Macro Policies in Developing Countries

Rise up, study the economic forces which oppressyou . . . They have emerged from the hand ofman just as the gods emerged from his brain. You can control them.

— Paul LaFargue

CHAPTER

22

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Macro Policies inDeveloping Countries

22

Developing Countries in Perspective

• 5 billion people live in developing countries

• Per capita income in developing countries is around $500 per year compared to $40,000 in the U.S.

• Americans who are classified as poor find it hard to contemplate what life is really like in a truly poor country

• You can’t judge just an economy; you must judge the entire culture

• Often economically poor societies have cultures that provide individuals with a deep sense of fulfillment and satisfaction

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Macro Policies inDeveloping Countries

22Some Comparative Statistics

on Rich and Poor Nations

• The low average income in poor countries has its effects on people’s lives, most people:

• Drink contaminated water

• Consume about half the minimum calories needed for good health

• Do physical labor

• Have life expectancy of about 60 years

• Purchasing power parity (PPP) is a method of comparing income by looking at the domestic purchasing power of money in different countries

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Macro Policies inDeveloping Countries

22

Growth versus Development

• Development refers to an increase in productive capacity and output brought about by a change in a country’s underlying institutions

• Development occurs through a change in the production function

• Growth refers to an increase in output brought about by an increase in inputs, given a production function

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Macro Policies inDeveloping Countries

22

Monetary Policy in Developing Countries

• The primary goal of central banks in developing countries is to keep the economy running

• Central banks in developing countries are generally less independent than ones in developed countries

• Buying and selling foreign currencies in order to stabilize the exchange rate is an important function

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Macro Policies inDeveloping Countries

22

Various Types of Convertibility

• Full convertibility is when individuals may change their currency into any currency they want for whatever legal purpose they want

• Convertibility on the current account is a system that allows people to exchange currencies freely to buy goods and services, but not assets in other countries

• Limited capital account convertibility is a system that allows full current account convertibility and partial capital account convertibility

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Macro Policies inDeveloping Countries

22

Various Types of Convertibility

• Exchange rate policy is an important central bank function when the developing country has partially convertible exchange rates

• Trade in the currency is thin because there are not many buyers and sellers

• Exchange rate policy is buying and selling foreign currencies in order to stabilize the exchange rate

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Macro Policies inDeveloping Countries

22Conditionality and

Balance of Payments Constraints

• Developing countries often rely on advice from the International Monetary Fund (IMF)

• The IMF is a major source of temporary loans to stabilize their currencies

• The basis for most IMF loans is conditionality which is the making of loans that are subject to specific conditions, usually that deficits be lowered and money supply growth be limited

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Macro Policies inDeveloping Countries

22

Obstacles to Economic Development

Seven problems facing developing countries are:

1. Political instability

2. Corruption

3. Lack of appropriate institutions

4. Lack of investment

5. Inappropriate education

6. Overpopulation

7. Health and disease

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Macro Policies inDeveloping Countries

22

Political Instability

• Political instability closes off external and internal sources of financial investment

• Foreign companies and wealthy citizens are reluctant to invest when the government is unstable creating a high risk of loss

• An unequal distribution of income contributes to the instability because economic prospects are so bleak that many people are willing to support or join a guerilla insurgency

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Macro Policies inDeveloping Countries

22

Corruption

• Developing countries often lack a well-developed institutional setting and public morality that condemns corruption

• As a result, bribery, graft, and corruption are ways of life in most developing countries

• Knowing that bribes must be paid prevents many people from doing things that would lead to growth

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Macro Policies inDeveloping Countries

22

Lack of Appropriate Institutions

• Markets require the establishment of property rights, which is a difficult political process

• The existence of markets is meshed with the cultural and social fabric of society

• Some of the cultural and social institutions in developing countries may not be conducive to growth

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Macro Policies inDeveloping Countries

22

Lack of Investment

• Savings for investment can be generated internally or brought in from outside the country

• With very low per capita income, people in developing countries aren’t able to save

• Savings from abroad is in the form of private investment or aid from foreign governments

• Foreign aid are funds that developed countries lend or give to developing countries

• Foreign aid amounts to about $14 per person in developing countries

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Macro Policies inDeveloping Countries

22

Inappropriate Education

• The right education is a necessary component for growth

• Often educational systems in developing countries resemble Western educational systems and may be irrelevant to growth

• Basic skills like reading, writing, and arithmetic, are likely to be more conducive to economic growth in developing countries

• Developing countries often experience a brain drain which is the outflow of the best and brightest students from developing countries to developed countries

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Macro Policies inDeveloping Countries

22

Overpopulation

• Thomas Malthus predicted that population would outrun the means of subsistence

• Malthus’ prediction has been avoided in developed countries

• Many developing economies have not avoided the Malthusian fate because diminishing marginal productivity has exceeded technological change

• Some developing nations have tried to limit population growth by various means, from advertising campaigns to forced sterilization

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