Economics of Development June 2004 Worked Answers
Question 1 (data response)
(a) What is the difference between economic development and economic growth?
Economic development is a much broader term than economic growth. Economic growth refers to the annual increase year on year of real income/output, the rate at which the level of economic activity is changing. Economic development encompasses the progress of social conditions and the average quality of life as well as the rate and sustainability of growth within the economy.
(b) (i) Relatively low HDI values are usually related to low GDP per head. From the countries shown in Table 1, identify the two countries which least support this relationship. Explain your choices.
Gambia has the third lowest HDI but the second highest GDP per head out of the 8 economies listed. Yemen has the third lowest GDP per head and yet the second highest HDI. All the other economies rank in the same order based on GDP per head or HDI.
(ii) Yemen and Chad have a similar GDP per head. Explain possible reasons why their HDI values are substantially different.
HDI also includes life expectancy, adult literacy rates and education enrolment. For the HDI of Yemen to be 30% higher than Chad when GDP per head is very similar other measures must be higher or the GDP be more equally distributed in Yemen. Life expectancy indicates the health care, so it is possible the health care in Yemen is better than that in Chad. Higher literacy and education enrolment rates indicate that education is better and more available in Yemen than in Chad, or a combination of both better education and health care. This might be due to different government priorities (military spending or the inefficient allocation of resources through corruption).
Note a technique point here to discuss HDI rather than just a point on education and a point on health to get the full four marks.
(c) Compare ways in which the HDI and HPI-1 are measured.
Both measures share the same three components. The HDI is a positive measure of what has been achieved such as adult literacy rates for the knowledge component, whereas the HPI-1 is a negative measure of what is still left to achieve, using adult illiteracy rates to measure knowledge.
Longevity is measured by the chance of surviving to 40 in the HPI-1 whereas the HDI uses the (average) life expectancy at birth to determine longevity, the latter figure more likely to be skewed by extreme values than the former.
The final component used to measure the standard of living is significantly different in the recent HPI-1 figure. The HDI uses GDP per head, typically a PPP rate in US dollars, though this figure does not take into account distribution or proportion of population living in poverty.
The HPI-1 uses two figures to give an idea of the distribution of income and the standard of living and access to basic necessities and infrastructure.
(d) Discuss whether rapid industrialisation will necessarily increase a country‘s level of economic development.
Definitions
- Industrialisation is the increase in the size of the secondary industry or manufacturing sector within an economy.
- Economic development is a sustained rise in economic welfare or living standards achieved through growth of GDP and an equitable distribution of income.
Positive effects of rapid industrialisation
- Employment growth creating a multiplier effect and stimulating economic activity so creating economic growth which is part of economic development to create a better quality of life.
- Attracting FDI to transfer technology and create further multiplier effects further increasing growth.
- Creation of an export potential which can be used to pay for necessary imports or debt servicing.
- Rise in tax revenues creating scope for increased government expenditure investing in infrastructure, health and education services.
- Removal of the over dependency on agriculture and primary industries broadening the economic base of the economy.
Negative effects of rapid industrialisation
- The creation of an urban bias causes rural areas to suffer and creates economic stagnation slowing development as the term includes all citizens in the economy.
- Unsustainable growth created by negative externalities abusing resources of an economy.
- Inappropriate technology transfer lessening employment gains from FDI or imported technology.
- Unequal distribution of income between urban/rural areas created which works against development, part of the definition of which is equality.
Note a technique point here that continuous prose is not necessary and points can be made in bullets in the exam. There are no marks for a conclusion in this question, instead link points to the definition of development.
Question 2
(a) Explain why primary producers in developing countries face fluctuating prices for their exports. [10]
- Talk about the long run decline in prices as technology causes supply to increase at a faster rate than global demand increases, leading to a fall in food prices (with diagram).
- Fluctuations in prices caused by large fluctuations of supply year-on-year as farmer’s don’t know how good their harvest will be in advance.
- Policies to correct fluctuations (buffer stocks, cartels) are hard to get to work. In a cartel there is always the temptation to cheat and in a buffer stock scheme often a price that is too high is set which creates an expensive surplus in the long run, so not removing the turbulence.
- The solution to remove the turbulence then is to diversify and widen the economic base within the economy so fluctuations in the price of a single good do not have such a great impact on the economy.
(b) Agricultural engineers from the United Nations are currently involved in the introduction of labour-saving technology in farming in Kenya. Discuss whether such a policy may or may not be appropriate in developing countries.
How agriculture supports industrialisation
- The releasing of labour from agricultural work to industrial work.
- The rechanelling of other resources (like land) as farming becomes more efficient.
- Feeding the workers working in the industrial sector. Those workers left in agriculture are more productive so will receive a higher income, saving more of their income and allowing more funds to be available for investment.
- UN investment allows agriculture to play it’s role in development, removing the urban bias typical in planned economies.
