ECONOMIC DEVELOPMENT



Economic Development 324
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The term "economic development" is widely used by the ordinary public and the popular media. The concept, however, is not quite as well understood as its frequent use may suggest. First one must realize that the term "economic development" in one form or another keeps surfacing in the popular media. Instances of economic miracles (reflecting favorable effects of economic development) regularly make headlines. Japan was in ruins after World War II. Within 30 years, Japan emerged as an economic superpower and one of two main economic rivals of the United States (Germany being the other). Similarly, South Korea's economic situation was widely regarded as hopeless after the devastation of the Korean War, but it too has turned into another Asian economic miracle—South Korea now challenges Japan for a share of the export markets in the United States and other countries. The economies of Taiwan and Hong Kong are in such great shape that even mainland China (the country they were once part of) views them with great respect. Malaysia and Singapore are also cited as examples of economic success stories. Malaysia had only half of the per capita income of Chile as recently as 1963; only 25 years later Malaysia had caught up to Chile. While these success stories have grabbed public attention, one must also notice that many Asian, African, and Latin American economies continue to languish in utter poverty. Moreover, the financial crises of the late 1990s in many Asian countries, formerly considered miracle economies, have added a note of caution in judging economic development successes too fast. After all, Brazil's early development promise failed to materialize.

While referring to underdeveloped countries many different terms are used. The terms used are intended to describe the stage of development of these countries in comparison to those that are more developed. As a result, the terms used are almost always in pairs. The most dramatic way of referring to the two sets of countries is to make a distinction between backward and advanced economies, or between traditional and modern economies. As the term "backward" carries a negative connotation, it is rarely used these days. It is much more popular to put all countries of the world on a continuum based on the degree of economic development. Using this criterion, several pairs of terms are employed in distinguishing countries with different degrees of economic development—developed and underdeveloped countries, more developed and less developed countries (the latter are often simply referred to as LDCs), developing and developed economies. As the terms "less developed countries" and "developing countries" embody a sense of optimism, their use has become commonplace. Developed countries are also referred to as industrialized countries. Countries that have recently developed are referred to as the newly industrialized economies.

The distinction among economies is also made based simply on income levels, where income is expressed in per capita terms. Based on the income criterion, countries have been classified into poor and rich economies. The World Bank has further refined this division by categorizing poorer countries into low income (less than $675 in per capita income in 1992) and middle income (per capita income between $675 and $8,000 in 1992) economies. Countries with per capita income greater than $8,000, mostly members of the Organisation for Economic Co-operation and Development (OECD), are dubbed as high income or industrialized countries. A third category consists of five developing countries (Oman, Libya, Saudi Arabia, Kuwait, and the United Arab Emirates) that have relatively high per capita income (in the $6,000 to $22,000 range in 1992), but have economies that are more traditional than industrialized. These economies are referred to by the World Bank as the "capital-surplus oil exporters." Three other economies—Israel, Singapore, and Hong Kong—are also considered developing countries despite per capita incomes of more than $13,000 in 1992. Finally, developed or industrialized economies themselves are subdivided into market economies (capitalist economies of the West) and non-market economies (communist or centrally planned economies of Eastern Europe). The latter distinction is now largely irrelevant as Russia and countries in Eastern Europe are all following the capitalist route to economic development. These economies are referred to in the popular media as belonging to a new category called "transitional economies."

ECONOMIC DEVELOPMENT AND
ECONOMIC GROWTH

As one can see, labels used to distinguish between economically developed and developing countries vary quite a bit. The terms used to describe the economic development process itself, however, are much more rigorously defined. For example, while the terms "economic growth" and "economic development" are often used interchangeably, there is an important distinction between these two terms. The term "economic growth" refers to an increase (or growth) in real national income or product expressed usually as per capita income. National income or product itself is commonly expressed in terms of a measure of the aggregate output of the economy called gross national product (GNP). Per capita income then is simply gross national product divided by the population of the country. When the GNP of a nation rises, whatever the means of achieving the outcome, economists refer to it as a rise in economic growth. The term "economic development," on the other hand, implies much more. This can best be illustrated with the help of an example. If we look at the developments in South Korea and Libya since 1960, we discover fundamentally different situations. Both these countries experienced a huge rise in the real per capita income, but the reasons for the increases are vastly different. Libya's increased per capita income resulted from the discovery of crude oil reserves; Libya harvested these oil resources with the help of foreign corporations that were largely staffed by foreign technicians. Libya thus produced a single product of great importance that was exported mainly to the United States and Western Europe. While Libyans (both the government and people) received large incomes from selling oil, they did not play a major role in producing that income—income that increased based on a windfall gain.

