International Economic Development

International economic development must somehow find a way to bring world trade's zero-sum game to a close. The idea that someone gains only at someone else's expense makes the prospect of globalization far less appealing. Yet for better and for worse, that's exactly what happened from the sixteenth century onwards. We live today in one of two worlds — the developed and the developing — as a consequence. Such is the nature of seemingly intractable dilemmas economists specializing in development grapple with. Daily they ask themselves: How exactly can we ensure a more equitable sharing of wealth between countries and continents through the workings of competitive markets? Should developing countries invest in domestic or export industries? Is capital investment proper or the technological innovation it affords the true engine of growth? Must the agricultural poor seeking a better life make due indefinitely as subsistence-wage earners in nascent manufacturing industries to speed the domestic accumulation of capital? Can everyone win, albeit some perhaps more than others, without anyone necessarily losing?

Keywords Endogenous Growth Theory; Export Orientation; Harrod-Domar Model; Human Capital; Import Substitution; International Dependency Theory; International Monetary Fund; Lewis-Ranis-Fei Model of Surplus Labor; Neoclassical Growth Model; Neoclassical Theory; Purchasing Power; Rent-Seeking Behavior; Rowstow's Stages of Growth; Stabilization Policies; The World Bank

Economics > International Economic Development

Overview

Fairly or unfairly, wealth is unevenly distributed among people and places. Be it between classes, countries, or whole continents, the gulf between rich and poor goes as far back as recorded history itself. We live with its global consequences today. Some of us are fortunate to live in the twenty or so highly industrialized countries that collectively hold most of the world's wealth. The poverty endemic in the remaining hundred or so countries is so abject it must be seen first-hand to be believed. Yet it is all too real for billions of people who, until recently, had absolutely no hope of bettering themselves. That some now do is largely a planned outcome achieved by leveraging macroeconomic fundamentals to good effect. Greater aggregate output and the income it generates finances improved standards-of-living. This situation only happens in theory when all available labor, capital and land are actively utilized in the production of goods and services. Anything less than the 'full' employment of all these factors of production brings about scarcity; the root-cause of economic underdevelopment.

Economic Growth

Growth by definition involves going beyond existing limits. In macroeconomics, the boundaries being pushed outwards are the production possibility frontier and long-term aggregate supply. The first concept comes from microeconomics and refers to the range of maximum output of one good versus another in the short-run, when technology and capital remain unchanged. Aggregate economic growth entails the maximization of innumerable 'paired-goods' outputs in the long-run, however, it can also serve to demark the outer boundary of the trade-off in productive capacity between the manufacturing and agricultural sectors in general. The more capital and more efficient technology brought to bear over time in both sectors, the more the two's production possibilities frontiers expand. Aggregate supply and demand are macroeconomics concepts and manifest themselves in both the short and long-term. They differ however in one critical respect: Prices of some resources are assumed to be inflexible in the short term but flexible in the long-term. A price change in one resource, essentially, throws other, interdependent resources markets into temporary disequilibrium, for said rise signals an imbalance in supply and demand that must be redressed by the marketplace. Eventually, the full effect of a price change ripples through the economy as a whole and a general equilibrium reasserts itself. Whatever scarcity or surplus occasioned by the initial price change disappears. This is what is meant by price flexibility.

Trends in Economic Growth/Recession

What in theory seems a relatively straight forward distinction in practice, however, soon falls apart because there's widespread disagreement about the amount of time that must expire before the short-run turns into the long-run. Some say several months, others a year and still others several years. In the case of economic development in poor countries the more appropriate time span might be five to ten years. Then, too, maintaining general equilibrium at full employment for any length of time has proven next to impossible in 'have not' economies where 'variable' resources like labor and raw materials largely determine the extent of achievable productive capacity. Unlike more 'fixed' resources like capital and new technology, these factors of production can change fairly quickly. The minute output outstrips any of these available resources, scarcities arise and price hikes invariably follow.

