Economic Growth and Development
Economic Growth and Development
The Production Possibilities Curve of a Third World Country
Robert C. Graham,
Economics studies the process by which scarce resources are
allocated. Therefore, scarcity of resources is the most fundamental concept in
economics. However, given the relative abundance of commodities available in
the
Tell the class that they represent the government of a third world country. The country is characterized by a command economy and a high rate of population growth. The country's production possibilities curve looks as follows:
Figure 19‑1
Since the country has a command economy, it is up to the class to choose the combination of commodities that will be produced in the economy. However, their choices will be limited to either point A or point B on the production possibilities curve. Remind the students that in making their choices they need to take into account that consumer commodities include the food necessary to feed the people of the country, while capital commodities represent a resource which can shift the production possibilities curve outward in subsequent years. Inform students that by choosing point B the quantity of capital commodities produced is just sufficient to replace the machinery and equipment that wears out; therefore, no economic growth will occur. On the other hand, if point A is chosen, the amount of capital commodities produced is sufficient to shift the production possibilities curve to the dashed line in the following diagram.
Figure 19‑2
The students must now decide which combination of commodities to produce, the combination represented by point A or by point B.
One last thing to note, however, is the cost of a wrong decision. It is possible that a wrong choice of output combinations will result in the removal of our government from power, and, perhaps, in imprisonment.
It is now time to take a vote among students. First ask the students who have chosen point A the reason for their choice, which will be the economic growth for next year. Explain that the economic growth is great, but unfortunately people are starving this year because insufficient consumer commodities have been produced. As a consequence, they will be removed from office and imprisoned.
Now ask the students who have chosen point B the reason for their choice. They will respond with the comment that they wanted to produce enough food for the population. Explain that the concern for food production this year is great, but unfortunately people will be starving next year due to insufficient economic growth. As a consequence, they will be removed from office and imprisoned.
Typically
students will now want some choice between point A and B. Reply that such a
combination will result in some starvation both this year and next year. The
problem for this country is that it needs both CB in
consumer commodities and KA in capital commodities to provide for
both this year and next year. However, this combination of commodities is
unobtainable (outside of the curve) due to scarcity of resources. Therefore, in
this illustration, the scarcity of resources is such that there is no best
answer; starvation will always occur.
This illustration can also be used as a springboard for discussion of foreign aid or loans. It is only with this type of assistance from another country that the constraint imposed by scarcity can be overcome.
Economic Growth and the Capital‑Consumption Tradeoff
Thomas Wyrick,
The production possibilities model is often used to examine the rationale for investing in capital goods. If a nation forgoes consumption goods now, it can accumulate a larger capital stock and thereby experience more rapid economic growth than was previously possible. The higher rate of growth ultimately permits a higher level of consumption than was achievable along the original production possibilities frontier.
Not being national policy makers, some students do not identify with this example and eventually forget the underlying message about the tradeoff between present and future consumption.
The principle is more memorable if applied to something in the students' own experience. At one point or another, all students have decided to forego present consumption in order to invest in human capital, which they expect will increase their lifetime standards of living. Given their common experience, investments in human capital should be used to illustrate the tradeoff between present and future consumption before developing more complicated examples.
In Figure 19‑3, the decision maker allocates time between work and study. As one moves up the production possibilities curve from A to B, less time is available for earning an income so current consumption declines. However, the investment in human capital pushes the production (and consumption) possibilities curve outward over time, so, in the long run, consumption (at C) is far greater than would have been possible by following the no‑education alternative (A).
Figure 19‑3
Figure 19‑4 shows the relationship between academic degree and monthly earnings. Earnings are directly related to the level of education attained, which reflects the amount invested in human capital. Whether or not education is a wise investment requires a comparison between the additional earnings and the costs of acquiring more education, which goes beyond the limits of the production possibilities model.
Figure 19‑4
Foreign Investment and Capital Depletion
James S. Hanson
Professor of Economics
A frequent criticism of multinational corporations and banks which invest real capital or financial capital in third world nations is that nations are exploited through such activity because the corporations or banks repatriate in profits and principle much more than they initially invest.
To encourage my students to carefully analyze this contention I ask them to imagine that they have earned $5,000 in a summer job and deposit half of this in a bank savings account for use during the second semester. They deposit $2,500 and expect to withdraw $2,575 in six months (assuming simple interest at a 6 per cent annual rate). I then ask them if they would feel that as struggling college students they had "exploited" the rich, capitalist bank by taking out more than they had put in. They respond, of course, with sharp denial, pointing out that the bank probably earned a return greater than 6 per cent by investing their funds for the six months.
I conclude with a brief
review of net present value analysis, showing that any investment with a net
present value greater than zero requires that the future return flow exceed the
initial investment. The key point is that
both parties expect the investment to be a "positive sum game" in
which the borrower gains enough from the use of funds to repay the loan or
investment with interest and still retain net benefits. This applies to third world loans or the more
recent Japanese investments in the
Foreign Aid: Who Really Provides?
James S. Hanson,
Aid donors are criticized because private firms within their
own country often benefit from the resulting export contracts. I ask students to consider an
alternative. Suppose that the
This exercise does not support the tying of aid to purchases
within the donor country, a practice which reduces the real value of aid to the
recipient and often distorts development.
The point is that foreign assistance is not "really" given by
the formal donor unless or until actual products or services leave the donor
country with no imports flowing back in exchange.
