Development strategies image

Strategies to promote growth and development

There are many ways in which countries try to promote growth and development. These can be placed in two broad categories:

Those policies that rely on free markets to stimulate growth and development, and those approaches that rely more on state intervention and central planning.

Market-orientated strategies

Trade liberalisation

Free trade has long been seen as an effective means of achieving growth and development through what is commonly called an outward-looking approach.  Recognising the importance of trade dates back to Scottish economist, Adam Smith, and English economist, David Ricardo, who both considered that the 'wealth' of nations depended on specialisation and trade.

Free trade means trade without any barriers or restrictions and requires countries to specialise in goods and services for which they have a comparative cost advantage.

Removing barriers, such as tariffs, can help ‘create trade’, which can help create employment and output.

The view of the so-called ‘Washington Consensus’ is that free trade must be promoted in countries wishing to develop because protectionism is a significant impediment to growth and development. The Washington Consensus refers to the shared set of policy strategies of the IMF and World Bank which gained prominence in the 1980s as a prerequisite for granting loans to developing countries.

The background to the emergence of the Washington Consensus is that many developing countries ran into debt problems during the 1970s and 80s and sought loans from the IMF and the World Bank. Loans were offered on the condition that developing countries accepted the structural adjustment programme (SAP) that was attached to the loan.

A central pillar of most SAPS was the requirement to remove barriers to trade, to privatise key industries, and to reduce the size of the state. The Washington Consensus is associated with several policy recommendations, including:

  1. Tight fiscal discipline with government spending under control.
  2. Ensuring public expenditure is restructured to target priorities.
  3. Reform of tax systems to reduce tax burdens.
  4. Encouraging inward investment (FDI)
  5. Privatisation of key industries.
  6. Deregulation to enable barriers to entry into markets to be reduced or removed.
  7. Ensuring the full application of a system of property rights. [1]  

However, removing protection and pursuing free trade can lead to primary product dependency for many developing countries, and deteriorating terms of trade. This is largely because low value unbranded commodities tend to fall in price relative to finished goods, and services.

Not all countries embraced or even accepted the Washington Consensus, and developed their own approach to development.

The idea of an alternative Beijing Consensus was first considered by Joshua Ramo who, in 2004 [2] identified the approach to development adopted by China, which he argued includes:

  1. Incremental innovation, where changes are gradually introduced, with a focus on making improvements in those areas that people feel the most strongly about – using surveys of public opinion.
  2. A wide set of objectives, where a narrow focus on GDP per head is replaced by a wide range of objectives around quality-of-life and individual ‘equity’.
  3. The importance of self-determination, which means that China does not look to ‘import’ economic models from abroad but attempts to develop their own strategies which are suitable to their own unique situation.

It is this brand of development that China has been encouraging in Africa, and which is increasingly popular as it does not interfere with independence and self-determination, something critics of the Washington Consensus highlight. Recipients of Chinese investment do not have to follow strict SAPs.

Export promotion

An extension of the simple free trade approach is the push for export-led growth. This means shifting the focus of economic policy away from growth through increased domestic consumption or government expenditure towards targeting export markets. Depending on the role of government, this strategy straddles both the market-led and state-led approach to development. Certainly, China has adopted an export led approach to developing its economy given the relatively low purchasing power of a large proportion of its population.

However, what both approaches recognise is the importance of trade to development, though with a very different focus on how trade is best facilitated, and the role of the state in the process.

Promotion of FDI

Given the savings gap experienced by many developing economies, encouraging FDI can help fill this gap and increase aggregate investment in an economy when domestic saving is weak. The Harrod-Domar model points out the importance of capital accumulation and a more efficient use of capital as important determinants of economic growth.

Direct investment refers to a situation where the resident of one economy (as an individual or private or public organisation) acquires a lasting interest in an asset in another economy.

For example, if an electronics company in the USA purchases a components supplier in India, the flow is defined as FDI. In contrast, foreign portfolio investment, is investment where there is no long lasting involvement, and usually refers to holding ‘paper’ securities in other country.

The impact of FDI is to increase both AS and AD, through an initial effect on investment, and real output, and amplified through a positive multiplier effect.

Diagram impact of FDI on economic growth and development

FDI will also affect the balance of payments, and enable technology transfer where the recipient country benefits from access to new technology (and the skills to use it.) There are several positive externalities associated with an inflow of FDI in terms of human capital development and improvements in infrastructure.

