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Resource Allocation in Developing

Countries Kashif Ali
Since we are all aware of this fact that in comparison to the needs of people the resources are scare,
hence allocating these resources is the biggest challenge being faced by developing countries.
This chapter outlines the major topics of development strategy which describe the investment criteria
for the allocation of resources.
Two important aspect of resource allocation are discussed here i.e.
 Market Mechanism
 Role of State
Market Mechanism and Market Failures
As Adam Smith says, resources are allocated by “Invisible Hand” in free-enterprise market.
As the profitability of production of a commodity changes, the market prices behaves like a signal to
producer to increase or decrease supply.
It is not only allocation role of markets, but a creative function also, i.e. to provide an environment for
change that expands production possibilities. Change means all the dynamic forces that lead to technical
progress, innovation and ultimately investment.
The Market mechanism is emphasized since the role of state has been criticized due to various reasons
i.e.
 Collapse of Soviet Union and Eastern Europe
 Most Developing countries have failed to deliver fundamental public goods
 Developing Countries are facing fiscal crisis
 Fascination to copy the model of Asian Tigers
Hence the way forward in most developing countries must be a judicious mix of market capitalism
combined with state intervention.
The Role of State
The state is responsible for following major responsibilities
 Provision of public goods
 Correction of market imperfection
 To protect the vulnerable and ensure equitable distribution of income.
 Provision of institutional environment
In 1997 World Development Report conveyed three principal messages describing “The State in
changing World”
 Effectiveness of State is vital for development, hence state should work to complement markets,
not replace.
 For sustainable development and reduction of poverty the good economic policies, well
developed human capital and openness to the world economy are important
 It is proved historically that a two part strategy of matching the role of the state to its capability,
and improving that capability.
The report further says that many countries are trapped in a vicious circle of declining state capability
and thus declining credibility in the eyes of their citizens leading to increased crime and an absence of
security affecting investment and growth.
State credibility is particularly important if developing countries are to attract private foreign
investment. The statistical evidence shows that in countries with sound policies and good governance,
real per capita income grew at 3 per cent per annum on average over the period 1964-93, in countries
with bad policies and bad governance per capita growth was a mere 0.4 per cent.
The Wolrd Bank concludes that without an improvement in the economic and social welfare.
The Governments should be very much decisive about
 Law and order
 Maintaining macroeconomic stability
 Investing in basic social services and infrastructure
 Protecting the vulnerable
 Protecting the environment
But the state doesn’t have to be the sole provider of all infrastructure and social services. Neither does
the state have to be the monopoly supplier of public utilities such as electricity, gas, telecommunication
and so on. These activities can be privatized with state supervision.
CORRUPTION
In general poverty breeds corruption, and corruption can lead to severe inefficiencies in the function of
economies.
The World Bank defines corruption as ‘the abuse of public office for private gain including bribery,
threats and kickbacks. These rents seeking behavior arises because decisions over the allocation of
resources are in the hands of politicians and governments officials.
The World Development Report 1997 outlines three essential ingredients for improving the capabilities
of the state.
 To check public authority. Independence of Judiciary is important, and independent commission
against corruption would be helpful
 Opening up competition in employment in the delivery of services.
 All government programmes are likely to work better if there is democracy, if power is devolved,
and users are consulted.
The state also has a duty to reduce bureaucracy and regulation to allow market to flourish.
Development Plans
A development plan is an ideal way for a government to set out its development objectives and
demonstrate initiative in tackling the country’s development problems.
The World Development Report 1997 four economic and social objectives were set out
 To achieve sustainable economic growth conducive to higher per capita income
 To generate more employment opportunities
 To achieve a more equitable distribution of income
 To restore and control external financial imbalances
Four basic types of models are mainly used in development planning:
1. Aggregate models; that consist on number of equations representing effects of relevant
variables on the economy.
2. Sector models; that isolates major sectors.
3. Inter-industry models; which shows transactions and interrelationships between
producing sector of the economy.
4. Models and techniques for allocation of resources.
Policy Models
Some of the important questions that need to be answered with the help of the structural equations are
as follows:
 Can capital be guaranteed in the quantities required?
 Will exports and foreign assistance keep pace with the imports required?
 Will the future demand for consumption goods, out of increases in per capita income exceed the
supply and cause inflation?
 Can the required interrelationships between industries be maintained so that bottlenecks do
not arise?
The Allocation of Resources: The Broad Policy Choices
Given the scarcity of resources in developing countries in relation to development needs, one of the
central issues in development economics is the allocation of resources among competing ends. Apart
from the decision of how much to invest, three broad types of allocation decision may be distinguished:
 Which sectors to invest in
 Which projects should receive priority given the factor endowments of country and its
development goals
 Which combination of factors of production should be used to produce a given vector of goods
and services?
INDUSTRY VERSUS AGRICULTURE:
The issue of the choice between industry and agriculture and where the emphasis should lie, can be
discussed very rapidly due to the two sectors are very much complementary to each other. Actually the
fortunes of agriculture and industry are closely interlinked in that the expansion of industry depends to
a large extent on improvements in agricultural productivity and improvements in agricultural
productivity depends on adequate supplies of industry ‘inputs’ including the provision of consumer
goods to act as incentives to peasant farmers to increase the agricultural surplus.
THE COMPARATIVE COST DOCTRINE:
It is closely related with the goals of the developing countries. It produces the optimum pattern of the
production and trade for a country. Efficiency can be maximized when no commodity will produce that
can be imported at low cost.
As far as growth is concerned, it emphasis on the criteria for investment and saving. Like it may be
disadvantageous to channel resources in such activities for which all income is consumed. So
comparative cost doctrine provide an idea that efficiency in resource allocation will maximize present
output and consumption but it may impair growth and future consumption.
Present versus Future Consumption
The choice between present and future consumption is the same as the choice between consumption
and investment in the present. How much investment should be undertaken in the present depends on
the time interval over which society wants to maximize consumption and what value it places on
consumption in the future compared with consumption in the present. The answer to the question of
how much to invest depends crucially on the planning horizon taken on discount rate chosen.
Maximization of consumption within the horizon would mean consumption all income at the end of the
horizon, leaving no saving for future investment and consumption.
INVESTMENT CRITERIA:
In traditional micro economics theory, under perfect competition resources are optimally allocated
where marginal product and the product price become equal. This is so called marginal rule for
resources allocation. It implies efficiency in such a way that any other redistribution of resources could
not maximize goods and services. But there are two major drawbacks associated with marginal rule:
first, it emphasis on maximization of present level of output, consumption or welfare. Second, in moist
of the developing countries there is extreme imperfection of markets, the application of the marginal
rule will only lead to a socially optimal allocation of resources without of divergence of between market
price and social cost.
Finally, the application of marginal rule will be beneficial if income distribution is optimal and remain
unaffected by any activities. if pattern of income distribution is changed then welfare changes because
of unwanted change in income distribution.
Many criteria have been suggested by different writers however, attention has been paid to the effects
of resources allocation decisions on the balance of payment in recognition of foreign exchange.