These considerations of external economies and of available
market demand may be summarized by saying that investment should be directed to
“growing points” in the economy. In the initial stages of economic development
, it is highly useful to concentrate on certain focal points which seem to have
the promise of more rapid growth . From these local areas, a chain reaction
usually starts that gradually spreads chain to the remaining areas of the
economy. Thus even an unbalanced process of initial economic growth has every
possibility of ultimately merging into the broader requirement of balanced
growth.
Market
On the demand side, when considering particular industries,
one cannot assume that supply will create its own demand. There must be markets
for the commodities produced. Where are the potential markets in the poor
countries? Investment should be made in those industries which produce
commodities having a readily available demand. The demand for building and construction
is likely to be high, since poor countries are deficient in roads, railways,
houses and public utilities. Investment in export industries, for which there
is foreign demand , is another attractive area ,, and import competing
industries provide still another potential choice of investment
External Economies
It has generally come to be accepted that the basic consideration
in selecting industries for development in an under developed economy is the
prospect of external economies. Allyn Young drew attention to this important consideration
in 1928, and Rosenstein Rodan made out in 1943 a strong case of developing
those industries which would create conditions favorable to the growth of other
industries. For example, the development of transport or of sources of fuel and
power influences both the costs and the market possibilities of diverse
manufacturing industries. Similarly , iron and steel and engineering industries
increase the growth and potentiality of industry oil general . From the
standpoint of supply, it thus egress that one of the requirements of investments should be that it creates
additional external economies.
Relevant Constraints
These constraints are physical , legal , distributional
constraints and budgetary constraints. The most common physical constraint is
the production function which relates the physical inputs and outputs of a
project. This directly enters into the calculation of costs and benefits. One
of the inputs or some inputs may be in totally inelastic supply. Then the
investment must conform to the legal framework. The legal constraints a rise ,
for instance , from regulated pricing administrative constraints arise from
what can be administratively handled. The distributional constraints arise from
the fact that no section should be unfavorably affected in the matter of income
distribution. It is not always possible to make the gainers compensate the
losers.
Estimation of the Social Product
Here we repeat that, in the under developed countries, there
is likely ot be considerable divergence between the private and social product
, especially in the case of building up the necessary infrastructure or the
social and economic overheads. This divergence is due ultimately to external economies
which in practical life are not easy to define and calculate. An investment creates
external economies by increasing the demand for certain factors of production
and products and thus making it possible for the existing units of production
to turn out larger output. When completed, an investment helps to increase
productivity in existing units by either increasing the supply of inputs or
making possible new and more economical combinations of factors. Thus , there
is expansion of output, as a result of an investment . Sometimes this expansion
needs further investment . The divergence between the private and social
product of the initial investment will appear only to the extend that here induced investments are actually undertaken.
Rate of Discount
Now we come to the question of ascertaining the present
value of the future costs and benefits, discounting process. Which rate of
interest is to be used for the purpose?
There is a large number of interest rates prevailing in the private
sector and there seems to no ground for selecting any of them. It is not clear
whether any market determined rate would be sufficient for community investment
decision. It is said that social time preference rate attaches greater importance to the future than private time preference.
It seems best to use the government borrowing rate since it is easily
applicable and is also a risk free rate of interest. Usually the interest rate
is selected on the basis of observed rates ruling at the time for calculating
present values. Social cost of time has also to be determined. Projects differ
in their gestation period and in the durability of construction . On what basis
are we to impute social value of time? Take first the gestation period. The
social cost in gestation is the value of the output that could alternatively be
obtained in the meanwhile with the same resources, the maximum that could be
obtained with the shortest possible time. Projects with shorter gestation
period but with higher output have, of course, to be preferred.
Valuation of Cots and Benefits
As for the valuation of costs and benefits, if they are
expressed in terms of money , we have to make adjustments to the expected
prices of future inputs and outputs in order to make allowance for the
anticipated changes in the relative prices of the concerned items, but not for
expected changes in the general price level. The expected changes in the output
levels must also be taken into account. Notice has to be taken of monopolistic
elements or other market imperfections. In such cases, investment decisions
based on market prices will not be correct . Some corrections will be needed
for the distortions resulting from market imperfections. Account must also
create divergence between market price and social cost or benefit. Taxed inputs
should be measured at their factor cost instead of their market value. There is
still another cause of divergence between social cost and private cost unemployment.
When at the prevailing price there is excess supply of any input or factor of
production . the price exaggerates the social cost of a project using that input. The utilization of unemployed labor
in investment projects involves no social cost since it does not reduce output
anywhere, because the unemployed labor
us not supposed to make any contribution to output. In this case, the
society as a whole does not forego anything
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