Policies to Promote Development: Finding the Right Path
Welcome to one of the most important (and debated!) chapters in development economics. Here, we move from just measuring poverty and identifying problems to actually looking at the solutions. Think of this chapter as a toolbox filled with instruments governments and international bodies can use to help Less Economically Developed Countries (LEDCs) achieve sustained economic development.
The core challenge is: What is the best role for the government? Should it step back and let the market work its magic, or should it intervene heavily to guide the economy? Economists are split, and this chapter explores both sides of that argument.
1. The Great Policy Debate: Market vs. Interventionist Strategies
Policies designed to promote development are usually categorised into two main types. It is crucial to understand that the distinction is not always clear cut, and often, the most successful strategies involve a blend of both approaches.
Market-Based Strategies
These strategies prioritise the mechanisms of supply and demand, competition, and the price mechanism to allocate resources. The belief is that efficiency and growth are best achieved when the government minimises its involvement.
- Core Principle: Reliance on the private sector and competitive forces.
Interventionist Strategies
These strategies rely on the government actively planning, regulating, and spending to correct market failures, build capacity, and direct resources towards specific goals. The belief is that markets in LEDCs are often too imperfect or weak to achieve development alone.
- Core Principle: Active role for the state in economic management.
2. Detailed Examination of Market-Based Strategies
2.1 Trade Liberalisation
This involves reducing or eliminating barriers to international trade, such as tariffs (taxes on imports) and quotas (limits on import quantity).
- Mechanism: Removing protectionism encourages domestic industries to become more efficient due to foreign competition.
- Expected Outcome: Increased specialisation (based on comparative advantage) and potentially greater export revenues.
- Example: If a country removes a high tariff on foreign textiles, domestic textile producers must become more efficient or risk being replaced by cheaper imports.
2.2 Privatisation and Deregulation
Privatisation means selling state-owned enterprises (SOEs) to private individuals or firms. Deregulation means reducing the number or complexity of government rules and controls over economic activity.
- Justification: Private firms are assumed to be motivated by profit maximisation, leading to greater efficiency (productive efficiency) and innovation compared to government bureaucracies.
- Deregulation Effect: Makes it easier for new businesses (including foreign ones) to start up, boosting competition and potentially attracting FDI.
2.3 Encouraging Foreign Direct Investment (FDI)
FDI is investment made by a company or individual in one country into business interests located in another country (e.g., building a new factory).
- Policy Tools: Governments use low corporate taxes, fast permit approvals, and minimal bureaucracy to attract Transnational Corporations (TNCs).
- We will look at the specific pros and cons of FDI in Section 4.
2.4 Low Taxes and Minimising State Involvement
This strategy aims to empower the private sector by reducing the tax burden on firms and workers, arguing that lower taxes boost incentives to work, save, and invest (a key supply-side approach).
- Strategy: Keep government spending low and focus state involvement strictly on core functions (like defence and legal systems), leaving wealth creation to entrepreneurs.
2.5 Floating Exchange Rates
Under a floating rate system, the value of the currency is determined purely by the market forces of supply and demand. This is considered a market-based strategy because the government does not intervene to "manage" the rate.
- Benefit for Development: If a country runs a current account deficit, its currency naturally depreciates (falls in value), making its exports cheaper and imports more expensive, which automatically helps to correct the deficit.
Key Takeaway (Market-Based)
Market-based policies focus on efficiency and competition. They assume that if the government steps out of the way, the private sector will drive the growth necessary for development.
3. Detailed Examination of Interventionist Strategies
3.1 Protectionism
The opposite of trade liberalisation, protectionism involves implementing trade barriers (tariffs, quotas) to shield domestic industries from foreign competition.
- The "Infant Industry" Argument: The key justification is protecting new, potentially viable industries in LEDCs until they are large enough to compete globally.
- Risk: Domestic industries may become lazy, inefficient, and reliant on protection, slowing down long-run growth.
3.2 Public Ownership and Industrial Strategies
Public ownership involves the state controlling key industries (like utilities or raw materials). An Industrial Strategy is where the government actively identifies and promotes specific sectors it believes will drive future growth (e.g., investing heavily in green technology or manufacturing).
- Rationale: Ensures that strategic industries are developed even if they are not immediately profitable, or where initial capital requirements are too large for the private sector.
- Did you know? Many East Asian economic "miracles" (like South Korea and Taiwan) relied heavily on targeted industrial strategies guided by the state.
3.3 Government Spending on Human and Physical Capital
This is arguably the most critical interventionist strategy, focusing on building the foundations for long-run aggregate supply (LRAS) growth.
Investment Areas:
- Infrastructure: Building roads, ports, reliable energy grids, and communication networks.
Analogy: You can't run a race car (the economy) on a dirt track (poor infrastructure). - Education and Training: Increasing literacy rates and technical skills (building human capital).
- Health Care: Providing clean water, sanitation, and basic medical services. Healthier workers are more productive.
