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Factors Affecting Economic Development and Growth

by Angie Mohr

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Industry

Industries experience cycles of economic growth and contraction based on many factors. These
include the overall health of the markets, consumer preferences and even seemingly unrelated
world news and events. Although some companies perform better than others in their industry, the
global factors that affect the industry as a whole must be contemplated when planning to start or
grow a business.
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Interest Rates

Interest rates can impact the growth of an industry in several ways. In large-ticket industries such
as vehicle manufacturers or cruise companies, an increase in interest rates can prevent customers
from borrowing to finance the purchase of these types of products and services. High interest rates
also deter companies from investing in new capital and expansion. On the other hand, falling
interest rates can stimulate industries to grow, which can lead to innovation and higher
employment levels.

Currency Strength

The value of the U.S. dollar compared to other foreign currencies such as the yuan, yen and the
pound is important even for companies that do not import or export goods. Consumers have a
choice to purchase goods or services originating in the United States or in other countries. If the
U.S. dollar strengthens, companies in the industry that purchase inputs from other countries are
able to be more competitive in pricing. In industries that are heavily reliant on foreign raw
materials and processing, such as the clothing industry, the entire sector can be lifted or depressed
with a strengthening or weakening of the dollar.

Government Intervention

Many industries are regulated by the government in one form or another. Government agencies
such as the Environmental Protection Agency, the Food & Drug Administration or the U.S.
Department of Agriculture maintain standards that all operators in an industry must follow for the
safety of consumers, employees, or natural resources. Some industries are more heavily regulated
than others and new laws and rules can shake up an entire industry and depress growth. For
example, new child toy safety laws implemented under the Consumer Product Safety Improvement
Act in 2009 threatened to wipe out many small toy producers as the requirements to test and
certify the toys were cost-prohibitive to all but large toy manufacturers. Proposed changes to the
Act may help alleviate the burden on small manufacturers and resellers.

Environmental Impact

Economic growth in an industry can be impacted not only by the environmental effect the products
or services have but also by consumers' perceptions of that impact. For example, the market for fur
apparel declined drastically over the course of a few years in the 1990s when consumers perceived
that raising and killing small animals for their fur was both inhumane and a poor use of land.
Although the industry is once again picking up with international demand, the number of fur
farmers in the country has substantially declined. If the public views an industry's products or
services as being harmful or unsafe, most companies within the sector can experience a marked
decline in sales quickly.

Overall Economic Health

The economic state of the country and consumer confidence can also spur growth and
development or harm it. In recessionary times, consumers begin limiting their purchases to the
essentials, foregoing luxury or big-ticket items. Companies also scale back production, hiring and
the development of new products and services to ensure that their finances can weather the storm.
In periods of overall economic growth, these companies once again expand. The opposite is true in
industries that deal in basic consumer goods that everyone needs regardless of the economy: food,
diapers, and staple goods. Demand picks up for these necessities as consumers stock up on them
and substitute basic goods for luxury goods (example: people buy more groceries to eat in rather
than go to a restaurant). In inflationary times, the demand for staple goods declines as consumers
can afford more luxury substitutes.

Economic growth is an increase in real GDP; it means an increase in the value of goods
and services produced in an economy. here are several factors affecting economic
growth, but it is helpful to split them up into: Demand side factors (e.g. consumer spending)
Supply side factors (e.g. productive capacity)Feb 22, 201

Economic growth is an increase in real GDP; it means an increase in the value of goods and
services produced in an economy.
The rate of economic growth is the annual percentage increase in real GDP. T

here are several factors affecting economic growth, but it is helpful to split them up into:

Demand side factors (e.g. consumer spending)

Supply side factors (e.g. productive capacity)

Economic growth in UK

Demand side factors Aggregate Demand (AD)


AD= C+I+G+X-M.

Therefore a rise in Consumption, Investment, Government spending or exports can lead to


higher AD and higher economic growth.
Graph showing rise in AD

What could affect AD?

Interest rates. Lower interest rates would make borrowing cheaper and should
encourage firms to invest and consumers to spend. People with mortgages will have lower
monthly mortgage payments so more disposable income to spend. However, 2009-16 we
had a period of very low interest rates, but due to low confidence and reluctant bank lending,
economic growth was still sluggish.

Consumer confidence. Consumer and business confidence is very important for


determining economic growth. If consumers are confident about the future they will be
encouraged to borrow and spend. If they are pessimistic they will save and reduce spending.

Asset prices. Rising house prices create a positive wealth effect. People can re-
mortgage against the rising value of their home and this encourages more consumer
spending. House prices are an important factor in the UK, because so many people are
homeowners.

Real wages. Recently, the UK has experienced a situation of falling real wages.
Inflation has been higher than nominal wage, causing a decline in real incomes. In this
situation, consumers will have to cut back on spending in particular reducing their
purchase of luxury items.

Value of exchange rate. If the Pound devalued, exports would become more
competitive and imports more expensive. This would help to increase demand for domestic
goods and services. A depreciation could cause inflation, but in the short term at least it can
provide a boost to growth.