However, critics point out that FDI is often associated with unregulated global multinational companies who repatriate profits and often manage to operate complex tax avoid strategies - denying host countries of valuable tax revenue.

Removal of government subsidies

Government subsidies may be considered as a limit on economic growth and development in that government spending in this respect can crowd out the private sector, and lead to an inefficient allocation of scarce resources.

Again, this is a central pillar of the Washington Consensus.

Government subsidies can result in a series of other problems, including ‘x’ inefficiency, allocative inefficiency, and moral hazard.

For example, during the financial crisis many governments supported banks by providing large bailouts. While this may have been necessary in the short run, bailouts can prevent banks attempting to become more efficient, or operate more prudently.

Government involvement in a specific sector through subsidies may prevent FDI and act as a disincentive to the private sector. However, subsidies can also be used to encourage FDI and protect infant industries which may allow growth in the future.

Floating exchange rate systems

The idea that floating exchange rates are preferable to fixed exchange rates is a long held view associated with free market, liberal economics. The view here is that floating exchange rates can help achieve an external equilibrium with other countries, and that fixing exchange rates can store up problems in terms of ‘over’ or ‘under’ valuation of currencies.

For example, if a developing country pegs its currency to the US dollar, in the short run this may provide some stability and certainty for traders. However, if the US dollar rises in value, the developing country will artificially adjust its own currency upwards. But this means that its goods are now expensive in all markets, which may be to the general detriment of its export sales.

This is one reason why China switched from an exchange rate strategy that pegged the reningbi to the US Dollar to the use of a wider trade weighted basked of currencies. Floating rates allow market forces to operate more directly, and for this reason those who favour floating rates argue for allowing currencies to rise and fall as economic conditions in the global economy adjust. This is especially true when dealing with asymmetric shocks.

A shock facing a developing country could be eased by allowing the currency to appreciate or depreciate, depending on the type of shock faced. One reason for the prolonged recession in Greece is that it could not devaluate its currency to stimulate tourism, which makes up around 20% of Greek GDP [3].

Microfinance schemes

Microfinance relates to small scale financial schemes where investors put small amounts of money into a bank, and where borrowers can withdraw small amounts to develop their business ideas. It removes the need for collateral and conventional credit rating processes, and has been seen as a way to ‘fix’ the broken credit markets in developing countries [4]

Indeed, microfinance has been very popular since the mid-1980s, when the Grameen Bank started operating in Bangladesh. It can unlock finance that otherwise would not have been available, as well as encourage small scale entrepreneurs to develop.

According to the Grameen Bank, by 2021, it had 9.38 million members, of which 97 percent were women, and covers 93 percent of the total villages in Bangladesh. [5]

However, while acknowledging that microfinance has led to the evolution of new kinds of financial institution and inspired innovation in other sectors, including health and education, for some [6], the impact of microcredit on economic development is, at best, modest.

Privatisation

Privatising is the transfer of state assets into the private sector. While the push for privatisation traces its roots back to Europe in the 1970s, privatisation spread quickly to emerging and developing countries. In particular, privatisation was embraced by China in its ‘state capitalism’ reforms.

Privatisation in China

China's initial approach to privatisation was to carefully assess the productivity and efficiency of its main sate owned enterprises (SOEs), and then try to improve productivity before embarking on privatisation.

China's key strategy, which was launched in 1995, is often summarised as zhuada fangxiao, which translates to 'grasp the big and release the small' which meant privatising small firms while retaining control of the 300 largest and most strategically important ones.

This closely follows the Singapore model, where the state controls much of the economy through its state holding company.

Promoting management buy-outs (MBOs) was a key element in China’s privatisation programme. MBOs involved the selling of shares to existing managers, and quickly became the single most common method of privatisation in China, with nearly 50% of all privatisations through MBOs.

The second popular method was to sell shares in smaller enterprises to 'outsiders' not directly attached to the state - namely, to wealthy individuals and overseas investors. This approached counted for around 22% of privatisations.

Finally, share issue privatisation (SIP) was left for the largest enterprises, and typically involved the state retaining at least 50% control. [7]  However, in many cases shares are owned by employees, or trade union committees - at least according to the companies themselves, as is the case with the technology giant, Huawei. [8]

The main arguments for privatisation concern the potential gains in terms of efficiency and productivity which result from exposing the enterprises to the rigours of the market, and by removing control by ‘state monopolies’.

