Resource Allocation
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One characteristic of LDCs is that they have low levels of capital formation. This essay endeavors to critically explain the extent to which capital resources are allocated in LDCs, and to evaluate how various planning models can be used to allocate resources within an economy. The essay also explains how governments can play a role in allocating these resources, after which a conclusion to the matter will be addressed. Firstly, here are some definitions of key terms that will be used within the essay;
FACTOR MARKET: According to (www.investopedia.com) A factor market refers to a market used to exchange the services of factor productions. Factor productions refer to labor, capital, land and entrepreneurship. Unlike labor, capital resources and land are the only two resources that can be, and are legally exchanged through product markets. The value of the services exchanged through factor markets each year is measure as national income.
RESOURCES: Resources can be divided into two. Namely: natural resources and capital resources. A capital resource refers to an asset such as equipment, inventory and plants that is manmade and employed in generation of income.
INVISIBLE HAND: The invisible Hand is essentially a natural phenomenon that guides free markets and capitalism through competition for scarce resources. It was first coined by economist Adam Smith in his 1776 book “An inquiry into the nature and cases of the wealth of nations”. ( www.investopedia.com).
ROLE OF MARKETS IN DEVELOPING COUNTRIES
In order for project implementation to be successfully undertaken, there is need to ensure capital resource allocation for that project. However, Adam smith argues that capital resource allocation within an economy happens as a result of a concept he termed “invisible hand”, in accordance with consumer demand.
According to Todaro (2008), the supply of consumer goods depends on the level of consumer demand available within the market. A company needs to know the level of consumer demand, so that it knows how much of the product to make, and how much of capital resources will be required for production of the product. It will need to allocate this capital by inputting it from other industries.
Unfortunately, this is not easily attainable in LDCs. This is because labor, (which like machinery or land is a factor of production), is in surplus. This causes a distortion within the factor market. Meaning that there is more employment of labor then there is for machinery and other equipment. Consequently, there are poor forward and backward linkages of producer goods in LDCs. Therefore, it must be stressed that the extent to which markets in LDCs can be used to allocate resources is very low/poor.
For example, according to the CIA World fact book, Zambia in 2009had an estimated labor force of 5.524 million people, with 85% of this labor force based in the agriculture sector. Kanshahu (2004) states that “despite widespread recognition of the strong connection between agricultural development and poverty reduction, there has been a continuing under provision of investment in capital goods for over a decade.” This has resulted in an unbalanced economy due to low forward and backward linkages.
Alternatively, there have been many planning models that seek to explain how producers in LDCs can successfully allocate capital resources without solely relying on the market force of demand. This essay looks at 5 different models.
THE HORROD DOMER GROWTH MODEL
This model explains that there is a direct relationship between capital and economic output. (GDP). This relationship is referred to as the capital – output ratio. The model explains that for every increase in GDP, there must be an increase of capital within the economy. This capital increase is as a result of saving a certain proportion of the previous GDP, and thereby reinvesting in more capital. This improves technological progress, and brings about a corresponding increase in GDP.
The model is not only applicable to an economy as a whole, but even to individual firms and companies within the market. Companies are advised to save a certain proportion of their profits, in order to replace depreciated producer goods, or in order to invest in more capital. The advantage of increasing capital resources within an economy is to enhance forward and backward linkages, to increase industrialization, to increase infrastructure development, and to allocate resources for project implementation, ultimately increasing the countrys GDP. (Todaro 2007)
The Harrod Domer growth model is a good method of allocating capital resources, as it has been successfully used in various economies.
One example is India, which adopted the model in 1951, just after the end of turmoil that had the country partitioned. A large proportion of the GDP was saved to finance for capital formation in the agriculture sector. This move was made to maximize agricultural output, which would in turn provide raw materials for the industrial sector. Agriculture output rapidly increased, resulting in an increased GDP and industrial development. (www.nisearch.com)
Mauritius is another country that has shown a significant rise in its GDP and industrial growth, partly due to implementation of the process outlined in the Harrod Domer model. From the time of its independence in1968, Mauritius heavily relied on its rich sugar plantations for its national income. Despite this, the country still faced a number of Balance of Payments problems. In the 1990s, the country began to save a large proportion of its GDP, in order invest in more resources, thereby diversifying her economy. According to (www.time.com), by 2010, Mauritius had diversified its economy into the textile industry, tourism and financial services, as well as an advanced physical and telecommunications infrastructure. Mauritius is now a high middle income country, attracting foreign direct investment, due to a good economic performance and environment.
THE MONETORISTS MODEL
This model outlines a different method of allocating capital resources within an economy. It looks at how inflation in an economy can be used to finance reinvestment in resources. This model is also referred to as the “Chicago school of thought.”
This model argues that if interest rates are kept low, companies and firms are motivated to borrow money for investment. One way in which interest rates can be kept low, is to increase the circulation of money within the economy. It is the role of Central banks to print more money.
However, Noyoo (2008) argues that there is an inflationary threshold