Banking sector. The 2008 Credit crunch showed how influential the banking sector
can be in determining investment and growth. If the banks lose money and no longer want to
lend, it can make it very difficult for firms and consumers leading to a decline in investment.

Factors that determine long run economic growth

The average growth in real GDP is often known as the long-run-trend rate. This shows the
recession of 2008, caused a loss in potential GDP.
In the long run, economic growth is determined by factors which influence the growth of Long
Run Aggregate Supply (the PPF of the economy). If there is no increase in LRAS, then a rise
in AD will just be inflationary.
This graph shows an increase in LRAS and AD, leading to an increase in economic growth
without inflation.

LRAS can be influenced by


1. Levels of infrastructure. Investment in roads, transport and communication can
help firms reduce costs and expand production. Without necessary infrastructure it can be
difficult for firms to be competitive in the international markets. This lack of infrastructure is
often a factor holding back some developing economies.

2. Human capital. Human capital is the productivity of workers. This will be determined
by levels of education, training and motivation. Increased labour productivity can help firms
take on more sophisticated production processes and become more efficient.

3. Development of technology. In the long run development of new technology is a


key factor in enabling improved productivity and higher economic growth.

4. Strength of labour markets. If labour markets are flexible, then firms will find it
easier to hire the workers they need. This will make expansion easier. Highly regulated
markets could discourage firms from hiring in the first place.

Other factors that can affect growth in the short term


Commodity Prices. A rise in commodity prices such as a rise in oil prices can cause
a shock to growth. It causes SRAS to shift to the left leading to higher inflation and lower
growth.

Political instability. Political instability can provide a negative shock to growth.

Weather. The exceptionally cold December in UK 2010, led to a surprise fall in GDP

Annual Rate of Economic Growth in UK

Examples of Economic Growth


Obstacles to Economic Growth
Economic Factors Impeding Growth:
Most of the countries of Asia and Africa, which are under developed, have been at one time
or another under an alien rule. The most important cause of poverty in India and its under-
development is its subjection to the British rule. The foreign rulers, naturally, exploited the
dependent countries and used their resources to promote their own interest. These countries
were made to supply raw material at low prices. The foreign industrialist also made
investments in primary industries such as mining, drilling of oil wells, tea , coffee etc. Thus
the foreign masters used these countries as suppliers of raw materials to their industries and
markets for their manufactured goods. They did not take any interest I their economic
development.

Misuse of Resources due to Market Imperfections: Another important reason for the
economic back wardens of the under developed countries is the misuse of resources owing to
market imperfections by the market imperfections we mean the immobility of the factors of
production , price rigidities, ignorance regarding market , trends static social structure , lack
of specialization etc. This market imperfections are great obstacles in the way of economic
growth . It is due to market imperfections that productive efficiency in these countries is low,
the resources are either unutilized or underutilized and the resources are misallocated. When
the resources are perfectly mobile and there is perfect competition among them, they can
easily move from one sector to another in search of a better return and in this way they make
an optimum contribution to the national output.

Low Rate of Saving and investment: Another main reason of the poverty and under
development of the under developed countries is that the rate of saving and investment in
these countries is very low. In these countries only5-8 percent of the national income goes
into savings , whereas the rate is 15-20 percent and even more in the developed countries.
When the rat of saving in a country is low the rate of investment is bound to be low and the
rate of capital formation is low too. Since capital per man is low, the productivity is also low
productivity being low, the per capita income and the national income too are low.

Demonstration Effect: The under development of the economically backward countries is


also due to what has been called the demonstration effect the demonstration effect increases
propensity to consume which reduces the rate of savings and investment . A very important
principle has been propounded regarding consumption. That an individuals consumption
does not merely depend on individuals own income but it is very much influenced by the
standard of living or consumption of his friends and relations. When a man sees that some of
his friends and relatives have refrigerator , scooter, radio or TV set. Thus , consumption does
not depend upon absolute real income but on relative level of real income the is consumption
expenditure does not depend on our own purchasing power but on what in being spent by
other son the purchase of luxury articles.

Rapidly Growing Population: In the under developed countries , especially in the over
populated countries of Asia, population increases very rapidly. this has very adversely
affected their rate of economic growth . In fact rapid population growth is the greatest
obstacle to economic growth. Whatever increase takes place in the national output and
income in such countries as a result of development is devoured by the ever pouring torrent
of babies. It is like writing on the sand. That is why their standard of living and income per
capita cannot rise. For example the major part of increase in national income that has accrued
in India during the five year plans has been nullified by the rapid population growth.

