The Economic Growth And Development

Published Date: 02 Nov 2017

CHAPTER 2

LITERATURE REVIEW

2.1Introduction

The purpose of this chapter is review literaturesrelavant to topic under study so the objectives formulated in chapter one can be presented in more measurable terms.

This chapter first reviews the literature relavent foreign direct investment.Second exchange rate and inflation also review.Third focuses on using of economic growth.

2.2 Foreign Direct Investment (FDI)

One of the most striking developments during the last two decades is the spectaculargrowth of FDI in the global economic landscape. This unprecedented growth of globalFDI in 1990 around the world make FDI an important and vital component ofdevelopment strategy in both developed and developing nations and policies are designedin order to stimulate inward flows. Infact, FDI provides a win – win situation to the hostand the home countries. Both countries are directly interested in inviting FDI, becausethey benefit a lot from such type of investment. The ‘home’ countries want to take theadvantage of the vast markets opened by industrial growth. On the other hand the ‘host’countries want to acquire technological and managerial skills and supplement domesticsavings and foreign exchange. Moreover, the paucity of all types of resources viz.

financial, capital, entrepreneurship, technological know- how, skills and practices, accessto markets- abroad- in their economic development, developing nations accepted FDI as asole visible panacea for all their scarcities. Further, the integration of global financialmarkets paves ways to this explosive growth of FDI around the globe.

FDI is a key means of attracting inward flows of capital and technology, together with associated innovation in management techniques, the organisation of work and distributional networks. It is associated with the import of capital, work organisation and technological advantages to a host economy, thereby potentially improving aggregate productivity, facilitating

the rising skill level of the workforce through the provision of high-skill employment opportunities. FDI provides the UK with a significant proportion of high value-added, manufacturing jobs and is perceived as having potential to improve employment opportunities and promote regional economic evelopment.

There are many determinants of FDI, including demand- and supply-side factors, however this paper concentrates upon one variable identified in the literature, namely the degree of labour market flexibility.

The internationalisation of economic processes has prompted considerable interest in Foreign Direct Investment (FDI) as a key means of attractinginward flows of capital and technology, together with associated innovationin management techniques, the organisation of work and distributionalnetworks.

Foreign Direct Investment (FDI) may be defined as capital invested for thepurpose of acquiring a lasting interest in an enterprise, whilstsimultaneously exerting a degree of influence on its operations. It is thiscombination of ownership and control that distinguishes FDI from otherforms of trans-national investment and/or production, such as portfolioinvestment (i.e. ownership of financial assets without the same degree ofdirect control) and franchising (i.e. control over production technology andprocess but without ownership) (Dunning, 1979).

The international business literature proposes that firms tend to consider FDI once they have developed certain competitive advantages that they feelthey can more effectively exploit by engaging in a strategic location ofproduction abroad, rather than export goods and services, but maintaintheir direct control over the process to minimise transaction costs, retaincontrol over technological and other elements of the production processtogether with organisation knowledge (Morgan, 1997). Assuming rationalaction, firms must be responding to, firstly, incentives to locate productionabroad, rather than export from their existing home base, and secondly, aseparate set of incentives to internalise the production process. The lattermay centre upon the perceived risk inherent within the principal-agentproblem, whereby the reliance upon an agent to fulfil objectives establishedby the principal might lead to sub-optimal solutions, due to differences inself-interest, and may require costly solutions, involving the provision ofadditional incentives for the agent or otherwise intensive monitoring of theiractivities. Risk of this nature may include the threat of theft oftechnological knowledge, or, less dramatically, the provision of greateropportunities for the diffusion of technological knowledge, and hence

erosion of competitive advantage, together with possible loss of reputationand goodwill due to the operations of low quality franchise operations.

The United Nations World Investment Report (UNCTAD, 1998) argued thatFDI arises due to a combination of, firstly, host country (or locational)determinants, based upon the social and economic factors together with theattractiveness of government policy framework for the attraction of FDI.

Dunning John H.14 (2004) in his study "Institutional Reform, FDI and EuropeanTransition Economics" studied the significance of institutional infrastructure anddevelopment as a determinant of FDI inflows into the European Transition Economies.The study examines the critical role of the institutional environment (comprising bothinstitutions and the strategies and policies of organizations relating to these institutions)in reducing the transaction costs of both domestic and cross border business activity. Bysetting up an analytical framework the study identifies the determinants of FDI, and howthese had changed over recent years.

Tomsaz Mickiewicz, SlavoRasosevic and Urmas Varblane73 (2005), in theirstudy, "The Value of Diversity: Foreign Direct Investment and Employment in CentralEurope during Economic Recovery", examine the role of FDI in job creation and jobpreservation as well as their role in changing the structure of employment. Their analysisrefers to Czech Republic, Hungary, Slovakia and Estonia. They present descriptive stagemodel of FDI progression into Transition economy. They analyzed the employmentaspects of the model. The study concluded that the role of FDI in employment creation/preservation has been most successful in Hungary than in Estonia. The paper also findout that the increasing differences in sectoral distribution of FDI employment acrosscountries are closely relates to FDI inflows per capita. The bigger diversity of types ofFDI is more favorable for the host economy. There is higher likelihood that it will lead tomore diverse types of spillovers and skill transfers. If policy is unable to maximize thescale of FDI inflows then policy makers should focus much more on attracting diversetypes of FDI.

