Growing Points

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