BACHELOR OF ARTS

SEMESTER V

DEVELOPMENT ECONOMICS
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 Content

Unit - 1: Introduction To Development Economics...................................................................4

Unit - 2: Resources For Development.....................................................................................45

Unit - 3: Capital Formation And Development........................................................................72

Unit - 4: Theories Of Development.......................................................................................127

Unit – 5: State And Development..........................................................................................189

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UNIT - 1: INTRODUCTION TO DEVELOPMENT
ECONOMICS
STRUCTURE

1.0 Learning Objectives

1.1 Introduction

1.2 Meaning of economic development and growth Basis of Charge

1.3 Measurement GNP, PCI, HDI, GDI,

1.4 Happiness Index

1.5 Green GDP

1.6 Values in development

1.7 Economic and non-Economic Factors determining economic development

1.8 Obstacles to development

1.9 Market imperfection and social factors

1.10 Characteristics of a developing economy

1.11 Poverty

1.11.1 Absolute and relative

1.11.2 Inequality in income and wealth

1.11.3 Vicious circle of poverty

1.12 Sen’s capability approach

1.13 Summary

1.14 Keywords

1.15 Learning Activity

1.16 Unit End Questions

1.17 References

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1.0 LEARNING OBJECTIVES

After studying this unit, you will be able to:

 Understand the Meaning of economic development and growth Basis of

Charge

 Discuss the measurement GNP, PCI, HDI, GDI,

 Understand the concept of Happiness Index and Green GDP

 Analyse the Values in development

 Identify the Economic and non-Economic Factors determining economic

development

 Discuss the Obstacles to development

 Describe the Market imperfection and social factors

 Understand the Characteristics of a developing economy

 Discuss the concept of Absolute and relative Poverty

 Understand the Inequality in income and wealth

 Discuss the Vicious circle of poverty

 Analyse the Sen’s capability approach

1.1 INTRODUCTION

Development economics is a discipline of economics that studies the economic elements of

low-income countries' development. Its emphasis is not only on means of fostering economic
development, economic growth, and structural change, but also on increasing the potential of
the general population, such as via health, education, and workplace conditions, whether
through public or private channels.

[1] Development economics entails the development of ideas and procedures that aid in the
formulation of policies and practices that may be applied on a national or international scale.

[2] This could entail reshaping market incentives or employing mathematical approaches
such as intertemporal optimization for project analysis, or it could entail a combination of
quantitative and qualitative methodologies.

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[3] Some of the most common issues are growth theory, poverty and inequality, human
capital, and institutions.

[4] In contrast to many other branches of economics, methodologies in development

economics may combine social and political aspects in order to build specific programmes.

[5] Furthermore, unlike in many other subjects of economics, there is no agreement on what
students should know.

[6] Various ways may take into account the factors that influence economic convergence or
non-convergence across families, regions, and countries.

Economic development is described as the process of fostering the growth of a country's

economy by the application of several developmental plans and the implementation of a set
of successful economic tactics that make it more advanced and developed, hence positively
benefiting society.

Economic development is commonly defined as the amount of growth that occurs in the
economy and on the business cycle during a specific time period, or the collection of
measures and plans that many individuals who make decisions aim to implement within the
borders of the state.

These are essential and critical decisions that enhance the overall economic level as well as
improve the conditions of citizens and individuals who live in the country, which leads to an
improvement in the business cycle and all aspects of life.

1.2 MEANING OF ECONOMIC DEVELOPMENT AND GROWTH

BASIS OF CHARGE

Economics is all about making wise decisions in the face of shortage. Economic growth is the
most fundamental metric used to assess the success of resource allocation. Individuals keep
track of their earnings and the changing worth of their assets. Businesses monitor their
profitability and market share. Nations track a range of data to gauge economic growth,
including national income, productivity, and so on. Beyond growth and productivity, some
economists say that any assessment of the nation's economy must include distribution, equity,

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per-capita income, and so on. Furthermore, the country should focus on other societal needs,
such as environmental justice or cultural preservation, in order to sustain the economic
growth process and allow for overall human development in the economy through the
creation of more opportunities in the sectors of education, healthcare, employment, and
environmental conservation.

Economic development is described as a consistent improvement in society's material well-

being. Economic development encompasses a broader range of concepts than economic
growth. Aside from national income development, it encompasses social, cultural, political,
and economic changes that contribute to material advancement. It includes changes in
resource supplies, capital formation rates, population size and composition, technology,
skills, and efficiency, as well as institutional and organisational structure. These reforms
contribute to the larger goals of guaranteeing more equal income distribution, increased
employment, and poverty alleviation. In a nutshell, economic growth is a long chain of
interconnected changes in fundamental supply variables and demand structure that contribute
to an increase in a country's net national product in the long term.

Definition of Economic Development

Development is the process of structural transformation. Development economics is the study

of transformation of economies: transformation of agrarian and rural economies to urban and
modern economies, one with dominant traditional sector to one with dominant modern sector,
one with population of low skills to one with high skills and one with underdeveloped and
informal markets and institutions to one with developed and formal markets and institutions.
It analyses factors constraining and inhibiting the process of structural transformation and
studies policies and strategies which can facilitate such transformation.

Economic growth is a broad concept. It entails an increase in output in quantitative terms, but
it also includes qualitative changes such as social attitudes and practises, in addition to
quantitative growth in output or national wealth.

Economic growth is defined as the process by which a country's actual national and per capita
income increases over time.

This definition of economic growth consists of the following features of economic growth:

1. Economic growth denotes an increase in national and per capita income. The growth in
Per-Capita income is a better metric of Economic Growth since it indicates an
improvement in the living standards of the populace.
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2. Economic growth is assessed by an increase in real national income rather than a rise in
money or nominal national income. In other words, the increase should be based on an
increase in output of products and services rather than a simple increase in market prices
of current goods.

3. Long-Term Increase in Real Income: The increase in real national income and per capita
income should be sustained over a long period of time. Seasonal or transient income
increases should not be mistaken with economic development. z

4. Increase in Productive Capacity: An increase in income can only be sustained if it is the

result of a long-term increase in the economy's productive capacity, such as
modernization or the use of new technology in manufacturing, infrastructure
strengthening such as transportation networks, improved electricity generation, and so
on.

1.3 MEASUREMENT GNP, PCI, HDI, GDI

Measurement of GNP

The Gross National Product (GNP) is a metric that measures the value of all commodities and
services produced by a country's citizens and enterprises. It calculates the value of the final
goods and services produced by a country's citizens, regardless of where they are produced.

GNP is determined by adding personal consumption expenditures, government expenditures,

private domestic investments, net exports, and all income generated by foreign residents, less
income gained by foreign residents inside the domestic economy. Net exports are computed
by deducting the value of imports from the value of exports.

Unlike Gross Domestic Product (GDP), which estimates the value of goods and services
based on their geographical site of production, Gross National Product evaluates the value of
products and services based on their geographical location of ownership. It is equal to the
amount of a country's GDP plus any income earned by citizens from overseas investments,
less any income earned by foreign residents within the country. GNP excludes the value of
any intermediary commodities to avoid double counting, as these items are included in the
value of the final products and services.

Introduction to per capita income

You must have often heard the term “per capita income” or read it in the newspaper in the
economic section. Not only have that, but almost all of us learned about this term sometime
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in our growing years. But what does the term per capita income actually mean and why is it
you’ve probably heard the term "per capita income" or seen it in the economic section of the
newspaper. Not only have that, but practically all of us heard of this term at some point in our
lives. But, what exactly does per capita income mean, and why is it so essential in the realm
of economics? In economic and business disciplines, per capita income is frequently used to
measure by individuals in a population. A ratio is used to express per capita income. This
ratio is used to compare and conceptualize measurements for individuals. Depending on
where and how it is utilized, the ratio might potentially convey various information. To
comprehend the significance of per in the economic and business world, we need to go
through the fundamentals of this phrase and examine how it is calculated and applied in
various contexts.

The term per capita is derived from a Latin phrase which means “by head”. The term is
usually used to determine the average per person in a given measurement. The term is most
commonly used in economics, statistics and business as a way of reporting average per
person. By knowing the per capita, you get an idea about how the country, state or city affects
the people living there.

The per capita ratio is frequently used to compare economic statistics of countries with
varying populations. Per capita's interpretation and unit of measurement are determined by
the context in which it is employed. Income and gross domestic product are two typical
economic metrics that employ per capita data. When it comes to legal definitions, per capita
has a specific meaning. Given that definition, it means that an estate is divided equally among
all beneficiaries.

Because we are mostly discussing per capita income here, you should be aware that per capita
income is a measure of the amount of money earned per person in a country or geographic
region. This per capita income is frequently used to measure how much income there is per
person living in a specific location, which tells you about the level of living and quality of life
in that place. When calculating a country's per capita income, the national income is divided
by the population.

Every person in the population, including men, women, children, and even newborn babies, is
counted by per capita income because they are all a part of the region's or nation's population.
This distinguishes per capita income from other typical measures of a region's wealth.
Another type of measurement is household income, which includes all individuals living in a

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single family. Another metric is family income, which includes those members who are
related by blood, birth, marriage, or adoption who live under the same roof. Per capita
income is useful in determining an area's affordability. This is useful when combined with
real estate prices to determine whether homes in a certain area are out of reach for the
average middle-class family. Businesses utilise per capita income to assist them choose a
location for a new venture. If the per capita income in the area is high, the firm has a better
chance of succeeding there. Because people in such regions are more likely to spend money,
the business or firm has a better chance of producing more revenue. This is not practicable in
locations where the per capita income is low.

How is Per capita income calculated?

The income of each person in a population of a specific location is referred to as per capita
income. Based on this explanation, the following formula can be used to compute per capita
income.

Per capita income = total income of the population / population

Let’s understand this with an easy example; for instance, the total income of a small
geographic area with a population of 50,000 people is 50 lakh, the per capita income of that
region will be 50, 00,000 / 50,000 which is 500 rupees.

When calculating the per capita income of a nation, you can simply divide the nation’s total
income with the country’s population. Knowing the per capita income of a country gives you
an idea about the quality of life of people living in that country and the prosperity of the
nation.

Uses of Per Capita Income

The following are the most popular ways in which per capita is used: - Gross domestic
product (GDP) - Per capita income

 GDP Per Capita

GDP per capita is a measurement utilized to determine a country's economic output the
number of people living in the country. The GDP of your country is calculated by dividing
the country's total domestic output by its population. The formula for GDP is as follows:
Gross domestic product/population = GDP per capita

 Gross National Income Per Capita

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A similar method to the one used to calculate GDP per capita may also be used to calculate a
country's gross national income per capita. To calculate the gross national income per capita,
utilize the same statistics used to compute GDP, plus any income earned by residents from
overseas investments.

Limitations of Per Capita Income

Per capita income, like any other economic or financial tool, has limits, which are as follows:
*It does not account for income inequality among the population and hence cannot be
regarded a true indicator of people's standard of living. It does not account for inflation,
which is the rate at which prices rise over time. This has an impact on consumer purchasing
power and inhibits income growth. As a result of this, per capita income may exaggerate a
population's income.

* Per capita income does not include an individual's personal wealth and savings. Even
though they do not earn, children are included in the computation of per capita income.

This is why countries with a large number of children, such as India, may have skewed per
capita income figures.

To assess economic progress, qualitative indicators such as the HDI (Human Development
Index), gender-related indexes, the Human Poverty Index (HPI), infant mortality, literacy
rate, and so on are utilized. Although economic growth and economic development are
linked, they cannot be used interchangeably. Economists use several forms of economic
development indicators, indices, and metrics to analyses a countries or region's growth and
development.

Some of the most popular types of economic development indicators or indices available are
as follows-

Measurement of Gender Development Index

The UN has created the Gender-Related Development Index (GDI) and the
Gender Empowerment Index equality of a country. These are common types of economic
development indicator and indices that were introduced in the 1995 UNDP Human
Development Report.

The GDI is frequently regarded as a composite indicator used to assess the average
achievement of a country's population while accounting for gender differences. This sort of
economic development indicator and indices is used to learn about the gender gap by taking

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into consideration disparities between males and females via characteristics such as living
standards, knowledge, and health.

Measurement of HDI

Human development is a concept that is continually changing. The technique of the

organisation has evolved through time. HDI was calculated in the following manner until
2009. The original HDI was made up of three parts. The first was life-expectancy at birth,
which accounts for longevity and health status. It also reflects baby and child mortality rates
indirectly. The second was a measure of the society's educational attainment. Educational
attainment was calculated as a weighted average of adult literacy (with a weight of 2/3) and
enrolment rates in elementary, secondary, and tertiary education (with a weight of 1/3).The
final factor was per-capita income. In the design of HDI, all three components were given
equal weight. The HDI score of a country was calculated by combining all three components
(health, education, and income). In the creation of the HDI score, all three components were
given equal weight.

The Human Development Index (HDI) is one of the most widely used economic development
indicators and indices for measuring a country's average achievements. It was first
implemented as part of the United Nations Development Programme (UNDP) in 1990. It
considers three variables connected to human progress, such as living standards, knowledge,
and lifespan. The HDI assesses standard of living by GDP per capita income, knowledge
through adult literacy rates and total tertiary, secondary, and primary gross enrolment ratios,
and longevity through life expectancy at birth. This composite indicator tracks variations in a
country's level of economic development over time.

As previously said, the three dimensions of Human Development are people's capacities to
live a long and healthy life, acquire knowledge, and have access to resources necessary for an
acceptable quality of living. The Human Development Index measures the cumulative effect
of many components of human development (HDI). The HDI includes four variables: life
expectancy at birth, which represents the dimension of living a long, healthy life; adult
literacy rate and combined enrolment rate at the primary, secondary, and tertiary levels,
which represents the knowledge dimension; and real GDP per capita, which serves as a proxy
for the resources required for a decent standard of living. Thus, the HDI considers not only
GDP growth rate but also education, health, and gender inequality and income measures to
assess a country's human development.

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According to the United Nations Development Programme's (UNDP) latest available Human
Development Report (HDR) 2013 (which estimates the HDI in terms of three basic
capabilities: living a long and healthy life, being educated and knowledgeable, and enjoying a
decent economic standard of living), India's HDI was 0.554 in 2012, with an overall global
ranking of 136 (out of 186 countries) compared to 134 (out of 187 countries) in 2012.

India’s HDI has risen by 1.7% annually since 1980

1.4 HAPPINESS INDEX

The Happiness Index is a large-scale survey tool that measures happiness, well-being, and
dimensions of sustainability and resilience. The Happiness Index was created by the
Happiness Alliance to serve as a survey instrument for community organisers, researchers,
and others interested in using a subjective well-being index and statistics. It is the only
instrument of its kind that is freely available throughout the world and has been translated
into over 10 languages. This instrument can be used to assess life satisfaction and living
conditions. It can also be used to define income disparity, faith in government, a sense of
community, and other dimensions of happiness within specific demographics of a population.
This publication details the evolution of the Happiness Index between 2011 and 2015, as well
as implementation recommendations.

Bhutan served as an inspiration for the Happiness Alliance, which followed suit. Between
2011 and 2016, the Happiness Alliance's survey instrument was referred to interchangeably
as the Happiness Index and the GNHI. It was released under a Creative Commons Attribution
non-commercial licence (https://creativecommons.org/licenses/), which allowed users to use
it for any non-commercial purpose as long as they credited the Happiness Alliance.
Happiness Domains the Happiness Index assesses life satisfaction, happiness, and other
happiness categories such as psychological well-being, health, time management,
community, social support, education, arts and culture, environment, government, material
well-being, and job (Happiness Alliance, 2014c). The following qualities are measured in the
domains:

 Psychological Well-Being: optimism senses of purpose and of accomplishment;

 Health: energy level and ability to perform everyday activities;

 Time Balance: enjoyment, feeling rushed, and sense of leisure;

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  Community: sense of belonging, volunteerism, and sense of safety;

 Social Support: satisfaction with friends and family, feeling loved, and feeling lonely;

 Education, Arts, and Culture: access to cultural and educational events and diversity;

 Environment: access to nature, pollution, and conservation;

 Governance: trust in government, sense of corruption, and competency;

 Material Well-Being: financial security and meeting basic needs; and

 Work: compensation, autonomy, and productivity. (Happiness Alliance, 2014c)

Intended Uses of the Happiness Index

The Happiness Index is a resource for scholars, community organisers, and policymakers
who want to better understand and improve individual happiness, community well-being,
social justice, economic equality, and environmental sustainability. The index was created
with the goal of promoting social change by making the survey instrument and data available
to community organisers, educators, researchers, students, organisations, government, and
others. The index is unique in that it is the only widely comprehensive index available for
free online that allows survey participants to compare their own scores to the entire data set,
while also allowing users to customise the tool for a target population, add their own
questions to the survey instrument, and easily access data for their own sample as well as
comparison data in relation to the complete data set.

Basis for Practical Utility the aims of this resource are to

(a) Explain how the Happiness Index was created and refined in iterative rounds, and

(b) Describe how the Happiness Index can contribute to a new paradigm of sustainability,
social justice, and happiness.

For a future article, a robust statistical analysis of the Happiness Index across time is being
considered. However, with over 200 applications of the index to groups to date and after a
half-decade of work, it is reasonable to conclude that the index has passed the practical utility
requirement. Since 2011, the Happiness Alliance has collaborated with many of these
practitioners and researchers to implement the index, and has used input to develop the tool
through revisions. Users of the survey instrument, which include academics, policymakers,
and community organisers, largely believe that the index has face validity and is useful in
measuring happiness in communities and for groups, as intended.
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The Happiness Index Development

While the adoption of a happiness metre is a means of influencing social change in and of
itself, the validity and reliability of the survey and data obtained are equally significant. The
Happiness Alliance chose to offer this article as an explanation of the development processes
underlying the Happiness Index after working with communities, with researchers,
policymakers, and others. The purpose is to tell index users about the instrument's validity
and reliability, as well as the data collected thus far. It is worth repeating that the Happiness
Alliance plans to conduct more thorough statistical analysis in future investigations. The
Happiness Alliance, on the other hand, claims that the index, as it exists now, has established
face validity through a concretive iterative development process that has spanned several
years several academic and professional institutions did research.

The Happiness Index's development process was guided by the Happiness Alliance's goals of
supporting positive social change, the pursuit of social justice, increased individual and
societal happiness, and a sustainable future, as well as governmental adoption of broader
measures of wellbeing to guide public policy. Since 2010, changes to the Happiness Index
have been made in an organic and responsive manner in collaboration with communities and
community organisers. The survey instrument, like the European Social Survey (2006) and
other instruments, is changing, with core questions that remain constant. The index is
designed to be readily administered and completed quickly by survey respondents, while
accurately capturing the primary components that drive happiness. On the Organization for
Economic Cooperation and Development's Wiki progress page dedicated to the Happiness
Alliance, you can see examples of how researchers and community organisers have used the
survey instrument to collect data, analyse and report the data, and use it to educate the public
and inform policy.

Development Overview

In 2011, the Happiness Alliance commissioned the Personality and Well-Being Lab at San
Francisco State University to create the Happiness Index, which resulted in Round 1. The
Happiness Alliance's employees and advisors completed the remaining rounds. The following
explanation of the survey instrument's development phases clearly explains the survey and
index development process to date. The development techniques are explained so that survey

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instrument users can understand the history of data acquired by the Happiness Alliance and
utilise it when analysing data. The data may be useful to academics who want to understand
the historical background of their own data collection and compare it to data obtained by the
Happiness Index and other survey instruments. The disclosure of the development procedures
also ensures the survey instrument's reliability and validity.

Data Sources

The Happiness Index collects the majority of its data through convenience sampling, which
began in January of 2011. A minor percentage of the data (less than 5%) was gathered
through random sampling. The majority of survey respondents discovered about the
Happiness Index through word of mouth, the media, or from community organisers who
attended Happiness Alliance trainings on how to utilise the survey instrument in their
neighbourhood, workplace, city, or state.

1.5 GREEN GDP

Researchers have looked at a variety of solutions in their pursuit for a better way to account
for our economy. In previous articles, we looked at the GDP option and the sustainability
analysis option. However, as we have seen, both of these systems are at odds with one
another, and it appears that only one of these two other systems may exist. Because the
present economic system is founded on the market system, it appears that the market system
is the de-facto winner in this conflict!

The subject of environment, however, is too important to be just ignored because a correct
metric could not be found. It is for this reason that the search for alternate measures has
gained some momentum. One such alternate measure is the Green GDP. The Green GDP
was adopted by economic superpowers like China as early as 2004. India plans to adopt it
by 2015. This has lent considerable credence to this concept and analysts all over the world
now also pay careful attention to the Green GDP supplement that is released with the original
GDP figures.

Why Implement Green GDP?

The following are the primary arguments in favor of the Green GDP approach that have been
highlighted by scholars and recognized by several countries:

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  Interdependence of the market and nature: The Green GDP method is based on
the premise that nature and the market are not mutually exclusive variables. Indeed,
they are inextricably linked. Natural resources drive market growth, but too much
market growth has the potential to deplete natural resources. As a result, it is
necessary to actively regulate the interaction between these variables. Furthermore,
because measurement is the first step toward management, there is an instant
requirement for a metric that can assess and summarise the link between them.

 Comparison across peers and periods: Countries such as China have also said that
Green GDP may be used to compare the same country's environmental status over
time, or it can be used to compare a country's environmental status to that of another
country. The plan is to integrate information such as depletion analyses in GDP
reporting. This will allow analysts to estimate how the growth of those economies will
be affected in the future with more accuracy.

 Accountability: Last but not least, it will provide some accountability to governments

all around the world. It is now normal practise to ensure that the market system
thrives while the natural system dies.

What Green GDP Does Not Include?

When it comes to green accounting, there is a propensity to believe that natural resources will
be assigned a monetary value. Nations, like firms, have assets such as machines and factories,
but they also have assets such as mountains, forests, rivers, and oceans.

However, assets are typically associated with private ownership. That is why they are
valuable in the first place. These assets cannot be transferred to other persons in the absence
of private ownership, and thus have no value.

Oceans, mountains, and forests, for example, do not have private ownership. These are public
commodities that everyone can enjoy for free. As a result, pricing these assets and
incorporating them in a national balance sheet makes no sense. Furthermore, it is not possible
to count each and every asset and assign a monetary worth to it on a realistic level. It must
therefore be clear that green GDP is not about building fictitious assets in a country’s balance
sheet and this is generally excluded from any calculation.

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What Does Green GDP Include?

The services given by the environment are included in green GDP. For example, if one
geographical location has higher water quality than another, the residents in that region are
likely to enjoy healthier and more productive lives. The medical expenses linked with
contaminated water or air has a tangible and measurable cost. As a result, it is feasible to
establish a baseline for the quality of natural resources present in an ecosystem and the
benefits they give in terms of cost savings.

The most significant aspect of Green GDP is the depletion analysis. This is the document that
outlines the process of natural resource depletion in an economy. It also explains whether or
not the trend is sustainable. This information is useful for investors that make investments
based on a country's natural resources that can be used. Depletion of the natural resources
would therefore scare investors away maintaining an ecological balance. It must however be
noted that depletion analysis is an information only document. It has no legal backing and the
participants are still free to do as they see fit.

Challenges Facing Green GDP

The most difficult hurdle for Green GDP is realistic accounting. Because we are effectively
assessing the intangible, estimating the monetary values connected with them is quite
challenging. The Green GDP system is not without flaws. It is, nevertheless, evolving. Many
academics and researchers are working on a way to make Green GDP more pragmatic and
feasible.

The goal is to prevent the inadequacies of the GDP system from being replaced by another
problematic system. The procedure may take some time, but it appears to be on the right
track.

Importance of GDP

GDP: Building Block of Macro-economic:

The Gross Domestic Product (GDP) figure is the foundation of macroeconomics. This is
because modern macroeconomics is primarily concerned with the government enacting
policies to improve the economy's performance. We are now aware that the government
extensively employs the GDP statistic to construct policies, and hence this number serves as
the foundation for many of our policies.

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GDP: Identification of the Present State of Economy:

The GDP figure serves as the official definition of the current state of the economy. For
example, a recession is characterized in terms of GDP. When the GDP statistic falls for two
consecutive quarters, we call it a recession. On the other side, a slowdown occurs when the
GDP number shows a decreased rate of growth for two consecutive quarters.

As a result, any economy, and hence the entire world, officially defines itself on the boom-
bust cycle based on the GDP statistic.

GDP: Objective of policy formulation:

The Gross Domestic Product (GDP) figure is not just used to diagnose economic problems. It
can also be used to correct it. The goal of any government policy is judged in terms of its
impact on GDP. For example, if the GDP figure is declining, the goal of government policy
should ideally be to reverse this trend and establish a situation in which the GDP number is
rising. The government policy will specify in quantitative terms what changes they aim to
make to the GDP figure. The success or failure of government policy will be assessed against
the number given in its declared objectives.

GDP: Comparison between Economies:

The GDP figure allows us to compare economies on a cardinal and ordinal scale. The GDP
number can be used to rank the economy of nations or regions. Based on the GDP figure, we
can also draw judgments about the relative size of the economy. For example, the United
States' GDP is 14 times greater than India's economy. This remark actually means that the
GDP of the United States is 14 times greater than the GDP of India.

GDP: The Root Cause!

As we can see above, the GDP number is the sole thing that matters when it comes to
macroeconomic policy formation. As a result, the GDP figure is quite important. Now, if this
number was possibly defined incorrectly or if there were loopholes in the definition, it would
allow for a significant misallocation of public resources, and policies designed for one goal
could wind up having the exact opposite impact.

According to many notable economists, this is still the case today. The folks who are critical
of GDP are not conspiracy theorists. Rather, they are associated with Nobel laureates and
other mainstream economists. They argue that defining GDP incorrectly has numerous

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unforeseen implications. They link the recent economic crisis, in large part, to poor decisions
made as a result of this GDP misconception.

1.6 VALUES IN DEVELOPMENT

According to this concept, development is about more than only increasing the supply of
commodities (the focus of the per-capita income method), but also about improving
individuals' capacity to use these commodities and boosting people's freedom of choice. A
higher income is a crucial component of one's well-being. Individuals' well-being, however,
is also affected by their health, education, geographical and social environment, and political
system. There are three fundamental development values:

1. Sustenance: Sustenance is the ability to meet people's basic requirements. Life would
be impossible for everyone if they did not have certain basic needs. Food, housing,
health, and protection are examples of basic necessities. People should be able to meet
their basic necessities.

2. Self-Esteem: A sense of worth and self-respect, as well as a sense of not being

ostracised, are critical for an individual's well-being. All peoples and societies strive
for some level of self-esteem (identity, dignity, respect, honour etc.). The nature and
shape of self-esteem may differ from one culture to the next and across time. Material
values can influence self-esteem: Greater income or riches might be associated with
greater worthiness. Individuals may be deemed worthy based on their intellect or civic
service.

3. Freedom from Servitude: Individual well-being is dependent on human freedom, or

the power to choose. For societies, freedom entails a broader range of economic and
political options. It entails the abolition of bonds, serfdom, and other exploitative
economic, social, and political interactions.

According to the new perspective on the development process, per-capita income

alone cannot describe the process of progress. It cannot portray the multifaceted
nature of the growth process. A variety of various sorts of metrics have been
established in recent years to better reflect the multidimensional nature of the
20
 development process. Some of these new measures will be thoroughly examined in
the coming lectures. We will show that these measurements reflect the development
process and quality of life far better than per capita income. However, these are still in
the works and should be regarded as such.

1.7 ECONOMIC AND NON-ECONOMIC FACTORS DETERMINING

ECONOMIC DEVELOPMENT

Economic growth is a highly complicated phenomenon that is influenced by a wide range of

elements, including political, social, and cultural aspects. These elements are as follows:

A. Economic Factors

1. Natural Resources:

Natural resources are the most important factor influencing an economy's development.
Natural resources include land acreage and soil quality, forest wealth, a healthy river system,
minerals and oil resources, a favourable climate, and so on. The abundance of natural
resources is critical for economic progress. A country lacking in natural resources may be
unable to expand swiftly. However, the availability of abundant natural resources is a
necessary but not sufficient prerequisite for economic expansion. Natural resources are
underutilised, underutilised, or miss utilized in developing countries. One of the causes for
their backwardness is because of this. Countries such as Japan, Singapore, and others, on the
other hand, are not endowed with huge natural resources, but they are among the richest.
They are, however, among the world's developed nations. These countries have demonstrated
a commitment to protecting available resources, putting forth best efforts to manage
resources, limiting resource waste, and so on.

2. Capital Formation:

Another essential aspect in an economy's development is capital formation. Capital formation

is the process by which a community's funds are channelled into investments in capital goods
such as plant, equipment, and machinery, which boosts a country's productive capacity and
worker efficiency, ensuring a greater flow of products and services in a country. The process
of capital formation indicates that a community does not spend its whole income on products
for current consumption, but rather saves a portion of it and utilises it to make or acquire
capital goods that significantly increase the nation's productive capability.

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3. Technological Progress:

Technological advancement is a critical component in influencing the rate of economic

growth. Technological progress primarily entails study into the utilisation of new and
improved ways of manufacturing or the enhancement of existing processes. Natural resources
are sometimes made available as a result of technological progress. However, in general,
technical advancement leads to increased production. In other words, technical advancement
increases the ability to make more effective and fruitful use of natural and other resources for
boosting output. It is possible to produce a bigger output from a given set of resources by
using improved technology, or a given output can be obtained by using a smaller set of
resources. Technological growth improves the ability to make better use of natural resources,
for example, with the aid of power - powered farm equipment, agricultural production has
increased significantly. The United States, the United Kingdom, France, Japan, and other
sophisticated industrial nations have all gained industrial strength through the application of
superior technology. In reality, the adoption of new manufacturing techniques supports
economic development.

4. Entrepreneurship

Entrepreneurship entails the capacity to identify new investment opportunities, as well as the
courage to take risks and invest in new and developing company units. The majority of the
world's impoverished countries are poor not because of a lack of capital, a lack of
infrastructure, unskilled labour, or a lack of natural resources, but because of a severe lack of
entrepreneurship. As a result, it is critical in developing countries to foster entrepreneurship
by stressing education, new research, and scientific and technology advancements.

5. Human Resources Development:

A high population quality is critical in determining the level of economic growth. As a result,
investment in human capital in the form of educational, medical, and other social initiatives is
highly desirable. Human resource development improves people's knowledge, skills, and
capabilities, which raises their productivity.

6. Population Growth:

The increase in labour supply is a result of population growth, which creates a larger market
for goods and services. As a result, more labour produces more output, which a broader
market absorbs. Output, income, and employment continue to rise as a result of this process,
and economic growth improves. However, population growth should be expected to be
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typical. Population growth is stifling economic progress. Only in a sparsely populated
country is population expansion beneficial. It is, however, unjustified in a densely populated
country like India.

7. Social Overheads:

The provision of social overheads such as schools, colleges, technical institutions, medical
colleges, hospitals, and public health facilities is another key predictor of economic success.
Such amenities help the working population to be healthier, more efficient, and responsible.

Non-Economic Factors

Non-economic elements, such as socioeconomic, cultural, psychological, and political

factors, are as important as economic aspects in economic development. We will look at
some of the most important non-economic elements that influence an economy's growth.

1. Political Aspects:

Political stability and competent governance are critical to modern economic progress. A
stable, robust, and effective government, honest administration, transparent policies, and
their efficient implementation foster investor confidence and attract domestic and foreign
capital, resulting in faster economic development.

2. Social and Psychological Elements:

Social factors include social attitudes, social ideals, and social institutions, which alter as
education expands and culture shifts from one country to the next. Modern ideology,
values, and attitudes result in new discoveries and breakthroughs, as well as the rise of
new entrepreneurs. Outdated social traditions limit vocational and geographical mobility,
posing a barrier to economic development.

4. Education:

It is now widely acknowledged that education is the primary means of growth.

Greater progress has been made in countries where education is widely available.
Education is crucial in human resource development because it increases labour
efficiency and reduces mental barriers to new ideas and knowledge, which leads to
economic progress.

5. Desire for Material Advancement:

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 Desire for material advancement is a crucial requirement for economic development.
Societies that place a premium on self-satisfaction, self-denial, and confidence in fate, for
example, limit risk and enterprise, causing the economy to stagnate.

1.8 OBSTACLES TO DEVELOPMENT

Economic growth is regarded as one of the things and criteria that may alter depending on the
surrounding circumstances and may also not continue in accordance with the legislated plan.

Many impediments and limitations to economic development may exist, limiting its
evaluation and expansion. Economic obstacles make it harder for a company to access a
certain market.

From this perspective, successful strategies frequently take economic barriers into account,
place them at the forefront, and attempt to develop ways to tackle them by utilizing
successful means to conquer and control them.

It is possible that the economic growth process may encounter some challenges and
impediments, and that some revisions will be made to all of the plans that have been devised.

Many things happen to the economy in general that have a negative impact, but they are
unpredictable or even mitigated.

We've spoken about the hurdles to economic development and the different sorts of financial
threats that the economy faces today.

1. High population growth rates:

Depending on the circumstances, population expansion can have a beneficial or bad impact.

The random increase in population is one of the most significant challenges that any country's
economy may confront.

Population expansion is seen as one of the most significant impediments and roadblocks to
economic progress and development.

The huge population is regarded as a significant strain on economic resources, as economic

resources are frequently insufficient and do not cover the existing population, resulting in the
formation of strain on the resources and services given.

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For example, investment projects that in turn increase economic development may not lead to
sufficient numbers of employees.

2. Low level of the human factor: An increase in population numbers in comparison to the
hurdles to economic development causes labour to leave the country and intensifies the
processes of immigration abroad.

Building human elements is one of the most crucial factors for any economic plan's success,
and this necessitates boosting educational outcomes of all kinds.

The human factor is regarded as one of the most essential economic factors and constituents,
which increases project production, improves economic growth, and shifts the economic
cycle.

As a result, the state must endeavour to give special attention to all human resources, as well
as to university students, institutions, colleges, and so on, as well as to make all essential
provisions for their training.

 3. Lack of an attractive investment destination:

The lack of an appealing investment environment, as well as a lack of economic resources

and infrastructure, is among the most significant hurdles to economic development.

Economic development is primarily dependent on growing the number of investments, which

leads to an increase in the number of employees and their employment, as well as work to
move the economic wheel in general. The failure of economic projects causes an increase in
the number of unemployed people, as well as a slowing of economic development processes
.

Encouragement of investment and maintenance of infrastructure is one of the most important

means of achieving economic development and providing various job opportunities for the
unemployed, in addition to the investment's ability to exploit the resources available for
production and achieve profits that contribute to the economy's support.

4. Poor transportation network:

Transportation is regarded as one of the most significant factors of economic development,

contributing to the activation and development of all parts of life, as well as making life
easier and better.

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Poor transportation systems reduce economic and industrial competitiveness by increasing
freight unit costs. It also enhances the total inventory damages, transit expenses, ordering
costs, and overhead costs.

A well-developed transportation infrastructure reduces the cost of carrying people and

products. This boosts economic output.

5. Lack of innovative solutions:

One of the most significant barriers to economic development is the failure to identify new
solutions.

This issue manifests itself in major and obvious ways in some communities that rely on
traditional forms of conducting business. The full reliance of many cultures and countries on
oil is perhaps the most visible manifestation of this. It is possible to lower the oil bill by
putting in more effort to research and adopt alternate methods.

Some countries continue on using oil, while developed countries have become alienated from
and limited their use of it due to the significant harm it causes to humanity at all levels.

6. Market imperfection

Economists believe that ignorance of market conditions, a lack of labor support, a lack of
clear expansion plans, and a lack of jobs frequently result in market imperfection, which is
one of the most significant barriers to economic growth and development.

7. Underutilization of resource

Some economies are not utilizing their national resources to their maximum potential, which
constitutes a significant impediment to economic growth and development.

8. Lack of demand

Poor income, limited purchasing power, and a low standard of living will stymie economic
growth and progress.

1.9 MARKET IMPERFECTION AND SOCIAL FACTORS

According to market imperfections theory, complete competition between foreign markets

does not exist. Examine the most prevalent ways for rectifying these flaws, as well as foreign
direct investment, which involves investments that cross national borders.

26
If you've ever bought a foreign-made car, you're already familiar with the market
imperfections hypothesis and foreign direct investment. The automotive industry in the
United States is one of the most competitive in the world. Previously, American corporations
dominated the market. These firms now account for only half of the market. Toyota, Honda,
BMW, Nissan, Mazda, and Volkswagen are just a few of the automakers that presently
manufacture in the United States. Market imperfections theory and foreign direct investment
explain why these corporations chose to invest in the United States because of flaws in the
international trade market.

Market defects theory is a trade theory derived from international markets in which perfect
competition does not exist. In other words, at least one of the assumptions for perfect
competition is violated, resulting in what is known as an imperfect market. We all know that
a perfect market is unattainable. Even in the United States, markets are imperfect. Remember
that the following assumptions are made for a perfect market

1. Both buyers and sellers are price takers.

2. Companies sell products that are nearly identical.

3. Both buyers and sellers have complete information.

4. A modest market share is held by a number of enterprises.

5. There are no access or departure restrictions.

Market structures such as monopolies, monopolistic competition, and oligopolies are

examples of conditions that violate perfect competition. Firms are viewed as price takers in
international trade since they are only a small part of a foreign market. They cannot affect the
price, must cope with government involvement in trade, and must work with poor
information. This is why foreign automakers relocated certain operations to the United States.

Monopolies, monopolistic competition, and oligopolies are instances of market systems that
violate perfect competition. Firms are seen as price takers in international trade since they
constitute just a small portion of a foreign market. They cannot influence the pricing, must
deal with government intervention in trade, and must work with little knowledge. This is why
international automakers moved certain operations to the United States.

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Individual buyers and sellers can influence prices and output in an imperfect market, there is
no full disclosure of product and price information, and there are strong barriers to entry and
exit.

Perfect competition, market equilibrium, and an infinite number of consumers and sellers
constitute a perfect market.

Imperfect Markets' Consequences

Not all market flaws are innocuous or natural. When too few sellers dominate too much of a
single market, or when prices fail to respond appropriately to major changes in market
conditions, situations such as these might occur. The majority of economic argument stems
from these occurrences.

Some economists claim that any variation from perfect competition models warrants
government intervention to boost production or distribution efficiency. Monetary policy,
fiscal policy, and market regulation are all examples of such interventions. Antitrust law,
which is openly developed from perfect competition theory, is a common example of such
interventionism.

Imperfect Markets and Their Characteristics

When at least one requirement of a perfect market is not met, an imperfect market might
result. Every industry has flaws of some kind. The following structures exhibit imperfect
competition:

Monopoly

This is a system in which just one (dominant) seller exists. This entity's products have no
substitutes. These markets have significant entry barriers and a single supplier who
determines the prices of products and services. Consumers may be unaware of price changes.

Oligopoly

This construction has a lot of buyers but just a few sellers. These few market participants may
prevent others from entering. They may establish pricing jointly, or, in the case of a cartel,
one takes the lead in determining the price for goods and services, with the rest following.

Monopolistic Rivalry

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There are many suppliers in monopolistic competition who offer similar products that cannot
be substituted. Businesses compete with one another and set prices, but their individual
decisions have little bearing on the other.

Oligopoly and Monopsony

There are a lot of vendors in these structures, but there aren't a lot of purchasers. In both
scenarios, the buyer manipulates market prices by pitting companies against one another.

1.10 CHARACTERISTICS OF A DEVELOPING ECONOMY

Economic development is the process by which the general population's overall education,
well-being, health, income, and living conditions increase. This is where the economy will
gradually develop, alter, and advance. In other words, a country achieves economic
development when developing economies mature and there is a steady shift from agriculture
to industry to services, resulting in economic growth.

Economic development is a top goal for local, state, and federal governments since it will
lead to an increase in creativity and new ideas, greater literacy rates, job creation, a better
environment, higher wealth generation, labour support, and a higher quality of life. Students
at institutes such as the Norman Paterson School of International Affairs and the International
Institute of Social Studies can study economic growth and development.

Important features/characteristics of economic development are as follows

1. Economic Development is a continuous process

Every developing economy strives to implement economic policies and programmes that
promote economic growth and development. It is a long-term process that will result in better
use of financial and human resources, increased demand and supply of goods and services, a
higher quality of life, and rise in national income.

2. Economic Development boosts national income

One key feature of economic development is that it will help to raise per capita income,
resulting in an increase in national income. It is a proven truth that when a person's income
rises, so does a country's national income.

3. Economic Development improves the standard of living

A rise in per capita income leads to an increase in a person's purchasing power. A key feature
of economic growth is that increased consumption of goods and services results in a higher

29
quality of life, rising economies, company expansion, and a higher standard of living for
individuals.

4. Economic Development helps to utilize national resource property

An economy that believes in economic development would maximize the use of national
resource property and keep pace with global economies. It will make the best use of its
human, ecological, and physical resources and will offer its people and communities
incentives and opportunities such as better education, labor support, corporate expansion, and
more jobs.

5. Economic Development results in structural changes

One significant feature of economic growth is that the process will aid in structural changes
and increased opportunities in industries ranging from agriculture to manufacturing to the
service sector. Agriculture was formerly the major employment of a developing country, but
with new occupations and business prospects, it has been displaced by the services sector,
which now accounts for more than half of total national income.

