Pearson Edexcel International Advanced Level Economics: Development strategies (YEC11)

This study guide is aligned to the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11 for the full International Advanced Level), Issue 2, June 2018. It covers section 4.3.6 item 3, points a and b: the impact of market-orientated strategies and of interventionist strategies on growth and development. The specification labels Units 1 and 2 as the International AS and Units 3 and 4 as the extra International A2 content, so this material sits in Unit 4, Developments in the global economy, which is compulsory for the full International A Level only. Every figure below is invented and fictional.

Related pages: revision notes, practice questions, the Edexcel economics hub, the printable checklist, the free diagnostics, exam preparation and, for tariff welfare diagrams, trading blocs, the WTO and protectionism.

What this unit covers

Reference	Strategy	The idea in one line
3a	Trade liberalisation	Cut barriers so firms import cheaper inputs and export more
3a	Promotion of FDI	Attract foreign firms’ capital, technology and jobs
3a	Removal of subsidies	Let prices signal true cost and free public money
3a	Privatisation	Move state firms to private owners to raise efficiency
3a	Floating exchange rates	Let the market set the currency’s value
3a	Microfinance	Lend small sums to people banks ignore
3b	Human capital	Spend on education, training and health
3b	Protectionism	Shield young industries while they learn
3b	Managed exchange rates	Steer the currency to support exports or stability
3b	Infrastructure	Build roads, power and ports
3b	Joint ventures with TNCs	Share ownership to gain skills and technology
3b	Buffer stock schemes	Stabilise commodity prices by buying and selling stock

Items 3c and 3d (industrialisation, tourism, primary industries, debt relief, aid, and international institutions) are not taught here.

How to judge any strategy

Market-orientated strategies rely on prices and private owners to allocate resources. Interventionist strategies rely on the state to direct, protect or fund. Neither is better in every case. For each strategy, build the same chain: mechanism, effect on growth, effect on development (poverty, health, education, equality), who gains and loses, and what the outcome depends on. Typical dependencies are the country’s size, institutions, how strong its firms are, and the time horizon. Market-orientated risks are inequality, volatility and foreign control. Interventionist risks are government failure, corruption, cost and inefficiency.

3a: Market-orientated strategies

Trade liberalisation

Country Alba cuts its tariff on imported machinery from 20% to 5%. The world price is 200 per machine.

Landed price before = 200 x 1.20 = 240
Landed price after  = 200 x 1.05 = 210
Change = (210 - 240)/240 = -12.5%
Price elasticity of demand = -1.2, so quantity rises by 1.2 x 12.5% = 15%
Machines bought: 400 x 1.15 = 460
Tariff revenue before = 400 x 40 = 16,000
Tariff revenue after  = 460 x 10 = 4,600   (fall of 11,400)

Cheaper capital goods raise investment and productivity, and exporters gain from competition and bigger markets. The cost is lost tariff revenue, and domestic machine makers face tougher rivals. Developing countries that depend on tariffs for revenue lose most. Gains are larger if the country can export something in return.

Promotion of FDI

Suppose the construction phase of a foreign-owned plant injects 300 into the economy. The marginal propensity to save is 0.10, to tax 0.15 and to import 0.25.

Marginal propensity to withdraw = 0.10 + 0.15 + 0.25 = 0.50
Multiplier = 1/0.50 = 2
Rise in GDP = 300 x 2 = 600

Once running, the plant adds 400 a year to GDP, but 120 is profit sent abroad. GNI rises by 400 - 120 = 280, only 70% of the GDP gain. FDI brings capital, technology, management skills and export links. Evaluation: it can crowd out local firms, repatriate profit, use up resources and move on when incentives end, so the gain depends on linkages to local suppliers and on tax terms.

Removal of government subsidies

A fuel subsidy holds the pump price at 7 when the unsubsidised price is 10. The country uses 80 million litres a year, and government revenue is 1,200 million.

Subsidy cost = 80m x 3 = 240m, which is 240/1,200 = 20% of revenue
Price rise on removal = 3/7 = 42.9%

Removal frees funds for health, schools or infrastructure and ends over-use of fuel. The poor lose real income. Take 500,000 poor households, each buying 48 litres a year on an income of 1,200.

Loss per household = 48 x 3 = 144, which is 12% of income (if purchases do not change)
Full compensation by cash transfer = 500,000 x 144 = 72m
Net saving = 240m - 72m = 168m

So removal need not hurt the poor if a transfer system works. If administration is weak, the compensation fails and unrest can follow.

Privatisation

A loss-making state water utility loses 40m a year. It is sold for 500m, and the government borrows at 6%. The buyer expects a profit of 80m.

Interest saved = 0.06 x 500m = 30m a year
Buyer's expected return = 80/500 = 16%
Government gives up 80m - 30m = 50m a year if the buyer's forecast is right

Gains: a one-off receipt, ended losses and often higher efficiency from profit incentives. Risks: a private monopoly may raise prices, so a price cap and regulator are needed, and a sale price that is too low transfers value to buyers. Poor households may be cut off if prices rise.

Floating exchange rates

The market rate moves from 10 to 12 local currency units (LCU) per dollar.