Iyare Sunday O, BhaumikPradip K, Banik Arindam28 (2004), in their work"Explaining FDI Inflows to India, China and the Caribbean: An Extended NeighborhoodApproach" find out that FDI flows are generally believed to be influenced by economicindicators like market size, export intensity, institutions, etc, irrespective of the sourceand destination countries. This paper looks at FDI inflows in an alternative approachbased on the concepts of neighborhood and extended neighborhood. The study shows thatthe neighborhood concepts are widely applicable in different contexts particularly forChina and India, and partly in the case of the Caribbean. There are significant commonfactors in explaining FDI inflows in select regions. While a substantial fraction of FDIinflows may be explained by select economic variables, country – specific factors and theidiosyncratic component account for more of the investment inflows in Europe, China,and India.

Andersen P.S and Hainaut P.3 (2004) in their paper "Foreign Direct Investmentand Employment in the Industrial Countries" point out that while looking for evidenceregarding a possible relationship between foreign direct investment and employment, inparticular between outflows and employment in the source countries in response tooutflows. They also find that high labour costs encourage outflows and discourageinflows and that such effect can be reinforced by exchange rate movements. Thedistribution of FDI towards services also suggests that a large proportion of foreigninvestment is undertaken with the purpose of expanding sales and improving thedistribution of exports produced in the source countries. According to this study theprinciple determinants of FDI flows are prior trade patterns, IT related investments andthe scopes for cross – border mergers and acquisitions. Finally, the authors find clearevidence that outflows complement rather than substitute for exports and thus help toprotect rather than destroy jobs.

John Andreas32 (2004) in his work "The Effects of FDI Inflows on Host CountryEconomic Growth" discusses the potential of FDI inflows to affect host countryeconomic growth. The paper argues that FDI should have a positive effect on economicgrowth as a result of technology spillovers and physical capital inflows. Performing bothcross – section and panel data analysis on a dataset covering 90 countries during theperiod 1980 to 2002, the empirical part of the paper finds indications that FDI inflowsenhance economic Growth in developing economies but not in developed economies.

This paper has assumed that the direction of causality goes from inflow of FDI to hostcountry economic growth. However, economic growth could itself cause an increase inFDI inflows. Economic growth increases the size of the host country market andstrengthens the incentives for market seeking FDI. This could result in a situation whereFDI and economic growth are mutually supporting. However, for the ease of most of thedeveloping economies growth is unlikely to result in market – seeking FDI due to the lowincome levels. Therefore, causality is primarily expected to run from FDI inflows toeconomic growth for these economies.

Klaus E Meyer34 (2003) in his paper "Foreign Direct investment in EmergingEconomies" focuses on the impact of FDI on host economies and on policy andmanagerial implications arising from this (potential) impact. The study finds out that asemerging economies integrate into the global economies international trade andinvestment will continue to accelerate. MNEs will continue to act as pivotal interfacebetween domestic and international markets and their relative importance may evenincrease further. The extensive and variety interaction of MNEs with their host societiesmay tempt policy makers to micro – manage inwards foreign investment and to targettheir instruments at attracting very specific types of projects. Yet, the potential impact ishard to evaluate ex ante (or even ex post) and it is not clear if policy instruments wouldbe effective in attracting specifically the investors that would generate the desired impact.

The study concluded that the first priority should be on enhancing the generalinstitutional framework such as to enhance the efficiency of markets, the effectiveness ofthe public sector administration and the availability of infrastructure. On that basis, then,carefully designed but flexible schemes of promoting new industries may further enhancethe chances of developing internationally competitive business clusters.

Klaus E Meyer, Saul Estrin, SumonBhaumik, Stephen Gelb, HebaHandoussa,Maryse Louis, SubirGokarn, LaveeshBhandari, Nguyen, Than Ha Nguyen, Vo Hung(2005) in their paper "Foreign Direct Investment in Emerging Markets: A ComparativeStudy in Egypt, India, South Africa and Vietnam" show considerable variations of thecharacteristics of FDI across the four countries, all have had restrictive policy regimes,and have gone through liberalization in the early 1990. Yet the effects of thisliberalization policy on characteristics of inward investment vary across countries. Hence,the causality between the institutional framework, including informal institutions, andentry strategies merits further investigation. This analysis has to find appropriate ways tocontrol for the determinants of mode choice, when analyzing its consequences. The studyconcludes that the policy makers need to understand how institutional arrangements maygenerate favourable outcomes for both the home company and the host economy. Hence,we need to better understand how the mode choice and the subsequent dynamics affectcorporate performance and how it influences externalities generated in favour of the localeconomy.

Vittorio Daniele and Ugo Marani78 (2007) in their study, "Do institutions matterfor FDI? A Comparative analysis for the MENA countries" analyse the underpinningfactors of foreign Direct Investments towards the MENA countries. The maininterpretative hypothesis of the study is based on the significant role of the quality ofinstitutions to attract FDI. In MENA experience the growth of FDI flows proved to benotably inferior to that recorded in the EU or in Asian economies, such as China andIndia. The study suggests as institutional and legal reform are fundamental steps toimprove the attractiveness of MENA in terms of FDI.

