FANA HAGOS BERHANE (LL. B) (LL.M)
Sponsored by the Justice and Legal System Research Institute
DETERMINANTS OF ECONOMIC DEVELOPMENT
Today, countries of the world are divided into rich (developed) countries and poor (developing) countries. There is a wide gap between the rich and the poor countries. The statement that “the rich nations get richer and the poor countries get poorer” has become popular in the literature about world poverty. But what are the explanations for the poor performance of the developing countries? There are two approaches to explain the determinants of economic development; the traditional approach and the institutional approach. Thus at the end of this chapter you will be able to familiarize yourself with.
§ Traditional approach to development and
§ Institutional approach to development.
3.1 The Traditional Approach (Economic Factors) to Development
The traditional approach to development assumes that economic development is determined by economic factors, like natural resources, capital, technology, etc. Let’s see each of the major economic factors
A) Natural Resources
The principal factors affecting the development of an economy are the natural resources or land. “Land” as used in economics includes natural resources such as fertility of land, its situation and composition, forest wealth, minerals, climate, water resources, sea resources, geographical proximity with rich countries etc. For growth, the existence of natural resources in abundance is essential. A country which is deficient in natural resources will not be in a position to develop rapidly. As pointed out by Lewis, “Other things being equal, men can make better use of rich resources than they can of poor.” In LDCs natural resources are unutilized, underutilized or mis-utilized. This is one of the reasons for their backwardness. The presence of natural resources is not sufficient for economic growth. What is required is their proper exploitation.
It is often said that economic growth is possible even when an economyc is deficient in natural resources. As pointed out by Lewis, “A country which is considered to be poor in resources today may be considered very rich in resources at some later time, not merely because unknown resources are discovered, but equally because new uses are discovered for the known resources.” Japan is one such country which is deficient in natural resources but it is one of the advanced countries of the world because it has been able to discover new uses for limited resources.
B) Capital Accumulation Capital means the stock of physical reproducible factors of production. When capital stock increases with the passage of time, it is called capital accumulation or capital formation. Capital formation is investment in capital goods that leads to increase in capital stock, national output and income. Capital formation is the key to economic development. On the one hand, it reflects effective demand and on the other hand, it creates productive efficiency for production. Capital formation possesses special importance to LDCs. The process of capital formation leads to the increase in national output in a number of ways. Capital formation is essential to meet the requirements of an increasing population in such economies. Investment in capital goods not only raises production but also employment opportunities. It is capital formation that leads to technological progress. Technological progress in turn leads to specialization and the economies of large scale production. The provision of social and economic over heads, like transport, power education, etc. in a country is possible through capital formation. It is also capital formation that leads to the exploitation of natural resources, industrialization and expansion of markets which are essential for economic progress.
Organization is an important part of the growth process. It relates to the optimum use of factor of production and economic activities. Organization is complement to capital and labor and helps in increasing their product activities. In modern economic growth, the entrepreneur has been performing the task of an organizer and undertaking risks and uncertainties.
The underdeveloped countries lack entrepreneurial activity. Such factors as the small size of the market, capital deficiency, absence of private property and contract, lack of skilled and trained labor, non-availability of adequate raw materials, and infrastructural facilities like transport, power, etc increase risk and uncertainties. That is why such countries lack entrepreneurs.
D) Technological Progress Technological changes are regarded as the most important factor in the process of economic growth. They are related to changes in the methods of production which are the result of some new techniques of research or innovation. Changes in Technology lead to increase in productivity of labor, capital and other factors of production.
E) Division of Labor and Scale of production Specialization and division of labor lead to increase in productivity. They lead to economies of large scale production which further help in industrial development. Adam Smith gave much importance to the division of labor in economic development. Division of labor leads to improvement in the productive capacities of labor. Every laborer becomes more efficient than before. S/he saves time. S/he is capable of inventing new machines and process in production. Ultimately production increases manifold. But division of labor depends upon the size of the market. The size of the market, in turn, depends upon economic progress, i.e. the extent to which the size of demand, the general level of production, the means of transport etc are developed. When the scale of production is large, there is greater specialization and division of labor. As a result, production increases and the rate of economic progress is accelerated. Underdeveloped countries are unable to take advantage of the economics of division of labor and large scale production due to the presence of market imperfections, which in turn keep the size of the market small.
