Theme 4: Strategies influencing Growth and Development

Question 1

What are the 6 types of free market development strategies?

Answer 1

1. Trade liberalisation
2. Promotion of FDI
3. Removal of subsidies
4. Free floating exchange rates
5. Microfinance schemes
6. Privatisation

Question 2

What are 6 interventionalist strategies to encourage economic development

Answer 2

1. Education- improve human capital
2. Trade protection
3. Managed exchange rates
4. Infrastructure development
5. Global joint ventures
6. Buffer stock schemes

Question 3

What are the 3 other strategies for development?

Answer 3

1. Industrialisation
2. Fair trade schemes
3. Aid and debt relief

Question 4

Why might a country choose to follow protectionist trade?

Answer 4

Through a policy of import substitution, replacing imported goods with domestically produced goods in order to create jobs.

Question 5

What are the limitations to protectionist trade?

Answer 5

• May create jobs in the short run but in the long run output and growth of output will be lower than it would otherwise have been due to the lack of benefits gained from using comparative advantages and specialisation.
• Also leads to dynamic inefficiency as protected domestic firms have no incentive to reduce costs or improve products due to lack of competition.

Question 6

What are the limitations of using subsidies to improve economic growth?

Answer 6

1. Poorly targeted as rich households benefit as well as poorer households. Cash payments to poorer households may be a better way to target economic growth.
2. Ineffective The longer they are used and the larger the group that receives it is less likely that the subsidy will increase economic development.
3. Opportunity costs could be spent on education.
4. May be a source of corruption
5. Removal is very difficult

Question 7

How does the market based strategy of FDI influence development?

Answer 7

FDI can be promoted by lower corporation tax, subsidise MNCs.

FDI fills the savings gap and often results in a transfer of knowledge,

However FDI can result in exploitation and foreign companies taking far more from the investment than the country gets in benefits.

Can be counteracted by joint ventures

Question 8

How does the market based strategy of privatisation influence development?

Answer 8

Forces firms to cut average costs and give customers what they want to buy.

However, when firms are privatised as monopolies there are no competitive pressures, firms may profit-maximise at the expense of their product (creaming of markets) and corruption may lead to politicians selling companies below market value to friends.

Question 9

How does the market based strategy of trade liberalisation influence development?

Answer 9

Countries gain the benefits of specialisation and increased competition. Countries hope this will lead to export-led growth. However, short-term assistance to industries can be helpful to diversify away from commodities

Question 10

How does the market based strategy of exchange rates influence development?

Answer 10

With floating exchange rate systems, governments don’t need to intervene or worry about their gold and foreign currency reserves running out. Can lead to volatility, making it difficult for exporters and importers to make decisions, and large swings in macroeconomic variables due to changes in the exchange rate.

Question 11

How does the market based strategy of micro finance influence development?

Answer 11

Small loans at reasonable rates and opportunities to save are offered to individuals who couldn’t access the traditional financial system. Individuals can invest or set up businesses. May lead to debt and misspending, however loans are often given to groups such as villages and peer pressure encourages responsible.

Question 12

How does the interventionalist strategy of development of human capital influence development?

Answer 12

Development of human capital: raises productivity and can reduce unit labour costs, making the country more competitive.

Question 13

How does the interventionalist strategy of protectionism influence development?

Answer 13

Import substitution through tariffs, quotas and other trade barriers can create jobs in the short run but countries will likely lose out in the long run as they cannot specialise in their comparative advantage and lack of competition leads to dynamic inefficiency

Question 14

How does the interventionalist strategy of development of infrastructure influence development?

Answer 14

Infrastructure development: the government can build infrastructure such as schools and airports, increasing LRAS. The free market may under-provide quasi-public goods such as schools and roads. However, the government may not be cost-efficient at building infrastructure and infrastructure can fail due to being poorly built or maintained.

Question 15

How does the interventionalist strategy of exchange rates influence development?

Answer 15

Leads to exchange rate stability, making it easier for importers and exporters to make decisions. Tiered exchange rates can be set, e.g. high exchange rates for imports of essential / investment goods and low exchange rates for imports of consumer goods / exports. However, often lead to black markets and corruption

Question 16

How does the interventionalist strategy of promoting joint ventures with global companies influence development?

Answer 16

Governments insist that MNCs setting up firms in the country finds a local partner to jointly own the firm. This ensures that at least some of the profits remain in the country and there is some transfer of knowledge

Question 17

How does the interventionalist strategy of buffer stocks influence development?

Answer 17

Can reduce price volatility, encouraging investment and preventing poverty. Consumers can also benefit from lower volatility. However, a considerable amount of capital is needed to set them up and store the buffer stock, there is a free-rider problem disincentivising setting them up and if minimum prices are set too high, the scheme will be very expensive and likely result in failure and stocks being dumped onto the market.

Question 18

What are buffer stocks

Answer 18

Buffer stock schemes can stabilise commodity prices, encouraging investment and protecting export revenue A physical stock of the commodity is held in warehouses and is added to / reduced to maintain prices within a band.

Question 19

What are the advantages of buffer stocks

Answer 19

• Stabilise prices, encouraging investment.
• Prevents sharp falls in prices and resultant absolute poverty.
• Consumers benefit from lower price volatility.
• Buying at low cost and selling at high cost should yield a profit.

Question 20

What are the disadvantages of buffer stocks

Answer 20

1. Expensive to set them up, e.g. buying produce, administration, transport, storage, expiration.
2. Free rider problem - producers benefit from buffer stock schemes even if they do not contribute. Incentive to not pay for the scheme.
3. Maximum prices tend to be set too high which will lead to the government eventually running out of money and stocks being dumped onto the market

Question 21

What does the Lewis model predict?

Answer 21

The Lewis model predicts that development can be sustained through transferring marginal workers from agriculture (where their marginal productivity was 0) to urban industries such as manufacturing.

Developed countries have large service industries and very small agricultural industries; they’ve already gone through this process.

Question 22

What is a downside of the Lewis model?

Answer 22

However, forcing industrialisation often fails due to lack of adequate capital/skills, leading to a waste of scarce resources.

Marginal workers in cities can often have as low incomes and as high unemployment as rural workers. Migration to the town is likely a result of growth in incomes and growth in urban jobs rather than the other way round

Question 23

How does the general strategy of tourism impact development?

Answer 23

An income-elastic good. Developing tourism makes use of natural assets such as climate and landscapes, creates jobs that don’t require much education or training, and can lead to a significant multiplier effect if tourists buy local products. However, can lead to environmental degradation.

Question 24

How does the general strategy of Fairtrade schemes impact development?

Answer 24

Offer farmers a minimum price above market price for their goods and ensure workers are treated fairly and the environment is not degraded.

Guaranteed price makes long term planning easier.

However, this may cause overproduction of crops, flooding the market, and Fairtrade schemes cover a very small proportion of producers

Question 25

How does the general strategy of Aid impact development?

Answer 25

Foreign aid can fill the savings and trade gap.

However, governments may divert aid into their own interests, infrastructure projects can fail, unintended effects can occur such as subsidised food depressing local prices and discouraging local production and loans must be repaid with interest

Question 26

How does the general strategy of debt relief impact development?

Answer 26

Is where the debt of developing countries is written off. Debt can restrict growth by forcing governments to adopt fiscal austerity policies. Foreign creditors can strike off the debt, which is often extremely small compared to GDP due to inflation. Low cost to developed countries and great benefit to developing countries.

However, this creates a precedent and there is a moral hazard that governments may take on excessive debt expecting debt relief and it eases the pressure on governments to adopt appropriate economic policies and balance their budgets.