However, there was a heavy state involvement in the agricultural policies of the early development era. The agricultural productivity was needed to ensure supply of food and raw materials to the other sectors (food surplus), to provide a form of savings and taxation (investable surplus) to support investment in other sectors, to provide cash that will raise the demand in the rural sector for the manufactured goods (marketable surplus) and to earn foreign exchange through the export of agricultural products (export surplus). The government tried to control the growth of the agricultural sector by the use of taxation, pricing and extension policies. However, this caused a split between the modern and traditional agricultural sectors. The agricultural extension policies used by the government discriminated against small landholders and were in favor of the large landholders that had access to capital-intensive machinery, chemical inputs and credit.
The urban biased approach of the agricultural policies also resulted in the contraction of the agricultural sector of the economy. The governments put high pressure on to the agricultural sector in order to squeeze food out of the rural areas and bring the agricultural level with subsistence income levels to the modern industrial sector of the economy. Although the governments were trying to ensure the agricultural productivity, because the agricultural policies were based on the expansion of the modern sector of the economy, the indigenous sector contracted through the interaction and reallocation of resources between an advanced ‘capitalist’ sector and agricultural ‘non-capitalist’ sector. The poverty between the rural and urban areas increased during this time period. The lack of incentives to small landholders increased the inequality of income among individuals. Growth cannot take place when certain sectors in the economy are suppressed; rather the different sectors must complement each other’s growth. The lack of support towards the traditional agricultural sector slowed the growth of the economy as a whole as well as increasing the rural poverty.
Harrod-Domar theory of economic growth states that the rate of growth of GNP is determined jointly by the national savings ratio and the national capital-output ratio. In the developing countries, the voluntary savings are small since the average income of an individual is low. The wages of the workers were kept low in order to ensure that the industries made maximum profits. Savings are needed in the economy, which can in turn be used to finance the growth of industries. Hence, the governments had to induce “forced” savings through taxation. The economic policies of the governments encouraged capital-intensive technology where the amount of labor involved was also low. This has lead to a high rate of unemployment among the labor force. This has resulted in the expansion of the informal sector; yet the government policies were so biased towards large-scale industries, this informal sector has had no incentives to establish themselves. On the other had, most of the 3Rd World Governments has encouraged industrialization via import substitution, the production of consumer goods in domestic markets in order to substitute for imports. This has resulted in importing capital, technology and intermediate goods to which value has been added domestically. This has been done through the use of capital-intensive, labor-saving methods that resulted in high profits and high wages for a small elite group. However, unfortunately a big group of people beyond these elites were faced with unemployment and poverty which has increased the inequalities in income distribution. The unemployed workers in the agricultural sector of the economy had the last solution of migrating to urban areas to be able to find a job. However, the urban workers were experiencing the same problem of unemployment in the cities. As a result, migration from rural areas to urban areas has created overpopulation, extensive urban unemployment and urban poverty in the 3rd World cities.
As a result of the international economic policies, most of the developing countries have had to supplement domestic savings with foreign borrowings or investment to ensure necessary capital to stimulate economic growth. When the developing countries were spending more on investment than that they were receiving through savings and taxation, a resource gap has appeared. This resource gap was filled by the foreign-exchange gap via imports and exports. But when the imports exceeded the exports, the foreign-exchange gap has to be filled either by losing foreign-exchange reserves or by obtaining foreign financing. This over reliance on foreign capital has lead to foreign debt as the terms of trade (TOT) deteriorated.
During the early periods of economic development, the economies of the developing countries usually had high state involvements. As a result, the 3rd World governments tried to deal with the problem of foreign debt by controlling the exchange rates and tax levels. In the initial stage of the typical developments, there was in many instances an increase in net capital outflows by residents, especially when the authorities initially resisted making adjustments in interest rates and exchange rates in response to changes in the economic environment. Such outflows, of course, eventually led to greater exchange rate movement than would otherwise have occurred, and also induced the authorities to raise interest rates to high levels, there by further increasing government interest costs. Eventually, overvalued exchange rates, high interest rates and high taxation on domestic assets have lead to capital flight. Capital flight is defined as the outflow of capital from the developing countries, due to heightened domestic, economic and political uncertainty within the country. The foreign debt has increased even more due to capital flight and deteriorating Terms of Trade(TOT) while the poverty among the people has increased.
Increasing fiscal deficits in these countries led both to a crowding-out of private investment and to government expenditure cuts that reduced public investment programs. The scarcity of foreign exchange available for imports also led in many instances to quantitative restrictions; these, together with the depreciation of the real exchange rate, induced a decline in imports of intermediate and capital goods. The fall in net government saving was compounded by a fall in net saving of private residents retained domestically, as well as by a decline in the net inflow of foreign savings. The high inflation that occurred in many of the developing countries also reduced incentives for the productive use of investable funds, and incentives for productive investment were damaged by the decline in economic activity. Consequently, all the mentioned factors above have impeded the growth of the developing economies and delayed the economic development of 3rd World Countries.
The agricultural and industrialization policies of the early development era slowed-down the growth of the developing economies and increased both rural and urban poverty while the international economic policies that were prevalent during that time increased foreign debt which has led to further problems of growth and scarcity. Capital-intensive, import-substituting and urban-biased growth that has been induced by the government policies has only resulted in increasing the rural poverty. The destruction of the traditional industries and over-emphasis on modernization of industries within a short period of time has disrupted the growth of the developing economies. The ever-increasing foreign debt due to deteriorating TOT has been a major consequence of inadequate international economic policies of the developing countries. As a result, during the early periods of development, the growth of the developing economies has suffered while the foreign debt and poverty of the populations got out of control and increased significantly in the 3rd World Countries.
