Here is a video taking students through a suggested answer to this 25 mark essay question. “For developing countries in particular, economic growth must always be the most important macro policy objective.” With reference to examples, to what extent do you agree with this statement?
Economic growth is best defined as a sustained increase in a nation’s long-run productive potential or capacity. Growth comes from an expansion of both the quantity and quality of factor inputs reflected in higher productivity and the growth-enhancing effects of innovation.
1st Key Point:
For developing countries, sustained economic growth is crucial for reducing extreme poverty and improving basic living standards.
A period of rapid real GDP increases faster than population expansion will cause a rise in per capita incomes. This can help lift people out of poverty as measured by the $1.90 a day (PPP) benchmark used by the World Bank. If absolute poverty is cut, households can afford to consume more, helping to lower the debilitating effects of malnutrition. Improvements in basic health in turn can bring about gains in healthy life expectancy will is both an HDI indicator as well as a factor affecting future labour productivity. A good example is Ethiopia – which is one of the fastest growing economies in the world with growth averaging 10.9% over the last ten years, Ethiopia has successfully transitioned to lower middle-income status having been one of the poorest nations on the plant two decades ago.
However, economic growth in developing countries is not always inclusive. Indeed, whilst absolute poverty might be declining, relative poverty can rise as measured by an increase in the Gini coefficient. Countries such as South Africa and Botswana have very high levels of inequality.
2nd key point:
Another potential benefit of economic growth for lower and middle-income countries is that it will attract greater inflows of foreign direct investment (FDI).
There are many potential benefits from inward FDI. These include the supply-side gains from investment in critical infrastructure in transport, power, energy, telecoms and education and health-care. FDI can also create more jobs in the formal economy which in turn will bring the government more tax revenue. Inflows of capital help to improve a developing country’s capital stock which can then improve productivity and help a nation to achieve “catch-up growth” with richer countries as shown by the Solow Growth Model.
However, many economists have cast doubt on gains from FDI. They question how many new jobs actually go to domestic workers and point to the outflow of profits and non-payment of tax by some MNCs. FDI might contribute to environmental damage for example through rapid deforestation.
3rd key point:
A 3rd key reason why growth is important for developing countries is that it will increase tax revenues available to a government and help control their fiscal deficits and debt.
Tax revenues depend on many factors including the basic incomes flowing to households and profits made by businesses. If economic growth is sustained, an increase in tax revenues might help to fund higher levels of government spending on basic public services including better access to education and health-care. Both are important human development indicators and can help to improve a country’s supply-side capacity and capability. Greater fiscal stability might also give developing countries scope to weather external economic shocks and improve their credit rating making them less dependent on aid.
However there is no guarantee that rapid economic growth will lead to much higher tax revenues. In many countries there is endemic corruption and non-payment of tax. In countries such as Ethiopia and Zambia, tax collection is less than 15% of GDP, insufficient to fund public goods and welfare.
4th key point:
Developing countries need to focus on other objectives than economic growth – two important ones are controlling inflation and maintaining external balance.
Many fast-growing developing countries experience increases in inflation both from demand-pull and cost-push factors. High and volatile inflation damages growth by cutting real incomes (affecting poorer families especially) and hitting investment. It is also important to avoid rapid growth leading to an unsustainable increase in a nation’s current account deficit. One reason is that developing countries often have limited foreign exchange reserves and they may run into a currency crisis leading to a big depreciation of their exchange rate which makes essential imports expensive.
However fast economic growth does not necessarily always lead to high inflation, particularly if a country is succeeding in raising labour productivity.
The current account is also like to go into bigger deficit if a nation is importing technology that will support LRAS in the future.
Building the Evaluation - Final Reasoned Comments
On balance, the extent to which economic growth will be the dominant macroeconomic objective for emerging countries depends on where they are at their own stage of development. For nations such as Ethiopia, Vietnam and India, economic growth is crucial as part of their strategy to become mildly-prosperous middle-income nations in the years ahead and the meet the expectations of their fast-growing middle-class of consumers. Equally, we have seen in China a decision in the latest 5-year plan to move away from a fixation on the actual rate of growth to achieving a better quality of growth which is more sustainable, balanced and inclusive, focusing in particular on lifting the standard of living of the bottom 40 per cent of their population. Growth does not guarantee development but development is hard to achieve without an expansion of real GDP. Therefore I would argue that for most developing countries, growth will remain the leading objective of monetary, fiscal and supply-side policies.
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