2.3 Determinants of FDI

2.3.1 Minimising Risk

TNCs prefer to minimise the risk associated with their investments, andtherefore they prefer the combination of a stable political climate togetherwith a dependable macroeconomic framework (Wheeler and Mody, 1992).

Indicators of the latter include low rates of inflation, budget deficits andgovernment debt, together with a relatively stable exchange rate. Highrates of any or all of these variables threaten to erode the financial value ofthe assets purchased or developed by the inward investor, and therebyincrease the risk premium of FDI in that particular nation. Interestingly,

given the relevance to the issue for the membership of the Euro, this doesnot necessarily imply a preference for a fixed exchange rate, but doesindicate a general dislike of excessive exchange rate variability. Inwardinvestors additionally minimise risk through their preferences for operatingwithin a secure and transparent legal framework, designed to protect theirproperty and security of their business contracts. Additional attractivepolicy-related factors include the maintenance of a reasonable rate ofeconomic growth, low costs of borrowing (via a low rate of interest), lowlevels of taxation and/or the provision of specific investment incentivesintended to lower the cost of inward investment. Furthermore, thepotential offered by privatisation, through potential undervaluing of formerstate assets and/or the opportunity provided to purchase strategicallyvaluable assets, has further encouraged increases in FDI throughout thepast two decades.

2.3.2 Cost Factors

In addition to demand factors, FDI is influenced by the relative cost ofproduction and distribution within potential host nations. This isdetermined by the quality and reliability of physical and communicationsinfrastructure, relative unit costs, the cost and ease of access to rawmaterials and the cost of capital. The latter could be eased by monetarypolicy maintaining a relatively low rate of interest and/or full integrationwithin international financial markets. The existence of capital controls andother types of financial regulations would be perceived as generallyunattractive. Furthermore, relative unit costs can be influenced bygovernment policy.

2.3.3 Demand Factors

The international business literature suggests that there are many interrelateddeterminants of FDI, and that the ultimate decision for a TNC toinvest in a particular country will depend upon a composite of these variousvariables (see Appendix One for a partial summary of this literature).

Evidence tends to suggest that investors prefer nations with relativelyliberal trade regimes, perhaps some type of regional supra-national tradearrangement, such as the European Union single market, NAFTA, ASEANand so forth. The size of the national and/or regional market is thereforeof great significance, since it is primarily to serve this market by localized production, rather than export from the home nation, that FDI occurs(Culem, 1988; Jost, 1997; Pain and Lansbury, 1997). The relativeaffluence and growth rates enjoyed by the host market are of similarsignificance for potential entrant firms. Furthermore, in addition to marketconditions which will influence the potential demand for the firms’ products,there are additional nation-specific factors which may influence location ofFDI. These may relate to the existence of a natural resource, technologyor production method protected by legal patent, to which the TNC wishes togain access (Cantwell, 1989: Caves, 1996: Neven and Siotis, 1996;Dunning, 1988).

2.3Exchange Rate and and FID

Foreign Direct Investment (FDI) is an international flow of capital that provides a parent company or multinational organization with control over foreign affiliates. By 2005, inflows of FDI around the world rose to $916 billion, with more than half of these flows received by

businesses within developing countries.2 One of the many influences on FDI activity is the

behavior of exchange rates. Exchange rates, defined as the domestic currency price of a foreign currency, matter both in terms of their levels and their volatility. Exchange rates can influence both the total amount of foreign direct investment that takes place and the allocation of this investment spending across a range of countries.

When a currency depreciates, meaning that its value declines relative to the value ofanother currency, this exchange rate movement has two potential implications for FDI. First, it reduces that country’s wages and production costs relative to those of its foreign counterparts.

All else equal, the country experiencing real currency depreciation has enhanced "locationaladvantage" or attractiveness as a location for receiving productive capacity investments. By this "relative wage" channel, the exchange rate depreciation improves the overall rate of return to foreigners contemplating an overseas investment project in this country.

The exchange rate level effects on FDI through this channel rely, on a number of basicconsiderations. First, the exchange rate movement needs to be associated with a change in the

relative production costs across countries, and thus should not be accompanied by an offsetting increase in the wages and production costs in the destination market for investment capital.

Second, the importance of the "relative wage" channel may be diminished if the exchange rate movements are anticipated. Anticipated exchange rate moves may be reflected in a higher cost of financing the investment project, since interest rate parity conditions equalize risk-adjusted expected rates of returns across countries. By this argument, stronger FDI implications from exchange rate movements arise when these are unanticipated and not otherwise reflected in the expected costs of project finance for the FDI.

Some experts on FDI implications of exchange rate changes dismiss the empiricalrelevance of the interest-parity type of caveat. Instead, it is argued that there are imperfectcapital market considerations, leading the rate of return on investment projects to depend on the structure of capital markets across countries. For example, Froot and Stein (1991) argue that capital markets are imperfect and lenders do not have perfect information about the results of their overseas investments. In this scenario, multinational companies, which borrow or raise capital internationally to pay for their overseas projects, will need to provide their lenders some extra compensation to cover the relatively high costs of monitoring their investments abroad.

