Growth and Development

Current academic interest in development economics, and the study of development economics as a separate subject, are relatively recent phenomena. For the student today it will be difficult to appreciate that as recently as thirty years ago a course in development economics was a rare feature of an undergraduate programme in economics, and that textbooks on economic development were few and far between. Today no self-respecting department of economics is without a course in economic development; there are scores of texts; hundreds of case studies; and thousands of articles on the subject. And, as in medicine, the problems seem to grow with the analysis.

There are several ways in which the growth of income or output of a country may be expressed, but frequently they consist of identities which can tell us very little about the causes of growth without adequate theorising. For example, growth can be expressed as the product of a country’s ratio of investment to output (I/O) and the productivity of investment (∆O/I), i.e. By definition, slow growth is the product either of a low investment ratio, or a low productivity of capital, or both. It is this equation which forms the basis of the view that faster growth in developing countries requires more resources for investment, but by itself this does not constitute a theory of development.

In the production-function approach to the analysis of the sources of growth, land as a separate factor of production tends to be assumed away or subsumed into capital. There are two main reasons for this. The first is the traditional classical notion of land as a fixed factor of production, which in the long run is undoubtedly true. The second is the practical fact that land without the application of capital is of little use, justifying the treatment of land and capital as one factor.

The capital stock of a country increases through the process of net investment (I), which is the difference between a country’s net income in an accounting period (i.e. gross income minus depreciation) and how much it consumes out of that income in the same period. Capital accumulation enlarges a country’s capacity to produce goods. As we saw in Chapter 2, however, production-function studies, at least for advanced countries, cast some doubt on whether capital accumulation by itself is central to the development process. A lot depends on how capital is defined and whether it is inclusive of technological progress. Capital is certainly a wider concept than capital goods traditionally defined, i.e. goods which yield no immediate utility but produce goods which do. If capital is defined as any asset which generates an additional future stream of measurable income to society, many goods and services commonly regarded as consumption goods ought strictly to be included as part of a country’s capital stock. Expenditure on education, for instance, which may permanently enhance the earning capacity of individuals, as well as giving immediate satisfaction, must be regarded partly as investment expenditure. Similarly, if certain types of ‘consumption’ goods, e.g. clothes, durable consumer goods, etc., are necessary to induce peasant producers in the agricultural sector to increase their productivity, they, too, ought to be considered as part of the capital stock. If it is agreed, therefore, that the only way to build up a country’s productive potential, and to raise per capita income, is to expand the capacity for producing goods, this need not refer simply to the production of physical capital but to the production of other types of capital such as ‘incentive’ consumer goods and the expansion of facilities for investment in human capital, all of which can contribute to increased productivity and higher living standards.

It is easy to argue that poverty and backwardness are due to a general shortage and inefficient use of the key factors of production; it is much harder to determine precisely why there should be a dearth of some factors and an abundance of others, and why development may be a slow and lengthy process. It is certainly impossible to explain present-day international discrepancies in the level of development with reference to initial differences in factor endowments. The present development gap has arisen largely through industrial development in certain selected areas of the world which has, in turn, generated its own factor endowments. The purpose here, however, is not to consider why some countries were able to industrialise sooner than others, but rather to consider some of the potential obstacles to growth in the present developing countries, from which the developed countries do not suffer.

Population growth plays a conflicting role in the development process. It can act both as a stimulus and an impediment to growth and development. The question, to which there is no easy answer, is at what point do the economic disadvantages begin to outweigh the advantages? Where does the balance lie?

Given the scarcity of resources in developing countries in relation to development needs, one of the central issues in development economics is the allocation of resources among competing ends. For most developing countries the two major constraints on the growth of output are the ability to invest and import, and most theories of resource allocation and most investment criteria reflect this fact. A common starting-point in the consideration of resource allocation is how to maximise the level or growth of output from the domestic resources available, and how to minimise the use of foreign exchange.

Input-output analysis is a particular planning and forecasting technique with a wide variety of applications. The purpose here is simply to present the basic elements of the technique without going into its refinements. If the reader’s appetite is whetted, references for further reading are given in the bibliography.

The two extreme views on the valuation of labour in surplus-labour economies have already been touched on previously. On the one hand there is the ‘traditional’ view that if the marginal product of labour in agriculture is zero, labour ought to be considered ‘costless’ in the planning process in order for current total output to be maximised (see Chapter 3). This is also the programming solution where the objective function is to maximise current income subject to resource constraints, but where labour is not a scarce resource and capital- and consumption-goods prices are not adjusted to reflect the social valuation of them (see Chapter 10). On the other hand, there is the opposite ‘modern’ view that if the wage in industry is higher than the wage in agriculture, and the propensity to consume is unity, labour transference will involve an increase in consumption, so that to maximise growth and output in the future labour ought to be valued at the industrial wage to maximise the investible surplus (see Chapter 3).

Real capital formation from domestic resources requires investment and a commensurate increase in the volume of real saving. In the absence of international trade and foreign borrowing, capital formation is only possible through abstinence from present consumption and when society produces a surplus of consumer goods sufficient to meet the needs of labour engaged in producing capital. In a subsistence (Robinson Crusoe) economy, saving and investment are simultaneous acts, in the sense that if a producer is to develop the means of production he must sacrifice time and resources which would otherwise be used for consumption purposes. In a money exchange economy, savings and investment may be undertaken by different groups, and the process of capital formation is likely to require some form of finance and credit mechanism to ‘redistribute’ resources from savers to investors. In fact, in the early stages of development savings may not be the major barrier to capital formation but rather the unwillingness or inability to invest. The unwillingness to invest may stem from cultural attitudes or simply a realistic assessment of the risks involved. The inability to invest, on the other hand, may result from shortages of factors of production and supplies necessary for particular types of capital formation that would be profitable. In short, in the transition from the subsistence to the money economy, the main obstacle to capital formation may not be a shortage of saving but bottlenecks in the productive system which do not permit investment or make it too risky.

In an open economy domestic savings can be supplemented by many kinds of external assistance. In this section the role of foreign borrowing in the development process will be considered, together with the debt-servicing problems associated with it. Later, we shall consider types of foreign assistance such as private foreign investment and international assistance, both bilateral and multilateral.

In the previous chapter we attempted to establish the role of foreign borrowing in the development process. Using dual-gap analysis, it was shown that foreign borrowing can be used to bridge either a domestic savings-investment gap or a foreign exchange gap, whichever is the larger. We saw that the policy issue is the decision on how far borrowing should go. How large can the import surplus be without leading to severe future balance-of-payments difficulties in the form of large outflows of debt repayments, and without generating inflation due to currency depreciation and the necessity to develop high-cost import-substitute activities? The empirical evidence is overwhelming that the conflict is very real between maintaining an adequate growth rate and preserving a reasonable balance on international payments. The ultimate solution must lie in improving the balance of payments through trade. The growth rates of individual developing countries since 1950 correlate better with their export performance than with almost any other single economic indicator. The export performance of the developing countries, however, has continued to lag behind that of developed, industrialised countries. Throughout the 1950s and 1960s the volume of exports from developing countries grew at a rate of approximately 5 per cent per annum compared with 8 per cent for developed countries. The discrepancy in rates of growth was even wider in value terms, causing the developing countries’ share of the total value of world trade to fall from 28 per cent in 1950 to 16 per cent in 1972.

The major hope for an increased flow of resources to developing countries is that some, if not all, of the saving accruing to developed countries from the issue of costless Special Drawing Rights (S.D.R.s) as a means of international payments will be distributed to the developing countries.