NAME: CHINTU NANJA MUDENDA
SIN: 1405240636
PROGRAM: MASTER IN DEVELOPMENT STUDIES
COURSE: DEVELOPMENT ECONOMICS
Question 1
Describe and explain the main theories of economic growth
INTRODUCTION
The problems of economic development are complex and multidimensional, have
resulted in the development of a number of theories; this paper will review some of the
most prominent theories of economic growth development. These theories describe
tools and strategies for making development goals achievable.
Definitions will be given and then the paper will describe and explain the main theories
of economic growth and then a conclusion will be drawn. It will then proceed to discuss
the main theories of economic development and subsequently, contemporary theories
of economic development, including new growth theory will be discussed as well. They
are mainly two theories of economic development namely the classical and neo
classical theories of economic development
According to Todaro & Smith (2009) economic growth is the increase in the inflationadjusted market value of the goods and services produced by an economy over time. It
is conventionally measured as the percent rate of increase in real gross national
Product, or real GDP. Of more importance is the growth of the ratio of GDP to
population. GDP per capita, which is also, called per capita income. An increase in
growth caused by more efficient use of inputs such as physical, capital, population or
territory is further referred to as intensive growth. GDP growth caused only by increases
in the amount of inputs available for use is called extensive growth
A country's economic health can usually be measured by looking at that country's
economic growth and development. A country's general economic health can be
measured by looking at that country's economic growth and development. A country's
economic growth is usually indicated by an increase in that country's gross domestic
product, or GDP. Generally speaking, gross domestic product is an economic model
that reflects the value of a country's output. In other words, a country's GDP is the total
monetary value of the goods and services produced by that country over a specific
period of time.
A country's economic development is usually indicated by an increase in citizens' quality
of life. 'Quality of life' is often measured using the Human Development Index, which is
an economic model that considers intrinsic personal factors not considered in economic
growth, such as literacy rates, life expectancy and poverty rates.
While economic growth often leads to economic development, it's important to note that
a country's GDP doesn't include intrinsic development factors, such as leisure time,
environmental quality or freedom from oppression. Using the Human Development
Index, factors like literacy rates and life expectancy generally imply a higher per capita
income and therefore indicate economic development.
According to Caravale (1989) different theories of economic growth center on the
question of what circumstances lead to sustained economic development within an
economy. These tend to look at the interactions of the state and free enterprise. They
also look at other factors that affect economic performance. Each theory tends to grow
out of one person’s attempted to understand economics and then create a model to
maximize growth from it. Among the different economic growth theories are the
mercantilist, classical and neoclassical theories, Spontaneous Order and Monetarism.
Early economic theories developed as Europe moved away from feudalism and toward
capitalism. Two early and opposing schools of thought were the physiocratic and
mercantilist theories of economic growth. The former, an 18th century French theory,
believed that economic growth came only from land ownership and agriculture. The
latter, on the other hand, believed that trade was the sole producer of economic growth.
Classical theory of Economic Growth
According to Adelman (1961) Adam smith in his 1776 work Inquiry into the Nature and
Causes of the Wealth of Nations, developed the classical theories of economic growth
as a critique of both the physiocrats and the mercantilists. According to Smith, economic
growth depends on the specialization and division of labor and the accumulation of
wealth. For this to work, he believed, the government had to be small and noninterventionist, which would lead to a large free-enterprise sector.
Harrod (1948) also alludes that the main cause of the economic growth is the nation ́s
working population which is employed in productive labor Smith pointed out that both
agriculture and manufacturing sector were productive. However, Smith considered the
government expenditures as unproductive.
Another cause of the economic growth is the accumulation of capital. In order to have a
high level of working population employed in productive labor the accumulation of
capital must be high. This will provide the conditions for the division of labor and
specialization which are the main causes of economic growth.
Smith identified three aspects that correlate the division of labor with the increase in
productivity. The first is the increase in the number of workers; the second is the
Increase in efficiency of the workers; and the third is the accumulation of capital. He
explains this very clearly in one of his passages:
Blang (1999) advises
that this great increase of the quantity of work, which, in
consequence of the division of labour, the same number of people are capable of
performing, is owning to three different circumstances; first, to the increase in dexterity
in every particular workman; secondly, to the saving of the time which is commonly lost
in passing from one species of work to another; and lastly, to the invention of a great
number of machines which facilitate and abridge labor, and enable one man to do the
work of many. The process of capital accumulation plays an important role in Smith’s
theory of economic growth.
Smith thought that capital accumulation contributes to the expansion of the market.
With more capital, labor is equipped to perform specialized actions and wages can
increase above the subsistence level. This increases population which increases the
demand and perm it’s the expansion of the market.
According to Robert (2003), In Smith’s theory, the manufacturing sector was
incorporated as a generator of surplus and played a major role, although agriculture
was still of vital importance. He also appreciated the potential of the division of labor in
the manufacturing sector and its possible effects in raising the standards of living in the
population, and also the correlation between capitals.
Malthus is also another of the classical theorist these were the core components of
Malthus’ theory of economic growth. He stated that accumulation of capital would
generate an increase in wages, what would improve the living conditions in the short
term and increase the population growth rate. However, according to Bairoch (1993)
Malthus stated that in the long term, an increase in population would lower down the
standards of living due to the fixed nature of the land factor and the diminishing returns
in agriculture. He thought that even if accumulation of capital could grow constantly in
order to counteract the effects of population growth, it would still mean less output per
worker because land was fixed and technological change was absent in his economic
growth theory.
Ricardo being a classical theorist contemplated an improvement on the standards of
living in the short term. The explanation for this is the income distribution theory that
Ricardo developed. Ricardo stated that prices would rise, and the same would happen
to wages in the short term. This would cause an improvement of the standards of living
of the whole society. This process would decrease the profits of the landlords, and the
purchasing power would be transferred to the workers. Finally, the reduction of profits
would stop the accumulation of capital, and wages and prices would become constant
reaching the stationary state.
Hollander (1980),urges that prices in agricultural
commodities in the long term were expected to rise due to the use of less fertile land
and the decrease in productivity land would suffer diminishing returns, and because of
an increase in population.
Ricardo’s theory would change at the end of its career, coming closer to Malthus.
Ricardo contemplated an economy that would reach the stationary state due to capital
accumulation. In the long run, population would increase too, at a higher rate than
demand of labor, reducing the capital per worker and wages.
Neo Classical Theories of Economic Growth
The neo-classical theory of economic growth suggests that increasing Capital leads to
diminishing returns. Therefore, increasing capital has only a temporary and limited
impact on increasing the economic growth. As capital increases the economy maintains
its steady state rate of economic growth. Basically, to increase the growth it is
necessary to increase labor productivity, the size of the workforce or improve
technology. In other words economic growth requires an increase in all aspects of
growth. This model was first suggested by Robert Solow over 45 years ago.
Solow, along with Paul Romer and Paul Omerod, helped develop the neoclassical or
new economic growth theory. This theory developed Smith’s theories further. The
theory states that the growth of labor will cause a corresponding economic growth. This
is also said of rises in labor quality through education and training, the growth of
entrepreneurship and a growth in investment.
According to Lakatos (1970) this neoclassical growth theory lays stress on capital
accumulation and its related decision of saving as an important determinant of
economic growth. Neoclassical growth model considered two factor production
functions with capital and labor as determinants of output. Besides, it added
exogenously determined factor, technology, to the production function.
It emphasizes the factors that influence the growth of an economy, which includes
capital availability capital of labor and technology. It states that a temporary equilibrium
can be achieved when capital size, labor and technology is appropriately adjusted. The
theory also states that temporary equilibrium differs from
long term equilibrium, which
does not involve any of the three factors.
According to Malthus (1978), the development of new technology leads to growth.
Innovation and new products and services also lead to the creation of new markets and
the destruction of old ones a theory known as creative destruction.
Not all theories of economic growth are born at times of economic growth and stability.
Some, such as the theories of John Maynard Keynes, are born during times of
economic depression. Keynes believed that during a recession, the wealth creators or
wealth holders will hold onto their money and not invest it in the free market. As a result,
Keynes' theories on economic growth state that the government must invest in the labor
market to boost consumption and trigger economic growth.
Hahn (1965) believes that the main sources of criticism against Keynes have come
from Friedrich Hayek. Who believed that many elements of economic growth could not
be predicted. His theory on economic growth, one of which is called Spontaneous
Order, realizes that there is an "invisible hand" at play in the economy. This hand is
manmade but is accidental rather than by human creation.
New Economic Growth Theories (endogenous growth)
They place greater importance on the need for governments to actively encourage
technological innovation. They argue in the free market classical view, firms may have
no incentive to invest in new technologies because they will struggle to benefit in
competitive markets.