6. Economic Development leads to social-economic equality

Economic development has resulted in both social and economic equality in people's income,
wealth, position, quality of life, and standard of living.

1.11 POVERTY

Poverty is defined as not having enough money or resources to have a good standard of
living, such as a lack of access to healthcare, education, or water and sanitation services,
among other things.

Poverty is defined as the inability to procure or supply a basic amount of food, water, and/or
shelter or acceptable housing. What should be realized is that in many circumstances, it is not
the fault of these (financially) disadvantaged people. A family might fall into poverty for a
variety of causes, including death in the family, unexpected unemployment, and crop failure.

Some individuals believe that by hard work and ambition, anyone can simply rise out of
poverty. Statistics reveal, however, that people who are born into poverty are more likely to
remain poor, no matter how hard they work or strive. If the economic system, i.e. the poverty
cycle, is against them, the majority will be unable to find a route out of poverty. 

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Primary and secondary poverty

Primary poverty is defined as a situation where income is insufficient to meet basic needs –
even if every penny is spent wisely.

Secondary poverty is defined as a situation where money is misspent on luxuries – leaving

insufficient disposable income to buy necessities.

Joseph Rowntree in his groundbreaking study “Poverty: a study of Town Life” (1899)
investigated living conditions in York and found 24% of the population were living in
primary poverty. His detailed methodology showed that poverty was due to insufficient
income and not due to the extravagance of spending often attributed to poverty by the
Victorians.

1.11.1Absolute and relative

Definition of Absolute poverty

 Absolute poverty – is a condition where household income is below a necessary

level to maintain basic living standards (food, shelter, housing). This condition
makes it possible to compare between different countries and also over time.

There will be different concepts of what is a necessary level to maintain basic living
standards. The United Nations defined absolute poverty as:

“a condition characterized by severe deprivation of basic human needs, including food, safe
drinking water, sanitation facilities, health, shelter, education and information. It depends not
only on income but also on access to services.”

The absolute method is set at a fixed level that does not change over time. There might be a
huge gap between the current level of poverty and the historical standard when this approach
is used. Absolute poverty is, therefore, losing its status in the world of economics especially
in countries where the economy is growing and living standards are rising.

Relative poverty

Definition of Relative poverty

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  Relative poverty – A condition where household income is a certain percentage
below median incomes. For example, the threshold for relative poverty could be set
at 50% of median incomes (or 60%)

Relative poverty is important for determining the percentage of the population that has fallen
behind. Relative poverty is defined substantially differently in the 2010s than it was a century
ago.

Relative poverty occurs when a household's income is 50% less than the average household
income, implying that they have some money but not enough to afford anything beyond the
necessities. This form of poverty, on the other hand, varies according on the country's
economic growth.

 Relative poverty is also known as "relative deprivation" since persons in this group is
not living in total poverty, but they do not have the same level of living as the rest of
the country. It could be television, the internet, clean clothes, a safe home (a clean,
safe setting devoid of abuse or neglect), or even education.

 Relative poverty can also be permanent, which means that particular families have no
prospect of enjoying the same levels of life that other people in the same community
do. They are effectively "stuck" in a low relative income category.

When using the relative technique to quantify poverty, another notion – persistent poverty –
must be investigated. Every two out of every three years, households receive 50 to 60% less
income than average income. Because long-term poverty has a greater influence on economic
and social conditions, persistent poverty is an important notion to remember.

1.11.2 Inequality in income and wealth

Income disparity refers to how income is distributed unequally across a population. The more
unequal distribution, leads to greater the income inequality. Wealth inequality, or the unequal
distribution of wealth, is frequently associated with income inequality. Populations can be
segmented in various ways to demonstrate various levels and types of income inequality,
such as income inequality by gender or race. The Gini coefficient, for example, can be used
to examine the extent of income inequality in a population.

Barely 10 years past the end of the Great Recession in 2009, is the U.S. economy doing well
on several fronts. The labor market is on a job-creating streak that has rung up more than 110
months straight of employment growth, a record for the post-World War II era. The

32
unemployment rate in November 2019 was 3.5%, a level not seen since the 1960s. Gains on
the jobs front are also reflected in household incomes, which have rebounded in recent years.

However, not all economic indicators appear to be positive. Household income has expanded
fairly slowly this century, and household wealth has not recovered to pre-recession levels.
Economic inequality, as measured by income or wealth disparities between wealthy and
poorer households, is widening.

1.11.3 Vicious circle of poverty

In economics, the cycle of poverty is the “set of factors or events by which poverty, once
started, is likely to continue unless there is outside intervention.” The cycle of poverty has
been defined as a phenomenon where poor families become trapped in poverty for at least
three generations. These families have either limited or no resources.

There are numerous drawbacks that, when combined, form a vicious circle, making it nearly
impossible for anyone to break free. This happens when poor people lack the resources they
need to rise out of poverty, such as financial capital, education, or relationships.

The cycle of poverty is defined in economics as "the combination of reasons or events by

which poverty, once started, is likely to continue unless there is outside intervention." The
poverty cycle has been defined as a phenomenon in which disadvantaged households remain
impoverished for at least three generations. These families either have few or no resources.

There are numerous drawbacks that, when combined, form a vicious circle, making it nearly
impossible for anyone to break free. This happens when poor people lack the resources they
need to rise out of poverty, such as financial capital, education, or relationships.

In other words, poor people have difficulties as a result of their poverty, which exacerbates
their situation. This would imply that the poor will remain impoverished for the rest of their
life.

This cycle has also been referred to as a "pattern" of unchangeable behaviors and conditions.
When applied to countries, the poverty cycle is commonly referred to as the "development
trap.

Dr. Ruby K. Payne distinguishes between situational poverty, which can generally be traced
to a specific incident within the lifetimes of the person or family members in poverty, and
generational poverty, which is a cycle that passes from generation to generation, and goes on
to argue that generational poverty has its own distinct culture and belief patterns.

33
Economic development can be viewed as a virtuous loop. It could begin with an outside
factor, such as technological innovation. There may be learning curve effects and economies
of scale as individuals become more comfortable with the new technology. This could result
in lower costs and higher production efficiencies.

The vicious cycle of poverty refers to a circular constellation of causes that tend to act and
react on one another in such a way that a poor country remains poor. A poor guy, for
example, may not have enough to eat; if he is underfed, his health may suffer; if he is
physically weak, his working ability is low, which means he is poor, which means he will not
have enough to eat; and so on. A scenario like this in a country as a whole might be summed
up in the trite proverb: "A country is impoverished because it is poor.”

The basic vicious circle is caused by the fact that total productivity in LDCs is poor due to a
lack of capital, market flaws, economic backwardness, and underdevelopment. However,
vicious loops exist on both the demand and supply sides.

The demand side of the vicious circle is that a low level of real income leads to a low level of
demand, which leads to a low rate of investment and thus back to a capital shortage, low
productivity, and low income. Low real income reflects low production.

A low level of actual income implies a low level of saving. A lack of savings leads to a lack
of investment and a lack of capital. Capital scarcity, in turn, leads to low production and,
ultimately, low income. As a result, the supply side of the vicious loop is complete.

The low level of real income, which reflects low investment and capital insufficiency, is a
feature shared by both vicious loops.

Underdeveloped human and natural resources are engulfed in a third vicious loop. The
development of natural resources is dependent on the country's people's productivity
potential. If people are backward and illiterate, and lack technical competence, knowledge,
and entrepreneurial activity, natural resources will tend to go unutilized, underutilized, or
even depleted.

On the other hand, people are economically backward in a country due to underdeveloped
natural resources. Underdeveloped natural resources are, therefore, both a consequence and
cause of the backward people.

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1.12 SEN’S CAPABILITY APPROACH

The Capability Approach is distinguished by its emphasis on the moral significance of

individuals' abilities to live the kinds of lives they have reason to value. This contrasts it from
more established methods to ethical judgment, such as utilitarianism or resources, which are
solely concerned with subjective well-being or the availability of means to a good life,
respectively. A person's potential to live a good life is characterized by the set of valuable
'beings and doings' that they have real access to, such as good health or meaningful
connections with others.

Amartya Sen, an Indian economist and philosopher, was the first to articulate the Capability
Approach in the 1980s, and it is still most strongly identified with him. It has been widely
used in the context of human development, for example, by the United Nations Development
Programme as a broader, deeper alternative to primarily economic indicators such as GDP
per capita growth. In this context, 'poverty' is defined as a lack of ability to live a pleasant
life, and 'progress' is defined as capacity expansion.

The innovative focus of the Capability Approach has piqued the interest of a number of
academic philosophers. It is thought to be relevant for the moral evaluation of social
arrangements outside of the development context, such as when evaluating gender justice. It
is also considered as laying the groundwork for normative theorizing, such as a capability
theory of justice, which would include an explicit ‘metric' (that specifies which capacities are
valuable) and 'rule' (that specifies how the capabilities are to be distributed). The philosopher
Martha Nussbaum developed the most influential form of such a capacity theory of justice,
deriving from human dignity needs a list of essential capabilities to be incorporated into
national constitutions and guaranteed to all up to a particular level.

This article focuses on the philosophical aspects of the Capability Approach and its
foundations in the work of Amartya Sen. It discuss the development and structure of Sen’s
account, how it relates to other ethical approaches, and its main contributions and criticisms.
It also outlines various capability theories developed within the Capability Approach, with
particular attention to that of Martha Nussbaum.

The Development of Sen’s Capability Approach

35
a. Sen’s Background

Amartya Sen had an extensive background in development economics, social choice theory
(for which he received the 1998 Nobel Prize in Economics), and philosophy before
developing the Capability Approach during the 1980s. This background can be pertinent to
understanding and assessing Sen’s Capability Approach because of the complementarity
between Sen’s contributions to these different fields. Sen’s most influential and
comprehensive account of his Capability Approach, Development as Freedom (Sen 1999),
helpfully synthesizes in an accessible way many of these particular, and often quite technical,
contributions.

Sen first introduced the concept of capability in his Tanner Lectures on Equality of
What? (Sen 1979) and went on to elaborate it in subsequent publications during the 1980s
and 1990s. Sen notes that his approach has strong conceptual connections with Aristotle’s
understanding of human flourishing (this was the initial foundation for Nussbaum’s
alternative Capability Theory); with Adam Smith, and with Karl Marx. Marx discussed the
importance of functioning and capability for human well-being. For example, Sen often cites
Smith’s analysis of relative poverty in The Wealth of Nation in terms of how a country’s
wealth and different cultural norms affected which material goods were understood to be a
‘necessity’. Sen also cites Marx’s foundational concern with “replacing the domination of
circumstances and chance over individuals by the domination of individuals over chance and
circumstances”.

b. Sen’s Concerns

The Capability Approach attempts to address various concerns that Sen had about
contemporary approaches to the evaluation of well-being, namely:

(1) Individuals can differ greatly in their abilities to convert the same resources into valuable
functioning (‘beings’ and ‘doings’). For example, those with physical disabilities may need
specific goods to achieve mobility, and pregnant women have specific nutritional
requirements to achieve good health. Therefore, evaluation that focuses only on means,
without considering what particular people can do with them, is insufficient.

(2) People can internalize the harshness of their circumstances so that they do not desire
what they can never expect to achieve. This is the phenomenon of ‘adaptive preferences’ in
which people who are objectively very sick may, for example, still declare, and believe, that
their health is fine. Therefore, evaluation that focuses only on subjective mental metrics is

36
insufficient without considering whether that matches with what a neutral observer would
perceive as their objective circumstances,

(3) Whether or not people take up the options they have, the fact that they do have valuable
options is significant. For example, even if the nutritional state of people who are fasting and
starving is the same, the fact that fasting is a choice not to eat should be
recognized. Therefore evaluation must be sensitive to both actual achievements
(‘functioning’) and effective freedom (‘capability’).

(4) Reality is complicated, and judgement should reflect that complexity rather than taking a
shortcut by ignoring all types of information in advance. For example, while it may appear
evident that pleasure is important in determining how well individuals are doing, it is not
obvious that it should be the only factor examined at all times. As a result, assessing how
well people are doing must be as objective as possible. (Note: This results in a purposeful
'under-theorization' of the Capability Approach, which has been the cause of considerable
criticism and prompted the development of Nussbaum's alternative Capability Theory.)

Sen’s Critiques of Utilitarianism and Resourcism

Sen's assessment of competing philosophical and economic perspectives is central to his case
for the Capability Approach. He contends that, whatever their individual qualities, none of
them provide an explanation of well-being that is adequate as a universal concept; they are all
focused on the incorrect specific items (whether utility, liberty, commodities, or primary
goods), and they are too narrowly focused (they exclude too many important aspects from
evaluation). Sen's critiques of economic utilitarianism and John Rawls' primary goods are
particularly significant in the evolution and reception of his approach.

a. Utilitarianism

'Welfare Economics' is a field of economics that is specifically concerned with ethical

analysis. Sen's thorough critique of the utilitarianism underlying welfare economics identifies
and rejects each of its three pillars: act consequentialism, welfarism, and sum-ranking
utilitarianism.

37
i. Act-Consequentialism

Act consequentialism holds that actions should only be evaluated in terms of the goodness or
badness of their effects. This precludes any examination of the morality of the method by
which consequences are produced, such as whether it adheres to fairness or individual agency
principles. Sen instead advocates for a "comprehensive consequentialism" that considers the
moral significance of both consequences and principles. For example, it is important to
consider not only whether people have the same ability to live a long life, but also how that
equality is attained. For essentially biological reasons, women often outlive males in the same
conditions. If the only thing that counted was reaching equality in the ability to live a long
life, this fact suggests that health-care supply should be skewed toward men. However, as
Sen contends, attempting to attain equality in this manner would trump key moral demands of
fairness that should be considered in a full review.

ii. Welfarism

Welfarism is the belief that goodness should be measured solely by subjective value. Sen
claims that welfarism exhibits 'valuational neglect' as well as 'physical condition neglect.'
First, while welfarism is primarily concerned with how people feel about their lives, it is
mainly concerned with psychological states and not with people's reflective assessments.
Second, because it is solely concerned with sentiments, it ignores information regarding
physical health, which would appear to be obviously crucial to judging well-being. Subjective
welfare not only does not reliably reflect people's true interests or even their immediate
needs, but it is also prone to what Sen refers to as 'adaptive preferences.' People can become
so accustomed to their material deprivation and social injustice that they may profess to be
completely satisfied.

Our mental responses to what we really get and what we might reasonably hope to acquire
may frequently include compromises with harsh reality. The poor forced into beggary, the
vulnerable landless laborers precariously existing on the edge of subsistence, the overworked
domestic servant working around the clock, the humbled and submissive housewife
reconciled to her duty and fate, all tend to accept their own predicaments. The necessity of
endurance in uneventful survival suppresses and muffles the deprivations in the utility scale
(reflected by desire-fulfillment and happiness). (Sen, 1985, pp. 21-22).

38
iii. Sum Ranking

Sum-ranking focuses on maximizing the total amount of welfare in a society without regard
for how it is distributed, although this is generally felt to be important by the individuals
concerned. Sen argues, together with liberal philosophers such as Bernard Williams and John
Rawls, that sum-ranking does not take seriously the distinction between persons. Sen also
points out that individuals differ in their ability to convert resources such as income into
welfare. For example, a disabled person may need expensive medical and transport
equipment Sum-ranking seeks to maximize the total amount of welfare in a community
without consideration for how it is distributed, despite the fact that this is generally regarded
as significant by the individuals involved. Sen, along with liberal thinkers such as Bernard
Williams and John Rawls, contends that sum-ranking ignores the distinction between
persons. Sen also points out that people's ability to transfer resources such as income into
welfare varies. A disabled individual, for example, may require costly medical and
transportation equipment to obtain the same level of well-being. A society that attempted to
maximize total welfare would distribute resources in such a way that the marginal
improvement in welfare from giving an extra dollar to every individual would be the same.
As a result, resources would be diverted away from the sick and crippled and toward persons
who are more efficient at converting resources into utility.

Resourcism

Resourcism is defined by its agnostic attitude toward what defines a decent existence. As a
result, it examines how well people are doing in terms of having the general purpose
resources required for the development of any given excellent life. Sen's critique of John
Rawls' influential explanation of the fair distribution of primary goods stands in for a broader
critique of resource-based methods. Sen's core argument is that resources should not be the
sole center of concern for a fairness-based theory of justice, even if they are deliberately
chosen for their general utility to a happy existence, as Rawls' main goods are. The reason for
this is that this concentration ignores the heterogeneity in individuals' actual talents to convert
resources into valuable outcomes. In other words, two persons with the same vision of the
good life and the same set of resources may not be equally capable of achieving that life, and
thus resource neutrality is not as fair as resource managers assume it is. Sen specifically
opposes Rawls' argument that the principles of justice should be worked out first for the
'normal' case, in terms of a social contract conceived as a rational scheme for mutually
beneficial cooperation between people equally able to contribute to society, and then
39
extended to 'hard' cases, such as disability. Sen feels that such circumstances are far from
unusual, and that excluding them from the start risks creating a structure that permanently
excludes them. The overarching issue is that such explanations 'fetishize' resources as the
embodiment of advantage rather than focusing on the relationship between resources and
people. Nonetheless, Sen acknowledges that, while resource distribution should not be the
primary focus in assessing how well people are doing, it is crucial in terms of procedural
justice.

1.13 SUMMARY

● Development is the process of structural transformation.

● Development economics is the study of transformation of economies: transformation

of agrarian and rural economies to urban and modern economies, one with dominant
traditional sector to one with dominant modern sector, one with population of low
skills to one with high skills and one with underdeveloped and informal markets and
institutions to one with developed and formal markets and institutions.

● Economic growth denotes an increase in national and per capita income.

● The Gross National Product (GNP) is a metric that measures the value of all
commodities and services produced by a country's citizens and enterprises.

● Unlike Gross Domestic Product (GDP), which estimates the value of goods and
services based on their geographical site of production, Gross National Product
evaluates the value of products and services based on their geographical location of
ownership.

● Per capita's interpretation and unit of measurement are determined by the context in
which it is employed

● The Human Development Index (HDI) is one of the most widely used economic
development indicators and indices for measuring a country's average achievements.

● The Happiness Index is a large-scale survey tool that measures happiness, well-being,
and dimensions of sustainability and resilience.

● The Happiness Index is a resource for scholars, community organisers, and

policymakers who want to better understand and improve individual happiness,

40
 community well-being, social justice, economic equality, and environmental
sustainability.

1.14 KEYWORD

● Gross domestic product (GDP): the standard measure of the value added created
through the production of goods and services in a country during a certain period.

● Gross national product (GNP): Total market value of the final goods and services
produced by a nation's economy during a specific period of time (usually a year),
computed before allowance is made for the depreciation or consumption of capital
used in the process of production.

● Human Development Index: HDI is a summary measure of average achievement in

key dimensions of human development.

● The Happiness Index: It is a large-scale survey tool that measures happiness, well-
being, and dimensions of sustainability and resilience.

● Natural resources: Natural resources include land acreage and soil quality, forest
wealth, a healthy river system, minerals and oil resources, a favourable climate, and
so on.

1.15 LEARNING ACTIVITY

1. Define GNP.

___________________________________________________________________________
___________________________________________________________________________

2. What is GDP?

___________________________________________________________________________
___________________________________________________________________________

1.16 UNIT END QUESTIONS

A. Descriptive Questions

Short Questions

1. Define GDP. What are the objective of policy formulation?

41
 2. What Does Green GDP Include?

3. Write a note on Natural Resources.

4. What is Economic Factors?

5. What do you mean by Non-Economic Factors?

Long Questions

1. Explain the Economic and Non-Economic factors determining economic development.

2. Describe the various obstacles to development.

3. What are the characteristics of developing economy?

4. Define Poverty. Explain the two types of poverty in detail.

5. Explain Sen’s Capability approach.

B. Multiple Choice Questions

1. The …………………… is a metric that measures the value of all commodities and
services produced by a country's citizens and enterprises.

a. Gross National Product

b. Gross Domestic Product

c. Gross National Promotion

d. Gross Domestic Price

2. GDP stands for…………

a. Gross Domestic Promotion

b. Gross Domestic Place

c. Gross Domestic Price

d. Gross Domestic Product

3. The ……………… is one of the most widely used economic development

indicators and indices for measuring a country's average achievements.
42
 a. GDP

b. GNP

c. HDI

d. WTO

4. HDI was first implemented as part of the United Nations Development Programme
(UNDP) in …………

a. 1980

b. 1990

c. 1970

d. 1950

5. …………….is the belief that goodness should be measured solely by subjective

value.

a. Resourcism

b. Sum Ranking

c. Act-Consequentialism

d. Welfarism

Answers

1-a, 2-d, 3-c. 4-b, 5-d

1.17 REFERENCES

References book

● Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2000. “A New Database on the
Structure and Development of the Financial Sector.” World Bank Economic Review 14 (3):
597–605.

● Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2010. “Financial Institutions and
Markets across Countries and over Time.” World Bank Economic Review 24

43
● UKEssays. (November 2018). The role of savings and investment in the world economy.
Retrieved from https://www.ukessays.com/essays/economics/the-role-of-savings-and-
investment-in-the-world-economy-economics-essay.php?vref=1

● S, N. (2017, January 13). Role of Deficit Financing in Developing Countries | Economics.

Economics Discussion. https://www.economicsdiscussion.net/public-finance/role-of-deficit-
financing-in-developing-countries-economics/26184

● UKEssays. (November 2018). Role of Technology in Economic Development. Retrieved

from https://www.ukessays.com/essays/economics/role-of-technology-in-economic-
development-economics-essay.php?vref=1

● Das, S. (2015, February 20). Labour and Capital Intensive Techniques (With Diagram). Your
Article Library. https://www.yourarticlelibrary.com/economics/labour-and-capital-
intensive-techniques-with-diagram/47504

● S, N. (2017, January 13). Role of Deficit Financing in Developing Countries | Economics.

Economics Discussion. https://www.economicsdiscussion.net/public-finance/role-of-deficit-
financing-in-developing-countries-economics/26184

● Das, S. (2015, February 20). Labour and Capital Intensive Techniques (With Diagram). Your
Article Library. https://www.yourarticlelibrary.com/economics/labour-and-capital-
intensive-techniques-with-diagram/47504

● Incremental Capital Output Ratio (ICOR). (2021, August 12). Investopedia.

https://www.investopedia.com/terms/i/icor.asp

S, N. (2017, January 13). Role of Deficit Financing in Developing Countries | Economics.

Economics Discussion. https://www.economicsdiscussion.net/public-finance/role-of-deficit-
financing-in-developing-countries-economics/261

44
UNIT - 2: RESOURCES FOR DEVELOPMENT
STRUCTURE

2.0 Learning Objectives

2.1 Introduction

2.2 Role of natural resources in economic development

2.3 Human resources

2.3.1 Population growth

2.3.2 Economic development

2.4 Malthusian theory

2.5 Theory of demographic transition

2.6 Importance of human capital

2.6.1 Components of human capital formation

2.7 Rural- urban migration

2.7.1 Urbanization

2.7.2 Internal migration

2.7.3 The brain drain

2.8 Summary

2.9 Keywords

2.10 Learning Activity

2.11 Unit End Questions

2.12 References

2.0 LEARNING OBJECTIVES

After studying this unit, you will be able to:

● Understand the role of natural resources in economic development

● Discuss the Population growth and Economic development

45
 ● Describe the Malthusian theory

● Understand the Theory of demographic transition

● Identify the Importance and components of human capital

● Understand the Rural- urban migration.

2.1 INTRODUCTION

By human resources, we imply a country's population size as well as its efficiency,

educational skills, productivity, organisational ability, and foresight. We mean human capital
when we say "human resource." Human capital refers to the country's population's abilities,
skills, and technical know-how. A country should implement manpower planning in order to
enhance its people resources.

Human resources must be addressed from the standpoint of both assets and liabilities
associated with achieving economic development. The efficient utilisation of both natural and
human resources is critical for achieving economic development.

The extent and efficiency of human resources have a significant role in the proper utilization
of natural endowments and the level of production of national wealth.

However, an overabundance of population will once again consume all of the fruits of
development. Thus, studying human resources in depth is critical from the standpoint of
economic welfare. It should be emphasized that humans are the most important means of
production, and that the fruits of all economic operations are based on improving human
living conditions.

2.2 ROLE OF NATURAL RESOURCES IN ECONOMIC

DEVELOPMENT

Natural resources or land are the most important factors influencing the development of an
economy. In economics, "land" refers to natural resources such as land fertility, location and
composition, forest wealth, minerals, climate, water resources, and sea resources, among
others.

The abundance of natural resources is critical for economic progress. A country with
insufficient natural resources will be unable to expand swiftly. As pointed out by Lewis,
“Other things being equal, men can make better use of rich resources than they can of poor,”

46
In LDCs, natural resources are unutilized, underutilized or misutilised. This is one of the
reasons for their backwardness. The presence of abundant resources is not sufficient for
economic growth. What is required is their proper exploitation. If the existing resources are
not being properly exploited and utilized, the country cannot develop. J.L. Fisher has rightly
said, “There is little reason to expect natural-resource development if people are indifferent to
the products or services which such resources can contribute”.

This is due to economic lag and a lack of technological resources. As a result, greater
technology and increased knowledge may be used to develop natural resources. In actuality,
as Lewis pointed out, "the value of a resource depends on its usefulness and its usefulness
changes all the time due to changes in tastes, technique, or new discovery."

When such changes take place, any nation can thrive economically by making better use of
its natural resources. For example, between 1740 and 1760, Britain had an agricultural
revolution by implementing crop rotation.

Similarly, despite a lack of land, France was able to revolutionize her agricultural on the
British model. Asia and Africa, on the other hand, have been unable to improve their
agriculture due to the usage of outdated agricultural methods.

It is often said that economic growth is possible even when an economy 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 that is short on natural resources but is one of the worlds most
advanced because it has discovered new uses for scarce resources. Furthermore, with superior
technology, innovative research, and higher understanding, it has been effective in
overcoming the shortage of its natural resources by importing some raw materials and
minerals from other countries. Similarly, Britain has progressed in the absence of nonferrous
metals.

Thus, the presence of abundant natural resources is insufficient for economic progress. What
is critical is that they are properly used through improved processes so that there is less waste
and they can be used for a longer period of time.

It is often said that economic growth is possible even when an economy is deficient in natural
resources. As pointed out by Lewis, “A country which is considered to be poor in resources
47
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.”

2.3 HUMAN RESOURCES

We, as humans, are social animals. We need to interact and cooperate with other people for a
variety of reasons, including requesting their aid, assisting them in our day-to-day work, and
ensuring that others understand the aim and purpose of our actions. Now, what we saw here is
the need of other people in our daily lives, but when you look at it from the perspective of an
entire nation, you need to understand people's needs on a macro level.

Without a doubt, a country's greatest asset is its people. Their everyday skills and abilities are
what make them a valuable resource to the nation. People that are healthy, educated, and driven
create resources that meet their needs. These are businesses, organizations, and political parties
and NGO.

The union government formed the Ministry of Human Resources Development in 1985 in order
to increase the talents and significance of the people in the country (HRD). Human resources,
like any other resource, are not dispersed equally throughout the world.

Human resources are seen as an important form of resource for achieving a country's economic
development. Human resources are the most active sort of resource among the numerous types
of resources. The qualitative and quantitative development of human resources is critical for the
appropriate utilization of the country's natural resources.

2.3.1 Population growth

Population refers to the number of people who live in a given territory, state, country, continent,
or world. The fundamental difference between these people is that they are all different in terms
of age, gender, and where they live. The global distribution of humanity is now exceedingly
unequal. Population changes over time are caused by births, deaths, and migration of people.

Health, education, housing, social security, and employment are just a few of the sectors where
studies can assist the government prepare. In a nutshell, population distribution refers to how
people are distributed across the Earth's surface. As evidenced by the fact that the world's
population is exceedingly unequal. Some sections of Asia and Europe are densely populated,
whereas others are sparsely populated. 90% of the world's population lives in 10% of the world's
land area.

48
Features such as topography of the region are one of the reasons for the area being highly
populated or not. High mountainous areas, tropical deserts and areas of equatorial forests are
sparsely populated. Areas which are North to the equator are more populated than the areas
South of the equator because the climate and topography are warmer for humans to habitat and
life to grow. Three-quarter of the world’s people live in Asia and Africa. Almost 60 percent of
the world’s inhabitants live in just 10 countries.

Density of Population

Fig 2.1 Density of Population

The population density is defined as the number of people living in a certain area per square
kilometer of land. The global average population density is 51 people per square kilometer.
South-central Asia is the most densely populated region, followed by East and South East Asia.

With 324 people per square kilometer, India ranks 33rd, while Greenland has the lowest
population density at 0.026 persons per square kilometer.

Factors Affecting the Distribution of Population

49
Geographical Factors

Fig 2.2 Geographical Factors

 Topography– People dwells in densely populated places on lowlands rather than

plateaus and mountains. Plains are ideal for farming, transportation, and a variety of
other aspects such as water and power. The Ganges plains are the world's most densely
populated area.

 Climate– The existence of moderate climate and the avoidance of harsh climates are
the primary reasons why most people reside north of the equator. As a result, fewer
people live in the Sahara Desert and in Russia's and Canada's arctic regions.

 Soil– Fertile plains of the Ganges and Brahmaputra (India), Hwang-he, Chang Jiang
(China) and the Nile (Egypt) are the areas with a high population density.

 Water and Minerals– Areas with Water and Mineral pull people because of the potential
of economic development. Therefore, fewer people live in a desert than in river valleys.

Social, Cultural and Economic factors

 Social– Densely populated areas have superior housing, education, and health
care services. In India, for example, Pune and Bangalore.

 Cultural - People are drawn to cities having cultural and religious significance.
Varanasi, Jerusalem, and Vatican City, for example, is heavily inhabited.

 Economic– Wherever there is the emergence of a potential industry, people go

there. Mumbai's population is expanding only because it is home to several
industries.
50
Population Change and the Patterns of Population Change

Fig 2.3 Population Change and the Patterns of Population Change

Source: Oakton

The change in the number of individuals during a certain time period is referred to as population
change. As previously noted, this change occurs as a result of births, deaths, and migration of
individuals. Until the 1800s, the world's population grew at a slow pace due to a high rate of
death. There were no good health facilities, farm productivity was minimal, and food supply was
a serious issue, resulting in an extremely low birth rate.

The world's population reached one billion people in 1820. It surpassed 3 billion in 1970, only
150 years later. This is commonly known as the population explosion. In 1999, the population
was 6 billion, more than double what it was in 1970During this time, death rates fell while birth
rates skyrocketed. The number of live births per 1,000 people is referred to as the birth rate. The
number of deaths per 1,000 persons is referred to as the death rate.

Migration refers to the movement of people from one location to another. The gap between a
country's birth and mortality rates is referred to as the country's natural growth rate.

The rate of population growth varies across the world. Even though the world’s population is
rising, not all countries are experiencing this growth.

Population Composition

51
 Fig 2.4 Population Composition

(Source: kullabs)

The population composition refers to the population structure, which includes elements such as
gender, health, literacy level, health condition, occupation, and income level. It can also be
expressed in the form of a pyramid known as an age-sex pyramid. With the population separated
into age groups ranging from 5 to 9 years old and 10 to 14 years old. It is classified into two
categories: male and female. There are two types of dependents:

 Young dependants (aged below 15 years)

 Elderly dependants (aged above 65 years)

Those between 15 and 65 are the working age and economically active. In Japan, low birth rates
make the pyramid narrow at the base. Decreased death rates allow a number of people to reach
old age.

2.3.2 Economic development

Human resources are critical to a country's overall development. Capital, natural resources,
and other productive resources are dormant in nature. To mobilize them, human resources are
required. Nepal has an abundance of natural resources, and utilizing these resources is critical
for economic development. The following points can help to explain the role of human
resources.

1. Utilization of Natural resources:

Human resources are required for the usage of natural resources such as minerals, water,

52
forests, and so on. The use of these resources is required for economic progress. As a result,
only human resources can be mobilised and used effectively.

2. Compensate for the deficiency of natural resources:

The use of human resources compensates for the scarcity of natural resources. Many
countries, such as Japan, Hong Kong, and Singapore, are deficient in natural resources, but
they are able to achieve high economic growth by efficiently exploiting human resources.

3. Utilization of physical capital:

The presence of physical capital can contribute to economic development. They must be used
correctly. It is difficult to operate machinery and equipment, as well as run factories and
industries, without the involvement of human resources.

4. Increase in production:
A country's human resources contribute to increased production of various goods and
services. A country can generate a wide range of high-quality goods and services by utilizing
talented human resources.

5. Changes in technology:
A country's human resources can bring new technology. To bring about progress in the
country, advanced technology is required.

2.4 MALTHUSIAN THEORY

Thomas Robert Malthus was a famous 18th-century British economist known for the

population growth philosophies outlined in his 1798 book "An Essay on the Principle of
Population." In it, Malthus theorized that populations would continue expanding until
growth is stopped or reversed by disease, famine, war, or calamity. He is also known for
developing an exponential formula used to forecast population growth, which is currently
known as the Malthusian growth model.

We are most familiar with Robert Malthus as the proponent of his renowned Theory of
Population. However, it is crucial to recall that Malthus had some important things to say
about economic progress, and it is refreshing to notice that he foreshadowed later economists
such as Keynes and Kaleeki in various areas. Furthermore, the Malthusian form of economic
growth is, in several respects, a refinement of general classical theory.

He recognized the significance of a separate and systematic theory of economic development

earlier than the other classical economists. "There is rarely any study more curious or, from

53
its importance, more worthy of our attention than that which traces the causes which
practically stop the rise of wealth in different countries," he writes in Book II of his
"Principles of Political Economy."

According to Malthus, the challenge of development is explaining why the real gross national
product (current wealth) differs from the potential gross national product (power of producing
riches). He thus points out the way in which the potentialities of economic development in a
country should be realized. This can be done by larger production and fairer distribution.

Malthus contends that the process of economic development is not automatic. Rather
conscious, deliberate efforts are needed to bring it about. For instance, Malthus explains that
mere increase in population cannot by itself lead to economic development unless there is
increase in effective demand. (This is anticipation of the Keynesian doctrine). He says – “A
man whose only possession is his labor has, or has not, an effective demand for produce
according as he is, or is not, in demand by those who have the disposal of the produce.” He
rejects Say’s Law which says “supply creates its own demand” and that savings are
automatically invested and constitutes a demand for capital goods.

Malthus made an essential contribution by demonstrating that saving in the sense of not
spending is a negative act that, rather than creating greater demand, leads to a decrease in
effective demand. Only savings generated by increasing gains and invested generate effective
demand. Thus, "capitalist abstinence, far from accelerating economic growth, will in itself
delay it," he claims. As a result, Malthus highlights a crucial fact: in mature economies,
consumption, saving, and investment should all grow at the same time.

Role of Capital:

Malthus places a high value on capital acquisition for economic progress. He sees capital as
essential to progress. "No permanent and continuous development in wealth can occur
without a continuous expansion in capital," he claims. Furthermore, Malthus emphasized the
necessity of foreign commerce in accelerating economic development. Foreign trade
encourages investment by expanding the market for the items produced and allowing for
more division of labor, resulting in increased output.

Another key feature revealed by Malthusian analysis of economic growth is the structured
change that occurs in the process of economic development, specifically, a fall in the relative
importance of agriculture as the economy progresses. We all realize that economic
development is emerging countries, becoming significant is associated with the development
54
of industry. Agriculture is naturally overshadowed by the faster rise of industries. Malthus
proposed land changes as a means of increasing agricultural output.

The anticipated by Malthus of the notion of 'dualism' as applied to underdeveloped

economies is significantly more important than what has been mentioned above. He saw the
economy as being divided into two big sectors: agriculture and industry. His examination of
the interrelationship between these two industries is both fascinating and illuminating. The
industrial sector was subject to the law of growing returns, whereas the agricultural sector
was subject to the law of decreasing returns, with the rate of technological progress
accounting for the discrepancy.

Malthus brings out an important truth that when one of these sectors lags behind, it retards
the development of the other sector. We know how in India the failure on the agricultural
front was responsible for the slow rate of growth. “The development of the industrial sector
of underdeveloped countries is limited by the poverty of the agricultural sector.” This is due
to the fact that the lack of purchasing power in the rural masses reduces effective demand in
the economy and retards its growth.

Assessment of Malthus’s Contributions:

There is no doubt that Malthus made an important contribution to economic development

theory. His rejection of Say's Law and emphasis on the necessity of effective demand and its
relationship to saving and investment are notable for their contemporary relevance. Much of
what he said on the subject is germane to a developing economy, particularly the theory of
dualism.

Critics of Malthus' theory of economic development have pointed out that he focuses on
describing the variables that impede growth rather than the factors that encourage economic
progress. However, some aspects of his philosophy contribute positively to the growing
process. For example, he regards production and distribution as the two most important
components of economic growth. Production distribution is as vital as production itself or
long-term economic development. He also emphasizes the importance of capital
accumulation in achieving economic development.

2.5 THEORY OF DEMOGRAPHIC TRANSITION

Theory of Demographic Transition is a theory that throws light on changes in birth rate and
death rate and consequently on the growth-rate of population.

55
Birth-rate and death-rate trends differ in tandem with economic progress.

Because of it, growth rate of population is also different.

“Demographic transition refers to a population cycle that begins with a fall in the death rate,
continues with a phase of rapid population growth and concludes with a decline in the birth
rate”-E.G. Dolan.

According to this theory, economic development has the effect of bringing about a reduction
in the death rate.

The link between birth and mortality rates changes as a country's economy develops, and it
must go through various stages of population expansion. C.P. Blacker classified the
population into five categories: high, stationary, early expanding, low stationary, and
declining. Population increase, according to demographic transition theory, will have to go
through these stages as economic development progresses.

The four stages of demographic transition mentioned by Max are explained as follows:

First Stage:

This stage is referred to as the high population growth potential stage. It is characterized by
high and fluctuating birth and mortality rates that practically cancel one other out. People
generally live in rural areas, and their main source of income is agriculture, which is in a state
of decline. The tertiary sector, which includes transportation, commerce, finance, and
insurance, is undeveloped.

All of these things contribute to the masses' low income and poverty. Social beliefs and
norms play a vital influence in maintaining a high birth rate. The death rate is also high due to
poor sanitation and a lack of medical facilities. People live in filthy and unhealthy conditions.

As a result, they are disease-ridden, and the lack of competent medical care leads to a huge
number of deaths. The poor have the highest death rate. As a result, high birth and death rates
remain almost equal over time, resulting in a static equilibrium with negligible population
increase.

Second Stage:

It is known as the Population Explosion stage. At this point, the death rate is dropping but the
birth rate stays high. Agricultural and industrial productivity rises, while transportation and
communication improve. There is a lot of labor mobility. Education broadens. Income rises

56
as well. People are getting more and better food products. Medical and health facilities are
being upgraded.

Fig 2.5 Theory of demographic transition (a)

Economic development is accelerated during this period as a result of individual and

government efforts. There is an increase in the use of better technology, mechanisation, and
urbanisation. However, there is no significant shift in men's attitudes, and so the birth rate
remains high, indicating that economic development has not yet begun to alter the birth rate.

Because of the growing disparity between birth and mortality rates, the population is growing
at an unusually rapid rate, which has earned it the moniker "population explosion stage." This
is a "Expanding" stage of population development, in which the population grows at an
increasing rate, as indicated in the figure, with a decrease in death rates and no change in
birth rates.

57
 Fig 2.5 Theory of demographic transition (b)

Third Stage:

It is also characterized as a population stage because the population continues to grow at a

fast rate. In this stage, birth rate as compared to the death rate declines more rapidly. As a
result, population grows at a diminishing rate. This stage witnesses a fall in the birth rate
while the death rate stays constant because it has already declined to the lowest minimum.
Birth rate declines due to the impact of economic development, changed social attitudes and
increased facilities for family planning. Population continues to grow fast because death rate
stops falling whereas birth rate though declining but remains higher than death rate.

Fourth Stage:

It is called the stage of stationary population. Birch rate and death rate are both at a low level
and they are again near balance. Birth rate is approximately equal to death rate and there is
little growth in population. It becomes more or less stationary at a low level.

These stages of demographic transition can be explained with the help of diagram 3 given
below:

Stage I is characterized by high birth rate, death rate and low rate of population growth.

Stage II is characterized by high and stationary birth rate, rapidly declining death rate and
very rapid increase in population.

Stage III is characterized by a falling birth rate, low and stationary death rate and rapidly
rising population.

Stage IV is characterized by low birth rate and low death rate with stationary population at a
low level.
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2.6 IMPORTANCE OF HUMAN CAPITAL

Human capital is the primary driver of economic progress. It is a source of enhanced

production as well as technical progress. In fact, the main distinction between industrialised
and developing countries is the rate of human capital advancement. Human capital is required
in developing countries to staff new and expanding government services, to implement new
land use systems and agricultural practises, to develop new modes of communication, to
advance industry, and to strengthen the education system. Prof. Galbraith is correct when he
says, "We now derive a higher share of economic development from investment in men and
advances brought about by better men.''