Social and political obstacles to growth: There are several other factors
which have retarded the economic growth of under developed countries, Among
this we may mention the following in the under developed countries like india
agriculture has been carried on in a very inefficient manner. Lack of adequate
irrigation facilities and fertilizers, primitive agricultural practices. Poverty of the
peasant out molded systems of tenure. The under developed countries are
generally wanting in dynamic entrepreneurship. No wonder trade and industry
have been conducted at a very low level and few new grounds have been
broken. Economic development requires an army of trained and skilled personnel
who serve as instruments of economic progress these the under- developed
countries lack and consequently remain backward. Not only have the economic
factors handicapped economic progress of the under developed countries but
social factors too. Have played their part to keep them economically backward .
has divided the Indian society into ware tight compartments and has rendered co
operation in the economic sphere impossible. It has created divergence between
aptitude and the occupation actually pursued. By making functions here dietary.
It killed imitative and enterprise. Un touch ability has demolished millions of our
propel striking at the very root of dignity of labor
Homework Help > Social Sciences

What are some obstacles to economic growth


in developing nations?
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Asked on August 12, 2013 at 4:54 AM by kristenmarieb...
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pohnpei397 | College Teacher | (Level 3) Distinguished Educator


Posted on August 12, 2013 at 5:31 AM

There are many obstacles to economic growth in developing countries. Let us look at a few
of them.

Governmental problems. Governments in developing countries can often be corrupt. They


can act in ways that enrich only a few of the elite members of society without helping the
population as whole. They can be very unpredictable as well. This can scare off foreign
investors.

Cultural issues. Some scholars argue that some countries lack the right culture for economic
development. Their people might not want to take risks in order to start new businesses.
Their people might feel that traditional cultural duties are more important than showing up to
work every day. These sorts of cultural issues can slow a countrys growth.

Foreign debt. Sometimes, countries have to take actions that they do not want to take
because they need to pay off their creditors. They might have to do things that bring money
in the short term even if that hurts their ability to invest for the long term.

Lack of human resources. This may be a type of governmental problem. Many developing
countries lack the educational infrastructure needed to develop a workforce that could support
a more modern economy.

Foreign competition. Developing countries have to compete against companies from the
developed world. This can be very difficult. It can force developing countries to stay with
making low value-added products using cheap labor instead of becoming more modernized.

All of these factors (and more) can hinder developing countries economic growth.
What are the obstacles and potential opportunities
for economic growth in India?
There are two main obstacles. The first is labor regulations. Developing economies usually
transition from agriculture to manufacturing. But the transition in India has been to the
service sector. This is due in part to labor regulations. For instance, a firm with 100 or more
workers has to seek permission from the government to reassign the workers to different
tasks, to lay off workers or to close the firm. Such regulations impede large-scale
manufacturing operations that could employ thousands of workers producing unskilled-labor-
intensive products. As a result, the movement of workers from agriculture to manufacturing is
practically nonexistent. This is evident in the share of labor force in agriculture in India: It is
almost 50 percent. That is a large number.

The second is infrastructure. This is a well-known problem. Decades of underinvestment


have left the country with dire deficits in critical areas, such as railways, roads, ports,
airports, electricity and water. In the World Economic Forum's Global Competitiveness
Report for 2013-14, India ranked 85 out of 148 countries for infrastructure.

The opportunities are extensive. The first one, which people usually are aware of, is that
India is well-equipped with talent in science and engineering. The second, not so well-
known, is the size and age distribution of the consumers. The chart below depicts the age
distribution of the population. Just to give you some perspective, there are more than 600
million people in India aged 25 or younger. How big is that? Well, if you added up the entire
populations of the U.S., Mexico and Canada, you wouldn't come to even 500 million. So,
India is a big market. And this, of course, will be the working-age population in the next few
decades, when these millions will be not only earning but also spending. These are
potentially good opportunities not only for India but also for U.S. firms that sell consumer
goods abroad.
To overcome the obstacles and take advantage of the opportunities, India has to be more
efficient at managing its resources. Economists use total factor productivity (TFP) to
measure such efficiency. A country with a high TFP produces more with a given amount of
inputs, such as capital and labor, than does a country with a low TFP. The economic reforms
since 1991 have indeed increased India's efficiency. Before the reforms (1960-1991), TFP
growth accounted for 15 percent of GDP growth, but between 1991 and 2011 TFP growth
accounted for almost 25 percent of the GDP growth. So, the prognosis based on TFP looks
promising for India's future.

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[[File:Construction barriers.jpg|thumb|252px|right]

Poverty cycle: Edit

productive members of society. But little do we know, Judy "Jewish" Gleen is a poor helpless slut with no life and
ambitions. Thanks for calling and goodbye.

Another cycle consists of the fact that low income leads to low savings which leads to low investment which leads to
low income again. If the general income in a country is low, people in that country have less money to save.
Additionally, they are unable to save a substantial percentage of their income because they must spend a greater
percentage on necessary goods, such as food, making savings low. Since the quantity of loanable funds is low, it is
very difficult to borrow money. This discourages investors from taking out loans, which makes investment low. Since
investment is low, there is nothing to raise the general income of the country. Income remains low and the cycle
repeats itself. Because you have lower investment power, it is harder for companies to trust their money in your hands.
Also, foreign direct investment tends to decrease because the foreign countries see less opportunity to make money
because the general population doesn't have very much money. The only way to escape from the poverty cycle is to
raise two or more of these three aspects: income, savings, and investment. The most effective is investment if raised
high enough, the cycle could be broken because a great amount of investment has a higher potential to bring in greater
revenue for businesses, thus increase in income, which leads to more saving.