Place emphasis on increasing both capital and labor productivity.

They argue that increasing labor productivity does not have diminishing returns,
but, may have increasing returns

They argue that increasing capital does not necessarily lead to diminishing
returns as Solow predicts. They say it is more complicated, it depends on the
type of capital investment.

These theories associated with Paul Romer
The goal of economic development in its simplest form is to create the wealth of a
nation. Prior to the 1970s, rapid economic growth has been considered a good proxy for
other attributes of development (Todaro and Smith 2009). Economic performance is
measured by an annual increase in gross national product (GNP 1) an alternative
measure is gross domestic product (GDP)]. For the purpose of comparability, GNP is
expressed in a common currency, usually US dollars, and reported in per-capita terms
to take into account the size of a nation’s population. The World Bank (2001) now
replaces GNP per capita with gross national income (GNI) per capita to compare wealth
among countries. The World Bank defines GNI as 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. Meanwhile, the World Bank still uses GDP in many other featured
economic indicators
Conclusion
References
Adelman, Irma. 1961. Theories of Economic Growth and Development. Stanford:
Stanford University Press
Bairoch, Paul., 1993. Economic and World History. Geneva: Simon and Schuster Int.
Group Barro,
Robert J. Sala i Martin,Xavier. 2003. Economic Growth, 2nd ed. Cambridge, Mass: MIT
Press.
Blaug, Mark., 1962. Economic Theory in Retrospect. Second ed. Illinois: Richard D.
Irwing, Inc
Blaug, Mark., 1999. Who’s Who in Economics. 3rd ed. United Kingdom: Edward Elgar
Publishing Limited
Caravale, G., 1985. The Legacy of Ricardo. Great Britain: Basil Blackwell Doyle, William.,
2001. Old Regime France. Oxford University Press Eltis,
Hahn, F. H. and Matthews, R. C. O. 1965. The Theory of Economic Growth:
SurveyIn Surveys of Economic Theory, Growth and Development, Vol. II.
London:Macmillan
Harrod, R. F. 1948. Towards a Dynamic Economics. London: Macmillan.
Hollander, Samuel.1980. On Professor Samuelson’s Canonical Classical Model of
Political Economy. Journal of Economic Literature, 18: 559-74-----. 1987.
Classical Economics. Oxford: Blackwell.
Lakatos, Imre. 1970. Falsification and the Methodology of Scientific Research
Programmes. In Lakatos, I. and Musgrave A. (eds.), Criticism and the
Growth of Knowledge. Cambridge: Cambridge University Press.
[Malthus, T. R.] 1798. An Essay on the Principle of Population as it affects The
Future Improvement of Society, with Remarks on the Speculations of Mr Godwin, M.
Condorcet
Todaro, Michael P and Stephen C. Smith (2002), Economic Development, (8th
edition), Longman
World Bank (2 001) Review by: Elizabeth Asante The Canadian Journal of Sociology
Cahiers canadiens de sociologie Vol. 27, No. 2 (Spring, 2002), pp. 291-294
Question 2
Discuss the merits and demerits of foreign direct investments in developing
countries
Introduction
A Foreign Direct Investment (FDI) is a controlling ownership in a business enterprise in
one country by an entity based in another country. It is an investment made by a
company or entity based in one country, into a company or entity based in another
country. Foreign Direct Investments (FDI) differs substantially from indirect investments
such as portfolio flows, wherein overseas institutions invest in entities listed on a
nation's stock exchange. Entities making direct investments typically have a significant
degree of influence and control over the company into which the investment is made.
Open economies with skilled workforces and good growth prospects tend to attract
larger amounts of Foreign Direct Investment than closed, highly regulated economies.
This paper will discuss the advantages and disadvantages of FDI in developing
countries. Firstly definitions of main concepts will be given and then the advantages and
disadvantages will be given and then a conclusion will be drawn.
According to World bank (2003) foreign direct investment are the net inflows of
investment to acquire a lasting management interest (10 percent or more of voting
stock) in an enterprise operating in an economy other than that of the investor. It is the
sum of equity capital, reinvestment of earnings, other long-term capital, and short-term
capital as shown in the balance of payments.
According to Bouma (1996), FDI is the category of international investment that
reflects the objective of obtaining a lasting interest by a resident entity in
one economy in an enterprise resident in another economy. The
l a s t i n g interest implies the existence of a long-term relationship between the direct
investor and the enterprise a nd a significant degree of influence by
t h e investor on the management of the enterprise
Foreign direct investment (FDI) is made into a business or a sector by an individual or a
company from another country. It is different from portfolio investment, which is made
more indirectly into another country’s economy by using financial instruments, such as
bonds and stocks.
The investing company may make its overseas investment in a number of ways - either
by setting up a subsidiary or associate company in the foreign country, by acquiring
shares of an overseas company, or through a merger or joint venture.
An example of foreign direct investment would be an American company taking a
majority stake in a company in China or Zambia. Another example would be a Canadian
company setting up a joint venture to develop a mineral deposit in Chile or Zimbabwe.
There are various levels and forms of foreign direct investment, depending on the type
of companies involved and the reasons for investment. A foreign direct investor might
purchase a company in the target country by means of a merger or acquisition, setting
up a new venture or expanding the operations of an existing one. Other forms of FDI
include the acquisition of shares in an associated enterprise, the incorporation of a
wholly owned company or subsidiary and participation in an equity joint venture across
international boundaries. According to Gujarati (1995), almost all modern (FDI) is
carried out by corporations rather than individuals. Somewhat like portfolio investment,
the flows of FDI have historically been highly concentrated, both in terms of geography
and by industry and at both the investor and receptor poles. Geographically, the
ownership of global stocks of FDI is highly skewed towards only a few large, high
income countries. Each investing country has, whether by accident or design, tended to
direct the major part of its FDI to only a very few receiving countries; in fact the pattern
of global distribution of FDI have been highly similar to historical relationships based on
colonial ties or other.
FDI in Developing Countries
FDI is now increasingly recognized as an important contributor to a developing
countries economic performance and international; competiveness. After the debt crisis
that hit the developing world in the early 1980s, t h e conventional wisdom quickly
became that it had been unwise for countries to borrow so heavily from international
banks or international bond markets. It has also been widely observed that the structural
adjustment efforts of the 1980s failed to lead to new patterns of sustained
growth in developing countries. According to Anand (1997) structural adjustment
programs failed to restore private investment to desirable levels. Again it is hoped that
FDI could play an important role; the World Bank observes that FDI can be an
important complement to the adjustment effort, especially in countr ies having
difficulty in increasing domestic savings. Against this background of balance of