Multinationals would prefer to finance these projects out of internal capital if this were an option, since internal capital is increasing in the parent company’s wealth.Consider what occurs when exchange rates move. A depreciation of the destinationmarket currency raises the relative wealth of source country agents and can raise multinational acquisitions of certain destination market assets. To the extent that source country agents hold more of their wealth in own currency-denominated form, a depreciation of the destination currency increases the relative wealth position of source country investors, lowering their relative cost of capital. This allows the investors to bid more aggressively for assets abroad.

Empirical support for this channel is provided by Klein and Rosengren (1994), who show that

the importance of this relative wealth channel exceeded the importance of the relative wagechannel in explaining FDI inflows to the United States during the period from 1979 through1991.

Blonigen (1997) makes a "firm-specific asset" argument to support a role for exchangerates movements in influencing FDI. Suppose that foreign and domestic firms have equalopportunity to purchase firm-specific assets in the domestic market, but different opportunities to generate returns on these assets in foreign markets. In this case, currency movements may affect relative valuations of different assets. While domestic and foreign firms pay in the same currency, the firm-specific assets may generate returns in different currencies. The relative level of foreign firm acquisitions of these assets may be affected by exchange rate movements. In the simple stylized example, if a representative foreign firm and domestic firm bid for a foreign target firm with firm-specific assets, real exchange rate depreciations of the foreign currency can plausibly increase domestic acquisitions of these target firms. Again, this channel predicts that foreign currency depreciation will lead to enhanced FDI into the foreign economy. Data on Japanese acquisitions in the United States support the hypothesis that real dollar depreciations make Japanese acquisitions more likely in U.S. industries with firm-specific assets.

In addition to these arguments supporting the effects of levels of exchange rates, volatility of exchange rates also matters for FDI activity. Theoretical arguments for volatility effects are broadly divided into "production flexibility" arguments and "risk aversion" arguments. To understand the production flexibility arguments, consider the implications of having a production structure whereby producers need to commit investment capital to domesticand foreign capacity before they know the exact production costs and exact amounts of goods to be ordered from them in the future. When exchange rates and demand conditions are realized, the producer commits to actual levels of employment and the location of production. As Aizenman (1992) nicely demonstrated, the extent to which exchange rate variability influences foreign investment hinges on the sunk costs in capacity (i.e. the extent of investment irreversibilities), on the competitive structure of the industry, and overall on the convexity of the profit function in prices. In the production flexibility arguments, the important presumption is that producers can adjust their use of a variable factor following the realization of a stochastic input into profits. Without this variable factor, i.e. under a productive structure with fixed instead of variable factors, the potentially desirable effects on profits of price variability are diminished.

By the production flexibility arguments, more volatility is associated with more FDI ex ante, and more potential for excess capacity and production shifting ex post, after exchange rates are observed.

An alternative approach linking exchange-rate variability and investment relies on riskaversion arguments. The logic is that investors require compensation for risks that exchange rate movements introduce additional risk into the returns on investment. Higher exchange-rate variability lowers the certainty equivalent expected exchange-rate level, as in Cushman (1985, 1988). Since certainty equivalent levels are used in the expected profit functions of firms that make investment decisions today in order to realize profits in future periods. If exchange rates are highly volatile, the expected values of investment projects are reduced, and FDI is reduced accordingly. These two arguments, based on "production flexibility" versus "risk aversion", provide different directional predictions of exchange rate volatility implications for FDI.

The argument that producers engage in international investment diversification in orderto achieve ex post production flexibility and higher profits in response to shocks is relevant to the extent that ex post production flexibility is possible within the window of time before therealization of the shocks. This suggests that the production flexibility argument is less likely to pertain to short term volatility in exchange rates than to realignments over longer intervals.When considering the existence and form of real effects of exchange rate variability, aclear distinction must be made between short term exchange rate volatility and longer termmisalignments of exchange rates. For sufficiently short horizons, ex ante commitments tocapacity and to related factor costs are a more realistic assumption than introducing a modelbased on ex post variable factors of production. Hence, risk aversion arguments are moreconvincing than the production flexibility arguments posed in relation to the effects of short-term exchange rate variability. For variability assessed over longer time horizons, the production flexibility motive provides a more compelling rationale for linking foreign direct investment flows to the variability of exchange rates.

As exposited above, the exchange rate effects on FDI are viewed as exogenous, unanticipated, and independent shocks to economic activity. Of course, to the extent thatexchange rates are best described as a random walk, this is a reasonable treatment. Otherwise, it is inappropriate to take such an extreme partial equilibrium view of the world. Accounting for the co-movements between exchange rates and monetary, demand, and productivity realizations of countries is important. As Goldberg and Kolstad (1995) show, these correlations can modify the anticipated effects on expected profits, and the full presumption of profits as decreasing in exchange rate variability. Empirically, exchange rate volatility tends to increase the share of a country’s productive capacity that is located abroad. Analysis of two-way bilateral foreign direct investment flows between the United States, Canada, Japan, and the United Kingdom showed that exchange rate volatility tended to stimulate the share of investment activity located on foreign soil. For these countries and the time period explored, exchange rate volatility did not have statistically different effects on investment shares when distinguished between periods where real or monetary shocks dominated exchange rate activity. Real depreciations of the source country currency were associated with reduced investment shares to foreign markets, but these results generally were statistically insignificant.