Economists do not usually consider Libya's increased per capita income as an instance of economic development. "Economic development" embodies a greater number of characteristics than a rise in per capita income alone—it implies certain fundamental changes in the structure of the national economy. South Korea provides an example of a country that has experienced economic development. The South Korean economy has also undergone a large increase in its per capita income. In addition, it has witnessed some important structural changes. Two of the most important changes taking place in South Korea are: (1) A rising share of industry in the total national output (the real gross national product) and the accompanying falling share of the agricultural sector in GNP; (2) An increasing percentage of the total population of South Korea living in cities rather than in the countryside. Aside from these two fundamental changes, a nation undergoing economic development goes through a number of additional changes. The demographic composition of the population (age groups that comprise the total population) changes as economic development progresses. Consumption patterns of individuals also change—people no longer have to spend the majority of their income on food and other necessities. Instead, they spend a small fraction of their income on necessities and the remaining large fraction on consumer durables and items that pertain to leisure activities.

A key characteristic of economic development is that the people substantially participate in the development process and in changing the fundamental structure of the economy. While some foreign involvement is generally inevitable, for economic growth to be described as economic development, the people of the country must participate not only in the enjoyment of benefits from the rise in per capita income, but also in the production process itself. Moreover, economic growth must confer benefits on a broad group of individuals—if it benefits only a small minority, it is not deemed as economic development. It should be noted that while much more is implied by economic development than economic growth, there can be no economic development without economic growth (that is, a rise in the real per capita income).

THE ROLE OF SCIENCE AND
INNOVATION IN ECONOMIC
DEVELOPMENT

Perhaps the most important prerequisite of economic development is the aspiring nation's access to the discoveries of modern science and innovators to adapt these discoveries to the needs of marketplace. It would be impossible to imagine the mighty industrial economies of the 20th century in the absence of the technological knowledge arising out of many fields such as physics, chemistry, and biology. A large majority of products used today did not exist before the advent of modern science. While modern science is considered absolutely crucial for the economic development of a nation, no country today is fully cut off from the main fruits of science. Even the poorest developing economies have access to the scientific knowledge, while fruits of scientific discoveries are often embodied in many domestically produced goods (some of them exported to more advanced countries). While developing countries do not have to rediscover the basic laws of thermodynamics, they do have to convert the scientific discoveries into products and processes; such successful conversions are called innovations. The latter task is often more difficult than discoveries of pure science. Thus, as an alternative to internal innovations, developing countries may be able to copy others' innovations or collaborate to learn from those that have succeeded in converting scientific discoveries into desirable products or processes. In fact, technology transfer has become an important aspect of the quest for development. As the latest technology also tends to be more efficient and productive, developing countries attempt to borrow these in some fashion. Many of the latest innovations come with patent rights, and thus the innovators of these products or processes must consent. As a consequence of this constraint, developing countries have resorted to the use of the joint venture, in which a firm from a developing country collaborates with a firm from an advanced country in a production process involving advanced (and sometimes not so advanced) technology.

While scientific knowledge is important for economic development, many economists assume that most developing countries have access to basic scientific discoveries. Further, while most economists believe that a nation's failure to achieve economic development is mainly the result of economic forces within the country, both economic and non-economic barriers exist to economic development.

ECONOMIC BARRIERS TO DEVELOPMENT

Different models of economic growth and development reveal that capital formation is an important vehicle of economic development. Capital formation essentially refers to an accumulation of capital resources that are used in the process of production (such as machines, plants, equipment, buildings, etc.). Of course, capital assets will also embody technology. Sometimes, capital formation itself can be considered to have two components: non-human and human capital. A machine or a factory shed is an example of non-human capital. Human capital formation takes the form of education and training of individuals. Both human and non-human capital formations are important as they both increase productivity and lead to economic growth. Moreover, a non-human capital asset embodying an advanced technology also requires a better-trained human operator of the machine. The view that capital formation was central to economic growth, called capital fundamentalism, was reflected in the development strategies and plans of many countries over decades. Thus, the solution to the problem of economic development was viewed primarily as securing enough investment funds to generate a certain targeted rate of economic growth.

Capital formation is essentially based on two factors: generating the desired level of savings and converting them into investment in capital equipment (and/or human capital formation). When savings from domestic sources were deemed inadequate to generate the targeted rate of economic growth, foreign aid donors were approached. Foreign aid and developmental assistance from advanced industrialized countries in the 1950s and 1960s were justified by the need to fill the savings gap. During those days, capital shortage in developing countries was considered the single most important barrier to economic growth and development. A heavy emphasis was put particularly on designing economic development plans that embodied this point of view. Pakistan's third five-year plan in the early 1960s, for example, showed a heavy initial requirement of capital and a consequent need for an inflow of foreign capital (in the form of foreign aid). It was believed that a large initial injection of foreign aid would spur additional domestic savings, ultimately reducing the foreign aid requirement in the long run.