Definition of human capital: Human capital is described as the skills, training, and health
acquired through on the job training and education. Michael Pakistan Park defines it as, ''The
skill and knowledge of human beings.'' It is also defined as the "endowment of abilities to
produce that exists in each human being."

Importance of human capital

Although the accumulation of physical capital is vital in the process of a country's economic
growth, it is becoming increasingly clear that the expansion of tangible capital stock is
heavily dependent on human capital production and must be given proper consideration.

In the lack of significant human capital investment, the utilization of physical capital will be
slow, resulting in a slowing of progress.

Economists such as Harbison, Schultz, Kuznets, Kendrick, and Denison observed that one of
the important factors responsible for the American economy's rapid growth is the increasing
allocation of outlays on education, which has resulted in a significant improvement in the
level of human capital formation.

Prof. Galbraith observed, “We now get the larger part of our industrial growth not from more
capital investment but from investment in men and improvements brought about by improved
men.” Unless these developed economies spread education, knowledge, know-how and raise
the level of skills and physical efficiency of their people, the productivity of physical capital
would have been reduced at this moment.

Most of the underdeveloped countries are suffering from low rate of economic growth which
is again partially resulted from lack of investment in human capital. These underdeveloped

59
countries are facing mainly two basic problems. They lack critical skills very much needed
for the industrial sector and again have a surplus labor force.

Thus human capital formation wants to solve these problems by creating necessary skills in
man as a productive resource and also providing him gainful employment.

Human capital is thus required "to staff new and expanding government services, to introduce
new land use systems and agricultural technologies, to develop new modes of
communication, to carry on industrialization, and to build the education system."

In other words, innovation or the process of transitioning from a static or traditional culture
necessitates massive amounts of strategic human capital."

It is absolutely vital to enhance the level of knowledge and skills of the population in order to
eradicate the impoverished countries' economic backwardness as well as to instill the
capacities and incentives to development.

Thus, in the absence of effective development of the human component, undeveloped

countries will be unable to achieve the necessary pace of growth.

2.6.1 Components of human capital formation

The term human capital formation implies the development of abilities and skills among the
population of the country. In order to transform the liability of the huge size of population
into assets adoption of various measures for human capital formation is very much essential.

According to Harbison, the human capital formation indicates, “the process of acquiring

and increasing the number of persons who have the skills, education and experience
which are critical for the economic and the political development of the country.
Human capital formation is thus associated with investment in man and his
development as a creative and productive resource.”

A country should implement manpower planning for the development of its human resources
in order to improve various areas of the economy. Manpower planning refers to the planning
of human resources to satisfy the economy's development needs.

A country should educate its people and train its labor force in technology, engineering,
management, medicine, and a variety of other subjects related to the development of various
sectors of the economy in order to make the most use of its human resources.

60
The development of top skills is the most significant aspect in human capital production.
Because skill development takes time, the entire process of human resource development
necessitates a long-term policy.

i) Health and Nutrition:

Because poor health and malnutrition have a negative impact on labor quality, the best
method to increase labor quality in developing nations is to provide appropriate food and
nutrition to people, as well as adequate health and sanitation facility.

(ii) Education and Training:

The second component of human capital formation is to give education and training to the
general public. Education investments have the potential to accelerate economic growth. The
proper utilization of labor is dependent on the education, training, and industrial experience
of the worker.

Prof. Singer has rightly observed, “Investment in education is not only highly productive
but also yields increasing returns”. In order to raise the general living standards of the
people, investment in human capital for making provision for education and training is very
much required. Moreover, adult education and training is also another integral part of
manpower planning.

(iii) Housing Development:

The third component of human capital construction is the creation of public housing, which is
an essential predictor of human resource development. Special incentives for private housing
construction should be provided in developing nations in order to provide people with healthy
living conditions. Furthermore, steps must be done to implement subsidised housing projects.

2.7 RURAL- URBAN MIGRATION

In India, rural-urban migration is unusually low. Changes in the rural and urban populations
between decennial censuses from 1961 to 2001 show that the migration rate for working-age
adult males (ages 25-49) fluctuated from 4% to 5.4%.

An independent measure of migration derived from the 2005 nationally representative India
Human Development Survey implies a male rural-urban movement rate of 6.8 percent,
whereas the male subsample of the Indian Demographic and Health Survey (DHS) shows a
migration rate of 5.3 percent. To put these figures in context, the similar migration rate from

61
the 1997 Brazil DHS, which also contains a male sample, is more than twice as high, at
13.9%. The extremely low rural-urban migration rate in India Its unusually low rural-urban
migration is mirrored in its urbanization rates.

The percentage of the adult population for four large developing countries — China, India,
Indonesia and Nigeria — who are living in cities, as well as the change in this percentage
between 1975 and 2000, are plotted in chart. Urbanization in all four countries was low in
1975, but India had fallen far behind the others by 2000.

Previous studies have documented that rates of urbanization in India are lower — by one full
percentage point — than countries with similar levels of urbanization. What’s more, the
fraction of the population of India that is urban is 15 per cent lower than in countries with
comparable GDP per capita.

Perhaps the most relevant comparison is with China, a country that has experienced explosive
economic growth over the past three decades accompanied by historically unprecedented
rural-urban migration, despite restrictions on residential mobility. The absence of a similar
movement in India, where there are no such explicit restrictions, evidently demands an
explanation.

2.7.1 Urbanization

Internal or international migration has long been one of the drivers propelling urbanisation
and delivering possibilities and difficulties to cities, migrants, and governments. Municipal
governments are increasingly being acknowledged as major actors in migration management,
and they have begun to incorporate migration into their urban planning and execution.

Data on migration and urbanisation are critical for cities to better manage migration. These
statistics, however, are not always available or, if available, are not used or accessible at the
urban level, nor are they disaggregated, complete, or comparable, particularly in low-income
nations. 

Data could improve urban planning and delivery of public services, as well as help measure
progress toward Sustainable Development Goals (SDGs) related to cities and migration,
implement the Global Compacts on Migration and Refugees, which emphasize the role of
cities as stakeholders in migration, and fulfil migration-related commitments in the UN
Habitat’s New Urban Agenda.

62
The term "urban" is difficult to define, as there is no single globally accepted definition of
what makes an urban settlement. What national statistical offices designate as "urban" differs
from country to country and, in many cases, changes over time within countries. Some
countries designate urban areas based on a minimum population threshold and population
density, whilst others use an administrative definition. Others incorporate additional factors
such as the proportion of the workforce employed in non-agricultural industries, as well as
the availability of infrastructure or education, health, and other services (IOM, 2015 and UN,
2018). The majority of urban population thresholds are between one and five thousand people
(IOM, 2015).   

2.7.2 Internal migration

Internal migration is the movement of individuals within a country from one specified
territory to another. The Census provides data on internal migration within Australia.
The Census asks a series of questions relating to each person's usual address, and data from
these questions are recorded as the Usual Address Indicator Census Night (UAICP), Usual
Address One Year Ago Indicator (UAI1P) and Usual Address Five Years Ago Indicator
(UAI5P).

Using the following variables, it is possible to identify a person's change of address for one
year prior to the Census date, and for five years prior to the Census date:

 Place of Usual Residence (PURP)

 Place of Usual Residence One Year Ago (PUR1P)

 Place of Usual Residence Five Years Ago (PUR5P).

The Census data only reflect migrations that occurred at these specific moments in time (i.e.
one year ago and five years ago), even if there may have been several movements over this
time period.

This data is also used to calculate household mobility indices. It should be noted that people
who are temporarily absent, visitors, and households with only visitors are not included in
these factors. For Census data, the following two indicators are available:

63
• Household One Year Mobility Indicator (MV1D), where: all residents (aged one year or
more) changed address during the last year; some residents changed address during the last
year; no residents changed address during the last year; or not stated (including households
where one or more residents did not state his/her usual residence one year ago).

 Household Five Year Mobility Indicator (MV5D), where: all residents (aged 5 years and
over) have changed address during the last five years; or some residents have changed
address during the last five years; or no residents have changed address in the last five
years; or not stated (including households in which one or more residents did not state
his/her usual residence of five years ago).

The data for place of usual residence are used, mainly in conjunction with household mobility
indicators, for detailed studies of internal migration.

Such studies must be carried out with caution, and the points presented in the following
situations should be taken into account.

Because the indicators are calculated based on normal residence at specific dates, only the net
effects of any numerous movements between these dates may be calculated. For example, at
the time of the 2006 Census, John A Citizen was residing in a rural area of South Australia.
Six months later, he relocated to Melbourne for two years before relocating to Adelaide,
where he remained at the time of the 2011 Census. Census data would only show movement
from country to city in South Australia.

No movement is shown in the internal migration data for 'out and back' movements – for
example, where a family moves away from their place of usual residence to live elsewhere,
then returns before the end of the reference period to live at their previous address.

2.7.3 The brain drain

Assume you've recently graduated from college. You have a gleaming new degree in a highly
specialized field, such as Chinese language or computer engineering. Where are you planning
to relocate? If you're like most people, you won't be returning to a small farm with your
degree. Instead, especially if you have numerous job offers, you will want to relocate
64
somewhere exciting with other like-minded people. Some areas, whether in Silicon Valley,
Washington, DC, Austin, Texas, or Portland, Oregon, are simply more exciting than others.

As a result, parts of the country are experiencing a brain drain, in which highly educated
people leave in order to pursue better opportunities elsewhere. While many countries
experience this, it is also a fact of life for some states and countries within the United States.
To counteract this, they often offer extreme incentives for both companies and workers.

Brain drain occurs when a country's highly skilled and intelligent citizens emigrate. Learn
about brain drain in economics by exploring its definition, causes, effects, and examples, and
review possible actions that can curb brain drain. Recognize how brain drain affects a home
country, and take a closer look at brain drain in India and Russia.

Definition of Brain Drain

Brain drain can be described as the process in which a country loses its most educated and
talented workers to other countries through migration. This trend is considered a problem,
because the most highly skilled and competent individuals leave the country, and contribute
their expertise to the economy of other countries. The country they leave can suffer economic
hardships because those who remain don't have the 'know-how' to make a difference.

Brain drain is also characterized as the loss of academic and technological labor force due to
the relocation of human capital to more advantageous geographic, economic, or professional
situations. The majority of the time, migration occurs from impoverished countries to
developed countries or areas.

Causes of Brain Drain

There are numerous causes of brain drain; however they vary depending on the country
experiencing it. The major reasons are a desire for work or higher-paying occupations,
political instability, and a desire for a better quality of life. Brain drain causes can be divided
into two categories: push forces and pull ones.

The push factors are negative qualities of the home nation that provide impetus for competent
people to migrate from LDCs (LDC). Other push factors, in addition to unemployment and
political instability, include a lack of research facilities, job discrimination, economic
underdevelopment, a lack of independence, and terrible working conditions.

65
The positive qualities of the developed country from which the migrant wishes to benefit are
referred to as pull factors. Pull influences include higher-paying jobs and a better quality of
life. Other attractive aspects include a favorable economic outlook, the prestige of
international education, a relatively stable political climate, a modernized educational system
that allows for superior training, intellectual independence, and diverse cultures. These are
not exhaustive lists; there may be more elements, some of which may be peculiar to countries
or even individuals.

Effects of Brain Drain on the Home Country

When brain drain is prevalent in a developing country, there may be some negative
repercussions that can affect the economy. These effects include but are not limited to:

 Loss of tax revenue

 Loss of potential future entrepreneurs

 A shortage of important, skilled workers

 The exodus may lead to loss of confidence in the economy, which will cause persons
to desire to leave rather than stay

 Loss of innovative ideas

 Loss of the country's investment in education

 The loss of critical health and education services

Brain drain is usually described as a problem that needs to be solved. However, there are
benefits that can be derived from the phenomena. When people move from LDC countries to
developed countries, they learn new skills and expertise, which they can utilize to the
advantage of the home economy once they return. Another benefit is remittances; the
migrants send the money they earn back to the home country, which can help to stimulate the
home country's economy.

Possible Actions to Curb Brain Drain

Because the disadvantages of brain drain outweigh the benefits, governments can take steps
to minimize the number of highly educated and skilled workers who relocate to other nations.

66
One method for governments to retain competent workers is to make citizens feel safe and to
take measures to boost economic activity.

2.8 SUMMARY

● Natural resources or land are the most important factors influencing the development
of an economy.

● Population refers to the number of people who live in a given territory, state, country,
continent, or world.

● Human capital is the primary driver of economic progress.

● The term human capital formation implies the development of abilities and skills
among the population of the country.

● Internal or international migration has long been one of the drivers propelling
urbanisation and delivering possibilities and difficulties to cities, migrants, and
governments.

● Data could improve urban planning and delivery of public services, as well as help
measure progress toward Sustainable Development Goals (SDGs) related to cities and
migration, implement the Global Compacts on Migration and Refugees, which
emphasize the role of cities as stakeholders in migration, and fulfil migration-related
commitments in the UN Habitat’s New Urban Agenda.

● Brain drain is also characterized as the loss of academic and technological labour
force due to the relocation of human capital to more advantageous geographic,
economic, or professional situations.

2.9 KEYWORDS

● Home Country: The country where one was born or lives permanently.

● Human resources: The set of people who make up the workforce of an organization,

business sector, industry, or economy.

● NGO: A non-governmental organization, or simply an NGO, is an organization that

is, generally, formed independent from government.
67
 ● Population: It refers to the number of people in a single area, whether it be a city or
town, region, country, or the world.

● Demographic: Relating to the structure of populations.

2.10 LEARNING ACTIVITY

1. What do you mean by Natural resources?

___________________________________________________________________________
___________________________________________________________________________

2. What is Population?

___________________________________________________________________________
___________________________________________________________________________

2.11 UNIT END QUESTIONS

A. Descriptive Questions

Short Questions:

1. What is Human Resources?

2. What is Topography?

3. Explain Social, Cultural and Economic factors of Human Resources.

4. Explain Role of Capital.

5. What is Economic development?

Long Questions:

1. Explain Malthusian theory.

2. Describe the role of natural resources in economic development.

3. Discuss Human resources in detail.

4. Explain Theory of demographic transition.

5. Discuss the importance of human capital.

B. Multiple Choice Questions

1. ………………….is one such country that is short on natural resources.

68
 a. Europe

b. America

c. Japan

d. China

2. Education investments have the potential to accelerate …………. growth.

a. political

b. social

c. cultural

d. economic

3. ………………refers to the number of people who live in a given territory, state, country,
continent, or world.

a. Economy

b. Development

c. Population

d. State

4. The union government formed the Ministry of Human Resources Development in ……….

a. 1984

b. 1985

c. 1986

d. 1987

5. HRD stands for…………….

a. Human Resources Development

69
 b. Human Resources Distribution

c. Human Resources Demand

d. Human Resources Decision

Answers

1-c, 2-d, 3-c, 4-b, 5-a

2.12 REFERENCES

References book

● Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2000. “A New Database on the
Structure and Development of the Financial Sector.” World Bank Economic Review 14 (3):
597–605.

● Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2010. “Financial Institutions and
Markets across Countries and over Time.” World Bank Economic Review 24

● UKEssays. (November 2018). The role of savings and investment in the world economy.
Retrieved from https://www.ukessays.com/essays/economics/the-role-of-savings-and-
investment-in-the-world-economy-economics-essay.php?vref=1

● S, N. (2017, January 13). Role of Deficit Financing in Developing Countries | Economics.

Economics Discussion. https://www.economicsdiscussion.net/public-finance/role-of-deficit-
financing-in-developing-countries-economics/26184

● UKEssays. (November 2018). Role of Technology in Economic Development. Retrieved

from https://www.ukessays.com/essays/economics/role-of-technology-in-economic-
development-economics-essay.php?vref=1

● Das, S. (2015, February 20). Labour and Capital Intensive Techniques (With Diagram). Your
Article Library. https://www.yourarticlelibrary.com/economics/labour-and-capital-
intensive-techniques-with-diagram/47504

● S, N. (2017, January 13). Role of Deficit Financing in Developing Countries | Economics.

Economics Discussion. https://www.economicsdiscussion.net/public-finance/role-of-deficit-
financing-in-developing-countries-economics/26184

70
● Das, S. (2015, February 20). Labour and Capital Intensive Techniques (With Diagram). Your
Article Library. https://www.yourarticlelibrary.com/economics/labour-and-capital-
intensive-techniques-with-diagram/47504

● Incremental Capital Output Ratio (ICOR). (2021, August 12). Investopedia.

https://www.investopedia.com/terms/i/icor.asp

S, N. (2017, January 13). Role of Deficit Financing in Developing Countries | Economics.

Economics Discussion. https://www.economicsdiscussion.net/public-finance/role-of-deficit-
financing-in-developing-countries-economics/261

71
UNIT - 3: CAPITAL FORMATION AND
DEVELOPMENT
STRUCTURE

3.0 Learning Objectives

3.1 Introduction

3.2 Importance of capital formation

3.2.1 Causes for low capital formation

3.3 Sources of finance for economic development

3.3.1 Domestic resources: Savings, Taxation, Deficit financing, public borrowing

3.3.2 External sources: foreign capital, Role of foreign capital, foreign aid, Tied and
untied

3.4 Role of technology in development

3.4.1 Labour and capital intensive

3.4.2 COR ACOR, ICOR

3.5 Summary

3.6 Keywords

3.7 Learning Activity

3.8 Unit End Questions

3.9 References

3.0 LEARNING OBJECTIVES

1. To make learner more productive human capital by understanding its importance.

2. To analyse performance of internal and international sources of finance.

3. To examine role of technology and its intensity suitable for economic growth.

4. To understand capital-output ratio and its impact on nations productivity and growth.

5. To understand importance of capital formation and its link with economic development.

72
3.1 INTRODUCTION

The term 'capital formation' is used in both a limited and a wide sense. In a strict sense,
however, it refers to physical capital stock, which comprises machineries, machinery, and
other equipment. Non-physical capital or human resources, such as public health, efficiency,
craft, visible and invisible capital, are included in a broader sense.

According to Prof. Colin Clark, capital goods “are reproducible wealth used for purpose
of production. But capital formation refers to the net addition made to the existing stock
of capital in a given period of time.” As a result, capital creation is defined as the sacrifice
of present consumption in order to gain more consumable products in the future, whereas
'capital' is the portion of the current product that is employed for further production rather
than being consumed immediately.

We must distinguish between 'keeping capital intact' and 'capital development' in this case.
When resources are utilised to replace worn out assets, such as wear and tear on machinery,
rather than adding to the economy's productive potential, the practise is known as preserving
capital intact. Capital creation, on the other hand, refers to the process of expanding the stock
of real capital, which obviously aids in increasing the level of output of goods and services.
As a result, the essence of the capital creation process is the diversion of a portion of society's
now available resources toward the possibility of future increases in consumable output.

The notion may thus be expanded to include human capital creation. In actuality, only real
physical assets such as stocks, bonds, currency notes, and bank deposits are included in
capital formation since they improve the economy's productive potential.

The quote Prof. Nurkse, “The meaning of capital formation is that society does not apply
the whole of its productive activity to the needs and desires of immediate consumption
but directs a part of it to make capital goods, tools and instrument, machines and
transport facilities plant and equipment—all the various forms of real capital that can
so greatly increase the efficiency of productive effort.”

According to Prof. Simon Kuznets, “Domestic capital formation would include not only
additions to construction, equipment and inventories within the country, but also other
expenditure expects those necessary to sustain output at existing lands. It would include
outlays on education, recreation and material luxuries that contribute to the health and

73
productivity of individuals and all expenditures by society that serve to rase the morale of
employed population.”

Capital formation is a term used in macroeconomics, national accounts, and finance

economics to describe how money is created. It's also utilised in corporate accounts on
occasion. There are three ways to define it:

1. It is a statistical concept in national accounts statistics, econometrics, and macroeconomics

that is also known as net investment. It refers to a measure of net additions to a country's (or
an economic sector's) (physical) capital stock during an accounting interval, or a measure of
the amount by which the overall physical capital stock rose over an accounting period in that
sense. Standard valuation principles are utilised to come up with this figure.

2. It's also a modern phrase for capital accumulation in economic theory, referring to the total
"stock of capital" that's been generated, or the expansion of that total capital stock.

3. The term "capital formation" has recently been used in financial economics to refer to
savings drives, the establishment of financial institutions, fiscal measures, public borrowing,
the development of capital markets, the privatisation of financial institutions, and the
development of secondary markets in a much broader or vaguer sense. It refers to any means
of growing the quantity of capital possessed or under one's control, as well as any method of
utilising or mobilising capital resources for investment goals, in this context. Thus, capital
might be "created" in a variety of ways, in the sense of "being gathered together for
investment objectives." This expanded definition has nothing to do with the statistical
measurement idea or the traditional economic theory understanding of the phrase. Instead, it
arose from credit-fueled economic development in the 1990s and 2000s, which was
accompanied by fast financial sector expansion and, as a result, a rise in the usage of finance
language in economic discourse.

3.2 IMPORTANCE OF CAPITAL FORMATION

Capital generation or accumulation is recognised as the most important aspect in an

economy's economic progress. Prof. Nurkse believes that capital production may easily break
the vicious cycle of poverty in developing countries. Capital creation quickens the speed of
growth by maximising the use of existing resources. In reality, it causes a growth in the

74
amount of national employment, income, and output, resulting in severe inflation and balance
of payment concerns.

1. Formation of Sound Infra-Structures:

The most important aspect of capital accumulation, particularly in its early phases, is that it
encourages the construction of social overheads in poor nations, which are in desperate need
of these infrastructures. In this sense, capital accumulation contributes significantly to the
development of fundamental capital goods in developing economies.

2. Use of Round-about Methods of Production

In a developing country, the capital formation process allows for the employment of
complicated or roundabout production methods, which allows for the division of labour into
phases using contemporary technology, and the production process leads to specialisation.
This leads to a rapid increase in production.

3. Maximum Utilisation of Natural Resources

In developing countries, risk-taking ability is increasing as a result of capital growth, which

makes new natural resources available. It is made feasible through careful and methodical
exploitation.

4. Proper Use of Human Capital Formation

In the qualitative development of human resources, capital building is extremely important.

The production of human capital is dependent on people's education, training, health, social
and economic security, freedom, and welfare amenities, all of which require adequate capital.
The labour force need modern implements and equipment in sufficient quantities so that, as
the population grows, output increases optimally and additional labour is readily absorbed.

5. Improvement in Technology

Capital generation provides overhead capital and the essential atmosphere for economic
development in developing nations. This aids in the instigation of technical advancement,
which makes the use of additional capital in the field of production difficult, and as capital in
the field of production increases, the abstract form of capital changes. It is clear that current
capital structure changes lead to changes in technique structure and size, and the public is
therefore increasingly impacted.

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6. High Rate of Economic Growth

A country's economic growth rate is proportional to its rate of capital formation. In compared
to advanced countries, the pace of capital formation or accumulation is often quite low. The
rate of capital formation in impoverished and underdeveloped nations ranges from 1% to 5%,
whereas it might even surpass 20% in the latter.

7. Agricultural and Industrial Development

Adequate money is required for the use of modern mechanised processes, input, and the
establishment of various heavy and light industries in modern agricultural and industrial
growth. Lack of capital results in decreased pace of development and capital formation. In
reality, the growth of these two industries is impossible without the accumulation of capital.

8. Increase in National Income

Capital formation improves a country's manufacturing conditions and methods. As a result,

national income and per capita income have increased significantly. This leads to an increase
in output quantity, which in turn leads to an increase in national revenue. The pace of capital
creation is inextricably linked to the rate of growth and the quantity of national revenue. As a
result, increasing national income requires the right adoption of various production methods
and their productive application.

9. Expansion of Economic Activities

Productivity rises swiftly when the rate of capital formation rises, and available capital is
used in more profitable and extensive ways. Complicated strategies and approaches are used
for the economy in this way.

This leads to an increase in economic activity. Capital formation boosts investment, which
has two consequences on economic development. To begin with, it raises per capita income
and boosts purchasing power, resulting in more effective demand. Second, more investment
leads to increased output. Economic activity may be extended in underdeveloped nations as a
result of capital formation, which helps to alleviate poverty and achieve economic growth.

10. Less Dependence on Foreign Capital

The process of capital building in developing countries increases reliance on indigenous

resources and domestic savings while decreasing reliance on foreign capital. Economic
progress imposes a burden on foreign capital; as a result, in order to pay interest on foreign
money and cover the costs of foreign experts, the government must impose an unfair tax
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burden on the general population. Internal savings suffer a setback as a result of this. As a
result of capital formation, a country can achieve self-sufficiency and become independent of
foreign capital.

11. Increase in Economic Welfare

The public is obtaining more amenities as the pace of capital production rises. As a result, the
average person benefits economically. Their standard of life rises as a result of capital
development, which leads to an unanticipated increase in their productivity and income. This
improves and increases the possibilities of finding job. This contributes to improving people's
well-being in general. As a result, capital development is the primary answer to impoverished
nations' complicated challenges.

STAGES OF CAPITAL FORMULATION

The stock of all created means of production that an economy holds at any given moment is
referred to as capital. Only human-produced means of production are the term "capital
formation" refers to the process of adding to an existing stock of capital. Capital creation may
be described as the annual process of increasing the stock of capital, Including in capital,
Plant and machinery. For example, as well as tools and instruments.

Savings refers to the portion of one's income that is not spent on consumption. This
expenditure is referred to as investment if our savings are used to purchase capital goods such
as machinery, instruments, or factories, or to increase the stock of raw materials or completed
items. Capital products are produced or capital stock is increased as a result of investment.
Capital creation is the process of increasing capital stock. The term "physical capital
creation" refers to the accumulation of physical capital. Capital creation may be divided into
two categories: Gross Capital Formation (GCF) and Net Capital Formation (NCF) (NCF).

Gross Capital Formation (GCF) is a term that refers to total investment. It encompasses
both replacement and net investment.

Net Capital Formation simply refers to an increase in net investment. Depreciation is

subtracted from gross investment to calculate net investment.

1) Creation of Saving

The initial stage of capital production is the establishment of savings. It indicates that the
volume of real savings must rise in order for the sources to be employed for the manufacture
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of consumption goods and then freed for other uses. As a result, some present consumption
must be sacrificed in order to get a bigger share of the flow of consumer goods in the near
future for capital development. For example, if a society saves nothing and consumes all it
produces, no new capital will be created, resulting in a decrease in consumer goods output in
the future due to the wear and tear on current capital assets. As a result, it is critical that
individuals save from their current consumption. Savings are based on the ability to save, the
desire to save, and the ability to save.

Ability to save is depends upon

(i) Ability (or power) to save,

(ii) Willingness (or desire) to save, and

(iii) Opportunity to save.

2) Mobilisation of Saving

The next step in the saving process is to turn the cash into investable ones. The presence of
banks and other financial institutions is required for this purpose. Banking facilities play an
important role in promoting a high rate of savings mobilisation and channelization. In
summary, a stable and efficient banking system allows investors to increase their investment.

3) Investment of Saving

Savings are then invested in capital goods as the last stage. It requires a new breed of
entrepreneurs who are efficient, energetic, adventurous, and skillful. An astute and effective
businessperson is always prepared to invest in the production of capital goods. In a nutshell,
saving and investing are both necessary for capital accumulation.

As a result, the process of capital accumulation requires that national income (Y) surpass
consumption over time (c). The income (Y) is split into consumption and savings, resulting in
Y = C + S. We also know that Y + E equal income. Similarly, spending can be classified as
either consumption (c) or investment I (I). Because Y = E and C = S, C + I is equal. S + I,

The difference between national income and consumption, on the other hand, is communal
saving, which is investment. The link between investment (I) and capital creation (C) is as
follows: investment (I) refers to investible surplus, whereas capital formation (C) refers to the
net addition to the existing stock of capital. If any part of the investible excess is utilised to

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produce consumer products, capital formation is hampered. As a result, the value of capital
formation in a particular period may not be equal to the value of investible surplus. As a
result, good investment value is a prerequisite for capital formation. However, it is important
to remember that it does not ensure capital generation. Even yet, it may be increased by
moving investible resources from consumer products to capital goods production.

FACTORS AFFECTING CAPITAL FORMATION

1. Saving volume

Saving is intimately related to capital accumulation. The gap between income and spending is
referred to as savings. The difference might be used to start a business. "Greater the volume
of savings, larger the size of capital," MARSHALL says, "lower the volume of savings,
smaller the size of capital." The money that has been saved is mobilised and turned into
capital assets.

2. Ability to save

It is directly proportional to an individual's income and the government's taxation policy.

Higher rates of capital production are associated with higher income and lower taxation.

3. Willingness to save

Many personal, familial, and national concerns, such as family fondness, a desire to establish
a company, considerations for old age, and unanticipated situations, all play a role.

4. Public Sector Enterprises

A public sector enterprise is an extremely significant type of business entity. Because these
businesses are held by the government rather than people, all revenues may be utilised by the
government to fund capital formation.

5. Market condition

Prosperity fosters and increases saving, but melancholy diminishes people's saving. Market
circumstances such as booms and busts have a significant impact on capital formation.

6. Investment facilities

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When people are given more opportunities to mobilise their assets, they are more likely to
save and invest. Commercial banks, mutual funds, and other financial institutions urge
customers to save more. More capital formation occurs as a result of increased saving.

7. Changes in income tax policies

The government might encourage capital creation by assisting potential investors in a variety
of ways. For example, performing techno-economic studies of various lines of production,
providing tax incentives to newly established production units, or providing income tax
benefits to persons who want to save are all examples (e.g., exempting from income tax that
part of income which is saved). These measures are especially beneficial when investment is
restrained not by a savings policy, but by the producers' unwillingness to deploy the available
savings in the economy.

8. Monetary policy

The government's economic policies are also a significant element influencing capital
formation in the country. While these policies do not operate as sources of capital formation
in and of themselves, they do influence the sources.

9. Commodity taxes

Commodity taxes can also be used to boost savings rates. If consumption products,
particularly luxury consumption items, are exposed to high sales tax rates, the costs of
consumption goods will rise (because the sales taxes are added to the prices of the goods).
Consumption in the country will be reduced as a result of this. If income remains constant,
savings will naturally rise.

10. Deficit budget

There are also additional fiscal policies that might be implemented in order to boost capital
formation in the country. The government is frequently called upon to construct significant
public-sector projects. These help to generate capital by generating social overhead capital.
Budget shortfalls are frequently used to finance the expenditures of these initiatives.

11. Rate of Capital Formation:

The ratio of gross capital formation to gross domestic product at current prices is known as
the rate of capital formation. It denotes the percentage of GDP that may be used for self-
growth. Gross capital formation is calculated by dividing GDP by gross capital creation.

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Gross Capital Formation of Central government

Fig 3.1 Gross Capital Formation of Central government

3.2.1 Causes of low capital formation

In the lack of these concrete assets, economic progress is impossible. The usage of modern
technology and capital goods is necessary for industrialization and agricultural development.
At the same time, the presence of an integrated infrastructure is a major determinant of
economic development (or social overhead capital).

Most LDCs, on the other hand, find it difficult to increase capital formation in order to
achieve quicker economic growth. For a variety of factors, the rate of capital formation is
low. To put it another way, there are a number of impediments to capital development. Such
impediments exist on both the demand and supply sides. We may now explore capital
creation issues from both sides in order to have a full picture of what Nurkse refers to as the
"vicious circle of poverty" (or in a broad sense, the vicious cycle of underdevelopment).

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Supply of Capital in LDCs

It is well knowledge that most LDCs are unable to save much due to poor per capita income
and widespread poverty. Furthermore, whatever little money is saved is not put to beneficial
use. The international demonstration impact appears to be the immediate cause.

Because most individuals in LDCs seek to follow the consumption patterns of those in
affluent nations, saving does not grow significantly when income rises. Instead, the majority
of extra money is spent on luxury products or non-essential consumption items. This is due in
part to a lengthy colonial history and in part to a strong desire to quickly catch up with the
West, or in other words, consumerism. This is true not only for city dwellers, but also for
rural dwellers. Things are, however, changing as of late. Some developing nations have taken
a variety of tactics to increase their savings rates, and they have had some success. In certain
nations, fiscal policies such as taxes, borrowing, modest savings plans, and deficit financing
have shown to be highly effective. In several other nations, public sector businesses have
been successful in producing surplus and increasing capital creation rates.

The undeveloped or rather fragmented character of financial (money and capital) markets is
another important supply-side impediment to capital development. Due to the lack of banking
facilities and stock markets in most rural regions, most individuals in rural areas are unable to
save much money, even if they choose to. A significant part of savings is wasted or used to
acquire non-productive assets such as gold and jewellery. A percentage of the money saved is
hoarded.

Thus, it is self-evident that inactive savings can only be mobilised for productive purposes by
establishing a strong and sound financial infrastructure, i.e., by establishing a strong network
of commercial banks and public financial institutions or development banks (such as IFCI or
IDBI), as well as stock exchanges and insurance companies in rural and semi-urban areas.

Demand for Capital in LDCs

On the demand side, there are a number of barriers to capital formation. It should be noticed
right away that the demand for capital is a derived demand, meaning that it is based on the
demand for consumer products. As a result, in a country with high consumer goods demand,
a substantial amount of capital goods is necessary to grow production capacity in the relevant
industries.

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If there is a high demand for a product, manufacturers may expect to make a lot of money,
which will naturally encourage them to spend heavily in plants, equipment, and machinery.
The majority of people in LDCs, on the other hand, live in inhumane conditions.

Furthermore, the vast bulk of the population lives in rural regions and relies on agriculture for
a living. A sufficient demand for manufactured articles or industrial commodities is unlikely
to exist in such nations. Even those in the so-called middle class do not have enough money
to purchase industrial products. The little sums spent by urban and rural elites are insufficient
to provide adequate incentives to investment. In summary, non-agricultural products and
services are in low supply in most LDCs. This appears to be the primary cause for the lack of
capital demand in these nations. The reality is that the domestic market's small size limits the
incentive to invest. In 1953, Nurkse popularised the notion of the vicious cycle of poverty,
based on Adam Smith's study of the restrictions to division of labour imposed by market size.
He pointed out that developing countries lack purchasing power, which limits the expansion
of local marketplaces. The need for capital is also low due to the low demand for consumer
goods and services.

It is self-evident that increasing the enticement to invest is critical to breaking the vicious
cycle of poverty in a developing country. Only through expanding the market can this be
accomplished. Nurkse believes that raising the money supply artificially will not improve the
size of the domestic market. It will have the impact of generating demand-side inflation. The
only method to enhance the market's size is to boost resource productivity (or total factor
productivity). The quantity of output not only determines the scope or size of the market, but
it also establishes a limit to its expansion. An rise in factor productivity improves both the
flow of commodities and, as a result, the amount of revenue. Consumption is naturally
stimulated as income rises. This, in turn, will boost output even more. As a result, if LDCs
are to escape poverty, they must increase production in both agriculture and industry. The use
of modem technology can also boost productivity. Because technological knowledge is
frequently incorporated in new machinery and equipment, adoption of modern technology is
linked to capital formation. However, there is a practical issue. The majority of LDCs have a
labour surplus. As a result, the adoption of capital-intensive production processes is likely to
result in unemployment, both in urban and rural regions.

Causes of low capital formation

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1. Low Level of National Income and Per Capita Income

The primary cause of capital insufficiency in developing nations is a lack of real national and
per capita income, which restricts savings and investment motivations.

Capital formation has remained flat due to a lack of required investments. As a result of the
low output, there is a low national and per capita income, which causes poor capital creation.
This condition tends to repeat itself, resulting in poor countries becoming poor. In such
nations, the low rate of capital formation constitutes a partial link in a vicious spiral. The pace
of capital production cannot be increased until the vicious circle of poverty is broken.

2. Lack in Demand of Capital

Another reason for the low rate of capital formation in developing nations is a lack of capital
demand. Prof. Nurkse puts it this way: "Low productivity in underdeveloped nations means
individuals have little real income and, as a result, low purchasing power. As a result of low
demand, investment has a negative impact on national income and productivity, and the rate
of capital creation stays low.

3. Lack in Supply of Capital

Low capital formation is due to a lack of capital supply, just as it is due to a lack of demand
for capital. However, the process of capital development in underdeveloped nations is slowed
due to a lack of essential capital supply. As a result, capital formation has remained stagnant.
As a result, Prof. Nurkse believes that Because underdeveloped nations have a low rate of
real income per capita, they have a limited ability to save, resulting in a lack of capital.
Because basic businesses and industries cannot be formed due to a lack of finance,
production suffers.

4. Small Size of Market

Investment is discouraged in underdeveloped nations due to the tiny size of the local market.
It does not extend economic development efforts, and contemporary machinery cannot be
employed since excess production has no market access.

5. Lack of Economic and Social Overheads

Basic overheads like as roads, buildings, communication, education, water, health, and so on
are often lacking in underdeveloped nations, resulting in an unfavourable environment for
capital development and a delayed capital formation process.

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6. Lack of Skilled Entrepreneurs

Entrepreneurs who are capable and efficient are few in developing nations. It is the sole cause
of the low capital creation rate. Because of a lack of risk-taking entrepreneurs, the formation
and expansion of enterprises is restricted, industrial diversification is not carried out, and no
balanced economic development is conceivable.

7. Immobility of Savings

Savings immobility also results in a poor rate of capital accumulation. Poor countries have
restricted financial operations due to a lack of banks and other credit institutions. Whatever
financial institutions exist, they are tiny and unable to gather funds from remote locations,
resulting in a lack of passion for saving in a population. As a result, there is a problem of
hoarding, and money is saved for nonproductive uses.

8. Backwardness of Technology

Technical knowledge is often a concern in developing nations. Production is conducted out

using outdated and inefficient methods. As a result, these nations' productivity and per capita
output are poor, and their income is low, lowering the quality of capital formation.

9.  Demonstration Effect

The demonstration impact also obstructs capital formation. Prof. Nurkse attributes the low
rate of capital creation to "demonstration patterns of people coming into touch with finest
commodities or superior patterns of consumption in which old wants are met by new goods
and new plans, and then they become dissatisfaction and discontent after a period of time."
As a result, their knowledge expands, their imaginations are piqued, and new passions are
sparked also propensity to consume increases.

Furthermore, individuals in these nations have a propensity to emulate the higher

consumption standards of industrialised countries. In fact, all of these behaviours occur as a
result of the demonstration effect, which raises the desire and ability to save in society by
increasing the inclination of consumption based on new ways and things.

10.  Lack of Effective Fiscal Policy

In underdeveloped nations, a lack of competent fiscal or financial policy also slows capital
accumulation to some extent. The tax burden is too great, and people's ability to tolerate it is
limited due to their poor income. Furthermore, inflationary situations arise, causing prices to
skyrocket. This results in an increase in the cost price of capitalization goods rather than
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consumption goods, causing exported commodities in the internal market to lose ground in
the external market to the best and cheapest items. This leads to an issue of unfavourable
trade and payment balances. As a result, these countries' economic development and capital
formation rates are extremely low.

11. Lack of Investment Incentives

Another factor contributing to the slow pace of capital formation is the absence of investment
incentives in most developing nations. This results in a low rate of productivity, which limits
capital accumulation.

12. Deficit Financing

Deficit finance is now widely regarded as a key source of capital creation. However, if it
exceeds its bounds, it tends to have a poor rate of capital production. Whenever a country's
deficit is financed, prices rise, and all items become more expensive as a result. It is difficult
to save in this circumstance because the entire sum has been spent. As a result, there is a high
rate of saving and a low rate of capital production.

13. Unequal Distribution of Income and Wealth

Since the distribution of income and wealth in most underdeveloped and backward nations is
extremely uneven, the rate of capital formation remains low. In reality, it hinders actual
investment in the economy, which has a significant impact on capital creation.

14. Demographic Reasons

The population growth rate in developing nations is quite high, resulting in a low rate of
capital development. It's because the majority of their earnings are spent on boosting the
figures. As a result, there is limited room for saving, which exacerbates capital creation
growth.

3.3 SOURCES OF FINANCE FOR ECONOMIC DEVELOPMENT

The financial sector refers to the institutions, instruments, and markets, as well as the legal
and regulatory framework that enable credit-based transactions. Fundamentally, the goal of
financial sector growth is to reduce "costs" in the financial system. Financial contracts,
markets, and intermediaries emerged as a result of this process of lowering the costs of
getting information, enforcing contracts, and conducting transactions. Various types and
combinations of information, enforcement, and transaction costs, as well as various legal,

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regulatory, and tax regimes, have prompted various financial contracts, markets, and
intermediaries across countries and throughout history.

A financial system's five key functions are: (i) generating information ex ante about potential
investments and allocating capital; (ii) monitoring investments and exercising corporate
governance after providing finance; (iii) facilitating risk trading, diversification, and
management; (iv) mobilising and pooling savings; and (v) facilitating the exchange of goods
and services.

Financial sector growth happens when financial instruments, markets, and intermediaries
reduce the impacts of information, enforcement, and transaction costs, allowing the financial
sector to perform its core duties more effectively.

(A) Importance of financial development

A considerable body of research demonstrates that the growth of the financial sector has a
significant impact on economic development. By boosting the savings rate, mobilising and
pooling funds, creating investment information, enabling and promoting foreign capital
inflows, and optimising capital allocation, it fosters economic growth through capital
accumulation and technical advancement.

