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Chapter 11

Chapter 11. Investment, Productivity, and Growth. Investment and development. Relationship between investment and development The two categories of investment, public and private. Investment and development. Private investment plays a dominant role in developing countries.

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Chapter 11

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  1. Chapter 11 Investment, Productivity, and Growth

  2. Investment and development • Relationship between investment and development • The two categories of investment, public and private.

  3. Investment and development • Private investment plays a dominant role in developing countries. • The importance of the effective use of capital. • Allows the firms and governments to escape diminishing returns to capital.

  4. Investment and development • The efficient use of investment is often more important for growth than the sheer volume of investment. • Depends, inter alia, on whether prices (including wages, exchange rates, interest rates) are aligned with the social cost of resources. Distortions (tariffs/subsidies, externalities, market power) impede proper allocation.

  5. Investment and development • Text example: • Country A subsidizes new activities (in industries where the country lacks comparative advantage), but materials and managers are expensive and scarce. • Country B emphasizes industries in which the country has a comparative advantage, builds infrastructure, removes regulations and tariffs.

  6. The Investment Decision • In analyzing which projects to undertake, both the public and private sectors rely on traditional cost-benefit analysis. • Compare: • Costs, expected payoffs, risks. • Not economy-wide net present value. • What is the time-profile of cash flow?

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  8. The Investment Decision • In calculating Net Present Value (NPV), public and private projects take into account different aspects of opportunity costs. • What are the alternative investments for a government? For a private firm? • What return could have been earned? • What are the alternative uses of resources?

  9. The Investment Decision • Public projects must consider • shadow prices (when market prices do not reflect the true cost of resources) • and welfare weights (valuation of non-economic benefits). • Projects are typically public if there are high entry costs and large externalities, such as in infrastructure.

  10. The Investment Decision • The private sector focuses on the comparison between the marginal revenue product • (marginal product x marginal revenue)

  11. The Investment Decision • The private sector also often considers factors that can be influenced by government policy such as • macroeconomic and political stability, • infrastructure, • trade policy, • institutions, • the cost of doing business. http://siteresources.worldbank.org/INTWDR2005/Resources/02_WDR_Overview.pdf

  12. The Investment Decision • The cost of doing business includes administrative costs and bureaucratic procedures. • Some of these procedures are directed at obtaining unnecessary information and slowing business down, but others reflect relatively underdeveloped information systems. • These procedures typically do not result in the same protection for private property.

  13. FDI • Foreign direct investment (FDI), which accounts for about half of all private flows, has generated considerable controversy because it involves foreign ownership and management of productive enterprises. • FDI is hoped to provide jobs, technical progress, management skills, and access to world markets.

  14. FDI • The impact of FDI, which comes from multinational corporations (MNCs), depends greatly on policies adopted by the host countries, including performance requirements, trade protection, and incentives such as tax holidays.

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