Merit Goods & Inward Foreign Direct Investment (HL IB Economics)

Revision Note

Provision of Merit Goods

  • Merit goods are beneficial to society but are under-provided in a market

  • Governments often have to subsidise these goods in order to lower the price and/or increase the provision

  • The provision of merit goods can result in significant improvements to human development and quality of life

 

The Provision of Merit Goods to Aid Economic Growth & Development


Strategy


Explanation


 Advantages


Disadvantages 

Education programs

  • These include pre-school, primary, secondary and tertiary education programs which are free at the point of consumption, but paid for with tax revenue

  • Education helps to intervene and break the poverty trap by increasing human capital

  • Increased human capital results in higher productivity and output

  • Higher output can lead to higher wages which improve the standard of living

  • Higher wages may lead to more consumption and an increase in aggregate demand

  • Education programs take a long time before there is an increase in productivity

  • There is an opportunity cost associated with the provision of education

  • Education may still be under consumed in developing nations as children are required to work for the family: family survival depends on the income they generate

Health programs

  • These range from emergency-only healthcare to full healthcare and preventative healthcare (e.g. cancer screening) programs, which are free at the point of consumption, but paid for with tax revenue

  • Universal access to vaccinations can improve life expectancy and productivity significantly

  • Improved health care helps to break the poverty trap

  • Each health care intervention by the government requires expenditure and so carries an opportunity cost

  • How much health care should be provided is a normative issue and is subject to political pressure and ideology

Infrastructure projects

  • Infrastructure - including energy, transport, telecommunications, clean water and sanitation -  

  • Infrastructure can play a direct role in improving the health and standard of living

  • Telecommunications speed up the flow of information and exchange of knowledge and ideas which can directly help to improve human capital and the standard of living

  • Access to energy has a significant effect on productivity e.g. the opportunity cost of previously spending time looking for heating fuel can now be used more productively

  • Each infrastructure project requires significant government spending and so carries an opportunity cost

  • Infrastructure projects may take a long time to complete

  • Infrastructure projects are subject to political pressure and lobbying

Inward Foreign Direct Investment (FDI)

  • Inward FDI occurs when investment by foreign firms results in more than a 10% share of ownership of domestic firms

  • Foreign FDI has the potential to generate significant economic growth as more economic activity, employment and output is generated

  • Foreign FDI has the potential to raise household income which helps to break the poverty cycle

  • The impact of FDI on economic growth depends on how the FDI occurs

    • E.g. Chinese firms frequently invest overseas, but bring their own employees with them - and send all of their profits home - the economy and individuals within the economy benefit less than they could have

    • E.g. Indian firms frequently invest overseas and tend to hire local employees and reinvest more of the profits than Chinese firms generally do
       

Advantages and Disadvantages of FDI to Generate Economic Growth and Development


Advantages of FDI


Disadvantages of FDI

  • FDI can be a major source of finance in less economically developed countries

  • FDI helps to generate extra national income which can increase the level of savings - and higher savings can help to increase funds available for domestic investment

  • Expansion of supply can lead to increased employment opportunities

  • The government may receive higher tax revenue generated by the increased profits from the additional level of national output

  • As more foreign firms invest, governments often start to develop new infrastructure to support their business activity

  • Weak local regulations are often exploited leading to poor working conditions and increased negative externality's of production

  • Profits tend to be moved off-shore or returned to the home country of the multinational firms which means that less is reinvested back into the development of the host nation

  • Multinational firms often pay very little tax to host nations as they use sophisticated corporate practices to reduce the amount of tax they are liable for (e.g.transfer pricing )

  • Local firms may struggle to compete with multinational firms who are now based in their country - and they go out of business

  • Multinationals are likely to have the power to keep wages low

  • Multinationals may use workers from their country for management roles and only employ local unskilled labour for manual tasks. The workers may not develop many new skills from the role

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