clarity on this fundamental issue so that planning is drawn up
according to the socio-economic objective of that system and a path of development
laid out.

Remedial Measures for Economic Development

We have discussed the major obstacles to economic development. The practical

means of setting aside the barriers to economic development are now to be stored out.
It is a big challenge to the planners. We are of the opinion that if following measures
are right earnestly applied, the rate of economic development can go up.

(1) Expanding the tax base. For expanding the resource base, it is necessary that the
coverage of indirect taxes be reduced. In designing the tax reforms, care has to be
taken to minimise burden on the common man. The share of direct taxes has also to be
increased.

(2) Tax on agriculture income. The government can raise more revue by brining the
agriculturists income in the tax net on proper footings.

(3) Self reliance. Pakistan is knee deep in foreign debt. If we are really desirous of
increasing the rate of economic development, we shall have to lessen our dependence
on foreign assistance. The strategy of self reliance, as far as possible, should be
followed for financing development projects.

(4) Export led growth. For the rapid development of the economy, the strategy of
export led growth should be carefully chalked out. The production of value added
goods on large scale, having comparative advantage in production will greatly solve
the problem of limited size of the domestic market. The production of import
substitutes at home will save the precious foreign exchange.

(5) Industrialization. Another approach to development planning within the

framework of mixed economy is to give priority to the establishment of those
industries which meet the basic needs of the various sectors of the economy. The
production of improved basic agricultural implements will greatly help in raising the
agricultural production.

(6) Strategy of self-management. In communist countries, the development planning

is being decentralized. Development planning is declared a right and obligation of the
planning agents. The system if adopted in a coordinated manner shall help in
quickening the tempo of economic development in this country.

(7) Development of agricultural sector. The Government of Pakistan, in view of the

importance of agriculture in the national economy, is attaching high priority to the
development of this sector. Expanded credit facilities, provision of fertilizer,
pesticides and improved seeds are the right steps in improving agricultural production
which contributes 20.9% of GDP and accounts for 46% of foreign exchange earnings
in Pakistan.

(8) Improvement of the infrastructure. A great deal of improvement in the means of

transport, power, roads, banking, education, etc. has to be made for economic
development.

(9) Constitutional cover. The state owned industrial units which are being privatized
and other private units should be given Constitutional cover. The state of uncertainty
of their nationalization again be removed once for all.

(10) Stable fiscal and monetary policies. In order to accelerate the rate of economic
development, the fiscal and monetary measures should be carefully chalked out There
should not be frequent changes after a few months in the import and export policies,
revision of taxes etc.
(11) Promoting Technology. For economic take off, it is very essential that we take
effective steps in promoting science and technology. The technological development
will help in keeping our products and exports competitive in the world market.

(12) Administrative Reforms. There should be far reaching administrative reforms in

the country. The professionally qualified personnel should be inducted and assigned
specific targets to be achieved in the allocated sectors. There should be reduction in
the administrative expenditure also.

(13) Development of physical and human capital. Development of physical

infrastructure, roads, railways etc. and increased investment on education, health and
nutrition etc. can play a dominant role in increasing economic development in the
country.

(14) Slowing the rate of population growth. High rate population growth

(about 1.8%) is also intensifying constraint on the development of savings, foreign
exchange and human resources. If we want the qualities of human life, prosperity in
place of poverty, education in place of ignorance, health in place of illness,
environmental beauty in place of deterioration, we shall have to take measures to
control the family size.

During the last four years, the government has identified five key sectors for
promoting economic growth and bringing it to the level of 8% growth rate. These
sectors include (i) agriculture (ii) housing and construction (iii) small and medium
enterprises (iv) information technology and (v) oil and gas sectors.

QNO#4: Define capital formation .why capital accumulation is important for the
development of a developing country like Pakistan?

ANS:.

Capital formation refers to the increase in the stock of real capital in

an economy during an accounting period. In other words, the creation of
things that help us produce more. We commonly used the term in the study
of macroeconomics. The term capital accumulation has the same meaning.
I use the two terms interchangeably in this article.

Capital accumulation involves the creation of more capital goods. For

example, buildings, equipment, tools, machinery, and vehicles are capital
goods. We use capital goods to make products and provide services.
In economics, capital means the factors of production that we use to create
goods.

