Book 5 Development Economics

Humanities and Social
Sciences Department
ECONOMICS NOTES
Grade 12
Economic Development Book:

Sources and Barriers of/to Economic
Growth and Development; Growth
Models
Humanities and Social Sciences Department
Content Page
No Title Page No
1 Understanding Economic Development 3
2 Topics in Economic Development 41
3 Foreign Sources of Finance and Foreign Debt 55
Evaluation of Growth and Development Strategies

4 73
(Supplementary)
5 Glossary of Definitions (Development) 83
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TL/ACS Jakarta/G12/Economics Notes/Development Economics/2016
Humanities and Social Sciences
1. Understanding Economic Development
What is the meaning of growth if it is not translated into the lives of the people?
UNITED NATIONS, Human Development Report, 1995
Although growth and development are often interchangeably in newspapers, economists

draw an important distinction between those two concepts. While economic growth is seen as
a quantitative change in the scale of the economy (an overall increase in output,
consumption, investment and income), economic development corresponds to a qualitative
change. Development implies an improvement in the lives of the people. It does just
correspond to greater consumption but also involves improvements in society.
1.1 Introduction to Economic Development
A. Economic Growth versus Economic Development
Economic growth
Economic growth is the increase of per capita gross domestic product (GDP) or other
measure of aggregate income, typically reported as the annual rate of change in real GDP.
Economic growth is primarily driven by improvements in productivity, which involves

producing more goods and services with the same inputs of labor, capital, energy and
materials.
The important elements in the growth process are as follows:

- Investment, which increases the amount of capital per person employed and increases
productivity. This may be generated domestically or may come from abroad.
- Education and training which enhance human capital, again making people more
productive.
- Technological change which leads to the availability of bigger and better machines, and
also helps to create better ways of managing people.
- Exports to new markets which increase demand for the country’s products.
These four factors in combination have a big impact on growth rate. All have a healthy effect
on the way resources are used to increase production. However, GDP figures must be
interpreted with caution. A developing country may have strong growth in GDP and also a
high birth rate. This means that per capita income growth is less than the growth of GDP.
Also, increases in GDP do not always improve welfare because some of the external effects
of growth are not always positive. Pollution, deforestation and climate change can all reduce
the positive effects of growth and this will not show in the GDP figures.
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Economic Development
Economic development is the increase in the standard of living in a nation's population with
sustained growth from a simple, low-income economy to a modern, high-income economy.
Also, if the local quality of life could be improved, economic development would be
enhanced. Its scope includes the process and policies by which a nation improves the
economic, political, and social well-being of its people.
- The term is usually used to describe what is happening in relatively poor countries which
are referred to as developing countries.
- Rapid economic development is usually associated with high levels of investment and
improvements in education and training opportunities and sometimes with a policy of
allowing relatively free trade and an increasingly open economy.
B. Difference Between Economic Growth and Economic Development
What is economic growth? What is Economic development?

Economic growth is an increase in the Economic development is the efforts
amount of goods and services produced that seek to improve the economic well-
per head of the population over a period being and quality of life for a community
of time – i.e., increases over time in by creating and/or retaining jobs and
national output and the growth of national supporting or growing incomes and the
incomes. Standard measure of economic tax base – i.e., will improve the standards
growth include the percentage increase in: of living for the whole population.
 Gross domestic product (GDP) Economic development is concerned with

how increases in income and output can
 Real GDP lead to better living conditions, better
healthcare services and health outcomes,
 GDP per capita
education and training, and working
 Real GDP per capita conditions (especially safety in the
workplace and non-exploitative practices
such as the use of child labour). The
equitable distribution of wealth and
income, equality of opportunity and the
protection of human rights are all
encompassed in measures of economic
development, as too are the very basics
of human welfare – the reduction of
hunger and poverty and ensuring housing
is adequate. Social welfare can be
measured in many ways, and
improvements in any of these areas
increase human welfare.
Photo 1
Thus, the economic development
approach rejects that output and income
are the only ways to measure living
standards.
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C. PPC to show Economic Growth and Economic Development
Using the PPC to show Economic Growth and Economic Development:
Think: Is it possible for economic development to occur without economic growth?
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D. Economic Development is Somewhat Dependent on Economic Growth
Economic growth leads to increased national income – real GDP per capita will increase.
However, this where the distribution of national income becomes so important. Is economic
growth benefiting a handful of the elite, or are more and better paying jobs distributing the
share of increasing national income more widely within the economy? If economic growth
benefits relatively few within an economy, then economic development will not follow and
standards of living will not improve for the majority of people.
Economic growth should drive economic development in two ways:
Firstly, economic growth in LEDCs should provide employment for an ever greater proportion
of the population and wages should increase as labour becomes more productive. This will
lift people out of poverty and increase the economic well-being of families benefiting from
employment.
Secondly, as incomes increase and as governments become better at collecting tax
revenues, then the governments of LEDC can increase spending. Considered government
spending will increase economic development, deficient fiscal policies will not. Economic
growth should provide extra government revenue for schools, healthcare and other social
services, including income support and transfers for the poorest. Investment in government
institutions, transport systems and other productive infrastructure will further drive productivity
improvements within an economy and drive economic growth. All of which will increase
economic development and living standards.
Corruption and the misappropriation of revenues, spending on the military and vanity projects
(e.g., building new stadiums) do little to improve economic development.
Economic growth has some negative impacts on welfare. Pollution, environmental

degradation and urban congestion are all examples of negative externalities of production
and consumption signalling market failure and the loss of welfare.
The exploitation and intensive farming and harvesting of land and natural resources such as
minerals and oil can lead to increased economic growth in the present, but will reduce the
ability of future generations to benefit from these resources and maintain or increase their
living standards.
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1.2. Sources of economic growth in economically less developed countries
a. Natural factors
b. Improving the quality of human capital through education and training
c. Improving the quantity physical capital
d. the development and use of new technologies that are appropriate to the conditions of
the economically less developed countries
e. Improving the Institutional factors such as banking system, legal system, education
system, political stability etc.
The less economically developed countries (LEDCs) are a group of countries that have been
classified by the UN as "least developed" in terms of their low gross national income (GNI),
their weak human assets and their high degree of economic vulnerability.
A country will sustain long-term economic growth by increasing its productive capacity. The
quantity and productivity of the factors of production (land, labour, capital and
entrepreneurship) determine the level of potential output. It is unlikely that increased
economic growth in LEDCs will be achieved by increasing the amount of human capital
available, and this is especially true of social welfare where scarce resources will be divided
between more and more people. As the population of an LEDC grows, nominal economic
growth may follow in terms of increased GDP, but it is much more likely that real GDP per
capita will decline, reducing average income.
Rather, improvements in the productivity of human and physical capital should be the focus
of economic growth, the quality of which must be improved to increase output and income
per person. Education is key. Increasing a nation’s numeracy and literacy rates, and
providing skills training are key steps to be taken to increasing the productivity of human
capital. Healthcare, access to nutritious food, clean drinking water and good housing will
increase the productivity of labour and boost a country’s potential output.
The role of physical capital is important too. If a country can both increase the stock of capital
goods it uses to produce goods and services, as well as improving the efficiency of such
physical capital, then it will increase its productive capacity. Examples of physical capital
include necessary infrastructure such as schools, hospitals, electricity and
telecommunications networks, universities, roads, ports, railways and airports. The
construction of commercial property, factories and residential housing are included here. As
too are the capital goods, machinery and equipment, which will increase the capital intensity
of an economy and increase the productivity of labour in the production of goods and
services.
However, this begs the question, where does an LEDC source its needed investment capital
from?
LEDCs are relatively poor, and as such these countries have a low marginal propensities to
save and a high marginal propensity to consume. Average incomes are very low, and
households will spend most of their incomes on necessities such as food and shelter,
healthcare and transport to and from work. Low incomes do not really allow for any significant
amount of savings in aggregate.
Savings make it possible for entrepreneurs to make capital investments, and with only a
small deposit base banks cannot make meaningful levels of business loans within the
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economy. Thus, there are relatively limited funds that are available for firms to invest in new
capital goods and research and develop new technologies to increase productivity and drive
economic growth. Foreign direct investment then becomes necessary for the capital
intensification of an LEDC’s economy.
Governments in LEDCs are less able to make important investments in necessary

infrastructure, which would improve productivity levels and increase potential output. There
are two problems governments of LEDCs face in financing such investment infrastructure,
and both are caused by low tax revenues. The first issue is that because average incomes
are low, so too are tax revenues. Secondly, LEDCs will not have the systems in place to
monitor economic activity and ensure compliance. It is difficult for an LEDC to know who is
making sales and how many sales are being made to collect sales taxes; who is being
employed and how much they earn for income taxes; and which firms are operating and how
profitable they are. Much economic activity takes place in the black market which, by
definition, does not have any government oversight. Thus, the governments of LEDCs have
relatively limited finance available for investing in transport networks, hospitals and schools.
Similarly, for sustained economic growth a country must have certain institutions in place,
and for these to be functional. Political stability is important, because with increased certainty
around the social and business environment, both local and foreign direct business
investment will increase. The banking sector needs to be available and stable as to provide
savers with interest on their deposits and to use as a source of investment funds. The
government of an LEDC must ensure that a functioning and enforceable legal system is in
place. For business confidence and investment to improve, firms should have confidence that
contracts and property rights can be enforced in a court of law. Corruption and bribery should
be minimal.
Essential statement: The growth of an economy depends largely on the quantity and
productivity of a country’s factors of production, as well as a general environment where a
country’s institutions provide confidence for investors.
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1.3. Common Characteristics of Economically Less Developed Countries
The development economist, Michael P. Todaro, produced a list of the common

characteristics of developing nations:
1. Low standards of living, low GDP per capita, low incomes, inequality, poor health,
inadequate education
2. Low level of productivity and high levels of poverty
3. High rates of population growth, High birth rates and dependency burden
4. High and rising levels of unemployment and underemployment
5. Substantial dependence on agricultural production/primary sector
6. Prevalence of imperfect markets i.e. Lack of banking, legal system, adequate
infrastructure, imperfect information.
7. Dominance by developed nations and dependence in terms of international relations.
Figure 1.1 below illustrates the common characteristics of developing countries. In IB

Economics it is very important to make clear that these characteristics do not apply
uniformly to all LEDCs.
Figure 1.1: Common Characteristics of Less Economically Developed Countries
1. Low Standards of Living, characterized by low incomes, inequality, poor health and
inadequate education:
Low Standards of living tend to be experienced by the majority of the population. The main
indicators of these low living standards are high poverty levels (i.e very low incomes), high
levels of inequality, very poor housing, low standards of health, high infant mortality rates,
high levels of malnutrition and a lack of education.
Developing countries have low levels of GDP per capita. Gross Domestic Product (GDP) is
the market value of all final goods and service produced in a country in a year, and GDP per
capita is this income divided by the population of a country. Low average incomes means
that most people living in LDCs such countries are relatively poor, and often have a sizeable
proportion of their populations living in absolute poverty.
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Labour productivity will be low because investment in infrastructure and capital goods is also
low. Low output per unit of labour weighs down on average incomes.
Some countries do relatively well on the GDP per capita index but perform poorly in terms of
economic development. This is the case when national income is high, but income
distribution is very unequal. For example, some countries have good oil and mineral
resources owned by the state and/or corrupt firms which siphon off profits to the massive
benefit of a few elite.
Figure 1.2: Countries by GDP per capita.
2. Low Levels of Productivity and High Levels of Poverty:

The main causes are low education standards within the countries, the low level of health
among workers, lack of investment in physical capital and lack of access to technology.
Low productivity levels leads to high levels of poverty in LEDCs which is related to low GDP
per capita. Absolute poverty is a condition characterised by severe deprivation of basic
human needs, including food, safe drinking water, sanitation facilities, health, shelter,
education and information. It depends not only on income but also on access to services.
Low levels of income means that individuals cannot afford the basic necessities, let alone
services such as health care and education. As a result, malnourishment and ill health may
be endemic in the population, and high infant and child mortality and low literacy rates are
often prevalent. Low incomes mean low government revenues which, in turn, lead to low
investment in services such as social housing, education and healthcare which increase
economic development.
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3. High Rates of Population Growth & Dependency Burdens:
Developing countries tend to have crude birth rates that are on average more than double the
rates in developed countries. The crude birth rate is annual number of live births per 1,000 of
the population. The world average in 2005, was 20.15, but in some developing countries, it
can be as high as 50 per thousand. The high crude birth rates in developing countries tend
to be transformed into high dependency ratios. The high crude birth rate means that there are
lot of young people under the age of 15 in developing countries. Those of working age,
usually assumed to be 15 to 64, have to support a much larger proportion of children than
does the work force in developing countries.
Dependency Ratio: The dependency ratio is the percentage of those who are non-
productive, usually those who are under 15 and over 64, expressed as a percentage of those
of working age, usually 15 to 64. The equation would be:
Dependency Ratio =
(% of population under 15) + (% of population over 64)

(% of population 15 to 64)
Most LEDCs are experiencing rapid population growth. Most LEDCs are in a stage of
demographic transition. This means that they have falling death rates, due to improving
health care, while birth rates remain high. The recent history of population management
policies in China illustrates population-change management problems.
Causes of population growth in LEDCs include limited access to family planning services and
education about contraception. Contraception and other methods of family planning may not
be culturally or religiously acceptable. Further, children may be seen as a valuable source of
labour and income for a family. They can work on the land from a young age and as they get
older they can earn money in other jobs. Children can also help to care for younger children
and elderly family members.
High rates of infant mortality (infant deaths) mean that women need to have many children in
order to ensure that some survive through to adulthood. It may be traditional or culturally
important to have a large family.
LEDCs have a high population-growth rate which means that they have many young
dependants. Governments in LEDCs and international bodies and charities are working to
reduce birth rates and slow down rates of population growth.
Youthful populations. The high birth rate in LEDCs results in a high proportion of the
population under 15. This youthful population gives a country specific problems, including:
 Young children need health care - for example, immunisations. This is expensive for a
country to provide.
 Young people need to be educated – providing schools and teachers are expensive.
Resources for lessons are difficult to access, and costly to buy.
 In the future, more children will reach child bearing age, putting more pressure on
health services
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Figure 1.3: The World’s Least Developed Countries health services.
Table 1.1: Countries that are considered Poor
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4. High & Rising Levels of Unemployment & Underemployment:
Developing countries tend to have relatively high levels of unemployment, typically between
9% and 16% of the labour force. In addition, to the official unemployment statistics, there are
three more groups that need to be considered:
i. Hard Core: those that have been unemployed for so long that they have given up
searching for a job and no longer appear as unemployed.
ii. Hidden Unemployed: those who work for a few hours a day on the family farm or in a
family business or trade.
iii. Underemployed: those who would like full-time work but are only able to get part-time
employment, often on an informal basis
It is when all the groups previously mentioned are put together that the full extent of
unemployment in developing countries can be really understood. It is impossible to be
accurate, but it would be fair to say that in many developed countries, the true rate of
unemployment is over 40%.
5. Substantial Dependence on Agricultural Production & Primary Product Exports:

An underdeveloped economy is predominantly an agrarian economy. Predominance of
agriculture is viewed from two angles – first is the contribution of this sector towards national
income. In LEDCs, agriculture contributes roughly 30-50 per cent towards national income.
On the other hand, in developed countries, agriculture occupies a secondary position since 2
to 8 per cent of national income comes from this sector.
Secondly, LEDCs mainly depend upon agriculture and extractive industries like mining,
fisheries and forests. This means that the bulk of the population is engaged in agriculture and
allied pursuits. About 55-75 per cent of the population are engaged in agriculture. Only 10 per
cent are employed in the secondary sector, and the rest in the tertiary sector.
In advanced countries, agriculture provides employment to a small fraction of the people (2 to

5 per cent).
To compound matter, the agricultural sectors of LEDCs will be characterised by low levels of
productivity. Farms will be smaller and use less capital equipment than agriculture in
developed economies. Thus agriculture in LEDCs is highly labour intensive whereas in
developed economies it tends to be highly capital intensive.
6. Prevalence of imperfect markets & limited information:

The trend in developing countries in the last 20 years has been towards a more market-
oriented approach to growth. This has sometimes been promoted or encouraged by
international bodies such as the IMF and the World Bank. However, this is possibly
problematic, since while market-based approaches may work well in economies that are
efficiently functioning, many developing countries face imperfect markets and imperfect
knowledge.
Developing countries may lack many of the necessary factors that enable markets to work
efficiently.
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i. They may lack a functioning banking system, which enables and encourages savings and
then investment.
ii. They lack a developed legal system, which ensures that business takes place in a fair
and structured manner.
iii. They lack adequate infrastructure, especially in terms of transport routes of all types,
which would enable raw materials, semi-finished products and final goods to more around
the country, and to be moved out of the country , efficiently and at low cost.
iv. They lack accurate information systems for both producers and consumers, which often
leads to imperfect information, the misallocation of resources and misinformed
purchasing decisions.
7. Dominance, Dependence and Vulnerability in International Relations:

In almost all cases, developing countries are dominated by developed countries because of
the economic and political power of the developed countries. In addition, they are dependent
upon them for many things, such as trade, access to technology, aid and investment. It is not
really possible for economically small, developing countries to isolate themselves from world
markets.
Developing countries are vulnerable on the international stage, and are dominated by, and
often harmed by the decisions of developed countries over which they have no control. Some
would argue that what is needed is for the developing countries to act as a bloc, to gain more
power in trade negotiations.
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A. Understanding Poverty
Poverty Cycle (Trap)

Some countries there may be communities caught in poverty trap (poverty cycle) where poor
communities are unable to invest in physical, human and natural capital due to low or no
savings; poverty is therefore transmitted from generation to generation, and there is a need
for intervention to break out of the cycle.
Figures 1.4 and 1.5 below illustrate a poverty cycle (trap)
Figure 1.4: Poverty Cycle (Trap) 1
Figure 1.5: Poverty Cycle (Trap) 2
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Households spend all of their income when their incomes are very low. LEDCs are relatively
poor, and as such these countries have a low marginal propensities to save and a high
marginal propensity to consume. Average incomes are very low, and households will spend
most of their incomes on necessities such as food and shelter, healthcare and transport to
and from work. Low incomes do not really allow for any significant amount of savings in
aggregate. Without savings there are no funds to finance investments in both physical (e.g.,
capital goods) and human capital (e.g., education) which are both necessary to increase the
productivity of labour and land. Thus, productivity increases only incrementally over time.
Investment is required to achieve economic growth, and without economic growth incomes
will stay low. With low incomes and low spending by firms and households, direct and indirect
government tax revenues will remain low. With only low tax revenues, governments will find it
very difficult to finance the necessary infrastructure and services spending (education, health
transport networks, etc.) that would increase national productivity.
Photo 2: Water is essential
A country that is very poor is not able to save and, therefore, there are few funds available for
investment in human capital and physical capital – because there is little investment
productivity changes very slowly. Investment is needed for economic growth, without it the
economy cannot grow and incomes remain low. Income and expenditure are low, therefore
direct tax and indirect tax revenue is low. The government has very little money to invest in
infrastructure and with low levels of investment in infrastructure productivity remains low.
Thus, the only way to break out of the poverty cycle is by foreign direct investment,
otherwise, generation after generation could be stuck in the poverty trap. In order to escape
the poverty trap, it is argued that individuals in poverty must be given sufficient aid so that
they can acquire the critical mass of capital necessary to raise themselves out of poverty.
This theory of poverty helps to explain why certain aid programs which do not provide a high
enough level of support may be ineffective at raising individuals from poverty. If those in
poverty do not acquire the critical mass of capital, then they will simply remain dependent on
aid indefinitely and regress if aid is ended.
Essential statement: Low GDP per capita means that national incomes are too low to
generate the savings needed to generate the private and public investment needed to
increase productivity rates. And, without increased productivity, national income will
remain low. The only way for an LDC to break out of the poverty trap is by attracting
foreign direct investment.
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1.4. Diversity among Economically Less Developed Nations
Economically less developed countries differ enormously from each other in terms of:
Figure 1.6: Sources of Diversity in LEDCs
No two developing countries are the same. Developing countries display notable diversity in
a number of areas.
1. Natural Resource Endowments

Natural resources can be exploited to generate income. Some LEDCs are relatively fortunate
to have large oil and gas reserves (e.g., Angola), others have marketable minerals (e.g.,
diamonds in Botswana), and some LEDCs have no such natural resources.
Some developing countries will have forests (e.g., Myanmar), fertile land (e.g., Kenya) or
relatively large coastlines for fishing (e.g., the Philippines), while others will be dry and arid
(e.g., Libya) and/or landlocked (e.g., Chad)
2. Climate
In general, most developed economies have temperate climates and almost all LEDCs have
tropical and subtropical climates. Climate is thought to have be one of the different factors
that can affect the level of economic development.
Climate is an important factor in determining the types and nature of economic activity that
occurs within economies. Climate will affect what type of agricultural production can take
place and it can also affect the productivity of labour. For example, it is difficult to work
outside in the monsoon season in India, the Siberian winter or Yemeni summer. Soil quality is
lower in tropical and subtropical climates, than more temperate climates.
3. History
Certain historic events have had a long-term impact on economic development. For example,
colonial rule affected the subsequent development of domestic institutions and economic
development. Examples include the importance of colonial land revenue systems within
India, and that Africa’s slave trade adversely affected subsequent development. Systems of
colonial rule were based on an economic model to transfer resource wealth from the
colonised to the colonisers, rather than to encourage economic development.
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4. Political System
A political system is a coordinated set of principles, laws, ideas, and procedures relating to a
particular form of government, or the form of government itself. Essentially it is how the
government is structured and functions. For example, democracy is a political system in
which citizens govern themselves.
Political systems and institutions are extremely important for economic growth in low-income
countries. Specifically, the longer the same elite is in power, the more fragmented the party
system is; and the greater the number of parties in the governing coalition, and the more
party-centred the electoral system is, the smaller economic growth will be for low-income
countries. On the other hand, the greater the district magnitude and the more choice within
the electoral system, political polarisation and federalism help poor countries to achieve
better economic performance.
There are the odd exceptions. Modern Korea shows that dictators may be able to bring about
economic development – but only to a point. Then political openness becomes crucial to
keep that growth and development story going. Korea therefore provides important lessons
for the rest of the emerging world, especially China.
5. Human and Capital Resources

Some LEDCs are investing heavily in education to boost literacy, numeracy and skills among
the general population, and children and adolescents specifically. Education leads to the
increased productivity of labour and boosts the level of entrepreneurship within an economy.
Many countries have committed themselves to more than the achievement of universal
primary education and now include several years of secondary school in their national
targets. Globally, 83 per cent of lower secondary-school-age children are in either primary or
secondary school, dropping to less than 70 per cent in low-income countries. From 2000 to
2013, the number of out-of-school children of lower secondary school age shrank from 97
million to 65 million. But progress has slowed since 2007. Challenges to secondary-school
participation are greatest in sub-Saharan Africa and South Asia.
There are variations between LEDCs in the number of girls in education and the workforce.
For example, Morocco has relatively few girls in school as a proportion of the population
compared to neighbouring Libya. There is also considerable variation between the
performance or how much value-added comes from education between LEDCs. In Vietnam
less than 10 per cent of 15-year-old students failed to achieve even a minimum proficiency in
mathematics, whereas in Columbia it is more than 70 per cent.
6. Political Stability
Political stability is the durability and integrity of a current government regime. This is
determined based on the amount of violence and terrorism expressed in the nation and by
citizens associated with the state. Generally, the more politically stable a country is, the
greater the level of economic development. There are obvious exceptions, three generations
of Kim have ruled North Korea since 1948 but their 70 years of stable rule has not led to any
significant economic development.
The main reasons that political stability tends to generate higher levels of economic growth
and development include:
 Effective decision-making within government depends on stability. Economic policies and
their implementation typically need years of continuity to be successfully achieved. For
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example, a policy of compulsory schooling for children will need years to establish the
financing, build new schools, establish the curriculum, train new teachers and principals
and drive through the changes on an institutional level (e.g., a Ministry of Education).
 Uncertainties surrounding the investment environment, property rights and tax legislation
all increase with increased political instability. Business confidence is important in driving
domestic investment decisions. Foreign direct investment is less likely with political
instability. For example, Venezuela has expropriated the businesses and assets of
foreign companies operating there with little to no compensation being paid.
 Similarly, political instability often results in capital flight – which is when assets or money
rapidly flow out of a country, due to an event of economic consequence. If governments
look on the verge of collapse or when it looks likely that they will institute radical
economic policies such as devaluing a currency, then firms and citizenry may well believe
that their money will be safer offshore. The country will then lose access to ready capital
and a balance of payments crisis may well follow.
 Vulnerability to hunger and famine will increase with political instability. Governments will
find it more difficult to provide relief. Resources may need to be diverted to additional
policing or the military. For example, in the Democratic Republic of the Congo during the
Second Congo War (1998–2004), 3.8 million people died, mostly from starvation and
disease.
In addition, there is a high correlation between political instability and low levels of GDP per
capita. Cause and effect runs in both directions. Political instability leads to lower income
levels, and lower incomes lead to political instability as frustration and dissatisfaction with
governments increase.
Photo 3: Crazy like a fox? Maybe, but politically stable.
To conclude, we can say that while there are some common characteristics that are held by
developing countries to some degree, there are also several significant differences. One
must be very cautious in making generalizations that imply that all developing countries are
the same.
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1.5. International Development Goals
The Millennium Development Goals (MDGs) are eight international development goals that
were officially established following the Millennium Summit of the United Nations in 2000,
following the adoption of the United Nations Millennium Declaration. All 193 United Nations
member states and at least 23 international organizations have agreed to achieve these
goals by the year 2015.
The goals are:

1. eradicating extreme poverty and hunger,
2. achieving universal primary education,
3. promoting gender equality and empowering women
4. reducing child mortality rates,
5. improving maternal health,
6. combating HIV/AIDS, malaria, and other diseases,
7. ensuring environmental sustainability, and
8. developing a global partnership for development
1. Eradicate extreme poverty and hunger.

Reduce by half the proportion of people living on less than a dollar a
day and suffer from hunger.
2. Achieve universal primary education.

Ensure that all children, both boys and girls, complete a full course
of primary schooling.
3. Promote gender equality and empower women.

Eliminate gender disparity in primary and secondary education
preferably by 2005, and at levels by 2015.
4. Reduce child mortality.

Reduce by two thirds the mortality rate among children under five
years of age.
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5. Improve maternal health.
Reduce by three quarters the maternal mortality ratio – the number of
women who die from pregnancy – related causes while mother is
pregnant.
6. Combat HIV/AIDS, malaria and other diseases.

Halt and begin to reverse the spread and incidence of HIV/AIDS,
malaria and other diseases.
7. Ensure environmental stability.

Reduce by half the proportion of people without sustainable access to
safe drinking water, achieve significant improvement in the lives of at
least 100 million slum dwellers by 2020, and integrate the principles of
sustainable development to reverse loss of environmental resources.
8. Develop a global partnership for development.

Develop a comprehensive commitment between the International,
National and Local Level to develop partnerships to achieve the
Millennium Development Goals.
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1.6. Measuring Economic Development
A. Single Indicators
1. GNI per capita

GNI per capita (formerly GNP per capita) is the gross national income, divided by the mid-
year population.
GNI is the sum of value added by all resident producers plus any product taxes (less
subsidies) not included in the valuation of output plus net receipts of primary income
(compensation of employees and property income) from abroad. GNI, calculated in national
currency, is usually converted to U.S. dollars at official exchange rates for comparisons
across economies, although an alternative rate is used when the official exchange rate is
judged to diverge by an exceptionally large margin from the rate actually applied in
international transactions.
To smooth fluctuations in prices and exchange rates, a special Atlas method of conversion is
used by the World Bank. This applies a conversion factor that averages the exchange rate for
a given year and the two preceding years, adjusted for differences in rates of inflation
between the country, and through 2000, the G-5 countries (France, Germany, Japan, the
United Kingdom, and the United States). From 2001, these countries include the Euro area,
Japan, the United Kingdom, and the United States.
2. GDP per capita (current US$)

GDP per capita is gross domestic product divided by midyear population.
GDP is the sum of gross value added by all resident producers in the economy plus any
product taxes and minus any subsidies not included in the value of the products. It is
calculated without making deductions for depreciation of fabricated assets or for depletion
and degradation of natural resources.
3. GDP per capita, PPP (current international $)

GDP per capita based on purchasing power parity (PPP). PPP GDP is gross domestic
product converted to international dollars using purchasing power parity rates.
An international dollar has the same purchasing power over GDP as the U.S. dollar has in
the United States. GDP at purchaser's prices is the sum of gross value added by all resident
producers in the economy plus any product taxes and minus any subsidies not included in
the value of the products. It is calculated without making deductions for depreciation of
fabricated assets or for depletion and degradation of natural resources.
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Difference Between GNI and GDP
GNI vs GDP
GNI, or Gross National Income, and GDP, or Gross Domestic Product, are economic terms
that deal with National income. The GNI and GDP are often considered to be the opposite
sides of the same coin. Well, one can see that the GNI and GDP differ in all features.
So, what actually is Gross National Income and Gross Domestic Product? The GDP is said to
be the measure of a country’s overall economic output. It is the market value of
all services and goods within the borders of a nation. The GNI is the total value that is
produced within a country, which comprises of the Gross Domestic Product along with the
income obtained from other countries (dividends, interests).
One of the main differences between the two, is that the Gross Domestic Product is based on
location, while Gross National Income is based on ownership. It can also be said that GDP is
the value produced within a country’s borders, whereas the GNI is the value produced by all
the citizens.
Well, it is easier to understand with an example. Suppose a firm in the United States has an
establishment in Canada, the profits from the products will not be part of the US Gross
Domestic Product, as production has not taken place in another area. However, this would
count towards the US Gross National Income, as the firm is owned by US citizens even
though it is located in another country.
Gross Domestic Product helps to show the strength of a country’s local income. On the other
hand, Gross National Income helps to show the economic strength of the citizens of a country.
Summary:
1. Gross Domestic Product is the value produced within a country’s borders, whereas the
Gross national Income is the value produced by all the citizens.
2. GDP is said to be the measure of a country’s overall economic output. The GNI is the total
value that is produced within a country, which comprises of the Gross Domestic Product
along with the income obtained from other countries (dividends, interests).
3. Gross Domestic Product helps to show the strength of a country’s local income. On the
other hand, Gross National Income helps to show the economic strength of the citizens of
a country.
4. GNI is based on ownership, and GDP is based on location.
Read more: Difference Between GNI and GDP | Difference Between | GNI vs
GDP http://www.differencebetween.net/business/difference-between-gni-and-gdp/#ixzz2iKbt0700
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4. Health Indicators
Health Indicator Description
Adolescent fertility rate (births per Adolescent fertility rate is the number of births per 1,000
1,000 women ages 15-19) women ages 15-19.
Crude birth rate indicates the number of live births

occurring during the year, per 1,000 population estimated
at mid-year. Subtracting the crude death rate from the
Birth rate, crude (per 1,000 people)
crude birth rate provides the rate of natural increase,
which is equal to the rate of population change in the
absence of migration.
Births attended by skilled health staff are the percentage

of deliveries attended by personnel trained to give the
Births attended by skilled health staff
necessary supervision, care, and advice to women during
(% of total)
pregnancy, labor, and the postpartum period; to conduct
deliveries on their own; and to care for newborns.
Contraceptive prevalence rate is the percentage of women

