The Benefits and Problems to less economically developed countries of free market development strategies

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Last updated: April 21, 2019

Multi-national firms have access to the markets necessary for making use of technological processes and implementing them. These firms have headquarters located within developed nations yet the expertise that they possess would be invaluable to less developed nations with struggling industries and economies. In order for poor countries to develop and increase their wealth they must attract these firms or possibly create their own.

However, these firms require a specific set of institutions within which they operate.The nations must have solid property laws, a corruption free government (that is stable and which abides by a set of laws), and a large internal market. There should also be some sort of physical infrastructure such as transport links, communication capabilities and educational facilities. These basic needs vary depending on the industry. For example, India’s computer industry requires good educational institutions and communications, yet transport is not as important. There are two main development strategies used in third world countries.

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These are Export Lead Growth and the Import Substitution Model. The one in favor at the moment is the export lead growth, although import substitution was preferred in the 60’s and 70’s. With the import substitution model, growth comes from ‘home-grown’ products manufactured by domestic firms that would substitute imports from foreign countries. Government tariffs, subsidies and quotas help to protect and support these local industries. As a form of national self-sufficiency it appeals to nationalistic governments, who must be corruption-free and well-functioning in order for it to work.

This is a difficult requirement for third world countries to fulfill, since economic underdevelopment is directly related to inefficiency in the public sector. The emergence of a local business elite means that they must be separated from government decision-making yet must have some input in national planning. This is also a particularly difficult compromise to reach as the local business elite invariably become a key component of local policy-making.

Another prerequisite for successful implementation of the import substitution model is that there must be a sufficiently large internal market.For instance, in Peru the population is little more than 24 million (of whom only a minority could afford a car) and yet the government protected the automobile industry with high tariffs on imported cars. Because there are substantial economies of scale in the production of automobiles, the cost per car in Peru was much higher than it should have been. Peru was therefore a high cost producer of automobiles.

Under these conditions, business success required political access and power, rather than business and technical expertise, one major disadvantage of this system.The other development strategy, export lead growth, encourages manufacturers in poor countries to produce goods for export, which must then be competitive on the world market. A success story of this is post-war Japan. It is now the general model of growth in Asia, where Taiwan, South Korea, Singapore, and Hong Kong successfully imitated the Japanese model in the 1970s and 1980s and now are rapidly developing middle-income countries. It is the most common model of growth for third world nations who export mainly minerals and agricultural products.However, they face uncertain and unstable markets where the ratio of export to import prices is unfavorable (or at least very unstable). A decline in the countries terms of trade means its imports of goods become relatively expensive, while its exports become relatively inexpensive in the world markets. Such a condition leads to a country exporting more but receiving less real income.

Therefore, the biggest problem with the export lead growth model is that it requires an appropriate stable and growing export industry.Unfortunately, large developing nations who rely heavily on the unstable prices of mineral and agricultural products have found it very difficult to alleviate the poverty of the majority. Chile’s situation supports this as it is a relatively advanced middle-income country (still with the large poverty population) that has developed a strong reliance on natural resource exports. Cellulose, the raw material for paper, is one of Chileans primary exports, second in importance to copper.With improved technology they could significantly reduce employment and expand output at the same time. Data shows that in 1999 they are the world’s low-cost producer of cellulose (they can deliver bleached pulp to a European port at $30 per ton, cheaper than their Swedish rivals). But unfortunately for Chile, with such low export prices, it is unlikely that enough long-term growth in this industry will significantly reduce Chile’s poverty.

On the other hand, Mexico has attracted many firms and mass migration from the USA.Traditionally it has relied on its natural resources for its exports, yet its unique geographical location next to the USA has meant that it has also expanded its export base. A rapid integration of the two countries’ economies has many implications, including increasing employment, and may propel Mexico into fully-developed status.

Mexican political policy has been heavily influenced by the USA’s corporate migration, as can be seen in the North American Free Trade Agreement (NAFTA).In the aftermath of the NAFTA job growth has expanded to the south, but there are still problems in Mexico of poor infrastructure, crime and corruption. In fact, the growth itself has caused Mexico some problems. These include various forms of pollution, water scarcity (in the desert cities of the north), and the increasing income gap between Mexico’s wealthy north and the poorer south. Overall, though, the development strategy of export lead growth has been very effective. In order for the developing country to be a desirable locale for the expansion or start-up of a firm, as before mentioned certain conditions must be present.The cost of labour is often a key attraction for foreign firms, as it is much lower than that of developed nations.

If transportation costs are significant a firm will tend to locate, either next to a source of raw material (if the material is heavy, bulky or fragile) or near its buyers. The Third World countries are suppliers of raw material and thus attract processing industries, but their remoteness from the buyers in the industrialized countries makes it difficult to attract these industries (unless there is a significant internal market).Services, one of the fastest growing economic sectors, generally need to be located near the buyers, yet service industries and other market-orientated industries are unlikely to be attracted to remote Third World locations. These are key difficulties in encouraging export lead growth, which remains the preferred option in free market development strategies in less economically developed countries.

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