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The Nature and Basis of Economic Growth

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  • Mahnoor Hussain
  • Sadia Gondal
  • Suha Qasim Memon


Before the Second World War, the idea of development was influenced by principles of free market economy. In the middle third of the twentieth century, the phenomenon prevailed that the main responsibility of the economic development depends on the government of the country. So accordingly, if a particular country is economically backward or underdeveloped, then the government is to be blamed. Hence, it is the government’s responsibility to catch up with the progress (the idea of convergence was introduced back then).

This belief developed mainly because of Russia. During that time, Russia (former USSR) was a communist state, where the role of government was greatest. Private sector had minimal role in the economy. Private and public goods were provided by the government. Government had the sole responsibility of providing welfare of the public. The greater the national self-consciousness, the greater will be economic backwardness of a country.

It is also believed that the colonial powers were behind the economic backwardness of the dependent, colonized countries for the reason that these territories did not carry out an effective economic policy, inactivity was the part of the colonizer’s general policy. Greater economic activity in the quest of economic growth was common amongst metropolitan, colonial and post-colonial countries. Our concern would be on the consequences faced by the federalist states who were inspired by the greater economic growth pursuit.

The consequences are categorized into financial and economic. Economic aspect of the consequence includes those things which cannot be reduced to the financial side of the consequences. The distinction between the two is necessary but neither of the aspects stressed upon the fact that arise in federations are peculiar to federations. Nor either of the consequence is a product of effective development policy – they were recognized, by every means, in the early times. The role of government was minimal. The problems that emerged out of the two heads were indeed separable, though each of them was intensified differently by the active development policy.

Beginning with the financial aspect of the consequences: the economic problems were thought of as a part of the financial side. Moreover there was just one approach to development that conceived both the term as one term.

Normally, economists differentiate a poor and rich country by the difference in the capital per capita (capital supply per head of population, k=K/L). With the help of this indicator, the stepping up of the rate of capital accumulation is evaluated..... It is difficult for poor country to get much from voluntary savings, hence, as an alternative; a compulsory saving is done through the state's budget. Old style public services, along with the new development expenditure are financed through taxation.

Funds raised through budget surpluses can be directly utilized into a nationalised industry or indirectly into a private industry. Indirect utilization of funds will be through development banks and other developmental institutions.

Apparently, newly self-governed regions tend to have experience a history of restrictive government activities. Such territories spend a larger share on development projects like expenditure on the provision of transport, health and education. Development expenditures have a certain share allocated in government budget, and most of the time, such expenditures are through tax collections.

The main difference between old style public expenditure and social expenditure is that the benefits/positive externalities of the former expenditure are shared by the whole society whereas the benefits/positive externalities of the latter expenditure are shared amongst a relative portion of the society.

Development has a relatively skewed impact on a respective society. Some parts of the territory are considerably better off than the rest, in the form of wealth and other goods... so the question arises whether the richer territories should be allowed to enjoy higher standards of social expenditure or a uniform/standard form of expenditures should prevail all over the country. This type of problems emerges in unitary as well as federal states. There is a presumption that uniformity is inevitable in a unitary state because there are no government rights. But it should be noticed that there is a clash between the privileges and general philosophy of economic development.

Several different forms of social expenditures are adopted by the regional and local administration authority. If these social expenditures are financed by the regional or local government finances, then the wealthier areas would be better off than the poorer areas, in the respect of higher standards of living and greater capability of taxing. The demand for social expenditure is not high, in other words, the concept of social expenditure is not fully developed, and therefore this problem is of acute importance. It should be noted that this is not the case for different countries; some countries are dependent and aware of the concept of social expenditures.

Rise in the demand for social expenditure would change the situation. This condition partly depends upon the resource sharing between federal, provincial and local governments. Sometimes, federal government does not have enough resources to spend on social expenditures, that is, when the provincial and local governments can finance such expenditures. But there are certain strict administrative reasons that call for as general rule that the federal government should have a stronger position in the administrative structure, as well as, in the resource distribution. Tax administration is very expensive and difficult task. It is useless to impose taxation on high income individuals if they lesser in quantity.

Provincial and local government cannot provide social expenditures solely from their resources. Federal grants are allocated for the purpose of financing social expenditures. Once this is approved, the grant distribution needs to be decided. When deciding the grant distribution, the questions over local inequality are placed.