It is now widely recognized that abundance of savings and capital formation are not adequate to guarantee an accelerated pace of economic development, in particular when capital is deployed in low-productivity projects. There are many examples of capital being employed in an improper manner. Examples include the large-scale showcase steel mills and thousands of small inefficient hydroelectric plants. Moreover, investment projects financed by foreign savings, even if highly productive, may have little effect on economic growth if the recipient country's policies are not well suited to capture a fair share of returns from these projects. Indeed, such was the experience of several natural-resource-rich countries before the mid-1960s. These countries had little to show at the end from major foreign investment projects.

The crucial role of savings and investments in generating economic growth has been well established in developed industrial economies. Based on one estimate, more than 50 percent of the growth in aggregate income of nine developed countries during 1960-1975 was due to an expansion in the physical capital inputs alone. Many now believe that the very low investment rate during the 1970s and early 1980s in the United States was the primary reason for the low U.S. per capita income growth since 1970, relative to the per capita income growth in Japan and Western Europe.

While capital formation is no longer viewed as the ultimate instrument of economic development in poorer countries, it is nevertheless recognized that even a mildly robust pace of economic growth cannot be maintained over a long time until these countries invest a sizable fraction of their gross national product. At the very minimum the investment rate (the fraction of gross national product invested) should be 15 percent and in some cases it may be required to go as high as 25 percent. The 15-25 percentage interval provides a range of likely requirements—the actual investment rate would depend upon the environment in which capital formation takes place and the desired rate of economic growth. Of course, the desired growth rate is generally based on the development experience of other countries. Average rate of per capita income growth in middle-income countries from 1965 to 1983 was about 3.5 percent. If developing countries desire to match the per capita income growth experienced by the middle-income countries in the post-1965 period, their per capita income will have to grow at the rate of at least 6 percent per year, given that the average rate of population growth in less developed countries is about 2.5 percent.

EXPORT-LED ECONOMIC GROWTH

Many low- and middle-income countries have attempted to use foreign trade, rather than foreign aid, as a vehicle of economic growth. Favoring different types of exports and imports, however, lead to different outcomes for economic growth. One such strategy is to utilize exports of primary goods (agricultural products and raw materials) to spur economic growth, often called primary-export-led growth. Even now, exports of food and raw materials remain principal means by which many developing countries generate resources to import capital equipment and other necessary inputs that are essential for development goals. However, dependence on primary exports as a vehicle of economic development is viewed as an option fraught with difficulty.

Many third-world leaders and some economists since the late 1950s have argued that primary exports (except petroleum) cannot be used as an effective vehicle of economic growth. This belief is based on several factors. First, markets for primary products grow very slowly and, as a result, exports of primary products grow slowly. There is an intrinsic reason for the slow growth in markets for primary products—the elasticity of demand for foods is probably less than one-half. This implies that if there is a ten percent increase in income of an advanced nation, its food requirements grow by less than five percent. Thus, imports of foods (and other primary products) would lag behind income growth in industrialized countries. Second, prices received for primary exports are relatively unfavorable. This implies that prices received for these goods will fall on world markets, relative to prices paid for manufactured products imported from industrialized nations by developing countries. Finally, export earnings from primary exports are not stable. The fluctuations in export earnings may be due to unstable demand for the product, supply of the product, or both.

For the preceding reasons, dependence on primary exports is not preferred by developing countries. More and more developing countries are attempting to export manufactured products to developed nations. In most cases, these manufactured products do not embody the highest level of technology. Efforts of China and India provide examples of this change in emphasis. It should be noted that manufactured big-ticket items (embodying high technology) are still exported by advanced countries. Thus, while China may export toys and Taiwan may export assembled televisions and radios, the United States still exports airplanes. Nevertheless, exporting manufactured products has spurred economic development in many developing countries, especially in smaller economies such as Singapore, Taiwan, and South Korea. More and more nations are using an export-led approach to economic development.

NON-ECONOMIC BARRIERS TO
ECONOMIC DEVELOPMENT

In eyes of most economists, there is no single economic barrier to development that can explain why so few countries were able to initiate economic growth prior to the 20th century. While savings rates in many of these countries were too low to finance investments necessary to achieve economic development, the important question then remains as to why the savings rates were low. Poverty alone cannot account for low savings rates—some poor countries in the late Ithh century, such as Japan, were able to generate large amounts of savings needed for growth. Japan's success in mobilizing large amounts of savings was partly due to a strong governmental structure that helped extract a surplus through taxation. Thus, economic explanations alone cannot account for why particular economic barriers exist and non-economic barriers need to be considered.

POLITICAL AND GOVERNMENTAL BARRIERS.