If sufficiently steep and/or swift, said price hike's knock-on effect unleashes inflationary pressures. A viscous cycle often develops that takes on a life of its own as producers begin to pass along supplier price rises to customers. As rises in income rarely come as quickly, the purchasing power of the individual consumer shrinks. Offsetting wage increases often only leads to even greater inflation and the value of the affected currency depreciates even further. Real economic growth slows as appreciating prices decrease demand which, in turn, pushes unemployment higher as suppliers respond by cutting back production. Resources go unused until prices stabilize again. When such a downturn occurs in the most advanced economies, existing productive capacity shrinks for a time. No matter how long a recession lasts, however, the expectation remains that a recovery will follow. In underdeveloped economies, there is no such expectation because non-existent productive capacity simply doesn't get built in the first place. Here setbacks in the short-run stymie a more efficient allocation of resources in the long-run where, in more developed economies, a more efficient reallocation is simply delayed. Fundamentally, then, successful 'development' hinges on the answer to this paradoxical question: How does one create something out of virtually nothing?

Further Insights

Since the mid-twentieth century, economists have put forth formal economic models as possible answers noteworthy for both their number and their conceptual diversity. All of them involve investment of one sort or another. In the strict sense of the term, of course, this means funds raised by stock floatations, joint-ventures, bonds and other kinds of loans as well as direct aid or debt-forgiveness. Whatever its source, these funds go towards the acquisition of capital goods, the equipment and plant used in production processes. In the broader context of economic activity per se, the term refers to any resource — labor, land, technical know-how, entrepreneurship — dedicated to one economic purpose instead of another where the pay-off might be more immediate but not as great. Any sacrifice of short-term gains for the sake of potentially larger long-term gains thus constitutes an investment in this broader sense of the word.

Early Formal Models

Harrod-Domar Model

One rather influential early theory of economic growth, the Harrod-Domar Model was built around the narrower sense of the term. Gross Domestic Product or GDP, the sum of all goods and services sold in a year, grows at a rate proportionate to the national savings ratio and inversely proportionate to the national capital to output ratio. The latter signifies the amount that must be invested in order to produce a certain amount of something, the former the percentage of total household income left in interest-bearing accounts. By setting a targeted rate of growth in GDP, fiscal and monetary policy-makers can calculate the exact amount of investment funds required to meet it by first empirically determining the capital to output ratio. Should savings recycled by domestic banks as loans not cover the required amount, the difference can be made up by borrowing from foreign banks and governments. The exactness of the relationship stems from the model's clear cut identification of three different types of growth: The warranted, the natural and the actual. All three concepts stem from Keynes' ground-breaking General Theory of Employment, Interest and Money which states that at full employment income, not interest, sets investment levels. So, the actual rate of growth here is defined as the general population's propensity to save and invest. The warranted growth rate, meanwhile, as the amount planned savings it will take to match planned investments. Meanwhile, the natural rate is the growth in population and thus the labor forces along with the rate at which new technologies improve national productivity. When these two rates are the same, the resulting equilibrium creates a steady rate of growth at full employment.

Rostow's Five Stages of Growth

Other models are more descriptive than normative. The earliest synthesis of development as a multi-phased progression came with Rostow's Five Stages of Growth, a model gleaned from an exhaustive analysis of economic history (Clever, 2002). It traced national economic and investment activity back to its origins in subsistence farming over two thousand years. Lack of any surpluses to speak of undermines nascent savings and investment to this day in some traditional societies. Barter economies where resource allocation decisions are guided by custom and obligation, production capacity and standards of living remain mired at low-levels. A transitional stage emerges as the division of labor encourages greater efficiency in production, yielding more substantial surplus for trade. This in turn occasions improvements in transportation and the evolution of a merchant class. The preconditions now exist for a 'take-off' by the economy as a whole, the third stage. Here growing income in the primary-product sector stimulates demand and investment in other emerging product-sectors. One or two manufacturing industries gain traction and establish themselves, giving agricultural laborers and more attractive employment alternatives. More importantly, perhaps, investment rises to as much as ten percent of GDP. Diversification ensues and technology comes to play a leading role in expanding productive capacity thereafter, creating new investment opportunities and more higher paying jobs as the so called 'drive to maturity' gathers pace, leading eventually to the fifth and final stage: the 'age of high mass consumption.'

