Role of Credit in Economic Development - Essay Example

Role of Credit in Economic Development Introduction Trade has been considered to be the principal engine of economic growth since the centuries backand today, seizing new economic opportunities in the context of globalization is a challenge to many developing countries. With a sound perception of the most desirable economic specialization in the light of the evolving international demand, the countries can be benefited from globalization. If an appropriate range of human resources and enough efficient producer services are available, even with minimal infrastructure many obstacles to economic efficiency (like transaction cost) can be limited. In the context of low developed countries, trade becomes crucial to i) reduce economic vulnerability and protect the environment and ii) to mobilize financial resources (UNCTAD, 2010). I. Positive Role of Trade in Economic Development The role of trade in the economic development and national development strategies are countless. Broadly the decisive role played by trade in economic development is discussed under five major heads in this paper. 1. Demand Expansion and Increasing Returns to Scale The goods and services which are produced locally have access to a larger market and the demand expansion effect of trade make the economy capable of overcoming the constraints of its local and domestic market size. This case becomes more relevant in the case of small and medium sized economies who have limited domestic purchasing power. The increasing returns to scale as a result of access to international markets can further reinforce the benefit of operating at a higher output level. The manufactured goods propose better prospects for export earnings by allowing for a more rapid productivity growth and production expansion and also offer the promise of greater price stability as volumes expand, thereby avoiding the declining terms of trade which hinders the long run economic performance of many developing countries (UNCTAD 2002) 2.Technological Dynamism and Investment Trade leads to acquisition of newly affordable goods that are necessary for technological dynamisms, poverty reduction and increasing economic development. Those goods would not available unless export or import occur properly and even if they are available, those may not be for the scarce domestic resources. The import-supply role of the imports like food, fuel, capital equipments, spare parts, intermediate inputs and machinery for long run investment are very critical in the context of low developed and developing countries where the agriculture sector is more predominant and the productive capacities of manufacturing industries are weak. If the foreign earnings from exports are appropriately re-invested, competitiveness would be enhanced and this leads to expansion of exports and greater investment. Trade with sufficient strategic support, incentives and guidance of the government can lead the economy to industrial diversification and other crucial economic development. The experience of South Korea is very relevant in this context. Export earnings have been used to import the selective capital goods and technologies which led to the inception of new and outstanding industries (in which the country had any initial comparative advantage) which are internationally competitive (for eg., Steel and Ship Building). 3. Loosening the Balance of Payments Constraints Increased earnings from exports play crucial role in favoring the balance of payment situation of a country and thus in sustained economic development. The role of loosening balance of payment constraints is decisive and fundamental in the context of developing and low developed countries in which there is continuous deficit of trade and frequent external debt. For achieving favorable balance of payment situation and sustainable economic growth, it is essential that exports grow in a stable manner and should be in sufficient speed to meet the import needs. If that does not happen, in the absence of external aids and grants, the economy will not be able to overcome even the temporary and mild external shocks and unmanageable foreign debt may be cumulated 4. Specialization of Production, Technological Advances and Spillovers The trade theories indicate that a nation exports the commodities which are produced out of its relatively abundant and cheap factors or resources and imports the commodities which are produced out of relatively scarce factors or resources. In another words, relatively labor abundant country exports relatively labor intensive commodity and imports the relatively capital-intensive commodity. Country 1 exports commodity X because X is the Labor (L) intensive commodity and L is relatively cheap and abundant factor in country 1. Country 2 exports commodity Y because Y is the Capital (K) intensive commodity and K is relatively cheap and abundant factor in country 2. The trade theories implicate two things: first, different supply conditions in terms of resource endowments explain comparative advantage and second, countries export goods that use abundant and cheap factors of production and import goods that use scarce and expensive factors. Hence under this comparative advantage situation, countries can specializes in production and exploit the economies of scale which in turn, allow the countries to overcome the entry costs. This leads to the exposure to foreign competition, marketing and in particular technological diffusion, which will not happen in a closed domestic economy. In addition to this, Foreign Direct Investment (FDI) can be attracted to an economy and if the FDI is selectively attracted and effectively diverted, new and more advanced technologies can be envisaged. These advanced technologies may generate positive externalities in the forms of spillovers to other sectors of the economy and the benefits of the economy will be beyond the increases in monetary value of the exports. Technological dynamism is said to be the most powerful factor in enhancing the economic growth. It is very common in every economy that in industrial sector, most of the innovations take place. And mostly industrial production typically occur in large, stable and concentrated firms unlike in agricultural production. The industrial sectors are said to be the ideal places for knowledge and capital (human) accumulation and provide a tax base for government revenue which can be diverted to enhance education and health care systems , other public provisioning and to support research and development including agriculture. Hence the positive spillovers from industrial innovations are crucial for the growth of agricultural sector and in turn, agricultural growth is decisive for the growth of industrial sector in the early stages of development of any economy. 