What is Harrod-Domar model?
The crucial role of saving in stimulating economic growth
What are the stages of the HD model?
→ Savings
→ Investment
→ Capital accumulation
→ Rising output
→ Rising incomes
→ Rising savings
Savings:
Begins the process of growth and development
Investment:
→ Banks loanable funds increase
→ Funds for entrepreneurs increase
→ Investment increases → liquidity increases
→ Confidence to invest increases
Capital accumulation:
Firms invest into capital → accumulates overtime
→ Eventually invest into high quality capital
→ Due to technological advancements overtime
Rising output:
Increase in capital → PC increases → Q^2 increases → output increases if labour and capital are compliments
→ By having better machines → Labour productivity high
Rising incomes:
Output high → cyclical unemployment decreases
→ DD high → MRPL of workers high
→ Firms willing and able to pay higher wages
→ Workers go from no income to some income
→ Virtuous cycle
Rising Savings:
Incomes increase → Can now afford basic necessities
→ RDY increases to save
→ Process repeats itself
What are criticisms to the HD model?
→ Investment into low quality capital
→ MPS in developing countries is low
→ Low human capital levels
→ Gap in savings in developing countries
Investment into low quality capital:
→ Depreciates over time
→ Maybe can’t invest into high capital → no skilled labour
→ Lack of Fx reserves → Cant afford to import capital
→ Due to weak ER
MPS in developing countries low:
→ Absolute poverty
→ May not trust their financial institution
→ Resort to hiding money in shoe box
→ May save in other countries (switzerland)
→ More financially stable institutions
→ Poorly capitalised in developing countries
→ Lack of entrepreneurs
Low human capital levels:
May be illiterate → Output doesn’t increase
→ MR doesn’t increase → Income doesn’t increase
Gap in savings:
Developing countries can’t save
→ Plugged by foreign aid & overseas borrowing
Foreign Aid: Strong conditionality
Loans: National debt increases
MNCs: Repatriate profits
What is the rate of GDP determined by:
APS: Aim to have a high APS → bank liquidity increases
Capital output ratio
GDP growth: Savings ratio/Capital output
Capital output ratio:
An amount that has to be spent on capital to produce ÂŁ1 worth of national output
→ It should be low, don’t have to spend on it
What are remittances?
Money sent home by migrant workers abroad, most often working in developed countries and repatriated to the developing country they’re from
Benefits of remittances:
→ Consumption increases massively
→ Remittances better than aid
→ Appreciation of foreign currency
Consumption increases massively:
£ to foreign currency → You get much higher supply
→ Able to afford needs → Absolute poverty reduced
→ HDI improves → They live for longer → multiplier
→ Effective demand increases → high MPC
→ Can now afford leisure → luxury items
{backwards bending supply curve}
Remittances better than aid:
Less likely to be cut off → working in developed
→ Fixed contracts → steady income flows
→ Historically the biggest driver of poverty reduction
→ Used in development indicators
Appreciation of foreign currency:
Once you send remittances → have to demand their own currency
→ Demand for foreign currency increases
→ Can now import capital → sophisticated machinery
What are the negatives of remittances?
→ Exports decrease
→ Consumption subdued
→ Unstable
Exports decrease:
Foreign currency appreciates
Foreign consumers have to give up more
Exports decrease → Incomes increase → Worsens current account → multiplier decreases → EG decreases → HDI decreases → export led growth decreases
Consumption subdued:
Remittances could just be saved instead of spent
Precautionary: Leakage → Banks poorly capitalised
→ Less liquidity in banks {HD model}
→ Developing : informal economy
Permanent income hypothesis: not sure about future
→ Remittance flow may be temporary
→ Remittances used to pay off debt
Unstable:
Depends on the economic cycle of the developed country
→ May lose their job if in a recession
Depends on the political cycle
→ Legal requirements may be imposed
What is microfinance?
Schemes that provides small scale projects/ loans in developing countries
→ Stimulates entrepreneurship
→ Helps employment levels
→ Absolute poverty decreases
→ AS increases → non inflationary EG
→ Multiplier → accelerator
Negatives of microfinance
→ Poorly regulated
→ Oversaturated
Poorly regulated:
→ Leads to exploitation
→ Interest may be high → leads to defaults
Oversaturated:
High number of microfinance lenders
→ People lend beyond their capacity
→ No way they could pay it back
→ Leads to big defaults
What is a HIPC?
Highly Indebted Poor Country
What are the conditions for a HIPC:
→ Implementation of market friendly policies (laissez faire)
→ Have to be a development of a poverty reduction strategy
(every country has to have their own plan to reduce poverty)
→ Should be a boost to private enterprise
→ Need to diversify their exports away from private commodities
Evaluation for financial sector in promoting development:
Human capital development is important
→ Mobility increases → tertiary sector
→ Good labour to improve capital → MRPL higher
Improvement in physical infrastructure
→ Attracts FDI
→ Geographical mobility
→ Transportation costs decrease → helps firms flourish