Under private ownership firms cannot rely on state subsidies to prop them up when they are under-performing. This saves tax revenue, while allocating scarce resources to where they are best used.

Critics argue that privatisation itself does not guarantee efficiency gains, especially in the case of natural monopolies – usually the large energy and water utilities.

Interventionist strategies

Development of human capital

Economic development depends to a great extent on the level of human capital that exists. Human capital is defined as the total skill, knowledge, and experience of an economy’s labour force, especially related to the use of new technology.

Given that education and, to some extent, training are merit goods, it is likely that free markets will fail to allocate sufficient resources to the provision of education. Hence the state will need to take an active role in educational provision.

The state can either provide all education, through 'public' education, or some of it in conjunction with the private sector.

Singapore provides a clear example of how state involvement – in conjunction with private educational providers – has elevated Singapore to one of the most envied economies in terms of human capital development. It is consistently ranked as number one by the OECD for educational achievement.

Modern growth theories all point to the importance of human capital development, and generally accept that the state has an important role in organising resources to improve educational achievement.

Protectionism

While those favouring the use of free markets to generate the right environment for economic growth, many countries have used protection of their industries as a way of stimulating growth. This is often referred to as an inward-looking approach.

Import substitution (or import substitution industrialisation) was a popular strategy for many developing countries from the 1950s, and involved governments investing in those sectors where imports were significant. For this to work, protectionism of industry – especially infant industries – was regarded as essential.

The notion of import substitution through protectionism was championed by Raul Prebisch, who criticised a focus on primary products as a means of achieving growth in Latin America.

However, with the rise of the Washington Consensus from the late 1970s, economists and governments began to accept that long term protectionism would be harmful, especially in terms of reducing competition and that protectionism simply meant protecting state-owned monopolies.

Even Prebisch himself thought protectionism had gone too far, and called for more regional co-operation across Latin America to encourage free trade within this region.

Managed exchange rates

In contrast to the free-market approach to growth and development, which stresses the importance of allowing markets to work, the interventionist approach considers it important to have managed exchange rates in order to reduce exchange rate volatility.

A stable exchange rate, they argue, encourages investment as firms can predict their imported costs and their expected revenue from sales abroad. While most systems today allow some flexibility, managing exchange rates ultimately means pegging one currency to the currency of the dominant export market, or indeed scrapping individual currencies and joining a currency union.

Since 1981, the Singapore dollar has been managed against a trade-weighted basket of currencies from leading trade partners and competitor countries. [9]

Fluctuations are allowed with an agreed band, and regular monitoring ensures that the currency does not go out of line with those currencies in the basket. China has adopted a similar approach.

Up until 2005 the Chinese renminbi was pegged to the US dollar, but then allowed to float (a ‘managed float’) within a narrow range of values against an index of other currencies, dominated by the US dollar, euro and yen.

Infrastructure development

Many developing countries, especially those in sub-Saharan Africa, have poor infrastructure, including inferior road and rail networks, and a lack of modern airports.

Many are land-locked and rely on road networks for exporting and importing key resources. Being land-locked, as in the case of 16 African countries [10] is a considerable constraint on development.

Infrastructure projects are extremely costly and usually relate to public and quasi-public goods, such as roads, bridges, tunnels, docks, and airport infrastructure.

These projects are likely to be too expensive for private firms to build on their own, hence public money is commonly used - either on its own, or in tandem with private finance – often through joint ventures with foreign companies.

Infrastructure creates a range of positive externalities, including reduced business costs, savings in travelling time, and an increase in tourism revenue.

Given the low levels of public revenue in many developing countries it is no surprise that joint projects with other countries is increasingly common, especially in Africa, where China has an increasing interest in investment.

Indeed, since 2010, one third of Africa's power grid and energy infrastructure has been financed and constructed by state-owned Chinese companies. [11]

Promoting joint ventures with global companies

As suggested, in the case of infrastructure improvements, joint ventures are a method of improving growth and development prospects of developing and emerging countries.

For example, Arla foods, the Swedish based multinational is typical of many international companies who are expanding by undertaking joint ventures with businesses in developing countries.

Arla has recently established joint ventures with companies in both Nigeria and Senegal and aims to increase its revenue from its operations across sub-Saharan Africa. 