Financial development is not simply an outcome of economic growth; it contributes to it.

Countries with better-developed financial systems tend to grow faster over long periods of
time, and a large body of evidence suggests that this effect is causal: financial development is
not just an outcome of economic growth; it contributes to it.

Additionally, it improves poverty and inequality by boosting poor and vulnerable people'
access to financing, enabling risk management by lowering their sensitivity to shocks, and
increasing investment and productivity, all of which result in higher revenue production.

Small and medium-sized firms (SMEs) can benefit from financial sector development by
having easier access to capital. Small businesses are often labor-intensive and generate more
jobs than huge corporations. They are crucial to economic growth, especially in emerging
economies.

Financial sector growth entails more than just putting in place financial intermediaries and
infrastructure. It necessitates the establishment of strong policies for the regulation and
oversight of all significant enterprises. The global financial crisis highlighted the negative

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implications of ineffective financial sector policy. The financial crisis has demonstrated the
potentially destructive effects of ineffective financial sector policy on financial development
and economic results. Finance is important for development, both when it works well and
when it doesn't. The financial crisis has thrown conventional wisdom about financial sector
policies into disarray, sparking a heated discussion over how to best promote long-term
growth. After the crisis, reassessing financial sector policies is a key step in shaping this
process. Publications like the World Bank's Global Financial Development Report can assist
achieve this goal. The report's first chapter and statistical appendix give facts and information
on financial development throughout the world.

(B) Measurement of financial development

To analyse the financial sector's progress and comprehend the influence of financial
development on economic growth and poverty reduction, accurate financial development
assessment is essential.

However, because financial progress is such a broad term with several characteristics, it is
difficult to quantify in practise. So far, most empirical work has relied on conventional
quantitative indicators that have been accessible for a lengthy time period for a wide range of
nations. For example: the asset-to-GDP ratio of financial institutions, the liquid-to-GDP ratio,
and the deposit-to-GDP ratio.

However, because a country's financial sector consists of a wide range of financial

institutions, markets, and products, these estimates are only a general guide and do not
account for all elements of financial growth.

To evaluate financial progress throughout the world, the World Bank's Global Financial
Development Database established a comprehensive yet relatively simple conceptual 4x2
framework. Financial depth, access, efficiency, and stability are four sets of proxy variables
that characterize a well-functioning financial system, according to this framework. The two
primary components of the financial sector, namely financial institutions and financial
markets, are then measured using these four dimensions

(C) Role of Finance in Development of an Economy

The financial structure of a country determines how well an economy runs. Banks, as a key
entity, are part of the financial system, as are other financial service providers. A country's

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financial system is firmly embedded in society and employs a huge number of people. The
financial system has three primary purposes, according to Baily and Elliott.

Credit provision - Credit is necessary for economic activity to take place. Governments may
invest in infrastructure projects by lowering tax revenue cycles and correcting expenditures,
corporations can invest more than they have in cash, and consumers can buy houses and other
utilities without having to save the whole cost up front. All stakeholders have access to this
credit facility, which is provided by banks and other financial service providers.

Liquidity provision- Banks and other financial institutions offer liquidity to companies and
people in the event of a cash shortage. Demand deposits are provided by banks and can be
withdrawn at any moment by a business or individual. They also offer credit and overdraft
services to companies. Furthermore, banks and financial institutions offer to purchase or sell
assets as needed, and sometimes in huge quantities, to meet the liquidity needs of
stakeholders.

Risk Management Service- By pooling risks, finance enables risk management from
financial market and commodities price hazards. Banks can provide risk management through
derivative transactions. These services are incredibly useful, despite the fact that they have
received a lot of criticism as a result of the financial crisis' excesses.

(D) Criticism

(a) Savings-investment relationship

Any economy's functioning and development activities rely on the aforementioned three key
tasks. Aside from these roles, the savings-investment connection contributes to an economy's
growth. Only when there are adequate savings can there be a significant amount of
investment and industrial activity. Financial organisations provide this savings option through
attractive interest plans. Financial organisations exploit the money saved by the general
population to lend to companies at high interest rates. These funding enable enterprises to
expand their manufacturing and distribution operations.

(b) Growth of capital markets

Another key function of finance is to promote capital market expansion. Businesses require
both fixed and operating capital. The money needed to invest in infrastructures such as
buildings, plants, and machinery is referred to as fixed capital. The money required to run a
firm on a daily basis is referred to as working capital. This might apply to recurring raw

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material purchases, finishing products costs, and completed goods transit to retailers or
customers. The financial system facilitates capital rising in the following ways

(c) Fixed capital - Businesses raise fixed capital by issuing shares and debentures. Public and
commercial financial service companies participate in these shares and debentures to generate
money with no risk.

Businesses raise short-term loans through issuing invoices, promissory notes, and other forms
of working capital. These credit products can be used in money markets.

(d) Foreign exchange markets

Foreign exchange markets exist to assist export and import firms by allowing them to receive
and transport funds to and from other nations and currencies. Banks and other financial
organisations can also borrow or lend money in other currencies through these foreign
exchange markets. Furthermore, financial organisations can invest their short-term idle
money in foreign currency markets and benefit from it. Governments also use these markets
to satisfy their foreign exchange needs. As a result, foreign exchange markets have an
influence on an economy's growth and reputation in international markets.

(e) Government securities

Governments rely on the financial sector to meet their short- and long-term funding needs.
Governments provide favourable interest rates on bonds and bills, as well as tax breaks.
Government securities fill in the holes in the budget. As a result, capital markets, foreign
currency markets, and government securities markets are critical in assisting enterprises,
industries, and governments with economic development and growth.

(f) Infrastructure and growth

Economic development is dependent on the development of the country's infrastructure. The

expansion of other sectors is determined by key industries such as power, coal, and oil. These
infrastructural industries are supported by the country's financial system. Infrastructure
businesses have a large capital demand. Because raising such a large sum is difficult for
private companies, governments have usually taken entire responsibility for infrastructure
projects. However, as a result of the economic liberalisation programme, private sector
engagement in infrastructure industries has increased. In India, development and merchant
banks like IDBI assist support these private-sector enterprises.

(g) Trade development

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The most significant economic activity is trade. The financial system supports both domestic
and international trade. Traders require financial assistance from banking institutions. On the
other hand, financial markets assist in the discounting of financial instruments such as
promissory notes and bills. Commercial banks provide pre- and post-shipment financing for
international commerce. Importers are awarded letters of credit, which assist the government
earn valuable foreign exchange.

(h) Employment growth

The financial system is critical to an economy's employment growth. Financial systems

finance businesses and industries, resulting in more employment and, as a result, increased
economic activity and domestic commerce. Increased commerce leads to increased
competitiveness, which leads to activities like sales and marketing, which creates more jobs
in these industries.

(i) Venture capital

Increased venture capital or venture investment will help the economy flourish. Currently,
India has a limited amount of venture capital. Individual corporations find it difficult to
engage directly in enterprises owing to the risk involved. Venture capital is generally
provided by financial entities. This area will benefit from an expansion in the number of
financial institutions that support projects.

(j) Balances economic growth

The financial system balances the expansion of diverse sectors of an economy. There are
industries in the elementary, secondary, and tertiary sectors, all of which require sufficient
finances to flourish. The country's financial system finances these sectors and ensures that
each – industrial, agricultural, and service – has sufficient cash.

As a result, finance is critical to the growth of every economy, and no economy can function
effectively without a healthy financial system.

3.3.1 DOMESTIC RESOURCES

According to the Monterrey Consensus, each country is responsible for its own economic and
social development, and the importance of national policies and development plans cannot be
overstated.

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Developing nations have achieved great progress in the implementation of development
strategies in key areas of their economic frameworks in the years after the Monterrey
Conference, contributing to improved mobilisation of domestic resources and higher levels of
economic growth in some cases.

"National ownership and leadership of development plans, as well as excellent governance,

are vital for successful mobilisation of domestic financial resources and encouraging
sustained economic growth and sustainable development," according to the Doha Declaration
of December 2008. "The scope for appropriate counter-cyclical policies to preserve economic
and financial stability must be expanded," according to the Doha Declaration, so that
macroeconomic policies "aimed at sustaining high rates of economic growth, full
employment, poverty eradication, and low and stable inflation" can be achieved.

The Declaration asked that "the Economic and Social Council explore the improvement of
institutional structures, particularly the United Nations Committee of Experts on International
Cooperation in Tax Matters," in order to promote domestic resource mobilisation.

The Declaration asked that "the Economic and Social Council explore the improvement of
institutional structures, particularly the United Nations Committee of Experts on International
Cooperation in Tax Matters," in order to promote domestic resource mobilisation.

The development of a strong and diverse financial sector is critical to mobilising domestic
financial resources and ensuring that the benefits of growth reach all people through
enhancing access to financial and credit services.

1. SAVING

Savings is the act of putting away a portion of one's current income for future use, or the flow
of resources collected in this way over time. Savings might take the shape of increased bank
deposits, securities purchases, or cash holdings. Individuals' willingness to save is influenced
by their preferences for future spending over current consumption, their expectations for
future income, and, to a lesser extent, the rate of interest.

An individual can quantify his savings for a specific accounting period in two ways. One
method is to calculate his income and remove his current outgoings, with the difference
representing his savings. Another option is to look at his balance sheet (his assets and
liabilities) at the start and end of the period and calculate the growth in net worth, which
indicates his savings. An individual can quantify his savings for a specific accounting period
in two ways. One method is to calculate his income and remove his current outgoings, with
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the difference representing his savings. Another option is to look at his balance sheet (his
assets and liabilities) at the beginning and end of the period and calculate his net worth rise
and savings. Total national saving is equal to national investment, or the surplus of net
national product over the sections of the product made up of consumption goods and services
and items purchased by government spending. As a result, in national income accounting,
saving and investment are always equal. The anticipated change in total net worth over time
is an alternative metric of saving.

Because of its relationship to investment, saving is critical to a country's economic success. If

there is to be a growth in productive wealth, some people must be ready to forego all of their
earnings. Progress cannot be achieved only via saving; individuals must be prepared to spend
in order to enhance productive capacity.

Working of Savings

Private and public savings are two types of savings. Public savings, national savings, and so
on. Investments involve both tangible and intangible assets, such as real estate and education.
Investing may be done in two ways: as a Net investment or as a Gross investment. The value
of a complete investment after depreciation is deducted is known as net investment. A gross
investment is one that is made without taking into account depreciation. "Investment" has a
distinct connotation in finance and refers to the acquisition of a security, such as a stock or a
bond. Consumption, population growth, political stability or instability, income rate, and
other factors can all impact saving. We all know that saving has a negative impact on an
economy's investment. As a result, saving is a critical aspect of investment.

Private saving

The portion of discretionary personal income that is not spent is referred to as private saving.
Personal savings is equal to personal income minus personal expenditures i.e., consumption
and interest). In general, personal savings refers to money that individuals save in their bank
accounts for future use or that they invest directly in real estate, bonds, stocks, and other
financial instruments.

Let, Mr. X ‘s income is to 20,000. According to government tax rules and regulations he pays
the government tax 2,000. So, Mr x’s disposable income is Tk (20,000-2,000) = Tk 18,000.
when the disposable income of Mr is Tk 18,000, at that period Mr x’s consumption is Tk
16,000. So, Mr x’s saving is Tk (18,000-16,000) = Tk 2,000.

From the above calculation we can briefly write down how the personal saving ean be found.
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Personal Income Tk 20,000

(Less): Personal taxes Tk 2,000

(Equals): Disposable Personal Income Tk 18,000

(Less): Personal outlays Tk 16,000

(Including consumption and Interest)

(Equals): Personal Saving Tk 2,000

Public Saving

After paying for its expenditures, the government saves a portion of its income, which is
essentially tax money. Ordinary government reserves a portion of its revenue for a variety of
uses, including human activities for the country's growth or providing citizens with security.

For the sake of good health, education, and other aspects of social welfare. Tax income minus
public spending equals public saving.

National Saving

We can use a model for showing National Income (GDP): (For closed Economy)

Y = C+I+G.

Here, Y = National Income

C = Consumption

I = Investment

And G = Government purchase.

The amount not spent on consumption and government purchases is referred to as national
saving. Anything left over after that is assumed to be invested.

National savings → Y-C-G=I

Replacing S for Y-C-G, We can write the equation as:

S=I

The term "national saving" refers to a mix of private and state savings. After paying taxes and
for consumption, a household's private savings is the amount of money left over. After
paying for its expenses, the amount of tax income left over is referred to as public savings. As
a result, a new term T is introduced into the equation.
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S= (Y-T-C) + (T-G)

In general, investments should be placed in industries that create goods that have a high
demand. Now we can clearly see that saving is a component of disposable income. Savings
leads to investment, which leads to capital accumulation. Gain in productivity, growth, and so
forth. A nation will not achieve its ultimate objective if its savings are not properly managed.
It is also true that affluent nations have a greater proclivity to save, whereas impoverished
countries have a lower proclivity to save. The amount of wealth in a country can influence
saving behavior. Saving is one of the most important factors in determining a country's level
of life. Saving allows a country to demonstrate its competence or quality in comparison to
other countries. The government and international leaders should take the necessary steps to
improve people's savings and investment tendencies, both in the private and governmental
sectors.

2. TAXATION

In order to finance economic development, tax policy plays two crucial responsibilities. One
is to keep an economy at a greater level of employment so that people's saving capacity
increases as their income per capita rises.

The second is to increase the community's marginal propensity to save as much as feasible
above the average propensity without discouraging labour effort or breaking fairness canons.
Savings can be achieved in one of two ways: by raising real production or by lowering real
consumption. Economists and politicians dispute over the utility or need of taxes in raising
resources to finance economic growth in emerging countries like India.

There is a need for compulsion in compelling individuals to consume less and save more at
the early stages of development, when the pace of growth is modest. Only via taxes can
forced saving be generated, which is critical for boosting the rate of capital formation, which
is a precondition for high per capita income development.

The design and execution of taxes to limit private consumption is focused with tax policy to
raise the MPS above APS. Most developing nations' tax collection as a proportion of GDP is
low, averaging 15—20 percent, compared to 25—30 percent in rich ones. Furthermore, as
compared to indirect taxes, direct taxes, particularly income taxes, are a modest source of
revenue. In developing nations, the proportion of the population that pays income tax is low,
averaging around 10%, compared to the great majority of the working population in
industrialised countries, which ranges from 20% to 40% of the entire population. As a result,
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there appears to be more room for utilising tax policy to increase aggregate saving as a
percentage of income. In this context, two key factors should be underlined.

Tax Systems

To begin with, the primitive character of the tax system in poor nations reflects the level of
development. As a result, the potential for boosting tax collection as a percentage of income
may be limited in practice.

Measuring the tax base

Second, there are the challenges of identifying and quantifying the tax base, as well as
assessing and collecting taxes, in a nation where the population is dispersed and
predominantly engaged in subsistence agriculture, with a high illiteracy rate.

There's also the issue that, in terms of income tax, the great majority of income-carers'
earnings are so low that they lie outside the tax system's reach. In rich nations, 70% of
national income is subject to income taxes; in poor countries, only about half of national
income is taxed.

In this context, A.P. Thirwall has argued that, “even if there was scope for raising
considerably more revenue by means of taxation, whether the total saving would be raised
depends on how tax payments are financed — whether out of consumption or saving — and
how income (output) is affected. It is often the case that taxes which would make tax revenue
highly elastic with respect to income are taxes which would be met mainly out of saving or
have the most discouraging effects on incentives.”

Progressive income tax and saving

We can use progressive income tax as an example, which will discourage work effort if the
substitution effect of the tax is stronger than the income effect; and to the extent that high
marginal tax rates fall primarily on high-income groups (i.e., rich people) with low
propensities to consume, saving may fall by nearly as much as tax revenue rises.

An expenditure tax on high-income groups, which exempts saving from taxes, is a preferred
alternative to a progressive income tax. For avoiding such huge losses in private saving, but
the negative effects on labour effort are not definitely avoided.

This is because, in order for the spending tax to generate the same amount of money as the
income tax, the tax rate must be higher. If individuals work to consume and consumer prices

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rise, labour effort will be reduced if the substitution impact of the change is greater than the
income effect.

The more successful the spending tax is at encouraging saving out of a given income, the
higher the rate of tax must be to maintain the economy balanced between the two taxes, and
the greater the incentive to labour effort will be.

In India, for example, direct taxes accounted for 18.5 percent of overall tax collection in
1995-96. This indicates that indirect taxes accounted for 81.5 percent of total tax revenue. As
a result, the government is compelled to expand the scope of indirect taxes on mass
consumption products in order to earn sufficient funds for development. Furthermore,
because agriculture is the economy's backbone and because developing nations often spend
heavily in agriculture and related sectors, agricultural taxes must play an important role in
resource mobilisation for planned economic growth.

Agriculture tax

Agricultural taxation is a potentially large source of tax income and a way of shifting
resources into productive investment since agriculture is so important in developing nations.

Agriculture is taxed using a variety of methods, including taxes on land area, land value, net
income, and land transfer. Agricultural marketing and export taxes are undoubtedly the most
efficient and easiest to collect if the government's goal is to increase money.

In principle, land taxes are the most desirable method of diverting resources away from
agriculture. In practise, however, land taxes constitute a minor source of revenue.

The balance between direct taxes on income and indirect taxes on consumption and trade in a
contemporary market-based economy like India is substantially skewed in favour of the
latter, notably in the form of import charges and sales taxes.

Business Tax

These taxes are simple to collect and administer, but they may just substitute one type of
saving for another. The MPS profit margin is generally rather substantial. The fundamental
argument for corporation taxes is to keep control of resources that might otherwise leave the
nation if the company was foreign-owned, or to replace private investment with public
investment since public investment is more socially beneficial than private investment.

Difficulty in Tax

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However, taxes as a source of development funding have its drawbacks. While involuntary
savings may rise as a result of subsidised reductions in consumption, voluntary savings may
decline as people struggle to maintain their current consumption levels in order to defend
their living standards. The flow of funding to the private sector is expected to be reduced as a
result of this.

Furthermore, taxes reduce the incentives to work hard, save, and take risks. As a result,
labour effort, savings, and venture capital (i.e., new business) investment will decrease.
Furthermore, agricultural taxation may have an impact on agricultural development. Farmers
may choose to eat more and save less rather than taking methods to increase agricultural
production through investment.

3. DEFICIT FINANCING

If traditional sources of funding are insufficient to support public spending, a government,

particularly in a developing country like India, may resort to deficit financing. The term
"deficit financing" refers to the production of fresh money to cover the difference between
planned spending and expected receipts.

It entails planning ahead for a shortfall. When the government's current expenditures exceed
its current receipts, the budget is said to be in deficit. The difference between total budgetary
expenditures (including revenue and capital accounts) and total budgetary income is known
as the budgetary deficit (on both accounts).

Keynes proposed that, in times of profound depression and high unemployment, a fiscal
deficit should be intentionally created, with taxes decreased to increase buying power and
stimulate demand.

When the expenditures budgeted for the current year exceeds the revenues projected over the
same time, a budget deficit occurs. The deficit can be closed by raising tax rates or increasing
the price of goods and services provided by the government (e.g., railway fares).

The government's accumulated cash reserves or borrowing from the banking sector might
potentially be used to cover the deficit. Deficit financing is defined as the use of the last two
strategies (expenditure from cash balances or borrowing). The government's budgetary deficit
(PSBR) or public sector borrowing need (i.e., the shortfall between projected government
expenditure and anticipated tax collection) establishes a relationship between budgetary
deficit and money supply. There are three primary methods for the government to fund the
PSBR. The government can first offer its bonds to non-bank private investors.
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Second, it has the ability to sell bonds to the banking industry. Third, it can sell bonds to the
central bank, even its own bonds, thereby creating money. The government may also borrow
money from other countries (external debt). We're talking about high-powered money here,
which includes currency plus bankers' deposits at the central bank. All government
expenditure raises the amount of money in the hands of the wealthy.

The government's budget constraint, which ties the PSBR to the available financing options,
emphasises the fact that fiscal and monetary policy cannot be evaluated apart in general.
Printing money and issuing bonds to the banking sector are two methods of financing the
PSBR, both of which involve an increase in the quantity of money. Selling bonds to the non-
bank private sector, on the other hand, does not expand the money supply.

The basic relationship

If the government wants to limit the increase of the money supply, it must sell as many bonds
to the non-bank private sector as feasible (given the demands of the PSBR). This might result
in significant interest rate hikes, which could contradict with other policy needs as well as
impose a future burden of paying high interest. If the government wants to keep interest rates
low, it will be difficult to keep the money supply under control.

In India, deficit financing is accomplished in one of two ways: either by depleting the
government's cash reserves or by borrowing from the Reserve Bank, which grants the loan by
printing additional notes. As a result, 'new money' enters circulation in both circumstances.
As a result, because the supply of products does not rise in lockstep with the increase in the
money supply, inflation may emerge.

Deficit financing is a critical component of any long-term economic growth strategy. It does,
however, have one serious flaw. It generates a surplus of purchasing power. As a result,
unless accompanied by a matching and proportionate decline in the income velocity of
money, it is fundamentally inflationary. In other words, the pricing impact inflates the
monetary worth of national revenue. On the plus side, it boosts effective demand, which may
enhance employment and output while partially offsetting the price effect if there are
unemployed labour and other factors of production.

The generation of economic surplus during the development phase is the most crucial item to
ensure from deficit financing. If this money is put to good use, it will result in a significant
quantity of capital formation and growth. The crux of the issue is whether extra public
spending on development projects is proportional to the savings realised as a result of the
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process. If the two are perfectly balanced, and public investment is invested in productive
projects that provide a consistent rate of return year after year, there is likely to be a little
dosage of inflation that is beneficial to the entire development process.

The primary cause of inflation in emerging nations like India is inelastic supply of vital
products. There is no risk of inflation if their supply can be raised as the money supply
expands. In practise, however, this does not occur, and some level of inflation is unavoidable.

Everything, however, is contingent on the size of the government's deficit financing and its
phasing across the development plan's time horizon. If the budget remains in deficit, new
taxes must be imposed to diminish the surplus purchasing power that is anticipated to be
produced as a result of the production of paper money. During these times, price control and
cum-rationing are also necessary.

4. PUBLIC BORROWING

Another fiscal approach for mobilising resources for economic growth is through government
borrowing. Borrowing is used by governments in emerging economies to finance economic
development projects. Because taxes alone cannot supply sufficient finances for economic
development, government borrowing, also known as public borrowing, becomes required.
Furthermore, excessive taxes has a negative impact on private savings and investment. It
should be emphasised that when the government raises spending, it frequently results in a
budget deficit, which is also referred to as a fiscal deficit. There are two ways to fund the
budget imbalance. To begin with, the government borrows from the market, which results in
a rise in national debt. Borrowing to cover the fiscal deficit is referred to as debt-financing of
the budget deficit. Second, the budget or fiscal deficit can be funded by printing more money,
which is known as money financing of the fiscal deficit. The amount of resources that should
be mobilised by the government by borrowing and creating money is determined by whether
the funds are employed for constructive objectives that result in increased GDP growth. In a
developing economy like ours, we believe that a delicate balance must be achieved between
the amount of resources that must be raised through taxation, borrowing (i.e., debt financing),
and freshly minted money.

Government Borrowing or Debt-Financing of Budget Deficit

Borrowing by the government, which issues bonds and sells them to the public, is a common
means of covering budget deficits. Interest-bearing bonds are often sold to the public through
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financial intermediaries such as banks. Banks use the public's monetary deposits to purchase
the government's bonds. As a result, borrowing by the government to finance the budget
deficit is referred to as bond-financing the budget deficit. The government can boost its
spending by borrowing money in this way, but it also adds to the national debt, which has
both short- and long-term effects. It should also be highlighted that a budget deficit occurs
when taxes are cut while government spending remains steady. This sort of budget shortfall
can potentially be covered by issuing bonds to banks or the general public. The government
must not only pay interest on borrowed funds on a yearly basis, but it must also repay the
principle amount borrowed, for which it may collect greater taxes in the future.

The expansionary effect of debt financing of government expenditure has been emphasised
by Keynesians. The use of borrowed money to augment government spending creates an
upward change in the aggregate expenditure (C + I + G) curve in the Keynesian model with a
fixed price level. If the economy is not operating at full employment and there is an output
gap, increasing debt-financed government spending will result in an increase in output or
income.

With a growth in income at a given tax rate, tax revenue will rise, reducing or even
eliminating the budget deficit over time and bringing the budget into balance. This may also
be seen where the IS and LM curves are shown in relation to the money supply in the
economy. The production level at full employment is Y*. The equilibrium is initially set at
income level Y0. IS curves now shift to the right from IS0 to IS1 as government spending
increases through borrowing, but the LM curve remains unchanged. As a result, national
income rises to Y1, as shown in Figure 3.1. This will result in increased tax income for the
government, and the budget deficit will be lowered or perhaps erased over time. Although the
interest rate rises, it does not entirely offset the expansionary effect of increased government
expenditure, as resulting in a net expansionary effect of debt-financed increases in
government expenditure.

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 Fig 3.2 Government Borrowing or Debt-Financing of Budget Deficit

Critics have pointed out; however, that debt-financed government spending is generally
countered by debt financing's crowding-out effect on private investment. The effect of
crowding out on private investment manifests itself in a number of ways. To begin with, it
has been pointed out that the government borrowing funds to cover the budget deficit will
result in an increase in demand for lendable funds, causing interest rates to rise. The increase
in interest rates will lead to a decrease in private investment. As a result, debt-financed
government spending drives out private investment. According to this viewpoint, the net
expansionary benefit of increased government spending is small owing to the crowding-out
effect on private investment.

On the other side, society will be burdened by a growth in public debt as a result of debt-
financed government spending increases. If a budget deficit develops as a result of tax cuts
while government spending remains constant, the interest rate will rise, causing a crowding-
out impact on private investment. This occurs because tax cuts encourage people to spend
more money, which diminishes their savings. Interest rates rise as savings shrink, resulting in
a drop in private investment.

Public borrowing and economic growth

The use of borrowed money by the government for investment or development purposes
leads to increase in GDP or national income, according to a key tenet of public finance
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known as the golden rule. Given the current tax rate, this increase in income will result in
more tax money being collected. As a result, the budget deficit will shrink and the debt-to-
GDP ratio will fall. This is something that has happened in India.

In reality, E.D. Domar identified the criterion for the sustainability of continuous budget
deficits and, as a result, rising public debt many years before (in 1994). Debt-financed fiscal
deficits, according to Domar, are sustainable if growth outpaces interest rates. This is because
economic development entails a rise in income or GDP from which yearly interest payments
may be paid, and if income growth exceeds the rate of interest, a portion of the additional
money can be utilised to pay down public debt.

In this approach, the fiscal deficit and debt-to-GDP ratio may be lowered as the economy
grows. "According to Domar, if the government finances part of its expenditure (amounting
to a given fraction of full-employment output) through borrowing, public debt and the
government interest outgo as a proportion of GDP will be stable in the long run in a growing
economy provided the growth rate exceeds the interest rate," Mihir Rakshit writes. When this
criterion is met, maintaining full employment through debt financing of the budget deficit
does not jeopardise fiscal stability or lead to a debt trap."

The viability and sustainability of India's macrodynamics may be illustrated using the
following equation –

Y = C (Yd) + Iv (Y1 –Y t-1) + Ig + G … (1)

where Y represents national income (i.e., GDPFC), Yd represents disposable income, C

represents consumption that is based on disposable income (Yd), I represents private
investment that is based on changes in national income (Y), Ig represents government
investment expenditure, and G represents government consumption expenditure.

Now, Yd = Y-T where T stands for tax revenue. If t is the rate of income tax, then T = tY.
Thus

Yd = Y-tY = (1-t) Y…. (2)

Because the difference between government total expenditure on consumption (G) and invest
ment (Ig) and tax income received equals the budget deficit (BD) in our simplified model, we 
have

BD = (Ig + G) – tY …(3)
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Now substituting (1 -t) Y for Yd in equation (1) above we have

Y = C [(1 – t) Y] + Iν (Y1 – Y t-1) + Ig + G…. (4)

In a developing economy, the viability and sustainability of government borrowing to finance

fiscal deficits must be dependent on the size of government investment expenditure (Ig) in
total spending (Ig + G).

Assume the economy is operating at full capacity, and the government raises its investment
spending, say on infrastructure, while financing the budget deficit by borrowing. This rise in
government investment spending will enhance income through both the demand and capacity
effects, stimulating private investment that is dependent on income changes (i.e., Y1 − Y t-1).
This rise in government and private investment will result in rapid income growth over time,
resulting in increased tax revenue. If the rate of increase in income (GDP) exceeds the rate of
interest, the budget deficit will be lowered, which will have a positive influence on the public
debt/GDP ratio.

As a result, it is evident that the fiscal deficit and public debt can only be sustained if
government spending is shifted toward investment. "Budgetary viability requires an
improvement in revenue balances in the medium term and the long run public investment in
agriculture, aided by the crowding-in effect, raises agricultural productivity and acts as a
stimulant to a rural economy, brings down poverty, and allows the government to reduce
expenditure on food or fertiliser subsidies and poverty alleviation measures over time," says
Mihir Rakshit. Increased government investment in rural and urban infrastructure facilities,
as a result of higher tax collections and lower subsidies, would boost the budgetary situation
not only in the medium and long term, but also in the immediate term."

The fund produced by public borrowing can be used to improve the economy's economic
infrastructure through irrigation, transportation, electricity, and communication programmes.
They can also aid in the development of the economy's agricultural and industrial bases. All
of these investments help to boost economic growth. There is no doubt that public borrowing
is a highly helpful and crucial tool for emerging nations to accelerate their economic growth.
Saving and investment, the two most important factors of economic development, are aided
by public debt. However, there are three issues with government borrowing. To begin with,
government borrowing increases public debt, putting a greater burden on future generations
who will be forced to pay more taxes to the government in order to repay the borrowed cash.
Furthermore, the government must pay interest on borrowed funds every year, and these

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yearly interest payments, which are very significant owing to the accumulated big public
debt, often result in a large deficit in the government budget's revenue account.

As a result, interest payments consume a significant portion of new borrowings each year.
Finally, government borrowing from the market increases demand for loanable money,
causing interest rates to rise. When interest rates rise, private investment reduces. As a result,
it is frequently claimed that government borrowing discourages private investment. When the
Central Bank, via its accommodating monetary policy, boosts the money supply to provide
abundant liquidity in the banking system, banks are able to make sufficient funds accessible
to fulfil the demand for funds in the business sector.

For the government's borrowing strategy to succeed, financial institutions must be created
and expanded into rural parts of the economy in order to instil the habit of thrift in the
populace and mobilise the quantity of savings generated in this sector for productive reasons.
Furthermore, it will be important to examine and restrict the diversion of savings into
unproductive investments such as real estate, gold and jewellery, and inventory buildup in
order to mobilise saves. Borrowing strategies that are appropriate must also be created. Bonds
issued by the government, for example, should be tailored to the tastes of the general public;
bonds with big denominations and lengthy maturities may be offered to institutional
investors, while those with small denominations and short maturities may be offered to retail
investors.

3.3.2 EXTERNAL SOURCES

1. FOREIGN CAPITAL

Foreign aid is reliant on the goodwill of affluent countries in providing funds to developing
countries. Its availability is determined by international political connections. Excessive
reliance on foreign help puts a country's sovereignty at jeopardy.

Capital inflows result from private foreign investment. It provides technical expertise as well
as entrepreneurial skills. However, the availability of foreign cash from private investment is
determined by the country's government policies. Private foreign investment will be
discouraged if nationalisation is a possibility. When two nations form a joint economic
enterprise, there may be public foreign investment. External funding can assist accelerate
progress, but relying on it too much might impede a country from becoming self-sufficient.

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As a result, foreign aid should be used first. However, once the development process has
gotten off the ground, the country should rely on overseas trade rather than foreign aid.

Trade is always political, but assistance is always economic. "Today, most of what is referred
to be foreign aid is in the form of bribes... These bribes are largely justified in terms of
economic development help from abroad."

"However, when help for economic development is camouflaged as military support, the
aims of aid for economic development are likely to suffer." As a result, actual development is
ultimately dependent on commerce, which involves expanding exports in order to import real
capital.

2. FOREIGN AID

The paucity of investment capital, both on a global scale and inside LDCs, is alleged to have
hampered impoverished nations' economic possibilities and even consigned them to a life of
suffering in a so-called "vicious cycle." As a result, aid was intended to supplement domestic
investment. According to neoclassical analysis, the function of foreign saving (including
assistance) is to supplement domestic saving, raise investment, and therefore accelerate
growth, i.e. help generates extra private capital flow since capital accumulation is required for
rapid and self-sustaining growth (Levy 1987). Both are thought to increase the economy's
productive potential and stimulate technological progress. Aid may have an impact on growth
through influencing the pace of investment. The purpose of international transfers is to
supplement domestic investment resources.

Another argument often propounded in favor of aid is its influence in reducing poverty and
redressing income inequality in developing countries, which is often associated with
economic growth (UNDP 1996). Moreover, in the 1980s new emphasis on promoting
democracy and human rights and environmental issues complicated these sentiments
(Graham and O’Hanlon 1997

In the 1990s, new objectives were established, such as support for export markets in LDCs.
Aid may not be able to meet all of these objectives at the same time. Aid is now primarily
viewed as a tool of improving recipient countries' utilisation of local resources. Aid is now
focused on supporting the adoption of growth-oriented fiscal, trade, and monetary policies,
rather than on development programmes in health, education, and agriculture.

Everything regarding foreign aid appears to be debatable. While aid has helped certain
nations achieve economic progress, it has failed in many others. It's sad, but maybe
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unsurprising, that the use of econometric methodologies yields such radically opposed
responses to the topic of the efficacy of aid to poor nations, according to research on the
subject. The exclusion or inclusion of any of the numerous components of help in
econometric research and models is not well established (Cassen 1986), and econometric
models of aid effectiveness do not currently have this characteristic. In addition, legislation,
variables, and conditions differ across country.

A smaller total volume of aid from rich countries that is more focused on recipients' actual
development needs and allows them more flexibility and autonomy in accomplishing their
development goals might be a beneficial move. Because a growing share of development
support is increasingly funnelled through multilateral assistance institutions like the World
Bank, political motivations are likely to be less strictly defined than in individual donor
countries. An increasing number of private NGOs in both rich and developing nations are
participating and sponsored by donor governments, which is a good shift.

3. TIED AND UNTIED FOREIGN AID

Untied aid is money donated to poor nations that can be spent on products and services in
almost any country. In contrast, linked aid requires that products and services purchased with
it be acquired only from the donor country or a restricted number of countries.

One of the key reasons in favour of untied assistance is that tied aid can cause significant
market distortions by restricting the number of nations from whom the recipient can acquire
goods. The restrictions make it difficult for the receiving country to discover the most cost-
effective method to spend the help it receives. Products and services purchased with linked
aid are projected to cost 15-30% more than equivalent goods and services purchased with
untied help. Furthermore, linked aid frequently favours capital-intensive commodities and
advice focused on the donor country’s expertise. As a result, recipient nations may make
acquisitions that are incompatible with their development objectives.

Furthermore, connected assistance management necessitates bigger bureaucracies in both

donor and recipient nations. Untying aid would presumably provide recipient nations more
flexibility in how they spend their resources, allowing them to focus on the goods and
services they require most and buy from the most cost-effective suppliers. Untying aid would
enable it to be used more effectively, hence enhancing its value.

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Tied aid is foreign aid that must be spent in the nation that is giving the assistance (the donor
country) or a group of countries. A developed nation will provide a developing country a
bilateral loan or grant, but the money must be used on goods and services produced in the
chosen country. As a result, untied assistance has no geographical boundaries. Tied aid is a
sort of foreign aid that must be invested in the nation or group of countries that is giving
assistance. A developed country can provide a developing country a bilateral loan or grant,
but the government will demand the money to be used on goods and services produced in that
country.

3.4 ROLE OF TECHNOLOGY IN DEVELOPME

Technology and poor countries may not be adopted by developed countries. The least
developed nations, with low income, limited capital resources, and an abundance of unskilled
labour, are the major markets of advanced industrial countries with high income, large capital
resources, and excellent managerial and technical capabilities. So, what can be done for these
countries in terms of advanced technology? Developing countries should implement relevant
technologies in order to provide the necessary jobs. The country's present economic policy
framework should be in the development stage.

(A) Importance of Technology

(1) Productivity gains in the workplace

The increase in workers’ productivity and the application of technology we can assist the
agricultural industry, a farmer with a tractor, for example, may work for more than 10
farmers.

(2) Increased human capital

Human capital refers to a workforce that is competent and educated. When we improve our
usage of technology with labour skills, to contribute to the production of human capital.

(3) Providing a higher level of living

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We enjoy the benefits of living amenities based on per capita income and quality of life.
Technology, as well as national and per capita economic development, all contributes to a
higher quality of life.

(4) The output rises.

The country's output level rises as worker productivity rises. This results in a rise in a
country's national income.

(5) Supply is rapidly increasing.

According to Keynes, technological advancements allow for a rapid expansion in supply. If

the demand for a commodity rises, technology can help meet that need. It eliminates the
threat of inflation.

(6) Trade

"A country exchanges its extra output with the excess production of another country," is the
foundation of international commerce. As a result of the increased use of technology, output
and international trade have increased as well.

(7) Infrastructure development

Infrastructure is made up of several components, one of which is technology. We can

enhance by utilising technological advancements. Such as the use of atomic energy, the use
of gas instead of gasoline, and the use of computers, etc.

(8) There will be no resource waste.

Technology aids in the reduction of resource waste in manufacturing. In the presence of

technology, it is feasible to produce more output with the same inputs.

(9) Minimizing costs

"The rising usage of technology in a society as grows efficiency," according to Gallbraith. In

the end, national income growth and cost containment were the most important factors.

(10) Large-scale economics

It suggests that there are benefits associated with a high level of output.

We know that, in this contemporary day, the use of technology will rise, resulting in lower
costs and more profits.

(11) Overcome the poverty cycle's vicious cycle.

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The country's income rises as a result of its usage of technology. When income rises, demand
rises, and as a result, investment and capital formation rise and assisting in breaking the
poverty cycle.

(13) Quality Enhancement

When we apply cutting-edge technology in the manufacture of new items, the product's
quality improves. In the textile business, for example, machine-made fabric is superior to
hand-made cloth in terms of quality. And their output will increase.

(14) Labor force that is useful

Skilled labour can also be utilised to increase output. If the work force is highly skilled, they
will be able to successfully operate the machines. This might be beneficial to both the country
and the sector.

Technology may be considered a key source of economic growth, and technical

advancements have a substantial impact on the development of developing countries.
Economic growth and technological innovation are inextricably linked.

Economic growth is also influenced by technological advancements. A high degree of

technology can be used to produce a quick pace of growth. According to Schumpeter, the
only determinant of economic progress is innovation or technological progress. However, if
the degree of technology remains constant, the growing process will come to a halt. Thus, it
is the technological progress which keeps the economy moving. Inventions and innovations
have been largely responsible for rapid economic growth in developed countries.

The increase in net national income in industrialised nations cannot be attributed only to
capital. According to Kindleberger, technical advancements are responsible for a large
portion of this improved productivity. After accounting for labour force and capital stock
growth, Robert Solow calculated that technical development accounted for nearly 2/3 of the
expansion of the US economy.

In reality, technology may be considered a main source of economic growth, and numerous
technical advancements have a substantial impact on the development of developing
countries. The influence of technological development on manufacturing functions can be
seen using the diagrams below.

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 Fig 3.3 Labor force that is useful (a)

R' is an isoquant of the production function before technical change in Figures 1 to 3, and R'
reflects the same amounts generated after the innovation in Figure 1. In terms of labour and
capital, the invention remains unaffected. After technological improvement, the new
production function R demonstrates that the same output may be generated with less labour
and capital.

The second graph demonstrates that innovation saves labour, while R' shows that the same
output can be generated with less inputs, but labour saves more than capital. The third figure
demonstrates that the innovation is capital saving, and R' illustrates that following technical
improvement, the same output may be generated with less inputs, but capital saving is bigger
than labour saving.

The prevailing consensus is that technical progress is more significant than capital formation.
However, capital formation alone can only bring about limited economic development, and
progress will halt if there is no technical advancement. A country cannot continue to rely on
technological imports. A country that invests more in science and technology will expand
quicker than one that accumulates more cash but spends less on technological innovation.

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 Fig 3.3 Labor force that is useful (b)

Nation A focuses on accumulating greater capital resources in the first picture (4), whereas
country B focuses on technological issues but does not control capital accumulation in the
second figure 5. Because of the high rates of technical growth, it is apparent that nation B is
progressing quicker than country A. The production function in figure 6 illustrates the
premise that technical improvement is more significant than capital formation.