More examples of solutions are...

small increase of what the person has now in savings = increase in everything else, so it can slowly begin to transform
into a positive feedback loop that actually helps the population instead of damaging it.

the more educated parents = more educated kids ; more education = higher income micro loans which can help the
nation develop without them going deep into debt. Small individual business borrowing a small amount of money for
investment.

== Institutional and political factors==


Ineffective Taxation Structure: A country that cannot tax effectively does not receive a steady flow of income,
leading to a unusual, unreliable pattern to government spending, eventually leading to a decrease in development
projects. When the taxation systems in a government of an undeveloped country is ineffective, the revenue collected is
lower. The ineffective taxation causes the government to provide little or no basic institutions such as education,
infrastructure, effective banking systems and health care. When such institutions are omitted in a government the
development of that country slows, and may halt competely.
Lack of Property Rights: Within a country lacking property rights it is more difficult for businesses to start up,
since property barriers are in general not respected. Because people are less likely to follow property rules, this will
cause for the demand for property to go down. A great example of a country lacking in property rights is North Korea,
which is currently in a dictatorship. The result is widespread famine and the country's overall unhappiness.
Political Instability: Political instability can lay waste to a country's infrastructure, and can prevent government
income from being distributed in the manner most likely to lead to development. In order to enforce rules and keep
order that allow society to function there is a need for government. (Political instability means people who don't listen
to higher authority.) People must be willing to obey the laws of a country or else it will not work. A government is the
system that would regulate this.
Corruption: When there is corruption in a government the whole country suffers. The people of living under the
rule of a corrupt government do not have the benefit of stable institutions, and thus will have a lower standard of
living due to lack of development. This is a likely problem in an undeveloped country because the government is
unable to do anything beneficial for the country and its people. A corrupt or an instable government will hinder any
development in a country.

- Informal markets is also a factor to instituitional makets. An example of informal market is someone who is selling
brand name shoes in a parking lot for very cheap. No capital market DOES NOT equal expanding and the informal
market being not taxed = BAD! VERY BAD!

Infrastructure Edit

Infrastructure is the foundation of services that an economy needs to function. Roads, water supply and sewers are all
types of infrastructure. These necessities need to exist in an economy. A lack of infrastructure prevents an economy
from developing. If there are fewer roads in an economy, there will obviously be less transportation, thus making
goods more inaccessible to distribute. If there is a lack of water supply, there will be a huge demand for water in
addition to immense disease and dehydration problems. People will have overdependence on primary goods and there
will not be enough to support everyone. A lack of infrastructure greatly affects a countries ability to grow and develop.

Infrastructure is one of the key factor to a developed economy. Without infrastructure an economy doesn't run. If
infrastructure within a country is fairly developed the country itself will mimic in it's development level.

Infrastructure includes roads, sewers, water supply, all basic things a developed country would have. It is also very
hard to have healthy workers without having these basic needs for a country.

== International trade barriers==

Overdependence on Primary Products - Overdependence on primary products has a downward trend in its history.
Primary products are income and price inelastic. Therefore, even if the economy goes up, it would have little to no
effect on the income. A country having only primary goods is unsustainable due to the limited amount of resources.
An example of the effects of overdependance would be countrys who rely on oil as their main source of income. As
oil is a non-renewable resource, the growth/development that results fromthe oil profits is not sustainable in the long
run. Also, the price for primary goods tends to fluctuate wildly and is highly subjective to the fluctuations in the global
market. Over time, a downward trend may appear. This means that countries lose money over time, growing power.
This overdependence on primary products is also the reason why many undeveloped countries are not as developed as
others.

Consequences of Adverse Terms of Trade - Adverse terms of trade can be a barrier to economic growth because
it means that import prices have increased in relation to export prices. This would cause an economy to find itself
deeper and deeper in debt, and less and less competitive with trading partners. Such consequences include higher costs
of debt servicing, current account deficits from falling export revenue, reduction in much-needed imports (Ex: fuel,
capital), and increase in market for illegal crops.

Consequences of a narrow range of exports- A narrow range of exports is usually due to a countries
overdependence on primary goods. These countries often put primary goods as the main focus and overlook the
opportunities of producing secondary and tertiary goods. There is also a lack of their products diversity. That is
because these countries are often good at making a certain good and if there was ever a destruction or depletion of
these goods, the exports drop dramatically down. These are the consequences of a narrow range of exports. This is
often the reason why it is complicated for less developed countries to become more developed. Due to their heavy
reliance on primary goods.

Protectionism in international trade- Protectionism is the act of putting barriers into place to give
domestic industries an edge over foreign competitors. Although domestic industries gain an advantage from
proctectionism, consumers do not, because they must pay the price of the implied higher cost for goods produced
domestically. In other words trade barriers are almost never a good idea, they represent a beggar thy neighbor
philosophy and generally result in poor relationships between countries. Although there are very rare circumstances
where trade barriers may be called for it is infrequent and should be taken as a general rule that trade barriers are bad.
Note Ricardo's comparative advantage theory.

