Good government is one of the most important factors in economic growth and social well-being.
Economic Growth in Developing and Transitional Economies
(Part A)
by
Charles Lamson
Economic Development: Sources and Strategies
Economists have been trying to understand economic growth and development since Adam Smith and David Ricardo in the eighteenth and nineteenth centuries, but the study of development economics as it applies to the developing nations has a much shorter history. The geopolitical struggles that followed World War II brought increased attention to the developing nations and their economic problems. During this period, the new field of development economics asked simply: Why are some nations poor and others rich? If economists could understand the barriers to economic growth that prevent nations from developing and the prerequisites that would help them to develop, they could prescribe strategies for achieving economic advancement. The Sources of Economic Development Although a general theory of economic development applicable to all nations has not emerged and probably never will, some basic factors that limit a poor nation's economic growth have been suggested. These include insufficient capital formation, a shortage of human resources and entrepreneurial ability, a lack of social overhead capital, and the constraints imposed by a dependency on the already developed nations. Capital Formations One explanation for low levels of output in developing nations is insufficient quantities of necessary inputs. Developing nations have diverse resource endowments---Congo, for instance, is abundant in natural resources, while Bangladesh is resource-poor. Almost all developing nations have a scarcity of physical capital relative to other resources, especially labor. The small stock of physical capital (factories, machinery, farm equipment, and other productive capital) constrains labor's productivity and holds back national output. Nevertheless, citing capital shortages as the cause of low productivity does not explain much. We need to know why capital is in such short supply in developing countries. There are many explanations. One, the vicious-circle-of-poverty hypothesis, suggests that a poor nation must consume most of its income just to maintain its already low standard of living. Consuming most of national income implies limited saving, and this implies low levels of investment. Without investment, the capital stock does not grow, the income remains low, and the vicious circle is complete. Poverty becomes self-perpetuating.  The difficulty with the vicious-circle argument is that if it were true, no nation could ever develop. For example, Japanese GDP per capita at the turn of the century was well below that of many of today's developing nations. The vicious-circle argument fails to recognize that every nation has some surplus above consumption needs that is available for investment. Often the surplus is most visible in the conspicuous consumption habits of the nation's richest families. Poverty alone cannot explain capital shortages, and poverty is not necessarily self-perpetuating. In a developing economy, scarcity of capital may have more to do with the lack of incentives for citizens to save and invest productively than with any absolute scarcity of income available for capital accumulation. Many of the rich in developing countries invest their savings in Europe or in the United States instead of in their own country, which may have a riskier political climate. Savings transferred to the United States do not lead to physical capital growth in the developing countries. The term capital flight refers to the fact that both human capital and financial capital (domestic savings) leave developing countries in search of higher expected rates of return elsewhere or returns with less risk. In addition, government policies in the developing nations---including price ceilings, import controls, and even outright appropriation of private property---tend to discourage investment. Whatever the causes of capital shortages, it is clear that the absence of productive capital prevents income from rising in any economy. The availability of capital is a necessary, but not a sufficient, condition for economic growth. The third world landscape is littered with idle factories and abandoned machinery. Other ingredients are required to achieve economic progress. Human Resources and Entrepreneurial Ability Capital is not the only factor of production required to produce output. Labor is equally important. First of all, in order to be productive the workforce must be healthy. Disease today is the leading threat to development. Health and nutrition are essential to workforce development. Programs in nutrition and health can be seen as investments in human capital, which lead to increased productivity and higher incomes.  But health is not the only issue. To be productive the workforce must be educated and trained. The more familiar forms of human capital investment, including formal education and on-the-job training, are essential. Basic literacy, as well as specialized training and farm management, for example, can yield high returns to both the individual worker and the economy. Education has grown to become the largest category of government expenditure in many developing nations, in part because of the belief that human resources are the ultimate determinant of economic advance. Just as financial capital seeks the highest and safest return, so does human capital. Thousands of students from developing countries, many of whom were supported by their governments, graduate every year from U.S. colleges and universities as engineers, doctors, scientists, economists, and so forth. After graduation, these people face a difficult choice: to remain in the United States and earn a high salary or to return home and accept a job at a much lower salary. Many remain in the United States. This brain drain siphons off many of the most talented minds from developing countries. Innovative entrepreneurs who are willing to take risks are an essential human resource in any economy. In a developing Nation, new techniques of production rarely need to be invented, because they can usually be adapted from the technology already developed by the technologically advanced nations. However, entrepreneurs who are willing and able to organize and carry out economic activity appear to be in short supply. Family and political ties often seem to be more important than ability when it comes to securing positions of authority. Whatever the explanation: Development cannot proceed without human resources capable of initiating and managing economic activity. Social Overhead Capital Anyone who has spent time in a developing nation knows how difficult it can be to send a letter, make a local phone call, or travel within the country itself. Add to this problems with water supplies, frequent electrical power outages in the few areas where electricity is available and often ineffective mosquito and pest control, and you soon realize how deficient even the simplest, most basic government provided goods and services can be.  In any economy, third-world or otherwise, the government has considerable opportunity and responsibility for involvement where conditions encourage natural monopoly (as in the utilities industries) and where public goods (such as roads and pest control) must be provided. In a developing economy, the government must put emphasis on creating a basic infrastructure---roads, power generation, and irrigation systems. There are often good reasons why such projects, referred to as social-overhead capital, cannot successfully be undertaken by the private sector. First, many of these projects operate with economies of scale, which means they can be efficient only if they are very large. In that case, they may be too large for any private company or group of companies to carry out. Second, many socially useful projects cannot be undertaken by the private sector because there is no way for private agents to capture enough of the returns to make such projects profitable. This so-called free-rider problem is common in the economics of the developed world. Consider national defense: everyone in a country benefits from national defense, whether they have paid for it or not. Anyone who attempted to go into the private business of providing national defense would go broke. Why should I buy any national defense if your purchase of defense will also protect me? Why should you buy any if my purchase will also protect you? The governments of developing countries can do important and useful things to encourage development, but many of their efforts must be concentrated in areas that the private sector would never touch. If government action in these realms is not forthcoming, economic development may be curtailed by a lack of social overhead capital.  *CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 731-733* end |
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