4.3.3 Development Strategies Part 2: Other strategies

Contents

Other strategies for development

Lewis model and industrialisation – key details

• The Lewis model is a theory of economic development.
• There are two sectors in the Lewis model:
  • A rural agricultural sector and
  • An urban manufacturing sector.
• To begin with, most labour is working in the agricultural sector.
  • There is diminishing marginal productivity of labour, with some workers having near zero marginal product of labour on the farm.
  • These extra workers with low marginal product are sometimes referred to as “surplus labour” in the Lewis model.
• Meanwhile in the urban sector, the marginal productivity of labour is higher than in rural areas, resulting in higher wages.
• This incentivises workers to move from rural agricultural areas to urban manufacturing areas to seek higher wages.
• This is one explanation for economic development:
  • Also, workers moved from agriculture, where they were producing near zero marginal product, to manufacturing, with higher marginal product of labour. So the total value of production has increased. Overall productivity in the economy has also increased – with the same labour, more is produced.
  • As workers from moved from lower paid jobs in agriculture to higher paying jobs in manufacturing, they are now better off, having increased their wages.
• An example of rural urban migration is South Korea. Starting in the mid-20th century, workers shifted from rural agricultural areas to urban centres such as Seoul.

Further details on the Lewis model – how migration continues and when it stops

• This increase in labour supply in urban areas leads to higher profits for firms in urban areas.
  • In the Lewis model, there is a surplus of workers in agriculture.
  • So workers are willing to move to cities for only slightly higher wages than they were earning on farms. [The labour supply for urban areas is perfectly elastic up to a point].
  • Therefore, urban factories can pay workers less than the value they create, keeping the difference as extra profit.
  • The increase in profits incentivises urban manufacturing firms to invest more to grow their business further.
  • This increases demand for labour in cities, further encouraging rural-urban migration.
• This rural-urban migration continues until wages are equalised across agricultural and urban areas.
  • Eventually surplus labour in agriculture is eliminated and rural labour supply falls further.
  • As there is diminishing marginal productivity of labour, a reduction in the labour force increases the marginal product of labour.
  • This raises wages in agriculture.
  • At some point, the difference in wages between agriculture and manufacturing is eliminated. So there is no longer an incentive to migrate from rural areas to cities.

What are the weaknesses of the Lewis model?

• Moving to urban areas may not lead to higher wages for workers compared with working in agriculture.
  • City-based workers may find themselves working in lower paid jobs in the informal sector, which could lead to lower pay than in agriculture.
• Also urbanisation can lead to overcrowding due to a lack of accommodation.
  • This could lower standards of living, for instance if it leads to poor sanitation or issues with water quality.
• The Lewis model assumes there is a large amount of surplus labour in agriculture.
  • Indeed while agricultural productivity may be lower than manufacturing productivity, most evidence suggests agricultural productivity is above zero, even at the margin.
  • So there is an opportunity cost with moving workers from the rural to the urban sector. That is the foregone production in the agricultural sector as labour leaves agriculture.

Development of tourism

• Middle Eastern economies such as Saudi Arabia and the UAE engage in advertising to promote tourism in their countries.
• Other examples include Croatia’s “Experience Croatia” advertising campaign.
• Another way to promote tourism is through tax breaks for hospitality or restaurants or government spending on infrastructure such as roads to enable tourists to visit.
• Tourism is an export. So making a destination more attractive for tourists increases exports.
  • As exports are a component of aggregate demand (AD), AD shifts right.
  • The shift right in AD can create a multiplier effect, where exporters are richer. So domestic workers are paid more, so workers consume more.
  • This can generate economic growth.
• As domestic firms earn more revenue from exports, this increases business profits. This provides the funds for firms to increase investment.
  • This can increase AD, as investment is a component of AD.
  • Investment also leads to an increase in the quality and quantity of factors of production. So LRAS may shift right.
• The development of tourism is particularly beneficial where a country has naturally occurring geographical attractions or other tourist attractions. This makes the country more likely to have an absolute or comparative advantage in tourism.
• Higher demand for tourist services boosts demand for labour (due to derived demand). This increases worker wages, which may lead to higher living standards.

What are the drawbacks of relying on tourism?

• However some of the revenue generated from tourism may flow to multinational companies such as global hotel chains. The resulting profits may leave the country rather than being reinvested.
• Also, demand for travel abroad can be very sensitive to changes in income.
  • In other words the income elasticity of demand may exceed 1.
  • This means the tourism industry is vulnerable to a global downturn, which reduces global real incomes and reduces tourism demand and revenue.
• Tourism may cause environmental damage. For example in Croatia there are concerns about damage to old city areas and littering.