Although theoretical arguments conclude that the share of total investment located abroadmay rise as exchange rate volatility increases, this does not imply that exchange rate volatility

depresses domestic investment activity. In order to conclude that domestic aggregate investment declines, one must show that the increase in domestic outflows is not offset by a rise in foreign inflows. In the aggregate United States economy, exchange rate volatility has not had a large contractionary effect on overall investment (Goldberg 1993).

Overall, the current state of knowledge is that exchange rate volatility can contribute tothe internationalization of production activity without depressing economic activity in the home market. The actual movements of exchange rates can also influence FDI through relative wage channels, relative wealth channels, and imperfect capital market arguments.

2.4Inflation and FID

In recent years interest in understanding the determinants of foreign direct investment (FDI) has intensified hand in hand with an increasing volume of FDI flows. From 1990 to 2005, the total worldwide FDI inflows increased from $203 billion to $974 billion. Almost all developing countries are competing to attract a major share of these inflows. In fact, the share of net FDI inflows in the gross domestic product (GDP) of middle income countries has risen from 0.74% in the 1970s to 1.08% between 1985 and 1994, and to 2.85% between 1995 and 2005. (1) The intensified competition to attract more FDI has led to changes in the regulatory frameworks provided by almost all countries. According to the recent World Investment Report (UNCTAD 2003), during the period 1991-2002, around 95% of the changes in worldwide laws governing FDI have been favorable to multinational firm activity. Establishment of investment promotion agencies as well as provision of fiscal incentives have accompanied these improvements in local regulatory environments. Given the objectives of host countries to attract high-quality investments and to ensure benefits from such foreign activity, it is important to fully understand the factors influencing the FDI flows. 

This article primarily studies the role of inflation among the factors that drive FDI. Inflation rates have increased from around 5 to 10% on average in developing countries during the 1970s, followed by an increase of 49% on average among developing countries between 1985 and 1994. This trend of increasing inflation rates has been reversed in the late 1990s; the inflation rates in developing countries have on average declined to 9.2% during 1995-2004, a period during which the net FDI inflows as a share of GDP have more than doubled in the middle income countries. Given the focus among developing countries to attract more FDI, it is interesting to analyze whether the increasing inflation rates in the 1970s and 1980s might have been a deterrent for FDI inflows and whether their reversal in the 1990s might have contributed to the increase in FDI inflows to these economies. Despite not providing conclusive evidence, the coincidences of high inflation and low FDI versus the low inflation and high FDI inflows into these developing countries motivates investigation of the possible links between the two variables.

2.5Economic Growth

The economic growth and development have been debated for centuries. Industrialization had brought forth permanent changes in the economic and human activity. After the Depression of the 1929-1933 span, the importance of these processes increases. Overcoming any economic difficulties, whether we speak about the decreasing of the unemployment rate or about the external equilibrium, a correlation was made with the economic growth and development. Any decision made at a state or supra-state level aimed at reaching these two objectives. Today, more than anytime, in a recessionary, liberalized economy, in a world marked by a strong demographic increase, by the depletion of natural resources, by changes of climate and of ecosystem destruction, we are more preoccupied than ever by the problems of economic growth and development. Hereinafter will make, an epistemological analysis of these two processes.

Though no unanimously accepted definition has been forgotten by now, most of the theoreticians think of the economic development as a process that generates economic and social, quantitative and, particularly, qualitative changes, which causes the national economy to cumulatively and durably increase its real national product.

In contrast and compared to development, economic growth is, in a limited sense, an increase of thenational income per capita, and it involves the analysis, especially in quantitative terms, of thisprocess, with a focus on the functional relations between the endogenous variables; in a wider sense, it involves the increase of the GDP, GNP and NI, therefore of the national wealth, including the production capacity, expressed in both absolute and relative size, per capita, encompassing also the structural modifications of economy.

We could therefore estimate that economic growth is the process of increasing the sizes of nationaleconomies, the macro-economic indications, especially the GDP per capita, in an ascendant but notnecessarily linear direction, with positive effects on the economic-social sector, while developmentshows us how growth impacts on the society by increasing the standard of life.

Typologically, in one sense and in the other, economic growth can be: positive, zero, negative.Positive economic growth is recorded when the annual average rhythms of the macro-indicators arehigher than the average rhythms of growth of the population. When the annual average rhythms ofgrowth of the macro-economic indicators, particularly GDP, are equal to those of the populationgrowth, we can speak of zero economic growth. Negative economic growth appears when the rhythms of population growth are higher than those of the macro-economic indicators.

Economic growth is a complex, long-run phenomenon, subjected to constraints like: excessive rise ofpopulation, limited resources, inadequate infrastructure, inefficient utilization of resources, excessive governmental intervention, institutional and cultural models that make the increase difficult, etc.

Economic growth is obtained by an efficient use of the available resources and by increasing thecapacity of production of a country. It facilitates the redistribution of incomes between population and society. The cumulative effects, the small differences of the increase rates, become big for periods of one decade or more. It is easier to redistribute the income in a dynamic, growing society, than in a static one.

There are situations when economic growth is confounded with economic fluctuations. Theapplication of expansionist monetary and tax policies could lead to the elimination of recessionarygaps and to increasing the GDP beyond its potential level.

Economic growth supposes the modification of the potential output, due to the modification of theoffer of factors (labour and capital) or of the increase of the productivity of factors (output per inputunit).