Contraceptive prevalence (% of who are practicing, or whose sexual partners are
women ages 15-49) practicing, any form of contraception. It is usually
measured for married women ages 15-49 only.
Crude death rate indicates the number of deaths occurring

during the year, per 1,000 population estimated at
midyear. Subtracting the crude death rate from the crude
Death rate, crude (per 1,000 people)
birth rate provides the rate of natural increase, which is
equal to the rate of population change in the absence of
migration.
Total fertility rate represents the number of children that

would be born to a woman if she were to live to the end of
Fertility rate, total (births per woman)
her childbearing years and bear children in accordance
with current age-specific fertility rates.
Total health expenditure is the sum of public and private

health expenditures as a ratio of total population. It covers
the provision of health services (preventive and curative),
Health expenditure per capita
family planning activities, nutrition activities, and
(current US$)
emergency aid designated for health but does not include
provision of water and sanitation. Data are in current U.S.
dollars.
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Public health expenditure consists of recurrent and capital
spending from government (central and local) budgets,
external borrowings and grants (including donations from
international agencies and nongovernmental
organizations), and social (or compulsory) health
Health expenditure, public (% of total
insurance funds. Total health expenditure is the sum of
health expenditure)
public and private health expenditure. It covers the
provision of health services (preventive and curative),
family planning activities, nutrition activities, and
emergency aid designated for health but does not include
provision of water and sanitation.
Total health expenditure is the sum of public and private

health expenditure. It covers the provision of health
services (preventive and curative), family planning
Health expenditure, total (% of GDP)
activities, nutrition activities, and emergency aid
designated for health but does not include provision of
water and sanitation.
Child immunization measures the percentage of children

ages 12-23 months who received vaccinations before 12
Immunization, DPT (% of children months or at any time before the survey. A child is
ages 12-23 months) considered adequately immunized against diphtheria,
pertussis (or whooping cough), and tetanus (DPT) after
receiving three doses of vaccine.
Child immunization measures the percentage of children

ages 12-23 months who received vaccinations before 12
Immunization, measles (% of children
months or at any time before the survey. A child is
ages 12-23 months)
considered adequately immunized against measles after
receiving one dose of vaccine.
Access to improved sanitation facilities refers to the

percentage of the population with at least adequate
access to excreta disposal facilities that can effectively
Improved sanitation facilities (% of prevent human, animal, and insect contact with excreta.
population with access) Improved facilities range from simple but protected pit
latrines to flush toilets with a sewerage connection. To be
effective, facilities must be correctly constructed and
properly maintained.
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Access to improved sanitation facilities refers to the
percentage of the population with at least adequate
access to excreta disposal facilities that can effectively
Improved sanitation facilities, urban prevent human, animal, and insect contact with excreta.
(% of urban population with access) Improved facilities range from simple but protected pit
latrines to flush toilets with a sewerage connection. To be
effective, facilities must be correctly constructed and
properly maintained.
Incidence of tuberculosis is the estimated number of new

Incidence of tuberculosis (per
pulmonary, smear positive, and extra-pulmonary
100,000 people)
tuberculosis cases.
Life expectancy at birth indicates the number of years a

Life expectancy at birth, female newborn infant would live if prevailing patterns of mortality
(years) at the time of its birth were to stay the same throughout its
life.
Life expectancy at birth indicates the number of years a

newborn infant would live if prevailing patterns of mortality
Life expectancy at birth, male (years)
at the time of its birth were to stay the same throughout its
life.
Prevalence of child malnutrition is the percentage of

children under age 5 whose height for age (stunting) is
more than two standard deviations below the median for
Malnutrition prevalence, height for the international reference population ages 0-59 months.
age (% of children under 5) For children up to two years old height is measured by
recumbent length. For older children height is measured
by stature while standing. The data are based on the
WHO's new child growth standards released in 2006.
Prevalence of child malnutrition is the percentage of

children under age 5 whose weight for age is more than
Malnutrition prevalence, weight for two standard deviations below the median for the
age (% of children under 5) international reference population ages 0-59 months. The
data are based on the WHO's new child growth standards
released in 2006.
Maternal mortality ratio is the number of women who die

during pregnancy and childbirth, per 100,000 live births.
Maternal mortality ratio (modeled
The data are estimated with a regression model using
estimate, per 100,000 live births)
information on fertility, birth attendants, and HIV
prevalence.
Mortality rate, infant (per 1,000 live Infant mortality rate is the number of infants dying before
births) live births in a given year. reaching one year of age, per 1,000
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Malaria incidence is expressed as the number of new
cases of malaria per 100,000 people each year. The
number of cases reported is adjusted to take into account
Notified cases of malaria (per
incompleteness in reporting systems, patients seeking
100,000 people)
treatment in the private sector, self-medicating or not
seeking treatment at all, and potential over-diagnosis
through the lack of laboratory confirmation of cases.
Out of pocket expenditure is any direct outlay by

households, including gratuities and in-kind payments, to
health practitioners and suppliers of pharmaceuticals,
Out-of-pocket health expenditure (% therapeutic appliances, and other goods and services
of private expenditure on health) whose primary intent is to contribute to the restoration or
enhancement of the health status of individuals or
population groups. It is a part of private health
expenditure.
Population, age 0-14 (% of total) is the population between

Population ages 0-14 (% of total) the ages of 0 and 14 as a percentage of the total
population.
Population, age 15-64 (% of total) is the population

Population ages 15-64 (% of total) between the ages of 15 and 64 as a percentage of the
total population.
Population ages 65 and above as a percentage of the total

population. Population is based on the de facto definition
of population, which counts all residents regardless of
Population ages 65 and above (% of
legal status or citizenship--except for refugees not
total)
permanently settled in the country of asylum, who are
generally considered part of the population of the country
of origin.
Population, female (% of total) is the percentage of the

Population, female (% of total)
population that is female.
Population growth (annual %) is the exponential rate of

Population growth (annual %) growth of midyear population from year t-1 to t, expressed
as a percentage.
Population, total Population, total refers to the total population
Pregnant women receiving prenatal care are the

Pregnant women receiving prenatal percentage of women attended at least once during
care (%) pregnancy by skilled health personnel for reasons related
to pregnancy.
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Prevalence of HIV is the percentage of people who are
Prevalence of HIV, female (% ages
infected with HIV. Youth rates are as a percentage of the
15-24)
relevant age group.
Prevalence of HIV is the percentage of people who are

Prevalence of HIV, male (% ages 15-
infected with HIV. Youth rates are as a percentage of the
24)
relevant age group.
Prevalence of HIV, total (% of Prevalence of HIV refers to the percentage of people ages
population ages 15-49) 15-49 who are infected with HIV.
Teenage mothers (% of women ages

Teenage mothers are the percentage of women ages 15-
15-19 who have had children or are
19 who already have children or are currently pregnant.
currently pregnant)
Unmet need for contraception is the percentage of fertile,

Unmet need for contraception (% of
married women of reproductive age who do not want to
married women ages 15-49)
become pregnant and are not using contraception.
source: World Bank
5. Other Economic Indicators:

a. World Development Indicators
b. Millennium Development Goals
c. Health Indicators
d. Income Poverty
e. Income Distribution
f. Demographic Indicators
g. Importance of Primary, Secondary and Tertiary Sectors
h. Literacy, Improved Water Source and Improved Sanitation
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B. Composite Indicators
National Income may not be the best indicator for measuring standard of living. It includes
output that is not used for current consumption and it may not reflect the non-material
aspects of standard of living.
Other indicators that are useful for assessing standard of living include:
 Leisure time/length of work week

 Quality of life
 Availability of medical and/or educational facilities per head
 Nature and quality of welfare services
 Economic development
6. Human Development Index

The Human Development Index (HDI) is a summary measure of human development. It
measures the average achievements in a country in three basic dimensions of human
development: a long and healthy life (health), access to knowledge (education) and a decent
standard of living (income). Data availability determines HDI country coverage. To enable
cross-country comparisons, the HDI is, to the extent possible, calculated based on data from
leading international data agencies and other credible data sources available at the time of
writing.
A composite index that brings together three variables adopted in 1990 developed jointly by
Amartya Sen and Mahbub ul Haq.
1. Long and healthy life; life expectancy

2. Improved education; adult literary
3. Decent standard of living; GDP per capita
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Category HDI Value
High Human development .800 and above

Medium human development .500 -0.799
Low human development Less than .500
7. Other composite indices
a) Gender Inequality Index

The Gender Inequality Index (GII) reflects women’s disadvantage in three dimensions:-
reproductive health, empowerment and the labour market - for as many countries as data
of reasonable quality allow.
The index shows the loss in human development due to inequality between female and male
achievements in these dimensions. It ranges from 0, which indicates that women and men
fare equally, to 1, which indicates that women fare as poorly as possible in all measured
dimensions. The health dimension is measured by two indicators: maternal mortality ratio and
the adolescent fertility rate. The empowerment dimension is also measured by two indicators:
the share of parliamentary seats held by each sex and by secondary and higher education
attainment levels.
The labour dimension is measured by women’s participation in the work force. The Gender
Inequality Index is designed to reveal the extent to which national achievements in these
aspects of human development are eroded by gender inequality, and to provide empirical
foundations for policy analysis and advocacy efforts.
More information at http://hdr.undp.org/en/statistics/gii/
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b) Inequality-adjusted Human Development Index (IHDI)
The Inequality-adjusted Human Development Index (IHDI) adjusts the Human Development
Index (HDI) for inequality in distribution of each dimension across the population. The IHDI
accounts for inequalities in HDI dimensions by “discounting” each dimension’s average value
according to its level of inequality. The IHDI equals the HDI when there is no inequality
across people but is less than the HDI as inequality rises. In this sense, the IHDI is the actual
level of human development (accounting for this inequality), while the HDI can be viewed as
an index of “potential” human development (or the maximum level of HDI) that could be
achieved if there was no inequality. The “loss” in potential human development due to
inequality is given by the difference between the HDI and the IHDI and can be expressed as
a percentage.
More information http://hdr.undp.org/en/statistics/ihdi/
c) The Multidimensional Poverty Index

The Multidimensional Poverty Index (MPI) identifies multiple deprivations at the individual
level in health, education and standard of living. It uses micro data from household surveys,
and - unlike the Inequality-adjusted Human Development Index - all the indicators needed to
construct the measure must come from the same survey. Each person in a given household
is classified as poor or non-poor depending on the number of deprivations his or her
household experiences. These data are then aggregated into the national measure of
poverty.
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The MPI reflects both the incidence of multidimensional deprivation, and its intensity—how
many deprivations people experience at the same time. It can be used to create a
comprehensive picture of people living in poverty, and permits comparisons both across
countries, regions and the world and within countries by ethnic group, urban or rural location,
as well as other key household and community characteristics. The MPI builds on recent
advances in theory and data to present the first global measure of its kind, and offers a
valuable complement to income-based poverty measures. The 2011 Human Development
Report (HDR) presents estimates for 109 countries with a combined population of 5.5 billion
(79% of the world total). About 1.7 billion people in the countries covered—a third of their
entire population—lived in multidimensional poverty between 2000 and 2010.
More information at http://hdr.undp.org/en/statistics/mpi/
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C. Problems of Using Gross Domestic/National Product
A) Difficulties Encountered in Measuring National Income
These problems can reduce the accuracy of the National Income figure computed.
1) Obtaining correct and reliable information

- Incomplete information due to lack of organized sources GNP data is a problem,
especially in less developed countries.
2) Danger of double counting

- Cost of raw materials and intermediate goods must be excluded from the calculations
to avoid double counting.
3) Non-marketed items
- Unpaid services, self-consumed output, voluntary services are not included in
National Income, thus understating the real level of production in the economy.
4) The underground economy

- Transactions are not declared either because they are illegal (e.g. sale of drugs) or
because of tax evasion.
5) Valuation of certain items

- Valuation of government expenditure on public goods, valuation of stock appreciation
and calculation of depreciation are only estimates and may lead to inaccuracy.
B) Difficulties in using National Income for comparison of a country’s Standard of

Living over time
Comparison over time refers to the use of a time series (national income figures year-by-
year) to compare standard of living between different periods of time. The difficulties for
inter-temporal comparison are as follows:
i. Changes in the price level
Nominal national income does not take into consideration changes in general price level over
years and thus may not be a very useful indicator of economic activity over time.
Numerical Example:
If the GDP is 10% higher than the previous year, but prices are also 10% higher,
there will be no increase in real GDP and the average person will be no better off.
To correct figures for changes in prices from year to year, all money values have to be
converted into real values, measured relative to a common base year via a price index.
Use real national income instead of nominal national income.
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ii. Growth of the population
Real national income may have increased but if the population has increased by a greater
proportion, standard of living has not improved. Real per capita national income is a better
measure.
Numerical Example:
If the real GDP is 20% higher than the previous year, but population also grew by
20%, there will be no increase in real GDP per capita and the average person will
be no better off.
Use real national income per capita instead real national income.
Thus, the preferred choice of statistics: Real GDP per capita or real GNP per
capita. But, there are certain limitations. These are:
iii. Distribution of income not reflected in National Income figures
An increase in real GDP per capita does not mean that the average individual will be better
off.
For example, the majority may suffer a fall in living standards while the increase in GDP is
enjoyed by only a small group of the rich. This results in an increase in income inequality and
welfare may fall.
iv. Quantity of consumer and investment goods produced
The types of good/services produced in an economy are completely hidden from view by a
GDP figure.
GDP figures – do not reflect anything about the composition of the economy’s output. For
example, increases in investment, though contribute to a higher current level of national
income, will not lead to an increase in current consumption and current living standards but it
will help raise future consumption and future standard of living.
v. Quality and composition of products
GDP is a quantitative rather than qualitative measure. Even if GNP is the same each year,
welfare may improve if there are improvements in the quality of output or development of new
products.
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vi. Length of working hours and conditions of work not shown
Amount of leisure time is an intangible factor that influences standard of living.
Output will rise if everyone worked more hours but welfare may actually fall as the reduction
in leisure time is a cost to the people.
vii. Government Expenditure on defence and government expenditure on goods and services
are not differentiated
More expenditure on defence may not increase goods and services available to the people.
viii. Unrecorded and Undeclared items
Non-marketed items like housewives services and self-consumed output are not reflected in
national income figures and actual figures will therefore be understated.
As the economy develops, previously non-marketed items may now be included. However,
the increase in national income may not mean increase in welfare since it is due to
monetization of transactions and not due to the production of more goods and services.
The underground economy consists of illegal and thus, undeclared transactions (e.g.
drugs, pirated VCDs, prostitution). Another example would be ‘moonlighting’ where people
do extra work outside their normal jobs and do not declare the income for income tax
purposes.
The greater the level of taxes and regulations in a country, the greater the incentive for
people to go underground. The severity of punishment for engaging in illegal transactions
also plays a part in affecting the size of underground economy.
Due to its nature, it is impossible to get precise estimates of these transactions.
ix. Social costs and benefits not accounted for
Negative externalities like pollution and congestion may reduce welfare even though
production (material welfare) has increased. It is hard to measure the extent of the
externalities. If these external costs are taken into account, net benefits may be much less.
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C) Difficulties in using NY for comparing Standard of Living between Different
Countries
When national income is used to compare standard of living in different countries especially
between developed and developing countries, certain qualifications have to be made.
The common choice of statistics for comparison: Real national income per capita.
But it has the following limitations:
a. Different structure of prices