payments problems and low level of private investment, it is probably not surprising that
attitudes in developing countries towards FDI have shifted. In the 1960s and 1970s
many countries maintained a rather cautious, and sometimes an outright
negative position with respect to FDI. However there are advantages of FDI and
they discussed below:
Advantages of FDI
In the context of foreign direct investment, advantages and disadvantages are often a
matter of perspective especially in developing countries. An FDI may provide some
great advantages for the Multinational Enterprises (MNE) but not for the foreign country
where the investment is made. On the other hand, sometimes the deal can work out
better for the foreign country depending upon how the investment pans out. Ideally,
there should be numerous advantages for both the MNE and the foreign country, which
is often a developing country. Some of the advantages FDI in developing countries are
explained below:
FDI helps to enhance Economic Development Stimulation. This means that FDI can
stimulate the target country’s economic development, creating a more conducive
environment for the investor and provides benefits for the local industry. This in turn
helps the local industry to benefit as well as the MNE.
FDI also a helps developing countries to have easy International trade,
commonly, a
country has its own import tariff, and this is one of the reasons why trading with it is
quite difficult. Also, there are industries that usually require their presence in the
international markets to ensure their sales and goals will be completely met. With FDI,
all these will be made easier.
According to Barrel (1997), this helps to boost
employment and the economy and boosts employment and the economy. Foreign direct
investment creates new jobs, as investors build new companies in the target country,
create new opportunities. This leads to an increase in income and more buying power to
the people, which in turn leads to an economic boost which eventually develops the
human capital resources. According to Benito (1992) another big advantage brought
about by FDI is the development of human capital resources, which is also often
understated as it is not immediately apparent. Human capital is the competence and
knowledge of those able to perform labor, more known to us as the workforce. The
attributes gained by training and sharing experience would increase the education and
overall human capital of a country. Its resource is not a tangible asset that is owned by
companies, but instead something that is on loan. With this in mind, a country with FDI
can benefit greatly by developing its human resources while maintaining ownership.
According to Hood (1979), FDI also helps developing countries in tax Incentives. This
means that the parent enterprises are able to provide foreign direct investment to get
additional expertise, technology and products. Foreign investors can receive tax
incentives that will be highly useful in their selected fields of business. It further helps
developing countries in resource transfer through the exchange of resources and
foreign exchange. Foreign direct investment also allows resource transfer and other
exchanges of knowledge, where various countries are given access to new
technologies and skills.
According to Fountas (1994), foreign direct investment can fill the gap between desired
investment and locally mobilized savings. Since local capital markets are often not well
developed, thus, they cannot meet the capital requirements for large investment
projects. Besides, access to the hard currency needed to purchase investment
goods not available locally can b e d i f f i c u l t , i t i s f o r t h i s r e a s o n t h a t F D I
becomes the best way to fill in this gap and create more of the
needed investment in developing countries.
Further,
investment
Humes
brings
(1993)
with
also
it
argues
that
foreign
direct
technological knowledge while transferring
machinery and equipment to developing
countries.
Production
units
in
developing countries use out-d a t e d e q u i p m e n t a n d t e c h n i q u e s t h a t c a n
r e d u c e t h e p r o d u c t i v i t y o f workers and lead to the production of goods of a lower
standard.
In addition Foreign Direct Investment can also lead to reduced disparity between
revenues and costs. This means that countries will be able to make sure that production
costs will be the same and can be sold easily. Which in turn lead to increased
Productivity. The facilities and equipment provided by foreign investors can increase a
workforce’s productivity in the target country.
According to Hymer (1975) FDI also leads to an Increment in Income in developing
countries for the nation as well as the people at large. With more jobs and higher
wages, the national income normally increases which in turn can reduce poverty As a
result, economic growth is spurred. It is important to note that larger corporations would
usually offer higher salary levels than what you would normally find in the target country,
which can lead to increment in income
FDI also offers some advantages for foreign countries Woodward (1992), argues that
FDI offers a source of external capital and increased revenue. It can be a tremendous
source of external capital for a developing country, which can lead to economic
development. For example, if a large factory is constructed in a small developing
country, the country will typically have to utilize at least some local labor, equipment,
and materials to construct it. This will result in new jobs and foreign money being
pumped into the economy. Once the factory is constructed, the factory will have to hire
local employees and will probably utilize at least some local materials and services. This
will create further jobs and maybe even some new businesses. These new jobs mean
that locals have more money to spend, thereby creating even more jobs.
Additionally, tax revenue is generated from the products and activities of the factory,
taxes imposed on factory employee income and purchases, and taxes on the income
and purchases now possible because of the added economic activity created by the
factory. Developing governments can use this capital infusion and revenue from
economic growth to create and improve its physical and economic infrastructure such
as building roads, communication systems, educational institutions, and subsidizing the
creation of new domestic industries.
Another advantage is the development of new industries. Remember that a MNE
doesn't necessary own all of the foreign entity. Sometimes a local firm can develop a
strategic alliance with a foreign investor to help develop a new industry in the
developing country. The developing country gets to establish a new industry and
market, and the MNE gets access to a new market through its partnership with the local
firm.
Woodward (1993) further alludes that FDI also increases Access to markets: FDI can be
an effective way for you to enter into a foreign market. Some countries may extremely
limit foreign company access to their domestic markets. Acquiring or starting a business
in the market is a means for you to gain access. FDI also helps MNEs to increase
access to resources to acquire important natural resources, such as precious metals
and fossil fuels. Oil companies, for example, often make tremendous FDIs to develop oil
fields.
FDI is a means for MNEs to reduce their cost of production if the labor market is
cheaper and the regulations are less restrictive in the target foreign market. For
example, it's a well-known fact that the shoe and clothing industries have been able to
drastically reduce their costs of production by moving operations to developing
countries.
Disadvantages of Foreign Direct Investment