Fig 3.3 Labor force that is useful (c)

In the figure 6, OP represents the production function which rises to OP,, OP 2 and OP., with
technological progress. On the production function OP if amount of capital per worker raised
from Rs. 150 to Rs. 200, the output per worker of labour is raised from SM to XM 1, when

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capital per unit of labour is Rs. 300 the output per labour is. ZM,. The main objective of
technological progress is to make a better utilization of labour and other resources and hence
the production function shifts upward which means that more output per labour can be
obtained by the same amount of capital per worker.

While the amount of capital per worker remains constant at Rs. 150, production per worker
continues to rise from SM to NM. This is related to the production function migrating higher.
Similarly, with different degrees of capital intensity, more production may be created. As a
result of technological advancement, the production function shifts upward, allowing for
higher output per worker with the same amount of capital per worker.

3.4.1 LABOUR AND CAPITAL INTENSIVE TECHNOLOGY

(A) Labour Intensive Technology

A process or industry that takes a lot of effort to generate its goods or services is referred to
as "labor-intensive." The degree of labour intensity is usually expressed as a percentage of the
capital necessary to create the goods or services: the greater the proportion of labour expenses
required, the more labor-intensive the firm. Industry or process in which labour expenses
account for a greater proportion of overall expenditures than costs associated with the
acquisition, maintenance, and depreciation of capital equipment. Labor-intensive sectors
include agriculture, construction, and coal mining, to name a few.

In plain terms, a labor-intensive strategy is one that employs a great quantity of labour with a
little amount of money. It is a manufacturing technique in which more labour and less capital
are required. It may, however, be characterised as a system that combines a great quantity of
labour with a little amount of capital. "Labour intensive techniques of production are those
that need a big quantity of labour with a given unit of capital," says Prof. Myint. It is feasible
to increase output using this technique of manufacturing by employing the same amount of
capital but more labour.

Less developed economies are more labor-intensive as a whole. This is a regular occurrence
since low income implies the economy or business cannot afford to invest in costly capital.
However, a corporation might stay competitive by employing a large number of people

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despite low income and poor salaries. Firms become less labor-intensive and more capital-
intensive as a result of this.

Agriculture employed 90 percent of the workers prior to the industrial revolution. Food
production required a lot of effort. Labor productivity has grown, labour intensity has
decreased, and employees have been able to migrate into manufacturing and (more recently)
services as a result of technological advancements and economic expansion.

This method accomplishes two goals: capital development and skill. It boosts agriculture
output by using modest irrigation, improved seeds, manure, and instruments, as well as the
introduction of short-term crops. With the aid of diagram I, a labor-intensive approach has
been demonstrated. Isoquant Q depicts the starting level of production created with OL
labour and OC capital in this graphic. With the implementation of new technology, the
isoquant Q1 represents a greater level of production that can be achieved with the same
quantity of capital, i.e. OC. A bigger amount of labour is OL in this instance.

Fig 3.3 Labor force that is useful (d)

(B) Capital Intensive Technology

The capital-intensive capacity of a corporate organisation is assessed by the capital invested

by the organisation in its plant and machinery, as well as other fixed assets, in order to boost
output, resulting in higher profits and better returns on investment.

To run a business, every company need funds. The capital intensiveness of an organisation is
determined by the amount of capital invested in the acquisition of fixed assets. It is defined as
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an organization's ability to invest in fixed assets. Higher investment yields higher returns,
attracting new investors and expanding market share. Some industries, such as the aviation
sector, require more cash to get started.

Companies require more money to keep operations running, which implies maintenance costs
are also greater in these industries. Because of their large investments in fixed assets and
machinery, these enterprises have a larger operational leverage. Sales volume is frequently
higher in capital-intensive businesses. These industries' market position is determined by the
services they provide, asset upkeep, labour efficiency, productivity, risk factor, and other
factors. In other words, if capital spending exceeds labour expenditure, the company is
considered to be capital intensive.

Examples of Capital Intensive

1. The transportation industry, such as railways, aeroplanes, and canals, need significant
investment in either purchasing or producing transportation medium. The revenues are freight
charges, and the number of receipts is determined by the level of service provided to
passengers by the organisation. The profit is determined by the operating costs. The higher
the operational costs, such as repairs and maintenance, labour costs, wages, and
administrative expenses, the lower the profit. The profit will be lower. Due to greater
depreciation costs, profit is also reduced.

2. Company ABC incorporated machinery from California, which is predicted to increase

sales by 50% and lower labour expenses by 50% since the technology can create things that
the present procedure can only produce with 25 personnel. The machinery costs $7,800,000,
and the labour cost savings are projected to be $300,000. Fixed assets, such as plant and
machinery employed in the firm, account for 80% of total assets. The firm a Ltd. mentioned
above is an excellent example of a high-capital-intensive industry.

Measurement

The fixed asset to sales ratio may be used to determine whether a firm is high capital
intensive or low capital intensive. If the ratio of fixed assets to sales is larger than 1, the
company is considered to have a high capital intensity; if the ratio is between 0.85 and 1, the

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company is said to have a normal capital intensity; and if the ratio is less than 0.85, the
company's capital intensity is said to be low.

The capital intensity of a company may also be determined by comparing capital and revenue
expenditures. A company is considered to have a high capital intensity if its capital spending
exceeds its revenue expenditure.

Harvey Leibenstein, Paul Baran, Rostow, Hirschamn, Prof. Harvey Leibenstein, Paul Baran,
Rostow, Hirschamn, Hirschamn, Hirschamn The most prominent proponents of capital
intensive approach are Maurice Dobb and Mahalanobis. They believe that this strategy is
essential for speeding up the growing process. Prof. Paul Baran is a firm believer in the use of
capital intensive technologies in developing nations. He said that if such countries wish to
industrialise quicker, they should take use of their potential to draw on the scientific and
technology advancements of more industrialised countries. A capital demanding method is
one in which a considerable quantity of capital is used in comparison to other techniques. The
quantity of capital needed per unit of production is higher in such a technique than in a labor-
intensive approach.

"The capital intensive or labour-intensive ways of manufacturing a certain commodity are

characterised by current factory techniques of producing consumer goods and automated
methods of constructing roads, irrigation works, and other projects," according to Prof.
Myint. The net production per unit of capital may be larger in this case due to lower labour
expenses and increased productivity." Diagram 2 depicts a capital-intensive method.

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 Fig 3.3 Labor force that is useful (d)

In this diagram isoquant Q represents the initial. Level of output is using OL amount of
labour and OC amount of capital. With the introduction of new technique, a higher level of
output is shown by labour (OL) but with greater dose of capital (OC1). Therefore, capital
intensive technique is using more capital with the same amount of labour.

Advantage

a. Because of the large capital demand, capital intensive industries have less
competition.

b. Because of the larger returns, capital intensive businesses are more appealing to
investors.

c. The majority of capital-intensive organisations' investments are in fixed assets, mostly

plant and machinery, which are believed to be safer than other types of investments
since the company can effectively use the asset to produce returns.

d. Non-operating costs, such as depreciation, are high in capital intensive businesses,

which results in a tax benefit because high depreciation results in little profit and
hence low tax.

Disadvantage

a. A substantial investment in capital intensive businesses carries a considerable risk.

b. Due to substantial investment and depreciation, the losses will be higher at first.

c. Because capital assets often account for more than 60% of an organization's assets,
liquidity is still a problem.

d. Maintenance costs are significant in capital-intensive businesses since fixed assets

and machinery must be maintained on a regular basis.

3.4.2 COR ACOR, ICOR

The capital-to-output ratio is the amount of money needed to create output worth Rs. 1. If Y
represents production or income and K represents the stock of capital utilised to create that

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output, the capital-output ratio is K/Y. It's important to distinguish between the marginal and
average capital-output ratios. The average capital-output ratio is the ratio of total capital to
total production or income in the economy, whereas the marginal capital-output ratio is the
ratio of capital stock to output increment.

As a consequence, the marginal capital-output ratio K/Y may be stated as where AK is the
increase in capital and AY is the rise in income or production as a result of the increase in
capital. As a result, the incremental capital-output ratio is also known as the marginal capital-
output ratio (ICOR).

The rate of capital creation and the capital-output ratio determine a country's rate of economic
growth. The capital-output ratio measures how quickly production rises in response to a given
amount of capital investment. In Indian rupees, a capital-output ratio of 4 means that a capital
investment of Rs. 4 results in the addition of Rs. 1 in production. As a result, if the capital-
output ratio is lower, less capital investment is required to achieve a given level of production
than if it is greater.

(A) Factors Determining Capital-Output Ratio

Estimating an economy's capital-output ratio is tricky. The degree of technological

development associated with capital investment, the efficiency of handling new types of
equipment, the quality of managerial and organisational skill, the existence and extent of
economic overheads, and the pattern and rate of investment are all factors that affect capital
productivity.

For example, the lower the capital-output ratio, the greater the proportion of investment
devoted to light consumer goods production; and the higher the proportion of investment
devoted to public utilities, i.e., economic and social overheads, the higher the capital-output
ratio, and vice versa.

Similarly, the larger the capital-output ratio, the bigger will be investment in fundamental
heavy industries, and vice versa. The capital-output ratio will be reduced due to stronger
organising abilities and the usage of better technologies. The capital-output ratio is also
affected by input prices. It is generally acknowledged that the capital-output ratio in
developing nations is larger, implying that their capital is less productive than in
industrialised countries. This is because the industries that manufacture capital goods are
relatively inefficient.
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Due to a lack of technical understanding, there is more capital waste during the
manufacturing process. Furthermore, due to indivisibilities, many types of investments are
always underutilised at first. The demand pattern in emerging nations evolves towards more
capital-intensive industries as development progresses.

To get the most out of capital formation, a country must also advance technologically and
organizationally, lowering the capital-output ratio. As a result, the pace of production growth
is influenced not only by the quantity of capital acquired, but also by the amount of capital
required per unit increase in output (i.e., incremental capital-output ratio).

Economic growth is increased when the incremental capital-output ratio is low. As a result, a
low capital-to-capital-to-capital-to-capital-to-capital-to-capital-to-capital-to However, a low
increase capital-output ratio necessitates technical and organisational improvement in order
for capital to become more productive.

(B) Limitations of Capital-Output Ratio

It should be noted, however, that the idea of capital-output ratio has several drawbacks. Its
exact computation poses some severe challenges. As a result, the capital-output ratio's
suggested quantity link between capital investment and production may be deceptive. As a
result, using such ratios to forecast an industry's or economy's capital requirements would be
risky.

The capital stock cannot be assumed with any precision, and neither can the opposite side of
the ratio, i.e. production, be measured precisely. Aside from the index number issues, a clear
separation between capital and non-capital items is not always possible. Returns on social
overheads, in particular, are difficult to calculate precisely.

Furthermore, various variables impact the capital-output ratio, such as technological

advancements, greater equipment use, organisational changes, and labour efficiency, all of
which are difficult to quantify.

As a result, the capital-output ratio notion has limited application since it cannot reflect the
actual contribution of capital alone in a specific investment strategy. As a result, using a
certain capital-output ratio in the formulation of real investment strategy requires extreme
prudence.

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INCREMENTAL CAPITAL-OUTPUT RATIO (COR)

The incremental capital output ratio (ICOR) is a commonly used measure for explaining the
link between the amount of investment made in the economy and the subsequent rise in GDP
(GDP). The additional unit of capital or investment required to create an additional unit of
output is denoted by ICOR.

The minimal amount of investment capital required for a country or other entity to create the
next unit of production is measured by ICOR. In general, a higher ICOR score is not
recommended since it implies inefficiency in the entity's output. The indicator is primarily
used to determine a country's degree of production efficiency.

Some detractors of ICOR have said that its applications are limited since there is a limit to
how efficient countries may become with current technologies. A developing nation, for
example, may potentially raise its GDP by a bigger margin with a given set of resources than
a developed country.

This is due to the fact that industrialized countries already have the most advanced
technology and infrastructure, whilst developing countries still have space to progress. Any
additional gains in a developed nation would require more expensive research and
development (R&D), but a developing country can improve its status by implementing
current technologies.

The ICOR may be computed as follows:

ICOR=Annual Increase in GDP/Annual Investment
Consider Country X, which has an incremental capital output ratio (ICOR) of 10. This means
that $10 in capital expenditure is required to create $1 in additional output. Furthermore, if
Country X's ICOR was 12 last year, it means that Country X's capital utilisation has gotten
more efficient.

Examples of ICOR

The Indian economy was built on the notion of planning and implemented through the Five-
Year Plans between 1947 and 2017. The Government of India's 12th Five-Year Plan was the
country's final Five-Year Plan.

In the 12th Five-Year Plan, the Indian Planning Commission assessed the required rate of
investment to attain certain growth goals. For an annual growth rate of 8%, an investment rate
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of 30.5 percent at market pricing is necessary, whereas for a growth rate of 9.5 percent, an
investment rate of 35.8 percent is required. Investment rates in India dropped from the level of
36.8% of the gross domestic product (GDP) in the year 2007 to 2008 to 30.8% from 2012 to
2013. The rate of growth during the same period fell from 9.6% to 6.2%.

Clearly, the reduction in India's growth was more severe and steeper than the drop in
investment rates during this time. As a result, there must have been factors other than savings
and investment rates that contributed to the Indian economy's slowing growth rate. The
economy, on the other hand, is becoming increasingly inefficient: In 2019, India's GDP grew
at a pace of 4.23 percent, with investments accounting for 30.21 percent of GDP.

3.4 SUMMARY

● We must distinguish between 'keeping capital intact' and 'capital development' in this
case. When resources are utilised to replace worn out assets, such as wear and tear on
machinery, rather than adding to the economy's productive potential, the practise is
known as preserving capital intact. Capital creation, on the other hand, refers to the
process of expanding the stock of real capital, which obviously aids in increasing the
level of output of goods and services. As a result, the essence of the capital creation
process is the diversion of a portion of society's now available resources toward the
possibility of future increases in consumable output.

● Personal savings are not just important for an individual's financial well-being; at the
national level, high personal savings rates lead to speedier economic recovery.

● With credit so readily available, many Americans began to use their credit lines (and
home equity) as if they were savings accounts in the two decades between 2000 and
2020.

● Unfortunately, this has resulted in a high rate of credit defaults; one example is the
chain reaction of defaults that contributed to the 2008 economic collapse, now known
as the Great Recession.

● Tax policy in emerging nations such as India is expected to have a significant impact
on saving and investment, the two most important determinants of economic
development. As a result, the major goal of tax policy in such nations should be to
move as much money as possible from the private to the public sector with the least
amount of harm.

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 ● The importance of information technology in today's world cannot be overstated, as it
has overtaken practically every sphere of business and industry, including the service
sector, and those who are not familiar with it will be unable to grow in the coming
century.

● We might claim that the value of technology in achieving economic progress cannot
be overstated.

● Organizations that spend heavily on capital assets are known as capital intensive.
Fixed assets, plant, and machinery typically account for 70 to 80 percent of total
assets. To stay afloat in the sector, many businesses need a lot of cash. Because these
companies' assets require constant upkeep, their operating and maintenance costs are
greater. However, these businesses can save money on taxes since their depreciation
and other costs are higher, resulting in lesser earnings. These firms will initially lose
money, but in the long term, they will be able to make more money. In capital-
intensive sectors, long-term growth is favourable. As a result of the increased risk,
competition is significantly reduced.

● The incremental capital output ratio (ICOR) explains the relationship between the
level of investment made in the economy and the consequent increase in GDP.

● ICOR is a metric that assesses the marginal amount of investment capital necessary
for a country or other entity to generate the next unit of production.

● A lower ICOR is preferred as it indicates a country's production is more efficient.

3.5 KEYWORD

● Capital Formation is used in both a limited and a wide sense. In a strict sense,
however, it refers to physical capital stock, which comprises machineries, machinery,
and other equipment

● Gross Capital Formation is a term that refers to total investment. It encompasses

both replacement and net investment.

● Net Capital Formation simply refers to an increase in net investment. Depreciation

is subtracted from gross investment to calculate net investment.

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 ● Monetary Policy The government's economic policies are also a significant element
influencing capital formation in the country. While these policies do not operate as
sources of capital formation in and of themselves, they do influence the sources.

● Deficit budget there are also additional fiscal policies that might be implemented in
order to boost capital formation in the country. The government is frequently called
upon to construct significant public-sector projects. These help to generate capital by
generating social overhead capital. Budget shortfalls are frequently used to finance the
expenditures of these initiatives.

● Fixed capital Businesses raise fixed capital by issuing shares and debentures. Public
and commercial financial service companies participate in these shares and debentures
to generate money with no risk

● Untied aid is money donated to poor nations that can be spent on products and
services in almost any country. In contrast, linked aid requires that products and
services purchased with it be acquired only from the donor country or a restricted
number of countries.

● Tied aid is foreign aid that must be spent in the nation that is giving the assistance
(the donor country) or a group of countries. A developed nation will provide a
developing country a bilateral loan or grant, but the money must be used on goods and
services produced in the chosen country.

3.6 LEARNING ACTIVITY

1. Examine capital formation in India.

___________________________________________________________________________
___________________________________________________________________________

2. State the problem of

___________________________________________________________________________
___________________________________________________________________________

3.7 UNIT END QUESTIONS

A. Descriptive Questions

Short Questions

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 1. What is capital formation?

2. What is saving?

3. What is public borrowing?

4. What is foreign capital?

5. What is Incremental Capital Output Ratio (ICOR)?

Long Questions

1. Examine capital formation in details

2. Explain various internal sources to finance economic development.

3. Explain various external sources in economic development

4. Elaborate causes of low capital formation in India

5. Describe capital- and labour-intensive technology

B. Multiple Choice Questions

1. Capital formation undergoes which of the following stage

a. Creation of saving

b. Mobilizing of saving

c. Investing of saving

d. All of the these

2. Investment on all man-made physical assets like building and machines are called

a. Physical Capital

b. Human capital

c. Money capital

d. Invisible capital

3. Production which required more capital as compare to labour is called

a. Labour intensive

b. Labour capital intensive

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 c. Capital intensive

d. Technology intensive

4. Public and commercial financial service companies participate in what to generate money
with no risk?

a. Real estate

b. Stock market

c. Equity

d. Shares and debenture

5. What is money donated to poor nations that can be spent on products and services in
almost any country

a. Tied aid

b. Untied aid

c. Government aid

d. Private aid

Answer

1-d, 2-a, 3-c. 4-d, 5-b

3.8 REFERENCES

● Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2000. “A New Database on the
Structure and Development of the Financial Sector.” World Bank Economic Review 14 (3):
597–605.

● Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2010. “Financial Institutions and
Markets across Countries and over Time.” World Bank Economic Review 24

● UKEssays. (November 2018). The role of savings and investment in the world economy.
Retrieved from https://www.ukessays.com/essays/economics/the-role-of-savings-and-
investment-in-the-world-economy-economics-essay.php?vref=1

● S, N. (2017, January 13). Role of Deficit Financing in Developing Countries | Economics.

Economics Discussion. https://www.economicsdiscussion.net/public-finance/role-of-deficit-
financing-in-developing-countries-economics/26184

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● UKEssays. (November 2018). Role of Technology in Economic Development. Retrieved
from https://www.ukessays.com/essays/economics/role-of-technology-in-economic-
development-economics-essay.php?vref=1

● Das, S. (2015, February 20). Labour and Capital Intensive Techniques (With Diagram). Your
Article Library. https://www.yourarticlelibrary.com/economics/labour-and-capital-
intensive-techniques-with-diagram/47504

● S, N. (2017, January 13). Role of Deficit Financing in Developing Countries | Economics.

Economics Discussion. https://www.economicsdiscussion.net/public-finance/role-of-deficit-
financing-in-developing-countries-economics/26184

● Das, S. (2015, February 20). Labour and Capital Intensive Techniques (With Diagram). Your
Article Library. https://www.yourarticlelibrary.com/economics/labour-and-capital-
intensive-techniques-with-diagram/47504

● Incremental Capital Output Ratio (ICOR). (2021, August 12). Investopedia.

https://www.investopedia.com/terms/i/icor.asp

● S, N. (2017, January 13). Role of Deficit Financing in Developing Countries | Economics.

Economics Discussion. https://www.economicsdiscussion.net/public-finance/role-of-deficit-
financing-in-developing-countries-economics/261

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UNIT - 4: THEORIES OF DEVELOPMENT
STRUCTURE

4.0 Learning Objectives

4.1 Introduction

4.2 Marxian approach to development

4.3 Rostow’s stage of development

4.4 Harrod – Domar Model

4.5 Balanced and unbalanced strategies

4.5.1 The Big Push Thesis

4.6 Summary

4.7 Keywords

4.8 Learning Activity

4.9 Unit End Questions

4.10 References

4.0 LEARNING OBJECTIVES

 To understand classical theories and there applicability in modern growth of

economy.

 To examine different stages of economic growth and development.

 To know importance of different sectors of economy in economic development.

 To understand importance of saving and investment for economic development.

 To measure needs for development in form of big push in different sector.

4.1 INTRODUCTION

Development economics is a discipline of economics that focuses on helping developing

nations improve their fiscal, economic, and social situations. Health, education, working
conditions, local and international legislation, and market circumstances are all variables

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considered in development economics, with an emphasis on improving conditions in the
world's poorest nations.

In addition, the study looks at macroeconomic and microeconomic issues that affect the
structure of emerging countries as well as local and international economic growth.

Development economics is the study of how developing countries become richer. Because
nations' social and political origins can differ substantially, strategies for converting a
developing economy tend to be distinctive. Not only that, but each country's cultural and
economic frameworks, such as women's rights and child labour regulations, are unique.

When considering growth theories, it's important to distinguish between those that seek to
explain growth (or lack thereof) in established nations and those that seek to explain growth
(or lack thereof) in developing ones. The majority of what follows will focus on the former.

Saving and investing are not generally done by the same people, as British economist John
Maynard Keynes pointed out in the 1930s. Savings motivation may not always translate into
investment. Total expenditure will fall if savers strive to save a bigger percentage of their
income than before (therefore consuming less) and this is not matched by an equal rise in the
willingness to invest by others. A natural reaction on the part of company will be to reduce
output, resulting in lower production income. As overall demand becomes insufficient to
employ the whole labour force, the end result may be a cumulative downward tendency.

The relationship between income and spending implies that a capitalist economy may cycle
between times of lengthy and severe unemployment (when desired savings at full
employment exceed what the economy wants to invest at full employment) and periods of
severe inflation (when the inequality is reversed). This had never happened before in the
history of industrialised economies until the early 1970s. The methods in which the various
growth theories account for this crucial historical fact will be discussed in the following
debate.

1. Role of Entrepreneur

Joseph A. Schumpeter is credited as being the father of modern growth theory. Unlike most
Keynesian and pre-Keynesian economists, Schumpeter emphasised the importance of the
entrepreneur, or businessman. It was his performance that defined whether capital would
increase quickly or slowly, and if this expansion would include innovation and change, such
as the creation of new goods and production procedures. Differences in growth rates across
nations and between times within a single country may be related mostly to entrepreneurial

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quality. The latter, in turn, mirrored some of the business class's historical and cultural ideals.
The entrepreneur, according to Schumpeter, is also responsible for most of the rise in
technological advancement and labour supply. In more current terms, Schumpeter's argument
for why demand and supply have expanded at roughly the same rate is that supply responded
to demand, while demand reflected the entrepreneur's activities and investments.

According to Schumpeter, capitalism's prosperity "sows the seeds of its own doom." In the
late 1930s, American economist Alvin H. Hansen contended that capitalism in the United
States was in jeopardy for other reasons. The shrinking of the global frontier, the slowing of
population growth, and the capital-saving nature of recent breakthroughs, according to
Hansen, have all contributed to the possibility of stagnation by lessening the need for
investment. At full employment, the amount of savings available in a mature economy would
tend to surpass the amount that the economy would desire to invest by progressively bigger
amounts as time went on. As a result of the disparity between supply and demand,
unemployment rates would inevitably rise. Investment was described as the most significant
element regulating the amount of spending in an economy in Keynes' General Theory,
despite the reality that it historically accounted for just one-fifth to one-sixth of overall
expenditure. This paradox may be explained in terms of a notion called the multiplier, which
was also invented in the 1930s. The multiplier was the factor by which a change in
investment was multiplied to get the ultimate effect on incomes or expenditures. If
investment rises by $10, for example, the extra $10 in spending will produce an extra $10 in
output and, in turn, revenue in the form of wages and profit, providing there are no idle
resources.

This increase, however, is far from sufficient, as the majority of the new earnings will be
spent on consumer items. Consumption will grow by $9 if nine-tenths of every increase in
income is spent on consumer items and one-tenth is saved. However, because one person's
expenditures equal another's income, earnings have increased by $9, with $8.1 spent on
consumer items. The procedure is repeated until expenditures, earnings, and production have
all grown by $100, with $90 representing consumption and $10 representing the initial
investment change. The multiplier in this example is ten.

However, if investment is not sustained at a rate adequate to drive demand for the products it
generates, it may become a cause of instability. Is there any assurance that supply or
productive capacity will rise at the same rate as demand, preventing excess capacity and
demand? R.F. Harrod, a British economist, and E.D. Domar, an American economist, posed

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this topic mathematically. The rate of supply growth (i.e., the production function as stated
above) is equal to the rate of capital stock increase in their equations. This capital stock is
increased by investment. The rate of increase in demand is determined by the rate of increase
in investment, or, more precisely, by the rate of increase in investment.

2. Demand and Supply

Because a model stating that capitalism systems are intrinsically unstable would not
correspond to historical events, most modern growth theory may be seen as an attempt to
build a theoretical model that would bring the rate of growth of demand and the rate of
development of supply into line. Models of growth can be categorised based on whether they
stress demand changes (supply-determined models) or supply changes (supply-driven
models) (demand-determined models). J.R. Hicks, a British economist, produced one of the
most well-known instances of the supply-determined model. Hicks predicted that consumers'
and investors' spending proclivities would drive demand to expand faster than maximum
output. This premise implied that during any "boom," the economy would ultimately hit a
"ceiling" that, although rising upward, would be slower than demand. The rate of ascent of
the ceiling, which is defined by supply variables such as the rate of growth of the labour force
and the rate of development of technical advancement or productivity, would determine the
economy's long-run rate of growth. If they grew at a faster rate for any reason, output would
expand at a faster rate as demand adjusted to the faster growth of supply.

Other growth models demonstrate the contrast between demand-driven and supply-driven
growth. N. Kaldor, a British economist, believed that there is a process at work that generates
full employment. Simply put, in his model, an insufficient rate of investment will be
countered by adjustments in the distribution of income between profits and wages, causing
consumption to vary in a compensatory manner, resulting in unchanged total demand. While
the Hicks and Kaldor models have significant variations, both may be defined as supply-
determined growth models.

A model of supply-driven growth that is implied in typical neoclassical analysis is another

option. The pricing mechanism, or Adam Smith's "invisible hand" of the market, is the
process that adjusts demand to expanding supply. This model posits a world free of
monopolies and uncertainty, in which capital and labour markets are able to react fast such
that "markets are always cleared" in the short term. The work of Dutch economist Jan

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Tinbergen and his colleagues provides a last example of a growth model that shows the
dilemma of supply and demand adjustment. Unlike neoclassical growth models, which
assume that the market adjusts demand to supply, Tinbergen's "target-instrument" models
assume that the government (as in the Netherlands and other European countries) regulates
demand and supply in order to achieve certain goals, such as full employment or a
predetermined rate of growth. Economists are supposed to give the fiscal authorities with a
model that approximates the economy's functioning and predicts what will happen if the
government does not adjust its tax and spending plans in the near future, for example. The
authorities evaluate these estimates in terms of what they think desirable in terms of social
and economic policy. The government adopts actions if it looks that unemployment will be
too high and growth will be too slow. To boost investment, the government may, for
example, lower corporate profit taxes. If investment is excessive and inflation is a concern,
the government may take additional steps to lower aggregate demand, such as reducing
spending. This kind of planning has been used in the past with varied degrees of
effectiveness. Sweden and the Netherlands are two countries that have made significant
efforts to balance swings in private expenditure in order to achieve full employment and
growth. It's worth noting that these models don't cleanly fall into either the demand-driven or
supply-driven categories. Both the rate of growth of demand and the rate of growth of supply
are essentially set by the fiscal authorities in the case just presented.

3. ECONOMIC STAGNATION

Beginning in the early 1970s, the rise in unemployment rates and slowdown in GNP and per
capita income growth rates throughout the capitalist world was obviously a scenario where
demand and supply did not expand at the same rate. Many economists have been working on
hypotheses to explain why the economy has been stagnant for so long. The negative impacts
of high unemployment and poor capital stock utilisation on investment and, as a result, on
productivity development were a frequent issue in much of their work.

The high unemployment rates for labour and capital may be traced back to monetary and
fiscal policies that stifled aggregate demand beginning in the first half of the 1970s.
Economists regarded this policy reaction as an attempt by the government to slow the pace of
inflation, which had begun to increase in the late 1960s. The authorities' prolonged
employment of restrictive measures is based on their worry that any move to boost their
economies will just reignite inflation. Tighter labour markets as a result of such stimulative
measures are thought to improve labor's negotiating strength, resulting in higher pay demands

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and settlements, which in turn feed into prices, accelerating price inflation. To defend real
wages, this leads to even greater wage demands, resulting in an explosive wage–price spiral.
Furthermore, more stimulative aggregate demand measures are thought to cause balance of
payments problems at current exchange rates. Any attempt to avert greater payments deficits
by lowering the exchange rate, on the other hand, results in the "importation" of inflation
through higher import prices. As a result of these issues, authorities are hesitant to use
stimulative measures to achieve full employment.

What emerges from these ideas is a chain of causation that illustrates how, after World War
II, inflation and growth have been causally linked through government reactions to real and
expected inflationary pressures. Inflation and the fear of inflation produce slow development
and high unemployment because governments are unable to manage inflation at full
employment by other ways, such as an income policy, forcing them to enact restrictive
measures to counteract or prevent inflationary pressures. As in the early 1970s, such reactions
result in high rates of capital and labour unemployment, as well as low rates of investment
and productivity development.

4. Foreign Trade

Foreign trade has received little attention. However, most economies' growth is heavily
reliant on imports and the capacity to export in order to pay for those imports. The fact that
certain economies recovered from World War II more swiftly than others and developed far
faster in the postwar period has sparked a lot of comparative research in growth theory.
Foreign trade accounts for Japan's and Germany's extraordinarily high growth rates
contrasted to the UK economy's overall sluggishness. Economists have referred to the United
Kingdom's frequent balance of payments crises and Germany's absence of similar problems.
As earnings grow during a boom, so does demand for imports, which is a natural element of
prosperity. However, if exports do not grow at the same rate, the government may be obliged
to adopt fiscal or monetary remedies and slow the economy in order to restore balance
between imports and exports. Alternatively, exports may not expand fast enough because
labour costs are quickly growing, pushing up export prices quicker than in competitive
nations.

Encouragement of growth has the effect of maintaining import demand high and tightening
labour markets, which tends to push up money wage rates. Simultaneously, such a strategy

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tends to foster highly productive inventions and investment projects, particularly if demand
pressures persist. A "halt" policy, on the other hand, has the polar opposite impacts, both
positive and bad for a country's balance of payments.

5. Mathematical Growth

A considerable body of literature incorporating abstract mathematical models has evolved in

addition to the notions outlined above. Because this is such a specialised topic, only a broad
overview of the kind of problems and concerns explored can be provided. First, a set of
equations is created to describe the essential relationships between economic variables such
as production, capital, investment, and consumption, as determined by the model builder.
These equations must connect economic variables at distinct times in time: for example,
output last year influences consumption this year, which influences output this year, and
hence consumption and output next year. It is possible to calculate the motions of the
variables throughout any time period. The idea of a steady-state rate of growth lies at the
heart of most of this analysis: one in which all of the economic variables in the set of
equations grows at the same constant rate equal to the growth of the labour force.

In the pursuit of maximum growth, a subset of research aims to account for the wellbeing of
employees and customers. These "optimal growth" methods are designed to increase
customer happiness over time. In a model like this, the best answer is one that maximises
customer welfare rather than the maximum potential growth rate. The value of such models
for planners appears to be contingent on the accuracy of their assumptions about consumer
demands and technology.

6. Laissez-faire

Laissez-faire (French: "leave to do") is a policy of minimal government intervention in

people's and societies economic matters. The term's origin is unknown; however tradition
believes it is derived from the response given by manufacturers to Jean-Baptiste Colbert,
comptroller general of finance under King Louis XIV of France, when he asked what the
government could do to aid them: "Leave us alone." The Physiocrats, a group of economists
who flourished in France from around 1756 to 1778, are often connected with the laissez-
faire concept. As it emerged in Great Britain under the influence of philosopher and
economist Adam Smith, the laissez-faire doctrine had considerable support in classical

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economics. During the nineteenth century, laissez-faire was a popular viewpoint. Its
proponents used classical economics' concept of a natural economic order as evidence for
their belief in unrestricted individual action. John Stuart Mill, a British philosopher and
economist, is credited with popularising this concept in his book Principles of Political
Economy (1848), in which he lays out the reasons for and against government intervention in
economic issues.

Laissez-faire was both a political and an economic philosophy. The prevailing notion in the
nineteenth century was that people would accomplish the greatest results for the society in
which they lived by following their own goals. The state's role was to preserve order and
security while not interfering with people' efforts to achieve their own objectives.
Nonetheless, proponents of laissez-faire say that the government plays an important role in
enforcing contracts and maintaining civil order. Around 1870, the popularity of the idea
peaked. The abrupt changes brought on by industrialization and the introduction of mass
production techniques in the late nineteenth century proven the laissez-faire concept
inadequate as a guiding ideology. Following the Great Depression in the early twentieth
century, laissez-faire gave way to Keynesian economics, which argued that government could
reduce unemployment and stimulate economic activity through suitable tax policies and
public expenditures. In many nations, Keynesianism drew widespread support and impacted
government budgetary policy. The school of monetarism, whose prominent proponent was
American economist Milton Friedman, reintroduced the concept of laissez-faire later in the
twentieth century. Monetarists argued that the best way to achieve economic stability was to
carefully limit the pace of expansion of the money supply.

Determine whether fast population increase promotes or hinders development, the structural
restructuring of economies, and the role of education and healthcare in development are all
parts of development economics.

TYPES OF DEVELOPMENT THEORIES

1. Mercantilism

One of the first kinds of development economics, mercantile economics, is considered to

have devised procedures to encourage a nation's success. From the 16th through the 18th
century, it was the dominant economic theory in Europe. The idea advocated for increasing
state power by reducing the risk of being exposed to competing national forces.

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Mercantilism emphasised government restriction by banning colonies from interacting with
other nations, similar to political absolutism and absolute monarchs. Mercantilism
monopolised markets with staple ports and prohibited the export of gold and silver. It was
thought that the greater the amount of gold and silver, the wealthier it would be. In general, it
aimed a trade surplus (exports exceeding imports), prohibited the use of foreign ships for
commerce, and maximised the use of domestic resources.

2. Economic Nationalism

Economic nationalism refers to policies that use tariffs or other obstacles to regulate capital
creation, the economy, and labour inside the country. It limits capital, commodities, and
labour movement. Economic nationalists are divided on the merits of globalisation and
unrestricted trade. They emphasise an isolationist attitude in order for a country's industry to
thrive without fear of competition from established enterprises in other nations.

The early American economy is a classic illustration of economic nationalism. As a young

country, it attempted to grow independently of external pressures. It established policies like
high tariffs to ensure that its own industries could develop unhindered.

3. Linear Stage of Growth Model

After WWII, the European economy was revitalised using the linear phases of growth
paradigm.

According to this idea, economic development can only come via industrialisation. Local
institutions and social attitudes, according to the concept, might stifle growth if they impact
people's savings and investment rates.

The linear phases of growth model depict an effectively structured capital addition combined
with government involvement. Economic development and industrialization are aided by the
influx of money and the imposition of public sector constraints.

4. Structural Change Theory

The structural-change hypothesis focuses on transforming a country's overall economic

structure, with the goal of transitioning from an agricultural to an industrial civilization.

Russia, for example, was an agricultural civilization prior to the communist revolution. When
communists deposed the monarchy and assumed control, they quickly industrialised the
country, allowing it to grow into a powerhouse.

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4.2 MARXIAN APPROACH OF DEVELOPMENT

Marx attempted to explain evolution in terms of society's passage through many phases,
including tribal, Asian, ancient, feudal, and capitalist. He sees conflict, which is inherent in
the material state of existence, as a key aspect in growth. He has recognised the agency of
social class as the major vehicle of class struggle in order to carry on this conflict. We
explored modernization and liberal approaches to development in the previous components of
this block. You must be aware of the importance of market forces in growth by now.

(a) Marxian Idea of Development

In the 19th and 20th centuries, Karl Marx (1818-1883) was the most prominent socialist
theorist on development. Marxian philosophy has recently been subjected to rigorous
examination in the wake of the socialist economy's failure.

Around half of the world's population followed his recommended route of social and political
transformation as well as economic prosperity. His contribution to development theory is
absolutely unrivalled and groundbreaking. Friedrich Engels, his lifelong partner and close
friend, said in his obituary after his death on March 14, 1883.

Just as Darwin discovered the law of organic evolution, so Marx discovered the law of human
evolution: the simple fact, previously obscured by an overgrowth of ideology, that mankind
must first eat, drink, shelter, and clothe itself before it can pursue politics, science, art,
religion, and so on; that, as a result, the production of immediate material means, and thus the
degree of economic development attained by a given people or is determined by the degree of
economic development attained by a given people.

Karl Marx's main interests were the evolution of human society through numerous phases,
the growth and change of the material situation, the existence and development of capitalism,
and the concomitant change in the class relationship and transformation in the method of
production. Let's take a look at some of these issues.

1) Production Relation and Development

Marx had a comprehensive philosophical perspective of human society's growth that may be
understood in terms of the material condition of existence and the dialectic, or innate conflict
in the material condition of life. He did not deny the importance of non-material forces in the
evolution of human society at various phases, but he emphasised that material forces and
their conflict constituted the most basic and essential condition of human society's

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development and change. The easiest way to understand Marx's concept of development is to
look at his analysis and interpretation of capitalist society, its evolution, structure, and
functioning. Karl Marx, a prolific writer, has addressed all of these difficulties in numerous
of his works, including the Communist Manifesto. All legal connections, politics, state
formations, and so on, according to Karl Marx, must be understood in terms of the material
condition of existence rather than the evolution of the human intellect. According to him, the
human being has evolved into a producing animal and is therefore linked to many production
relations as a result of the evolution of human civilization. To paraphrase him,

In the social production of their life, men enter into definite relations
That is indispensable and independent of their will, relations of production which correspond
to a definite stage of development of their material productive forces. The sum total of these
relations of production constitutes the economic structure of society, the real foundation, on
which rises a legal and political superstructure and to which correspond definite forms of
social consciousness. The mode of production of material life conditions the social, political
and intellectual life process in general (Marx 1859).

He was emphatic in stating that when the economic base shifts, the entire superstructure, i.e.
the legal, political, religious, artistic, or philosophical, shifts as well. Individual
consciousness is dictated in the course of such change not by what he believes, but by the
contradiction of material life, that is, the struggle between social productive forces and
production relations. Consciousness is an aspect of human society's evolution. According to
him, men's awareness does not determine their existence; rather, it is their material state of
being that determines this consciousness. According to Marx, the antagonistic production
relationship is the most important force for change and progress. He points out that at a
certain stage of development “the material productive forces come in conflict with the
existing relation of production… with the property relation within which they have been at
work hitherto. From forms of development of productive forces these relations turn into their
fetters. Then begins an epoch of revolution” (Marx 1976: 504).

To him, the Asiatic, ancient, feudal, and capitalist epochs in the economic construction of
society are progressive epochs. To him, the capitalist production relation is the final
antagonistic expression of the social production process.

2) Class Relation and change

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There have been particular types of class fights at every eras of society's economic change.
According to Karl Marx, the major agents of social change are social classes. However, the
shift is due to a clash of classes.

According to Marx, classes are constituted as a result of objective material conditions. These
are groupings of people who have a common economic standing in comparison to persons
from other social classes. In essence, these economic interests are at odds with and contradict
each other's social status. With the intermediation of class consciousness, these class relations
are converted into hostile action against one another. The objective material conditions serve
as the foundation for the establishment of "class-in itself," which is turned into "class-for-
itself" via the process of subjective class awareness transgression.

According to Karl Marx, while the class relationship was complex in past periods of history,
it has been simplified in the contemporary era of capitalism.

New classes have developed in modern capitalist society, with new operating conditions and
new forms of struggle between the bourgeoisie (the owners of the means of production, i.e.,
the 'haves') and the proletariat (i.e., the 'have-nots').

According to Marx, wage laborers under capitalism are paupers who develop faster than the
population and riches. The production and augmentation of capital are necessary prerequisites
for the bourgeoisie class's existence and power. The bourgeoisie's involuntary booster,
industry, substitutes the laborer's isolation, owing to competition, with their revolutionary
combination, due to association. As a result, the bourgeoisie's basic base on which it
generates and appropriates things is being eroded by the rise of modern industry. The
bourgeoisie, as a result, creates grave diggers over everything else. Its demise and the
triumph of the proletariat are both unavoidable.

3) Capitalism, Class Relations and Development

Modern industry has created the global market, which has opened up enormous opportunities
for land-based trade, navigation, and communication. These achievements have once again
cleared the road for industry expansion and free commerce.

