MBA Global Economy

Session 3C

Globalization & Growth Strategies

 Agenda
 Introduction
 The Developing Countries
 Economic Growth
 International Trade and Economic Growth
 Economic Development Strategies
 Official Development Assistance
 Summary

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 Introduction
 How does international trade affect the economic
conditions in developing countries?
 Improving the standard of living in developing countries
is one of the most important topics in economics
 The relationship between international trade and
economic growth is a controversial subject
 The first topic is the concept of economic development
 Their rate of economic growth is the critical factor

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 Economic Development

 Economic development is defined as the goal of

attaining a standard of living roughly equivalent to
that of the average citizen in a developed country
 Average income can be measured using per capita
GDP
 This is only a proxy for a variety of factors
 Low GDP per capita is associated with a host of
other factors that reduce the quality of life for most
of humanity

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 Developing Countries

 The first goal of economic development is the

alleviation of the dire conditions billions face
in developing countries
 Problems such as malnutrition, poor housing,
lack of basic health care, lack of an
infrastructure to provide amenities like clean
water, and illiteracy make it difficult for people
to improve the standard of living
 Economic development can be a complicated
concept

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 GDP of Developing Countries

 There are approximately 145 developing countries in

the world economy and they contain 84.3 percent of
the world’s population
 In 2005, GDP per capita in the middle-income
countries was $2,782 per year and for low-income
countries GDP per capita is on average $602 per
year
 Middle-income countries are the fastest growing
economies of the three groups

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 World Output & Population

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 Low-income Countries

 Although the standard of living in middle-

income countries is low, it pales in
comparison to the economic problem of the
low-income countries
 GDP per capita in these countries is
approximately $600 per year
 This implies a standard of living of
approximately $1.60 per day.
 Some of the worst effects of poverty are the
norm

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 Economic Geography
 From an economic geography point of view, levels of
development are not spread evenly around the world
 The high-income economies are concentrated in North
America and Western Europe
 The former communist countries of Eastern Europe are
middle-income countries that have a good chance of
becoming high-income countries
 In the Western Hemisphere, virtually all of the countries
except the U.S. and Canada are either low- or middle-
income countries

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 Economic Geography…….
 In Asia, Japan, Singapore, Australia, and New Zealand
are the only high-income countries
 2.5 billion people in Asia are concentrated in the low-
income economies of China and India
 Africa is split between low- and middle-income
economies
 The countries along the Mediterranean Basin are
middle-income countries
 Most of the countries of sub-Saharan Africa, with the
exception of South Africa, are in the low-income
category

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 Preconditions for Growth

 There are two important preconditions for economic

growth: property rights and the rule of law
 For markets to work, it must be clear who owns what
 If property rights are not being properly enforced,
then far fewer transactions occur with the result of a
lower level of economic activity

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 Preconditions for Growth……

 Normal economic transactions involve legally

binding contracts
 If there is no effective referee to enforce
business contracts, then far fewer business
contracts occur with the result of a lower level
of economic activity
 In many developing countries these
conditions are not being met
 Such countries are called failed states

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 Factors of Production
 In order for an economy to grow, it needs resources
– factors of production
 Since land is generally fixed, the focus will be on
labor, capital, and technology
 A country’s labor force can increase through
population growth or immigration
 An increase in the labor force will tend to increase
the GDP

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 Economic Freedom Index, 2007

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 Factors of Production…..
 Economic growth also requires an increase in the stock
of capital
 Capital is the amount of money invested in business
structures and equipment
 For a developing country, the stock of capital outside of
the private sector may be critically important
 In order for capital and labor to produce the maximum
output, the economic infrastructure of the country
needs to be appropriate to the level of economic
development

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 Technology

 In economics, technology is anything that

causes resources to be used in a more
efficient way
 Economic growth can also be enhanced by
having a country’s level of technology
increase over time
 A change in technology means that a country
can either produce more output with the same
amount of resources or alternatively produce
the same level of output with fewer resources

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 Basic Growth Theory

 The relationship between GDP and factors

of production is called the production
function
 The shape of the production function
reflects the phenomenon of diminishing
returns
 As the amount of a variable factor
increases, the resulting increase in output
becomes smaller
 This effect is especially applicable in
developing countries with low initial GDPs
and increasing labor forces
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 Production Function
Real GDP (Y)

Y4 F
Y3

Y2

Y1

L1 L2 L3 L4 Labor Force (L)

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 Growth: Shifting Production Function
Real GDP (Y) F2

F1

Y2

Y1

L1 Labor Force (L)

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 Openness To Trade

 The more a country trades, the faster the

economy should be able to grow
 There is evidence of a positive correlation
between openness to trade and growth
 Openness causes an improvement in
technology
 Improved technology leads to improved
total factor productivity, getting more
outputs from the same inputs

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 Globalizers Do Better

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 Capital Flows & Technology Transfer

 Increasing the capital stock and the level of

technology in developing countries is difficult
 In developing countries, the savings are low and the
level of technology is below the world average
 FDI helps developing countries increase their capital
stock

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 Capital Flows & Technology Transfer…..