When the rate of economic growth is big, the production of goods and services rises and,consequently, unemployment rate decreases, the number of job opportunities rises, as well as thepopulation’s standard of life.

Other economists think that if the rate of growth of the real GDP per capita were maintained at 2% ayear, then the GDP per capita would double every 35 years and, therefore, each generation could hope for a better standard of life than in the present. Fr this reasons, we should take into consideration the fact that the small differences in the rate of economic growth over long periods lead to big differences between the standard of life of the different successive generations. The economic growth is also the process that allows the receding of phenomena with a negative economic and social impact, like unemployment or inflation. But, obviously, a durable economic growth sustains human development.

According to Leszek Balcerowicz, economic growth is a process of quantitative, qualitative andstructural changes, with a positive impact on economy and on the population’s standard of life, whose tendency follows a continuously ascendant trajectory.

Leszek Balcerowicz thinks that the economic development has four dimensions :

- The initial level of development (reflected, for instance, by the income per capita) or thelevel existing when the rhythm of development starts being determined;

- The human capital or the people’s level of education and professional training;

- The internal economic condition or the economy’s structures;

- The external economic circumstances.

The last three factors should be related to the period for which the rhythm of economic evelopment isdetermined, which, in its turn, is the result of different interactions between the four groups of factors.

The initial level of development is essential for the subsequent rhythm of development. Staying behindinvolves certain impulses of acceleration – the countries with a lower rhythm of development canreach a faster one compared to the richer countries because a state not keeping pace can us at aninstitutional and technological level the solutions that the developed countries have already found andcould learn from their mistakes, an aspect that Balcerowicz deem more important than the former one.

The developing countries have an out-of-date economic structure, most of the population working infields of low productivity, especially in agriculture, but there are possibilities to transfer resourcestowards more productive domains. The third factor is characteristic to formerly socialist countries andrefers to the disproportion between the relatively high level of education of the population and thepossibilities to exploit this training. The high level of education represents an advantage for the

countries that joined the economic development trend.

It is also worth pointing out that between economic growth and economic development there aresimilarities and differences [6]. Similarities refer to the fact that:

- Growth and development are continuous processes, with stimulating effects in economy;

- Both processes involve the allotment and utilization of resources and the increase of

efficiency;

- The finality of growth and development is the improvement of the standard and quality of

life;

- Growth and development are cause and result of the general trend, influencing its rhythm

and ensuring passages from one level to the other.

The differences between economic growth and development refer to the fact that, while economicgrowth concerns the quantitative side of economic activity (the increase of results, of quantities, ofsizes), development has a larger scope, including qualitative changes that take place in economy andsociety. In fact, development is a qualitatively higher step of macro-economic evolution. We oftenrefer to growth theories when we speak about the developed countries and to the theories ofdevelopment when we approach the economic problems that are specific to the developing or lessdeveloped countries.

A country is able to develop fast when:

- industries and people have the possibility to plan their activity on the long run, which

requires political, legislative and monetary stability;

- the results of economic activity depend on free initiative, on the efficient utilization of

resources, on efficient labour, etc.

- investments are not sacrificed in favour of immediate consumption. When most of the

current incomes are reinvested, the productive capital increases and, consequently, the real

incomes too;

- the decisions regarding investments and production are correct, and the wealth

accumulated in time is adequately used to achieve assets as efficient as possible from an

economic standpoint;

- the degree of education and civilization rises and records a leap forward at the level of

consciousness;

- any decision takes into consideration the protection and conservation of eco-system

(durable development);

- economic, social, spiritual values are respected.

Economic growth and development determine social progress, that is the progressive evolution of thesociety, which involves an improvement of the human condition, a step higher on the scale of thehuman being’s standard [8], based on economic progress. The accentuation of the social side of

economic development should not be understood as abandonment of economic growth. The economicachievements create bases for the improvement of the standard of life, for adequate conditions ofmedical care, for the improvement of the educational system and a better redistribution of incomes insociety.

Thus, economic growth remains a priority, while the correlation of economic problems with socialones should lead to the development of any national economic system, especially when structuralcrises demonstrate that the limits of the system are about to be reached.

The final purpose of economic growth and development is, undoubtedly, the fulfilment andMultilateral development of human personality, the increase of the people’s material and spiritualwealth, their stepping higher on the scale of civilization and culture.

In the General Assembly of the United Nations in September 2000, also known as the MillenniumSummit, the status of human development was analysed, considering all its diverse aspects, and a setof eight objectives, with phases and deadlines, was adopted. The diversified approach of the widetopic of this process allows for a series of aspects, alarmingly intense and dramatic in different