Problems with industrialisation
- Employment opportunities are not maximised, so causing a worse distribution of income, counter to the goals of development.
Concluding remarks
- Agriculture is expected to play a role but in a centrally planned economy is given little investment to perform this role, meaning the planned increase in productivity is not delivered. Therefore to allow agriculture to play it’s role investment is needed, and
Question 3
(a) Explain how the World Bank seeks to promote economic development. [10]
Economic development is a sustained rise in economic welfare or living standards achieved through growth of GDP and an equitable distribution of income.
The World Bank categorises the development of economies by their GDP per capita income. Economies with low per capita incomes are likely to have a low savings ratio which means funds for investment are very scarce. Alternative finance is available from multinational firms in the form of Foreign Direct Investment, aid or loans.
The World Bank is an organisation that gives aid and loans for long term development projects with merit good characteristics and external economies of scale (investments that lower costs for subsequent firms investing in the area or market) such as infrastructure, education and health care. Conditions are imposed on the money given which include structural adjustment and a commitment to good governance.
Structural adjustment means establishing or improving the market system within an economy to bring about greater allocative and productive efficiency. This is likely to include the removal of state marketing boards, protectionist measures and the privatisation of many state industries. The liberalisation of prices and deregulation of markets increases competition and encourages investment.
The abolition of marketing boards is likely to cause a large increase in prices of essential food products which has the potential to cause high inflationary pressures. To combat this a tight monetary and fiscal policy must be implemented though this must be balanced given the likely desperate need for investment in health, infrastructure and education.
Centrally planned economies suppress entrepreneurship by allocating funds for investment to firms other than those with the highest projected rates of return and blocking export markets. The conditions imposed on loans by the World Bank aim to make sure the funds are used efficiently and mis-allocated through corruption or urban bias.
(b) Discuss whether international institutions such as the World Bank, make a positive contribution to economic development. [15]
How a positive contribution is made
- The IMF has a slightly different role (gives loans for the short term) but has the same conditions attached to loans&emdash;of a commitment to good governance and the establishment of market systems within the economy.
- The WTO aims to promote free trade by getting economies to agree on the removal of trade barriers and on supervising existing arrangements with the power to impose penalties. The adoption of free trade (removal of protectionist policies) is part of the conditions set down by the World Bank and IMF for a loan or aid to be given.
Limitations to the positive contribution
- Market failures mean the movement towards a market–based economy allows a sub-optimal allocation of resources (externalities, market dominance etc.)
- Lower government spending is required as part of tight the tight fiscal policy used to keep inflation under control but this means cutting investment in health care, education and infrastructure—contrary to the definition of development.
- Hypocrisy of developed economies promoting free trade whil the West practises protectionist policies.
- Problems of unequal trade meaning the benefits of trade are not equally distributed and comparative advantage cannot be effectively executed.
Concluding remarks
- A market–friendly approach involves the use of market systems with government intervention to correct market failure (the under consumption of merit goods, for example).
- The criteria for loans encourage the creation of a climate healthy for development—the removal of corruption and reduction in bureaucracy.
- There are still problems with the negative criteria, the existence of unequal and ‘unfair’ trade.
Question 4
(a)Explain two major obstacles to economic development afced by developing countries. [10]
Definitions
- Economic development is a sustained rise in economic welfare achieved through growth of GDP and an equitable distribution of income.
- Development is a broader term including, of which economic development is one characteristic. Development is more generally about the improvement in the quality of life which includes non-economic factors.
Two obstacles to economic development
- The lack of domestic savings for investment in developing economies and other sources of funds for investment are imperfect. Borrowing has an opportunity cost associated and a risk if re-payments become too large to handle. The Harrod-Domar model of development notes the necessity of a high savings ratio and productive investment for self-fuelling growth to lead to development.
- Reliance on a narrow economic base, the downward trend of primary prices in the long run and turbulent nature of prices in the short run.
(b) Discuss whether economic development should be left soley to the operation of market forces. [15]
Definitions
- ‘Market forces’ are supply and demand. There is a price mechanism to allocate resources at a level where the market clears, where supply equals demand. The price is a signal which shows the strength of demand relative to supply, demonstrating scarcity and so acting as an incentive for production. In a liberalised market prices would be unregulated to create competition in a (large) private sector.
The market system in the context of developing economies
- Efficient allocation is very important due to the extreme scarcity of funds for investment because of the large number of alternative uses and the limit on the absolute volume.
Limitations of the market system in the context of developing economies
- Inappropriate distribution of income that might result does not tie in with the definition we have for development.
- Sustainable development means care needs to be taken over the environment, where externalities might be overlooked while aiming soley toward development.
- Underconsumption of merit goods due to information failure, in particular education and health. Market systems need to be established throughout the economy, not just in urban areas.
Concluding remarks
- The adoption of a market friendly approach, which in the words of the World Bank means ‘allowing markets to do what markets do best, but intervening where the market cannot cope.’