Processing Conditions

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Unit 3 Development Finance

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to that of population expansion. Such capital formation includes all expenditures of a productivity increasing nature. It may take the form of investment in the public or the private sector. Particularly in the early stages of development, the former is of critical importance since, in the form of so-called infrastructure (power, communications, port facilities. etc.), it sets the framework for subsequent manufacturing investment whether public (in the socialist economies) or private (in the mixed economy case). Furthermore, capital formation includes investment in human resources in the form of education and training as well as in physical assets. Indeed, where human productivity is adversely affected by malnutrition and disease, increased food consumption and provision of sanitation and health facilities take on the aspect of investment in human capital. Thus, the use of resources for productivity-enhancing purpose, may take a wide variety of forms, and the actual mix must be determined in the process of expenditure and resource planning.

There has to be a reduction in current consumption to release the necessary resources for investment purposes except unutilized resources are brought into use or additional resources are procured from abroad. To a certain extent, the mobilization of unused resources may be possible. It has been argued, for example, that many low-income economies possess substantial amounts of underutilized labour which may be put to work on simple forms of public capital formation, such as drainage, irrigation, roads, and dams. The government then acts only as organiser of this improved resource use. Another possibility is to obtain the needed investment resources from abroad in the form of official loans and grants or as private investment. Neither source, however, is likely to do the whole job, and in any case, will not be forthcoming without supportive effort on the part of the host country. Private investors from abroad, like private investors at home, require the necessary infrastructure investment; and official aid will most likely be conditional upon well-formulated development plans which include provision for substantial tax-financed increases in domestic investment.

Taxation has an important role to play in providing savings incentives and/or disincentives to luxury consumption. Business saving may also be encouraged through a system of business income taxation which encourages the retention and reinvestment of earnings. Voluntary private saving, while useful and important, cannot be expected to be sufficient in itself, particularly at an early stage of development. An economic climate conducive to private saving takes time to develop, and in the meantime, the less developed country must look to the government budget as the most promising source of finance for development purposes. Thus, public sector saving may be increased by raising total tax revenue and/or reducing current expenditures. Tax revenue must be looked on as a precious and scarce resource and many development plans have failed as a result of the profligate spending policies of the government which in turn was often acting under political pressure. Government savings generated by a surplus in the current budget may be used to finance capital formation in either the public or the private sector. In the latter case, the government savings may be channeled into private investment as debt or equity capital through the medium of government lending agencies or development banks.

3.1.2 TECHNOLOGY, ENTERPRISE, AND EFFICIENCY

Improved technology is another important element in the development process, including manufacturing and agriculture. The massive improvements in agricultural productivity in a number of developing countries over the past decade attest to the benefits to be derived from improved technology in that sector. A principal benefit of private investment from abroad lies in the improved technologies which it brings, although it is important that these be adapted to the particular conditions and resource endowments of the less developed countries (LDCs). Tax provisions may be designed to stimulate and encourage the use of improved techniques. Business enterprise is needed if a flourishing private sector is to develop alongside the public sector. In its absence, government enterprise must fill the gap, as with technology, the tax structure can be designed so as to encourage the willingness to undertake productive investment

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Efficiency in resource use is of critical importance in the resource-scarce LDCs. This factor involves proper expenditure evaluation on the part of the government as well as a development plan which avoids wasteful bottlenecks arising during the development process.

3.1.3 SOCIAL AND POLITICAL FACTORS

Some of the most intractable problems associated with economic development include the whole range of social attitudes and organizations which have to be modified if development is to proceed, At the same time, a substantial degree of political stability is also needed to allow individual initiative to flourish, development plans to be implemented, and the necessary economic transformation to take place, It is therefore crucial that the fruits of development are broadly established and that extremes of income inequality prevalent in many of the LDCs be eliminated. While certain kinds of redistributors, (e.g., land reform) can be undertaken without prejudice to the level of output and indeed may be helpful in this respect, conflicts can arise between policies directed toward a more equitable distribution of income and the objective of increased saving and investment. Whereas public saving can be increased by raising the level of taxation, private incentives to invest may have to be traded off against redistributive tax policies.

3.1.4 FOREIGN EXCHANGE

Foreign trade plays a critical role in many of the less developed economies, with limited internal markets, foreign trade involvement permits greater specialization, economies of scale and exercise of comparative advantage. In addition, foreign exchange earnings allow the purchase of certain products (such as machinery and equipment) which are needed for the development process but for which the necessary technology is not available domestically. Another contribution of exports to development may be the provision of an expanding market around which "linkage" investments may be made, thereby creating an "export-led" nexus of development. Thus, public policy must be concerned with the division of resources not only between consumption and investment but also between domestic and traded products; and among traded products there are both import-competing and exported goods. The tax structure also has a part to play in the general allocation process embodied in the development plan.

3.1.5 BALANCE AND BOTTLENECKS

As economic development proceeds, various bottlenecks or limitations to the growth rate may crop up.

For example, it has been suggested that in the early stage, the rate of internal saving is the controlling factor. As the rate of saving, and with it the growth of the economy, increases (aided, perhaps, by capital inflow from abroad) the absorptive capacity of the economy becomes the limiting factor. i.e., all the supportive factors which are needed to render the investment productive. Finally, the development process begins to create strains in the balance of payments, outstripping the capacity of the economy to earn foreign exchange to meet imports through exports. Thus, the resources made available for development purposes may go to waste because of these bottlenecks. A sound development plan should therefore endeavour to keep the process running smoothly by a policy of balanced growth. Tax policy in particular may be employed to encourage capital inflow and influenced the level of imports and exports.

3.1.6 ROLE OF FISCAL SYSTEM

It is evident that the fiscal system plays a multifold role in the process of economic development. The level of taxation affects the level of public saving and thus the volume of resources available for capital formation. Both the level and the structure of taxation affect the level of private saving. Public investment is needed to provide infrastructure types of investment. A system of tax incentives and penalties may be designed to influence the efficiency of resource utilization. The distribution of tax burdens (along with the distribution of expenditure benefits) plays a large part in promoting an equitable distribution of the fruits of economic development. The tax treatment of investment from abroad may affect the volume of capital inflow and the rate of reinvestment of earnings there from and the pattern of

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taxation of imports and exports relative to that of domestic products will affect the foreign trade balance.

SELF ASSESSMENT EXERCISE

Discuss the important factors required for development purpose in a typical less developed economy.