Different countries experience different rates of inflation which makes it difficult for
comparison.
b. Different rates of foreign exchange

There is a need to convert GDP figures of different countries into a common currency (US$
most widely used) to make comparison.
Exchange rate conversion will distort the true purchasing power reflected by the GDP figures.
Example:
Per capita GDP in both Countries A and B after conversion is US$1000. But if prices in
Country A are much higher than in Country B, standard of living in both countries is
not the same. US$1000 in Country A will buy fewer goods due to higher prices there.
The problem can be solved by converting NY into common currency at the Purchasing
Power Parity (PPP) rate.
PPP measures the amount of foreign currencies needed to buy the same basket of goods
and services in the 2 countries. (E.g. A kg of sugar costs £1 in UK and US$2 in US)
c. Different treatment of some items

Some items in government expenditure are treated as transfers and defence items are
included in some countries.
d. Different coverage of items in National Income estimates

Less developed countries usually have a large underground economy and a larger proportion
of the population who are self-employed. Omission of non-monetary items and underground
economy transactions is a major problem in developing countries and NY tends to be
underestimated.
e. Different sources of statistical data

Statistical services are better developed in high income countries and thus their national
income figures are more complete and reliable.
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f. Difference in tastes
Lower expenditure in certain countries may not imply lower standard of living. Consumers
may prefer to spend more on foreign products than on domestically-produced products.
Difference in pattern of demand may be due to different lifestyles and climatic conditions.
g. Difference in expenditure on defence

Some countries spend a lot more on defence and less on consumption. Thus welfare may
not be higher for this country even though its GNP can be higher than another country.
h. Difference in quality of goods

Some countries may produce better quality goods and this increases welfare. Their GDP may
be lower than another country which produces goods that are not as good in quality.
Question:
Do National Income statistics alone give a good indication of a country’s standard of
living?
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Content Mastery
By now, you should be able to:
1. Distinguish between economic growth and economic development.

2. Explain the multidimensional nature of economic development in terms of reducing
widespread poverty, raising living standards, reducing income inequalities and increasing
employment opportunities.
3. Explain that the most important sources of economic growth in economically less
developed countries include increases in quantities of physical capital and human
capital, the development and use of new technologies that are appropriate to the
conditions of the economically less developed countries, and institutional changes.
4. Explain the relationship between economic growth and economic development, noting
that some limited economic development is possible in the absence of economic growth,
but that over the long term economic growth is usually necessary for economic
development (however, it should be understood that under certain circumstances
economic growth may not lead to economic development).
5. Explain, using examples, that economically less developed countries share certain
common characteristics (noting that it is dangerous to generalize as there are many
exceptions in each case), including low levels of GDP per capita, high levels of poverty,
relatively large agricultural sectors, large urban informal sectors and high birth rates.
6. Explain that in some countries there may be communities caught in a poverty trap
(poverty cycle) where poor communities are unable to invest in physical, human and
natural capital due to low or no savings; poverty is therefore transmitted from generation
to generation, and there is a need for intervention to break out of the cycle.
7. Explain, using examples, that economically less developed countries differ enormously
from each other in terms of a variety of factors, including resource endowments, climate,
history (colonial or otherwise), political systems and degree of political stability.
8. Outline the current status of international development goals, including the Millennium
Development Goals.
9. Distinguish between GDP per capita figures and GNI per capita figures.
10. Compare and contrast the GDP per capita figures and the GNI per capita figures for
economically more developed countries and economically less developed countries.
11. Distinguish between GDP per capita figures and GDP per capita figures at purchasing
power parity (PPP) exchange rates.
12. Compare and contrast GDP per capita figures and GDP per capita figures at purchasing
power parity (PPP) exchange rates for economically more developed countries and
economically less developed countries.
13. Compare and contrast two health indicators for economically more developed countries
and economically less developed countries.
14. Compare and contrast two education indicators for economically more developed
countries and economically less developed countries.
15. Explain that composite indicators include more than one measure and so are considered
to be better indicators of economic development.
16. Explain the measures that make up the Human Development Index (HDI).
17. Compare and contrast the HDI figures for economically more developed countries and
economically less developed countries.
18. Explain why a country’s GDP/ GNI per capita global ranking may be lower, or higher,
than its HDI global ranking
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Reflections – TOK Questions:
1. Does the term “economic development” mean different things in different cultures?
2. Are there two ways of thinking about economics: from the point of view of an
economically more developed country or from that of an economically less
developed country? If so, what is the difference? Are there two different sets of
values in which such a distinction is grounded?
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2. Topics in Economic Development
2.1. Role of Domestic Factors in Economic Development
The following factors contribute to economic growth:
1. Education and Health

Education is one of the most important domestic factors in any country. Not only does it
provide benefits to the educated individuals; it also brings benefits to society. The workforce
as a whole will be able to produce more than it previously could, but that is not all. Increased
level of education improves communication and sparks social debate, which may help to
reform the very foundations of society. Because of the all-important role of education in
achieving development, the U.N has made universal enrolment in primary education one of
its Millennium Development Goals to be achieved by 2015.
Improving healthcare in less-developed countries is another key in achieving economic

development. Better healthcare means that the quality of the labour factor of production
improves, and that the country can potentially produce more. However, one of the most
important aspects of improved healthcare is perhaps a reduction in child mortality. Studies
show that a reduction in child mortality reduces the long-term need to have many children, as
the certainty of them surviving to adult age increase. A reduction in child mortality is, in itself,
a very significant factor in achieving development since it means that parents have more
resources to spend per child, and this increases their quality of life.
2. The use of Appropriate Technology

“Appropriate” technology is technology suitable for use with the factor endowments of
particular developing countries. The factor endowments of developing countries are labour
intensive. Whereas in more developed countries, technology is mainly used in production in
order to save firms from having to hire more workers, this would not be appropriate in
developing countries as it would only add to unemployment rather than increase the
productivity of each worker. Instead, appropriate technology would be such technology that
makes use of the labour surplus in order to increase production.
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3. Access to Credit and Micro-credit
The limitations of the formal financial sector and the informal financial sector in providing
financial services, especially credit, encouraged the micro-credit program to evolve. Micro
credit is an enabling, empowering, and bottoms-up tool to poverty alleviation that has
provided considerable economic and non-economic externalities to low-income households
in developing countries. Credit creates opportunities for self-employment rather than waiting
for employment to be created. It liberates both poor and women from the clutches of poverty.
It brings the poor into the income stream. Given the access to credit under an appropriate
institutional structure and arrangement, one can do whatever one does best and earn money
for it.
The aim of microfinance is not just about providing capital to the poor to combat poverty on
an individual level, it also has a role at an institutional level. It seeks to create institutions that
deliver financial services to the poor, who are continuously ignored by the formal banking
sector. It is believed that the poor are generally excluded from the financial services sector of
the economy so micro financing Institutions have emerged to address this market failure. By
addressing this gap in the market in a financially sustainable manner, an micro financing
institution can become part of the formal financial system of a country and so can access
capital markets to fund their lending portfolios, allowing them to dramatically increase the
number of poor people they can reach.
a) Micro-Credit Scheme
“Microcredit is the extension of very small loans (microloans) to impoverished borrowers who
typically lack collateral, steady employment and a verifiable credit history. It is designed not
only to support entrepreneurship and alleviate poverty, but also in many cases to empower
women and uplift entire communities by extension.”
In many communities, women lack the highly stable employment histories that traditional
lenders tend to require.
i) Strengths of Micro-credit
 Micro-credit provides a means of escaping the poverty trap: Low income individuals
can borrow money at low interest rates without the need of collaterals and micro-
credit thus break the poverty trap. They can generate/increase their incomes.
 Micro credit given to women allows them to improve their physical and social well-
being, and gives them the opportunity to raise the standards of living for their children.
 Micro-credits create employment opportunities for the community. An individual

starting a business by taking micro-credit not only creates employments for self but
also generates employment for others.
 There is no need of collaterals to access micro-credits. This gives access to people

who are unable to obtain loans from financial institutions as a result of having no
security to offer.
 Micro-credit may save people from ‘loan sharks’ by offering loans at lower interest
rates.
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 Micro credit fosters self-reliance and the use of entrepreneurial skills through self-
employment.
 Micro-credits is often accompanied by provisions of basic skills that enable the

borrowers to make better use of loans
ii) Limitations of Micro-credit

 Micro-credit may cause the government to feel that it no longer needs to invest in
poverty-reducing programmes.
 There may be insufficient regulations of the growing informal sector, resulting in new
avenues for ‘loan sharks’ to take advantage of impoverished borrowers.
 Many people who take micro-credit loans are not natural entrepreneurs and do not
have appropriate business experience. This makes it quite possible that they will be
unable to pay back the loans.
 Businesses started with micro-credit loans are likely to remain small; while they might
help individual borrowers out of poverty, this might not make a significant dent in
overall poverty in the society.
 In order to ensure that micro-credit loans reach the people who need them the most
the government needs to have a very efficient and well-oiled system. However, in this
is not usually the scene in third world countries, where the micro-credit loans don’t
reach the target population due to wide spread corruption and mismanagement.
4. The Empowerment of Women

Women make up a substantial majority of the world’s poor. They are more likely to be poor
and malnourished and less likely to receive medical services, clean water, sanitation and
other benefits. Given a preference for boys over girls that many male-dominated societies
have, gender inequality can manifest itself in the form of the parents wanting the newborn to
be a boy rather than a girl. Such a preference is obvious in China where the one-child policy
is known to be the cause of female infanticide as well as neglect and abuse of female infants.
Even when demographic characteristics do not show much of a bias, there are other ways in
which women can be discriminated against. Afghanistan may have been the last country in
the world where girls were barred from schools, but there are many countries in Asia and
Africa, and also in Latin America, where girls have far less opportunity of schooling than boys
do.
In the past decades, the health and education levels of women and girls in developing
countries have improved a great deal--in many cases they are catching up to men and boys.
But no such progress has been seen in economic opportunity: women continue to
consistently trail men in formal labor force participation, access to credit, entrepreneurship
rates, income levels, and inheritance and ownership rights. This is neither fair nor smart
economics: Under-investing in women limits development, slows down poverty reduction and
economic growth.
A host of studies suggest that putting earnings in women’s hands is the intelligent thing to do
to speed up development and the process of overcoming poverty. Women usually reinvest a
much higher portion in their families and communities than men, spreading wealth beyond
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themselves. This could be one reason why countries with greater gender equality tend to
have lower poverty rates.
For example, studies show that when income is in the hands of the mother, the survival
probability of a child increases by about 20 percent in Brazil, and in Kenya, a child will be
about 17 percent taller, because mothers will invest more of their income in health and
nutrition. In sub-Saharan Africa, agricultural productivity could be raised by as much as 20
percent by allocating a bigger share of agricultural input to women.
5. Income distribution
The view that that improved equality can help sustain growth—has become more widely held
in recent years. The main reason for this shift is the increasing importance of human capital
in development. Now that human capital is scarcer than machines, widespread education has
become the secret to growth. "Broadly accessible education" is both difficult to achieve when
income distribution is uneven and tends to reduce "income gaps between skilled and
unskilled labor."
A 2011 note for the International Monetary Fund by Andrew G. Berg and Jonathan D. Ostry
found a strong association between lower levels of inequality and sustained periods of
economic growth. Developing countries (such as Brazil, Cameroon, Jordan) with high
inequality (during the years being studied) have "succeeded in initiating growth at high rates
for a few years" but "longer growth spells are robustly associated with more equality in the
income distribution."
It is said that high levels of inequality might damage long term growth by amplifying the
potential for financial crisis, discourage investment with political instability, making it more
difficult for governments to make difficult choices in the face of shocks, such as raising taxes
or cutting public spending to avoid a debt crisis.
Inequality is associated with lower level of human capital formation (education, experience,
apprenticeship) and higher level of fertility, while lower level of human capital is associated
with lower growth and lower levels of economic growth. Inequality is associated with lower
levels of taxation which in turn are associated with lower level of economic growth
Inequality in the presence of credit market imperfections has a long lasting detrimental effect
on human capital formation and economic development.
The political economy approach, developed by Alesian and Rodrik (1994) and Persson and
Tabellini (1994), argues that inequality is harmful for economic development because
inequality generates a pressure to adopt redistributive policies that have an adverse effect on
investment and economic growth.
6. Infrastructure
Infrastructure refers to the numerous types of physical capital resulting from the investments,
making major contributions to economic growth and development by lowering costs of
production and increasing productivity: include power, telecommunications, piped water
supplies, sanitation, roads, major dam and canal works for irrigation and drainage, urban
transport, ports and airports.
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Why is physical infrastructure so important to economic development? The answer is that
once goods are produced, they need to be transported to the ports and airports for
transportation to other states and countries. This means that excellent roads are needed to
transport the goods or otherwise, they would be delayed leading to economic and
reputational losses. Indeed, if a manufacturer produces goods quickly but is unable to
transport them to the destination as fast as they can, then there is no point in making the
goods in an efficient manner in the first place.
a) Roads, Ports, and Airports

Moreover, good roads are also needed for manufacturers to obtain raw materials and other
components. In addition, ports that are well functioning and where ships do not need to wait
for longer periods of time or in other words, are not congested are very crucial for economic
growth as otherwise, the loading, and unloading of goods from the ships would cause losses
to the exporters and importers. Similarly, there is a need to develop airports that are modern
and efficient for freer and easier movement of people in and out of the countries. For all these
reasons, it is vital that the physical infrastructure needs to be as efficient and as productive
as possible.
b) Other Elements of Infrastructure

There are other elements of infrastructure and they are the power and water situation apart
from the development of a city’s infrastructure. Indeed, if there is power outages and
blackouts or what are known as “power holidays” or “industry holidays” wherein the
manufacturers cease production on certain days, then these timeouts would lead to losses
for them. Moreover, if a city is unable to cope with the influx of migrants and absorb the
growing numbers of people, then the people working in the plants and factories would be
unable to function effectively and work productively.
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2.2. Role of International Trade Barriers in Economic Development
A. Trade problems facing many economically less developed countries
1. Dependence on developed economies

Developing nations are highly dependent on the advanced or developed nations in terms of:
 Income dependence: A majority of the exports of developing nations go to the developed

nations.
 Dependence on Technology: Most imports of developing nations originate in the

developed countries (medicine, new machines). Trade among developing nations is
minor.
2. Primary products
Exports of developing nations are primary products (agricultural goods, raw materials, and
fuels). Some countries export drugs and low tech military goods to gain international
currencies. Shares of manufactured exports tend to be less than 10% among African
countries.
We have already established that countries should not over-rely on primary products. There
is little scope for economic growth based on the primary sector alone. While the demand for
manufactured goods is rather income-elastic, the demand for primary products (especially
foodstuffs) tends to be more income-inelastic. Besides, the prices of agricultural products are
very volatile depending on the weather conditions and other movements in supply (given the
relatively constant demand).
3. Price volatility of primary products

