Growth theories and their application to the beloved country

(This policy bulletin is an extract from an FMF monograph published in 2001, written by Henry Kenney)

The role of capital

Countries with high per capita incomes have far higher capital intensities of production than do poor countries. They are capital-rich, while Third World countries use relatively little capital. If the assumptions of Dr. Pangloss were correct then it could be expected that the marginal product of capital, i.e. returns to capital, would be very considerably higher in capital-scarce countries than in those where it is abundant. Given such discrepancies in return it would mean that capital would migrate in huge quantities from rich to poor countries. As Olson puts it: “Capital should be struggling at least as hard to get into the third world as labour is struggling to migrate into the high-wage countries. Indeed, since rational owners of capital allocate their investment funds across countries so that the risk-adjusted return at the margin is the same across countries, capital should be equally plentiful in all countries” (p.14).

Obviously, the world economy is not even close to such a state. The markedly unequal allocation of the global stock of capital, especially given the extreme mobility of capital in the world today, suggests not so much that opportunities for gain are not being exploited, but that rational owners of capital believe that the returns from investing in poor countries are really quite low. For whatever reason, the poor countries have not been achieving their potential. They can evidently do a good deal better, provided their rulers create an appropriate environment for increasing the returns on investment.

What is more, if countries were on the frontiers of their aggregate production functions, capital and labour would move in opposite directions, the former going to capital-scarce countries and labour going to those where it was in short supply. But this has not been happening. They often move in the same direction, with both “sometimes trying to move out of some countries and into some of the same countries” (ibid, p.15).

We are looking at a familiar conclusion. The economic policies and institutional defects of some poor countries may deter inflows of both labour and capital.

Source: This policy bulletin may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author's and are not necessarily shared by the members of the Foundation.


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