countries and areas, to be examined. Among other topics, the ones concerning extreme poverty,illiteracy, the lack of utilities and particularly the lack of access to running water, as well as thepollution of the environment, were considered. In the 21st century, in a phase of economic and socialevolution dominated by knowledge, the gaps of development get sharper. Many voices considered thatliberalization and, implicitly, globalization could be the salutary solution for the eradication ofnegative phenomena existing at an international level. On the one hand, the advantages associated witheconomic openness proved to be beneficial, on the other hand, we have seen how strong nations,playing the good Samaritan, used the natural and human resources of the poor states that they enslavedfor their benefit, and emptied of their own possibilities of development, under the promise of a betterfuture. Any hope for the better disappeared once the current economic crises began, whose sizes aremuch bigger than we could have anticipated. Of course, the wish for economic growth and development, fully justified, remains, but hope in the case of developing and less developed countriesdies while their dependence upon the powerful states of the world rises. Economic and socialvulnerability is the weak feature that the centres of power of the world would not hesitate to profitfrom. Yet, the differentiation of the two analyzed phenomena is obvious. If, theoretically, we continuetalking about them as a pair, in practice there is a gap between them. We can notice how the focus isplaced on growth, quantity, wealth at any price. We are aware of how much knowledge we can find,we have possibilities to stock and to use it, but we do not have the will to assimilate and to correlatethem in order to give value judgments. It is not actually possible to accumulate it all, and there is alsoa huge gap between the volume of existing information and the one that most of the people hold.

Knowledge will bring down those who will not be able or willing to assimilate, and will renderefficient those able to capitalize it; it will strengthen personality, change ways of action and of life.

The human being’s intelligence, imagination and intuition will become more and more importantcompared to machines in the decades to follow [10]. The developing countries aim at catching up withthe developed ones. In terms of wealth, obviously. Focusing on richness, people forget, more or lessdeliberately, how important education and solidarity are. The chase for money leaves time only forignorance, and this is the source of wrong decisions. The mechanism works. Due to the mirage ofglobalization and to the desire to "sit with the rich", many countries accepted to be manipulated,

accepted to grow and not to develop. This is how the current economic-social situation emerged.Wedo not blame liberalization or globalization, which are good if they are based on correct principles, butthe lack of morality, of education and spirituality that transform masses of people into weak, ignorantcharacters, avid for money. Economic and social growth and development should be consideredtogether, and the increase of quantities should have an equivalent in the increase of the humanity’sstandard of life and degree of consciousness. It would not be a bad thing to change the direction of theparadigm referring to economic growth and development. A step was made when the concept ofsustainable development was brought forth. The next step would be the introduction of the concept ofsustainable development in solidarity, based on moral and spiritual values as well.

Under these circumstances, granted by economic and social reality, any policy of economicdevelopment should consider three main objectives:

1. new possibilities to achieve and distribute the goods that satisfy the society’s basic needs,

starting from the inequality limited resources and unlimited needs;

2. the increase of the standard of life that involves high incomes, low unemployment rate,

the increase of the level of education, etc.;

3. the increase of the level of economic and social opportunities available for persons and

countries.

Although the issue of economic development pertains, first of all, to the economy of each country, theeffects at a world level are particularly important. Presently, the economic, technological and culturalgaps grow larger and larger, instead of being reduced. Some states do not hold resources tocompensate the imports of assets necessary to economic growth, sometimes not even for those meantfor basic needs, while the economically developed countries have inefficient commercial surpluses(Japan’s case at the moment when Asian crisis started), high unemployment rate, difficulties indissimulating the results of an increasingly productive and complex economy.

The internal problems of the developing countries are numerous and ample, and the pressure createdby these problems make difficult a classification of priorities. Approaching those needs sustainedinternal efforts, a democratic framework and a competent governing. John Keneth Galbraith said,about this, that the "success of an economy depends on a stable, efficient and active governmentalstructure, that would support and guide it. If it is absent, none of the main conditions of economicdevelopment could be fulfilled" . There should be as many equitable societies as possible, but "inan equitable society, nobody can suffer from starvation or for lacking a home. The first condition isthat of a sufficient number of job and gain opportunities, that would not stimulate inactivity" .

Though there are countries facing problems like unemployment or poverty, we could state that all ofthe world states are in a process in which individuals and wealth multiply and develop. thought that the world goes towards progress and freedom. He was right, but we realize that freedomand wealth are for the rich, not for the poor, according to the famous principle that "we are all equal,but some are more equal than others", to paraphrase George Orwell .Starting with 1990, the level of economic and social development is estimated by the calculation of theHDI (Human Development Index).

The permanent presence in the world reports of the human development index (HDI) as a basicsynthetic indicator, determined the Nobel prize winner for economics in 1998, AmartyaSen, to statethat this indicator became the "emblem of the World Report on human development".

Analysing the extreme values of HDI one can easily notice that in the field of human developmentsome progress was obtained reflected in the increase of its extreme values, and in the decrease of therelation between these values. On the other hand, maintaining a high level of the amplitude of extremevalues reflects the level of disparities existing at a world level.

Being a composite indicator, the HDI is a function of three elements: life expectancy at birth,education and incomes, and it does not take into consideration essential qualitative elements. HDI iscalculated starting from a basket of measurable indicators that do not reflect the evolution at the levelof human values.

The final purpose of practical utilization of the theories of economic growth and development and ofthe application of the policies of economic growth is the improvement of the quality of life, which isnot the same thing as the increase of the standard of life, as this is just one component of the quality oflife. "The standard of life reflects only the degree of fulfilment of the vital needs of a country’spopulation, of a social group or of a person. The quality of life, on the other hand, reflects the totalityof natural, technical, economic, social, political, cultural, ethical, etc. conditions that ensure theintegrity and the biological, social and spiritual progress of the human being" .