3.4 Managed Exchange Rates
Unlike floating rates, a managed or fixed rate system involves the central bank actively buying or selling foreign currency to keep the exchange rate within a certain band or pegged to another currency (like the US Dollar).
- Rationale: Provides stability and predictability for international trade and foreign investors, reducing risk.
- Trade-off: Requires the government to hold large reserves of foreign currency, and if the market pressure becomes too great, the fix can be broken (e.g., a devaluation).
Key Takeaway (Interventionist)
Interventionist policies focus on state direction and capacity building. They recognize that markets often fail to provide necessary public goods (like infrastructure) or to invest sufficiently in human capital.
4. Other Key Policies and Tools for Development
4.1 Foreign Direct Investment (FDI)
FDI is essential, but it comes with a mixed bag of consequences:
Advantages of FDI:
- Capital Inflow: Brings needed financial resources.
- Job Creation: Directly and indirectly through local suppliers.
- Technology Transfer: TNCs bring advanced management skills and superior technology, improving domestic productivity.
Disadvantages of FDI:
- Repatriation of Profits: TNCs send profits back to their home country, which is a withdrawal from the circular flow of income.
- Exploitation: TNCs might seek to exploit weak labour or environmental laws (sometimes called the "race to the bottom").
- Political Influence: Large TNCs may influence government policy to their advantage.
4.2 Buffer Stocks to Stabilise Commodity Prices
Many LEDCs rely heavily on exporting a few primary commodities (e.g., cocoa, copper, coffee). Since the supply of these goods can fluctuate (due to weather) and demand is often volatile, their prices are highly unstable. This price instability makes development planning impossible.
- How it works: A central agency buys the commodity when prices are low (increasing demand and price) and stores it. It sells the commodity when prices are high (increasing supply and reducing price).
- Objective: To achieve price stability, allowing producers (often poor farmers) to plan their income and investment.
- Drawbacks: Costly to store goods (especially perishables), and requires accurate price forecasting.
4.3 Microfinance and Fair Trade Schemes
These schemes focus on grassroots empowerment, often through NGOs.
- Microfinance: Providing very small loans (micro-loans) to individuals, often women in rural areas, who are too poor to qualify for traditional bank loans. This helps them start small businesses and increase income.
- Fair Trade: A certification system that ensures producers in LEDCs receive a guaranteed minimum price for their goods (often higher than the volatile world price) and that goods are produced sustainably and ethically.
4.4 Foreign Aid and Debt Relief
Foreign Aid is the transfer of resources (money, goods, technical assistance) from one country (donor) or institution to another (recipient).
- Types: Humanitarian aid (short-term, disaster relief); Development aid (long-term, project-based); Tied aid (must be spent on goods/services from the donor country).
- Debt Relief: Cancelling or restructuring the debt owed by LEDCs to reduce the burden of debt interest payments, freeing up funds for crucial spending (health, education).
- Arguments against aid: Can foster dependency, may be misused due to corruption, and can distort local markets.
4.5 Remittances and Tourism
- Remittances: Money sent back by migrants working abroad to their families in their home country. This is a vital source of foreign exchange and often exceeds official foreign aid flows in many LEDCs.
- Promotion of Tourism: A source of foreign currency earnings, creating jobs (especially in services) and stimulating demand for local goods and services. However, it can also lead to negative externalities (environmental damage, cultural erosion).
5. The Role of International and Non-Governmental Organisations
No country develops entirely on its own. Global institutions play a massive role, though often controversial.
5.1 The World Bank
The World Bank focuses on long-term development and poverty reduction. It provides low-interest loans, interest-free credit, and grants to LEDCs for projects designed to build human capital and infrastructure (e.g., dam construction, education programmes).
5.2 The International Monetary Fund (IMF)
The IMF focuses on global financial stability. It provides short-term financial assistance (loans) to countries facing balance of payments (BoP) crises.
- Conditionality: IMF loans often come with strict Structural Adjustment Policies (SAPs), which require the recipient government to adopt market-based reforms (e.g., cutting government spending, privatisation, deregulation). These are highly controversial because they can cause short-term hardship for the poor.
5.3 Non-Governmental Organisations (NGOs)
NGOs (like Oxfam, Doctors Without Borders) operate independently of governments. They focus on micro-level development, offering crucial services and promoting projects often overlooked by large state-led initiatives.
- Role: Focusing on grassroots, specific projects (e.g., providing wells in a particular village), often supplementing the broader efforts of the government or World Bank.
Quick Review Box
- Market-Based: Liberalisation, Privatisation, Low Taxes, Floating Rates. Goal: Efficiency and Competition.
- Interventionist: Protectionism, Industrial Strategy, Infrastructure spending, Managed Rates. Goal: Capacity Building and State Guidance.
- Key Debate: The best strategy uses both, ensuring the state provides the framework (education, law, infrastructure) while the market drives innovation and efficiency.