Growth Models and Development Strategies

In development economics, there are growth models, growth strategies and development strategies.  Be careful not to confuse them!

First, the IB requires the Harrod-Domar growth model and the Lewis / structural change / dual sector model be taught.  Unfortunately, at the higher tertiary level, these models are not really used anymore, so we will understand the basics.

GROWTH MODELS

The Harrod-Domar model (named for guess who) states that the rate of GDP growth equals the savings ratio divided by the capital to output ratio.  Therefore, to increase GDP growth, the model suggests consumers should save more (increase mps) or that capital should become more productive/efficient.  The rationale is that more savings leads to more investment which leads to more capital and output and thus higher GDP per capita.  However, in poor countries, many citizens make only enough to survive, so it is very difficult to increase savings (confounded by the fact that many banks in these countries are MNCs catering to the upper echelon of the socioeconomic spectrum).  Moreover, with capital flight (see relevant post) and little to no R&D, it is nearly impossible to make the capital more efficient.  These are two major reasons why this growth model (which was originally meant to be a business cycle model) doesn't really help.

Another rather outdated model is Lewis's dual sector model.  First, we assume there are two sectors: a large agricultural sector and a small industrial sector in the city.  There are far more workers in the countryside working in the fields and getting paid low wages.  The few workers in the city that manufacture products make more.  The idea is that the private firms in the industrial sector will take their profits and reinvest them which enlarges the industrial sector that can then hire people from the agricultural sector and pay them more.  This pattern repeats itself until equilibrium is achieved.  Although this model is helpful in understanding industrialization, it has fallen out of favor because of today's considerable urban poor, (possibly incorrect) assumption of extra rural labor, (possibly incorrect) assumption of reinvestment of profits and lack of known capital flight in LEDCs.

GROWTH STRATEGIES

Export-led growth is an impetus for a country's industrialization which focuses on creating, developing and selling g/s for which it has a comparative advantage (see relevant post).  For this to occur, the country needs to open its border to trade, which means we see a reduction in protectionist measures.  This is supposed to lead to economic growth through the increase in the net exports part of the GDP equation.  We have seen success with export-led growth in the Four Asian Tigers, but their difficulties during the Asian crisis of the 1990s questions the strategy's sustainability.  Furthermore, where do poor countries start?  How can they compete with MNCs and MEDCs?

A second strategy is import-substitution (inward).  The idea behind import substitution is that countries reduce trade and produce g/s that they would have imported domestically as replacements.  This would obviously lead to an increase in national output which is national income (or GDP growth).  Jobs would be created as well.  Although this technique is logical, it has several disadvantages.  These include a lack of efficiency, reduced consumer and firm choice for g/s, increased prices, and the possibility that the growth is only short-term (not sustainable?). 

Thirdly, foreign direct investment (FDI), or direct investment in a country through building a company or taking over part/all of an existing company, can assist in the growth of LEDCs.  These countries must open themselves to foreign MNCs to do this.  There are several advantages and disadvantages to FDI (analysis and evaluation!).  

Advantages - funds domestic savings, builds infrastructure, gives access to R&D and new technology, employs domestic citizens (amplified by mulitplier), can increase aggregate demand (amplified by accelerator), and gives tax revenue to the domestic government.

Disadvantages - who holds management / upper-level jobs?, negative externalities of production, possible transfer pricing, excessive power in domestic economy/politics?, possible repatriation of profits, low level of capital.


DEVELOPMENT STRATEGIES
Fairtrade
Besides growth strategy, there are also development strategies that focus on improving standard of living in LEDCs.  For example, there is the Fairtrade Organization.

According to their web site, the Fairtrade Labeling Organization (FLO) is "a non-profit, multi stakeholder body that is responsible for the strategic direction of Fairtrade, sets Fairtrade standards and supports producers".  From the web site as to what Fairtrade is, the web site says :

"Fairtrade is an alternative approach to conventional trade and is based on a partnership between producers and consumers.  Fairtrade offers producers a better deal and improved terms of trade.  This allows them the opportunity to improve their lives and plan for their future.  Fairtrade offers consumers a powerful way to reduce poverty through their every day shopping. 

When a product carries the FAIRTRADE Mark (seen above) it means the producers and traders have met Fairtrade standards.  The standards are designed to address the imbalance of power in trading relationships, unstable markets and the injustices of conventional trade.

For producers Fairtrade means prices that aim to cover the costs of sustainable production, an additional Fairtrade Premium, advance credit, longer term trade relationships, and decent working conditions for hired labor." 

Basically, Fairtrade ensures producers in "disadvantaged" countries get a price for their goods that allows them to take care of themselves economically.  This, of course, leads to higher prices due to the fact they do not have world efficiency levels of production, but some consumers are willing to pay more to help these people.

What types of products have the Fairtrade symbols?

Video examples from Uganda,  Nicaragua, and Dominican Republic.

Micro-finance 

In LECDs, oftentimes the vast majority of the population does not have access to banking services because of their lack of savings and collateral (Merriam-Webster - of, relating to, or being collateral used as security, as for payment of a debt or performance of a contract).  To address this deficiency, certain financial institutions have developed micro-finance offices (or entire banks) designed to provide standard banking services taken for granted in MEDCs (i.e. savings account, small business loans, insurance).

One example of a bank that focuses on micro-finance projects in the Grameen Foundation.  Click here for further information about this remarkable organization. 

Micro-credit is a part of micro-finance that extends small loans to entrepreneurs to start businesses.  These are designed to lift people and families, unit by unit, out of poverty.  Women have especially benefited from micro-credit because of their tendency (which is arguable and to be checked empirically) to be less risky and their certain gender disadvantage in many LEDCs.

The following are examples of micro-finance and micro-credit that have worked in Bangladesh, the "Arab World", and Botswana.