Demand- vs. Supply-side Economic Approach

YD Ahn

Oct. 2008

National Savings, Foreign Capital and Economic Growth

 

Determinants of National Income

 

Market Clearance Principle

Y+M  =  C+I+G+X

                                     Sources    Uses

By the Demand Side for the Short run

Y=C+I+G+(X-M)

 

I is investment and stands for increase in Physical Capital 

I=ΔK.

 

(X-M) stands for Net Exports which is identical to Net Capital Outflow or Net Foreign Investment, because the current account and the capital account should balance out.  

 

X-M⇒ NX=NCO ⇒NFI

 

By the Supply Side for the Long run

Y=α×f(L, K, H, N)

 

α denotes Total Factor Productivity (TFP)

L is Labor

K is physical Kapital

H is Human capital

N is Natural resources, stands for the quantity and quality of land

 

Short-Run Economic Stabilization

(Keynesian, Depression, or Demand-side Economics)

 

Management of the Aggregate Demand

Increase or decrease in C, I, or G through monetary/ fiscal policies

 

Medium-run Growth through International Trade

Export-promotion: As X ↑, so Y ↑, other things being equal.

Import-substitution: If M ↓, then Y ↑, otherthings being equal

  

Long-Run Economic Development

(Supply-side  or Development Economics)

 

 Early Stage: Increasing the Input (Economic Growth)

 

L:  birth rate, immigration, rural-urban mobility

K:  business prospects, interest rate, accessibility to finance, investment credit

H:  education and training of labor, keeping health

N:  natural resources exploration, land development (reclamation)

 

Late Stage: Enhancing TFP (Economic Development)

 

Institutions: free market, rule of law, transparency

 Socioeconomic Policies: stability, predictability

 Physical Infrastructure

 Management Savvy: leadership, strategies, innovations, other management expertise

 Industrial Technologies

 

Economic Growth and Capital Mobilization

 

    National and Foreign Savings 

S=Y-(C+G)

=[C+I+G+(X-M)]-(C+G)

=I+(X-M)

 National Savings are used in domestics Investment and Net Foreign Investment

 

If, X<M 

I=S+(M-X)

Foreign savings, which are the same as Net Capital Inflow, are used in domestic Investment supplementing national Savings

 

     Inward FDIs

 

Foreign Direct Investment

Portfolio investment: for capital gain (dividends and stock price appreciation)

 

Foreign direct investment: for management control, usually larger than 10%

 

 

Effects of Inward FDIs

Funds for increased Investment for this year

Increase in physical Kapital

Technology transfer and its spillover

Transfer of management expertise

Anchor in an industrial cluster

New life style

Forces to improve institutions

  

Promotion of FDIs

Business-friendly institutions

Well-devloped Infrastructure

Societal Transparency

Policy predictability