Governments role in development

It is easy to miss the major issues of developing economies from the comfort of the UK. One of them is the argument about the role government should play.

On one side of the argument are those who believe markets should drive development. There should be free trade, stable inflation and minimal government intervention.

On the other side of the argument are those who say that LDC's have not got the capital needed to provide the infrastructure that markets need (roads, power, education and health services for example). Therefore governments must take the lead by providing this.

But a third position takes this argument further. LDC's don't have the experienced entrepreneurs and necessary business skills to allow markets to allow development at the desired rate. Further they argue that the distribution of income that markets would cause will be far too unequal and this also requires intervention. In short the view is that the government must be responsible for the development process and most parts of the economy.

India is a country that has largely taken the third view. Indian industries are heavily subsidised, measures to even out the distribution of income are significant and prices are controlled. This has worked quite well for India, although their advantage as English speakers cannot be understated.

However now the policy is reaching its limits. The widespread involvement of government has stifled private enterprise, prevented the development of some industries and led to a corruption that diverts well intended funds from worthwhile projects.

So the time has come to reform and 'get the prices right' to allow India to unlock its potential. It's not going to be easy.

The Age reports on the next stage which includes the introduction of VAT (GST).

A false hope? Microfinance

One of the most intractable problems for the world is how to reduce poverty in less developed countries (LDC's). Make no mistake poverty is a massive problem that will persist long after the current financial crisis affecting Europe has passed.

One of the great hopes was the provision of 'microfinance' to small businesses in third world countries.

The problem of many LDC's is a lack of saving and capital. This is a problem for larger firms who cannot borrow the funds they need to grow. However most people in LDC's are hampered because they cannot establish their own small businesses, they too lack the necessary capital.

Of course small businesses, usually just employing one person, need far less capital to establish themselves. In the UK and other developed countries small businesses would go to the bank to obtain funds, but LDC's simply don't have the financial infrastructure for this.

Most people in LDC's don't have bank accounts and bank branches cannot be found in each village or even each high street.

Microfinance was an innovation that allowed ordinary people to obtain small loans to set up their own business. It partly relied on the goodwill of western donors but great things were claimed for it. It gave the chance for many to earn their own living and begin the overall raising of the standard of living in many areas of LDC's never helped by large development projects and multinational firms investments.

Now it seems that much of the optimism for this was a fallacy. This is devastating news for many. The Guardian article below gives details

The Guardian article is here

Chinese have been reading the Development textbooks

One of the pieces of advice given to Less Developed Countries (LDC's) by the 'First World' in the 1960's was to invest in 'leading sectors'. This was based on the view that certain sectors have high second round effects and so a high multiplier value.

While this advice was largely ineffective, and in many cases disastrous, the idea of government intervention and 'unbalanced growth' to kick start under developed economies has remained in the literature. Clearly the Chinese have read about it as they now wish to invest in British infrastructure in order to help boost economic growth.

The Chinese are, of course, acting in their own best interests. They need Europe to grow so they can buy more Chinese goods. They also need somewhere to invest their considerable wealth. They have established 'sovereign wealth funds' to do this, a very sensible move as China cannot possibly use all the profits currently earned by their exports.

There are several ideas to explore here. Will there really be a big multiplier effect as a result of the proposed new investment? Is this the golden goose the Public Private Partnership programme has been looking for (it has totally failed to attract significant private funds for nearly ten years)? Are sovereign wealth funds a good idea? And of course how long has China considered the UK an LDC?

Whatever the answers it is clear that old copies of Todaro have a ready market in China.

The BBC cover the story here

On the bright side for Africa

So much bad news makes many recall Carlyle's view of economics as 'the dismal science'. But there is some good news out there.

Africa has really had the worst deal in the second half of the last century. Real incomes actually fell in some parts of Africa from the 1980's to the early 2000's. But now Africa is growing and there are several reasons for hope.

China's demand for raw materials has pushed up the price of commodities, improving Africa's terms of trade considerably. This has already raised the real incomes of countries which export these minerals, rising living standards. Africa has large reserves of these commodities and is benefiting from international investment to expand capacity, especially from China, which sees the chance of both influence and cheaper supplies.

Now there is news of an ambitious plan to expand the production of renewable energy from North Africa. The energy produced will be used locally and exported to Europe. Northern Europe isn't a great place to produce solar power efficiently, but North Africa is.

One problem that particularly holds Africa back is the lack of domestic saving due to the very low real incomes of the population. Saving is needed to provide the investment funds required for growth. With the funds coming from Europe, a process known as Foreign Direct Investment (FDI), Africa can grow more quickly.

The benefit to Africa comes in two ways. 

1. They get a better energy infrastructure which will allow them to build other industries and provide power to their own population raising the standard of living. 

2. There will also be the multiplier effects on local economies as the investment in the infrastructure takes place. Local incomes will rise improving employment and so reducing poverty. 

For Europe this also helps to reduce the use of damaging fossil fuels in energy production and so aids the efforts to mitigate climate change.

The Guardian covers the project here.