The ‘dual-gap’ consists of two parts: (a) the savings gap—investment— savings (i.e. I=S); and (b) the trade gap or the difference between imports M and exports X (i.e. M−X). In national income accounting, ex post
the two gaps must be identical, though ex ante they need not be so. Notice that the two gaps cannot be added together. The algebraic representation of dual-gap analysis can be described following the analysis of Chenery and Strout (1966) and Maizels (1968).
C+I+X≡Y+M (6.11)
C+S≡Y (6.12)
S+FR≡I (6.13)
M≡X+FR (6.14)
where C is consumption, I is investment, X is exports, Y is GDP, M is imports, S is savings and FR is the current account balance of payments or the net inflow of foreign resources. The first three are independent identities and the fourth equation can be determined when the three others are given. Since there are seven variables, four more equations should be added to three independent identities to make the system determinate. Thus, the following five structural equations are suggested of which only four work at any particular period of economic growth.
So we have
(6.15)
where is the target GDP at the target year t, Y0 is the GDP at the initial year 0 and g′ is the target growth rate.
Planned investment is given by
(6.16) where k is the incremental capital-output ratio.
Exports in the year t are given by
Xt=X0(1+x)t (6.17)
where x is the growth rate of exports which is regarded as exogenous or given.
Planned savings would be equal to
(6.18) where s1′ is the planned marginal propensity to save.
Similarly, planned minimum imports to sustain would be given by
(6.19) where m1′ is the marginal ‘necessity’ to import.
When planned investment is greater than planned savings, i.e. I′−S′, the savings gap exists; when planned imports are greater than planned exports, i.e. M′ − X, a trade gap exists. The two gaps need not be equal ex ante except by chance. Usually, one of the gaps would be greater than the other. When the trade gap exceeds the savings gap the last equation, i.e. (6.19), operates, but not equation (6.18); contrariwise, when the savings gap exceeds the trade gap, equation (6.18) works, but not equation (6.19).
The basic solution of the Chenery and Strout model in the absence of Table 6.1 Solution of Chenery-Strout model without skill constraint
Variables Trade-limited growtha Savings-limited growthb
(6.20) (6.21) (6.22) (6.23)
Variables Trade-limited growtha Savings-limited growthb
(6.24) (6.25) (6.26) Source: Maizels 1968
Notes: aAdding equation (6.11) to (6.14) with (6.15) to (6.17) and (6.19).
bAdding equation (6.11) to (6.14) with (6.15) to (6.18).
any skill constraint has been well summarized in Maizels (1968) and this is illustrated in Table 6.1.
To find the relationship between the target growth rate g′ and FR the following approximations could be used.
(1+g′)t=1+g′t (6.27)
(1+ x)t=1+xt (6.28)
To find the net inflow of FR in the savings-limited growth path we obtain the following equation:
(6.29) Differentiating with respect to g′ we obtain
(6.30) given p=kg′ or the necessary ratio of investment to Y. The model predicts a rise in even when planned propensity to save is equal to the necessary ratio of investment to income, if s1′<2p+k/t.
In the trade-limited phase of growth the net inflow of FR is given by the following equation:
(6.31) With a fixed x, rises at a rising rate while rises at a fixed rate as g′ rises, given the quadratic form of the equation of
With given , g′ depends on x:
(6.32) Some extensions of this basic model have been made. Maizels (1968), for example, tried to use the model by relating savings to exports. The model can be altered if some variables are converted into parameters and vice versa. Further, modification of some of the behaviouristic equations could change the model. The basic model suggests that when exports grow faster than national income, the trade gap will be smaller with given parameters even when FR get smaller because such FR form only a small fraction of exports. Further, should there be import substitution, the minimum import requirement will be smaller over time, and thus in the path of economic growth the savings gap is likely to be the dominant one, although at the outset the trade gap might have been the dominant one.
Evaluation of the dual-gap model
Dual-gap models have been criticized on two grounds. The model is criticized either because of its assumed adjustment mechanism or because of its assumptions which have engendered the idea of two separate types of constraints, or both. It is attempted to meet the first criticism by relaxing the assumption regarding saving and the work of Maizels has been mentioned in this connection. But such modifications do not destroy the existence of the two gaps.
More serious criticism of dual-gap analysis could be made on the grounds that such a model is based on the assumption that FR cannot be regarded as a substitute for domestic savings (Joshi 1970). To the extent that FR are substitutes for domestic savings, only one gap exists. Next, some of the assumptions about fixed savings and capital-output ratios in the dual-gap analysis cease to be valid if FR can alter the composition of output of the recipient country in a manner which would reduce the capital-output ratios. But if the rate of transformation of FR into domestic capital is zero or takes a long time, then two gaps exist. Figure 6.1 illustrates the problem.
In Figure 6.1 let TT1 be the domestic transformation curve—the ‘availability envelope’ a la Baldwin in an open economy. Let the horizontal axis measure consumer goods X and let the vertical axis denote capital goods Y. Let us assume that OC1 and C1K1 are the initial levels of consumption and investment respectively.
To increase the rate of growth, suppose the planner has managed to reduce consumption (and increased saving) to OC2 but finds it difficult to squeeze consumption (or raise savings) any more. This, then, is the
‘savings constraint’ which may be lower than the planned level of investment to achieve a target growth rate. Optimum welfare in the Paretian sense will be obtained where TT1 is tangent to the highest possible social indifference curve Si1, say, at K2. Here consumption does not enter into the social welfare function of the planner; it only acts as a constraint. The savings constraint still exists given the nature of the transformation function and given the fact that the planner fails to raise investment by lowering consumption beyond OC2. Also, in a pure savings constraint, trade is not a constraint and FR will be used for extra consumption. Likewise, in the case of a pure trade constraint, saving is not a constraint. Domestic savings are equal to domestic investment, but a higher growth rate will be unattainable in the absence of some critical imports which underline the lack of FR. This trade constraint is shown in Figure 6.1 in the flat T2K2 section of the transformation curve TT2. Clearly, T2K2 shows zero substitution possibility between X and Y. The savings constraint operated before at OC2. Let us assume that this constraint does not hold any longer and consumption could fall to OC3. But investment fails to rise. If the minimum consumption was OC2 with the availability envelope TT1, there is a savings constraint but no trade constraint. Given TT2, at K2 both the saving and the trade constraints operate. As long as a transformation curve like TT1 slopes downwards monotonically, it is not possible to envisage a trade constraint. The advocates of the dual-gap Figure 6.1
analysis deny the existence of such a transformation curve in the LDCs, given rigidities in their economies (McKinnon 1964). Such rigidities are no doubt present in many LDCs partly owing to economic policies followed in the LDCs themselves, partly owing to the policies of the DCs and partly because of the present international economic order. As long as the substitution possibilities between foreign and domestic resources are limited, the empirical estimates of the sizes of the two gaps are not without their merits (see for example Chenery and Strout 1966; Adelman and Chenery 1966; Maizels 1968).
6.8
GAINS AND LOSSES OF INVESTMENT BY THE MULTINATIONAL