Through the creation of new markets, the introduction of new technologies, the extraction of
surplus value, and the exploitation of the proletariat, the bourgeoisie class continuously
maximises its profit. However, new sources of contradiction emerge inside the capitalist
system as a result of these developments. Despite the advent of new sources of opposition,
the bourgeoisie's vision and actions were highly revolutionary. "The bourgeoisie has played a

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most revolutionary role historically," Marx writes, "the bourgeoisie cannot survive without
continuously revolutionising the tools of production, and hence the relations of production,
and with them the whole relations of society."

The bourgeoisie has given the production and consuming process a cosmopolitan character
by exploiting the global market. The ancient industries were obliterated. The old national
industries were thrown out. In the capitalist system, industry no longer relied just on local
raw resources, but also on raw materials sourced from the farthest reaches of the planet,
whose products are consumed in every corner of the globe.

According to Marx, capitalists also subordinated nature to the power of man and machines by
applying chemistry to industry and agriculture, as well as new technologies like as steam
navigation, railroads, electric telegraph, river canalisation, and so on. All of this broadened
the reach of free economic commodification on a global scale. There was also the emergence
of free competition, which was followed by the adaptation of social and political institutions.

The essence of the captor, according to Marx, is to maximise profit by commoditizing the
manufacturing process. The earnings of private producers are maximised as long as
capitalism is based on private ownership of the means of production. This profit is maximised
once again by exchanging money for money via commodities. Gradually, the transition from
money to money via commodities results in having more money than one had at the start
(Aron 1965: 128). Marx discussed the theories of value, wage, and surplus value in order to
explain the origins of profit. Any commodity's value, according to him, is roughly
proportionate to the quality of human labour it contains.

The wage capitalists give to employees as recompense for their labour power, the worker rent
to the capitalist, is equal to the amount required for the workers and their families to survive
in order to create the capitalist's merchandise. Workers in the capitalist system are paid a pay
that is less than the real duration of their job; in other words, they are paid less than the worth
of the item they create. The concept of "surplus value" is introduced here, which refers to "the
quality of value created by employees beyond the required labour time." Workers in the
capitalist economy are not paid for the quality of the value created beyond the required labour
time. In exchange, a worker's salary is limited to the resources available to him for
subsistence and survival. According to Marx, the price of a commodity, and hence "also of
labour," is equal to its cost of production. If a result, as the repulsiveness of employment
grows, the wage reduces in proportion. The weight of toil of the labour grows as the amount

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of machines and division of labour increases, resulting in longer working hours and more
work.

Gradually, the proletariat grows in numbers, gaining power and knowledge. In their war
against the bourgeoisie, the lower middle class, small manufacturers, craftsmen, and peasants
join the proletariat's army. According to Marx "All past historical movements were
movements of minority, or movements in the interests of minorities,” The proletariat
movement is a self-aware, independent movement of the vast majority, acting in the vast
majority's interests." In depicting the most general phases of the development of the
proletariat, we traced the more or less veiled civil war raging within existing society, up to
the point where that war breaks out into open revolution, and where the violent overthrow of
the bourgeoisie lays the foundation for the sway of the proletariat, writes Marx.

4) Marx’s Plan of Action

After the working-class revolution, the proletariat would be elevated to the position of ruling
class in order to win the democratic battle, to centralise all instruments of production in the
hands of the state, to rapidly increase total productive forces, and to completely revolutionise
the mode of production. He proposed the following actions:

Abolition of private property and Application of rents of land.

ii) A heavy progressive or graduated income tax.

iii) Abolition of all rights of inheritance.

iv) Confiscation of the property of all emigrants and rebels.

v) Centralisation of credit in the hands of the State, by means of a national bank with State
capital and an exclusive monopoly.

vi) Centralisation of the means of communication and transport in the hands of the state.

vii) Extension of factories and instruments of production owned by the State; the bringing
into cultivation of waste-land, and the improvement of the soil generally in accordance with a
common plan.

viii) Labor obligation is shared equally by everyone. Industrial armies, particularly for
agriculture, are being formed.

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ix) Integration of agricultural and industrial industries; eventual eradication of the divide
between town and country as a result of a more evenly distributed population across the
country.

x) Free public-school education for all children. Factory work for youngsters in its current
form should be abolished. Education and industrial production are combined.

(b) Marx and Historical-Sociological Perspective

After the effective accomplishment of the programme of action by the proletarian

dictatorship, Marx predicted that the state would vanish. However, history shows that the
state system has not only been strengthened, but has also taken on an oppressive shape at
times. It is a reality that centralised planning cannot be achieved without a well-functioning
state apparatus. Thus, both in terms of historical events and the implementation of centralised
planning, Marx's concept of the state withering away remains fundamentally inconsistent.

It is claimed that a proletarian dictatorship would bring in a society without classes.

Following the conquest of state power, however, the political elites, not the proletariat, take
control. Power ownership is a major factor in determining social class. Indeed, new political
classes form, with a few people in positions of power and the overwhelming majority being
impotent.

Marx popularised ideas on class formation, class change, and the significance of economic
structure in determining history's trajectory.

In terms of the economics, Marx defined social collectivities or groups. In this case, "class"
has been viewed as the sole agent of social change through revolution. However, the
importance of nationality, ethnicity, colour, gender, caste, estate, and other factors among
these groups is greatly underestimated. Indeed, Marx described all social interactions and
conflicts in terms of class relations and conflicts, neglecting the social and historical
functions that these collectives play in different cultures.

(c) Neo-Marxian Approach: World-Systems Analysis

The world systems analysis, a neo-Marxian method centered on studies of modes of

production, is one of the most important historical-sociological viewpoints. This method
arose from a study of the economic and material world, particularly capitalism as it evolved
and flourished in Europe in the 1500s. This new economic and social system, according to

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global-systems analysis, destroyed the dominance of past political and economic empires and
systems, and evolved into a dominating world system. While it began in Europe, the
international system that has formed over the previous 500 years has no bounds and extends
its tentacles all over the world.

Immanuel Wallerstein (1930- ), a professor at Columbia University, McGill University, and

now the State University of New York at Binghamton, established the world-systems
approach. The Modern World-System, written by Wallerstein in 1974, is his best-known
work. He examines the beginnings of the current system, beginning around 1500, when a
transition from political and military forms of domination to economic influences and power
began. In subsequent volumes, Wallerstein chronicles the evolution of this new system,
demonstrating how it is transforming the world's core, periphery, and semi-periphery sectors.
While political and economic structures are intertwined, Wallerstein contends that a wide
range of political systems are compatible with the capitalist world order.

Karl Marx, the creator of scientific socialism, is regarded as one of history's greatest thinkers.
Millions of people hold him in great regard and regard him as a true prophet.

Prof. Schumpeter wrote,

“Marxism is a religion. To an orthodox Marxist, an opponent is not merely in error but in

sin”.

The Marxian analysis is the most comprehensive and in-depth evaluation of the economic
development process. He predicted that capitalistic transformation would stall owing to
sociological factors rather than economic stagnation, and that this would happen only when a
high level of growth had been achieved. 'Das Kapital,' his classic work, is regarded as the
Bible of socialism (1867). He explained how the capital economy grows and then collapses.

Assumption:

1. The society is divided into two classes. (1) Proletariat and (2) Bourgeoisie

2. Workers' wages are set at the subsistence level of living.

3. The labour theory of value is correct. As a result, labour is the primary source of value
creation.

4. Capitalists control the means of production.

5. There are two forms of capital: fixed capital and variable capital.

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6. Workers are exploited by capitalists.

7. Labor is uniform and completely movable.

8. The economy is in perfect competition.

9. Wages and profits are allocated as a percentage of national revenue.

Production, according to Marxian philosophy, refers to the creation of value. As a result,

economic growth is a process of increasing the amount of value created by labour. High
levels of output, on the other hand, may be achieved via increasing capital accumulation and
technical advancement.

At first, capitalism's expansion, value creation, and capital accumulation were all at a rapid
pace. There is a concentration of capital linked with a diminishing rate of profit once it
reaches its peak. As a result, the rate of investment and, as a result, the pace of economic
growth is reduced. Unemployment is on the rise. Conflicts between classes are on the rise.
There are labour disputes, as well as class revolts. In the end, capitalism will fail and
socialism will triumph.

4.3 ROSTOW’S STAGE OF DEVELOPMENT

Following the end of World War II (1939-45), there was a resurgence of interest in
development economics, with many experts once again focusing on the phases of growth. W.
W. Rostow's phases of economic progress (1960, 1971) are a non-communist manifesto that
attempts to categorise the breadth of contemporary economic history under capitalism into
clean and optimistic epochs.

Geographers typically use a development scale to describe regions, separating countries into
"developed" and "developing," "first world" and "third world," or "core" and "periphery." All
of these classifications are based on assessing a country's progress, but this begs the question
of what it means to be "developed," and why some countries have progressed while others
have not. Since the turn of the century, geographers and others working in the large subject of
Development Studies have attempted to address this issue, resulting in a plethora of models
to explain this occurrence.

Prior to Rostow, development techniques were founded on the premise that "modernization"
was associated with the Western world (at the time, wealthier, more powerful countries),

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which were able to progress beyond the early phases of underdevelopment. As a result, all
countries should aspire to a "modern" condition of capitalism and liberal democracy, as the
West has done. Rostow used these concepts to write his book "Stages of Economic Growth"
in 1960, which outlined five processes that all countries must go through in order to become
developed.

W.W. Rostow, an American economist and government official, was a prominent figure in
twentieth-century development studies. Prior to Rostow, development techniques were
founded on the premise that "modernization" was associated with the Western world (at the
time, wealthier, more powerful countries), which were able to progress beyond the early
phases of underdevelopment. As a result, other countries should follow the West's lead and
strive towards a "modern" state of capitalism and liberal democracy.

The version by Rostow is a fantastic example of continuity and progression. Furthermore, if

Marx's theory is considered as the flag of doomed capitalism, Rostow's interpretation may be
regarded as a viable capitalism.

ROSTOW’S MODEL OF STAGES OF ECONOMIC GROWTH

One of the most important development theories of the twentieth century is Rostow's Stages
of Growth model. However, it was also informed by the historical and political circumstances
in which he wrote. Stages of Economic Growth were released in 1960, during the height of
the Cold War, and it was blatantly political, with the subtitle "A Non-Communist Manifesto."
Rostow was a vehement anti-communist and right-winger who based his argument on the
industrialization and urbanisation of western capitalist countries. Rostow championed his
development model as part of US foreign policy while working in President John F.
Kennedy's administration. Rostow's concept demonstrates a desire to not only aid low-
income nations in their development, but also to establish the United States' influence over
that of other countries.

In 1955, W. Rostow proposed the most well-known non-spatial model, which defined five
phases of economic growth.

According to him, a traditional civilization went through several stages before reaching the
point of mass consumption. The economic stages of Rostow are depicted below.

1. Traditional society

2. Preconditions for take-off

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 3. Take-off

4. Drive to maturity

5. Age of High mass consumption

The model suggests that in stage 2, the low-tech and agricultural 'traditional society' (stage 1)
would gradually increase investments in infrastructure (such as roads and water supply) and
develop agriculture and extractive industries in a new social and political framework, as pre-
conditions for economic 'take-off' (stage 3). With the development of manufacturing
industries, investment and economic growth became self-sustaining. This is the drive for
achieving "economic maturity" (stage 4). Finally, the economy is considered fully developed
since consumer durable sectors are meeting the demands of an affluent population with a high
level of consumption (stage 5)

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 Fig 4.1 traditional society

(1) Traditional Society

Pre-Newtonian technology has been used to identify traditional civilization as one with
restricted productive functions. Political authority is held by feudal nobility, and the social
structure is hierarchical. More than 75% of the population works in agriculture, indicating
that this stage is marked by a stable, agricultural-based economy with hard labour and low
levels of commerce, as well as a people lacking a scientific understanding of the world and
technology.

This level of traditional culture represents a primitive society without access to contemporary
science and technology. To put it another way, it's a society built on rudimentary technology
and a primitive attitude toward the physical world. A traditional civilization, according to
Rostow, is "one whose structure is created within the constrained production function based
on pre-Newtonian science and technology, as well as pre-Newtonian ideas toward the
physical world."

Rostow, on the other hand, does not believe that traditional society is absolutely stagnant.
The extension of land under cultivation or the discovery and distribution of a new crop are
two ways for a society's production to increase at this stage.

However, there is a limit to the amount of production per person that can be achieved in this
form of society. This limitation develops as a result of a lack of current science and
technology. This sort of civilization devotes a significant percentage of its resources to
agriculture and is characterised by a hierarchical social structure with little vertical mobility.
Long-run fatalism is the value system that dominates in such a society, according to Rostow.
These civilizations' citizens believe that little economic improvement is feasible for them and
future generations.

Characteristics:

1 Per Capita: There is a low ceiling per capita output within a narrow spectrum of available
technology.

2 Agriculture Employment: A large majority of the workforce (75 percent or more) is

employed in the production of agricultural products. The agricultural segment also
receives a significant amount of resources.

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3 Social Mobility: At the period, society's mobility was constrained by a hierarchical,
hereditary, status-oriented social framework.

4 Political Power: Political power was largely based on land ownership and was localistic
and region-bound.

5 A civilization that is less developed in terms of science and technology

6 A production function that is limited.

7 While industry activity appears to be on the rise, development is hampered by a lack of

scientific information.

8 Low labour iv. Low labour productivity 

9 Agriculture's dominance leads to a hierarchical social structure 

10 Political power concentration 

11 Conventional techniques

(2) Pre-Condition of Trade Off

The second stage is a preconditioning phase, which was triggered by four forces: the
Renaissance, the New Monarchy, the New World (political upheaval), and the New Religion
or Reformation. These forces were key drivers of shifts in societal attitudes, values, and so
on.

External influences have created the pre-conditions. The situation in most regions of Britain
altered with Napoleon's dominance, whose victory ushered in new revolutionary ideals.
Industrial development necessitates changes in non-industrial sectors, such as

(i) The accumulation of social overhead capital, particularly in transportation;

(ii) Agricultural practices undergoing technological advancements, resulting in increased

agricultural productivity; and

(iii) Import expansion.

These conditions primarily include fundamental shifts in society's attitudes toward science,
(a) risk-taking, and profit-making; (b) the labour force's adaptability; (c) political
sovereignty; (d) the development of a centralised tax system and financial institutions; and (e)
the construction of certain economic and social infrastructure such as railways, ports, power

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generation, and educational institutions. During the First Five-Year Plan era, India
accomplished some of these goals (1951-56).

Fundamental changes in the social, political, and economic spheres, for example, are
among these requirements.

(a) A shift in society's attitudes toward science, risk, and profit;

(b) The labour force's adaptability;

(c) Political sovereignty;

(d) The development of a centralised tax system and financial institutions; and

(e) The construction of certain economic and social infrastructure, such as railways, ports,
power generation, and educational institutions. During the First Five-Year Plan period, India
did some of these things (1951-56).

Features

(a) Economic Progress:

Economic progress has come to be regarded as a social good. At this time, people's minds
began to alter, and they were able to think about their own countries.

(b) New Enterprises:

In today's world, new types of enterprising people have evolved. Their goal was to develop a
company or business that could manufacture goods for a long time.

(c) Investment:

As new innovative individuals entered society, gross investment increased from 5% to 10%,
causing production growth to outpace population growth.

(d) Infrastructure:

As diverse sectors grew in different sections of the country, more mobile communication,
highways, railways, and ports became necessary. As a result, infrastructure was constructed
throughout the United States.

(e) Credit Institutions:

Credit institutions were established at the time in order to mobilise savings for investment.

(f) Workforce Mobilization:

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As a result of industrialization, a significant share of the workforce was shifted from
agriculture to manufacturing. This was the case in the United Kingdom during the
"Industrialisation" period (1760 onwards).

(g) Birth Rate Decline:

Medical knowledge was still in its infancy at the time. The need of controlling the birth and
death rates was recognised by the citizens. The death rate was first kept under control,
followed by the birth rate. The wealthy countries were now in the second stage of
demographic transition.

(h) Political Authority:

Land-based localistic or colonial power was superseded by centralised political power based
on nationalism.

As seen above, the foundations for economic transformation are created during this second
stage of expansion. People begin to use contemporary science and technology to boost
agricultural and industrial output.

Furthermore, people's attitudes are changing as they begin to see the world as a place with
potential for future growth. A new class of entrepreneurs forms in society, one that mobilises
savings and invests in new businesses while assuming risks and uncertainties. In terms of
political organisation, it is at this point that a functional centralised nation-state begins to
emerge.

As a result, Rostow sees agriculture as playing three functions during the pre-launch phase.

● To begin, agriculture must produce enough food grains to meet the demands of an
expanding population as well as agricultural employees.

● Second, rising farm earnings would raise demand for industrial goods and encourage
investment in the sector.

● Finally, expanding agriculture must yield a significant portion of the savings required
to increase the industrial sector.

According to Rostow, there are two distinct transition patterns in history.

From a traditional culture:

1. Changes in the socio-political structure and production practises of basic nature. This
pattern has been seen across Europe, Asia, the Middle East, and Africa.

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 2. Changes in the economic and technological spheres. This pattern has been noticed in
the United States, Australia, and New Zealand.

3. The Take off Stage

This is the critical stage, which lasts two to three decades, during which the economy
transforms itself in such a way that economic growth follows almost effortlessly. "The take-
off" is defined as "the period during which the rate of investment rises to the point where real
output per capita rises, and this initial increase is accompanied by radical changes in
production techniques and the disposition of income flows that sustain the new scale of
investment and thus the rising trend in per capita output."

The take-off stage marks the transformation of a society from one that is stuck in the past to
one that is on the point of breaking free from the factors that stifle progress. In actuality, it is
a stage in which society is through a dynamic transition, with a rapid rise in the standards
established by society's members in all areas of life, including industry, agriculture, science
and technology, medicine, and so on.

To surpass expected population growth, the percentage of investment to national income

must climb from 5% to 10% or more; second, the period must be relatively short; and third, it
must culminate in self-sustaining and self-generating economic growth.

As a result, during the take-off stage, society is dominated by the desire to achieve economic
growth in order to enhance living standards. In both agriculture and industry, revolutionary
developments occur, and productivity levels skyrocket.

Greater urbanisation is occurring, as is an increase in the number of people working in cities.

Both the underlying structure of the economy as well as the social and political structures is
transformed in a very short period of a decade or two in order to maintain a self-sustaining
development rate.

It's worth mentioning that the creation of the new elite (i.e., the new entrepreneurial class)
and the establishment of a nation-state, in Rostow's opinion, are critical for economic
development. The first two phases, as well as the stage of take-off, are separated by a
significant distance. Winds of change are sparked by a major political event that transforms
the political system, or by the sudden infusion of new techniques and methods of production
attributed to tremendous developments in science and technology.

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The former occurred in countries such as the former Soviet Union, East and West Germany,
Japan, China, and India. The latter type can be found in countries such as the United
Kingdom, the United States, and the OPEC countries. Events such as the "Industrial
Revolution," which began in Britain in the 1760s and was the brainchild of technological
innovations, or the "Manhattan Project (1940s)," which signaled the arrival of the United
States on the world political scene with a, are living examples of the "take-off stage," as
Rostow describes it.

The characteristics of this stage

(a) The Investment Rate:

The rate of investment is the initial feature of the stage of take-off. The rate of investment
ranged from less than 5% to more than 10% of national revenue during the "Industrial
Revolution." Agricultural fields were purchased for industrialization during this period.

This resulted in depression in the following years. For Britain, colonisation was essential for
this objective. As a result, they first moved to India and other colonies for business and then
eventually gained political control of the country.

(b) Growth of a Single Leading Sector:

From the period of the Industrial Revolution (1760 onwards), we saw the growth of a certain
secondary sector in each country in Europe. The textile and iron and steel industries in the
United Kingdom have seen significant growth. Because the iron and steel sector is so
important for a country's development, every country in Europe has seen its iron and steel
industry flourish. The use of iron and steel per capita is now used to gauge a country's
progress.

(c) Existence of Different Frameworks in Society:

There was a political, social, and institutional framework that exploited impulses to
expansion in the modern sector, as well as the potential external economies, which influenced
the take-off and gave the growth process a sustained and cumulative character.

It's a time when a society effectively utilises the whole spectrum of contemporary technology
to the majority of its resources, and growth becomes the norm. Heavy engineering, iron and
steel, chemicals, machine tools, agricultural inputs, autos, and other industries are in the
driver's seat.

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Because of the abrupt acceleration of industrial activity, electric power generation and
consumption are both high. Given the foggy or indistinct demarcations between the end of
take-off and the beginning of maturity, it is difficult to date this phase precisely. It was
around 60 years after take-off, according to Rostow.

Economic Characteristics

(a) Occupational Distribution Shift:

Many industries were founded in Britain and other nations as a result of the Industrial
Revolution. The workforce in Western Europe was shifted from the agrarian to the
manufacturing sectors. The share of the workforce employed in the agriculture industry has
decreased to less than 20%.

(b) Consumption Pattern Shift:

The phrase "white-collar employees" was used to describe a new sort of workforce. They
were mostly officials or management officials from the governing body of a factory. Their
tastes switched to luxury goods as a result of their higher money. As a result, non-agricultural
commodities consumption has increased. This resulted in the expansion of established
sectors, as well as a faster rate of change in tastes and preferences throughout this time
period.

(c) Shift in Leading Sector Consumption:

The makeup of the leading sector was seen to differ from nation to country. Timber exports,
wood pulp, and pasteboard products propelled Sweden to prominence, followed by railways,
hydropower, steel, and animal husbandry and dairy products. Grain exports were the first to
take off in Russia, followed by railways, iron and steel, coal, and engineering.

4. The Drive to Maturity

The drive to maturity refers to the point at which a society has been able to apply a wide
range of technologies to development processes, allowing it to achieve long-term economic
growth that has lasted for more than four decades.

As a result, the workforce is becoming more skilled. The majority of people prefer to live in
cities. Real earnings are increasing, and workers are becoming more organised to ensure
social and economic stability. The tough entrepreneurs give way to a new generation of
skilled managers and CEOs, as society grows tired of the rapid speed of industrialization and
seeks reforms that will lead to more change.

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There are some significant modifications at this point:

1. As a result, the workforce is becoming more skilled. The majority of people prefer to live
in cities. Real earnings are increasing, and workers are becoming more organised to ensure
social and economic stability.

2. The tough entrepreneurs give way to a new generation of skilled managers and CEOs, 

3. The tough entrepreneurs give way to a new generation of skilled managers and CEOs, 

In Rostow's thesis, maturity refers to the state of the economy and society as a whole when
winning on all fronts has become a habit or addiction. Every endeavour to stimulate the
economy succeeds, and the period during which the society enjoys prosperity is quite long,
and the progress accomplished on all fronts is permanent. It's a time when a society
effectively utilises the whole spectrum of contemporary technology to the majority of its
resources, and growth becomes the norm. Heavy engineering, iron and steel, chemicals,
machine tools, agricultural inputs, autos, and other industries are in the driver's seat. Because
of the abrupt acceleration of industrial activity, electric power generation and consumption
are both high. Given the foggy or indistinct demarcations between the end of take-off and the
beginning of maturity, it is difficult to date this phase precisely. It was around 60 years after
take-off, according to Rostow.

Features

(a) Occupational Distribution Shift:

Many industries were founded in Britain and other nations as a result of the Industrial
Revolution. The workforce in Western Europe was shifted from the agrarian to the
manufacturing sectors. The share of the workforce employed in the agriculture industry has
decreased to less than 20%.

(b) Consumption Pattern Shift:

The phrase "white-collar employees" was used to describe a new sort of workforce. They
were mostly officials or management officials from the governing body of a factory. Their
tastes switched to luxury goods as a result of their higher money. As a result, non-agricultural
commodities consumption has increased. This resulted in the expansion of established
sectors, as well as a faster rate of change in tastes and preferences throughout this time
period.

(c) Shift in Leading Sector Consumption:

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The compositional change was observed to differ from country to country. Timber exports,
wood pulp, and pasteboard products propelled Sweden to prominence, followed by railways,
hydropower, steel, and animal husbandry and dairy products. Grain exports were the first to
take off in Russia, followed by railways, iron and steel, coal, and engineering.

The non-economic factors of “The Drive to Maturity” are:

(a) Entrepreneurial Leadership:

During the drive to maturity stage, there was a shift in entrepreneurial leadership. Cotton
barons, steel barons, railroad barons, and oil barons all gave way to the managerial
bureaucracy.

(b) Ennui:

A certain amount of boredom with industrialization led to social protests against its expenses.

Note: A forward linkage is created when investment in a particular project encourages

investment in subsequent stages of production. A backward linkage is created when a project
encourages investment in facilities that enable the project to succeed. –Hirschman

5. The Age of Mass Consumption

Consumption of durable goods, household appliances, automobiles, and other items has
characterized the age of high mass consumption. Demand is given greater weight in society
than supply, and problems of consumption are given more weight than concerns of
production and human welfare.

During the post-maturity phase, there are three forces that increase welfare:

The government makes provisions for more equitable distribution of income, social security,
and leisure to the workforce in order to achieve the goal of a welfare state; commercial
centers of cheaper automobiles, houses, and sophisticated household devices, among other
things, are set up to achieve the goal of a welfare state.

From maturity to high mass consumption, the stage at which durable consumer items such as
radios, television sets, vehicles, refrigerators, and other durable consumer goods, as well as
life in the suburbs and college education for one-third to one-half of the population, become
affordable. Furthermore, the economy demonstrates a readiness to dedicate more resources to
social welfare and security through its political process. This stage was characterised by a
shift in focus away from production issues and toward consumer issues.

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As a result, focus naturally shifts to resource allocation issues, which, according to Rostow,
have come to be regulated by the following considerations:

(i) The pursuit of national power and global influence,

(ii) The welfare state dispersing income to remedy market process aberrations, and

(iii) The expansion of consumer demand for durable consumer items and high-quality foods.

COMPARISON OF MARX AND ROSTOW

According to Rostow, there are five distinct stages. The take-off, which was propelled by one
or more "leading sectors," was the most important of them. The economy's less active
sections were dragged along by the quick expansion of the leading sectors.

According to Rostow, large supply and demand price elasticities in the leading sectors meant
that demand pressures elicited a supply response, and lower prices resulted in higher total
revenues for the emerging industries.

The leading industries also benefited structurally from strong income elasticities of demand,
resulting in market size expansions that were disproportionate to the amount of income
growth in the economy as a whole. Finally, demand in sectors related to the leading sector
was boosted by external economies generated by the leading sectors. The upshot, at least in
the countries to which the research applied, was a self-sustaining increase in output growth—
a permanent transition from low (or no) growth to steady growth rates owing to these
structural linkages between the leading sectors and the rest of the economy. The approach
was "non-Marxist" because it did not rely on class struggles, rising unemployment, falling
profit rates, or any of the other Marxian analytical tools in its analysis.

Criticism to Rostow’s Model

(i) Growth Reduction:

According to Rostow's theory, economic growth can be reduced to a single pattern. He

merely mentioned the expansion of one or more economic areas. He made no mention of the
economy's overall state.

(ii) Evolutionary Mechanism:

Rostow's stages of growth failed to describe the evolutionary mechanism that connects
distinct stages of growth. He explained the stages in a non-interrelated manner.

(iii) Economic Variables:

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According to Rostow's stage theory, existing economic variables diminish the country's
growth rate. However, he made no mention of how these issues will be resolved. He didn't go
into detail on how the variables interact to produce economic growth.

(iv) Lack of Symmetry: Rostow's stage theory lacked symmetry because it was not based on a
systematic causation scheme.

(v) Predictive Value:

According to Paul Baran, Rostow's theory has little predictive value and has no operational
significance for developing countries striving to overcome development constraints.

(vi) Hoffman Thesis:

Although Rostow appeared to be influenced by Hoffman's thesis, his results differed from
those of his mentor. Rostow's views on the rate of investment were based on the assumption
of a constant marginal capital-output ratio. In the manufacturing sector, Hoffman's research
emphasised an increasing ratio of net capital goods to net consumer goods. This meant that as
industrialisation progressed, the capital-to-output ratio grew.

(vii) Savings Habits:

As a work of academic research, it lacked novelty. It heavily drew on the pioneering work of
Max Weber and Tawney in the field of sociology. Rostow's references to changing saving
habits, the rising pursuit of economic objectives in everyday life, and so on, echo Weber and
Tawney's sentiments.

(viii) Traditional society is not a necessary condition for growth. When the United States,
Canada, Australia, and New Zealand were founded, they were not 'conventional' countries.

(ix) A pre-flight preconditioning process is not required. On the basis of the data, it is
difficult to think that a period of agricultural revolution and the accumulation of overhead
social capital in transportation must precede take-off.

(x) Stages tend to bleed into one another. Agricultural development has boosted the
economies of countries like New Zealand and Denmark. The different stages proposed by
W.W. Rostow are not distinguishable in their cases.

There are inconsistencies in the take-off process. Rostow himself was sceptical about the
take-off date. His incongruous reference to the years 1937 and 1952 as the years of India's
take-off suggests this. During takeoff, he did not contemplate the possibility of an economic

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downturn. The impact of historical heritage, the extent of backwardness, and other related
aspects are rarely included in take-off analyses.

There are some flaws in the take-off conditions:

a. It is determined that the rate of productive investment exceeding 10% of net national
product is arbitrary.

b. Rostow's emphasis on the involvement of some prominent sectors in the take-off,

such as textiles, railroads, and so on, is difficult to back up.

c. In the third condition, Rostow contended that mobilisation is necessary.

(xi) The quest for adulthood can be perplexing. The stage includes all of the characteristics of
take-off, such as net investment exceeding 10% of national income, development of cutting-
edge production techniques, and so on. As a result, there is no longer a requirement for a
separate stage when growth is self-sustaining. In actuality, no growth is completely self-
sufficient or self-contained.

(xii) In the stage of high mass consumption, chronological order is not maintained. Some
countries, such as Canada and Australia, have already reached this point.

(xiii) The concept of take-off is particularly well suited to the needs of developing countries.
Rostow's proposal for a capital formation and development rate was more than 10%.

The road to adulthood can be confusing. All of the features of take-off are present in this
stage, including net investment surpassing 10% of national income, development of cutting-
edge production processes, and so on. As a result, when growth is self-sustaining, a separate
stage is no longer required. In reality, no growth is totally self-contained or self-sufficient.
The chronological order is not maintained throughout the high-mass-consumption stage.
Canada and Australia, for example, have already arrived at this point. Take-off is a notion
that is especially well adapted to the needs of emerging countries. Rostow’s idea for a capital
formation and development rate was over 10%.

4.4 HARROD-DOMAR MODEL

Interest in the difficulties of economic growth has prompted economists to develop a variety
of growth models since the conclusion of WWII.

These models address and emphasise the numerous facets of industrialised economies'
growth. They are, in a sense, alternative stylized depictions of a growing economy.

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They all have one thing in common: they're all based on Keynesian saving-investment
analysis. The Harrod-Domar Model, the original and most basic model of growth, is the
direct result of projecting short-run Keynesian analysis into the long-run.

This model assumes that capital is the most important component in economic progress. It
focuses on the possibility of sustainable growth through capital supply and demand
adjustments. Then there's Mrs. Joan Robinson's approach, which considers technical
advancement as a source of economic growth in addition to capital formation. The neo-
classical growth model is the third type of growth model.

It presupposes that capital and labour are substituted, and that technological development is
neutral in the sense that it neither saves nor absorbs labour or capital. Even when neutral
technical is utilised, both components are applied in the same proportion. Here, we'll look at
some of the most well-known growth models.

Although the Harrod and Domar models differ in some features, they are fundamentally the
same. Harrod's model may be considered the English equivalent of Domar's model. Both of
these models emphasise the importance of establishing and maintaining consistent growth.
Capital accumulation plays a critical part in the growth process, according to Harrod and
Domar. In fact, they emphasise capital accumulation's dual role.

New investment, on the one hand, provides income (according to the multiplier effect); on the
other hand, it expands the economy's productive capacity (because to the productivity impact)
by increasing its capital stock. It's worth noting that classical economics placed a premium on
the investment's productivity while ignoring the income component. Keynes had paid close
attention to the issue of revenue generation but had overlooked the issue of increasing
productive capacity. Harrod and Domar took extra effort to address both of the issues that
arise as a result of investing in their models.

Assumption

(i) There is already a full-employment level of income.

(ii) The government does not interfere with the economy's operation.

(iii) The model is based on the "closed economy" assumption. To put it another way,
government trade restrictions and the problems that come with international trade are ruled
out.

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(iv) There are no lags in variable adjustment, i.e., economic variables such as savings,
investment, income, and expenditure all change in the same amount of time.

(v) The marginal propensity to save (MPS) and the average propensity to save (APS) are
equal.

 APS = MPS, or written in symbols

S/Y= ∆S/∆Y

(vi) The tendency to save as well as the "capital coefficient" (i.e., the capital-output ratio) are
both held constant. Because the capita-output ratio is fixed, this corresponds to believing that
the law of constant returns operates in the economy.

(vii) Income, investment, and savings are all defined in a net sense, that is, they are taken into
account after depreciation. As a result, depreciation rates are excluded from these variables.

(viii) Saving and investment are equivalent in ex-ante and ex-post senses, i.e., accounting and
functional equivalence exists between saving and investment.

These assumptions were made to make growth analysis easier; they can be relaxed later.

(A) Harrod Model

Assumptions of the Harrod Model:

Roy F. Harrod has presented his model in his publication “An essay on Dynamic Theory
(1931)” and “Towards a Dynamic Theory (1948)”.

Roy Harrod is credited with introducing the concept of economic growth to twentieth-century
economists. Harrod drew on Keynes' income-determination theory. Though Harrod's earliest
version of the theory was published in "An Essay in Dynamic Theory," the Harrod-Domar
model (named for Harrod and Evsey Domar, who worked on the notion independently) is
detailed in Towards a Dynamic Economics.

The notions of warranted growth, natural growth, and actual growth were developed by
Harrod. The justified growth rate is the pace at which all savings are reinvested in the
economy. If people save 10% of their income and the capital-to-output ratio in the economy
are 4, the economy's justified growth rate is 2.5 percent (ten divided by four). This is the rate
of growth at which the capital-to-output ratio remains constant at four.

Assumption

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1. Content return to scale

2. The ex-ante level of aggregate saving is a constant fraction of total income.

3. Technical improvement will remain constant

4. The ratios of capital to labour output are considered to be constant.

5. Entrepreneurs are interested in making investments based on how quickly output grows.

Harrod’s growth model raised three issues

(i) How can an economy with a fixed (capital-output ratio) (capital-coefficient) and a fixed
saving-income ratio achieve constant growth?

(ii) How can the constant rate of growth be maintained? Or, to put it another way, what are
the prerequisites for continuing to grow at a steady rate?

(iii) How do natural circumstances impose a limit on the economy's growth rate?

In order to discuss these issues, Harrod had adopted three different concepts of growth rates:
(i) the actual growth rate, G, (ii) the warranted growth rate, G w (iii) the natural growth rate,
Gn. The Actual Growth Rate is the growth rate determined by the actual rate of savings and
investment in the country. In other words, it can be defined as the ratio of change in income
(AT) to the total income (Y) in the given period. If actual growth rate is denoted by G, then

G = ∆Y/Y

The Actual Growth Rate is the rate of growth defined by the country's actual savings and
investment rates. To put it another way, it's the ratio of change in income (AT) to total
income (Y) over a particular period. If G stands the actual growth rate, then

GC = s … (1)

where G denotes the actual rate of growth, C the capital-output ratio (∆K/∆Y ), and s the
saving-income ratio ∆S/∆Y. The simple truism that saving and investment (in the ex-post
sense) are equal in equilibrium is preserved by this relationship. The following derivation
demonstrates this.

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This relationship indicates why ex-post savings must be equal to ex-post investment in order
to achieve steady state growth. The term "warranted growth" refers to the economy's growth
rate when it is operating at full capacity. Full-capacity growth rate is another name for it. This
Gw growth rate is defined as the rate of income growth required to fully utilise a growing
stock of capital, allowing entrepreneurs to be content with the amount of investment actually
made.

Warranted growth rate (Gw) is determined by capital-output ratio and saving- income ratio.
The relationship between the warranted growth rate and its determinants can be expressed as

Gw Cr = s

Where Cr shows the needed C to maintain the warranted growth rate and s is the saving-
income ratio.

Let us now look at the topic of how to create consistent growth. According to Harrod, the
economy will be able to maintain stable development if

G = Gw and C = Cr

First and foremost, the actual growth rate must be identical to the warranted growth rate.
Second, given the saving co-efficient, the capital-output ratio required to accomplish G must
be equal to the capital-output ratio required to sustain Gw, saving co-efficient (s). This means
that for the specified saving rate, actual investment must be equal to expected investment.

Instability of Growth

As previously established, steady-state economic growth necessitates equality between G and

Gw on the one hand, and C and Cr on the other. These equilibrium conditions would be met

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relatively rarely, if at all, in a free-enterprise system. As a result, Harrod looked into what
happens when these conditions aren't met.

We investigate the case where G is bigger than Gw. When the pace of increase of income
exceeds the rate of growth of output, the demand for output (because to the higher level of
income) exceeds the supply of output (due to the lower level of output), and the economy
experiences inflation. This can be explained in another way too when C < Cr Under this
situation, the actual amount of capital falls short of the required amount of capital.

This would result in a capital shortage, which would have a negative impact on the volume of
commodities produced. A drop in output would result in a scarcity of products and, as a
result, inflation. The economy will be trapped in a quagmire of inflation as a result of this
circumstance.

Than the production growth rate. There would be an abundance of items for sale in this
situation, but the income would not be sufficient to buy them. In Keynesian terms, there
would be a demand deficit, resulting in deflation. When C is bigger than Cr, this scenario can
be explained. The actual amount of funds available for investment would be greater than the
amount required. In the long run, a bigger pool of capital accessible for investment would
reduce capital's marginal efficiency. Chronic depression would result from a long-term drop
in capital's marginal efficiency.

It may be deduced from the preceding study that constant growth indicates a balance between
G and Gw. It is difficult to find a balance between G and Gw in a free-enterprise economy
because the two are determined by whole separate sets of circumstances. Knife-edge
equilibrium is named thus because a small variation of G from Gw pulls the economy away
from the steady-state growth path.

Natural factors such as labour force, natural resources, capital equipment, technical expertise,
and so on determine Gn, or natural growth rate. These variables impose a limit on the amount
of output that can be increased. The Full-Employment Ceiling is the name given to this
constraint. This top limit may shift as the production variables improve or as technology
advances. As a result, the natural growth rate is the highest rate of growth that an economy

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may accomplish using its natural resources. The third essential relationship in Harrod's
concept of natural growth rate determinants is

GnCr is either = or ≠s

Interaction of G, Gw and Gn:

Fig 4.2 Instability of Growth (a)

When we compare the second and third relationships between the justified growth rate and
the natural growth rate, we can see that Gn may or may not be equal to Gw. The prerequisites
for steady growth and full employment are met if G„ equals Gw, However, such a possibility
is unlikely because a variety of obstacles are likely to arise, making balancing all of these
aspects challenging. As a result, there is a distinct probability of Gn and Gw being unequal. If
G„ exceeds Gw, G would also exceed Gw for the vast majority of the time, as illustrated in
Figure, and the economy would be prone to cumulative boom and  full employment.

An inflationary trend will emerge as a result of this predicament. Savings become desirable to
counteract this trend since they allow the economy to maintain a high level of employment
while avoiding inflationary pressures. If, on the other hand, Gw surpasses G„, G must be
below G„ for the majority of the period, resulting in a cumulative recession and
unemployment.

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 Fig 4.2 Instability of Growth (b)

(B) The Domar Model

Domar's main growth model resembles Harrod's in certain ways. In fact, Harrod saw Domar's
formulation as a seven-year-long rediscovery of his own version.

Domar’s theory was just an extension of Keynes’ General Theory, particularly on two
counts

1. Effect of investments:

(a) A revenue-generating effect

(b) Capacity creation has a productivity effect.

2. Unemployment of labour gets a lot of attention, and people sympathise with the
unemployed, but unemployment of capital gets little attention. It's important to remember that
capital unemployment prevents investment and, as a result, lowers income. Reduced income
leads to a decrease in demand and, as a result, unemployment. As a result, the Keynesian
view of unemployment overlooks the underlying reason of the problem. Domar sought to
look at the origins of unemployment from a broader perspective.

 The implications of Domar model

1. Income is calculated by a multiplier applied to an investment. The saving-income ratio (s)

is assumed to be constant for the sake of simplicity. This suggests that

Y(t) = I(t)/s

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If Y represents the output, I represents the actual investment, s represents the saving-income
ratio (saving propensity), and t represents the time period.

2. Investment creates productive capacity to the extent that the prospective (social) average
productivity of investment is denoted by a. This is likewise considered to be constant for the
sake of simplicity. The relationship can be represented in notation as

Y (t) –Y (t-1) = I (t)/α

Where Y shows the productive capacity for output, a is the actual marginal capital-output
ratio which is the reciprocal of “potential social average investment productivity” (α= 1/σ).
Therefore, Equation (2) can also be expressed as ∆Yt = σIt. This equation shows that the
change in productive capacity is the product of capital productivity (σ) and investment. As
such it reveals the productivity effect.