Why is
Population Growth in the
J. Michael Swint, The
University of
To partially explain the behavior of the leaders of some third world countries who encourage high rates of population growth in their countries (and accuse the West of racial bigotry):
a. GDP = f(L, K, technology, etc.) and L = g(population). There is evidence that at least over the short‑to‑medium run GDP is a positive function of population growth.
b. The growth rate in GDP/POP roughly equals the net rate of investment divided by the incremental capital‑output ratio, with the percent growth in population then subtracted from that fraction. Thus GDP/POP, except in unusual circumstances, is negatively influenced by population growth.
GDP simply represents economic growth and is a better gauge of political and military power of a country internationally than GDP/POP. Per Capita Gross Domestic Product is a better measure of social economic development, i.e., more closely related to the welfare of the population than is GDP. Thus the motivations of those favoring continuing high population growth may not be fully inspired by the desire for improvements in the welfare of the populace.
Investment Distortions in Developing Countries
J. Michael Swint, The
University of
Even where there is little investment risk in developing countries, the local government often tends to operate with a higher necessary internal rate of return required for investments‑‑including situations where there is not an abundance of attractive projects. This in part can be explained by considering one component of the social discount rage (the standard to which the internal rate of return (IRR) is compared for project approval)‑‑the social time rate of preference (STP). This reflects society's impatience to have commodities now rather than later, and this impatience will reflect the personal "costs" of postponement. In societies where a large portion of the population lives at the subsistence margin, postponement means greatly increased mortality rates, and the STP is very high. Thus the social discount rate, comprised of the STP and the social opportunity cost of capital, is driven upward as a standard which the IRR must exceed for project approval.
The
Problem of
James Angresano, Hampden‑Sydney College
Most students are inclined to assume that all nations, including the underdeveloped countries, can experience economic growth and development by emulating our strategies and institutions. To dispel this misconception I ask students to list a few factors that contributed to our own successful development efforts.
Their list usually includes: favorable climate; an abundance and variety of natural resources; low population density with frontiers to absorb excess population; a stable, honest system of government; an immigrant labor force eager to work for modest wages; the establishment of land‑grant institutions of higher learning (which contributed to the development of technology suitable for our own particular resource development); and an absence of foreign influence in the form of a colonial power imposing its rules and technology upon us.
I then emphasize that all of these factors have been absent in nearly every underdeveloped nation, putting these countries at a significant disadvantage. Students generally understand at this point that the third world nations cannot simply realize economic development and cultural change by emulating our own methods.
A Dilemma
for
Scott Brunger,
Imagine
you are a college student in the
Your country has been independent since 1960. Since then, it has experienced three military revolts. Most educated people work for the government. Some big foreign companies are setting up business and employing college graduates at starting salaries of U.S. $6,000 per year. The minimum wage is 40 cents per hour. You know life is better in North America, Europe, and Japan. The best things you buy come from there. Your favorite T.V. program is "Dallas."
Question: How would you explain why your country is poor?
Ralph T. Byrns
One way to induce students to learn the Rule of 72 is to apply it to business situations. For example, if you suggest that this is a way to compute how long it takes a bank account to double if the compounded interest rate is fixed, business students especially are prone to learn this rule. We also suggest that they learn the formula for the relationships between rates of return, annuities, and prices (P = A/i, or PV = A/r) for much the same reason, and this does get students to learn how to use these formulas.
The Costs and Benefits of Growth
Ralph T. Byrns
Discuss the pros and cons of economic growth with your class. Among the benefits of development are the eradication of poverty, illiteracy, and health problems that are almost unknown in the developed countries. If there is growth in per capita GDP, longevity expands and the income distribution tends to become somewhat more equal. Growth also seems to induce political stability. The costs of growth include environmental pollution, urban congestion, alienation and the breakdowns of families.
Ralph T. Byrns
Many countries that seek more rapid development, including even China and the USSR, appear to increasingly rely on elements of the market system and international trade for sources of economic development. Discuss with students why how China under Deng, the USSR under Gorbachev, and numerous countries in Africa and Asia have diverged from the largely socialist paths they pursued for decades in their quest for growth and development. Were desires to reshape human nature (e.g., Mao Zedong) doomed to failure? The work of P.T. Bauer is directed at the importance of the development of markets on the path for development, and may be of interest if you want to extend this lecture.
Price Formation in Developing Countries
Eduardo F. Goldszal,
Students of macroeconomics learn from the neoclassical
theory that one of the effects of a decline in the aggregate demand is a
decrease in the price level. And that
prices are determined by the relationship between demand and supply. Although, when we demonstrate some practical
examples for many developing countries, in particular Latin American countries
with historically high rates of inflation, we may find that the juxtaposition
of demand and supply curves inadequate in explaining price formation for those
countries. For instance, in
Real GDP per capita, and Index
of Inflation in
_________________________________________________________________
Years Dollar GDP Per Capita Index Of Inflation
(1980 Prices) (CPI)
_________________________________________________________________
1981 1,908 100
1982 1,879 101.2
1983 1,787 176.8
1984 1,844 207.5
_________________________________________________________________
Source: Baer, W.,
1989, The Brazilian Economy (
Table 19-1
The
expected result would then be a fall in the inflation rate due to a decline in
the aggregate demand. But in fact, the
inflation rate, as measured by the CPI, rose 1.2 percent in 1982, about 75
percent in 1983, and more than 17 percent in 1984. So, is the neoclassical supply and demand
mechanism of price formation inappropriate in explaining this real world
example? Because the neoclassical
analysis presupposes the formation of prices through the market mechanism, this
answer shall be in the positive. Unlike
competitive systems,