Indebtedness- Country A borrows money from country B and uses it in such a way that doesnt improve their
economy. Country A will then borrow money from country C, in order to pay off country B's loan. This therefore
causes indebtedness and is an international trade barrier. Generally to prevent this from happening institutions are put
in place to provide assurance that countries will spend money well. See institutions for more info.

Non-convertible currencies- Non-convertable curriences is when a country has a fixed exchange rate, so their
country is unable to buy or sell currencies. They won't be able to convert thier currieces which makes it harder for
their country to import or export goods. Because their country is not able to import or export goods, their GDP must
be pretty low since it's only their own country who is buying their own things. Not having a relationship with other
countries as in imports/exports makes it harder for the country to become develope. Not only can't the country be able
to buy or sell, other countries may be unattracted to it also and not buy nor sell with the country that has the non-
convertible currencies problem.

Capital flight- Capital flight is when foreign investments take all their money away from a country because
something occured in their economy to "spook" them out of investing in that country. They decrease their investments
and flow of money into the country. This is an international barrier to develpment because when the foreign
investment is taken away, the investment in the country decreases which reduces the inward flow of money to the
country. This doesn't help their growth in the slightest, and there would be less development in the country. This
generally happens when the country is doing poorly. So as a result of the country doing poorly and the disppearance of
the foreign investment, the country as a whole is serverely crippled.

An example of Capital flight is when the United States completely moved Google out of China. China was using
google to spy on certain people through the Gmail account system. Google didn't like that they were doing this so they
prohibited the use of google anywhere in China. They moved Google over to Japan to do business with them.

Social and cultural factors acting as barriersEdit

Social barriers to growth and development are any social issues that create barriers to economic development in either
a moral or immoral way. These barriers are often results of philosophical and co-operative beliefs.

Religion: Religion acts as a barrier to development because conflicting religions will fight, which impedes the
growth of a country. Instead of working together, religions battle it out. Some problems may lead to persecution,
which distracts the country so they put less time, and effort into developing their counrty. Another reason why religion
acts as a barrier is because it ties into tradition. Some religions have certain rules and regulations that will halt the
development process and slow it down. The ways of the old act as a barrier to development due to a common fear of
change (this fear exists in all humans).
Culture: Culture acts as a barrier to trade in a similar way as religion, meaning it prevents development through
restrictions over what is socially acceptable. For example, if contraceptives are considered taboo, diseases such as
AIDS will be more common in a country, lowering that country's human capital and chances for development.
Tradition: Traditionalism acts as a barrier to development because traditions can be old and out of date as a result of
social conservation. This means cultures with many traditions are at a disadvantage to other countries with more
modern methods because those who believe in traditionalism do not want to change certain habits, and if the country
does not change, it will never get developed. For example, attempting to create competitive and entrepeneurial forces
in agriculture has sometimes been met with confusion in countries where people cannot imagine individuals
personally owning land.
Gender Issues: Most often, "gender issues" refers to sexism. If women are not allow to contribute to the economy, it
is much harder for a country to develop due to the fact that women could increase productivity many times over.
Having only men lead the government of a developing country can be a sign of corruption. This is a problem present
in many developing country's governments. Also, if male children are preferred over female, it can lead to infanticide.
In extreme circumstances, there may be considerably less females in respect to males in the country and overall
efficiency will decrease, thus hindering development. Gender equality is dependant upon several factors, including
education (educated women can take control of their rights; this enables them to join the workforce), legal rights
(equal legal rights make women less dependant upon men for economic stability), and health care. An economy that
does not fully utilize its resources -- in this case all potential persons in the workforce -- it is at a serious disadvantage
in terms of development.

Categories:

Top 3 Methods for Measuring


Economic Development
Article Shared by

In the recent past, different economists described many new techniques of


measuring economic development.

These methods has emphasized that one should account for all such
components that determine welfare of the common masses.

These measures/methods are discussed in detail:


1. Physical Quality Of Life Index (PQLI):
In 1979, D. Morris constructed a composite Physical Quality of Life Index
(PQLI). He found that most of the indicators were inputs to development
process rather than result of the development process. These indicators
reflected that economically less developed countries are simply
underdeveloped versions of industrialized countries. He therefore,
combines three component indicators of Infant Mortality, Life Expectancy
and Basic Literacy to measure performance in meeting the basic needs of
the people.

However, the choice of indicators are:


1. Life Expectancy Indicator (LEI)

2. Infant Mortality Indicator (IMI)

3. Basic Literacy Indicator (BLI)

ADVERTISEMENTS:

These three indicators can be improved in a variety of ways. However, Prof.


Morris used Life Expectancy (LE) at birth as the indicator. Infant mortality
implies deaths before age one instead of life expectancy at birth. In case, the
figure for life expectancy at age one was not available, it could be worked
out by using a formula which relates life expectancy at birth, infant
mortality and the proportion of children.