There are still differing opinions over the kind of grants that is neutral, neither de-equalizing nor equalizing in nature (United States of America is a perfect example for welfare grants). From one point of view, welfare grants on the basis of population is neutral (grants equal per head of population), because firstly, the richer areas are given the free will to secure/expand their high standards from their own resources and secondly, this way the poorer regions would be relatively better off with higher standards, which they could not have achieved through their own pool of resources.

In reality, this policy on the basis of population is not in any case equalizing, such that it can be called as a general philosophy of development. Higher weightage should be given to poorer regions in order to equalize the effect. Such equalization policies can only be practiced in the light of national unity and greater political power of the poorer areas, otherwise, policies would never be translated into action. Federal government is indicated as prima facie, that is, unity does not exist in federal government. So if this type of equalization is adopted, then it means that the federal government is out of commission.

Importance should be placed on determining the size of richer region, whether they are small or large. If the size of richer region is small, it depicts that the country is underdeveloped. Moreover, smaller regions put serious constraints on the equalization. In loose federations, where national unity is weak, equalization on the basis of population remains unacceptable. As richer areas tend to pay more (greater proportion in the central tax collection), therefore they demand greater share in the equalization grants (principle of derivation). This principle will only benefit the rich and make them relatively better off. As a result, inequality will prevail between the richer and poorer regions. Derivation principle is not easily carried out.

Now, coming to the non-financial aspect of development: more prominent than the financial aspect of development. Social expenditures, let alone, cannot be regard as the only source of development. Social development has its repercussions if it only focuses on the social aspect, rather a balance of both. For instance, improvement in health facilities will raise the population level and improvement in education will create intellectual proletariat.

In order to sustain development, it is important that it based on productivity, for instance, by expansion of productive activities, besides yielding a surplus over the cost of production. The initial financing of productive activities is general and not difficult, while the expansion can be from the profits earned. As governmental institutions don't earn profits, expansion for them is difficult. The productive activities should follow the comparative advantage principle. A country should expand its operation in the industry where they comparatively better so that greater share of profits are acquired.

Natural advantage can be either in mineral resources or climatic conditions. Government policies should be adopted in a way that it exploits the benefit out these natural advantages. For example, New Zealand was able to enjoy higher standards of living only by developing policies that favoured their natural advantage (natural resources). Same was the case of Malaysia (comparative advantage in rubber), oil and other resource rich countries. Large supply of natural resources and per head population is a prerequisite of this phenomenon.

Typically, underdeveloped countries have a large supply of labour in relation to the land supply. Hence, labour availability is the main beneficiary that it offers. Countries with large supply of labour have lower labour costs. Cheap labour results in low labour costs resulting in lower production costs. Although it is a sign an underdevelopment, cheaper labour confer a comparative advantage over the developed countries where the cost of labour is comparatively high.

If industries are built on this low labour cost principle, with time they can attain efficiency and accumulate capital, which will later when the labour costs are no longer low. (Japan is the perfect example of this textbook cum practical procedure). Cheap labour are usually unskilled, therefore, they are more suitable for unskilled, mechanical work. Training them would raise the employer's cost. Even if these obstacles are not present, a general obstacle prevails: absence of economies of scale.

Protectionism is very common amongst the underdeveloped countries because of the prevalence of infant industries. High rate tariffs are imposed in order to discourage purchases of imports by making them more expensive than domestic, home-produced goods. When setting up industries, it is important that the location and the nature of industry are taken into consideration. For instance, weight gaining good should be near the factor of production, while weight losing good should be near the factory outlet. For example, cement is an example of weight gaining good.

Moreover, it is stated that you cannot find any empirical evidences of a country that has industrialised itself, without the aid of infant industry protection and special raw material (natural) advantage. Applying protectionism through the restriction of imports is inevitable if only if, the country demands imported goods. Otherwise, its application is worthless. Prior to the protectionism, the importing country must be financing the foreign good through the exports.

Let’s take an example of a country where the export industry is already developed. if the industry was built during the colonial times, then there are high chances that it was built during the free trade times (capitalist economy) and must have exploited the natural resources. Apparently, the country would be based on a primary industry, such as mining or agriculture. The wages earned by the labour and the profits generated by the entrepreneurs would have been spent on imported goods. Otherwise, the industry would have financed through external sources (profits transferred abroad). The balance of payment equalized, without affecting the country’s economy. Apart from when the local labour is attracted to work in the export industry, the impact on the situation would be slight.

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