The fluctuations of commodity prices remain a central issue for developing countries. Often
the collapse of commodity prices spells disaster for developing countries, since exports are
needed for obtaining essential imports. But also, high commodity prices, particularly of food
and energy, may be a significant problem for less economically developed countries (LEDCs)
creating food and energy shortages.
4. Labor intensive exports

Exports of manufactured goods tend to be labor intensive (such as textiles). The absolute
value of manufactured goods produced by the developing nations is low.
The rise in manufactured goods in developing nations is due to a handful of newly
industrializing countries (NICs) such as Korea, Taiwan, and Singapore until 1980s. However,
these countries have lost their export markets to China, which has emerged as an industrial
giant in the 1990s.
5. Over-specialization on a narrow range of products

In most of the least developed and other low-income countries, primary products -
incorporating low levels of processing - continue to account for the bulk of both national
production and exports. Given the changing structure of world trade described at the
beginning of this paper, it is not surprising that most of the countries that have participated
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little or not at all in global integration are primary commodity-dependent countries with
relatively small and highly inefficient manufacturing sectors. As a result, these countries are
especially vulnerable to external (or domestic) shocks and are generally viewed as having
limited growth prospects.
B. Trade strategies for economic growth and economic development
1. Import Substitution Industries (ISI)

Import substitution refers to the deliberate effort by a government to replace major imports by
promoting the emergence and expansion of domestic industries such as textiles, shoes,
automobiles and household appliances. Such a policy requires the extensive use of
protective measures such as tariffs and quotas to protect infant industries.
The following diagrams illustrate the benefit of import-substitution policies. Figure 2.1,
diagram I illustrates how different tariff levels can reduce imports (from Q0Q1 to Q2Q3 and
then to Q4Q5) and increase domestic production (from Q0 to Q2 and then to Q4). Diagram II
shows the combined benefit of tariffs and subsidies. Imposing a tariff and granting subsidies
will boost domestic production to Q6. Although both methods would lead to approximately the
same reduction in imports, the subsidy-cum-tariff effect would lead to higher domestic
production (Q6 rather than Q4) and lower price.
I: Tariff II: Tariff + Subsidy III: Scale Economy

Costs
P P
Sd Sd
Sd + s
Sw + t1 B
Sw + t
Sw + t0 Pw C Sw
Sw Sw
LRAC
D D
Q0 Q4 Q5 Q1 Q/t Q0 Q2 Q6 Q3 Q1 Q/t Q/t

Q2 Q3
Figure 2.1
The increase in domestic production would eventually translate into a lower unit-cost as seen
on Diagram III. This would benefit infant industries which would otherwise be producing at the
higher unit-cost at point A (please note that to reach a relatively low unit-cost, the country
needs a significant market size unless it exports as well. Singapore could hardly consider
import-substitution for say the automobile industry). If the domestic industry eventually
becomes as competitive as foreign competitors, and protections are removed, local firms
may reach point C.
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Import-substitution was very popular in the 1950s and 1960s as most developing countries
were eager to be independent of imports from their former colonial masters (and Japan eager
to regain some international standing after the loss of WWII). While South Korea and Japan
definitely benefited from such strategies, it cannot be denied that some countries such as
India failed to benefit from it.
The import substitution approach substitutes externally produced goods and services,
especially basic necessities such as energy, food, and water, with locally produced ones. By
doing so, local communities can put their (hard-earned) money to work within their
boundaries. Import substitutes are meant to generate employment, reduce foreign exchange
demand, stimulate innovation, and make the country self-reliant in critical areas such as food,
defense, and advanced technology. Protectionism and subsidies to domestic industries will
encourage inefficiency in the sense that domestic firms do not need to compete with other
firms on the world market. There will thus be a loss of consumer welfare, both because the
products produced domestically will be more expensive, and also because the government
will have to levy higher taxes in order to finance the subsidies. Consumer welfare will also be
reduced due to a more narrow range of choices. Furthermore, a policy of import substitution
will not go unnoticed by other countries, and they will thus retaliate by using protectionist
measures of their own.
2. Export Oriented Industries (EOI)

This involves promoting exports industry. By promoting exports the economy can earn
valuable foreign exchange which can be used to funding economic development projects.
This can be achieved by improving the competitiveness of domestic firms and making use of
the country’s specific factor endowments. Most products produced by less developed
countries are primary commodities. Even if the prices of such products are competitive, the
export revenue is still unlikely to pay for the costs of imports.
Costs As seen on the left, a country with a

small market (such as Singapore) would
not be able to reap sufficient economies
of scale selling a product meant for
A domestic consumption only and would
probably end up at point A.
B
If this country could successfully
Pw C Sw integrate the world market and produce
products catered for exports, it could
LRAC achieve a unit-cost of as low as C.
Q/t Figure 2.2
Countries that opt for outward-oriented strategies generally have to adopt a (quasi) free-trade
regime so that the price of imported factor inputs may not be inflated and to avoid retaliation
from other trade partners. Capital markets are also often liberated to facilitate the inflow of
foreign direct investment (FDI) and portfolio investment. The former would generally come in
the form of multi-national corporations (MNCs) relocating to low wage areas (usually labour-
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intensive activities) while the latter would be welcomed to complement scarce domestic
savings. The advantage of relying on FDI and portfolio investment is that the host country
would not have to take up colossal loans to start new industries and face little risk in the
event of collapse of the industry. FDI is extremely conducive for export-led growth as MNCs
bring in with them the technology and expertise which allow them to produce quality products
of export quality at a relatively low-cost. Besides, MNCs guarantee an export market (home
market). While export-led growth is often accompanied by free-trade, it does not necessarily
mean laissez-faire. The government may not be imposing quotas and tariffs but it certainly
can intervene by granting preferential loans, export subsidies or tax-holiday schemes to
MNCs.
Small countries are definitely more suited for this strategy. Hong Kong, Taiwan (Initially a
proponent of import-substitution but quickly adopted export-led growth for some industries)
and Singapore are probably the best examples of successful export-led growth. Although
Singapore initially embarked on an import substitution phase based on the prospect of a
large common market with Malaysia, the authorities quickly switched to export promotion
policies in 1967.
3. Trade liberalization
Trade liberalisation refers to the reduction or complete removal of protectionist measures that
prevent free trade. This includes for example tariffs, quotas and subsidies to domestic
producers. Many developing countries suffer from the protectionist measures used by the
more developed countries as this reduces the competitiveness of their exports. For example,
both the United States and the European Union offer substantial subsidies to farmers who
produce agricultural products. This is to ensure that the European countries remain self-
sufficient in terms of food production. However, it also means that the relatively cheap
agricultural imports from e.g. African countries appear, by comparison, expensive. Many
developing countries are therefore heavy critics of the protectionist measures which they
argue act as a major constraint on worldwide economic development. This is where Fair
Trade organisations come in.
Fair trade organisations guarantee not only fair prices for poor producers but also that certain
standards are met in the production and trade of the products where the various fair trade
labels appear. Fair trade certification guarantees ethical production and trade principles such
as those banning child and slave labour, guaranteeing a safe workplace and the right to
unionise, adherence to the United Nations charter of human rights, a fair price that covers the
cost of production and facilitates social development, and conservation of the environment.
a) Washington Consensus
The name 'The Washington Consensus' was coined by the English economist John
Williamson. He noticed that the following ten policies were often suggested by Washington
D.C. based financial institutions, including the International Monetary Fund (IMF), World
Bank, and the US Treasury Department, to promote growth in developing countries.
1. Fiscal policy discipline - criteria for limiting budget deficits

2. Public expenditure priorities - redirection of public spending from subsidies toward
poverty reducing areas, like primary education, primary health
care and infrastructure investment
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3. Tax reform - broadening the tax base and reducing marginal tax rates. This means more
people pay tax, but the amount an individual pays per additional dollar earned is less than
previously.
4. Market determined interest rates that are positive (but moderate) in real terms
5. Competitive exchange rates
6. Trade liberalisation - lower tariffs and minimal quantitative restrictions
7. Liberalization of inward foreign direct investment by reducing barriers
8. Privatisation of state enterprises
9. Deregulation, meaning the abolition of regulations that impede market entry or restrict
competition, except for those justified on safety, environmental and consumer protection
grounds
10. Legal security for property rights
These policies were partially in response to the uncontrollable inflation effecting countries in
Latin America during the 1980s and early 1990s. However, it has been argued that the USA
was primarily motivated by its own desire to have greater access to foreign markets and
increase capital mobility. The International Monetary Fund offered bridge loans to countries
that agreed to adopt free market principles with privatisation and reduced restrictions on
money. Recipient countries included Mexico, Canada, Argentina and Bolivia. Prior to the
Washington Consensus, the majority of Latin American countries had import substitution
policies to protect their domestic economies, where foreign imports were replaced with
domestic products. As their economies moved towards freer markets, some of the countries
greatly suffered.
For instance, the World Bank and the International Development Bank made it a requirement
for Bolivia to privatise its water supply if they wished to continue receiving state loans. In
addition, mines were privatised and then closed. It is believed that such policies caused the
significant increase in unemployment and poverty, whilst worsening income inequality within
the country. Within these countries, governments were following tight monetary policies to
reduce inflation, which added to the financial suffering for individuals. In Bolivia prices
reached a more stable level which encourage foreign direct investment, however, political
unrest and the economic decline of the late 1990s led to a fall in foreign investment.
b) The Role of the WTO

The main objective of the WTO, the World Trade Organisation is to promote free trade
among its members. The current round of negotiations in the WTO is known as the Doha
round negotiations, but it has been suspended due to fundamental disagreement and failure
to reach consensus regarding issues relating to trade in relation to less developed countries.
The main concerns were that the United States and the European Union refused to abandon
their subsidies on agricultural products in order to increase the competitiveness of exports
from developing countries. On the other hand, large developing countries such as India and
Brazil refused to get rid of their protectionist measures levied against the import of
manufactured goods. While most people agree that such measures would do much to
improve economic development, a compromise currently seems beyond reach.
c) Bilateral and regional preferential trade agreements

By implementing different trading blocs is the hope that world trade, and thereby world
output, should increase. That is, it is hoped that trading blocs should result in trade creation
and not only trade diversion. A preferential trade agreement (PTA) is an agreement whereby
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the products from one country become cheaper due to a reduction, but not abolition, of tariffs.
A bilateral PTA is an agreement between two parties, e.g. India and Nepal, while a
multilateral or regional PTA, as the name suggests, is an agreement involving several
countries. Examples of the latter include the Asia-Pacific Trade Agreement and the Latin
American Integration Association. It is believed that more agreements to promote trade with
reduced protectionism, and eventually completely free trade, will result in economic growth
and eventually economic development as the standard of living increases.
4. Diversification
One of the major problems that many developing countries face is their over-dependence on
a narrow range of agricultural products. As such, they are vulnerable to the volatile nature of
the prices of such products, originating in the fact that both price elasticity of demand and
price elasticity of supply for such products are low. If prices fall in one year, due to a good
worldwide harvest, the quantity demanded from any particular country would be reduced
dramatically, and the country would be unable to rely on other exports to make up for the
loss.
Diversification involves broadening the range of goods and services that developing countries
are able to provide. For example, production of manufactured goods (i.e. industrialisation)
would both reduce unemployment levels and enable the country to produce goods that,
because they are income elastic (link), would allow the developing countries to benefit from
worldwide economic growth. By doing so, the country would also be less vulnerable to
volatile primary product prices and instead be able to stabilise their export revenue.
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2.2 Barriers to Economic Development
1. Poverty cycle
The poverty cycle – also called the under-development trap – apply to countries locked into
a low per capita income situation that reinforces itself. Poor countries have a large labour
supply but suffer a severe lack of complementary factor inputs such as physical capital. A low
level of capital per worker produces a low output per worker (low productivity). This low per
capita output leaves little room for savings and thus low rate of capital accumulation. The
capital stock remains low and the cycle repeats itself.
Poverty cycle: low incomes low savings low investment low incomes
Savings is the source of finance for capital formation. It is difficult to save when incomes are
low. Borrowing from abroad is equally difficult and expensive – especially if one keeps in
mind that poorest nations suffer from perennial depreciation of exchange rates. This problem
is only reinforced by the typical high birth rate of less developed nations. Sometimes the
slight increase in capital stock is eaten up by the increase in working population.
2. Non-convertible currencies
By means of an overvalued exchange rate, the governments of LEDCs are able to lower the
domestic currency price of their imports and increase the price of their exports. The net –
desired – effect of overvaluing exchange rates is to encourage capital-intensive industries
(because the price of imported capital goods is artificially lowered) and discourage traditional
primary-product production by artificially raising the price of exports in terms of foreign
currencies. This overvaluation then causes farmers to be less competitive in world markets.
Overvaluation is common for countries eager to develop through rapid industrialisation and
import-substitution policies (substitute domestic products for imports).
We have already learnt that maximum and minimum prices encourage the formation of
parallel – black – markets. Similarly, overvaluing the exchange rate will mean that there will
be an excess demand for foreign currencies – notably US$. If the authorities have no means,
as is often the case, to purchase the excess of domestic currency, a parallel, illegal, market
for foreign currencies will develop. On the one hand, firms who need to purchase capital
goods will have access to foreign currency at the artificially low price (with the help of the
government). On the other hand, the rest of the population who wants to purchase “cheap”
imported goods with have to buy foreign currency at a higher price on the black market.
With two exchange rates applying to the same currency, foreign currency traders will refuse
to deal with such unstable currency. It thus follow that foreign investors would be reluctant to
invest being unsure of what rate would apply to their returns. Exporters and importers in
developed countries will also be unwilling to trade with such uncertainty. As such, countries
who issue what would then be considered non-convertible currencies suffer as foreign
investment will become scarce and trade considerably reduced.
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Content Mastery
1. With reference to a specific developing economy, and using appropriate diagrams where
relevant, examine how the following factors contribute to economic development: a.
Education and health; b. The use of appropriate technology; c. Access to credit and
micro-credit; d. The empowerment of women and e. Income distribution.
2. With reference to specific examples, explain how the following factors are barriers to
development for economically less developed countries: a. Over-specialization on a
narrow range of products; b. Price volatility of primary products and c. Inability to access
international markets.
3. With reference to specific examples, explain how the following factor is a barrier to
development for economically less developed countries: a. Long-term changes in the
terms of trade.
1. What criteria could we use to determine whether a particular method for measuring
development is effective?
2. What knowledge issues might be encountered in constructing a composite indicator to

measure development?
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3. Foreign Sources of Finance and Foreign Debt
3.1 Foreign direct investment
“Foreign direct investment (FDI) is direct investment into production in a country by a