How to Normalize Indicators:

We are familiar that life expectancy is measured in terms of years, infant


mortality rate in terms of per thousand and basic literacy rate in terms of
percentage. They cannot be simply added. Moreover, basic literacy can have
a natural zero for minimum and 100 for maximum, thus there exists no
natural minimum or maximum values for other indicators. For comparison,
each of the levels should be normalized. Prof. Morris choose the best and
worst levels in each of the three cases.

In the case of positive indicators of life expectancy and basic literacy the
best is shown by the maximum and worst by the minimum. While in case of
negative indicator of infant morality, the best is denoted by the minimum
and the worst by the maximum. For converting the actual levels of a
positive variable into normalized indicators, first the minimum values are
subtracted from the actual values and then the gap is divided by the range.

For positive indicators, the formula is:

Choice of Minimum and Maximum Values:


In case of life expectancy and infant mortality, there exists no natural
minimum and maximum values. The conversions from values to indices are
linear. Put the actual value of these indicators of the country in the
expression and get the reasonable indices as Physical Quality of Life Index.
2. Human Development Index (HDI):
Considering quality of Life Index, the United Nations was the first to
prepare and publish Human Development Index in the year 1990.

Human Development Index studies the following three basic


human aspects:
(i) Living a long life or Longevity (LEI)

(ii) Being knowledgeable on Educational Attainment (Index EAI).

(iii) Standard of living on Real per capita GDP (SLI).

These three indices can be expressed as

HDI = (1/3) (LEI + EAI + SLI)


Let us discuss these three aspects.

(i) Longevity (LEF):


Longevity means life expectancy at birth. It refers to the number of years a
newly born baby is expected to live. Life expectancy in India at present is 63
years.

(ii) Educational Attainment (EAI):


It means education attained by the people of the country on an average
basis.

The constituents of educational attainment are expressed


through the following two variables:
() Adult literacy rate (ALR)

(b) Gross enrolment ratio (GER)

(a) Adult Literacy Rate (ALR):


The rate or the percentage of people aged 15 and above who can
understand, read and write a short and simple statement in their everyday
life are known as literate. It implies that every literate must be capable of
reading and writing certain sentences. If someone is able to sign but not
capable of reading and writing simple statement is not literate. Thus,
capability of reading only or writing only does not make a person literate.
Literacy is the symbol of the quality of the people.

(b) Gross Enrolment Ratio (GER):


Gross Enrolment Ratio refers to the number of students enrolled at
different levels of education. It is the percentage of population of different
age groups engaged in educational pursuit. The education level consists of
primary, secondary and tertiary level. Basic elements of education are
provided at primary level.

Secondary level education is studied at middle and secondary level.


University level education is studied under tertiary level. General
enrolment ratio shows the percentage population enrolled at primary,
middle, secondary and university level. The higher GER indicates higher
quality of life. It will be the sincere effort of every economy to increase
general enrolment ratio as far as possible.
(iii) Real GDP Per Capita or Standard of Living (SLI):
It is considered as a measure of the standard of living of the people of a
country. In order to calculate human development index we are required to
study and analyse longevity, educational attainment and real GDP per
capita.

Quality Of Life Index (QLI):


Quality of life of the people is another index to measure the standard of
living of the people in an economy. It is influenced by national and per
capita income of the people. Many other factors like consumption, output,
health, environment, education, freedom, security, non-violence peaceful
atmosphere etc. also influence human welfare directly or indirectly. In
other words, none of these factors alone determines the welfare of the
people. At the same time, we should note that National Income is not itself
the single representative factor of welfare.

It is as such necessary that all the determinants of welfare should be


combined together to measure the quality of life index. But it is not possible
that every variable should be accounted for because of conceptual and
statistical difficulties. It is, therefore, said that an index comprising of
certain selected social factors be made to determine the quality of life index.
For example Human Development Index (HID) has been prepared under
United Nations Development Programme (UNDP).

In fact, they make an attempt to measure quality of life and we should make
reference to it towards the end. At the same time, we should remember that
these indices were developed in the international context. They were used
for ranking different countries according to its numerical value of
achievement in descending order.