Lewis-Ranis-Fei Model of Surplus Labor

A third theory to gain currency in the two decades immediately after World War Two has the distinction of being the only to start from the premise that underemployment was the major obstacle to development, not under-investment. In the Lewis-Ranis-Fei Model of Surplus Labor, the engine of economic growth is, ironically, the subsistence wage. At the stage in economic development when a traditional agriculture and modern industrial manufacturing co-exist, workers migrating from farm to factory end up receiving the same subsistence wage because of the huge untapped reserve of labor readily available in the countryside. Unskilled workers, in effect, have no real bargaining power. And the lower the manufacturing overhead, the greater the profits available for interest-free investment; the ideal means of stimulating further economic growth. The manufacturing workforce's fortunes eventually improve, too, but only after industrialization has absorbed all of the excess agricultural workforce. At that point, workers in both sectors would begin to be paid their marginal product of labor. A follow up on development theory, the Lewis Two-Sector Surplus Model, calls upon governments to actively shape policies to encourage structural changes that foster the migration from the rural, agricultural sector to the urban, manufacturing one.

Policies Inspired By Early Models

These three theories were quickly put to the test in the 1960s and 1970s as sovereign independence replaced colonial rule in Africa and industrialization increasingly topped national economic agendas in Asia and Latin America. With perhaps the exception of oil, economic planners and policy makers in the emerging world saw little future in remaining solely suppliers of commodities and/or raw materials. Attention turned to the very real problem of how to transition quickly from a traditional to a modern economy, the goal in Lewis-Ramis-Model, from Rostow's 'take off' through the 'drive to maturity' in effect, using capital drawn from domestic savings whenever possible as the Harrod-Domar Model proscribes. Promoting the domestic production of capital and consumer goods, of course, was the obvious solution. The problem quickly became how to do this most effectively in the shortest amount of time.

Import Substitution

Given that manufactured goods were already being imported, one ready-made solution was to impose tariffs and quotas and finance domestic production of these goods to satisfy demand. Import Substitution as a development plan would create much needed infrastructure, expand productive capacity, generate income that, as 'savings,' could provide further investment-capital, and promote economic self-sufficiency in one fell-swoop (Lauterberg, 1980). Compelling arguments all, import substitution in practice had unintended consequences that proved its undoing in the long run. Foremost among these was that the tariffs and quotas made it much more expensive to acquire the capital goods abroad that domestic producers relied upon and were not manufactured locally. Heavy industry's development in particular suffered from a lack of modern equipment. And without heavy industry to cost-effectively supply intermediate products to end-product manufacturers, consumer goods prices remain high. Restricting the flow of consumer goods through preexisting import channels, what's more, invariable leads to temporary scarcities, pushing high prices even higher and triggering inflation. Worse still, import substitution turns a national economy into a de facto protected-market, stifling competition.

Export Orientation

In short, import substitution failed to live up to expectations. Yet, its underlying objective — industrialization — remained sound, so the focus shifted to finding another, far less problematic means to the same end. Export Orientation proved the most promising candidate. As opposed to turning their backs on world markets, domestic industries should be actively encouraged to produce manufactured goods tailor-made for them. Underemployment, the curse of the developing world, now becomes a strength, for foreign manufacturers seeking cheap labor will invest in local production plants, finance the acquisition of capital goods and greatly accelerate specialization of the local workforce. Producers, moreover, have to turn out truly competitive goods to gain a share of world markets. Domestic capital accumulation benefits too as workers have wages to put into savings accounts; businesses operating profits to reinvest (Holt, 1996). Hong Kong, Singapore, Taiwan and South Korea, known collectively as the East Asian 'tigers,' implemented this strategy with spectacular success in the 1960s and 70s. Results elsewhere proved mixed.