Governments and political institutions play an important role in the economic development process even in capitalist countries. While early experiences with economic development, such as England's experience during the 18th century, did not involve a large role for government, the role played by the government has steadily increased in importance. At the current time, if a government is unable or unwilling to play an active role in the economic development process, then the government itself is considered an obstacle to economic development.

A government can foster economic development in many ways. First and foremost, governments must create and maintain a stable political environment and a climate of peace in which modern enterprises, private or public, can flourish. China's inability to initiate modern economic growth before 1949 is largely explained by prolonged instability connected with civil war and foreign invasions. After the creation of a stable political environment when Communists took power in 1949, economic growth began. Civil strife, tribal warfare, and political instability in several African countries have prevented them from embarking on a path of serious economic development.

A stable government in itself, however, is not enough. In most cases, colonial governments were able to provide political stability—often for a prolonged period. This was the case for India under British rule and Korea under Japanese rule. Nevertheless, very few European or Japanese colonies experienced significant economic development. The benefits of the stable environment under colonial rule mainly accrued to a small group of traders and investors from the colonizing nation. Moreover, ruling Colonial nations made no serious attempt at economic development through investment in training or through promotion of industries. Many colonial nations initiated economic development strategies after gaining independence. India provides such an example. After gaining independence from the British in 1947, the Indian government started planning to develop the country in an organized way. While India is still relatively poor, it is one of a small group of countries, seven or so, that possess space technology.

It should also be noted that political independence does not necessarily imply that a sovereign government would pursue an active policy to promote economic development. The decisions to pursue economic development involve trade-offs—some people may become better off following economic development while others may become worse off. If political power is in the hands of those who will become worse off, the country's leaders may impede efforts towards economic development. In some instances, nations have pursued social goals rather than economic development. In Cuba during the 1960s, much effort was expended to redistribute income to benefit the poor and to improve education, rather than to promote economic development. Nevertheless, sooner or later, stable governments in developing countries are bound to pursue economic development.

SOCIAL BARRIERS.

Economic development rides on the shoulders of entrepreneurs who venture to do things that benefit them and the society. Whether or not a society has a sufficient number of entrepreneurs to foster modern economic growth may depend on the society's values and structure. Many of the developed nations of today encouraged entrepreneurs who pursued dreams in search of reaping potential profits from innovations. What has prevented the development of entrepreneurship in underdeveloped economies? Some believe that certain individuals in a traditional society are blocked from becoming entrepreneurs, which normally implies more social prestige, power, and wealth. These blocked minorities attempt to rise through entrepreneurship. However, it is difficult to establish a clear causal relationship between the blocked minorities and entrepreneurship. Perhaps more important than this relationship are the factors other than minority status that induce people to become entrepreneurs. David McClelland, a Harvard University psychologist, believes that the need for achievement is a factor—certain societies produce a high number of individuals with strong desire to improve themselves financially or to be recognized by the society for their achievements. The experience of Malaya provides a historical example that illustrates McClelland's premise. Malaya was a country rich in resources, but natives of Malaya—primarily fishermen and farmers comfortable with their lives—did not become entrepreneurs until the middle of the 20th century. Meanwhile, migrant Chinese mining workers who survived diseases such as malaria became entrepreneurs in Malaya. One interpretation of this episode is that the Chinese possessed a strong desire to rise and the Malays did not.

GOVERNMENT POLICIES AIMED AT
ECONOMIC DEVELOPMENT

Modern governments are playing an active role in promoting economic development, primarily within two categories. The first category includes communist and socialist governments that use a centralized planning process to promote growth. In a centrally planned economy, the government literally makes the consumption and savings decisions, channeling the surplus funds into investment to promote economic growth. The Soviet Union used such a centrally planned system after the Communists took power in 1917. While Russia no longer follows the central planning model, a few countries, such as China and Vietnam, still do.

The second category consists of governments that primarily believe in market economies, but play an active role in promoting economic development. These governments promote economic growth in many ways. One way of promoting growth is to make active use of monetary and fiscal policy to spur savings and investments. Fiscal policies are also used to provide tax incentives that are conducive to risk-taking and innovations. Some capitalist governments have an industrial policy in place—directly or indirectly the government supports a pattern of industrial development. Finally, a government may follow an active policy of promoting foreign trade.

[ Anandi P Sahu , Ph.D. ]

FURTHER READING:

Barro, Robert J. Determinants of Economic Growth: A Cross-Country Empirical Study. Boston, MA: MIT Press, 1998.

Gillis, Malcolm, Perkins, Dwight H., Roemer, Michael, and Donald R. Snodgrass. Economics of Development. 4th ed., New York: W. W. Norton & Company, 1996.

Todaro, Michael P. Economic Development. Reading, PA: Addison-Wesley Publishing Co, 1996.



Also read article about Economic Development from Wikipedia

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