As investors search the globe for the highest returns, they are often drawn to places
endowed with bountiful natural resources but are handicapped by weak or ineffective
environmental laws. Many people and communities are harmed as the environment that
sustains them is damaged or destroyed villages are displaced by the large construction
projects, for example, and indigenous people watch their homelands disappear as
timber companies level old-growth forests. Foreign investment-fed growth also
promotes western-style consumerism, boosting car ownership, paper use, and Big Mac
consumption rates towards the untenable levels found in the United States -- with grave
potential consequences for the health of the natural world, and the stability of the earth’s
climate, and the security of food supplies.
According
fluence
to
Grosse
political
(1995),
decisions
in
foreign
developing
firms
may
in
countries. In view of
their large size and power, national sovereignty and control over economic policies
may be jeopardized. In extreme cases, foreign firms may bribe public
officials at the highest levels to secure undue favors. Similarly, they may
contribute to friendly political parties and subvert the political process of the host
country. Because political issues in other countries can instantly change, foreign direct
investment is very risky. Plus, most of the risk factors that you are going to experience
are extremely high.
According to Aliber (1970) further argues that foreign direct investments can
occasionally affect exchange rates to the advantage of one country and the detriment of
another. While FDIs may increase the aggregate demand of the host economy in the
short run, via productivity improvements and technological transfers, critics have also
raised concerns over the efficacy of purported benefits of direct investments. This
theory follows the rationale that the long-run balance of payment position of the host
economy is jeopardized when the investor manages to recover its initial outlay. Once
the initial investment starts to turn profitable, it is inevitable that capital returns from the
host country to where it originated from, that is the home country. Considering that
foreign direct investments may be capital-intensive from the point of view of the
investor, it can sometimes be very risky or economically non-viable.
Anand
dualistic
(1997),
also
add
socio-economic
that
foreign
structure
and
firms
reinforce
increase income and
political inequalities. They create a small number of highly paid m o d e r n s e c t o r
e x e c u t i v e s . T h e y d i v e r t r e s o u r c e s a w a y f r o m p r i o r i t y sectors to the
manufacture of sophisticated products for the consumption of t h e l o c a l e l i t e .
A s t h e y a r e l o c a t e d i n u r b a n a r e a s , t h e y c r e a t e imbalances
between rural and urban opportunities; accelerating flow of rural population to
urban areas here the government will have control over your property and assets
Many third-world countries, or at least those with history of colonialism, worry that
foreign direct investment would result in some kind of modern day economic
colonialism, which exposes host countries and leave them vulnerable to foreign
companies’ exploitations.
Conclusion
Investing into another country’s economy, buying into a foreign company or otherwise
expanding your business abroad can be extremely financially rewarding and might
provide you with the boost needed to jump to a new level of success. However, foreign
direct investment also carries risks, and it is highly important for you to evaluate the
economic climate thoroughly before doing it. Also, it is essential to hire a financial expert
who is accustomed to working internationally, as he can give you a clear view of the
prevailing economic landscape in your target country. He can even help you monitor
market stability and predict future growth.
Remember that we live in an increasingly globalized economy, so foreign direct
investment will become a more accessible option for you when it comes to business.
However, you should weigh down its advantages and disadvantages first to know if it is
the best road to take.
References
Aliber, R.Z:" A Theory of Direct Foreign Investment", in, Kindleberger C.P The
International Corporation, A Symposium, MIT press, 1970.
Anand, J & Kogut, B: “Technological Capabilities of Countries, Firm Rivalry and
Foreign Direct Investment", in, Journal of International Business Studies
hereafter JIB, vol. 28, no. 3, 1997.
Aristotelous, K. & Fountas, S: "An Empirical Analysis of Inward Foreign Direct
Investment Flows
in the EU with Emphasis on the Market Enlargement
Hypothesis", in, Journal of Common Market Studies, [hereafter JCMS], vol. 34, no. 4,
1994.
Barrel, R & Pain, N: "The Growth of Foreign Direct Investment in Europe", in, National
Institute Economic Review, No. 160, April 1997.
Benito, G.R.G. & Gripsrud, G: " The Expansion of Foreign Direct Investments:
Discrete Rational Location Choices or a Cultural Learning Process?", in, JIBS, vol.
23, no. 3, 1992.
Bouma, E: (1996) " Foreign Direct Investment", in, Jepma, C.J & Rhoen, A.P. [ edit]:
International Trade: A Business Perspective, Longman,
Grosse, R & Kujawa, D (1995)International Business, Theory and Managerial
Applications: London: Irwin,
Gujarati, D.N (1995) Basic Econometrics, McGraw Hill,
Hood, N & Young, S (1979) The Economics of Multinational Enterprise, Longman,.
Humes, S (1993) Managing the Multinational: Confronting the Global-Local Dilemma,
Prentice Hall,
Hymer, S.H "The Multinational Corporation and the Law of Uneven Development", in,
Radice, H [edit]: International Firms and Modern Imperialism, Pengiun Books, 1975.
Woodward, D.P& Rolfe, R.J: "The Location of Export-Oriented Foreign Direct
Investment in the Caribbean Basin", in, JIBS, vol. 24, 1993.
Woodward, D.P "Locational Determinants of Japanese Manufacturing Start-ups in the
United States", in, Southern Economic Journal, 1992.
QUESTION 3
Use the Harrod- Domar model to explain the barriers to growth that may be faced
by developing countries.
Introduction
The Harrod–Domar model is an early post-Keynesian model of economic growth. It is
used in development economics to explain an economy's growth rate in terms of the
level of saving and productivity of capital. It suggests that there is no natural reason for
an economy to have balanced growth. The Harrod-Domar model was developed
independently by Sir Roy Harrod in 1939 and Evsey Domar in 1946. It is a growth
model which states the rate of economic growth in an economy is dependent on the
level of saving and the capital output ratio. If there is a high level of saving in a country,
it provides funds for firms to borrow and invest. Investment can increase the capital
stock of an economy and generate economic growth through the increase in production
of goods and services.
The capital output ratio measures the productivity of the investment that takes place. If
capital output ratio decreases the economy will be more productive, so higher amounts
of output is generated from fewer inputs. This again, leads to higher economic growth.
According to Aghion ( 1998), This model is mainly used in development economics. It
suggests that if developing countries want to achieve economic growth, governments
need to encourage saving, and support technological advancements to decrease the
economy’s capital output ratio. The Harrod-Domar model provides a framework for
economic development and has been an important influence to government policies,
such as India’s Five Year Plan (1951- 1956).
The Harrod-Domar model is unsurprisingly named after two economists, RF Harrod and
ED Domar, who were working in the l930s. The model suggests that the economy's rate
of growth depends on:

The level of saving

The productivity of investment, i.e. the capital output ratio
According to Jones( 2002) this model therefore placed considerable emphasis on
investment, savings and technology as the main agents of economic growth. Increased
investment would, in turn, force the production possibility curve outwards and create
more wealth. The impact of this increased investment on the production possibility
frontier is shown in Figure 1 below.
The model concludes that:

Increasing the savings ratio, or the amount of investment or the rate of
technological progress are vital for the growth process

Economic growth depends on the amount of labor and capital.

As developing countries often have an abundant supply of labor it is a lack of
physical capital that holds back economic growth and development.

More physical capital generates economic growth.

Net investment leads to more capital accumulation, which generates higher
output and income.

Higher income allows higher levels of saving.
The key to economic growth is therefore to expand the level of investment both in terms
of fixed capital and human capital. To do this, policies are needed that encourage
saving and/or generate technological advances which enable firms to produce more
output with less capital, i.e. lower their capital output ratio.
It concluded that:

Economic growth depends on the amount of labor and capital.

As LDCs often have an abundant supply of labor it is a lack of physical capital
that holds back economic growth and development.

More physical capital generates economic growth.

Net investment leads to more capital accumulation, which generates higher
output and income.

Higher income allows higher levels of saving.
Barrow (1995) postulates that Keynes in his general theory was concerned with the
determination of income and employment in the short run He explained that since in the
short-run situation of developed capitalist economies aggregate demand was deficient
in relation to the aggregate supply of output, the equilibrium will be established at less
than full employment level.
Since the propensity to consume is given and remains constant in the short run, if the
amount of investment as determined by expected rate of profit and the market rate of
interest is not equal to the amount of saving at the full-employment level of income, the
economy will be in equilibrium at less than full capacity level which is less than
employment level of output.
However, investment has a dual effect. Firstly, investment increases aggregate
demand and income of the people through the multiplier process, and secondly, it raises
the productive capacity of the economy through the addition it makes to the stock of
capital. Indeed, investment by very definition means the addition to the stock of capital.
While Keynes took into account the demand effect of investment, he ignored the
capacity effect of investment.
Harrod and Domar extended the Keynesian analysis of income and employment to
long-run setting and therefore considered both the income and capacity effects of
investment. Harrod and Domar models of economic growth explained at what rate
investment should increase so that steady growth is possible in an advanced capitalist
economy.
In addition Romer (1996) adds that in the growth models of Harrod and Domar, the
rate of capital accumulation plays a crucial role in the determination of economic
growth. The problem of present-day mature economies lies in averting both secular
stagnation and secular inflation.
It was the pioneer works of Harrod and Domar that set the ball rolling in regard to this
issue, i.e., the maintenance of steady growth in advanced industrialized countries. The
Harrod and Domar models seek to determine that unique rate at which investment and
income must grow so that full employment level is maintained over a long period of
time, i.e., equilibrium growth is achieved.
Harrod and Domar developed their models of steady growth quite separately, though
Harrod published his theory earlier than Domar. Although their models of steady growth
differ in details, yet the underlying basic idea is the same. Both of them assigned to
capital accumulation a crucial role in the development process.
But they emphasized the double role of the investment process, viz., generating income
(increasing demand) and adding to the productive capacity of the economy. The
classical economists confined their attention to the capacity side only, whereas the
earlier Keynesian economists studied the problem of demand only whereas Harrod and
Domar consider both sides.
They start with full employment equilibrium level of income. According to them, to
maintain full employment equilibrium, demand (total spending) generated by investment
must be sufficient to be the additional output caused by this investment. To ensure
steady growth with full employment the absolute amount of net investment must keep
increasing and there must also be continuous growth of real national income.
Because if demand and income did not increase while annual investment went on
occurring, the additions made to the capital stock would remain un-utilized and also
employment could not be provided to the growing labor force which would result in
unemployment of these two major resources. Obviously, such a situation is not
conducive to steady economic grow
However, According to Grossman (1991) the model has a range of problems as it tends
to focus heavily on economic growth. The problems may be:

Economic growth and economic development are not the same. Economic
growth is a necessary but not sufficient condition for development

Savings and investment are a necessary but not sufficient condition for
development

On a practical level, it is difficult to stimulate the level of domestic savings,
particularly in the case of developing countries where incomes are low.