Revisionist Thinking

International Dependency Theory

Interestingly, the most vocal criticism of export orientation policies came from the developing countries themselves. Adherents of International Dependency Theory argued that in most developing economies, primary products, not locally manufactured goods, made up the bulk of exports. These rarely earned enough to cover import purchases. But, without import substitution policies in place, there was no other ready source of manufactured goods. So, developing countries gain little beyond mounting debts from this uneven exchange. Developed countries, what's more, had no real incentive to change this, making it very hard indeed for developing countries to break free of a deepening dependency. Export-driven development was, in a word, really just colonialism in a different guise.

Neoclassical Theory

A contrarian view, Neoclassical Theory, soon emerged inspired by the work of early proponents of 'laissez-faire' capitalism, Adam Smith and David Ricardo. For developing countries, it argues that the surest, fastest route to development lay in unrestrained market competition. Government intervention in any form — tariff restrictions, low cost loans to export industries, etc. — hindered rather than helped. Championed by leading lender-countries in the 1980s and 1990s, Neoclassical Theory's ascendancy as the dominant model of development was swift, its application wide-spread. Both the International Monetary Fund and the World Bank saw to this by making free-market reforms a pre-condition for further development assistance. By then, export-driven economies of the Asian 'tigers,' Mexico, Brazil and Argentina urgently needed financial bail-outs and were in no position to argue. In each case, currency devaluations had eroded their terms of trade, bringing about soaring inflation and/or prolonged economic recession. Some like Argentina and Mexico could not meet short-term debt obligations. Reeling from higher oil prices, many other lesser developed countries found it necessary to borrow to replenish energy stocks, adding to already high debt burdens. Additional loans, restructured repayment schedules and debt forgiveness were extended to developing countries that put free-market 'stabilization' policies in place.

This renewed emphasis on classical economic theory's role in development led to the reevaluation of the importance of technology that Adam Smith assigned to fostering growth. Investment's singular virtue might well be the reorganization of work flows around the ever more efficient production processes it facilitates (Kregal, 2004). Such, at least, was the conclusion drawn by Robert Solow who estimated technology single-handedly accounts for almost all of the economic growth the industrialized world experienced before and after the turn of the twentieth century. This insight forms the core of the Exogenous Growth Model that extols the developmental virtues of technology as an agent of change and, by implication, the value of investing in human capital. Without the funding or the infrastructure to support education, in effect, no country can expect to harness human capital successfully. And, if technology is in fact the engine of growth, any country that fails to adequately educate its people will stagnate economically.

Issues

Much progress has thus been made on the theoretical front. Much less progress alas has been made on the practical front. There are, of course notable successes like Brazil, China and India. But unlike most developing countries, all three are geographically enormous and teeming with so called 'surplus' labor. Progress measured in material improvements has been uneven at best. Even successful development, moreover has its ugly side: Massive population dislocation, squalid urban slums, tremendous income disparities separating rich from poor, environmental pollution, etc. Where there are expectations of future improvements, these conditions, fortunately, are tolerated. But in many places such expectations remain wishful thinking because development there is moving afoot at a snail's pace, if at all. Theory does not factor in corrupt governments nor rent-seeking local industrialists, trade barriers erected by developed countries denying developing countries access to profitable markets for agricultural exports, or world capital markets' reluctance to refinance the majority of 'third world' debt on terms more favorable to less developed countries.

Terms & Concepts

Endogenous Growth Theory: A refinement of Neoclassical Theory that emphasizes the tremendous influence technological innovation has on economic growth.

Export Orientation: The deliberate policy in developing countries of concentrating investments in industries that produce goods in demand in world markets as opposed to demand in domestic markets.

Harrod-Domar Growth Model: A theory that emphasizes the primacy of savings as a source of investment funds and the importance of output achieved from a given level of investment.