company in another country, either by buying a company in the target country or by
expanding operations of an existing business in that country.”
Foreign direct investment is done for many reasons including to take advantage of cheaper
wages, special investment privileges such as tax exemptions offered by the country as an
incentive to gain tariff-free access to the markets of the country or the region.
FDI strategies can be categorised into three different types:
1. Horizontal: the company carries out the same activities as it does abroad. For example,
Tesco is a UK supermarket that now has stores in 11 other countries. It is now not only
the leading supermarket in the UK, but also in Ireland, Hungary, Malaysia, and Thailand.
2. Vertical: the company carries out different stages of activities abroad. For instance, in
2014 Jaguar Land Rover opened up its first full overseas manufacturing plant in China.
3. Conglomerate: the company carries out activities unrelated to its domestic business. For
example, the Swire Group has its headquarters in London, many of its businesses in the
Asia-Pacific region and operations predominantly in Hong Kong and Mainland China. Its
businesses are diverse, although most focus on property, aviation, beverages, marine
services, or trading and industrial.
FDI can also be separated into two different types:
1. Greenfield investment: the company starts a new venture abroad by constructing new
factories or stores. For instance, Starbucks and MacDonalds tend to do this.
2. Browfield investment: the company purchases existing factories or stores to begin new
production.
A. Why do FDI expand to less economically developed countries (LEDCs)?
1. Less developed countries have huge untapped natural resources. Moreover, these
countries lack the capital investment and the technology to tap into these resources. This
provides FDI with a lot of opportunity to exploit these resources and earn high returns on
their investments.
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2. In recent years, FDI has been used more as a market entry strategy for investors,
rather than an investment strategy. Despite the decline in trade barriers, FDI growth has
increased at a higher rate than the level of world trade as businesses attempt to
circumvent protectionist measures through direct investments. With globalization, the
horizons and limits have been extended and companies now see the world economy as
their market.
3. Additionally for investors, FDI provides the benefits of reduced cost through the
realization of scale economies, and coordination advantages, especially for integrated
supply chains. The preference for a direct investment approach rather than licensing and
franchising can also been viewed in terms of strategic control, where management rights
allows for technological know-how and intellectual property to be kept in-house.
4. Less developed countries usually have less stringent labour and environment laws.
This provides MNCs with an opportunity to lower their cost of production by taking
advantage of these loopholes.
5. Labour is usually cheaper and available in abundance in LDCs. The MNCs can
considerably lower their cost of production. This gives advantage to the MNCs to
compete in the international market.
6. LDCs understand the importance of FDIs and have special policies to attract them. This
might involve tax holidays, provision of cheaper land and government support. All these
factors make it an attractive proposition for FDIs to invest in LDCs., examples include, tax
holidays, Duty exemptions and drawbacks, export tax exemptions, subsidized credits and
credit guarantees.
7. Some developing countries provide great promises in terms of being emerging markets.
Brazil as well as India and China are all markets with huge populations and growing
incomes. As incomes rise, the demand for all normal goods and services will increase,
and there is thus potential for substantial profits to be made by companies that
manage to establish a presence in these markets.
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B. Advantages and Disadvantages of FDI
Advantages of FDI
1. One of the advantages of foreign direct investment is that it helps in the economic
development of the particular country where the investment is being made. This is
especially applicable for developing economies. During the 1990s, foreign direct
investment was one of the major external sources of financing for most countries that
were growing economically. It has also been noted that foreign direct investment has
helped several countries when they faced economic hardship.
An example of this can be seen in some countries in the East Asian region. It was
observed during the 1997 Asian financial crisis that the amount of foreign direct
investment made in these countries was held steady while other forms of cash inflows
suffered major setbacks. Similar observations have also been made in Latin America in
the 1980s and in Mexico in 1994-95.
2. Resource transfer, in terms of capital and technical knowledge, is also a key motivator
that encourages inward FDI.
3. FDI allows the transfer of technology—particularly in the form of new varieties of capital
inputs—that cannot be achieved through financial investments or trade in goods and
services. FDI can also promote competition in the domestic input market.
4. Recipients of FDI often gain employee training in the course of operating the new
businesses, which contributes to human capital development in the host country.
5. Profits generated by FDI contribute to corporate tax revenues in the host country.
6. Foreign investment gives advantages in terms of export market access arising from
economies of scale in marketing of foreign firms or from their ability to gain market
access abroad. Besides their contributions through joint ventures, foreign firms can serve
as catalysts for other domestic exporters. In an empirical analysis, the probability a
domestic plant will export was found to be positively correlated with proximity to
multinational firms
7. Foreign investment can aid in bridging a host country’s foreign exchange gap. Growth
requires investment and investment requires saving-whether domestic or foreign. Two
gaps may exist in the economy: insufficient saving to support capital accumulation to
achieve a given growth target; and insufficient foreign exchange to transform domestic to
foreign resources. If investment requires imported inputs, then domestic saving may not
guarantee growth if the saving cannot be converted to foreign exchange to acquire
imports. Capital inflows help ensure that foreign exchange will be available to purchase
imports for investment.
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Disadvantages of FDI
1. Loss of sovereignty by host nation.
2. MNC have their parent companies and shareholders in the country of origin. Repatriation
of profits by MNC to the parent country causes a flow of capital out of the developing
country. This might also lead to depletion of foreign exchange reserves with the host
country.
3. There is a chance of rise in inflation.
4. The country or industry that attracts foreign investment may become entirely dependant
for growth and increase the risk.
5. If the domestic companies are not competitive and efficient, they may suffer losses.
6. In absence of proper regulatory policies, MNCs might exploit the labour and natural
resources.
7. Foreign direct investment is an expensive and risky option for companies than licensing
and exporting. They face expropriation, political risk and currency inconvertibility.
8. Capital intensive technology, by the MNC, rather than labour-intensive technology limits
benefits to host country.
9. In very poor nations, MNCs may sometimes exert political control in other to suit their
vested interests. This might bring about political stability and chaos in the host nation.
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C. Multinational Corporations or Transnational Corporation
Foreign direct investment is the movement of capital across national frontiers in a manner
that grants the investor control over the acquired asset. Thus it is different from portfolio
investment which may cross borders, but does not offer such control. Firms which source FDI
are known as Multinational Corporations (MNCs) or Transnational Corporations (TNCs).
Ultimately MNCs expand into economically less developed countries in order to either
increase their sales or to reduce their costs, and therefore increase their profit margins. Here
are some more detailed reasons for MNCs expanding abroad...
1. Natural resources are only available for extraction from certain locations, therefore, it may
be more feasible to have refineries nearby, such as for oil and copper.
2. Labour costs are often lower in developing countries, so MNCs employ workers in these c
3. Developing countries tend to have slacker regulatory framework, meaning that there are
fewer restrictions on business activities. This gives greater freedom to MNCs and can
with lowering costs of production. For example, laws concerning environmental
safeguarding may not be as well enforce, thereby giving firms more choice of where to
set up factories.
These are the characteristics that developing countries tend to have which attract FDI:
 Low cost factor inputs, including low labour costs and natural resources.
 A regulatory framework that favours profit repatriation.
 Favourable tax rules as firms generally prefer to pay lower taxes as then more of their
revenue can be kept as profit.
 Stable macroeconomic environment and political as this gives MNCs greater certainty
that they will profit from their investments.
 Weak regulatory system and environmental laws.
 Weak trade unions as it is easier to hire and fire workers. Also these would otherwise
give workers greater power to bid up wages.
 Cultural similarities, perhaps due to proximity or former colonies.
 Plentiful natural resources
 High levels of labour productivity and human capital
 High quality infrastructure, including roads and ports
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Both MNCs and host countries benefit from the former relocating to the latter:
MNCs Host Country
1. Greater employment and economic

1. Lower cost of production, especially for
activity
labour-intensive industries
2. MNCs fill the savings gap of LEDCs
2. Direct access or proximity to a large
market (lower transport cost, easier
3. MNCs contribute to foreign currency
monitoring of changes in fashion and
earnings through the initial investment
trend)
and then through export earnings
3. Some countries attract MNCs by
4. Foreign companies generate tax
offering tax holiday schemes, lower
revenue
environmental conservation standards,
weaker trade unions or labour laws.
5. MNCs bring in with them knowledge
and expertise which may remain long
4. MNCs may relocate to bypass
after the company leaves the country
protective measures (Many Japanese
companies relocated activities to
6. Foreign companies create a demand for
America when the latter imposed
a variety of services and semi-finished
higher tariffs.)
products which may be provided by
local firms
There is however a very heated controversy over FDI and in particular MNCs. Many do see
the latter as being pro-development. Amongst the often cited reasons are:
 MNCs may lower domestic savings and investment rates by stifling competition through
exclusive agreements with host governments and failing to reinvest profits.
 MNCs may lead to an increase in the price of raw materials (increase in demand) at the
expense of local firms. Furthermore, the most qualified and educated workers would
most likely be hired by MNCs, depriving domestic firms of talents. All this could impede
domestic entrepreneurship.
 MNCs may actually worsen the balance of payments. The current account may
deteriorate as a result of substantial importation of intermediate products and capital
goods, and the capital account may worsen because of the overseas repatriation of
profits, interest, royalties, management fees and other funds.
 Although MNCs do contribute to tax revenue, their contribution is considerably less than
it should be as a result of tax concessions and transfer pricing.
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3.2 Foreign Aids
“Foreign aid, the international transfer of capital, goods, or services from a country or
international organization for the benefit of the recipient country or its population.”
A. Classification on the Basis of Origin
1. Government (official) aid

Aid organised by the government. It can
 Bilateral aid is assistance given by a government directly to the government of

another country. This is usually the largest share of a country’s aid. It is often directed
according to strategic political considerations as well as humanitarian ones
 Multilateral aid is assistance provided by governments to international organisations

like the World Bank, United Nations and International Monetary Fund that are then
used to reduce poverty in developing nations. In 2006-7, the Australian Government
committed $400 million in multilateral aid.
2. Non-government (unofficial) aid

Non-government aid is assistance provided by non-government organizations (NGOs)
like World Vision, the Red Cross and Oxfam. The money for this aid is mainly provided by
public donations from individuals and businesses. However, NGOs also receive some
funding from government.
B. Classification on the Basis of Purpose
1. Humanitarian aid
This type of aid is traditionally extended to nations which are victims of natural disasters,
such as floods, famines and epidemics. This is short term aid and does not have to be
repaid. Humanitarian aid is per se non-political.
Traditional responses to humanitarian crises, and the easiest to categorise as such, are
those that fall under the aegis of ‘emergency response’:
 material relief assistance and services (shelter, water, medicines etc.)
 emergency food aid (short-term distribution and supplementary feeding programmes)
 relief coordination, protection and support services (coordination, logistics and

communications).
But humanitarian aid can also include reconstruction and rehabilitation (repairing pre-
existing infrastructure as opposed to longer-term activities designed to improve the level
of infrastructure) and disaster prevention and preparedness (disaster risk reduction
(DRR), early warning systems, contingency stocks and planning). Under the Organisation
for Economic Cooperation and Development (OECD) Development Assistance
Committee (DAC) reporting criteria, humanitarian aid has very clear cut-off points – for
example, ‘disaster preparedness’ excludes longer-term work such as prevention of floods
or conflicts. ‘Reconstruction relief and rehabilitation’ includes repairing pre-existing
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infrastructure but excludes longer-term activities designed to improve the level of
infrastructure.
Humanitarian aid is given by governments, individuals, NGOs, multilateral organisations,

domestic organisations and private companies.
2. Development aid
Development aid is financial aid given by governments and other agencies to support the
economic, environmental, social and political development of developing countries. It is
distinguished from humanitarian aid by focusing on alleviating poverty in the long term,
rather than a short term response.
Major part of the developmental aid comes from government sources as official
development assistance (ODA). The remaining comes from private organisations such as
"Non-governmental organisations" (NGOs), foundations and other development charities
(e.g., Oxfam).
3. Financial Aid
The simplest form of capital inflow is the provision of convertible foreign exchange, but
very little foreign capital indeed comes to the underdeveloped world so conveniently.
Financial aid is further divided into various sub-forms, i.e.:
(i) Tied Aid: Tied aid is of two types:
Nation Tied Aid: is given to the recipient country on the condition that she will spend
it in the donor country to solve the BOP problems of that country and to stimulate
exports, i.e., if Pakistan is given aid by US and is asked to import raw materials or
machinery from US only then it is ‘nation tied aid’ or ‘resource tied aid’.
Project Tied Aid: is given only for specific projects and the recipient country cannot
shift it to other projects.
(ii) Untied Aid: Untied aid is the aid which is not tied to any project or nation. It is, in all
respects, better than the tied aid because it offers more efficient use of foreign
resources. It is much desired because in the case of untied aid the recipient country
is not bound to spend the foreign resources on specific projects or in the donor
country which may charge higher prices than international market.
(iii) Grants: A grant is that form of foreign aid which does not entail either the payment of
principal or interest. It is a free gift from one government to another or from an
institution to a government. It is much desired because it increases the internal
expenditures and generates income. It is given on the basis of humanitarianism,
especially in days of emergencies, earth quakes, floods, wars, etc.
(iv) Loans: It is the borrowing of foreign exchange by the poor country from the rich
country to finance short-term or long-term projects. They are further sub-divided into
two types:
Hard Loans: Hard loans are also called short-term loans. In order to finance
industrial imports they are given usually for a period less than five years, and they are
paid in the currency borrowed. It contains no concessional element but interest rate
is usually lower than the prevailing rate of interest in the international market.
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Soft Loans: Soft loans are also known as long-term loans. Soft loans are made for
10-20 years and it is repaid in the currency of recipient country. Interest on these
loans is lesser than hard loans and often these loans invoice grace period.
Concessional elements are comparatively greater.
4. Commodity Aid
Commodity aid, in fact, is another type of tied aid, which relates to agriculture products,
raw materials and consumer goods. Under commodity aid, the donor country has much
political influence on the recipient country. Commodity aid may be received in cash form
or in the form of food grains:
(i) In Cash Form: If it is received in cash form it may be more helpful because then a
country may buy more commodities from cheaper sources.
(ii) In Food Grain Form: It is a special type of commodity aid, which is given in the form of
food grains only.
5. Food Aid
There is more than enough food produced each year to feed adequately everyone on
earth. However, food is so unevenly distributed that malnutrition and hunger exist Food
aid in the same country or region where food is abundant.
Critics of food aid argue that it increases dependence, promotes waste, does not reach
the most needy and dampens local food production. Nevertheless, the food aid has
frequently been highly effective. It plays a vital role in saving human lives during famine
or crisis, and if distributed selectively, reduces malnutrition. Unfortunately, poor transport,
storage, administrative services, distribution networks and overall economic complex
hinder the success of food aid programmes, but the concept itself is not at fault.
6. Technical assistance aid