5. International Trade and Employment International trade creates greater international demand for the domestic goods and services which will increase the capacity utilization of the country and growing export requirements may lead to the employment of previously idle and surplus land and labor resources. The inception of export-oriented and labor intensive industries will create large volume of jobs, by benefiting thousands of previously disadvantaged workers and unemployed people. Many of them are women and other poor sects of the society (For example, the garment industry of Bengladesh is highly acknowledged to the transformation of both national economy as well as the women’ enhancement and rights over the last two decades). While trade creates employment opportunities, it will in turn, reduces the inequalities within and among the groups and increases the productivity. The trade will also affect the price equalization or wage equalization as trade is dependent on the comparative advantage in factor endowments. Critical Appraisal of Trade and economic Development As per the theories on international trade, trade and foreign direct investment give large efficiency benefits by envisaging the international division of labor and by disseminating the benefits from the technological dynamism. This results in economic development and which in turn lead to poverty reduction and human development. Empirical studies have also proved the decisive benefits that the developing countries reaped from integration into world economy. But this trade-development link is not automatic. Market access alone does not bring economic development. In the context of the pattern of trade during the present era of globalization over the last two-three decades, international trade has created the risk of delivering growth and employment in a ruthless (exploitation and plunder by a few of the many), jobless, rootless (absence of backward linkages in the domestic economy), voiceless (very few determines the policies while majority is silent) and futureless (more relevant for those who are already marginalized). Quality and Character of Economic Growth Though trade can promote economic development through different mechanisms and channels, such contributions are not automatic and uniform. Whether trade affects economic development is a question which depends on the domestic policy environment, composition of exports and interaction of trade with other components of the economy. Through trade, it is expected booster in economic development and that in turn, boosts in poverty reduction and human development efforts. But export growth and promotion of trade happen without yielding these positive results and hence the empirical studies do not prove correlation between trade, economic growth and human development. Even though in some cases, there exists correlation between export expansion and economic growth, the effort to prove casuality is failed. Experiences also show that in many countries where trade expansion exists without corresponding economic development and human development. Unequal economic capacities Although trade is universally considered to be the principal engine of economic development, capturing of new trading opportunities is a challenge to many developing countries. Seizing the newly emerged opportunities is a task among the countries with unequal economic capacities. Because of the structural handicaps, the developing and low developed countries are disadvantaged in their efforts to increase the contribution of trade in economic development. Again, considering the multilaterization of the policies of international trade, the participation of under developed countries in the multilateral trade systems is very critical. It is very difficult for many LDCs to participate in these multilateral trade systems by deriving the benefits of new trading opportunities and avoiding the situation of irreversible marginalization. It has been widely recognized that many LDCs have no any effective participation in negotiations with the World Trade Organization and this is because of the absence of the intensified capacity building efforts. Increasing economic Vulnerability A major symptom of the structural adjustment weaknesses of the under developed countries is the vulnerability to the economic shocks which are beyond the domestic control. Under free trade, it is expected alleviating the vulnerability by reducing the exposure of the economy to the relevant external shocks. Another notable example of the vulnerability is the adverse impacts of natural resources. It is desirable to reduce the economic dependence on primary sectors which are highly vulnerable to the external shocks of price changes. External stocks of price change are the best incidents caused out of market related shocks. External fragility is not an LDC-specific issue, but it can be exacerbated, in LDCs, by the context of poverty and lack of appropriate technology. Moreover, LDCs are practically unable to prevent the impact of adverse environmental phenomena originating from outside, in particular, the multiple consequences of global warming, from coral bleaching (a factor discouraging island tourism) to sea-level rise, which necessitates all countries to envisage costly strategies for population re-location. Discrepancies in the Mobilization of Financial Resources The domestic resource mobilization capacities in under developed countries are relatively absent and hence they are not able to meet their important and essential financial needs. As a result of this, low developed countries have to depend on the external financial aid to a larger degree. Coming out of the syndrome of external help implies that there are deliberate successful efforts to make the most effective of financial aid and other financial inflows to the country so as to improve the business environment and attract the foreign investment. Paving new ways to enable the virtuous circle to take place and to convince development partners of the relevance of the country’s vision is an ideal situation, but mostly lacking situation. Concluding Remarks From the above discussion, it can be inferred that international trade especially in the context of liberalization has not benefited all regions of the world or all sections of the society equally. There is increasing and upsetting split between a group of middle income developing countries which are the active participants in global trade, and a large number of developing and transferring economies are virtually excluded from the list of active participants. The reason for this split are many: but most of them lies in the domestic policies of the countries themselves. Successful domestic policies will address a comprehensive range of institutional and structural needs of the society such as good governance, social inclusion, efficient civil services, free information flows, environmental policies and like. Sound and efficient domestic policies will create stability and security which in turn create the atmosphere for investment and regional integration helps to development of large markets and working of economies of scale. Hence, the domestic policies are critical for developing countries to tap the benefits of globalization and to alleviate the negative effects. References Dixit, A. and Norman, V. 1980. Theory of International Trade. Cambridge: Cambridge University Press Jones, R. 2002. Heckscher-Ohlin trade models for the new century, in Bertil Ohlin: A Centennial Celebration, MIT Press Jones, R. 2006. ‘Protection and Real Wages : The history of an idea’. Japanese Economic Review. 57, 457-66. Leamer, Edward E. 1995. The Heckscher –Ohlin Model- in Theory and Practice. Prinston Studies in International Finance, 77. February Samuelson, P.1992. Factor-Price Equalization by Trade in Joint and Non-Joint Production. Review of International Economics, Vol.1., 1-9. Uekawa, Y. 1971. Generalization of the Stolper-Samuelson Theorem. Econometrica 39. 197-213. UNCTAD. 2002 and 2010. extracted from http://r0.unctad.org/ldcs/issues/page3.html . Read More