In sub-Saharan Africa, joint ventures in energy generation are also commonplace. Governments of developing countries are often involved in facilitating joint ventures – a strategy encouraged by the World Bank. [12]

Countries can benefit from joint ventures in several ways. The companies are often oligopolies, with considerable profit potential, and the joint venture ‘host’ company can benefit from such profits. In addition to inflows of capital, technology is also transferred from the multinational to the host.

Joint ventures are attractive to multinational because:

  1. They require a smaller capital commitment than a wholly owned foreign enterprise.
  2. Governments may offer tax concessions.
  3. The partner company can deal directly with Government organisations.

Joint ventures can also provide a cultural bridge between the foreign company and the overseas market helping to encourage the development of products suitable for local markets.

The drawbacks of joint ventures include:

  1. Less control over the joint venture.
  2. The resources supplied by the host partner, including the workforce, factory, or raw materials, may not be of the appropriate quality.
  3. There may be disagreements over whether profits are repatriated or ploughed back into the venture. [13]

Buffer stock schemes

Other strategies

Industrialisation: the Lewis model

The work of Nobel Prize winning economist, Arthur Lewis was highly influential during the 1960s and 70s in terms of raising awareness of the benefits of structural change through industrialisation.

Lewis argued that industrialisation will improve labour productivity, free-up surplus labour and lead to rapid economic growth.

Lewis’s model if often referred to as the two-sector model, which contrasts an inefficient rural agricultural sector which aims simply for subsistence, with a more efficient urban industrial sector which is concerned with productivity and profits.

Lewis argued that if inefficient workers were transferred from the agricultural sector to the industrial sector there would be a net gain in output (and economic growth). This is because the marginal productivity of labour in the agricultural sector is virtually zero, and there is, in effect, surplus labour available for work elsewhere.

Hence the removal of one worker from the land and transferring them to industry would improve national output.

Although China might point to a range of factors, it is clear that the Lewis model applies well to China, and its push for industrialisation.

While popular in many developing countries, the Lewis model has come in for some criticism, including:

  1. The problem of capital flight – industrialisation that requires FDI would often see capital flight rather than the ‘trickle down’ effect that was hoped for.
  2. The assumptions of perfect competition in the industrial sector.  In the real world, monopolies and monopsonies may not pay fair wages, or employ sufficient numbers to prevent urban unemployment.  [14]
  3. There may be issues relating to rapid urbanisation as labour moves from rural areas into the cities, including pressure on housing and on education and healthcare.

Development of tourism

Tourism has long been seen as providing a solution to low development for smaller economies, including Caribbean islands.

Tourism requires infrastructure and accommodation, and in developing this sector wider benefits can be gained through FDI.

Tourism also has many linkages to other sectors, including energy, construction and, education and, critically, the wider service sector. There is also a significant positive multiplier effect from tourism.

Greater linkages generally translate into higher levels of local economic activity (and growth), which tend to occur when tourism enterprises source their goods and services (including labour) locally rather than from imports. [15]

Cuba provides a clear example of how tourism was seen as an important industry to develop following the collapse of the Soviet Union in the 1991. Resorts were developed, with employment and output gains, and improved transport links. The majority of growth in Cuban and Caribbean tourism has been fuelled by the rapid rise in European tourism.

A similar story can be seen in many parts of the developing world. More recently, the tourist industry has become increasingly diversified, with a greater focus on nature-based and sustainable tourism, also referred to as eco-tourism.

Tourism also generates considerable tax revenue to governments, which can be used to develop human capital, infrastructure or agricultural improvements.

However, unstable exchange rates, global shocks (including the COVID-19 pandemic), increased competition for tourist revenue, and a high income elasticity of demand for tourism means that a reliance on tourism can be risky.

Also, uncontrolled tourism can lead to environmental costs, including damage to historic sites. Climate change may also have an impact on tourist economies over the next 20 years.

Development of primary industries

While dependency on primary products has been a concern and a potential constraint on economic growth and development, a switch to secondary industry is seen as a sensible way forward. However, the alternative view is that improvements in agricultural efficiency and reform of rural economies is an importance development strategy, without which industrialisation is not possible.

Over 75% of the world’s poorest work on small areas of land, using low grade technology, or none at all.