Borrowing from overseas to fill the gap caused by insufficient savings causes
debt repayment problems later.

The law of diminishing returns would suggest that as investment increases the
productivity of capital will diminish and the capital to output ratio will therefore
rise.
Barriers to growth in Developing Countries.
It is widely agreed that there are many barriers to growth and development that hold
back developing countries. It is perhaps easiest to understand them if they are
separated into different categories; however, you should not lose sight of the fact that
many of the barriers, although in different categories, are interconnected.. You also
need to be aware of the ways in which some barriers act as an obstacle to economic
growth, some to economic development, and some to both.
Insufficient provision of education
One of the Millennium Development Goals is to “Ensure that by 2015, children
everywhere, boys and girls alike, will be able to complete a full course of primary
schooling”. While progress has been made in the provision of education, particularly
primary education, throughout the world, there are still more than 115 million children of
primary school age that do not attend primary school. 80% of these children are in
Africa or Southern Asia. At the most basic level, the provision of education requires vast
funding and this simply may not be available in sufficient quantities. Within
According to Kaimen( 1991), a country there may be large disparities in the provision of
education, with urban areas receiving more of the education funds than rural areas.
There are also family economic conditions that prevent children from attending school;
they may be needed to work within the home or farm, or they may be involved in
external work as “child laborers”. For the most part it is children from poor households
and from families where the mothers also received no formal education, who did not
attend school. Enrolment in secondary schools tends to be far lower than primary
schools, with the necessity of earning an income as the greatest obstacle to attending
school.
Insufficient health care systems
There has been much progress made by many developing countries in terms of the
training of doctors and nurses, the building of hospitals and clinics, and the provision of
public health services such as improved access to safe water and sanitation and the
widespread availability of immunizations. Throughout the world infant mortality rates
have fallen, life expectancy has increased, more children are immunized than ever
before, and maternal mortality rates are falling. Nevertheless there is still significant
shortcoming
The financial system:
Developed and independent financial institutions are essential if economic growth is to
be achieved, and these are often underprovided in developing countries. Most
developing countries have dual financial markets. The official markets are small and
tend to be dominated by foreign commercial banks who often have an outward-looking
emphasis to their operations and restrict their lending to foreign businesses and the
already established large manufacturing local businesses. The unofficial markets are
not legally controlled and so are illegal. Their main operation is to lend money, usually
at very high interest rates, to those who are desperate and poor enough to have to
borrow it. Saving is necessary to make funds available for investment and investment is
necessary for economic growth. According to Romer (1986) saving is difficult enough in
countries where there are high levels of poverty, but it is even harder if there is nowhere
to save money that is safe and will give a good return. When there are weak or
untrustworthy financial institutions, people with investment income tend to buy assets,
such as livestock, or invest their money outside the country. Financial services are
necessary if low-income people are to be able to manage their assets and to allow them
to increase in value. The difficulties associated with saving and borrowing money are a
significant barrier to economic growth and development. It makes it exceedingly difficult
for low-income people to raise themselves out of poverty
Obsolete technology
Political instability and corruption
These are both barriers to growth and development. Political instability causes
uncertainty and, at its most extreme, complete economic breakdown. Sudan, in Africa,
is a relevant case. Civil wars from 1955 to 1972, and then from 1983 to 2005, together
with a new civil war in the western region of Darfur, which began in 2003 and is still
ongoing, have caused significant loss of life and displacement of the population. In
addition, their neighbor, Chad, declared war on Sudan in December 2005. Therefore
Kamihigash (2001) further alludes to the fact that such extreme political instability is
bound to lead to very poor economic performance, high levels of poverty, and low
standards of living for the majority of the population. The likelihood of attracting foreign
investment, or even aid, becomes much smaller. A number of developing countries are
experiencing civil wars as a result of ethnic and/or religious conflict or border conflicts.
For example, since 1980 there have been ethnic- and/or religious-based conflicts in
Afghanistan, Algeria, Côte d’Ivoire, Democratic Republic of the Congo, India, Indonesia,
Iraq, Israel, Laos, Lebanon, Mexico, Myanmar, Nepal, Philippines, Russia, Rwanda,
Senegal, Somalia, Sri Lanka, Turkey, and Uganda. The loss of life, damage to
infrastructure, loss of investment and sometimes aid, and political instability have
undoubtedly affected economic growth and development in these countries
Conclusion
References
Aghion, Philippe and Peter Howitt, Endogenous Growth Theory, Cambridge, MA: MIT
Press, 1998.
Barro, Robert J. and Xavier Sala-i-Martin, Economic Growth, McGraw-Hill, 1995.
Jones, Charles I., Introduction to Economic Growth, New York: W.W. Norton and
Co.,2002. Second Edition.
Romer, David, Advanced Macroeconomics, New York: McGraw-Hill, 1996.
Grossman, Gene M. and Elhanan Helpman, Innovation and Growth in the Global
Economy,Cambridge, MA: MIT Press, 1991.Articles by Romer, Grossman-Helpman,
Solow, and Pack, “Symposium on NewGrowth Theory,” Journal of Economic
Perspectives,Winter 1994.
Barro, Robert J. and Xavier Sala-i-Martin, Economic Growth, McGraw-Hill, 1995.
(Especially Appendix 1.3).
Kamien, Morton I. and Nancy L. Schwartz, Dynamic Optimization: the Calculus of
Variations and Optimal Control in Economics and Management, North Holland,
1991.
Arrow, Kenneth and Mordecai Kurz, Public Investment, the Rate of Return, and
Optimal Fiscal Policy, Baltimore: Johns Hopkins University Press, 1970.
Romer, Paul M., “Cake Eating, Chattering, and Jumps: Existence Results for
Variational Problems,” Econometrica, 1986, 54, 897–908.
Kamihigashi, Takashi, “Necessity of Transversality Conditions for Infinite Horizon
Problems,” Econometrica, Forthcoming 2001.
Question 4
Discuss the concepts of poverty and inequality amongst nations and outline the
strategies that are aimed at alleviating poverty.
Introduction
Although poverty is one of the most familiar and enduring conditions known to humanity,
it is an extremely complicated concept to understand. Some researchers view it as a
reaction to the stress of being poor, whereas others perceive it as a process of adapting
to the condition of poverty. Historical definitions are numerous, but can be classified as
relating to either lack of financial income or lower social status. Numerous factors
contribute to the concept of poverty, including political, economic, social, and cultural
forces. The one that has consistently had the greatest effect on the evolving concept is