For the process of economic growth to have positive effects, it must be accompanied by economicgrowth as well, that is by the increase of the quality of life per capita from one phase to the other, andby progress at the level of the moral and spiritual human values. It is possible for a country to recordeconomic increase, but not to achieve economic development. Thus, it is possible for the GDP/percapita to increase and no improvement of the standard of life and of the quality of life to be recorded,no improvement, therefore, in the demographic structure, in the structure and amount of incomes andin the goods and services consumption by the population, in the work conditions, health condition,access to education and culture, while the natural and social environment could degenerate. Manycountries have led and continue to lead a policy of increase of the military power, they wasted greatamounts of resources by irrational macro-economic policies and by investments in inefficient hugeprojects, damaging the standard of life and the quality of life. For that, it is necessary for the economicgrowth to be recorded together with a policy of rational utilization of resources, in order to achieveindividual and social progress in each country.

The ideal situation, from the standpoint of the standard of development, would be equality, if a widerange of opportunities existed that would allow a faster development and would bring forth as fewinequalities as possible. Between development and progress there are a series of contradictions that wewill approach in the following.

One of the contradiction of development and progress for any economy is the one between its limitedresources (raw materials, power, capacity of production, labour, financial means) and the increasingproductive and individual consumption needs, more and more diversified. This calls for each countryto act for a better capitalization of the resources it has, for their saving, for the discovering theattraction in the economic circuit of new resources, for the promotion of the technical-scientificprogress, etc. The system of social needs, specific to each country, and the necessity to fulfil the continuously regenerating, evolving and diversifying needs maintain the progress of nationaleconomies. We should take into consideration the fact that between needs, their generation and theirfulfilment, come production, distribution of incomes, the market and its varied mechanisms, the socialsystem, provoking big discrepancies and distortions in the system of needs, in their evolution, in thedegree and manner of fulfilling them.

Another contradiction is that between the great potential of resources of a country in certain fields andits limited or insufficient possibilities of assimilation, processing and effective utilization of thispotential. This could be solved by increasing internal and external investments, by creating new jobopportunities, by raising the technical level of production, etc.A different contradiction emerges between the needs of consumption, of growth, of diversification,and the possibilities to fulfil them. This stimulates the development of production of consumer goodsand services.

In some countries, one can notice a contradiction between the level of the production forces and theirstructure, and the forms of organization and management of the economic activities. A country canhold rich natural resources, and yet be deprived of the technical and financial possibilities necessary incapitalizing them and fulfilling needs. The adoption of some systems and methods of organization andmanagement adapted to the changes that occur systematically create a framework that encourageseconomic progress.

The existence of these contradictions is a warning signal as for the factors on the basis of which higherrates of growth are recorded and as for the way in which the results of the process of growth aretransposed in the economic and social development.

2.6Relation between Exchange&Inflation Rate and Economic Growth

From traditionally standpoint, the real exchange rate had not constituted an important dimension in the analysis of economic growth. The first generation of neo‐classical economists did not consider exchange rate  in  the  growth  models  or  in  their  practical  policy  incarnations that  focused  on  savings  and  investment  as  determinants  of  growth.  The  above  indicates  that  these  were  closed‐economy  models  that  dictated  that  exchange  rate,  defined  as  the  ratio  of  relative  prices  of  non‐treaded  goods  (all  goods  being  non‐traded  in closed economies) had no role in the growth process. 

The literature on the impact of inflation on economic growth present extremely diverse  opinions.  In  the  1960s,  many  economists  believed  in  permanent  output‐inflation  trade‐off  due  to  Phillip  curve.  Contrarily,  theoretical  arguments  from  various  researchers  undermined  the  above  opinion  and  relief.  However,  subsequent  econometric  investigations  did  not  find  any  significant  relationship  between  inflation  and  unemployment (Lucas 1990). 

 However,  recent  empirical  researches  detected long‐run  non‐linear  relationships  etween inflation and economic growth. The result of these empirical studies demonstrates that inflation has a negative impact on  growth  only  if  it  exceeds  a  certain  threshold.  Otherwise,  inflation  has no  adverse  impact  on  growth  nor  accelerates growth. The level of threshold varies  from various results obtainedfrom various investigations, however, depending on a sample of countries, time periods and estimation methods. Besides,  inflation  distorts  the  tax  system,  and  investors  are  uncomfortable  with  it  because  of  money  illusion.  The  level  of  inflation  is  positively  correlated  with  its  volatility.  Greater  inflation  volatility  is  consistent with higher inflation rates and hence increase uncertainty and discourages long‐term investment  (Romer, 1990).  However, inflation possesses economic benefits as well. These benefits rest on three main arguments that  favour  positive  inflation.  First,  there  is  a  trade  off  between inflation, tax and other indirect taxes so that overnment tax optimization translates to positive inflation. Second, a commitment by the policy makers to maintain low inflation restricts the Central Bank ability to respond to adverse supply shocks. This restriction  may  have  been  a  major  factor  leading  to  stagnation  of  the  Japanese  economy  during  deflation  of 1990 (Krugman, 1998). Third, and probably, the most important, inflation serves as a lubricant making  nominal  prices  wages  more  flexible  (Lucas,  1990).  A  number  of  research  studies reveal that prices and wages aremore rigid in the downward direction than in the upward movement (Cover, 1992).