A key benefit of developing agriculture is that creating a diverse economy relies on an efficient agricultural system. Crop yields in many developing countries, especially those of sub-Saharan Africa are extremely low compared with more developed and emerging economies. The need to improve agriculture and promote sustainable was recognised in the United Nations adopted the Sustainable Development Goals (SDGs), agreed in 2015.

Aid

Overseas aid is also a means of promoting development.

Aid falls into one of two categories – humanitarian aid, which is provided to countries suffering from natural disasters, or military conflict, and development aid. Development aid can be provided by governments, or by non-governmental organisations (NGOs). Official aid is referred to official development assistance, ODA.

Aid can also be direct ‘bi-lateral’ aid, when the provider gives aid directly to another country, or ‘multi-lateral’ when aid is provided by countries to NGOs, who then distribute it according to their own plans. While helping fill any savings gap, as well as provide a means of achieving development, aid can be targeted to important projects, such as agricultural improvements, clean water supplies, infrastructure projects and education.

However, critics argue that aid can be squandered or misused, and helps create a dependency culture. Aid may also come with constraints and the country giving aid may expect benefits in return – so-called ‘tied aid’.

In addition, there is the likelihood of significant government failure, largely resulting from information failure. For example, governments may not allocate aid to the most useful causes simply because they are unaware of all the possible options and are unable to appraise them effectively. There may be asymmetric information, where those requesting aid may not provide full information about how the aid will be used to those giving aid.

Debt relief

Debt relief is also a means of promoting development. Debt can be a considerable drain on the finances of a developing countries, meaning that scarce financial resources are diverted away from other needs, such as agricultural improvement.

Debts can be re-structured, or re-scheduled to enable it to be sustainable in the long run. Debts can also be completely written off, as was the case for some of the world’s most heavily indebted countries following the G8 meeting at Gleneagles in Scotland in 2005. Following this, the IMF launched its Multilateral Debt Relief Initiative (MDRI).

The Paris Club, formed in 1956, is a group of creditor countries who meet to discuss requests from countries who are in debt to reschedule or restructure debts. In return, debtor countries agree to implement policies to stabilise and improve their macroeconomic and financial positions.

What is the Paris Club?


Remittances

Finally, remittances cannot be ignored when considering factors that influence growth and development.

Remittances arise when workers who are employed abroad send back money to their families, and can contribute significant amounts, and outstip the importance of aid.

It is estimated that around one billion people, are involved with remittances, either by sending them as migrant workers or by receiving them, with one in seven people globally benefitting from these flows. In over 70 countries, remittances contribute over 4 per cent of GDP. [16]

In fact, they are the main source of external finance for many developing economies. While remittances bring well established benefits in terms of growth, countries lose labour, which offsets some of the benefits. [17]

Endnotes and sources

[1] Turin, D (2010) The Beijing Consensus: China's Alternative Development Model 

[2] Ramo, J (2004) The Beijing Consensus

[3] Tourism's Effect on the Greek Economy - The Borgen Project

[4] [6] Cull, Robert; Morduch, Jonathan. 2017. Microfinance and Economic Development. Policy Research Working Paper; No. 8252. World Bank, Washington, DC. © World Bank. https://openknowledge.worldbank.org/handle/10986/28913 License: CC BY 3.0 IGO.

[5] Grameen Bank - https://grameenbank.org/

[7]  Jie Gan, 2008, Privatization in China: Experiences and Lessons Hong Kong University of Science and Technology

[8] Parker, D & Kirkpatrick, C 2005 Privatisation in Developing Countries: A Review of the Evidence and the Policy Lessons, The Journal of Development Studies

[9] Singapore's Exchange Rate Policy colorado.edu

[10] wikipedia https://en.wikipedia.org/wiki/Landlocked_developing_countries

[11] Ze Yu, S, April 2021, blogs-LSE

[12] Mayson, D, 2003, Joint ventures Evaluating land and agrarian reform in South Africa.

[13] Chung, M 2011 Doing Business Successfully in China

[14] Chituka, Albert, 2013 “The Lewis Growth Model - a Critical Analysis.” 

[15] MDPI http://www.mdpi.com/journal/sustainability

[16] IFAD https://www.ifad.org/en/web/latest/-/11-reasons-why-remittances-are-important

[17] Dridi J, Gursoy T, Perez-Saiz H and Bari M 2019, IMF Working Paper, African Department, The Impact of Remittances on Economic Activity: The Importance of Sectoral Linkages