UNIT
1
CLASSICALTHEORY
Structure
1.1
Introduction1.2 Classical Philosophy of Development1.3Class
ical Theories of Economic Growth and Development1.4An
Overview of Classical Theory of Economic Growth
andDevelopment1.5The Relevance of Classical
Theory to Under Developed Countries1.6
A
Critical Appraisal of Classical
Theories1.7 Let Us Sum Up1.8 References and Selected
Readings
1.9
Check Your Progress
-
Possible Answers
1.1
INTRODUCTION
Asyouknow,theoriesarefundamentaltoanysubject.
If
you are a student of ArtswithPoliticalScienceandEconomics as
subjects, youmighthavestudiedPoliticalTheory and Economic
Theory. Likewise, in development studies also, theories
ofdevelopment are fundamental to the concept of development.
This unit discussesthe classical theory of development. The
leading members of the classical schoolare Adam Smith,
David Ricardo, and
J.
S. Mill. This unit mainly discusses thethoughts of these
important economists who belong to the
classical school ofdevelopment.
In
the subsequent unit you will read about the Marxian
Theory.After studying this unit you should be able
to:explain classical philosophy of development;discuss classical
theories of development; andpoint out the criticisms of
classical theory of development.
1.2
CLASSICAL PHILOSOPHY OFDEVELOPMENT
The philosophical foundation of the classical school is
embedded in anindividualistic outlook. The classical
economists were basically concernedwith the
activities of individuals. According to classicists, it is
the welfareof each individual that leads to the
welfare of the society and not vice versa.There is no
conflict between the interests of the individuals and
those ofsociety. The welfare of society is the sum total
of the well-being of all theindividuals living in that
society. The classical economists derived
theirconclusions by different reasoning. By adopting
the inductive process, Smithsays that individualism is
the outcome of the principle of natural liberty. Adam5

Theories of Development
says that individualism is the outcome of the principle of
natural liberty. AdamSmithcontendsthatwheneachindividual
acts
freely,accordingtothenaturallawsoperating
within
him,
hemaximizeshisindividual welfareandhissociety'swelfarein the physical
world.
In
Smith's view, the ideal economy is a self-
regulatingmarket system that automatically satisfies the
economic needs of the people. Hearrivedatthisconclusionmore
fromhisobservationsofindividualbehaviour andfunctioningofsociety
than
fromsomeabstractprinciple.Hedescribesthemarketmechanismasan
"invisiblehand'' thatleadsallindividuals, inpursuitoftheirownself-interests,to
producethegreatestbenefitforsocietyasawhole.Heapprovesofonly
threefieldsforgovernmentaction:defense, justice, andpublic
works andinstitutions.
On
theother hand,classicaleconomistssuch
as
Ricardoand
Bentham
rejectedtheconceptsof
naW
awand
natural
liberty,and derivedtheirconclusionsonthe'principleofutility'.Accordingto
thisprinciple,eachindividualstrivesto
maximize
pleasure'
in
hisvariousdecisions.Another important aspect of the classical
school of development is the doctrineof laissez-faire. The
doctrine of laissez-faire upholds the idea of
economicliberalism.
In
other words, it says: let the natural forces of the
economicsystem work independently, and they will produce
results beneficial to boththe individual and to society. Guided
by his philosophy of Naturalism andOptimism, Smith
advocated a policy of economic liberty. This policy hasboth
negative and positive arguments. Negative arguments are
set against theinterference of government in economic
activities, while positive argumentsdemonstrated the
desirability of free trade.Smith gave two arguments in
support of the doctine of laissez-faire:i)Economic liberty
allows for full and free working of the mechanism ofthe
invisible hand in a competitive economy, which ensures the
maximumnational wealthii)Economic liberty facilitates
setting in forces which are responsible forthe growth of
the wealth of a country over a period of time.Thus, the
doctrine of natural order works in the economic field
through thelaws of the market and the laws of motion.The
classical economists are followers of the doctrine of laissez-
faire. Theycriticized the mercantilist system of protection.
Smith incorporated some ofthe Physiocrats' ideas, including
laissez-jbire, into their economic theories,but rejected the
idea that only agriculture was productive. The
classicaleconomists were against the subsidization of
agriculture in the form of theCorn Laws. They rejected the
mercantilist's protectionist policy of trade.They opposed all
kinds of restrictions on economic activities. According
tothem, all economies function best under private initiatives
and competitiveconditions, rather than under state control.
Individual action motivated byenlightened self-interest
and regulated by competition tends to
promoteindividual as well as social welfare. The classical
economists opposed thesystem of relief, or subsidy, to the
poor on the ground that it promotedlaziness, and increased
their family size. The economists in the classicalschool
produced their "magnificent dynamics" during a period in
which
6
capitalism was emerging fiom a post feudal society. A free
market economy,
Theories of
Development
12)
Smith also failed to
distinguish between
the conditions of
a stm.+ic ociety
andthose of a
dynamic society.
2
3)
Ricardo's
real interest was
in
the theory of
distribution, and
not
in
the
theoryof growth.
He did not analyze
the problems
of employment
and
cyclicalfluctuations.
You have read about
the classical
theory
of growth and
development,
its
relevanceto
uilderdeveloped co
untries and
criticisms of
classical theories.
Now,
try
andanswer the
following questions
given in the Check
Your Progress
3.
Check Your
Progress
3
Note:
a) Write your ans
wer in about
50 words.b) Check
your answers with
possible answers g
iven at the
end ofthe unit.
1)
Explain, briefly, the
Classical Theory of
Economic Growth.
2)
Write thrt'e
important
criticisms
of classical theory.
1.7
LET
US SUM
UP
In
this unit, we
explained the
classical theory of
economic growth.
We
st~~cl~cci
mith's model,
Ricardo's model
and
J.S.
Mill's theory of dev
elopmentseparatel
y.
We
made a critical
appraisal of
classical theo~y, n
d examined
itsrelevance to the
developing
countries.
REFEREN
CES AND
SELECTE
D
READINGS
Adelman,
I.
(1
961),
Theories
ofEconomic Growt
h and
Development,
Stanford
University
Press,
California.Dixit,
A.K.
(1976), Theory
ofEquilibrium
Growth, Oxford
University
Press,Oxford.Eltis,
W.
(2000), The
Classical Theory
ofEconomic
Growth, 2nd
Edition,Palgrave
Macmillan.Higgin
s,
13.
(1999). Economic
Development,
Universal Books,
New
Delhi.K~iidIberrre
r,
.
P.
(1984),
E'corzonric
Development, Mac
Graw
Hill, Singapore
Kuznet, S.
(1971),
Economic
Growth
ofNations,
Harvard
University Pres,
Cambridge.Mar
k,
B.
(1987), "Classical
Economics," The
New Palgrave
Dictionary
of
Economics, Vol.
1,
pp. 414-
45.Myrdal,
6.
(1968),
Asiun Drama,
Pantheon, New
York.Samuel
H.
(19871, Classical
Economics,
Oxford:
Blackwell.
1.9
CHECK
YOUR
PROGRESS-
POSSIB1,EAN
SWERS
Check Your
Progress
1
1)
Explain the
doctrine of
laissez-faire