3. Output growth and entrepreneurial confidence both encourage investment. Junking, or the
untimely loss of capital value due to the unprofitable operation of older facilities, has a
negative impact on the latter. This could be due to a labour scarcity, the development of new
products, or the introduction of labor-saving devices. The relationship demonstrates this
assumption.

Where G is a decreasing function of the "Junking ratio" but an increasing function of the rate
of output acceleration (t).

When the junking ratio is zero, investment grows in lockstep with output.

4. Employment is determined by the "utilisation ratio," which is defined as the ratio of actual
output to productive capacity. It can be stated as follows:

Here A’ refers to employment and L to the labour force. II is the employment coefficient,
Yd the actual output and the productive capacity, (I) being the time period. This equation
explains that the ratio of employment to labour force is determined by employment
coefficient (II) and the ratio of output to productivity. The dots are meant to indicate the

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existence of other determinants of the employment ratio. If we assume that the employment
coefficient takes the maximum value of unity (i.e., H = I), then Yd(t) = Ys(t)

5. At a specific ratio, both past and current investment can develop productive capacity.
However, due to managerial blunders, new investment projects may hasten the collapse of
existing projects and plants. If "junking" exists, it will reduce investment productivity. The
basic assumption of Doinar's model is this premise. It can be expressed as follows in
notations:

Where K is capital, / shows investment, d(t). K(t) is the amount of capital junked, and d(t) is
the junking ratio.

Domar looked at growth from both the demand and supply sides. On the one hand,
investment enhances productive capacity while also generating revenue. The solution for
stable growth is to balance the two sides. In Domar's model, the following symbols are
utilised.

Yd = level of effective demand at full employment or level of net national income (demand
side)

Ys = full-employment level of productive capacity or supply (supply side)

K stands for real capital.

I = net investment which results in the increase of real capital i.e., ∆K a = marginal
propensity to save, which is the reciprocal of multiplier. a = (sigma) is productivity of capital
or of net investment.

The following relationship summarises the demand side of the long-term effect of
investment. This is a straightforward Keynesian investment multiplier application.

Yd = 1/a . I

This relationship tells us (I) that the amount of effective demand (Yd) is directly tied to the
level of investment via a multiplier equal to 1/α Any increase in investment will raise
effective demand in a direct manner, and vice versa. (ii) The marginal propensity to save is
negatively related to effective demand (a). Any rise in the marginal inclination to save (a)
reduces effective demand, and vice versa.

The supply side of the economy in the Domar model is shown through the relation.

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Ys = σK

This relation explains that the supply of output (Y s) at full employment depends upon two
factors: productive capacity of capital (σ) and the amount of real capital (K). Any increase or
decrease in one of these two factors will change the supply of output. If the productivity of
capital (σ) increases, that would favorably affect the economy’s supply. Similar is the effect
of the change in the real capital K on the supply of output.

The demand Yd and supply Ys sides of the economy should be equal for long-term
equilibrium. As a result, we can write:

This relationship states that when investment equals the product of the saving-income ratio,
capital productivity, and capital stock over time, stable growth is feasible.

The demand and supply equations can be expressed in incremental form as follows: The
demand side is as follows:

∆Yd =∆I/α … (1)

But the increment has not been shown in because it is a constant in terms of the assumptions.
Since 1/α is nothing but a and ∆I leads to ∆K, we can write the supply relation as follows

∆Ys = σ ∆K

This equation shows that a change in the supply of output (∆Y s) can be expressed as the
product of the change in real capital (∆K), and the productivity of capital (σ). Substituting the
value of ∆K as I in the above equation, we get the supply side of the economy as

∆Ys= σ I … (1)

We can obtain the criterion for constant development from equations (1) and (2). We get by
combining equations (1) and (2).

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According to Equation (3), the income growth rate ∆Y/Y should be equal to the product of
marginal propensity to save (α) and capital productivity (α) if steady growth is to be
maintained. If a rising economy with an expanding stock of capital is to maintain continuous
full employment, an increase in productive capacity (∆Ys) due to an increase in real capital
(∆C) must be balanced by an equal rise in effective demand (Yd) due to an increase in
investment (∆I)."

Domar’s condition of steady state growth can be explained with the help of numerical
example. Suppose the productivity of capital (σ) is 25% and the marginal propensity to save
is 12%, then the growth rate of investment (AHI) would be equal to a, a, i.e.,

If a consistent growth rate is to be maintained, income and investment must grow at a rate of
3% per year.

Analysis of disequilibrium

Long-term inflation would emerge in the economy under the first scenario, because the faster
rate of income growth would provide greater purchasing power to the population, and the
productive capacity (σα) would be unable to deal with the increased level of income. As a
result of the first state of disequilibrium, the economy will experience inflation.

Overproduction will occur in the second circumstance, in which the rate of growth of revenue
or investment lags behind the productive capacity. The people's purchasing power will be
limited as a result of the lower growth rate of income, lowering demand and resulting in
overproduction. This is the condition under which secular stagnation would occur. As a

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result, we've arrived at the identical conclusion about steady growth instability as we got
from the Harrod model.

(C) Diagrammatic representation of Harrod-Domar Model

The horizontal axis represents income, while the vertical axis represents savings and
investment. The line S(Y) drawn through the origin depicts the levels of saving that
correspond to various income levels. The slope (tangent) of this line represents the average
and marginal inclination to save. The acceleration co-efficient v, which remains constant at
each income level of Y0, Y1, and Y2, is measured by the slopes of lines Y0I0, Y1I1, and
Y2I2.

Fig 4.4 Diagrammatic representation of Harrod-Domar Model (a)

The saving is S0Y0 at an initial income level of Y0. When this money will put to work, the
income changes from Y0 to Y1. Savings increase to S1Y1 as a result of the increasing
income. When this amount of money is saved and reinvested, the level of income rises to Y2.
Savings will rise to S2Y2 as a result of the increasing income. The acceleration effect on
output growth can be seen in this process of rising income, saving, and investment.

With the help of the diagram below, we will now give a diagrammatic presentation of the
Harrod model.

The horizontal axis represents income, while the vertical axis represents saving and
investment. The line S(Y) that passes through the origin represents the level of saving that
corresponds to various income levels. The different degrees of investment are I0I0, I1I1, and
I2I2. The capital productivity indices Y0P0 and Y1P1 relate to different levels of investment.

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 Fig 4.4 Diagrammatic representation of Harrod-Domar Model (b)

The lines Y0P0 and Y1P1 are drawn parallel so as to show that productivity of capital remains
unchanged. This diagram shows that the level of income is determined by the forces of saving
and investment. The level of income Y0 is determined by the intersection of saving line S(Y)
and the investment line I0I0.

At the level of income Y0, the saving is Y0S0. When the saving Y0S0 is invested, it will
increase the income level from OY0 to OY1. The productive capacity will also rise
correspondingly. The extent of the income increase depends upon the productivity of capital,
which is measured by the slope of the line Y0P0 (α).

The higher degree of income, leads to greater the potential for production. Similarly, when
the income level is OY1, the saving level is S1Y1. With an S1Y1 investment, income will
climb to a level of Y2. This increase in income translates to an increase in the economy's
purchasing power. However, the capital productivity coefficient would remain constant,
which is a key assumption in Domar's model.

4.5 BALANCE AND UNBALANCED STRATEGIES

Balanced growth strives to develop all sectors at the same time, but unbalanced growth
suggests that investments should be made solely in the economy's top sectors.

Underdeveloped countries lack the human, material, and financial resources to invest in a
variety of complementary businesses at the same time. New investment opportunities arise as
a result of investments made in specific areas. By preserving tensions and disproportions, the
unbalanced growth implies the formation of discord, inconsistency, and disequilibrium,

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whereas balanced growth aspires for harmony, consistency, and equilibrium. The execution
of balanced growth necessitates a significant investment of money. goal is to keep the
disequilibrium alive rather than to erase it.

Unbalanced growth, on the other hand, necessitates a less quantity of money, as it focuses on
only the most profitable industries. Balanced growth is a long-term plan because the
development of all economic sectors is only achievable over time. Unbalanced growth, on the
other hand, is a short-term plan because only a few dominant industries can thrive in a short
period of time.

The doctrines of balanced and unbalanced growth have two similar issues relating to the
function of the state and the role of supply constraints and inelastic supply. In undeveloped
countries, private enterprise is only capable of making investment decisions. Therefore,
balanced growth presupposes planning. States play a leading role in supporting SOC
investments in an uneven growth plan, generating instability.

If development begins with DPA investment, political forces drive the government to invest
in SOC. The lack of demand is the primary worry of the balanced growth hypothesis, which
ignores the significance of supply constraints.

This is not true since undeveloped countries lack access to capital, expertise, infrastructure,
and other inelastic resources. Similarly, the uneven growth concept overlooks the importance
of supply constraints and supply elasticity. In such circumstances, a careful balance must be
struck between the benefits of balanced and unbalanced growth.

There is no doubt that developing countries are committed to democracy and should strive to
control the twin evils of inflation and a negative balance of payments while pursuing any
economic development strategy. It is imperative that something be done to strengthen and
vigorize the doctrine's effectiveness as a tool for economic development.

ECONOMIC GROWTH STRATEGIES: BALANCED AND UNBALANCED

There are now two broad schools of thought among development experts about the economic
development plan that should be implemented in underdeveloped countries. On the one hand,
economists such as Ragnar Nurkse and Rosenstein-Rodan believe that investment strategy
should be structured in such a way that the various sectors of the economy develop in a
balanced manner. As a result, they urge for simultaneous investment in a variety of
businesses in order to ensure that diverse industries flourish in a balanced manner.
Economists such as H.W. Singer and A.O. Hirschman, on the other hand, argue that for rapid

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economic growth, investment should be concentrated in a few important areas rather than
distributed evenly across all businesses. In other words, unbalanced growth, in the opinion of
these latter economists, is more favourable to economic progress than balanced growth. We
may now take a closer look at both of these points of view.

(A) STRATEGY OF BALANCED GROWTH

We also mentioned how tough it was to break free from this vicious cycle. On both the
supply and demand sides of capital development, we illustrated how the vicious circle of
poverty occurs. Nurkse proposed the balanced growth concept in order to break the poverty
cycle on the demand side of capital production. A short examination of this vicious circle will
be beneficial.

The level of per capita income in an underdeveloped country is low, implying that people's
purchasing power is poor. Their demand for consumer products is minimal due to their poor
wages and purchasing power. Because of the low demand for commodities, there is less
incentive to spend, and capital equipment per capita (i.e., per worker) is low. Because there is
a little amount of capital per capita, productivity per worker is poor. Low per capita
productivity equates to low per capita income, which equates to poverty.

Poverty's vicious loop is now complete. Because the size of the goods market in a poor
country is tiny, there are few prospects for lucrative industrial investment. This is the primary
cause for the absence of investment incentives that we are currently discussing.

1. Size of Market and Inducement to Invest

Investment is defined as spending on the manufacturing and installation of capital goods,

such as the construction of factories and the manufacturing and installation of machines, the
execution of irrigation and power projects, the construction of roads and railways, and so on.
Obviously, if an entrepreneur expects a significant return on his investment, he will be
enticed to invest in factories, machines, and other assets. Businessmen will be motivated to
invest solely for the purpose of profit. People are too poor to eat two square meals a day, live
in decent housing, or wear clothes that cover their bodies. As a result, there is a pressing need
for large-scale consumer goods production, but this cannot be accomplished without large-
scale capital goods production and consumption. Agricultural advances, the formation and
expansion of industries, the most efficient use of natural resources, and putting natural
resources to work for the people all necessitate capital. The demand for capital may be
tremendous, but there may be little incentive to contribute.

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The degree of investment is determined by the temptation to invest in the form of a desire to
profit from the capital invested, rather than by the necessity for capital. Much capital will not
flow into investment if there is no credible expectation of profit.

The amount of profitable investment in a country is determined by the market's size.

"Division of labour is limited by the size of the market," Adam Smith observed. In a similar
vein, we can say. The size of the market, or the level of demand, determines the incentive to
invest. Entrepreneurs are discouraged from investing in industries due to the tiny size of the
market or the low degree of demand for the products in question.

Which entrepreneur would dare to launch such a company?

Entrepreneurs should be confident that the capital equipment will be used profitably as an
incentive to invest. This can only be possible if the machinery can be kept in continuous
operation, which will be impossible unless there is adequate demand for the product produced
by the machinery. Let me give you another example. Assume that a cloth with a unique
design is particularly appealing and may command a high price. However, installing a large
machine to create a special design cloth would not be cost-effective because there will be
insufficient demand for this sort of cloth due to its high price and low incomes of the
population, i.e., the market will be too small.

2. Nurksian Strategy of Balanced Growth:

We've already discussed how the small size of the market or restricted demand for
commodities in developing countries impedes economic growth and capital formation. When
a business owner decides to open a factory or install equipment and machinery, he must first
determine whether there is sufficient demand for the goods he plans to produce and whether
the investment will be successful.

We have shown that low demand for industrial goods discourages investment due to low
profitability. As a result, poverty's vicious loop operates on the demand side of capital
formation. The population of developing countries is poor and has a low per capita income.

As a result, demand is limited and the market is small. Because the market is tiny,
entrepreneurs are discouraged from investing in equipment and machinery that can only be
used for large-scale production. As a result, the country's capital formation is discouraged.
Productivity is low due to a lack of capital, and because productivity per worker is low, per
capita income is low, implying poverty. In developing countries, this is how the vicious cycle
of poverty works. According to Nurkse, the vicious circle that exists in undeveloped

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countries is preventing them from developing economically, and if this vicious circle can be
broken, economic progress will follow.

3. The operation of the vicious circle can also be described thus:

Demand, or the size of the market, is ultimately what motivates people to invest. Because the
capacity to buy is ultimately reliant on the ability to produce, the size of the market is
determined by productivity. The use of capital, in turn, has a big impact on productivity.
However, for an entrepreneur, the limited size of the market will limit the use of capital,
resulting in low productivity and, as a result, a tiny market size. The vicious cycle will then
start all over again. According to Nurkse, this vicious cycle of poverty can be ended by
making simultaneous investments in a wide range of businesses, i.e., by achieving balanced
economic growth.

We've already discussed how Say's rule won't benefit developing countries if they only invest
in one area. Any single industry that is initially established with capital equipment cannot
generate its own demand.

Because human desires are various, those working in the new business will not want to spend
all of their earnings on their own items. Assume that a shoe manufacturing industry has been
established. If nothing happens in the rest of the economy to boost productivity and
employment, and thus people's purchasing power, the market for further shoe production is
likely to be weak. People outside the shoe industry will not forego basic foods, clothing, and
other necessities in order to generate a sufficient demand for shoes each year. The supply of
shoes is expected to outstrip demand, and focusing investment solely on one area will not
provide results.

4. External Economies and Balanced Growth:

It appears appropriate to mention external economies in this context. It will be profitable for
the other industry if one industry generates demand for another. We say external economies
are available from one industry to another when one industry benefits from the growth of
another.

As we've seen, investing in complementary businesses pays off because people in those
industries become one another's clients or create demand for one another. As a result, it is
apparent that the balanced growth philosophy is built on the concept of external economies.

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It's worth noting that we don't use the phrase "external economies" in the way that Marshall
did. Marshall meant 'external economies,' which are those that originate from the localization
of a certain industry in a specific location, and which are enjoyed by each firm in the sector
as a result of the formation of multiple enterprises there.

External economies, on the other hand, are the benefits that accrue to other industries as a
result of the foundation of new industries or the extension of existing businesses in
development economics. We've seen how, according to Nurkse's balanced growth concept,
these advantages accrue to other industries through the development of new industries or the
extension of established industries through concurrent investment in both.

5. A Critique of Balanced Growth

Balanced growth, according to Singer, cannot solve the problem of underdeveloped countries,
nor do they have the resources to achieve it. "A hundred flowers may thrive whereas a single
flower would wither away for lack of sustenance," Singer claims. But where do you find the
materials to grow a hundred flowers? Singer believes that the tagline "stop thinking
piecemeal, start thinking big" is sound counsel for developing countries, but he also believes
that the balanced growth theory in its Nurksian form has "many areas of uncertainty."

First, if the balanced growth philosophy is taken as advising developing countries to start on a
large and diverse package of industrial investment while ignoring agricultural production, it
might cause problems.

During the early phases of growth, when income rises as a result of new industrial investment
and employment, there will be a growing demand for food and other agricultural items.
Agricultural productivity would have to be considerably increased in order to sustain
industrial investment.

As a result, if the country is not to run out of food and agricultural raw materials throughout
the transition to an industrialised society, a major push in industry must be supported by a
major push in agriculture.

(B) Hirschman’s Strategy of Unbalanced Growth

Professor Albert Hirschman expanded on Singer's theory in his book "Strategy of Economic
Development," arguing that deliberately unbalancing an economy in accordance with a preset
strategy was the greatest method to achieve economic growth.

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He, like Singer, believes that balanced growth theory necessitates massive amounts of
precisely those qualities that have been identified as being in short supply in developing
countries. He describes J.M. Keynes' balanced growth philosophy as "the application of a
therapy initially intended for an underemployment condition" to underdevelopment. During a
depression in an advanced country, "industries, machinery, managers, and workers, as well as
consumption patterns" are all present, although this is clearly not the case in underdeveloped
countries. Because an underdeveloped country is incapable of simultaneously financing and
managing a balanced "investment package" in industry and the necessary investment in
agriculture, Hirschman recommends giving a big push in strategic selected industries or
sectors of the economy in order to lift an underdeveloped economy out of stagnation.

After all, he points out that "balanced growth" did not get the industrialised countries to
where they are now. True, many things have expanded since 1850 if you compare the
economy of the United States in 1950 to the condition in 1850, but not everything has grown
at the same rate over the century. Growth has been conveyed from the leading sectors of the
economy to the "development has proceeded with growth being communicated from the
leading sectors of the economy to the "development has proceeded with growth being
communicated from the leading sectors

Professor Hirschman claims that the actual scarcity in developing countries is "not the ability
to bring them into play," but rather "the ability to bring them into play." He breaks down the
original investment into two categories: (a) directly productive activities (DPA) and (b) social
overhead capital (SOC).

Unbalanced growth can be pursued by an underdeveloped country by making initial

investments in social overhead capital or directly productive activities. Regardless of the sort
of investment, it will result in a 'extra dividend' of induced decisions, which will lead to
increased investment and output. Because of the limited ability to employ resources, he
claims that social overhead capital and directly productive activities cannot be grown at the
same time.

1. Hirschman’s Illustration of Balanced and Unbalanced Growth Paths

Should we pursue "growth by excess SOC capacity" or "development via SOC scarcity"?
According to Hirschman, the development sequence that is "vigorously self-propelling"
should be used. With the use of Hirschman's diagram, as illustrated in diagram, we may
explain the rationale for this contention.

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The units of SOC investment are measured along the vertical axis, whereas the units of DPA
investment are measured along the horizontal axis in this diagram. The isoquants are the
curves I, II, and III, which reflect the various combinations of SOC and DPA that result in the
same gross national products at a particular period. We obtain a higher level of gross national
product as we progress from curve I to II to III. The curves have been drawn in such a way
that their optimal points lie on the 45° line for analytical simplicity. In reality, this line is the
site of balanced DPA and SOC growth.

Assuming that balanced growth of SOC and DPA is not achievable due to the
underdeveloped countries' intrinsic limited ability to utilise resources, we must discover the
development sequence that maximises induced decision-making.

Figure: 4.5

Let's start with the development sequence via SOC excess capacity. The thick line A—>A1
—>B —> B2—>C would thus represent the economy's expected route of development.
Starting at A, increasing SOC to A1 causes DPA to rise until the equilibrium is reached at B.
The government may invest more in SOC to B2 as a result of the higher gross national
product. As a result, the DPA will rise to the level of point C. If, on the other hand, the
economy follows the development path indicated by the dotted line AB1BC1C, the economy
will follow the path indicated by the dotted line AB1BC1C. To begin, we raise DPA from A
to B1 in this scenario. This will be followed by an increase in SOC from B1 to B to restore
equilibrium. If DPA is increased to C1, SOC will have to follow suit until the equilibrium at
C is restored.

It's worth noting that both methods of uneven growth produce a "extra dividend" of
"influenced easy-to-take or compelled decisions resulting in greater investment and output."

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In the sense that it is more continuous and smooth, the sequence of development via surplus
capacity of SOC is what Hirschman refers to as "self-propelling." The second option,
'development through a scarcity of SOC,' lacks this feature because it may take some time for
political pressure to be developed, delaying SOC adjustment. As a result, the DPA cost of
producing a certain amount of output is increased. According to Hirschman, "development
via surplus SOC is fundamentally a permissive sequence," while "development via scarcity of
SOC is essentially a compulsive sequence."

After demonstrating the benefits of strategic imbalances, we must now determine which type
of imbalance is most likely to be beneficial. Any one investment project may have both
"forward linkage" (that is, it may stimulate investment in subsequent stages of production)
and "backward linkage" (that is, it may encourage investment in earlier stages of production)
(that is, it may encourage investment in earlier stages of production). The goal is to identify
the initiatives that have the most "total linkage." The projects with the highest overall
connectivity will differ from country to country and over time, and can only be identified by
empirical research of "input-output tables." When deciding on the order of projects, planners
should take into account the change in "pressure-creating" and "pressure-relieving"
investments. In countries where the private sector is rapidly expanding, the government's role
can be essentially confined to "pressure relief."

As private investment grows, shortages and bottlenecks in transportation, public utilities,

education, and other conventionally allocated functions will emerge (in whole or in part to
public enterprises in such societies). When constrained to this "induced role," the government
should not feel "restless and slighted."

When private investment is not guaranteed, the government must take a more active role. It
could, for example, construct an iron and steel plant. "It's interesting to observe," Hirschman
says, "that iron and steel has the highest combined connection score." Because of the large
total linkage effects of the iron and steel sector, perhaps underdeveloped countries are not
being dumb and solely motivated by prestige in assigning main significance to this industry."
The government's construction of it will result in a surge of investment and production in a
range of industries, both before and after this industry.

It increases economic growth in this way. The government must fill gaps in the preceding and
subsequent industries as a result of investment in the iron and steel industry. Further

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investment will be encouraged to address these flaws and roadblocks. When these gaps are
addressed, more private investment will flow in, and the growth process will continue.

2. A Critique of Unbalanced Growth

All that is required, according to it, to accelerate growth in developing countries is to provide
inducements and incentives to private industry to engage in projects. Once this is
accomplished, sufficient financial resources will flow into investment initiatives.

In the context of developing economies, this is not a reasonable assumption to make. Due to
low savings rates in underdeveloped countries, financial resources are scarce, hampereding
economic growth. Hischman didn't pay much attention to how to get around this bottleneck
and boost expansion. As a result, not only are physical resources rare, but financial means for
sponsoring development projects are also constrained.

Hirschman's imbalanced growth approach has also been criticised for potentially causing
inflationary pressures in the economy. People's incomes will rise regardless of whether more
investment is made in social overhead capital (SOC) or directly productive activities (DPO),
resulting in higher demand for consumer products, particularly food grains. Prices will rise if
sufficient investment in agriculture and other consumer goods is not made, as was the case in
India during the second and third five-year plans.

Third, if private firms do not respond adequately to the incentives and pressures created by an
uneven growth strategy, imbalances will be established in the economy without promoting
expansion in other related sectors, resulting in excess capacity in some industries or sectors.
This unused capacity is a waste of money and resources.

Finally, Paul Streeten has noted that an unbalanced growth plan overlooks the prospect of
resistance to the imbalances caused by the unbalanced growth approach. These growth
inhibitors can take a variety of forms.

4.5.1 The Big Push Thesis

The big push model is a notion in development or welfare economics that highlights that a
firm's decision to industrialise or not depends on what it expects from other enterprises. It is
based on the assumption of economies of scale and an oligopolistic market structure, and it
explains when industrialisation would occur.

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Paul Rosenstein-Rodan was the first to propose this notion in 1943. Murphy, Shleifer, and
Robert W. Vishny made additional contributions in 1989. Game theory is commonly used to
analyse this economic model. The model's philosophy highlights that undeveloped countries
require significant investments to go from their current level of backwardness to a position of
economic development. According to this hypothesis, a "bit by bit" investment programme
will not have as much of an impact on the economic process as is required for developing
countries. Small investment infusions, on the other hand, will just waste resources. "There is
a minimum amount of resources that must be allocated to... a development plan if it is to have
any chance of success," says Paul Rosenstein-Rodan, citing a Massachusetts Institute of
Technology research. Getting a country off the ground and into self-sustaining growth is
similar to getting an aeroplane off the ground.

According to Rosenstein-Rodan, the entire industry that is to be established should be viewed

and planned as a massive unit (a firm or trust). He backs up this claim by claiming that
because an investment's social marginal product is always different from its private marginal
product, when a group of sectors is planned together based on their social marginal products,
the economy's rate of growth is higher than it would be otherwise.

In poor countries, according to Rosenstein-Rodan, there are three indivisibilities. External

economies are based on these indivisibilities, which justifies the need for a major push. The
following are the indivisibilities:

1. In the production function, indivisibility is important.

2. Demand indivisibility.

3. Indivisibility in the savings supply

1. Demand indivisibility (or complementarity)

Low per-capita income and purchasing power characterise developing countries. As a result,
these countries' markets are small. Modernization and greater efficiency in a single industry
have no effect on the economy as a whole in a closed economy since the output of that
industry will not find a market. A significant number of industries must be established at the
same time so that individuals working in one industry consume the output of others, creating
complementary demand.

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Rosenstein-Rodan uses the example of the shoe business to demonstrate his point. When a
country invests heavily in the shoe business, all of the hidden labour from other industries
finds work and a source of income, resulting in an increase in shoe production and their own
earnings. This additional cash will not be used solely to purchase shoes. It's possible that
higher salaries will lead to more expenditure on other items as well. However, there isn't
enough of these products on the market to meet the rising demand for the other commodities.
The prices of these commodities will grow as a result of the basic market forces of demand
and supply. To avoid this, funding should be dispersed over a variety of industries.

2. Indivisibility in the savings supply

A high level of investment necessitates a high level of savings. We can't always rely on
foreign help since massive investments in many industries must be made not only once, but
several times. As a result, domestic savings are essential. However, in a developing economy,
this is difficult due to low income levels. Following the increase in income due to greater
investment, the marginal rate of savings must be increased.

3. Indivisibilities in the production function can occur in any of the following areas:

Inputs

Processes

Outputs

These lead to higher returns (i.e., economies of scale) and may necessitate a large firm's
optimum size. Even in underdeveloped countries, this can be accomplished because many
industries can have at least one optimum scale firm. However, social overhead capital
investment includes all basic industries (such as power, transportation, and communications)
that must come before directly productive investment activities. The nature of social
overhead capital investment is 'lumpy.' Such capital requirements cannot be met by importing
capital from other countries. As a result, a significant initial investment in social overhead
capital (about 30 to 40 percent of total capital) is required.

1. In time irreversibility: It must come before other immediately productive investments.

2. Minimum equipment durability: Any lower level of durability is either impossible or

ineffective owing to technical constraints.

3. Long periods of gestation: Returns on investments in social overhead capital take time
to appear, and their economic influence is not immediately or directly obvious.

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 4. Minimum social overhead capital–industry combination is irreducible: Investment
must be of a particular minimum size and diversified throughout a variety of
industries, otherwise it will have little impact on the growth process.

Criticism

Difficulties in execution and implementation:

As a result of plan revisions, delays, and deviations from the intended procedure, the
execution of connected projects during the course of industrialization may involve
unanticipated or unavoidable adjustments. Hla Myint points out that the many departments
and agencies engaged in the development process must work closely together and analyse
and amend plans on a regular basis. The governments of emerging countries face a difficult
task.

Inadequate absorption capacity:

Ineffective disbursement, short-term obstacles, macroeconomic issues and instability, loss of

competitiveness, and institutional weakness may all impede the implementation of
industrialization programmes. Credit is frequently used at low rates or over long periods of
time. Due to the Dutch disease effect, there is frequently a loss of competitiveness.

Historical inaccuracy:

No country has shown any indication of development due to huge industrialization

programmes over the last two centuries, according to historical experience. Stationary
economies do not grow by putting enormous amounts of money into social overhead capital.

Mixed-economy issues include the following:

The environment for growth in a mixed economy, where the private and public sectors
coexist, may not be favourable. There will be competition between the sectors unless there is
complementarity between them, with government departments keeping their plans secret to
avoid speculative actions by the private sector. The private sector's actions are hampered at
the same time by a lack of knowledge about government policies and the overall economic
environment.

Neglect of production methods:

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Rather than capital formation, productive techniques influence a country's economic growth
performance. In its support for capital accumulation and industrialisation, the big push
approach ignores productive techniques.

Shortage of resources in developing countries:

Eugenio Gudin rejects the large push theory, claiming that developing countries lack the
capital necessary to give the big push needed for rapid development. An underdeveloped
country would not be considered as such if it had a plentiful supply of money and a scarcity
of factors. The primary hurdle for such countries is a scarcity of resources. Though foreign
help may be able to solve this challenge, if aid flows are erratic, industrialization may not
take off as planned.

4.5 SUMMARY

● Production, according to Marxian philosophy, refers to the creation of value. As a

result, economic growth is a process of increasing the amount of value created by
labour. High levels of output, on the other hand, may be achieved via increasing
capital accumulation and technical advancement.

● Under pre-trade-off Agrarian society should try to evolve into an industrial

civilization. Trade and trade should not be restricted to a single location. The scope of
society's business activity should be expanded. Income surpluses will be used to
expand industries and construct infrastructure.

● Rostow has conceived five universal stages; viz:

(i) The traditional society,

(ii) The preparation for the take-off—a stage in which communities build up their
propensities in such a way as would be conducive to the take-off,

(iii) The period of takeoff in which the productive capacity of the community registers
a distinct upward rise,

(iv) The stage of drive to maturity, the period of self-sustained growth in which the
economy keeps on moving, and

(v) The stage of high mass consumption.

● Summary of Harrod-Domar

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 1. Investment is the most important variable in achieving stable growth because it
serves a dual purpose: it provides income while also creating productive capacity.

2. Depending on how income behaves, increasing capacity from investment can result
in higher output or higher unemployment.

3. Income behaviour can be represented in terms of growth rates, such as G, Gw, and
Gn, with equality between the three growth rates ensuring full employment of labour
and full utilisation of capital stock.

4. These requirements, on the other hand, merely stipulate steady-state growth. The
actual pace of growth may differ from the forecasted rate. The economy will
experience cumulative inflation if the actual growth rate exceeds the authorised rate of
growth. The economy will slide into cumulative inflation if the actual growth rate is
lower than the required growth rate. The economy will tumble into cumulative
deflation if the actual growth rate is lower than the justified growth rate.

5. Business cycles are seen as detours from a steady growth path. These alterations
aren't going to function indefinitely. Upper and lower limitations restrain these; the
'full employment ceiling' serves as an upper constraint, while effective demand, which
includes autonomous investment and consumption, serves as a lower limit. Between
these two boundaries, the actual growth rate varies.

● The Big Push hypothesis emphasises the importance of planned industrialization in

developing countries where agriculture is the primary sector, which is backward and
impoverished. A strong drive toward industrialisation is expected to put the system on
solid ground, preventing agricultural production from becoming unpredictable.

(i)Indivisibilities in the production function, i.e. capital lumpiness, particularly in the

creation of social overhead capital

(ii) Indivisibility of demand, i.e., complementarily of demand.

(iii) Indivisibility of savings, i.e., kink in the supply of savings

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4.6 KEYWORD

● Development economics is a discipline of economics that focuses on helping

developing nations improve their fiscal, economic, and social situations. Health,
education, working conditions, local and international legislation, and market
circumstances are all variables considered in development economics, with an
emphasis on improving conditions in the world's poorest nations.

● Laissez-faire (French: "leave to do") is a policy of minimal government intervention

in people's and societies economic matters.

● Mercantilism emphasised government restriction by banning colonies from

interacting with other nations, similar to political absolutism and absolute monarchs.

● Economic nationalism refers to policies that use tariffs or other obstacles to regulate
capital creation, the economy, and labour inside the country

● An investment is an asset or item acquired with the goal of generating income or

appreciation. ... For example, an investor may purchase a monetary asset now with the
idea that the asset will provide income in the future or will later be sold at a higher
price for a profit.

● Savings refers to the money that a person has left over after they subtract out their
consumer spending from their disposable income over a given time period. Savings,
therefore, represents a net surplus of funds for an individual or household after all
expenses and obligations have been paid.

● Balanced growth strives to develop all sectors at the same time, but unbalanced
growth suggests that investments should be made solely in the economy's top sectors.

● Unbalanced growth, on the other hand, necessitates a less quantity of money, as it

focuses on only the most profitable industries

4.7 LEARNING ACTIVITY

1. Define investment taken place as a big push in an economy.

___________________________________________________________________________
___________________________________________________________________________

2. Compare Harrood-Domar model with each other

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___________________________________________________________________________
___________________________________________________________________________

4.8 UNIT END QUESTIONS

A. Descriptive Questions

Short Questions

1. Which book is written by Karl Marx to give socio economic factor?

2. What is economic stagnation?

3. What is balanced growth?

4. What is the meaning of unbalanced growth?

5. What is Harrod equation of economic growth?

Long Questions

1. Explain Marx theory of economic growth?

2. Describe Harrod-Domar model of economic growth in detail.

3. Explain various stages of economic growth.

4. Elaborate various theories of balanced and unbalanced growth.

5. Examine Big Push theory in detail.

B. Multiple Choice Questions

1. What are Karl Marx’s main interests were on the evolution through numerous phases?

a. Human society

b. Modernisation

c. Cultural changes

d. Human development

2. How many stages of economic growth are given by Rostow model?

a. One

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 b. Three

c. Five

d. Seven

3. Balance growth means growth will take place at the same time in

a. Different sector

b. All sector

c. Agriculture sector

d. Industries

4. Policies that use tariffs or other obstacles to regulate capital creation, the economy,
and labour inside the country is called

a. Foreign trade

b. International policy

c. Trade restriction

d. Economic nationalisation

5. Big Push theory is giving importance to planned investment in

a. Industrial sector

b. Service sector

c. Agriculture

d. Public sector

4.9 REFERENCES

References book

● Britannica, T. Editors of Encyclopaedia (2014, December 10). Arab Bank for

Economic Development in Africa. Encyclopedia Britannica.
https://www.britannica.com/topic/Arab-Bank-for-Economic-Development-in-Africa

187
● Benjamin, Walter 2000. The Work of Art in the Age of Mechanical Reproduction.
http://pixels.filmtv.ucla.edu/gallery/web/julian_scaff/benjamin/benjamin.html

● Braaten, Jane 1991. Habermas’s Critical Theory of Society. State University of New
York Press: Albany Farganis, James 1996. Readings in Social Theory: The Classic
Tradition to PostModernism. McGraw-Hill: New York

● Guru, S. (2014, April 28). Strategies of Balanced and Unbalanced Economic Growth.

Your Article Library. https://www.yourarticlelibrary.com/economics/strategies-of-
balanced-and-unbalanced-economic-growth/38359

● Wikipedia contributors. (2020, November 12). Big push model. Wikipedia.

https://en.wikipedia.org/wiki/Big_push_model#:%7E:text=The%20big%20push
%20model%20is,explains%20when%20industrialization%20would%20happe

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UNIT – 5: STATE AND DEVELOPMENT
STRUCTURE

5.0 Learning Objectives

5.1 Introduction

5.2 Role of the state in promoting economic development

5.3 State ownership and regulation

5.4 Government failures and corruption

5.5 Role of monetary policy and fiscal policy in development

5.6 Summary

5.7 Keywords

5.8 Learning Activity

5.9 Unit End Questions

5.10 References

5.0 LEARNING OBJECTIVES

After studying this unit, you will be able to:

 Understand the Role of the state in promoting economic development

 Discuss the State ownership and regulation

 Explain the Government failures and corruption

 Understand the Role of monetary policy and fiscal policy in development

5.1 INTRODUCTION

We will make an effort to comprehend the impact and influence of institutions on the
economic growth process. Adam Smith believed that the invisible hands of demand and
supply were capable of allocating resources most efficiently, but he assumed that the market
was perfectly competitive. Markets, on the other hand, are imperfect in real life. We must
realise two things: (a) Noneconomic variables are just as essential, if not more so, in
determining the level of economic progress. Non-economic factors have an impact on

189
economic factors. (a) Institutions are not homogeneous or static. The role of social
institutions in determining the rate of economic development is distinct.

Economic development is the process by which an economy's real national income and per
capita income increase over time. In this case, the process denotes the impact of particular
forces that work over time and embody changes in dynamic aspects. It includes changes in
resource supply, capital formation rates, demographic composition, technology, skills, and
efficiency, as well as institutional and organisational structure.

It also entails changes in the structure of demand for commodities, the level and pattern of
economic distribution, population size and composition, consumption patterns and living
standards, and the pattern of social interactions, religious dogmas, ideas, and organisations. In
a nutshell, economic growth is a long chain of interconnected changes in fundamental supply
variables and demand structure that contribute to an increase in a country's net national
product in the long term.

Definition of Economic Development

The term ‘economic development’ is generally used in many other synonymous terms such as
economic growth, economic welfare, secular change, social justice and economic progress.
As such, it is not easy to give any precise and clear definition of economic development. But
in view of its scientific study and its popularity, a working definition of the term seems to be
quite essential. Economic development, as it is now generally understood, includes the
development of agriculture, industry, trade, transport, means of irrigation, power resources,
etc. It, thus, indicates a process of development. The sectoral improvement is the part of the
process of development which refers to the economic development. Broadly speaking,
economic development has been defined in different ways and as such it is difficult to locate
any single definition which may be regarded entirely satisfactory

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5.2 ROLE OF THE STATE IN PROMOTING ECONOMIC
DEVELOPMENT

Development economics is concerned with the causes of underdevelopment as well as

measures that might increase the pace of per capita income growth. While these two issues
are connected, it is possible to adopt policies that are likely to accelerate growth (for
example, by studying the experiences of other developing nations) without fully
comprehending the reasons of underdevelopment.

1. Subject-Matter: In many ways, the state has emerged today as an active player in the
process of economic development. The laissez-faire doctrine has died.

Now, the government is becoming more involved in producing activities and, through its
monetary and fiscal policies, is directing the direction of economic activity. It also determines
how products and services are distributed in the economy.

The process of development in industrialised countries was stretched over a lengthy period of
time, but underdeveloped countries now have no time to wait and must shorten the duration
of growth. In this scenario, the government plays a vital part in the growth process.

These countries have stayed stagnant, and positive government involvement is required to get
them back on track. The state must play a strategic role in order to minimise the many
rigidities inherent in an underdeveloped country.

According to UN Study Group, “In addition to the functions, governments normally perform,
there is a large borderland of functions which they ought to perform for the simple reason that
they are important, and are not carried out sufficiently, by private effort. This borderland can
exist in any country, but it is wider in under-developed countries, because private enterprise
in the latter is more knowledgeable and more enterprising than in the former.”

Planning is not restricted to intervention in developing nations, but is viewed as a

fundamental condition for economic progress. Because resources are rare in developing
countries, it is vital to plan their allocation as well as their utilisation in these initiatives.

Thus, underdeveloped countries cannot avoid planning if they want to improve in a

reasonable amount of time, implying that time is a critical component.

Private firms cannot tackle the challenges that exist in developing countries, hence state
intervention is required for these countries' economic progress.

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It has control over the production, distribution, and consumption of commodities, and in
order to do so, the government must establish physical regulations as well as monetary and
fiscal policies. These measures are critical for decreasing economic and social inequities that
exist in developing countries.

The scope of state action is broad. It entails "maintaining public services, regulating resource
use, influencing income distribution, controlling the quantity of money, controlling volatility,
assuring full employment, and influencing investment level."

As a result, the state must undertake significant duties in order to assure rapid economic
development in developing countries. This activity can be accomplished using two sorts of
measures: (A) direct and (B) indirect.

2. Measurement Types:

Direct Measures: The state has directly involved itself in the economic development of
underdeveloped countries and performs certain key functions, which are stated below:

1. Organizational Transformations:

Organizational changes are critical in the economic development process. It entails the
increase of the market's size as well as the organisation of the labour market. Because private
sector is incapable of implementing such programmes, the state can create means of
transportation and communication in order to enlarge the size of the market.

Furthermore, the government can aid in the expansion of agriculture and industry. The
organisation of the labour market is also one of the government's tasks.

It boosts worker productivity. The government assists in labour organisation by recognising

labour unions. It sets machinery for the resolution of labour disputes, provides for social
security measures, and so on.

This develops a relationship between employers and employees, which promotes labour
efficiency, which boosts productivity and lowers costs.

The majority of people who lives in rural areas work in agriculture. They are unaware of the
employment opportunities available in cities and industrial centres. The government can
assist people in finding work by establishing information centres in rural areas. As a result,
the government can aid in labour mobility.