Development of primary industries

• An example of developing primary industries is Botswana. Diamonds are the top export of Botswana, accounting for 90% of export revenues.
• The development of primary industries could involve government subsidies or providing other types of support (such as protectionism) for primary products.
• Growing primary industries provides a source of export revenue for domestic businesses when they export the primary product.
• Increased revenue and profits for domestic businesses also increases tax revenue for the government.
  • In cases where the company is owned by government, the export revenue directly goes to the government.
• Governments can spend the extra revenue on schools and hospitals, as has been the case in Botswana.
• There are other benefits of specialising in a good. This includes exploiting comparative advantage and trading, leading to gains from trade. It also includes the potential for economies of scale, lowering long-run average costs.

What are the risks of relying on primary industries?

• However specialising in primary products can hold back development.
• This is because it makes the country dependent on highly volatile global commodity prices. This can increase business uncertainty and hence stifle investment.
• Relying on primary resources can lead to a resource curse.
  • For instance, when export revenue from a primary product rises, this causes an appreciation of the currency.
  • This reduces demand for other exports, such as other primary products, manufacturing, or services including tourism.
• Also, primary products may be finite in their supply. This means their supply may run out eventually, reducing the extent to which primary products can be a sustainable source of revenue.
• For more about how relying on primary products can be a barrier to development, including the Prebisch-Singer hypothesis, see the link here.

Fair trade schemes

• Fair trade products include some types of coffee, bananas, cocoa tea and sugar. Example products include Maltesers and Tate and Lyle icing sugar.
• Fair trade labels on products enable firms to charge a higher price for agricultural products such as coffee.
• Such labels on products can indicate to consumers that farmers are being paid fairly and are working in good conditions.
• Fair trade also involves longer-term contracts between buyers and sellers of agricultural produce, increasing certainty for producers.
• Consumers may still be willing to buy from fair trade sources as they know farmers are being paid more fairly for their produce.
• This could lead to higher incomes for farmers, allowing for a better quality of life for farmers.
• Employee working conditions and pay may also improve. This is because fair trade employers must prove they treat their workers fairly.
• Farmers may also use this extra income for investment. This could include spending money on fertiliser or new machinery to boost farm productivity.

What are the potential issues with fair trade schemes?

• However some consumers would prefer to buy the cheaper product rather than pay more for a fairtrade product. So fairtrade products may only help a small fraction of crop producers.
• Fair trade schemes may force farmers to continue to produce certain crops to remain part of the fair trade scheme, even if these crops are no longer profitable.
• Joining fair trade schemes is difficult. It requires particular knowledge and skills, which some farmers in the poorest countries may lack. Thus fair trade may help farmers in middle income countries more than farmers in lower income countries.

Aid

• Examples of aid include:
  • The UK’s $8 billion Climate Investment Funds support climate action in lower and middle income countries.
  • The Brazil Prosperity Fund programme invests £56 million over three years. The money includes supporting solar power projects and events to promote trade.
• Aid can boost aggregate demand (AD) for the recipient country.
  • This can occur either through G if aid is given to government or through C and I if the aid money is given to consumers or businesses.
  • Raises growth but also inflation.
  • Aid can create a multiplier effect. The one-off increase in AD resulting from aid can lead to an even greater increase in AD.
• Aid can shift right in LRAS if aid goes toward a supply-side policy. This means increasing productivity or productive capacity e.g. building a hospital or school or infrastructure.

What can go wrong with aid?

• Aid can crowd out domestic funds.
  • Suppose the aid goes to the government who then spends the money.
  • This raises demand for inputs like labour, raw materials and also loanable funds.
  • As a result, these inputs rise in price. This increases business costs, reducing profits and the ability of firms to invest. So private investment falls.
• Can encourage aid dependence.
  • Aid reduces the need for businesses to innovate to survive or make profits. This may reduce private sector investment.
• Aid can come with conditions. The conditions can be beneficial or harmful for the recipient economy. A typical condition may be that the recipient economy has to engage in supply-side, anti-corruption and fiscal reforms to receive the aid. Organisations like the International Monetary Fund have used this kind of condition for countries such as Ecuador.
  • This incentivises the recipient government to reform its economy. This can include reducing the budget deficit, encouraging transparency to prevent corruption, privatisation of state owned assets.
  • But such reforms can increase inequality and can lead to other undesirable outcomes. Indeed there were anti-IMF protests in Ecuador as a result of IMF conditions to aid. Cuts to the health service due to IMF deficit reduction recommendations contributed to Ecuador’s health service being underprepared for the health consequences of the Covid pandemic.