Human Capital: The economic value of a worker's cumulative training and experience, both of which can be broadened and deepened through an additional investment of time and money, further increasing the worker's value.

Import Substitution: The deliberate policy of erecting high tariffs and other restrictions on imports for the express purpose of stimulating their domestic production

International Monetary Fund (IMF): A multilateral body originally responsible for the maintenance of a fixed exchange rate mechanism. When exchange rates were subsequently allowed to float, the IMF assumed a leading role in managing the debt crisis in the developing world.

Neoclassical Growth Model: The theory that savings, investment and all other aspects of economic activity operate most efficiently when prices rise and fall in unregulated markets.

Purchasing Power: The amount of goods and services that can be bought using a given currency. Because currencies' values frequently change relative to each other, a consumer may be able to purchase more per unit value in one currency than another. Problems arise when imports must be paid for in a strong foreign currency with a weak domestic one because the unfavorable exchange rate makes these imports more expensive.

Rent-Seeking Behavior: The penchant for individuals and firms to secure largely unearned income by obtaining favorable treatment or concessions from government officials.

Rowstow's Stages of Growth: The theory that economic growth progresses through five distinct phases: Traditional, transitional, take-off, drive to maturity, and high mass consumption.

Stabilization Policies: Measures recommend by the IMF and World Bank designed to control and ameliorate financial crises.

The World Bank: The unofficial name of the International Bank for Reconstruction and Development that provides loans to developing countries.

Bibliography

Clever. T. (2002) Chapter 11: Development, growth and Asian dragons. Understanding the world economy (pp. 209-235). United Kingdom: Taylor & Francis Ltd. Retrieved September 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=16867396&site=ehost-live

Diamond, L., & Mosbacher, J. (2013). Petroleum to the people. Foreign Affairs, 92, 86-98. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89749158&site=ehost-live

Hafer, R. W. (2013). Economic freedom and financial development: International evidence. CATO Journal, 33, 111-126. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85491858&site=ehost-live

Hout, W. (1996). Development strategies and economic performance in third world countries, 1965-92. Third World Quarterly, 17, 603-624. Retrieved September 9, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=9701172896&site=ehost-live

Hughes, H. (2003). Trade or aid? Which benefits developing countries more? Economic Papers, 22, 1-19. Retrieved September 9, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=18665304&site=ehost-live

Kregel, J. (2004). Two views on the obstacles to development. Social Research, 71, 279-292. Retrieved September 9, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=13986323&site=ehost-live

Lauterbach, A. (1980). The erosion of the development concept: Prospects for a new international economic order. ACES Bulletin, 22, 53. Retrieved September 6, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=6586020&site=ehost-live

Marangos, J. (2012). The post Keynesian retort to "After the Washington Consensus". Journal of Post Keynesian Economics, 34, 583-610. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=77496335&site=ehost-live

Suggested Reading

Gopinath, M., & Upadhyay, M. (2002). Human capital, technology, and specialization: A comparison of developed and developing countries. Journal of Economics, 75, 161-179. Retrieved September 9, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=6338616&site=ehost-live

Parker, D., & Kirkpatrick, C. (2005). Privatisation in developing countries: A review of the evidence and the policy lessons. Journal of Development Studies, 41, 513-541. Retrieved September 9, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=17472037&site=ehost-live

Shafaeddin, S. (2005). Towards an alternative perspective on trade and industrial policies. Development & Change, 36, 1143-1162. Retrieved September 9, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=19050411&site=ehost-live

Sen, S. (2005). International trade theory and policy: What is left of the free trade paradigm? Development & Change, 36, 1011-1029. Retrieved September 9, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=19050417&site=ehost-live

Weisbrot, M., Baker, D., Kraev, E., & Chen, J. (2003). The scorecard on globalization 1980-2000: Twenty years of diminished progress. Social Policy, 33, 42-42. Retrieved September 9, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=9458191&site=ehost-live