With the help of a circular flow diagram, discuss how a policy of export-led growth might affect the standard of living in a developing economy. [25]
Circular flow of income (CFI) shows the flow of Goods and money between agents in an economy. As diagram 1 shows the households provide factors of production (land, labour and capital) to firms (enterprise) to produce goods and services in the economy. In return firms will reward interest, wage and rent for the usage of these factors of production. Household then spends the money in the economy to buy goods and services. The diagram shows the money flow in the economy; however not all money that is rewarded goes back to the firm. In a mixed economy with the government as another agent, households and firms are required to pay taxes. Hence the income circulating the economy is lesser than that was paid for. The tax paid is a form of leakage in the economy. There’s other forms of leakages in the economy as well. They are savings (households save a portion of their income for transitionary and precautionary reasons) and imports (when households use the income to buy goods and services from another country. These leakages will cause an imbalance in the economy. To balance the equilibrium, injections in the form of government spending, investment and exports are needed.
An export-led growth could provide much needed injection in a developing country. This is because government spending in the country could be low due to low tax collections and one of the characteristics of developing countries also points to low savings. For instance, a country like Zambia has a low savings rate, which results in a low investment rate in the economy. As such, one of the optimum ways to improve injection in the circular flow income of a developed country is through export-led growth.
Government can improve its international ties by joining trade unions and lowering protectionism measures. This helps to increase demand for goods and services as firms are forced to be competitive to increase demand for exports. Furthermore, removal of protectionism will make imported raw materials cheaper which helps lower the cost of production. Additionally, the government can pursue supply-side policies which improves productivity through training and skill upgrades. This will decrease the cost of production and improve the competitive advantage of the country. Government could also provide subsidies to strategic firms to help them compete in the international market.
An increase in export growth will help increase output of the economy. With an increase in output, employment and income may increase. The increase in income will increase the amount of money available in the economy and through the multiplier process the economy grows larger. As a consequence people are able to afford more goods and services which improves the standard of living of people.
However, the extent of the effectiveness of this strategy depends on several factors. The size of multiplies will determine the final increase in output. If marginal propensity to import, marginal propensity to save and marginal propensity to tax is high in the economy, then the withdrawals will be higher. Hence, the size of the multiplier will be smaller and the effect in improvement in the standard of living may not be significant.
Furthermore, Presbich Singer theory argues that developing countries' exports are lower in value since their exports are mainly primary goods. These goods normally have low value added compared to goods manufactured and exported by developed countries. This is a disadvantage since the developing country’s terms of trade will be poor. As a consequence, for every import by developing country they have to export more of their goods for the economy to have any significant impact in the injection of circular flow of income.
Besides, removal of protectionism may backfire as well. If the developing country lacks the necessary skills and technology to produce goods and services that meet international standards, the country’s export may fail to grow as expected. Additionally, if the country ;acks the necessary infrastructure to support its domestic industries, it may be difficult for these industries to take advantage of new export opportunities.
In conclusion, export led strategy is important to improve the circular flow of income which in turn will help improve the standard of living of a developing economy. However it may be challenging in the short run. The process of gaining an international niche is a long one since the government may need to provide support to key industries, investment in infrastructure and education, establishing regulatory frameworks and and many more. Therefore, this strategy should be pursued hand in hand with other policies that help improve the injection in the short run such as attracting foreign direct investments and expansionary demand side policies as well.