 Transfer of technology from developed to

developing countries also increases the rate
of economic growth
 But technology and knowledge are hard to
measure
 Thus limits the ability to accurate analyze the
effects of these technology transfers
 FDI flows bring in improved technology
 Trade drives specialization and learning which
improves knowledge which increases total
factor productivity even without FDI

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 ECONOMIC DEVELOPMENT
STRATEGIES
 Import Substitution
 The purpose of an import substitution development
strategy is to increase the relative size of the
manufacturing sector
 It can allow faster initial growth of the manufacturing
sector
 The country may conserve on supplies of foreign
exchange by importing fewer manufactured products
which may improve the trade balance
 Some of the protected industries might in the future have
a comparative advantage

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 ECONOMIC DEVELOPMENT
STRATEGIES

 If the economy at an early stage of economic

development does not have a comparative
advantage in manufactured products, is there a
way to increase the size of this sector?
 Governments can use domestic policies such as
low taxes on manufacturing, direct government
subsidies, or trade policy to favor the
manufacturing sector
 If tariffs are insufficient to increase output, then
quota protection is often used instead of or along
with tariffs

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 ECONOMIC DEVELOPMENT
STRATEGIES

 Import substitution has created a number of

problems for the countries that pursue it
 Infant manufacturing sector is not internationally
competitive and is producing substitutes for
imports that cost more and may be of lower
quality
 This reduces the welfare of consumers and/or
their ability to produce other goods and services
at competitive prices
 Protected industries are larger than they should
be in a free market

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 ECONOMIC DEVELOPMENT
STRATEGIES

 Since the economy is not using its

resources efficiently, it is not growing as
fast as it could
 Slow economic growth may mean slow
growth in employment
 With a growing labor force this is a
problem
 An import substitution policy tends to
make the domestic industry more capital
intensive than would otherwise be the
Session 3C-09
case further reducing job creation
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 ECONOMIC DEVELOPMENT
STRATEGIES

 Another problem relates to public choice

 An economy with a lot of protectionism,
there is a lot of rent-seeking activity
 It will be difficult to withdraw
protectionism as firms and workers in the
protected industry will lobby to keep the
current level of protection from being
removed
 The industries never adjust fully to world
competition and over time become
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relatively more inefficient
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 ECONOMIC DEVELOPMENT
STRATEGIES

 Beginning in the 1970s and continuing

into the 21st century, most countries
pursuing the import-substitution
development policy are in the process of
abandoning it
 Countries are willing to go through this
process now due to the widespread
realization that an inefficient
manufacturing sector does not enhance
overall economic growth
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 Growth in Developing Countries

Region/Country Percent Change in GDP 1990-2000 Region/Country Percent Change in GDP 1990-2000
Developing Countries 4.8
Latin America 3.3 Asia 6.0
Argentina 4.3 China 10.3
Brazil 2.9 Hong Kong 4.0
Chile 6.7 India 5.9
Columbia 3.0 Indonesia 4.2
Ecuador 1.8 Iran 3.6
Mexico 3.1 Israel 5.1
Peru 4.7 Malaysia 7.0
Uruguay 3.4 Pakistan 3.7
Venezuela 1.6 Philippines 3.3
Korea 5.8
Saudi Arabia 1.5
Singapore 7.9
Taiwan 6.4
Thailand 4.2
Turkey 3.8

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 ECONOMIC DEVELOPMENT
STRATEGIES

 Export Promotion
 A development strategy based on developing industries in
line with the country’s comparative advantage
 More effective than import substitution

 Export promotion implies an increase in the relative size

of the manufacturing sector
 For manufacturing to thrive , there is an active role for
government

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 ECONOMIC DEVELOPMENT
STRATEGIES

 The preconditions for growth are extremely

important
 Manufacturing usually is more infrastructure
intensive than agriculture
 The development of a sufficient infrastructure will
involve the participation of the government
 Services must be internationally competitive in
both price and quality
 Development of the manufacturing sector
requires increases in the amount of human
capital

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 ECONOMIC DEVELOPMENT
STRATEGIES

 Taxation of industries must be competitive

in relation to competitive countries
 The government needs to have reasonable
polices with respect to FDI
 The government needs to avoid
protectionism to the greatest extent
possible
 Exchange rates need to be determined by
market forces

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 ECONOMIC DEVELOPMENT
STRATEGIES

 If executed properly, export promotion has

a number of advantages
 More resources flow into the comparative
advantage sectors and away from
comparative disadvantage
 Faster economic increase the rate of job
creation
 May improve the country’s chance of
creating a more favorable balance
between exports and imports
 It works betterGlobal
Session 3C-09 than import
Economy substitution!
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 Commission on Growth & Development: Ingredients
for High & Sustained Growth

I. engagement with the global economy;

 Role of external demand

 Strong export sector

 Import of technology/knowledge

The Commission on Growth and Development is an independent body launched in April 2006. Its objective is to
deepen the understanding of economic growth for development and poverty reduction. It aims to highlight policy
actions which are likely to improve developing countries' growth prospects. The Commission comprises 21
memberswith policy and business experience, including 15 from developing countries, and two Nobel laureates,
Professor Michael Spence andProfessor Robert Solow. The report identifies distinctive characteristics of
successful growth, using 13 high-growth economies since 1950 as examples, and explores how developing
countries can emulate them.

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 Commission on Growth & Development: Ingredients
for High & Sustained Growth…….

II. Political Leadership

 Consensus building

 Competent, non-corrupt administration

 Picking the right model

 Getting everybody on board

 Making deals with Labor & Business leaders

 Pragmatism: making decisions with imperfect

knowledge

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 Commission on Growth & Development: Ingredients
for High & Sustained Growth…….

III. very high savings and investment levels;

 Overall, public and private sector investment rates
of 25 percent of GDP or more are needed.
 Investment in infrastructure, education and health
are crucial
IV. a stable macro environment and
V. a pretty heavy reliance on the basic characteristics of
market allocation, price signals, etc; and
VI. being willing to put up with rather chaotic microeconomic
dynamics

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