A country uses capital stock together with labor to produce goods. Capital
accumulation occurs when this capital stock increases.

The greater the capital accumulation of an economy is, the faster it can
grow its aggregate income.

Capital accumulation is impotant :

Capital plays a vital role in the modern productive system. Production

without capital is hard for us even to imagine. Nature cannot furnish goods
and materials to man unless he has the tools and machinery for mining,
farming, forestry, fishing, etc.

If man had to work with his hands on barren soil, productivity would be very
low indeed. Even in the primitive stage, man used some tools and
implements to assist him in the work of production. Primitive man made use
of elementary tools like bow and arrow for hunting and fishing net for
catching fishes.

ADVERTISEMENTS:

With the growth of technology and specialisation, capital has become more
complex and is of superior and advanced type. More goods can be
produced with the aid of capital. In fact, greater productivity of the
developed economies like that of USA is mainly due to the extensive use of
capital, i. e. machinery, tools or implements in the productive process.
Capital adds greatly to the productivity of worker and hence of the economy
as a whole.

Much economic development is not possible without making and using of

industrial machinery, making of agricultural tools and implements, building
of dams, bridges, factories, roads, railways, airports, ships, ports, harbours,
etc., which are all capital. All these capital goods are man-made
instruments of production and increase the productive capacity of the
economy.

Therefore, accumulation of capital goods every year greatly increases the

national product or income. Capital accumulation is necessary to provide
people with tools and implements of production. If the population goes on
increasing and no net capital accumulation takes place, then the growing
population would not be able to get necessary tools, instruments, machines
and other means of production with the result that their capacity to produce
would be seriously affected.

Besides this, capital, accumulation makes possible the use of indirect or

round-about methods of production which greatly increase the productivity
of the workers. Under these indirect or round-about methods of production,
workers instead of working with bare hands, work with the aid of more
productive tools, instruments and machinery.

ADVERTISEMENTS:

Under these indirect or round-about methods some workers and other

productive resources are first employed in producing capital goods and
then with the help of these capital goods workers produce consumer
goods. The greater the extent to which the methods of production would be
indirect or round-about, the greater their productivity and efficiency.

But, as we have seen above, for the use of indirect or round-about methods
of production capital has to be accumulated. Therefore, we see that capital
accumulation makes the use of indirect or round-about methods of
production possible and thereby greatly increases the national product and
is helpful in bringing about rapid economic growth.

Moreover, productivity of the workers depends upon the amount of capital

per worker. The greater the quantity of capital per worker, the greater the
productivity of the workers. It is not capital accumulation alone that
increases the amount of capital per worker.

Capital per worker rises when the rate of capital accumulation is greater
than the rate of population growth. With the increase in capital per worker,
productivity per worker will increase with the result that national product
and income will increase. Therefore, capital accumulation, by increasing
the productivity of the workers, plays an important role in the growth of the
economy.

ADVERTISEMENTS:

From the viewpoint of economic growth capital formation is important also

because it makes large-scale production and greater degree of
specialisation possible. Thus, with capital accumulation the advantages of
large-scale production and specialisation are obtained.

The advantage of large-scale production and specialisation is that they

greatly increase output and productivity and thereby bring down the cost of
production per unit. Without adequate capital accumulation neither the
scale of production can be increased nor greater’ specialisation and
division of labour in the production process is possible. Hence, capital
accumulation by enlarging the scale of production and specialisation
increases the production and productivity in the economy and thereby
promotes economic growth.

Another way in which capital accumulation contributes to growth is that it

makes the technological progress of the economy possible. Different
technologies need different types of capital goods. Therefore, when new,
superior and better technology is discovered, its use can be made for
production only if that technology is embodied, in capital goods, that are if
capital goods according to that technology are made. Therefore, without
capital accumulation, no technical progress can be made.

If there is no capital accumulation, then the various new inventions or

discoveries will remain unused for production. If is, therefore, clear that
capital accumulation promotes technical progress in the country and
through this accelerates the economic growth of the country.

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Another important economic role of capital formation is the creation of

employment opportunities in the country. Capital formation creates
employment as two stages. First, when the capital is produced, some
workers have to be employed to make capital like machinery, factories,
dams, irrigation works, etc. Secondly, more men have to be employed
when capital has to be used for producing further goods.

In other words, many workers have to be engaged to produce goods with

the help of machines, factories, etc. thus, one sees that employment will
increase as capital formation is stepped up in the economy. Now, if the
population grows faster than the increase in the stock of capital, the entire
addition to the labour force cannot be absorbed in productive employment
because not enough instruments of production will be there to employ
them.
This results in unemployment. The rate of capital formation must be kept
sufficiently high so that employment opportunities are enlarged to absorb
the additions to the working force of the country as result of population
growth. In India the stock of capital has not been growing at a fast enough
rate so as to keep pace with the growth of population.

That is why there is huge unemployment and under-employment in both

the urban and rural areas. The fundamental solution to this problem of
unemployment and underemployment is to speed up the rate of capital
formation so as to enlarge employment opportunities.

Role of Capital: Diagrammatic Illustration:

ADVERTISEMENTS:

A diagrammatic illustration will make it clear as to how a greater rate of

capital accumulation steps up the growth rate and also what it costs to the
society. A given amount of resources has to be distributed between the
production of consumers’ goods and capital goods.

But, the greater the amount of resources that are invested in production of
capital goods, the smaller quantity of resources will be left for the
production of consumer goods. Thus, greater accumulation and therefore
greater rate of economic growth comes at the cost of present consumption.

Of course, with greater rate of growth, the productive capacity and

consumption in the future years will increase, but greater capital
accumulation means less consumption in the present. This is what is
generally described as “more jam tomorrow means less jam today”.

But, as said above, if a poor country wants to raise the standards of living
of its people, it must step up its rate of economic growth through greater
investment of resources in the production of capital goods. Consider Figure
42.1 in which the X-axis measures consumption goods and the Y-axis
measures capital goods.

With a given amount of resources we have drawn a production possibility

curve PP’. Suppose the allocation of resources between the consumers’
goods and capital goods is such that the economy is operating at point D
on the production possibility curve so that it is producing OC amount of
consumers’ goods and OK amount of capital goods.
With the capital accumulation the productive capacity of the economy will
increase and as a result the production possibility curve will shift outwards.
If the same proportion of resources continues to be allocated to the
production of capital goods, the economy will be growing at a certain rate,

say 2% as is indicated by the ray OA.

Now, if the economy wants to step up the rate of economic growth, say to
3%, it will have to allocate a greater proportion of its resources towards the
production of capital goods than before. Thus when the economy is
operating at point D on production possibility curve, PP’, and wants to build
up more capital, it will have to allocate more resources to the production of
capital goods and less to the production of consumers’ goods.

Suppose the economy reallocates its resources so that it produces OK’

capital goods and OC’ consumer goods on the production possibility curve
PP’. It is clear from the figure that with greater capital accumulation, the
production of consumer goods has fallen from OC to OC’.

Therefore, consumption will have to be cut down for the sake of more
capital. But greater capital accumulation will mean greater growth of
productive capacity with the result that production possibility curve will shift
outwards more rapidly and if the same higher proportion of resources
continues to be allocated, the economy will be having a higher rate of
economic growth, say 3%, and will move along the ray OB.

Cost of Capital Formation:

It is thus clear from above that the process of capital accumulation and
economic growth is not a painless job. The price for it has to be paid and
this price is paid in terms of the reduction in present consumption. But it
should be remembered that greater capital formation will more than
compensate this loss of present consumption.

Thus, in our figure, when the economy has chosen the growth path of ray
OB by having greater capital accumulation, then after some years it will
reach point W at which the consumption is OC. Thus, at point W, the
previous level of consumption has been restored. As the economy keeps
up its higher rate of capital accumulation and moves along the growth path
OB beyond W, it will be having higher consumption than along the growth
path OA.

Role of Capital: A Dissenting View:

It is generally agreed among economists that capital accumulation late

progress of economic growth are closely correlated. In Harrod-Domar
models of economic growth as well as Lewis’ model of “economic
development with unlimited supplies of labour”, capital accumulation plays
a crucial role in raising both output and employment. However, some
economists have objected to such a great emphasis and importance being
given to the physical capital.

Thus, Professor Caimcross remarks, “there is a great danger that the

importance of capital in relation to economic progress will be exaggerated
than that it will be underrated.” According to Prof. Cairncross, the rate of
economic growth achieved in developed countries cannot be wholly
explained by increases in labour and physical capital. He points out that
technological progress has played a more important role than accumulation
of physical capital in the process of economic growth.

According to him, only one quarter of the rate of economic growth can be
explained with the accumulation of physical capital. To quote him, “There
seems no reason to suppose that capital accumulation does by itself
exercise so predominant an influence on economic development. In most
industrialized communities the rate of capital accumulation out of savings is
equal to about 10 per cent of income. If one were to assume that innovation
cam? To a standstill and that additional investment could nevertheless yield
an average return of 5 per cent, the consequential rate of increase in the
national income would normally be not more than ½ per cent per annum?
We are told that the national income has in fact been rising in such
communities at a rate of 2.3 per cent per annum. On this showing, capital
accumulation could account for, at most, one-quarter of the recorded rate
of economic progress”. Nor were things very different in the nineteenth
century.

A.K. Cairncross thinks that capital accumulation need not necessarily take
place along with technological progress. Technological progress can occur
independently of any net capital accumulation. What is needed is that the
funds kept for depreciation may be used for building up new assets and
capital equipment, embodying new technology. He points out that new
capital equipment embodying new advanced technology may even cost
less and therefore technological progress is possible even with decline in
physical capital.

ADVERTISEMENTS:

Moreover, Prof. Cairncross thinks that besides technological progress,

improvements in social and economic organisation, trained management,
new attitudes, play as important a role in raising production and promoting
economic growth as the accumulation of physical capital.

The process of economic development, according to him, “is a complex

situation and it may exist in some underdeveloped countries. But it is by no
means obvious that additional capital, whether borrowed from abroad or
accumulated through the exertions of surplus labour in the countryside,
would by itself suffice to start off a cycle of industrialization. The problem is
often one of organisation quite as much as of capital creation: of training
management and men, of creating new attitudes towards industrial
employment, of taking advantage of innovations that need little capital and
using the resulting gains to finance investment elsewhere.”

We agree with Prof. Cairncross that technological progress, human capital,

improvements in economic organisation, trained management, etc. are also
important factors in economic growth. However, the crucial importance of
physical capital also cannot be denied. In our view, both physical and
various forms of human capital are important in promoting economic
growth.

QNO#5: explain main factors influencing the capital formation in

Pakistan ?