Dollar value of 1 LCU: 1/10 = 0.1000 to 1/12 = 0.0833, a fall of 16.7%
Export priced 600 LCU: 60 dollars to 50 dollars
Imported fuel priced 80 dollars: 800 LCU to 960 LCU, a rise of 20%

Floating needs no large reserves and lets the rate absorb shocks, such as a fall in commodity prices. Depreciation helps exports only if demand responds enough. The Marshall-Lerner condition says a depreciation improves the trade balance in the long run when the two price elasticities of demand (exports and imports) add to more than 1. Here 0.8 and 0.5 add to 1.3, so it holds. Short-run elasticities of 0.3 and 0.4 give 0.7, so the balance first worsens (the J-curve). Imported inflation, volatile capital flows and dollar-denominated debt growing in local terms are the main costs.

Microfinance schemes

A woman borrows 300 to buy a sewing machine, repaying 30 a month for 12 months.

Total repaid = 12 x 30 = 360, so flat interest = 60/300 = 20%
The loan is repaid down over the year, so the true rate is higher.
Solving for the monthly rate gives 2.92%, an effective annual rate of about 41%.
Extra income of 55 a month less 30 repayment = 25 a month gain

Microfinance widens access to credit, builds small businesses, and group lending cuts default risk. Evaluation: high effective rates, over-indebtedness, tiny loans that cannot finance growth, and little help for those with no business skills.

3b: Interventionist strategies

Development of human capital

The state trains a worker at a cost of 1,200. Earnings rise by 180 a year for 15 years. Use a 5% discount rate.

Simple payback = 1,200/180 = 6.7 years
Annuity factor = (1 - 1.05^-15)/0.05 = 10.380
Present value = 180 x 10.380 = 1,868
Net present value = 1,868 - 1,200 = +668
If 20% of trainees emigrate: 0.8 x 1,868 - 1,200 = +295

Education and health raise productivity, attract investment and reduce poverty, but results take years and brain drain cuts the return. The programme still pays if fewer than about 36% leave (1,200/1,868 = 64% must stay).

Protectionism

An infant industry has a unit cost of 117 against a world price of 90. A 30% tariff makes the landed price 90 x 1.30 = 117, so it can sell. Its cost falls 9% a year through learning.

Year	Unit cost	Tariff needed to match 90
0	117.0	30%
1	106.5	18.3%
2	96.9	7.7%
3	88.2	none

A declining tariff schedule is the case for the policy. In year 0, buyers of 8,000 units pay 27 extra each, 216,000 in total. Evaluation: firms may never “grow up” if protection stays, retaliation can hurt exporters, and lobbying makes removal hard.

Managed exchange rates

Alba pegs at 5 LCU per dollar when the market would give 4. An export priced 1,000 LCU falls from 250 dollars to 200, a cut of 20%. To hold the peg, the central bank buys 3bn dollars a year, creating 15bn LCU. If the monetary base is 300bn, that is a 5% rise, which risks inflation unless sterilised. Imported fuel at 80 dollars costs 320 LCU at 4 but 400 at 5, a rise of 25%. Managed rates give stability for trade and investors but build reserves, invite retaliation and can end in a crisis if the peg is out of line with fundamentals.

Infrastructure development

A road costs 900m and brings net benefits of 120m a year for 15 years. Use 8%.

Annuity factor = (1 - 1.08^-15)/0.08 = 8.559
Present value of benefits = 120 x 8.559 = 1,027
NPV = 1,027 - 900 = +127
With a 20% cost overrun: 1,027 - 1,080 = -53
Break-even overrun = 1,027/900 - 1 = 14.1%

Infrastructure lowers firms’ costs, shifts long-run aggregate supply right, and attracts FDI. It also adds to demand while being built. Evaluation: high cost, opportunity cost, long delays, corruption in contracts, and benefits that reach rural poor only if links are built.

Joint ventures with TNCs

A joint venture earns 200m profit. Tax is 25%, the TNC owns 60% and the local firm 40%.

Tax = 50m; profit after tax = 150m
TNC share = 90m (sent abroad); local share = 60m
Stays in the economy = 50m + 60m = 110m, or 55% of profit
Wholly foreign-owned plant: only the 50m tax stays, 25%

Local partners learn technology and management and keep more of the profit. The TNC may refuse to share its best technology, and the local partner may be junior in decisions.

Buffer stock schemes

Demand is Qd = 1,000 - 5P. Normal supply is Qs = 200 + 5P, giving a price of 80 and quantity of 600. A bumper harvest moves supply to 380 + 5P; a poor harvest to 20 + 5P. The authority sets a floor of 72 and a ceiling of 88.

Bumper: market price 62, below the floor. At 72, Qd = 640, Qs = 740. Buy 100 x 72 = 7,200.
Poor: market price 98, above the ceiling. At 88, Qd = 560, Qs = 460. Sell 100 x 88 = 8,800.
Net profit = 8,800 - 7,200 = 1,600, before storage costs of, say, 2 per unit (200)

The band stabilises farm incomes and prices. If the floor is set above the long-run price, say 85, there is a surplus of 625 - 575 = 50 each year, costing 4,250, and the stock grows by 50 a year. Funds run out. Evaluation: needs accurate price forecasts, storage costs, and does not help countries that grow no stored crops.

Common errors

• Writing “privatisation” when the policy is deregulation or liberalisation.
• Treating a rise in GDP from FDI as a rise in national income.
• Saying a depreciation always improves the trade balance.
• Quoting a flat microfinance rate as the true cost.
• Giving a list of strategies without a judgement about which suits the country described.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics, Specification, Issue 2, June 2018, published by Pearson Education Limited. Section 4.3.6, Growth and development in developing, emerging and developed economies, item 3, points a and b.