3.2 Institutional Approach to Development
The institutional approach to development is a recent phenomenon. It argues that explanations of the poor economic development are found not only in economic factors but also in non-economic factors. In fact most of these factors are explained by non-economic factors or institutional factors. The institutional approach to development emphasizes more on the institutional factors than the economic factors. They explain this using the case of a metropolitan city. The central city in a metropolitan area, while gaining some high-rise buildings, has a stagnant population and an increasing proportion of poor people. On the other hand, suburbs are prosperous and growing rapidly.
To a certain degree, modern economics is like such a metropolitan area. The traditional economics is at the center of the city. At the same time, the suburbs of economics are expanding rapidly in all directions. The institution approach to development is a case in point. For example, consider shifting the focus from capital and other resources toward the quality of governance. In the suburbs of economics governance is a focus, but not in the city center where capital is the focus.
The institutional factor further argues that most of the economic factors can be obtained in the globalize, market. For example, many Multinational National Corporations (MNCs) are ready to invest a significant amount of capital if conditions are favorable. Besides, LDCs can also borrow technologies from DCS. The institutional factors that determine economic performance include;
A) Type of Government
A country with a monarchy system is less likely to develop as compared with a country with a democratic government. The nature of democracy depends on the level of education, discipline, culture, etc. of the people. In maintaining rules, governments could be soft or strong. To maintain rules and there by prepare the ground for development, governments need be strong. To provide for the enforcement of contracts, the prevention of anarchy, and the provision of other public good, the coercive power of government is necessary.
Good governance is another important factor which determines economic performance of countries. According to Olson M, “Governance is a decisive determinant of economic performance and that with the right economic policy and institutions, poor countries can grow at a very rapid rate.” Good governance is reflected by long trem vision, correct policies and effective implementation. For example, in Japan the government decided what type of industries to develop after World War II. It gave emphasis to textile, iron and steel, shipbuilding etc. In recent years, the government shifted towards electronics in response to a change in world market.
Another aspect of good governance is the development of infrastructure. Countries like Hong Kong, Singapore, Malaysia, etc develop infrastructure and attract foreign capital.
Availability of technology like the capital good, complementary factors like infrastructure, highly skilled labor, innovation, etc. are required for an economy to grow. To have such technological changes requires a good institution. For example, in making innovations, there could be resistance. To calm such resistance, government effort is required. Thus, institutions that encourage technological innovation and suitability of institution for successful adoption of new ideas is an important question. Political and cultural dynamism help in adoption of new technology and the negative forces such as labour union orthodoxy should be managed properly by good governance. Spread of education and scientific culture are necessary for adoption of new technology Reservation/Affirmative Action/. Social justice requires that if some sections of the society are deprived, they must be given special attention i.e. reservation is needed. The supporters of reservation justify its use in terms of social justice, equity and to rectify historical mistakes. However, from the point of view of efficiency, it is not justified.
C) Social Structure of Population
In some countries, we get a homogenous type of population. Homogeneity of the population leads to the development of national feelings, which is helpful for economic development – for example China, Japan, Korea, and Russia. On the other hand, population of a country could also be heterogeneous _ divided on the basis of language, religion, ethnicity, caste, etc. In such societies, some groups play entrepreneurial role.
D) Human Capital and Cultural Traits.
The difference in per capita income among countries could be explained by human capital and cultural traits. In the DCs, human capital and cultural traits in the form of work culture, discipline, good entrepreneurship etc have played an important role. Poor countries are poor because they lack these traits. The cultural traits that perpetuate poverty are the result of centuries of social accumulation and they can’t be changed quickly.
Cultural advancement according to M. Olson results in two types of human capital:
a) Marketable Italic capital; These include more skill, propensity to work harder, more entrepreneurial personality; These qualities result in increase in the quality and quantity of productive outputs. These results in increase in income of persons, groups as well as of nations.
b) Civic culture. A civic culture leads to the election of good government which adopts good policy. It also results in a disciplined society. Corruption will be less. People pay tax.