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possible to manage it, but implement policies with a big part of black economy is not an easy


Capacity development means helping countries to avoid economic problems. There have been

critics on how the IMF performed these tasks as well.

World Bank Bretton Woods Conference

It has been created in the and it had to provide finances for the post-

war reconstruction. It is not a single institution but a group.

The function of lending is strictly related to BP problem (IMF), and the task of the World Bank

was lending for reconstruction. Nowadays, the main principle is still the same: it lends not to

solve BP problems but to help a country grow and improve its overall economic situation.

“fighting poverty

It has set two goals to achieve by 2030 and its mission is to help in achieving it:

and fostering growth”.

IMF is focused on a day-to-day activity: GDP=C+I+G+EXP-IMP. In the short run there is a

maximum amount of GDP a country can produce (potential GDP: what a country can produce

given a certain amount on resources) determined by:

Potential GDP = f (K, L)


K=stock of physical capital (e.g. machinery, equipment, buildings, etc.)

L= labour force (the share of population that is working and looking for a job).

The maximum amount a country can produce depends on the resources (K, L) but also from

the function (f): the technological level of the country; there are countries that with same

amount of resources produce less because they have a lower level of technology.

The function is positively related to both elements: the much K or L, the higher the GDP.

declining/diminishing marginal return:

Moreover, we assume a the production function has a

positive first derivative but a negative second derivative.


>0 ; >0

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£ £


< 0; <0

£ £

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With a constant level of equipment, the contribution of a worker is still positive but always less

and keeps getting smaller and smaller. Each worker on average has a similar level of

productivity but to perform its task he needs some sort of equipment: if two people have to

share the same tool, the combined productivity will be higher but still less than the sum of the

two single. There is a complementarity between machineries and the people using it.

Mechanics of medium or long-term growth of a country: if we keep constant the amount of

either K or L and the technology that is used, the maximum level of GDP will also stay constant.

If the GDP maximum changes and we have GDP >GDP , then we have either:

t+1 t

- Increase of labour force

- Increase of capital stock

- Technology development

Or a combination of them.

If we have an increase in population, it will normally translate in an increase of labour force

(L); but L can increase also without an increase in population – in this case we force the increase

(e.g. people work for longer period in their life or more women that work). 22

But if only L grows we have two problems:

- Diminishing marginal return.

- The country becomes economically bigger but will produce less than the increase

because of diminishing return (e.g. if we double one factor of production, we cannot

double the output): f (K , L ) < 2 GDP

t+1 t+1 t+1 t

L =2L

t+1 t

If we want to know if a country is going well, we have to see how much people are

enjoying (GDP/pop or GDP/L). Countries with a rapid increase (higher number of

people with needs) can create problems (because the GDP is not growing so quickly):

individually people have a smaller amount of goods to use.

With a demographic increase, there is the need to increase either the level of technology or the

K to keep at least the level of GDP constant.

How to obtain improvements in technology or increase in K? It is possible thanks to

investments. Investment: today you make something to increase the production capacity (e.g.

equipment, buildings, factory, etc.) in the future.

K = (K - ∂) + I

t+1 t t

(where ∂=depreciation)

Innovation rarely occur by chance: investment in R&D are needed, investment devoted to

improve the way you use materials, make processes, etc. so basically you are using resources

to expand future production capacity.

The most important form of investment is the investment in human capital (knowledge and

education): the higher the knowledge, the higher the level of productivity.

Basically, investments:

- Accumulation of capital;

- Improvement of technologies.

In market economies, there is not a central entity telling to invest to individuals or individual

firm; but investment decisions are made anyway because people expect a return (e.g. we go to

university to have a higher wage). Investments take place as long as we have a reasonable

expectation of return. But who pays the return? Companies can pay higher wages because they

have higher productive people so they are producing and having more.

Also at the aggregate level, the incentive to make investment comes from the expectation of

having higher return.

But there are important constraints: you have to be able to make the investment (the return

will be later) and what allows investment to occur are savings (=someone is consuming less

than its income e.g. in our case they are our parents). In advanced country you will have a

government loan (the government is saving) to let you go to university and you will return the

loan when you will start working: the government do it as an investment to increase the level

of productivity.

Financial markets collect savings and provide them to the part of the economy that now is

investing or consuming more. Investments are made of savings (S=I from a financial point of


Savings can occur for many reason with if you decide to put them in a bank (financial assets,

you make a financial investment) it is because you expect a return from the investment that

will be financed with your savings. 23

To grow we need someone who finance the investment: if an economic system has adequate

savings capability is fine but it may not save enough to make investments (when economic

system is very poor). GDP=C+I+G+(EXP-IMP)

(EXP-IMP) = 0


GDP-TX-C=S (private savings)


Balanced budget = (G-TX) =0

S =I

à PR

If G-TX>0

=I+ government deficit


Government have to sell bonds to finance the deficit and part of the saving goes to finance the

deficit. If the government has a surplus (public savings): G-TX<0

S =I – government surplus (S )


If the government is not saving but balance his budget (S = I) and you do not have enough


domestic savings, your investments can be financed by the difference between IMP and EXP. So

you can borrow from the rest of the world (foreign debt) to finance your investments:



(where IMP-EXP is the foreign debt).

Same if you cannot create technological innovation, you can import them having a debt with

the rest of the world (you borrow from the rest of the world if you cannot pay for it).

Typically, in a very poor country with a low level of GDP, almost everything that is produced is

consumed since it is necessary for the population to survive. So if a country is poor, it is very

likely to remain poor if it is not able to squeeze consumption enough or produce more;

alternatively, you can borrow from the rest of the world.

To increase private savings, it is possible to reduce taxation but in this way you are just using

public savings (that decrease) to increase personal savings: you are just shifting it. An

international institution is necessary to finance growth. (Same after the war, to rebuild the

world external finances were necessary).

To make countries grow you have to make investment, to make investment you have to be rich

enough, otherwise you can lend from outside. The World Bank finances only investment

projects, not imbalances.

Reduce the number of countries that have imbalance (I = S + IMP – EXP) is a public good.


Some countries can grow with help and can become potential lenders. A normal healthy

corporation is happier to face a rich market because it can sell more so there is a public good

effect of growth at the world level: poverty is in nobody’s interest. There are potential negative

externalities given by poverty, for example, the migration issue: also from an egoistic point of

view, fighting poverty is good.

The role of the World Bank is to promote investments in developing countries, because savings

might not be enough. There are specific market failures in developing countries that may break

the growing mechanism. 24

‘Solow Model’

The model introduced is called the made by Robert Solow, who won the Nobel

prize. GDP=f (K, L)

For sake of simplicity, we assumed only two factors of production that are combined to produce

output for the economy. If we increase the amount of K or L, we expect a higher amount of

output (first derivative is positive); but the second partial derivative is negative meaning we

have declining marginal revenues.

According to Cobb-Douglas: ¨ ª



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Corso di laurea: Corso di laurea magistrale in ingegneria gestionale
A.A.: 2018-2019

I contenuti di questa pagina costituiscono rielaborazioni personali del Publisher franciig_ di informazioni apprese con la frequenza delle lezioni di International Markets and European Institutions e studio autonomo di eventuali libri di riferimento in preparazione dell'esame finale o della tesi. Non devono intendersi come materiale ufficiale dell'università Politecnico di Milano - Polimi o del prof Tajoli Lucia.

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