Answer:
The doctrine of
laissez-faire
upholds the idea
of
economicliberali
sm. That is, let
the natural
forces of the
economic system
workindependen
tly, and they will
produce results
beneficial to both
theindividual,
and to society.
Guided by his
philosophy of
naturalism
andoptimism,
Smith advocated
a policy of
economic liberty.
This policyhas
both negative
and positive
arguments. Neg
ative wments
are setagainst
government
interference in e
conomic
activities, while
positiveargume
nts
demonstrated th
e desirability of
free trade.
2)
Discuss Adam
Smith's
argument in
favour of
laissez-faire.

Answer:
Smith gave two
arguments in
support of the
doctrine
oflaissez-
faire:i)Economi
c liberty allows
for full and free
working of
tl~.:
mechanism of
the invisible
hand
in
a
competitive
economy,
whichensures the
maxi murE
yationa1 wealth
ii)
Econclrnic
liberty facilitates
setti;?;
ir:
ft

,r
cc:;
e;hk
'1

.:re
responsible
f~r
he
growth of the
wealth
ol'
a
~otintry vzr pel-
ioal of time.
Check Your
Prugress
2
1)
Discuss
key
features of
Ricardian
theoryAnswer:
Accordiilg to
KIC?.:.'~!.
czpital
accumulation
increases
thedemand for
labour by
pushing up
market wages.
Rising wages
lead tothe
growth
of
pop1;l~tionwhic
h, in
turn,
brings wages to
the
equilibriumlevel
of subsistence
minimum.
The marginal
product (or, total
product-less-
rent) of
capital and
labour fall as a
consequence
of the law of
diminishingretur
ns. The relative
share of labour
(wages)
increases and
the relativeshare
of capital
(profits) falls.
In
the Ricardian
analysis, two
more
forcesdetermine
the pattern of
developmeiir.
'I'hey
are: the law of
population
andthe law of
diminishing
returns. The
process of
growth
will continue
untilprofits fall to
zero. At
this stage, capital
accumulation sto
ps, and
an
economyreaches
a stationary stat
e.
2)
What is Say's
Law?
Explain.Answer:
Say's law means
"Supply creates
its own
demand".
Thisimplies
three things:
(I)
Money is a veil;
its only function
is to serve
Classical
Theory
T h eo r i e s o f D ev el op me n t
as a medium of exchange;
(2)
general over-production (market glut) isimpossible;
(c) full employment equilibrium is automatically
ensured.So, in the long run, there can never be a
market glut. Therefore, thefree economy always
attains full employment equilibrium in the long
run.

An
imbalance in the labour market is the result of an
imbalancein the goods market. Full employment
equilibrium is automaticallyrestored by free market
forces.
Check Your Progress
3
1)
Explain the Classical Theory of Economic Growth,
briefly.Answer:
According to classical economists, an increase in
profits bringsan increase in investment. This
augments the capital stock, which, in
turn,
permits technological progress, and raises the
wages fund.Increased wages lead to population
growth, which raises labour costs(through
diminishing returns to labour on land), and reduces
profits.The cause-and-effect process is circular, and
proceeds as follows:
2)
Write three important criticisms of classical
theory.Answer:
The following are three important criticisms of
classicaltheoriesi)It is
a

static model as it does not exhibit any sequence.


While itlooks like a growth model, in a real sense it is
not really agrowth model.ii)The classical model does
not emphasize the role of entrepreneurs,who really
bring about innovations that lead
to capital formation.iii)The classical theory is
based on the unrealistic assumption ofperfect
competition. However, free and fair competition is

neverfound anywhere .
SIMILAR TO CLASSICAL THEORIES OF ECONOMIC GROWTH