Technical assistance is designed to disseminate knowledge and skills rather than goods
or funds. Under this aid programme, training facilities are provided by the donor country’s
government and it bears all the expenditures involved in the training of advisory
technocrats. Technical assistance from the donor’s point of view takes two main forms:
(i) Through Recruitment: Technical assistance may be given through recruitment.
Selected people of recipient country are recruited in the donor country for service
overseas, partly, often largely, at the expense of the donor government.
(ii) Through Scholarships & Training Facilities: The second form of technical assistance
is scholarship and training facilities in donor country for foreign students (from
recipient country).
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C. Examples of Aids given to Countries
1. Syria
In 2012, Syria received $1.5 billion in international humanitarian assistance and was
therefore the largest recipient that year. Turkey, the United Kingdom and Germany were its
largest donors. In terms of net official development assistance (ODA) per capita, Syria
received $74.6 in 2012.
In 2011, Syria's human development index (HID) was 0.662. This actually decreased to
0.658 by 2013, ranking it 118th in the world.
2013 Statistics:
Life expectancy at birth: 74.55
Mean years of schooling: 6.6
Population in multidimensional poverty (%): 6.36
Homeless population (% of population): 0.002
2. Pakistan
Pakistan received $529 million in international humanitarian assistance in 2012. The United
States was its largest donor, followed by the EU institutions and the United
Kingdom. Pakistan received $11 ODA per capita in 2012.
Pakistan's HDI was 0.531 in 2011 and increased to 0.537 in 2013, ranking it 146th in the
world.
2013 Statistics:
Life expectancy at birth: 66.57
Mean years of schooling: 4.73
Population in multidimentional poverty (%): 45.59
Homeless population (% of population): 6.197
The statistics concerning humanitarian assistance are from the Global Humanitarian
Assistance website, whilst all other data is from the World Bank website and the Human
Development Reports website.
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D. Effectiveness of Aids
Aid is usually most effective when it is targeted to specific development projects and it does
not require the recipient country to buy products from the donor countries. It is also important
that the recipient government is not corrupt. However, aid is less effective when it replaces
domestic investment and enables countries to postpone policies that would improve the
macroeconomic environment. Ideally, the technologies introduced should be appropriate,
usually labour intensive, in order to increase job opportunities.
Benefits of trade over aid:

 Improves long-term international cooperation as their are mutual benefits. The
economic relationships between countries can help to improve political relations as
well.
 Encourages private savings and investment by reducing dependence on foreign aid.
Whereas countries that become over reliant on foreign aid which could be withdrawn by
donors, leaving them in a worse situation as they become unable to sustain themselves
and afford their expenditures. Therefore, they go into greater debt.
 The benefits of aid are seriously undermined when corrupt governments are in charge
as the additional income tends to remain within a small percentage of the population.
 Encourages competition which leads to increased efficiency and innovation. This helps
countries to support themselves.
 Aid is necessary in crisis, such as during droughts and tsunamis. It is extremely difficult
to trade in these circumstances as the infrastructure is often very poor.
 Aid is allocated to areas most in need, whereas, trade can lead to wealth be confined
within a small group of the population.
 Developing countries do not only need money, but advice, knowledge and resources.
Aid can be provided in these different forms, whereas trade requires good
infrastructure.
 It can be very destablilising to introduce a previously insular country to free trade over a
short period of time.
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3.3 The Role of Foreign Debt
Foreign debt: the amount of money owed by one country to foreign lenders, including
international financial institutions, governments and commercial banks.
Many of the world’s poorest countries are saddled with high levels of foreign (external)
debt owed to other governments, institutions such as the IMF and foreign companies, banks
and individuals
 The near $5 trillion of external debts owed by developing countries costs them more than
$1.5 billion a day in repayments – and much of that comes from the poorest countries
 Most of the world’s poorest countries have limited access to international capital
markets – their sovereign debt does not have an official credit rating
 Without conditional loans from the IMF, World Bank and others, they would have to pay
interest rates many times higher on private sector loans
 Some developing countries have chosen to borrow from other emerging economies such
as China or Brazil as a way of avoiding conditional loans from international institutions
 Countries with persistent trade deficits end up accumulating large external debts, so
too a government where spending greatly exceeds annual tax revenue leading to high
fiscal deficits
 A country defaulting on loans will find it harder and more expensive to attract future loans.
Foreign debts can act as a severe constraint on growth and development – often times,
the interest payments on existing public sector debt takes up a large percentage of a nation’s
export revenues or annual tax revenues.
These debt repayments have an opportunity cost, they might be better used in supporting
development policies such as investment in health and education to boost the human capital
of the population.
To what extent should richer nations be prepared to write-off external debts of poor
countries?
The Jubilee Debt Campaign pushes for debt cancellation and debt relief avoiding where
possible conditions built into debt reduction agreements that create further problems for
vulnerable countries.
One option is to reschedule debt payments and change the nature of the interest rate paid
on these loans.
In July 2012 a United Nations report made the case for introduced indexed loan
repayments where the interest rate is tied to a country’s rates of economic and/or export
growth. This would help balance the risk of loans more equally between lender and borrower.
In good years when growth of GDP is strong, the borrower country would repay more of their
debts. During hard times (i.e. a recession caused by a fall in export revenues), the rate of
interest on debt would fall.
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A. Debt Rescheduling and Conditional Assistance - Examples
The stock of developing countries’ foreign debt increased to $4.9 trillion at end 2011, but at
an average of 22 percent, remained moderate in relation to Gross National Income (GNI),
and to exports (69 percent).
High income countries have, on average, a much higher level of external debt: 126 percent of
GDP for G7 countries in 2011 compared to 19 percent for the top ten developing countries.
General government debt (external and domestic) is also much higher, with an average of 76
percent in Euro-zone (17) countries in 2011, more than twice the comparable ratio for the
largest borrowers among developing countries.
1. Djibouti (East Africa)

The Djibouti government’s external debt has increased significantly over the last decade from
40 per cent of GDP in 2001 to 70 per cent in 2009, and now stands at $700 million. For 2012,
the IMF predicts the government will spend 14 per cent of revenues on foreign debt
payments. Since 2001, over 70 per cent of lending to the country has been from multilateral
institutions such as the IMF, World Bank and African Development Bank. In May 2012 the
IMF agreed to lend a further $10 million to help the country meet its debt and import
payments. As part of the loan programme the Djibouti government has agreed to reform
diesel fuel subsidies, freeze any hiring in the public sector, except for health and education
and freeze public sector pay, except for the lowest salary band. Inflation is 4% this year.
Djibouti has not yet been considered eligible for the Heavily Indebted Poor Countries (HIPC)
initiative, which allows countries to have some debts cancelled in return for following IMF and
World Bank economic policy conditions.
Source: Jubilee Debt Campaign Website, accessed, August 2012
2. Brazil writes off debt of African nations

In May 2013, the Brazilian government announced that it plans to cancel or restructure
almost $900m in debt owed by African countries. The move is designed mainly to expand
Brazil's economic ties with Africa and fast forward the growth of trade and investment
between emerging countries and regions. In the aftermath of this move, Brazil’s future aid
assistance is likely to target infrastructure, agriculture and social programmes. Among the 12
countries set to benefit are Tanzania, which owes Brazil $237m, along with oil-producing
Republic of Congo and copper-rich Zambia.
Source: Adapted from newspaper reports, May 2013
3. Heavily Indebted Poor Countries Initiative (HIPCI)

This is an initiative to provide debt relief to heavily indebted low income countries. Under the
initiative, the International Monetary Fund and World Bank calculate the proportionate
reduction required in the country’s external debts in order to return them a level <150% of the
value of the country’s annual exports – this is considered to be a sustainable level. All
creditors – multilateral, bilateral and commercial – are expected to provide the proportionate
reduction to achieve this. The Ivory Coast is an example of a country that has benefited from
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HIPCI – it has been granted external debt relief of $7.7bn. As a result the stock of Ivorian
public debt decreased from 69% of GDP in 2011 to 40% of GDP in 2012.
4. Debt Relief for the Comoros

The International Monetary Fund (IMF) has agreed to US$176 million in debt relief for the
Comoros, representing a 59 percent reduction of its future external debt service over a period
of 40 years. The requirements met by Comoros included the maintenance of macroeconomic
stability, reforms on telecommunications and energy, a national measles vaccination
campaign for children to achieve 90 percent coverage nation-wide, and improvements in debt
management.
Source: International Monetary Fund, December 2012
B. Consequences of High Levels of Foreign Debt
Foreign or external debt represents the amount a country (both public and private sector)
owe to other countries.
Foreign debt can involve:

 Outstanding loans to foreign private banks (both principal and outstanding interest)
 Due payments to international organisations like the IMF
 Outstanding payments for a current account deficit, with country owing money for
imports
Debt includes both:

 Short-term liabilities – loans which need to be paid in near future (within one year)
 Long-term liabilities – long-term loans which are scheduled to be repaid over a longer
term.
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1. When is external debt a problem?
The easiest guide is to look at the level of external debt to GDP. However, countries with
large financial sectors, such as the UK and Hong Kong have both higher levels of
liabilities, but also a higher level of assets because of its role as a financial centre.
There are no precise rules for when external debt becomes a problem. But, a key factor
is whether a country can satisfactorily meet debt interest payments from export earnings.
The IMF has suggested external debt should be kept below:
i. A country’s level of debt in Net Present Value to either 150 percent of exports or 250
percent of government
Foreign debt interest

Countries with foreign debt have to meet the interest payments on the debt. This can
only be met with:
 Foreign currency earnings from exports
 Gold reserves / foreign currency reserves
 Further borrowing
2. How foreign debt can become a problem?

 Excessive confidence in borrowing to promote economic growth and development.
Equally, there could be over-confidence in lenders to lend money in short-term
without evaluation of possible problems.
 Investment that is misplaced and fails to achieve a decent rate of return to help pay
the debt interest payments. For example, developing countries may struggle to make
use of funds for industrialisation if they lack the necessary skills and infrastructure.
 Unexpected devaluation in the exchange rate, which increases the real value of debt
interest payments denominated in dollars.
 A decline in commodity prices which leads to a decline in the terms of trade for
developing economies and relative fall in export earnings.
 Demand-side shock which reduces GDP. For example, conflict or global recession
which hits demand and GDP.
 Servicing external debt (paying debt interest payments) ceteris paribus, reduces GDP
because the monetary payments flow out of the country. These debt payments
reduce the amount available to invest in improving public services, which can help
economic development.
 Growing levels of debt can discourage foreign and private investment because of
concerns that the debt is becoming unsustainable.
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 If a country is struggling to meet interest payments, they may be tempted to borrow to
meet debt interest payments, but then the problem can spiral and magnify.
 Countries in regional areas may suffer from a regional downgrade in credit

assessment. For example, many Sub-Saharan African countries experienced rising
external debt ratios, and this made investors reluctant to lend at cheap rates.
3. Debt cancellation / debt forgiveness

Because of the problem associated with rising external debt, there has been pressure for
developed countries to cancel outstanding debt by developing economies.
The argument is that debt cancellation can make a significant contribution to improving
economic development because it frees up resources to invest in the recipient country –
rather than send abroad in debt interest payments.
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Content Mastery
1. With reference to specific examples, evaluate each of the following as a means of

achieving economic growth and economic development: a. Import substitution; b. Export
promotion; c. Trade liberalization; d. The role of the WTO; e. Bilateral and regional
preferential trade agreements and f. Diversification.
2. Describe the nature of foreign direct investment (FDI) and multinational corporations
(MNCs).
3. Explain the reasons why MNCs expand into economically less developed countries.
4. Describe the characteristics of economically less developed countries that attract FDI,
including low cost factor inputs, a regulatory framework that favours profit repatriation
and favourable tax rules.
5. Evaluate the impact of foreign direct investment (FDI) for economically less developed
countries.
1. What are the knowledge issues involved in compiling a list of development goals?
2. How can we decide if the distinction between economically more developed countries
and economically less developed countries is a meaningful one given that economic
development itself might not be so clearly defined?
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4. Evaluation of Growth and Development Strategies (Supplementary)
4.1 Evaluation of aid, trade and economic strategies in terms of growth and/or
development
We have seen that some import-substitution strategies have worked better for some
countries for others. Indeed, there is no absolute path for success when it comes to
development and one should be careful not to generalise.
1. Aid and trade
Many LEDCs believe the single most important contribution the rich nations can make is to
provide free access for their goods to the markets of the Developed countries. "Trade, not
aid” is a slogan often adopted by less developed nations. Indeed, we have seen that aid can
be a poisoned gift, often coming with strings attached. On the other hand, LEDCs need
foreign exchange to pay back debts, buy machines…
AID
In favour of… Against…

 Poor countries desperately need to  Aid may be military or politically
provide education to the people so that motivated (e.g. Vietnam war, Iraq War,
productivity may rise. They also need US support of Ferdinand Marcos)
healthcare services to decrease the
 Aid may not reach the people due to
infant mortality rate. Providing both at a
mismanagement or corruption
subsidised rate may be impossible
without foreign aid.  Countries may over-rely on aid. What
happens once aid is removed?
 Many nations (South Korea included)
have benefited from aid in the form of
technical expertise. Surely such form of
aid was not detrimental
 Aid may stimulate aggregate demand
and investment.
2. Market-led and interventionist strategies
The post-war era saw the emergence of government control in the economy. Many still
believed that the great depression happened because the government was not regulating the
economy. Moreover, there was a strong emphasis on rectifying market failures in Europe
through welfare states. Indeed, in many countries, the fear of unemployment and an
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inequitable income distribution had called for the mixed economy. In developing nations, the
good success of interventionist measures in Japan, South Korea and Singapore only added
to the conviction that the free market economy was not an option.
Views on interventionist policies became more divided in the 1980s with the increasing
number of interventionist failures. In many cases, government intervention had generated
inefficient and sometimes corrupt bureaucracies. Often tax revenue was not large enough to
support the massive government spending of some developing countries. This resulted in
indebtness, overvaluation of currencies and significant current account deficits.
The emergence of Thatcherism and Reaganomics only reinforced the view that the free
market economy was most efficient and that public enterprises should be privatised. It has
however been widely accepted that some form of government intervention was desirable and
many neo-classical economists have praised countries like Singapore for not interfering with
the economy but rather creating an environment conducive for business by granting tax
relieves and setting infrastructure to attract FDI. The conventional view on government
intervention is that the latter should only play a supportive role.
Of course some governments have intervened much more and were indeed successful in
helping their economy develop. This is definitely the case of South Korea where the
authorities had no problem stepping in, targeting specific industries, closing inefficient ones,
denying loans to some and so on. Perhaps the success of South Korea and failure of many
other interventionist states can be best reconciled by Chalmers Johnson’s view:
… the logic of the capitalist developmental state (interventionist strategies) can be best understood if it
is approached from the point of view of socialist theory. If one posits the existence of a developmentally
oriented political elite for whom economic growth is a fundamental goal, such an elite must then develop
a concrete strategy for attempting to reach that goal. If one further posits two more points, that such an
elite is not committed first and foremost to the enhancement and perpetuation of its own elite privileges
(something that cannot be assumed in Leninist systems or, for that matter, in the Philippines) and that
the elite appreciates that the socialist displacement of the market threatens its goals by generating
bureaucratism, corruption, loss of incentives, and an inefficient allocation of resources, then its primary
leadership tasks is to discover how, organizationally, to make its own developmental goals compatible
with the market mechanism…1
1
Johnson, C. (1987), "Political Institutions and Economic Performance: The Government-Business Relationship in Japan,
South Korea and Taiwan", Deyo, F.C. (ed), The Political Economy of the New Asian Industrialization, Ithaca: Cornell University
Press
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4.2 The role of international financial institutions
4.2.1 The International Monetary Fund (IMF)
A. Role of the IMF
The IMF describes itself as "an organization of 184 countries, working to foster global
monetary cooperation, secure financial stability, facilitate international trade, promote high
employment and sustainable economic growth, and reduce poverty". With the exception of
North Korea, Cuba, Liechtenstein, Andorra, Monaco, Tuvalu and Nauru, all UN member
states either participate directly in the IMF or are represented by other member states.
Since the 1980s, the role of the IMF is to act as go-between for deeply indebted developing
countries and creditors in developed countries. Indeed, the IMF aims to prevent crises by
encouraging countries to adopt sound economic policies; it is also—as its name suggests – a
fund (to which member countries contribute) that can be tapped by members needing
temporary financing to address balance of payments problems. Member states may request
loans and/or organizational management of their national economies. In return, the countries
are usually required to launch certain reforms, an example of which is the "Washington
Consensus". These reforms are generally required because countries with fixed exchange
rate policies can engage in fiscal, monetary, and political practices which may lead to the
crisis itself. For example, nations with severe budget deficits, rampant inflation, strict price
controls, or significantly over-valued or under-valued currencies run the risk of facing balance
of payment crises in their future. Thus, the structural adjustment programs are intended to
ensure that the IMF is actually helping to prevent financial crises rather than merely funding
financial recklessness.
The IMF aims to promote