Ans:
 Sources of long run economic growth in developed and developing
countries are the most debated question in the literature. There are two sources
of economic growth, either productivity growth or factor accumulation (physical
capital, employed labor force and human capital). However, there are three
strands in the literature, first who supported the view that, it is productivity
growth that caused economic growth (Chow, 1993; Hu & Khan, 1997; Iwata et.al.
2003; Nachega & Fontaine, 2006). Second who supported the other view that
economic growth is caused by factor accumulation (Krugman, 1994; Beddies,
1999; Young, 2000; Iwata et.al. 2003; Nachega & Fontaine, 2006). Third who
consider human capital as an important source of economic growth (Lucas, 1988;
Romer, 1986; Beddies, 1999; Haldar & Malik, 2010). Chow (1993), Hu and Khan
(1997) and Iwata et al. (2003) did not consider human capital as an input factor in
their research. Efficiency of human capital determines level of economic growth
(Zeng, 1997). Growth of total factor productivity (TFP) and human capital are
necessary to boost economic growth (Wang & Yao, 2003). Smith (1776) said that
growth actually depends on division of labor force but he did not give a clear link
between them. The concept of economic growth starts with Solow (1956) growth
model. Solow (1956) highlighted the idea that economic growth cannot be
explained by increasing labor and capital only but it was technical progress that
contributes to economic growth along with labor and capital. Solow (1956)
growth model was considered as central framework of economic growth. A
number of researchers highlighted the importance of human capital in past few
decades such as endogenous growth theory which was presented by Lucas (1988)
and Romer (1990). They found human capital a primary source of economic
growth. Moreover, it is evident that human capital successfully attracts other
factors of production like physical capital. Lucas (1988) considered education and
training as a measure of human capital. Development of human capital is the sole
purpose of education to attain economic growth. Lucas (1988) and Romer (1990)
suggested that a country should invest more on human capital because it can
contribute to economic growth and social welfare. It has purely positive link with
labor productivity and will result into high wages and high expected lifetime
returns. Later on, Fogel (1994) highlighted the point that education and training
with good health, strong physical and mental capabilities can enhance the
production of human capital or labor force. Seren and Marti 2 (2013) suggest that
in developing countries like Pakistan (where tax payers avoid taxes) with low
nominal tax rate human capital did not contribute to economic growth but
inversely. In spite of the importance of human capital, still the most debated
question is what are the key indicators which are considered as human capital?
What should be the most appropriate proxies for human capital? These proxies
are varying across researcher to researcher but they all focused on either mixture
of education and health or separately to measure human capital. In the earlier
literature, literacy rate is used by Romer (1990), to capture the impact of human
capital and he found that it had positive link with growth. Mankiw, Romer, and
Weil (1992) prefer enrollment in secondary school to measure human capital and
they conclude that human capital can boost up the economy. Khan (2005)
conducted a single country analysis by using gross secondary school enrollment,
average years of schooling, and life expectancy as an indicator of human capital.
Some studies used education and health expenditure to capture stock of human
capital but all these proxies did not reflect true picture of available human capital
stock. Conceptually, all these proxies were unable to measure the available stock
of human capital adequately. Barro and Lee (1993) developed a proxy
(educational attainment) for available human capital stock for 73 countries by
using enrollment at different level of education. Wang and Yao (2003) used the
same methodology but with different flow variables to develop a series for
available stock of human capital in China. Almost every developing country is
suffering from two major issues; first how to attain economic growth and second
how to sustain economic growth. Sustaining high growth rate is more difficult in
developing countries. Pakistan economy was growing around 5% per year till 2008
but after that government was unable to sustain this growth rate due to failure of
various policies including political instability. Growth rate was 8% in 2004-05
which was the highest level but now the million worth question is what
government should do to catch that high level of growth and to sustain it? Many
researchers in Pakistan focus on the importance of human capital by using
different proxies to find its link with the economic growth. Abbas (2000) used
enrollment at different level of education (i.e. primary, secondary and higher) as a
stock of human capital (in comparative analysis between India and Pakistan) to
analyze its effect on economic growth. He found that these proxies have positive
impact on economic growth. Khan (2005) analyzed four different measure to
capture stock of human capital i.e. literacy rates, 3 average years of schooling,
gross secondary school enrollment, and life expectancy. His finding supports the
view of Fogel (1994) that high education and strong physical and mental health
will result in a more productive work force, these active participants can increase
total factor productivity, and help the country’s production function to move
outward. Ali et al. (2012) used traditional inputs incorporating human capital as
education enrollment and expenditure on health under ordinary least square
technique they concluded that human capital contribute to economic growth
significantly. Qadri and Waheed (2014) developed a new series for human capital
by using primary enrolment ratio and health indicator (expenditure on health)
and conclude that this series is comparatively a better series than previously used,
because earlier studies used health or education indicators separately in their
analysis. With reference to above literature there is a gap in the literature in
context of relationship between factor accumulation and GDP per worker in
Pakistan. Although this question is addressed in previous studies but no one
address issues regarding the measure of human capital. They used directly
measureable proxies (traditional measures) to measure human capital which do
not reflect the true picture of human capital stock. Moreover, none of the
researcher constructed series for human capital to capture available stock of
human capital and real physical capital stock. Using direct measure is technically
incorrect as they do not reflect the true stock of real physical capital stock and
human capital stock. It is observed that initial studies used education as a
measure of human capital in both cross country analysis and single country
analysis. Recently, studies are focusing on education, training and health all
together to measure human capital stock. This study focuses on long run
relationship between factor accumulation and economic growth under
endogenous growth theory and ARDL framework for the time period 1973 to
2014 in Pakistan. Specific objectives of this study are: to develop a series for
human capital to calculate stock of human capital, to develop a series for capital
stock to calculate stock of real physical capital, to investigate the relationship
between factor accumulation and economic growth. This study challenges the
notion of human capital. Conceptually, earlier proxies of human capital used by
different researcher did not reflect the exact picture of the human capital stock in
Pakistan. This study develops a human capital index for Pakistan by following the
methodology 4 of Wang and Yao (2003) and generates a series for human capital
in Pakistan. The series for real capital is also generated unlike the previous studies
that used gross fixed capital formation or gross domestic investment as proxy for
physical capital stock. Results of the study may help the policy makers to design
appropriate policies by considering human capital a growth accelerating factor

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