The idea of the free market system, believes that under development is a result of poor governments, whom are accused of adopting policies which are economically damaging, and suggests the free market system is the best option to stimulate growth. Simply put the free market theory states that scarce economic resources are best allocated by the forces of supply and demand.
The free market system relies on certain conditions for it to work sufficiently well, it assumes that the conditions for perfect competition exist in all the markets of the economy. That is that there are many consumers and producers of the good or service, there is perfect knowledge of the goods and price sexist on the part of both consumers and producers, the goods produced in the market are all perfect substitutes, meaning the goods are homogeneous, and finally the producing firms all have identical cost structures.
But during the twentieth century it has been seen that there has been many arguments for government intervention because the free market system wasn’t working well at overcoming economic problems. Such as the Great Depression in the 30’s. Previously governments intervened with the use of fiscal policy, how their use of taxes and government spending would raise or lower AD and affect growth. From the 70’s it was recognised that perfect competition does not exist, but the idea of supply and demand would affect efficiency, productive and allocative.
This would lead to a stable and growing economy. Free markets encourage productive and allocative efficiency because of the level of competition, and expensive, inefficient or poor producers will go out of business. International trade will enable a country to focus on one area of production, where they have a comparative advantage and export these goods, and import others which would be relatively cheaper than if the country attempted to produce them themselves.
These could lead to a more out looking economy and enable a developing country to begin to compete with developed countries on price and quality of goods and services if they had a comparative advantage, and from here could begin to trade and generate profits that could be reinvested to bring about development, be it in the infrastructure or by the population having more disposable income to increase living standards etc… This became known as neo classical growth theory.
But it can be argued that if the country does operate under a free market system without government intervention this could have positive results. Because surely the ideas of supply and demand determining what is produced will still exist. Meaning competing firms in the market will have to work efficiently to stay in business, so all factors of production will need to be utilised to their best effect. This in itself would do much to improve living standards in developing countries.
There could even be the possibility to increase the production possibility, if a firm is making abnormal profits, then there is the possibility to re invest, and improve the available capital this should inevitably lead to growth and development. But it isn’t this simple for developing countries often they cannot do this, because the labour is paid such low wages profits are often difficult to come by and so investment is unlikely. This is the poverty cycle, and is major problem to development in developing countries.
Also a free market economy doesn’t over come the problem of poor natural resources, which can be a problem faced by developing countries. Poor natural resources mean there will be low productivity in the primay sector, making it difficult for the economy to get started and to begin to develop a free market system and hope to develop because of the proposed advantages this can bring about. Another problem it doesn’t really overcome is the possibility of the country having a poor infrastructure, such as roads, health or education.
With a poor infrastructure similar to the idea of poor natural resources it can be difficult to get the economy started and enable to grow and develop. But what the neo classical growth theory also neglected was that markets can fail. The benefits of the market will only be available if the correct requirements are in place for the market system. So as said earlier infrastructure, natural resources will be vital if the market system is going to be a success. Possibly the idea of a planned economy could be better at relieving the obstacles to development, in developing countries.
It argued that investment was the key to development. It was believed that economic plans could and would overcome problems in an unstable market, such as fluctuating prices, or recessions etc… It could enable a country to focus and co ordinate their resources into their best area of trade, that market in which they have a comparative advantage, or to bring about structural changes to enable development, such as road infrastructure or health care, this could then lead to balanced growth.
Growth where all areas and markets in the economy are growing at a similar rate. In some cases development plans were needed to gain foreign investment, so by presenting them to other countries they would be allowed a loan and this would increase investment and could provoke economic growth which could ease the obstacles to development. But they weren’t as clear cut as that. There is the possibility of increased unemployment if industrialization is an aim, and would be impossible to say that increased unemployment shows signs of development.
But this isn’t necessarily the case for developing countries. If a government uses taxes or subsides to affect the production of a good at the expense of others then this will distort price signals and cause inefficiency. So the economy and country will not grow at the same rate and the negative affects in some aspects of the market could even worsen the situation of the countries economy. In some cases government intervention has worsened the situation, and government failure is evident.
This could be due to corrupt officials who waiver policies towards their best interests, with no consideration for the rest of the economy. So if governments do pose policies in an attempt to provoke development or growth, which is necessary in developing countries, they could be bias and selfish, only implemented to benefit themselves and could have an incredibly negative affect on the economy. I feel that government intervention and planned economy are a must to enable development. Because without them the benefits of a free market system cannot be exploited.
In many cases developing countries don’t have the equipment or resources to sustain a free market, such as road infrastructure, or education. So firstly these need to be put into place before development can occur, so the best way to do that is via government intervention, and investment to build a stable platform for growth and development to occur in the surroundings of a free market. So I feel neither can resolve or ease the obstacles to development on their own, but if both are used and the foundations are set in place the obstacles could be eased and development will occur.