the passage of time, which encompasses all these forces in a very intricate manner.
Poverty hampers the development of any country where a section of the population is
being economically marginalized.
As a result, theoretical and practical aspects of poverty eradication-related activities
seem unpractical and theoretically unsound in many circumstances. Moreover, the
incidence of poverty at individual and community level has increased despite of the
technology advancement in the modern society. That is, the poverty issue is
unexpected in the midst of technology advancement whereby food production is four times
as compared to the need of world’s population.
This paper will discuss the concept of poverty and inequality among nations and will show strategies
that have been put in place to alleviate poverty.
Many arguments have been put forward to describe the poverty issue as well as to
predict the future trends of poverty incidence. On the other hand, the poverty of definition has
always been debated by different set of technical and theoretical assumptions. Those
assumptions are made for various socio-political reasons whereby rational and logical
explanations are intermingled together to adapt the requirement and needs of various
stakeholders.
As such, different definition should be accepted accordingly by
considering the local context, political, demographic and economical the needs of the
poor.
Generally, poverty is defined as an inability to access resources in order to enjoy a
minimal or acceptable living.
World Bank (2011), defines poverty as a denial of choices and opportunities, which is a
violation of human dignity. In other words, it is suggested that people are poor due to lack of the
basic capacity to participate effectively in society. For instance, any person not having
enough resources to feed a family, not having a school or clinic to go to, not having the
land on which to grow one’s food or a job to earn one’s living and not having access to
credit.
United Nations Development Programme describes poverty as a human condition
characterized by sustained or chronic deprivation of the resources, capabilities, choices,
security and power necessary for the enjoyment of an adequate standard of living and
other civil, cultural, economic, political and social rights. Meanwhile, the World Bank
(2011) further suggests that poverty includes low incomes, the inability to acquire basic
goods and services necessary for survival, low levels of health and education, poor
access to clean water and sanitation, inadequate physical security, lack of voice and
insufficient capacity and opportunity to better one’s life.
There are two main types of poverty namely, absolute and relative poverty. According to
Zin (2011), Absolute Poverty is the extreme kind of poverty involving the chronic lack of
basic food, clean water, health and housing. People in absolute poverty tend to struggle
to live and experience a lot of child deaths from preventable diseases like malaria,
cholera and water-contamination related diseases. This type is usually long term in
nature, and often handed to them by generations before them.
This
kind
of
poverty
is
usually
not
common
in
the
developed
world.
Relative Poverty is the kind is usually in relation to other members and families in the
society. For example, a family can be considered poor if it cannot afford vacations, or
cannot buy presents for children at Christmas, or cannot send its young to the
university. Even though they have access to government support for food, water,
medicine and free housing, they are considered poor because the rest of the community
have access to superior services and amenities.
Some of the factor that causes poverty are discussed below:
Income inequality
According to Craig (2003), Research shows that when a country grows economically,
overall poverty reduces. If the national income is not equally distributed among all
communities in the country, there is a risk that poorer communities will end up poorer,
and individuals will feel it most.
Conflicts and Unrests
The
World
Bank 2011 further stress that about 33% of communities in absolute
poverty live in places of conflict. In the past, countries like Rwanda and Sri-Lanka have
suffered poverty as a result of years of tribal and civil wars. In recent years,
Afghanistan, Iraq and the like are all going through difficult times and poverty is rife in
these areas. Unrests result in massive loss of human live, diseases, hunger and
violence, destruction of property and infrastructure, economic investments and quality
Labour. It is also a put-off for foreign investments. Wealth can never be created in such
an
environment.
Location,
adverse
ecology
and
location
Location of countries, as well as communities within the country can make people poor.
Geographic and ecological factors such as mountains, swamps, deserts and the like
have also made life conditions unbearable in many places. This is why some rural areas
are poorer than others, even in the same country. For example, poverty in the Andes,
Peru
is
six
times
higher
than
communities
in
the
Amazonian
region.
In other instances, some communities are cut off from the main economic centers of the
country. They find themselves located so far from roads, markets, health services,
schools and economic facilities. This makes it just impossible for the locals to access
support and assistance, and also makes it discouraging for economic investors to
consider investing there. In Bangladesh for example, poverty is severe in areas of
physical remoteness, as indicated by the fact that seven rural districts are home to half
of
the
country’s
severely
stunted
children.
Natural disasters
Droughts, floods, hurricanes and other unexpected natural events cause deaths, illness
and loss of income. According to Zin (2001) in Ethiopia alone, there were 15 droughts
(and famines) between 1978 and 1998 that led to the displacement, injury, or death of
more than 1 million people. In better connected communities, families are able to come
out of poverty and get on with their lives, but other remote and less accessible
communities
suffer
for
longer
periods.
Health and Disability Poverty can also get worse if communities are affected with
diseases such as Malaria and HIV aids. Diseases cause many deaths and children are
left with no parents or care givers. Household wealth can also drain quickly with disable
members. In many communities, disabled members are looked down upon and not
allowed to inherit assets. They are considered a stigma and excluded from public
events and exposure. This mentality can adversely affect the well-being of families. For
example, the incidence of poverty is 15-44% higher in households with a disabled head
or
adult.
Inheritances of Poverty
Families that have had a lifetime of poverty tend to pass on the situation to their
children. They cannot afford education for their children and children grow with no skills.
Children work on the same family farms, and marry into families with similar conditions
as they turn adults. They in turn pass on the tradition to their children.
Education, Training and skills
People who are educated or had some training or skills are in a better position to apply
ideas and knowledge into fixing basic problems and enhancing their livelihoods. They
are able to plan, follow instructions and get reach out to access information, tools and
support that can improve their livelihoods. In the absence of training, skills or education,
people cannot help themselves. They cannot prevent diseases, and cannot apply new
ways of doing things. The result is that their poverty situation is worse of and is even
more
vulnerable
than
before.
Gender discrimination