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The urbanisation problem emerges as development labour shifts from rural to urban regions,
and it is addressed by the government. Such issues include housing, drinking water supply,
energy, slums, transportation, and so on.

2. Overheads in the social and economic spheres:

The biggest impediment to underdeveloped countries' economic development is a lack of

economic overheads such as means of communication and transportation, ports, energy
irrigation, and so on. These services are offered by commercial firms in industrialised
countries.

However, in developing nations, private firms are unwilling to invest since the return is
insufficient, and such large investments are beyond the capacity of the private sector.

Aside from that, there is a scarcity of entrepreneurial talent in developing countries, and
entrepreneurs choose to invest in trade, housing, gold, and jewellery, among other things,
where the rate of return is quite high. As a result, it is the obligation of the state to provide
these economic overheads in developing countries.

It must also provide education and training facilities, as well as health services, in order to
speed economic development. According to Prof. Meier and Baldwin, the expansion of
educational institutions and public health initiatives in developing countries lessens the
barriers to development.

3. Formal education:

Education is critical to the process of economic development.

According to Myrdal, “To start on a national development programme, while leaving the
population largely illiterate seems to be futile. The educational facilities provided in under-
developed countries increase their geographic and occupational mobility, raising their
productivity and facilitating innovations. The quality of labour is very important for
economic growth.”

Unskilled workers, even if they work long hours, have a poor per capita income. The state
can enhance the effective labour supply and thus their productivity by investing in public
education. Primary education should be provided for free and compulsory, and secondary
schools should be established.

Various training institutions should be established to train mechanics, electricians, artisans,

nurses, teachers, and others.
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Thus “Programme of education at the base of the effort to forge the bonds of common
citizenship to harness the energies of the people and develop the nation and human resources
of every part of the country.” Education is both a consumer and an investment service. Prof.
Galbraith regards that investment in educating each and every man is directly productive.

He argues that, to rescue farmers and workers from illiteracy may certainly be a goal in itself,
but it is also a first indispensable step to any form of agricultural progress. Education so
viewed, becomes a highly productive form of investment.

He argues that, to rescue farmers and workers from illiteracy may certainly be a goal in itself,
but it is also a first indispensable step to any form of agricultural progress. Education so
viewed, becomes a highly productive form of investment.

4. Public Health and Family Planning:

Public health measures in general include improving environmental sanitation in both rural
and urban areas, removing stagnant and polluted water, better sewage disposal, controlling
communicable diseases, providing medical and health services, particularly in the field of
maternity and child welfare, health and family planning education, and training of health and
medical personnel, all of which necessitate planned efforts on the part of public authorities.

In developing countries, public health is more important because of its ability to improve
labour composition and efficiency. All development efforts, however, will be in vain if
population increase is not slowed.

They promote development by strengthening the labour force's qualitative composition. At

the same time, they make the demand for development even more pressing by increasing
population size. Improvements in health will result in a lower death rate, which will increase
the population and have a negative impact on economic growth.

In developing countries, public health is more important because of its ability to improve
labour composition and efficiency. All development efforts, however, will be in vain if
population increase is not slowed.

Poverty in developing countries cannot be addressed until the rapid increase in population is
slowed. Fertility rates in highly developed countries must be reduced. For this purpose,
family planning clinics should be established in rural, industrial, and other underserved areas.
Incentives should be provided to encourage parents to have fewer children.

5. Changes in the Institutional Framework:

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Economic development cannot take place in static institutional frame work. The rigid
institutional frame work is a positive hindrance in the path of development in UDC. Prof.
Paul Streeten has rightly observed that, “The difference between economic growth in
advanced countries… and development in so called developing countries is that in the former
attitudes and institutions are by and large, adopted to a change and the society has
innovations and progress built into the system, while into the latter attitudes and institutions
and even policies are stubborn obstacles to development.”

The people of a country must desire progress and their social, economic, legal and political
institutions must be favourable to it but in UDC these conditions are largely absent and there
is a great need of social and cultural revolution. UNO has rightly observed that, “the people
of a country must desire progress and their social economic, legal and political
institutions must be favourable to it.”

These criteria are largely absent in developing nations, and many of them require a social and
cultural revolution. In this regard, a United Nations Report argues that "rapid economic
improvement is impossible without unpleasant adjustments."

Ancient ideas must be abandoned, old social institutions must be dismantled, caste, creed,
and racial links must be broken, and a significant number of people unable to keep up with
progress must have their hopes for a pleasant existence dashed."

Economic transformation is not caused solely by institutional changes. It is the result of both
economic and noneconomic forces. As a result, there must be a causal relationship between
economic and institutional changes, or else these changes will be independent of one another.

The government is crucial in modifying the institutional structure of developing countries and
establishing circumstances for the evolution of new institutions. "New inventions may result
in the creation of new commodities or the reduction of the costs of manufacturing old
commodities."

According to Lewis, “Every government has to take an attitude on such questions as whether
it favours large or small scale enterprise, competition or monopoly, private entrepreneurship,
co-operatives or public co-operation and whether its attitude is to be backed by legislation
and by administrative action. In addition to helping the evolution of suitable economic
institutions, the government can also do a lot in moulding the social and political institutions
of a country.”

6. Increasing the Investment Rate:

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By raising the rate of investment, the development process is hastened. UDC's savings rate is
woefully low in comparison to their investment needs. As a result, it is critical for the
government to increase the rate of capital production in these countries, which it can do
through taxation or inflation.

Because of their government's active engagement in capital development, communist

economies have also been able to save and invest a very high percentage of their national
income.

7. Development of Agriculture:

The majority of people in UDC rely on agriculture for a living. The biggest impediments to
economic development are a lack of irrigation and financing facilities. Agriculture is the
basic industry, and all other businesses rely on it for raw materials, therefore if it remains
stagnant, the rest of the economy would suffer.

8. Industrial Growth:

Natural resources are underdeveloped or underdeveloped in LDCs. This is because these

countries were colonialized for a long time and their natural riches were cruelly exploited for
selfish purposes. There was no rationale in leaving the development of these riches in the
hands of foreign dominating powers after gaining their freedom.

Furthermore, these impoverished countries lack essential and critical industries such as iron,
steel, cement, heavy engineering, and so on. The fact is that these businesses necessitated
significant capital commitment as well as technological competence. These necessities are
out of reach for private investors in these countries. Furthermore, private entrepreneurs are
quite hesitant to enter these areas of manufacturing.

9. Influencing Resource Utilization:

Underutilization and misutilization of resources are common characteristics of UDC. As a

result, the government must take steps to ensure proper resource utilisation. There is an issue
with the conservation of natural resources such as forests and minerals. They should not be
allowed to be used in an inefficient manner.

In this case, the government must take a role in influencing the usage of scarce resources.
There are also issues with proper land use, municipal planning, and industrial location, which
necessitate long-term and extensive government planning.

10. Elimination of Inequalities:

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Another major function of the state is the elimination or at least reduction of economic and
social inequities. Because of the very unequal distribution of income, there is a significant
social imbalance between various classes in society. Indeed, economic and social inequality
are inextricably linked.

The government must take adequate measures to ensure equal wealth distribution. The
government should levy progressive taxes on income and wealth, as well as on luxury
products, in order to aid the poor through prudent public spending policy.

Prof, Gunnar Myrdal has rightly remarked, “The usual argument that economic inequality by
resulting in enriching the upper class being able to save more of their higher income has even
less relevance in most UDC where landlord and other rich people are known to squander their
income in conspicuous consumption and investments and sometimes in capital flight.”

5.3 STATE OWNERSHIP AND REGULATION

Regulation is a significant method in which the government controls the market economy in
the United States. The breadth of government rules is extensive, including all sectors of the
economy as well as many parts of our everyday life. But, exactly, what is regulation?

The worldwide Organization for Economic Cooperation and Development (OECD) has
recently conducted extensive study on regulatory regulation. Their overriding viewpoint is
that while laws are frequently required for a well-functioning, market-based, capitalist
society, they do not always live up to public expectations or fulfil their social purposes. In
other words, regulations do not necessarily make things better in practise:

Indeed, while government involvement in the market is frequently justifiable, it does not
always meet the textbook ideal of "first-best." The market pricing system is elegantly
efficient, enabling resources to flow naturally to their highest-valued uses as signalled by
providers and demanders; but, there is still a need for government if markets fail to price
products and services to represent society values. Government will enhance economic and
social results when government involvement may assist "fix" pricing, whether through
regulations or fiscal (tax and expenditure) policies. However, this is not a blanket support of
government action, as public policies are frequently flawed "solutions" that might exacerbate
rather than enhance results. A respectable government function does not imply that we should
cede complete control of markets to the government. The free market may still outperform
government in terms of determining most resource pricing and flows.

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As a result, government regulations that conform to broad economic principles rather than
imposing limited statutory requirements are more likely to help rather than hinder economic
performance. Principles-based regulation systems have the benefit of being more responsive
to changes in economic conditions and opportunities when new markets emerge and specific
enterprises grow and fall in response to appropriate pricing signals. To be sure, the lack of
definition in principles-based legislation can lead to unexpected activity being labelled as
"compliant." On the other hand, whereas a highly prescriptive rules-based approach makes it
more difficult for businesses and regulators to "fudge" compliance, such brighter-line
regulations can become so specific and tailored to the situation of the moment that they can
easily become obsolete or even counter-productive as the economy evolves, particularly from
a public interest or societal perspective. They can also be explicitly intended to assist
incumbent enterprises (supporting "cronyism"), to the disadvantage of new business creation
and overall economic innovation and productivity development.

Government judgments are more prone to prejudice due to the influence of special-interest
money and politics, whereas free market results are fair to all market players who clearly
communicate their views by the prices they are ready to pay or get.

As a result, a well-justified approach to government policy is one in which private market

pricing continue to be the dominant signal for directing resources, but regulations or other
public policies augment (or "correct") the signals to more fully represent public costs and
benefits.

The government can intervene in the market economy in a variety of ways, including
regulation. Fiscal and monetary policy are two additional key avenues. These three sorts of
public policy levers interact and overlap, and they can work toward the same goals—but they
can also (sadly) operate against one other. Regrettably, the government does not plan for and
examine the consequences of regulatory policy as thoroughly as it analyses the effects of
fiscal and monetary policy. This disparity can be attributed to a number of factors. First, the
consequences of rules are more difficult to quantify—on both the benefit and cost sides, but
especially on common terms (typically in monetary values) so they can be compared.

Second, because regulations do not typically have the same direct or explicit impact on the
federal government's budget (bottom line) as fiscal policy, it is more difficult and there is less
incentive for the federal government to measure the costs—which are frequently shifted to
lower-level governments or the private sector—even though the effects on the economy as a

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whole can be just as large or larger. Given that they emanate from a self-interested, rather
than entirely public-interested, perspective, cost estimates issued by the very organisations
who disproportionately face the expenses of regulatory regulations are often viewed with
suspicion and a presumption of exaggeration by federal officials. (Regulated entities,
predictably, are sceptical of statements made by regulators.)

"Regulation policy" relates to how regulations are created, managed, and reviewed in
practise. Over the last few decades, global regulatory policy has advanced from regulatory
reform or deregulation to regulatory management and, most recently, regulatory governance.
The OECD summarises this development of concerns and aspirations in a 2011 study on
"Regulatory Policy and Governance":

According to a popular corporate viewpoint on regulatory policy, rules may frequently be

beneficial to the economy by fostering competition, levelling the playing field, and
generating lively and dynamic markets that are more responsive to changing public interests.
Businesses, on the other side, complain about restrictions that are too onerous, inefficient,
and sometimes unsuitable and unwarranted. Individual firms, of course, can find a lot to
complain about in specific rules that impose extra expenses on them, and they may want
regulations that offer their business a competitive edge over others.

"Modernizing Government Regulation: The Need for Action," the most recent CED policy
statement on regulatory policy, was produced in 1998. 7 While government regulation is
necessary to achieve many important economic and social goals, the report concluded that the
regulatory system "produces too few benefits at excessive cost," a shortcoming exacerbated
by a lack of regular scrutiny and analysis of the justification for and effectiveness of
regulations. The report also noted that "current efforts to effect meaningful regulatory reform
are severely hampered by distrust on both sides of the regulatory debate," emphasising the
importance of reconciling and narrowing the gap between the "polar extremes" through
"sound science and analysis"—that is, evidence-based guidance, transparency, and
accountability.

Main Economic Effects of Regulation

The following are the major ways in which regulatory policies impact the economy:

 Allocative or economic efficiency across economic sectors: How our country's

resources (labour, capital, and natural resources) are employed in the creation of

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 various commodities and services, and if those inputs are dispersed to the actual
highest-valued uses;

 Vibrancy and competition within industries: how easy it is for new businesses to
establish and for the most successful enterprises to grow and prosper, as well as (less
frequently acknowledged) how simple it is for failing firms to quit or close down.

 Costs against advantages of supporting the public good, public goods: For
regulations justified by a public good, social benefit perspective, whether such rules
take into account the advantages obtained vs the economic costs, or the cost-
effectiveness of other ways;

 Macroeconomic and employment effects: The effects of regulations on both the

short-term, cyclical movements of the economy (such as employment during a
recession) and the longer-term growth of the economy (such as through investment
and innovation); and 

 Distributional effects: Which businesses—and, more fundamentally and

meaningfully, which types of real people—end up bearing the burden of the economic
cost of regulations.

5.4 GOVERNMENT FAILURES AND CORRUPTION

All classical and most neoclassical economists say that laissez faire is the greatest policy
since each individual is the best judge of his or her own interests. If all individuals are
allowed to be free, the collective usefulness of society will be maximised. However,
economists later learned that competitive markets lead to the most effective resource
allocation if and only if specific conditions are met. The competitive market does not
function properly or work perfectly if these conditions are not met.

The above-mentioned market failure clarified that market mechanisms are not always
efficient. Markets can collapse in certain circumstances. The concern now is whether the
planning authority will be able to achieve Pareto optimality if all choices are made by it. The
answer is no. These are examples of government failure. The government performs a variety
of roles in the economy. It is involved in the creation of products and services; it is involved
in economic planning; it announces monetary, fiscal, and other policies for the economy as
needed; and it is also responsible for the country's effective administration. However, in
practise, the government may not be able to bring the market to Pareto optimality and may

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not achieve its goals of the most effective allocation of resources. This is referred to as
government failure.

We must understand that if the market is not capable of being efficient in some instances, the
government is also not omniscient to know all facts and be free of flaws. In many
circumstances, it is also unable to fulfil its declared aims, and in some cases, it has
established its objectives incorrectly. These are referred to be instances of government
failure.

The following are the causes of government failure:

(a) Limited Information: The government will never have as much information as the market.
It is also possible that the state bases its objectives and policies on inaccurate future
assumptions.

(b) Limited Influence: The government has limited control over the private sector, which
includes both consumers and producers. Despite imposing high tariffs on cigarettes and
prohibiting their use in public places, the government was unable to significantly curtail
tobacco production or consumption.

(c) Bureaucracy: In spite of legislation being created it is not implemented so efficiently for
many reasons. A good example can be abolition of Zamindari system in India. The law was
passed but implementation was not so successful because of bureaucracy.

(d) Constraints of Political Process: If the decisions taken by the government are liked by
influential people in the society, it may create problems in the economy. They might create
many types of problems. So government has to consider many aspects. Lipsey puts it
beautifully when he says that economic efficiency is only one ingredient of the recipe of
decisions taken by the government.

(e) Nobel Prize winner Gunnar Myrdal explanation to the causes of government failure :
According to Myrdal, following reasons are responsible for government failure :

(i) Politicians and government authorities may pursue their self interest which leads to
corruption and sub-optimal results

(ii) Political parties are also compelled by concern for their vote bank to make populist
decisions that are not ideal. Reservations under Indian constitutions, for example, were
anticipated to decrease over time but continued to increase in order to positively influence the
vote bank.

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(iii) Government with a short-term vision may be unable to effect structural reforms, resulting
in many problems going unresolved. One example is India's population problem. We made
policy announcements but did little to bring about structural adjustments that would
immediately solve the situation.

(iv) The government seeks to achieve not just economic but also social and political
objectives. As a result, a policy may achieve suboptimal economic results while producing
good social improvements that may be more important than economic goals.

(v) A lack of information can lead to coordination issues.

(vi) Most importantly, and unfortunately, democratic countries are eroding democratic
values. Some interest groups may improperly influence government policies in their favour.

Corruption

The word corruption is derived from the Latin word “corruptus,” which means “corrupted”
and, in legal terms, the abuse of a trusted position in one of the branches of power (executive,
legislative and judicial) or in political or other organizations with the intention of obtaining
material benefit which is not legally justified for itself or for others.

Corruption can take many forms that vary in degree from the minor use of influence to
institutionalized bribery. Transparency International’s definition of corruption is: “the abuse
of entrusted power for private gain”. This can mean not only financial gain but also non-
financial advantages.

The definition of corruption and the amount of money involved is not a difficult concept to
grasp. This report, on the other hand, draws the reader's attention to the economic necessity
of battling corruption. The goal is to demonstrate to the reader:

 the role of law in economic development,

 the negative effects of income inequality on long-term economic development, and

the importance of redistribution on the basis of the Marginal Utility theory
redistribution

 as the most effective method of eradicating poverty the negative effects of low
approval ratings (unhappiness) on long-term economic development,

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  and the negative effects of corruption on redistribution as well as approval ratings,
and thus on long-term economic development

Causes of corruption

Although corruption varies each country, some of the fundamental common driving forces
that cause it can be identified. Svensson [10] highlighted what is common to all of the
countries that are among the most corrupt; they are all developing or transitional countries.

 Low-income countries, with a few exceptions,

 The majority of countries have a closed economy.

 Religion's influence is palpable (Protestant countries have far the lowest level of
corruption),

 limited media freedom and

 a mediocre level of education

Regardless of the foregoing, corruption cannot be judged objectively since there is never a
single phenomenon responsible for its occurrence and growth; corruption always results from
a combination of many, interconnected elements that can differ significantly from one
another. Political and economic environments, professional ethics and legislation, as well as
purely ethnological variables such as customs, habits, and traditions, are among the most
frequently listed factors that impact the emergence of corruption.

Political and economic circumstances

The political and economic environments have a profound influence on the phenomena of
corruption. The more restricted and limited economic activity in the country, the greater the
authority and power of officials in decision making, and the greater the risk of corruption,
because individuals are willing to pay or offer payment in order to circumvent constraints.
There is a high risk of corruption, especially where officials are subject to regulation and
have the ability to make decisions on their own.

Monetary policy has an impact on the extent of corruption as well. In their investigation,
Goel and Nelson [11] discovered a strong correlation between monetary policy and corrupt

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activities in the United States. States with a well-regulated financial sector and little informal
economy or black market are also less corrupt than those with the opposite. They also
discover that countries with greater economic and political independence have lower levels of
corruption.

Dimant [12] makes an excellent point when he claims that the level of efficiency in public
administration influences the extent to which corruption can find fertile soil and flourish.
Such efficiency is decided by the quality of the regulations and permissions, because
ineffective and unclear regulations contribute to a rise in corruption in at least two ways:

The system is entrenched with an artificially generated monopoly of power that allows civil
workers to receive bribes.

Ineffective and confusing regulations, on the other hand, generate restriction and, as a result,
encourage natural persons to pay bribes in order to expedite the bureaucratic system.

Corruption is also heavily influenced by the low pay of public administration employees
(state officials), who are attempting to improve their financial status by accepting bribes, and
thus the socioeconomic circumstances of government officials impacts the phenomena of
corruption. This is also demonstrated by Allen et al. [13] in their study, where they discover
that corruption arises because agencies, institutions, and the government can no longer
effectively control corruption due to underpaid officials, which is a problem particularly in
developing countries, where there is insufficient tax revenue to properly reward local
officials.

As a major element influencing corruption, several authors point to officials' contentment

with their employment—the more unsatisfied they are with their work or place of work, the
higher the degree of corruption, as confirmed by Sardoska and Tang [14] in their study.
According to the authors, the private sector has greater ethical standards than the public
sector, particularly those that affect job satisfaction, and is hence less unethical (especially
regarding thefts and corruption).

Svenson [10] indirectly confirms this, stating that the income level of civil officials impacts
the reception of a bribe (the higher it is, the smaller the chance that the person will act
corruptly). However, he goes on to say that a higher salary strengthens the official's
negotiating power, which leads to higher bribes, and that, based on existing research, it is
very difficult to determine whether a higher salary causes less corruption, implying that the
level of salary is not a decisive factor, but merely one of many.

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Legislation and professional ethics

Lack of professional ethics and ineffective legislation governing corruption as a criminal

violation, as well as its prosecution and punishing, are also significant contributors to the
emergence and spread of corruption. A significant influence comes from the ineffective
sanctioning of corruption, which simply enhances the potential of those involved continuing
their corruptive behaviours while also creating a considerable likelihood that others may join
in the corruption as a result of this ineffective sanctioning.

Corruption leads to a lack of openness and oversight by supervisory organisations. As a

result, if there is insufficient legal foundation or political will to control, which allows for a
non-transparent functioning of both politics and the economy, corruption thrives. Corruption
is also influenced by extensive, opaque, or inadequate legislation, in which laws can be
interpreted in a variety of ways (for the benefit of the one who pays).

The Economic Impact of Corruption

Corruption increases the volume of public investments (at the price of private investments),
because there are various alternatives for manipulating public expenditures that are carried
out by high-level officials in order to obtain bribes (which means that more general
government expenditures or a large budget offer more opportunities for corruption).

Corruption shifts the mix of public expenditure away from the expenditures required for basic
operation and maintenance and toward investment on new equipment.

Corruption tends to shift the composition of public expenditure away from the necessary
fixed assets for health and education, as commissions are less likely to be obtained from
other, maybe needless initiatives.

Corruption decreases the effectiveness of a country's public investments and infrastructure.

Corruption can diminish tax collections by undermining the state administration's ability to
collect taxes and fees, albeit the total effect relies on how the nominal tax and other
regulatory burdens were chosen by corrupt officials.

The influence of corruption on businesses: The impact of corruption on a business is mostly

determined by the company's size. Large companies are better protected in a corrupt
environment, they avoid taxes more easily, and their size protects them from petty corruption,
while they are often also politically protected, which is why the survival of small (especially
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start-up companies) and middle-sized companies is much more difficult than the survival of
large companies, regardless of their importance for the growth of the economy and
development.

Corruption impacts

(a) Total investments,

(b) The size and type of investments made by foreign direct investors,

(c) The magnitude of governmental investments, and

(d) The quality of investment decisions and investment projects.

Through the influence of corruption on the allocation of talents: Indirectly, corruption has
a negative impact on economic growth through the allocation of talents, because gifted and
prospective students are driven, for example, to study law rather than engineering, which
would add value to the country, due to the influence of the environment and the situation in
the country.

Corruption's influence on public spending: Corruption has a detrimental impact on public

spending, with a particularly strong impact on education and health. There is also evidence of
a link between corruption and military spending, implying that a high level of corruption
affects economic growth due to increased military spending.

Through the impact of corruption on taxes: Because of the impact of corruption on taxes,
fewer taxes are levied than would otherwise be levied, as part of the taxes end up in the
pockets of corrupt tax authorities. In corrupt countries, there are also frequent tax reliefs,
selective taxes, and various progressive taxes; in short, there is much less money than the
country could have, and thus corruption, through the country's financial deficit, also affects
economic growth; and conclude the findings on the negative impact (both indirect and direct)
of corruption on economic growth.

Corruption for various reasons also affects the following:

Employment, because the work does not go to the most suited or qualified individual, but to
the person who is willing to pay for it or return the favour in some other way.

Total investment is also affected.

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 1. The size and composition of foreign investments, as well as the size and content of
public investments.

2. The efficiency with which investment decisions and initiatives are made.

When there is corruption, entrepreneurs are less likely to invest since they are aware that
they will have to bribe officials or even offer them a profit share in order to successfully
operate a firm. Entrepreneurs are unwilling to invest as a result of the increasing costs.

Corruption frequently reduces the effectiveness of various financial assistance programmes

(both state and international), as money is "lost somewhere along the way" and does not
reach those who need it or for whom it is intended, because the financial benefits of
corruption are not taxable because they are hidden. As a result of corruption, the state loses a
portion of its tax revenue, while public spending as a result of corruption (or limited private
interests) has a negative impact on the budget.

Impact on businesses: According to a survey performed by the EBRD and the World Bank,
bribes paid in smaller company’s amount for 5% of yearly earnings, while bribes paid in
medium-sized companies account for 4% of annual profits. However, when compared to
large enterprises, where bribes account for less than 3%, both are in a considerably worse
position, demonstrating how bribery are generating problems or putting these smaller
companies in a subservient position compared to the large ones, leading to their collapse.

We formed five categories based on the degree of corruption, categorised the nations, and
evaluated their common characteristics. The results were as follows:

 The level of GDP is related to corruption (the higher the GDP, the lower the rate of
corruption).

 The degree of education is connected to corruption (the higher the average level of
education, the lower the level of corruption).

 Corruption is intimately tied to a person's location. Asia (particularly Central Asia),

Africa (North and Central Africa), and South America have the greatest levels
(according to the Transparency International map).

 Corruption is inextricably related to the dominant religion in the nation.

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  Corruption is connected to freedom in a country (personal freedom, freedom of
expression, economic freedom, and so on), with regard to the rule of law in a country,
and inefficiency of public administration, which is frequently also locally limited or
corrupt.

5.5 ROLE OF MONETARY POLICY AND FISCAL POLICY IN

DEVELOPMENT

Monetary policy in economic development

Monetary policy is concerned with changes in the money and credit supply. It refers to the
policy actions made by the government or central bank to impact the availability, cost, and
usage of money and credit through the use of monetary tools in order to achieve specified
goals. Monetary policy tries to influence economic activity in the economy primarily through
two primary variables: (a) money or credit supply and (b) interest rate.

Monetary policy tools are the same as credit control measures available to the central bank.
Thus, monetary policy measures such as bank rates, open market operations, variable cash
reserve requirements, and selective credit restrictions are used. According to R.P. Kent,
monetary policy is the management of the expansion and contraction of the volume of money
in circulation with the stated goal of achieving a certain goal, such as full employment.

1. Appropriate Adjustment of Demand for and Supply of Money: Economic development

results in increased demand for money since economic expansion and a commensurate
contraction of the subsistence sector boost the transaction demand for money significantly.

Furthermore, as per capita income and population expand during the development process, so
does the demand for money to carry out day-to-day transactions. Because of the always
expanding demand for money, the monetary authority must raise the money supply at a rate
nearly equivalent to the rate of increase in real income, so that prices do not decrease as a
result of a gain in national production.

A lowering price level slows economic growth by triggering a vicious downward spiral of
prices and output. Similarly, if the quantity of money exceeds the needs of commerce and
industry, it may be utilised for speculative reasons, stifling growth and producing inflation.

2. Price Stability: Maintaining price and exchange rate stability at home is a crucial factor
for economic progress. Economic development, on the other hand, causes inflationary
pressures in developing nations due to a range of structural rigidities and imbalances.

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Inflationary price increases reduce the proclivity to save and shift invertible resources
towards speculative and unproductive ventures such as real estate, jewellery, gold,
stockpiling of products, and so on. As a result, the monetary authority should maintain a
continual eye on the movement of prices and manage the supply and direction of money and
credit in such a way that growing prices are kept in line.

3. Credit Control: In order to ensure a faster rate of economic growth, the monetary
authority should use credit control tactics to influence and shape the character and pattern of
investment and output.

This will, of course, rely on the variety of credit institutions in the economy, as well as the
kind of credit regulations used by the Central Bank. The financial system is not completely
established in the majority of developing nations.

Commercial banks primarily fulfil the short-term credit needs of businesses and dealers, and
they are hesitant to give medium and long-term credit to meet the financial needs of industry
and manufacturing in general.

4. Financial Institutions Creation and Expansion: Monetary policy may hasten the process
of economic growth by enhancing the country's currency and credit system. More banks and
financial institutions are needed to provide greater loan facilities and mobilise savings for
constructive purposes, according to this proposal.

Financial institutions are dying in developing nations, and banking services are only offered
to a restricted number of people. As a result, people's savings cannot be efficiently mobilised
for economic development, and the pace of growth is very slow.

5. Appropriate Interest Rate Structure: Economic development need massive investment from
both the public and private sectors. For this cheap money policy to be followed because it
makes public borrowing cheap, keeps the cost of servicing public debt low, and thus
stimulates both public and private investment, the financing of very ambitious economic
development programmes in all sectors of the economy requires that credit be made available
to private entrepreneurs at the lowest possible rates. As a result, a low-interest-rate policy
encourages economic development investment. It is countered that a cheap money policy
may incentivize traders and speculators to borrow more from banks and use these funds for
hoarding, stockpiling, and other speculative reasons.

However, some economists advocate a high-interest-rate strategy for the following reasons:

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  It will act as an anti-inflationary policy by restraining bank borrowing for speculative
reasons and unfavourable investments.

 It will boost the availability of investible sources by stimulating savings.

 It would ensure that scarce money is allocated to the most productive applications
while avoiding productive and wasteful resource utilisation. These arguments,
however, do not hold much weight. Direct controls and capital issue control can help
to ensure the productive and efficient use of investible resources.

6. Debt Management: In developing economies, the government must borrow on a large

scale to implement economic development programmes, and thus the responsibility of
managing public debt effectively and efficiently in order to serve the needs of economic
growth falls on the monetary authority, which is the country's Central Bank.

Low interest rate policy is important for strengthening and stabilising the government bond
market because a low interest rate improves the price of government bonds, making them
more appealing to the public and ensuring the success of the public borrowing programme.

Furthermore, a low interest rate structure reduces the burden of public debt. Thus, in order to
accelerate the process of economic growth, monetary policy should aim at effective
management of public debt, which entails optimal timing of the issuance of government
bonds, stabilising their prices, and minimising the burden of debt.

Fiscal Policy

Meaning

Fiscal policy refers to the government's use of taxation and public spending to achieve
stability or growth. "By fiscal policy, we refer to government acts impacting its receipts and
expenditures, which we typically consider as measured by the government's receipts, its
surplus or deficit," Culbarston writes. The government may compensate for unfavourable
changes in private consumption and investment by adjusting public expenditures and levies.

Arthur Smithies defines fiscal policy as “a policy under which the government uses its
expenditure and revenue programmes to produce desirable effects and avoid undesirable
effects on the national income, production and employment.” Though the ultimate aim of
fiscal policy in the long-run stabilisation of the economy, yet it can be achieved by
moderating short-run economic fluctuations. In this context, Otto Eckstein defines fiscal

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policy as “changes in taxes and expenditures which aim at short-run goals of full employment
and price-level stability.

Objectives of Fiscal Policy

1. To attain and sustain full employment.

2. To keep the pricing level stable.

3. To keep the economy's growth rate stable.

4. To keep the balance of payments in balance.

3. Fiscal Policy in Support of Economic Growth

The function of fiscal policy in economic growth refers to the stabilisation of an advanced
country's growth rate. Fiscal policy, through changes in government spending and taxation,
has a significant impact on national income, employment, output, and pricing. During a
depression, an increase in public spending adds to aggregate demand for goods and services,
resulting in a large increase in income via the multiplier process; whereas a reduction in taxes
has the effect of raising disposable income, thereby increasing people's consumption and
investment expenditure.

A reduction in public spending during inflation, on the other hand, reduces aggregate
demand, national income, employment, production, and prices; whereas an increase in taxes
tends to reduce disposable income, hence reducing consumption and investment
expenditures. As a result, the government can regulate deflationary and inflationary forces in
the economy by a careful balance of spending and taxing programmes. The government uses
compensating fiscal policy to accomplish this.

Compensatory Fiscal Policy:

By managing public spending and taxes, compensatory fiscal policy seeks to continually
compensate the economy for chronic inclinations toward inflation and deflation. As a result,
it needs the implementation of long-term economic policies rather than one-time solutions.

When the economy exhibits deflationary tendencies, the government should raise its spending
through deficit budgeting and tax cuts. This is necessary to compensate for the absence of
private investment and to increase the economy's effective demand, employment, production,
and income.

There are two ways to compensating fiscal policy:

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(1) Built-in stabilizer’s; and

(2) Discretionary fiscal policy.

(1) Built-in Stabilizers:

The technique of built-in flexibility or stabilizers entails the automatic adjustment of

spending and taxes in response to cyclical upswings and downswings in the economy without
the government taking any conscious action. Changes in the budget are automated under this
approach, and so this strategy is also known as one of automatic stabilization.

Corporate profits tax, income tax, excise taxes, old age, survivors, and unemployment
insurance, as well as unemployment compensation payments, are all examples of automatic
stabilizer’s. Taxes and expenditures are linked to national revenue as means of automatic
stabilization.

It’s Advantages:

As a fiscal tool, built-in stabilizers offer the following advantages:

1. The built-in stabilizer’s act as a buffer for falling private buying power, easing people's
sufferings during deflationary periods.

2. They keep national income and consumption expenditure from dropping below a certain
threshold.

3. This device implements automatic budgetary changes, avoiding administrative decision-

making delays.

4. Automatic stabilizer’s reduce the errors caused by incorrect fiscal forecasting and timing.

5. They combine short-term and long-term budgetary measures.

Its Drawbacks

It has the following drawbacks:

1. The efficacy of built-in stabilizer’s as an automatic compensation mechanism is

determined by the elasticity of tax receipt, the amount of taxes, and the flexibility of
government spending. The higher the elasticity of tax collections, the more effective
automatic stabilizers will be in managing inflationary and deflationary tendencies.

2. With low tax levels, even a high elasticity of tax collections would be insignificant as an
automatic stabilizer during a downturn.

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3. The built-in stabilizer’s do not take into account the secondary impacts of stabilizer’s on
after-tax company revenue and consumer expenditure on business

4. This gadget ignores the stabilizing impact of local governments, state governments, and the
private sector economy.

5. They are unable to abolish business cycles. They can only lessen its harshness.

6. They have a negative impact on the recovery from the recession. As a result, economists
argue that built-in stabilisers should be supported by discretionary fiscal policy.

Discretionary fiscal policy: Discretionary fiscal policy necessitates deliberate budgetary

changes, such as increasing tax rates or government expenditures, or both.

In general, it can take three forms:

 Changing taxes while keeping government spending steady,

 shifting government spending while keeping taxes steady, and

 changes in both spending and taxes at the same time.

Lowering taxes while keeping government spending constant increases families' and
companies' disposable income. This boosts private spending. However, the amount of the rise
will be determined by who is taxed, how much is lowered, and whether the taxpayers
consider the cut to be temporary or permanent.

If the recipients of the tax cuts are in the higher middle income bracket, aggregate demand
will rise significantly. Tax breaks are only transitory if they are business owners with little
motivation to invest. This policy will once again be ineffective. As a result, boosting taxes is
more successful in controlling inflation since high tax rates diminish disposable income of
individuals and firms, hence reducing aggregate demand.

(The second strategy is more effective in combating deflationary tendencies. When the
government raises its spending on goods and services while keeping taxes same, aggregate
demand rises by the same amount. Reduced government spending during inflation, on the
other hand, is ineffective due to strong corporate expectations in the economy, which are
unlikely to cut aggregate demand.

In regulating inflationary and deflationary tendencies, the third way is more effective and
superior to the other two methods. Taxes may be raised to manage inflation, and government
spending may be increased to combat depression.

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Its Drawbacks:

The timeliness and accuracy of discretionary fiscal policy are critical:

1. Accurate forecasting is required to determine the stage of the cycle in which the economy
is now operating. Only then may proper budgetary action be taken. Inaccurate forecasting
may amplify rather than mitigate cyclical fluctuations. In terms of accurate forecasting,
economics is not a precise science. As a result, budgetary action always follows the business
cycle's turning points.

I There is a "decision lag," which is the time necessary to examine the situation and make a
choice. This process's lag time may be excessive.

(ii) There is a "execution lag" after the choice is made. It entails spending that will be allotted
for the program's implementation. It might take two years in the United States and less than a
year in the United Kingdom.

(iii) Certain public works projects are so time-consuming that they cannot be accelerated or
slowed in order to increase or decrease spending on them.

5.6 SUMMARY

● Economic development is the process by which an economy's real national income

and per capita income increase over time.

● Development economics is concerned with the causes of underdevelopment as well as

measures that might increase the pace of per capita income growth.

● Private firms cannot tackle the challenges that exist in developing countries; hence
state intervention is required for these countries' economic progress.

● Organizational changes are critical in the economic development process.

● In developing countries, public health is more important because of its ability to

improve labour composition and efficiency.

● "Regulation policy" relates to how regulations are created, managed, and reviewed in
practise.

● All classical and most neoclassical economists say that laissez faire is the greatest
policy since each individual is the best judge of his or her own interests.

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 ● The definition of corruption and the amount of money involved is not a difficult
concept to grasp.

● The political and economic environments have a profound influence on the

phenomena of corruption.

● Lack of professional ethics and ineffective legislation governing corruption as a

criminal violation, as well as its prosecution and punishing, are also significant
contributors to the emergence and spread of corruption.

● Corruption tends to shift the composition of public expenditure away from the
necessary fixed assets for health and education, as commissions are less likely to be
obtained from other, maybe needless initiatives.

● Monetary policy is concerned with changes in the money and credit supply.

5.7 KEYWORD

● Corruption: A form of dishonesty or a criminal offense which is undertaken by a

person or an organization which is entrusted with a position of authority, in order to
acquire illicit benefits or abuse power for one's personal gain.

● Monetary policy: It is the control of the quantity of money available in an economy
and the channels by which new money is supplied.

● Price stability: It implies avoiding both prolonged inflation and deflation.

● Credit control: Credit control is a business process that promotes the selling of goods
or services by extending credit to customers, covering such items as credit period,
cash discounts, payment terms, credit standards and debt collection policy.

● Debt management: It is a way to get your debt under control through financial
planning and budgeting

5.8 LEARNING ACTIVITY

1. Define Corruption.

___________________________________________________________________________
___________________________________________________________________________

2. What is Debt Management?

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___________________________________________________________________________
___________________________________________________________________________

5.9 UNIT END QUESTIONS

A. Descriptive Questions

Short Questions

1. Explain Overheads in the social and economic spheres.

2. Discuss Public Health and Family Planning.

3. Write a short note on Corruption.

4. What are the Causes of corruption?

5. On what do Corruption impacts.

Long Questions

1. Explain the Role of the state in promoting economic development.

2. Describe the State ownership and regulation.

3. What is the monetary policy in economic development?

4. What is Fiscal policy? What are the Objectives of Fiscal Policy?

5. Explain the ways to compensate fiscal policy.

B. Multiple Choice Questions

1. Organizational changes are critical in the …………. development process.

a. political

b. cultural

c. social

d. economic

2. ………….is critical to the process of economic development.

a. Education

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 b. Material

c. Money

d. Machinery

3. The word corruption is derived from the …………. word “corruptus,”.

a. Indian

b. Latin

c. French

d. American

4. Maintaining price and exchange rate stability is known as…………….

a. Price Stability

b. Credit control

c. Debt management

d. controlling

5. ………………policy is concerned with changes in the money and credit supply.

a. Procurement

b. Development

c. Monetary

d. All of these

Answers

1-d, 2-a, 3-b. 4-a, 5-c

5.10 REFERENCES

References book

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● Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2000. “A New Database on the
Structure and Development of the Financial Sector.” World Bank Economic Review 14
(3): 597–605.

● Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2010. “Financial Institutions and
Markets across Countries and over Time.” World Bank Economic Review 24

● UKEssays. (November 2018). The role of savings and investment in the world economy.
Retrieved from https://www.ukessays.com/essays/economics/the-role-of-savings-and-
investment-in-the-world-economy-economics-essay.php?vref=1

● S, N. (2017, January 13). Role of Deficit Financing in Developing Countries |

Economics. Economics Discussion. https://www.economicsdiscussion.net/public-
finance/role-of-deficit-financing-in-developing-countries-economics/26184

● UKEssays. (November 2018). Role of Technology in Economic Development. Retrieved

from https://www.ukessays.com/essays/economics/role-of-technology-in-economic-
development-economics-essay.php?vref=1

● Das, S. (2015, February 20). Labour and Capital Intensive Techniques (With Diagram).
Your Article Library. https://www.yourarticlelibrary.com/economics/labour-and-capital-
intensive-techniques-with-diagram/47504

● S, N. (2017, January 13). Role of Deficit Financing in Developing Countries |

Economics. Economics Discussion. https://www.economicsdiscussion.net/public-
finance/role-of-deficit-financing-in-developing-countries-economics/26184

● Das, S. (2015, February 20). Labour and Capital Intensive Techniques (With Diagram).
Your Article Library. https://www.yourarticlelibrary.com/economics/labour-and-capital-
intensive-techniques-with-diagram/47504

● Incremental Capital Output Ratio (ICOR). (2021, August 12). Investopedia.

https://www.investopedia.com/terms/i/icor.asp

S, N. (2017, January 13). Role of Deficit Financing in Developing Countries |

Economics. Economics Discussion. https://www.economicsdiscussion.net/public-
finance/role-of-deficit-financing-in-developing-countries-economics/261

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