 the balanced expansion of world trade,
 stability of exchange rates,
 avoidance of competitive devaluations, and
 orderly correction of balance of payments problems
This may be achieved through

 the removal of trade barriers,
 eradication of exchange rate control,
 combating inflation by raising interest rates,
 a decrease in government spending and raise in taxation to balance the government
budget, and
 a number of supply-side policies such as the privatisation of state enterprises, the
removal of minimum wages and minimum price schemes and other market distortions
such as subsidies.
Page 74 of 83
B. Criticism of the IMF
The role of the IMF has been controversial to many and the institution has been blamed for a
wide range of “evils” from deliberately supporting capitalistic military dictatorships friendly to
American and European corporations to being ineffective. Amongst the most common
criticisms of the IMF are:
1. The stabilisation policies are anti-developmental. The harshest critics of the IMF
state that the policies impose austerity on countries in financial crisis. The IMF may
require an increase in taxes even when the economy is weak, in order to generate
government revenue and balance budget deficits, which is the opposite of Keynesian
policy. Similarly, trade liberalisation advocated by the IMF destroys domestic markets
and lead to unemployment. (The IMF based policies were criticised by Joseph E. Stiglitz,
former chief economist at the World Bank, in his book Globalization and Its Discontents.)
2. The IMF is not democratic and run according to rich countries’ interests. Voting
power is based on the contributions made by each member country. Those contributions,
in turn, are based on the size of the country’s economy. The US, with the world’s largest
economy, has always held the most votes (currently over 18 percent – more than the
whole of Africa), followed by the other Western industrialised countries and Japan. This
means that a handful of countries really control the IMF. Indeed, the G8 nations can
easily block all proposals which require a majority vote of 75%. Furthermore, the
recommended policies usually include keeping wages low; privatisation and
deregulation; eliminating trade barriers and restrictions on foreign investors; devaluing
the currency; and raising interest rates. These measures are in fact encouraging
production for export instead of internal development and produce favorable conditions
for foreign investors and lenders.
3. The IMF loans lead to moral hazard. The IMF loans simply bail out countries. This may
serve to perpetuate bad loans and bad debtor countries. When governments know that
their loans can be financed by further (IMF) loans or be written off, there is less incentive
to behave in a morally responsible manner.
4. IMF lending works poorly – if at all. There is a list of the IMF’s greatest mistakes on
which Kenya and Jamaica appear at the top. Argentina remains at the first position. The
South American republic experienced a catastrophic economic crisis in 2001 generally
believed to have been caused by IMF-induced budget restrictions.
Page 75 of 83
4.2.2 The World Bank
A. Role of the World Bank
A “sister organisation” of the IMF, the World Bank too has 184 members whose voting rights
are contingent upon economic size. Contrary to the IMF, the World Bank is an outright
development organisation which provides long term loans, grants, and technical assistance
to help developing countries implement their poverty reduction strategies. As such, World
Bank financing is used in many different areas, from reforms in health and education to
environmental and infrastructure projects, including dams, roads, and national parks. In
addition to financing, the World Bank Group provides advice and assistance to developing
countries on almost every aspect of economic development.
World Bank lending is also conditional. Loans or grants for specific projects are often linked
to wider policy changes in the sector or the economy. For example, a loan to improve coastal
environmental management may be linked to development of new environmental institutions
at national and local levels and to implementation of new regulations to limit pollution.
B. Criticism of the World Bank
The World Bank is also subject to long-standing and strong criticism (often similar to those on
the IMF) from non-governmental organisations and academics. In some cases, the Bank has
been accused of being a US or western tool for imposing economic policies that support
western interests. Critics argue that the free market reform policies – which the World Bank
advocates in many cases – in practice are often harmful to economic development if
implemented badly, too quickly, in the wrong sequence, or in very weak, uncompetitive
economies.
In some cases the Bank's own internal evaluations can produce negative conclusions. The
Human Development Report has shown clearly that the HDI has fallen in a number of
countries which have implemented structural adjustment programmes in order to qualify for
World Bank loans.
Page 76 of 83
4.3 Non-governmental organisations (NGOs)
A non-governmental organisation (NGO) is an organisation that is not part of a

government and was not founded by states. NGOs are therefore typically independent of
governments. They are social, cultural, legal, and environmental advocacy groups whose
goals are primarily noncommercial. NGOs are usually non-profit organisations that gain at
least a portion of their funding from private sources. In 1995, according to the UN, there were
nearly 29,000 international NGOs. National numbers are even higher: The United States has
an estimated 2 million NGOs, most of them formed in the past 30 years. Russia has 65,000
NGOs. India has 2 million NGOs. Dozens are created daily. In Kenya alone, some 240 NGOs
come into existence every year.
The proliferation of NGOs has had considerable positive impact on development:

 Many NGOs conduct and publish studies which bring to light a number of issues
which might otherwise be sidelined (e.g. Oxfam reports the effect of trade barriers on
developing countries).
 NGOs are strong pressure groups towards government policies and the activities of
MNCs (e.g. Greenpeace).
 Many NGOs are involved in development projects such as irrigation projects,
hospitals…
The Role of NGOs

The United Nations now describe a Non-Governmental Organisation as a not-for-profit,
voluntary citizen’s group, which is organised on a local, national, or international level to
address issues in support of the public good. Task oriented and made up of people with
common interests, NGOs perform a variety of services and humanitarian functions, bring
citizens concerns to governments, monitor policy and programme implementation, and
encourage participation of Civil Society stakeholders at the community level.
NGOs have, since the end of the Second World War, become increasingly more important to
global development. They often hold an interesting role in a nation’s political, economic or
social activities, as well as assessing and addressing problems in both national and
international issues, such as human, political and women’s rights, economic development,
democratisation, inoculation and immunisation, health care, or the environment.
However, in the developing world, the role of NGOs is often critical. In years of drought or
famine, the non-governmental organisations have been pivotal in providing food to those
most marginalised. NGOs often provide essential services in the developing world that in
developed countries governmental agencies or institutions would provide. Normally, NGOs
provide services that are in line with current incumbent governmental policy, acting as a
contributor to economic development, essential services, employment and the budget. In a
wider approach, NGOs are also the source and centre of social justice to the marginalised
members of society in developing countries or failed states. NGOs are often left as the only
ones that defend or promote the economic needs and requirements for developing states,
often bringing cases to the International Monetary Fund, World Trade Organisation and
World Bank. Developing nations and NGOs often find allies in one another when opposing
legislation, economic terms or agreements from global institutions.
Page 77 of 83
If the Millennium Development Goals are to be achieved in many of the developing, the role
of NGOs will have to be recognised by the international community. Their efforts are often
more effective than much bilateral aid. However, the role of NGOs has also been criticised,
as many international experts estimate that much of the work done by NGOs is not
harmonised or tailor-made to the countries preferences and peculiarities, causing the quality
of aid to suffer.
Page 78 of 83
Content Mastery
1. Explain that aid is extended to economically less developed countries either by

governments of donor countries, in which case it is called official development
assistance (ODA), or by nongovernmental organizations (NGOs).
2. Explain that humanitarian aid consists of food aid, medical aid and emergency relief aid.
3. Explain that development aid consists of grants, concessional long-term loans, project
aid that includes support for schools and hospitals, and programme aid that includes
support for sectors such as the education sector and the financial sector.
4. Explain that, for the most part, the priority of NGOs is to provide aid on a small scale to
achieve development objectives.
5. Explain that aid might also come in the form of tied aid.
6. Explain the motivations of economically more developed countries giving aid.
7. Compare and contrast the extent, nature and sources of ODA to two economically less
developed countries.
8. Evaluate the effectiveness of foreign aid in contributing to economic development.
9. Compare and contrast the roles of aid and trade in economic development.
10. Examine the current roles of the IMF and the World Bank in promoting economic
development.
11. Outline the meaning of foreign debt and explain why countries borrow from foreign
creditors.
12. Explain that in some cases countries have become heavily indebted, requiring
rescheduling of the debt payments and/or conditional assistance from international
organizations, including the IMF and the World Bank.
13. Explain why the servicing of international debt causes balance of payments problems
and has an opportunity cost in terms of foregone spending on development objectives.
14. Explain that the burden of debt has led to pressure to cancel the debt of heavily indebted
countries.
15. Discuss the positive outcomes of market-oriented policies (such as liberalized trade and
capital flows, privatization and deregulation), including a more efficient allocation of
resources and economic growth.
16. Discuss the negative outcomes of market-oriented strategies, including market failure,
the development of a dual economy and income inequalities.
17. Discuss the strengths of interventionist policies, including the provision of infrastructure,
investment in human capital, the provision of a stable macroeconomic economy and the
provision of a social safety net.
18. Discuss the limitations of interventionist policies, including excessive bureaucracy, poor
planning and corruption.
19. Explain the importance of good governance in the development process.
20. Discuss the view that economic development may best be achieved through a
complementary approach, involving a balance of market oriented policies and
government intervention.
Page 79 of 83
1. For each factor, what would you consider to be sufficient evidence that it plays a role in
enhancing or inhibiting development?
2. What criteria can economists use to decide on the balance between markets and
intervention?
3. Is development economics dependent upon external normative notions such as what

constitutes a good or fulfilled life??
Page 80 of 83
Page 81 of 83
4. Development of Economics
Terms Definition
Any circular chain of events starting and ending in poverty, such as low
Poverty Cycle income means low savings means low investment means low growth means
low incomes.
The large scale public systems, services, and facilities of a country that are
Infrastructure necessary for economic activity. They are accumulated through investment,
usually by the government.
Relates to the high levels of debt that developing countries owe to

Indebtedness developed countries. The repayments on this debt act as a significant
barrier to growth for developing countries.
Non-convertible The currency of a country that is not convertible on the international foreign
currency exchange markets.
Occurs when money and other assets flow out of a country to seek a “safe
Capital flight
haven” in another country.
Bilateral aid Aid that is given directly from one country to another.
Aid that is given by countries to international aid agencies, such as the

Multilateral Aid
World Bank, and then distributed by the agencies.
Loans given to developing countries that have a rate of interest significantly

Soft loans
below the usual market rate.
Short term aid provided as a gift that does not have to be repaid (food aid,
Grant aid
medical aid, and emergency aid).
Aid that is provided to a country by another government or an official

Official aid
government agency. It may be multilateral or bilateral in nature.
Unofficial aid Aid that is organized by a non-government organization, such as Oxfam.
Grants or loans that are given to a country, but only on the condition that the
Tied aid
funds are used to buy goods and services from the donor country.
Page 82 of 83
Strategies based on openness and increased international trade. Growth is
Export-led growth
achieved by concentrating on increasing exports, and export revenue, as a
(outward-oriented
leading factor in the AD of the economy. Growth in the international market
strategies)
should be translated into growth in the domestic market, over time.
Strategies to encourage the domestic production of goods, rather than

Import substitution
importing them. It should mean that industries producing the goods
(inward-oriented
domestically should grow, as will the economy, and then should be
strategies /
competitive on world markets in the future. The strategies encourage
protectionism)
protectionism.
Sustainable Development that meets the needs of the present without compromising the
development ability of future generations to meet their own needs.
A scheme where products from producers in developing countries can be

certified to display the registered Fair trade mark encouraging consumers to
Fair trade buy them because they know that the producers of the products have been
paid a fair price and the products have been produced under approved
conditions.
Small loans usually given to enable poor people to start up very small-scale
Micro-credit
businesses in developing countries.
Foreign Direct
Long term investment by multinational corporations in another country.
Investment (FDI)
An organization whose main aims are to provide aid and advice to

The World Bank developing countries, as well as reducing poverty levels and encouraging
and safeguarding international investment.
The International
An organization working to foster global monetary cooperation, secure
Monetary Fund
financial stability, facilitate international trade, and reduce poverty.
(IMF)
Multinational
company/ A company that has productive units in more than one country.
corporation (MNC)
Non-governmental They are non-government organizations that exist to promote economic

organizations development and/or humanitarian ideals and/ or sustainable development.
(NGOs)
Page 83 of 83

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Humanities and Social

Economic Development Book:

1 Understanding Economic Development 3

2 Topics in Economic Development 41

3 Foreign Sources of Finance and Foreign Debt 55

Evaluation of Growth and Development Strategies

5 Glossary of Definitions (Development) 83

1. Understanding Economic Development

Although growth and development are often interchangeably in newspapers, economists

1.1 Introduction to Economic Development

A. Economic Growth versus Economic Development

Economic growth is primarily driven by improvements in productivity, which involves

The important elements in the growth process are as follows:

B. Difference Between Economic Growth and Economic Development

What is economic growth? What is Economic development?

 Gross domestic product (GDP) Economic development is concerned with

Using the PPC to show Economic Growth and Economic Development:

Think: Is it possible for economic development to occur without economic growth?

Economic growth should drive economic development in two ways:

Economic growth has some negative impacts on welfare. Pollution, environmental

Governments in LEDCs are less able to make important investments in necessary

The development economist, Michael P. Todaro, produced a list of the common

Figure 1.1 below illustrates the common characteristics of developing countries. In IB

Figure 1.1: Common Characteristics of Less Economically Developed Countries

Figure 1.2: Countries by GDP per capita.

2. Low Levels of Productivity and High Levels of Poverty:

(% of population under 15) + (% of population over 64)

Table 1.1: Countries that are considered Poor

5. Substantial Dependence on Agricultural Production & Primary Product Exports:

In advanced countries, agriculture provides employment to a small fraction of the people (2 to

6. Prevalence of imperfect markets & limited information:

7. Dominance, Dependence and Vulnerability in International Relations:

Poverty Cycle (Trap)

Figures 1.4 and 1.5 below illustrate a poverty cycle (trap)

Figure 1.4: Poverty Cycle (Trap) 1

Figure 1.5: Poverty Cycle (Trap) 2

Photo 2: Water is essential

Figure 1.6: Sources of Diversity in LEDCs

1. Natural Resource Endowments

5. Human and Capital Resources

Photo 3: Crazy like a fox? Maybe, but politically stable.

The goals are:

1. Eradicate extreme poverty and hunger.

2. Achieve universal primary education.

3. Promote gender equality and empower women.

4. Reduce child mortality.

6. Combat HIV/AIDS, malaria and other diseases.

7. Ensure environmental stability.

8. Develop a global partnership for development.

1. GNI per capita

2. GDP per capita (current US$)

3. GDP per capita, PPP (current international $)

4. GNI is based on ownership, and GDP is based on location.

Crude birth rate indicates the number of live births

Births attended by skilled health staff are the percentage

Contraceptive prevalence rate is the percentage of women

Crude death rate indicates the number of deaths occurring

Total fertility rate represents the number of children that

Total health expenditure is the sum of public and private

Total health expenditure is the sum of public and private