In many African communities, girls were not allowed to be in school. Families preferred
to invest in boys’ education than in girls. Women were also not allowed to do major
economic activity and had less ownership of lands and assets. This idea negatively
impacts on the well-being of women, and the development of their children is also
impacted negatively.
According to Nyasulu (2010) Concepts such as inequality, vulnerability, economic
exclusion and underdevelopment are so frequently used in conjunction with poverty that
the conceptual differences between them have become blurred. Therefore, before
attempting to review studies that have attempted to measure poverty in many countries,
much less examine policies and
programmes for its reduction, it is imperative to be clear about what definitions are
being applied. Inequality differs from poverty but is also related to .While inequality is
concerned with distribution of wealth within a population group, poverty focuses only on
those people whose standard of living falls below an appropriate threshold level such as
a poverty datum line this is according to World bank (2011).This threshold may be set
in absolute terms based on an externally determined norm, such as calorie
requirements or relative terms for example, a fraction of the overall average standard of
living. Intuitively speaking, relative poverty is more closely related to inequality, in that
what it means to be poor reflects the prevailing living conditions of the whole population.
It is thus not surprising to find that the analysis of poverty often employs indicators of
equality. This could be done in a number of ways, for example: through disaggregation
associating distributional measures with other poverty indicators or by specifying some
mathematical formulae. The notion for doing so, as some analyst would argue, is that
high levels of inequality contribute to high levels of poverty in several ways, for instance:
for any given level of economic development or mean income, higher inequality implies
higher poverty, since a smaller share of resources is obtained by those at the bottom of
the distribution of income or consumption.
However according to Driscoll Etal ( 2005) argues that higher initial inequality may
result in lower subsequent growth and, therefore, in less poverty reduction. For
example, access to credit and other resources may be concentrated in the hands of
privileged groups, thereby preventing the poor from investing; and higher levels of
inequality may reduce the benefits of growth for the poor, because a higher initial
inequality may lower the share of the poor’s benefits from growth. In the extreme case,
if one person has all the resources, then regardless of the rate of growth, the poverty of
the remaining population will never be reduced through growth. Based on the above
arguments, it would be appropriate to acknowledge that, in most cases, it would be
easier to reduce poverty under relatively egalitarian conditions
Craig etal (2003) further adds that poverty is a social, political, moral and economic
problem. The poor are often trapped in this situation for most of their lives with little
hope to escape for themselves and their children. They are being constantly connected
with some of the most pressing social and political problems of our time: crime,
violence, broken families, loss of communities, public health crises overpopulation, and
environmental degradation, corruption, poor governance, and ethnic conflict.
Data show that about a fifth of the world’s population survive on less than $1 per day
and almost half of the world’s population survives with only $2 per day.
Main strategies for alleviating poverty
According to Seshamani (2005) Poverty alleviation involves the strategic use of tools
such as education, economic development, health and income redistribution to improve
the livelihoods of the world’s poorest by governments and internationally approved
organizations.
Poverty cannot be completely eradicated, as it largely caused by human factors.
Over the past years there has been a lot of Poverty Alleviation Programs designed
to break the cycle of poverty in many households and communities in the world.
The
result
is
remarkable,
but
there
is
still
a
lot
to
be
done.
Poverty alleviation involves the strategic use of tools such as education, economic
development, health and income redistribution to improve the livelihoods of the
world’s poorest by governments and internationally approved organizations. They
also aim at removing social and legal barriers to income growth among the poor.
Some of the strategies that are supposed to be placed in order to alleviate poverty
are
as
follows:
Education
Quality education empowers people to take advantage of opportunities around
them. It helps children get knowledge, information and life skills they need to
realize their potential. Training teachers, building schools, providing education
materials and breaking down that prevent children from accessing education are
important features of poverty alleviation programmes.
Health, food and water
According to Kamruzziman (2009), Many programs aimed at feeding kids at school
and providing health services as well help to alleviate poverty in many
communities. This encourages parents to send the children to school and keep
them there. If children have food to eat, and are healthy, they can learn and
respond
to
the
needs
of
the
programme.
Provision of skills and Training
The youth and able-to-work in the communities are provided skills to help with farm
work or other economic activity, which helps them earn money to make a living and
take
care
of
their
families.
Income redistribution
It is important that the government extends its development programs such as
roads, bridges, and other economic facilities to rural areas, to make it easy for
goods and services and farm produce to move to and from the farming
communities.
With a bit of effort in the areas mentioned above, it won’t take long to see real
improvements
in
the
living
conditions
of
the
community.
Conclusion
Poverty, is wide spread and it cannot finish until something is done about it, this
paper tried to explain the concept of poverty and has shown what remedies can be
put in place in order to alleviate it. It is therefore important that many countries try
to uphold and come up with as many strategies as possible so that poverty will one
be eventually eradicated.
References
Craig, David; Doug Porter (2003). "Poverty Reduction Strategy Papers: A New
Convergence". World Development
Dijkstra, Geske (2011). "The PRSP Approach and the Illusion of Improved Aid
Effectiveness: Lessons from Bolivia, Honduras and Nicaragua". Development
Policy Review.
Driscoll, Ruth; Alison Evans (2005). "Second-Generation Poverty Reduction
Strategies: New Opportunities and Emerging Issues". Development Policy
Review.
Nyasulu, G. (2010). Revisiting
SustainableDevelopment in Africa
The
Definition
Of
Poverty.
Journal
of
Lazarus, Joel (2008). "Participation in Poverty Reduction Strategy Papers:
reviewing the past, assessing the present and predicting the future". Third
World Quarterly
Mat Zin, R. (2011). Poverty and Income Distribution in Rajah Rasiah. Malaysian
Economy: Unfolding Growth and Social Change . Oxford University Press. 213-24.
Seshamani, Venkatesh (March 2005). "The same old wine in the some old
bottle? Content, process and donor conditionalities of the PRSP"
Kamruzzaman, Palash (2009). "Poverty Reduction Strategy Papers and the
rhetoric of participation". Development in Practice
Williamson, D. L., & Reutter, L. (1999). Defining And Measuring Poverty: Implications For The
Health Of Canadians. Health Promotion International
World Bank. (2011). Countries & Regions