The effectiveness of aid depends on…

• Where aid is allocated – government bureaucracy vs schooling.
  • Suppose aid ends up not being used for a productive project like schooling but is used on government bureaucracy.
  • If aid is allocated to businesses to invest, this is more likely to boost the long run growth rate through investments in capital.
  • [Note allocating aid to households can boost long-run growth too, particularly where a households use aid to fund education or small business activity].
• The level of corruption.
  • Higher corruption means a greater fraction of the aid is likely to be wasted, all else equal. For example, wasted aid may go to projects with low returns or just to the pockets of politicians or firm managers.
• The skill level of the country’s workers.
  • Suppose the country’s workers do not have the skills required to use the aid in the intended way. For example, they do not have the construction skills necessary to build a train line.
  • Then a construction project may be more likely to use labour from abroad, which means a greater leakage from the circular flow of income when this money returns abroad.

Debt relief

• Debt relief could involve international organisations may decide not to take interest payments on a temporary basis. Alternatively, the lender could reduce the total value of the debt owed in a so-called “haircut”.
• An example of a country which has received debt relief support is Somalia.
  • The International Monetary Fund granted $4.5 billion in debt relief to Somalia.
  • As a result, external debt (debt borrowed from abroad) has fallen from over 60% of Somalian GDP in 2018 to 6% in 2023.
• Either way, this reduces government spending on debt interest. This frees up government funds that can be spent elsewhere.
• For example, the government could invest more in infrastructure or spend more in the welfare state and poverty reduction.
• Debt relief reduces the risk that the indebted government would fail to make its debt repayments and “default” on its debt.
• Because of this, debt relief may also help those lending the money to be more certain that they will receive the future interest payments on borrowing, even if they lose out on debt repayments today.

What are the drawbacks of debt relief?

• Debt relief may lead to higher interest rates in future. It makes other lenders worry about the possibility of future debt relief for the same government and acts as a signal that the government may have been close to failing to repay its debts.
• It could also incentivise the government to build up debt levels again. The government may believe they can get away with more debt by asking for further debt relief in the future.
• This is a kind of moral hazard – the protection against high debt may encourage governments to build up debt in the future.

The success of debt relief depends on…

• The conditions placed on debt relief.
  • Lenders could ask for reforms in exchange for debt relief.
  • If the reforms, such as supply-side policies or anti-corruption legislation, improve economic growth, they could help reduce debt levels permanently.
• How the government uses any “fiscal headroom” generated by the debt relief.
  • The freed up funds generated by debt relief could be wasted rather than used to pay down debt or to invest in the country’s infrastructure or education.

Extra reading: A live issue is about whether private lenders should be forced to join debt relief deals alongside government lenders.

The role of international institutions and non-government organisations (NGOs)

World Bank

• The World Bank is an international organisation.
• Its aim is to lower poverty by lending to the governments of poorer countries.
• This lending occurs below market interest rates or at zero interest rates for the poorest economies.
• The funding for the World Bank comes from its members contributions as well as the World Bank’s own borrowing and financial reserves.
• In addition the World Bank engages in development research and advises countries on topics such as education and healthcare.
• To read more about the World Bank, see the link here.

International Monetary Fund (IMF)

• The IMF is another international organisation. It aims to encourage free trade and economic growth.
• Also the IMF seeks to help its member economies stabilise and prevent financial crises.
• To achieve its objectives, the IMF offers advice on development policy as well as monetary support for developing economies (including loans).
• This includes monitoring activities to inform governments of risks.
• To read more about the IMF, see the link here.

The Washington Consensus is a set of free market economic policy recommendations supported by international organisations like the IMF and the World Bank.

These policies include trade liberalisation, deregulation, privatisation, fiscal disciplie and strong property rights.

Supporters would claim these policies support economic growth and can help attract FDI. However these policies could also contribute to higher poverty, inequality and social unrest.

Non-government organisations (NGOs)

• NGOs are non-profit organisations operating outside government control.
• Often these organisations have humanitarian, social or environmental objectives.
• NGOs engage directly in projects in health, education, poverty relief and post disaster support.
• They also offer policy advice and raise awareness of development issues.
• NGOs provide direct aid, filling gaps left by governments or international institutions or where there may be poor public services.
• However they depend on donations for funding and can face accountability issues.
• Examples of NGOs include Oxfam which focuses on reducing poverty and inequality, and Médecins Sans Frontières (Doctors Without Borders) which provides medical care in wartorn areas and in natural disasters.

Related economics resources

To return to Edexcel Economics A A Level notes, click this button below:

For more A-Level Economics Edexcel A style resources, click the blue button below: