Vicious Circle Of Poverty. The low capital formation in UDCs is attributed to vicious circle of poverty which operates in UDCs. It is because of VCP the incomes, savings, investment and productivity of the people remains limited and obstructed. In such all situation when savings remain lower the investment and capital formation will also remain lower. The lower capital formation leads to lower productivity in agri. and industry. The lower productivity means the lower incomes. In this way, the circle of poverty and stagnation remains operating keeping the poor countries poor, and reducing the possibilities of capital formation.

2.       High Birth Rates. In case of poor countries not only the volume of population is very high, but the rate of growth of population is also significantly greater. In such situation all of the incomes have to be devoted to the rising number of children and nothing is left to be allocated for savings. Moreover, in the economies like ours the ratio of dependants is very high leading to poor incomes and savings. The average age in these countries is very low and people are sluggish not fond of working very hard. Thus, due to number of demographic problems the savings, investment and capital formation remain obstructed. Again, the illiteracy, joint and extended family system, and inability to perceive regarding future needs are also the factors which are keeping savings and capital formation at low level.

3.         Hoarding. In case of LDCs most of the people keep their savings idle in the form of hoards in their houses. As the people living in rural areas spend their tiny savings to purchase the lands. While the act of purchasing the lands is nothing more than the change of hands, and it has nothing to do with capital formation. The women whether living in rural areas or in urban centers are highly found of ornaments, perhaps because of prestige. Accordingly, the savings are ‘diverted to purchase the gold. Such action in no way is capital formation. According to an estimate 13 % of GDP is being possessed by them in the form of

gold and precious stones. If such hoarded money is used it may lead to an appreciable rise in national income of these countries.

The people living in urban centers are highly interested in palacious and conspicuous consumption. Again, they replough their savings in business and commerce, rather in manufacturing. It is because of greater return and involvement of short period of time in such investment. Above all in these poor countries, a greater proportion of savings is diverted in the purchase of prize bonds, property, shopping plazas and foreign exchange — – all such in no way represents capital formation.

4.         International Demonstration Effect. According to Prof. Nurkse the biggest obstacle in the way of capital formation in UDCs is the existence of ‘International Demonstration Effect”. It means that the people of UDCs have the desire to attain that standard of living which has been attained by DCs; their consumption pattern must be similar to those of DCs, and their educational systems must be like those of DCs. In such situations, perhaps because of snobbery, the people of UDCs spend all of the increases in their incomes on consumption needs. Accordingly, in these societies the propensity to consume has gone very high (contradicting Keynes psychological law of consumption). In this way, the propensity to save remains low leading to a low capital formation.

But the critics are of the view that international demonstration may also affect savings, incomes, investment and capital formation positively. Through international media when people of UDCs come into contact with their rich counter parts they may try to improve their skill, expertise, working style, educational system, research and training etc.

In this way, the greater goods can be produced in greater amount. Such all will provide a way for capital accumulation.

5.         Lack Of Proper Infra—Structure. In case of UDCs there is an acute shortage of social overhead capital like power, transport, communication, and other economic  overheads. Thus in the presence of inadequate infra—structure the domestic as well as foreign investors ále not prepared to invest. With this the stock of capital and capital

formation remain low.

6.         Lack Of Entrepreneurial Abilities. The entrepreneurs are considered as the focal points in the process of economic development. But in case of LDCs the small size of market, deficiency of capital, reduced access to financial institutions and discouragement of entrepreneurial abilities are the factors which retard the entrepreneurs and their initiative.

Accordingly, the capital formation remains low.

7.           Unproductive Expenditures. In case of UDCs the lavish expenditures are made on unproductive fields, both by individuals as well as by govts. The individuals waste their precious savings by spending them on traditions, customs and litigations etc. While, govts. make expenditure on unproductive fields either due to traditional budgeting methods, or due to political purposes. Consequently a little surplus is available for capital formation.

8.           Unequal Income Distribution. In case of UDCs the incomes are unequally distributed. The people with high incomes, rather savings and investing spend them on the unproductive fields like gold, real estate and foreign currency. While majority of the population with the poor income is unable to make savings. Thus on the whole the savings, investment and capital formation remain at the lowest level.

9.           Inflation. In case of UDCs the inflation is a very common phenomenon. Because of persistent and appreciable rise in general level of prices the real incomes of the people decrease restricting their saving potentials. Again, in these countries the indirect taxes are imposed in a greater amount, rather direct taxes. This situation also discourages the saving potentials of the people. In such situation, the poor and middle class of the UDCs hardly contributes to savings and capital formation. On the other side, the direct tax system is a relic of colonial period. The businessmen and industrialists are always found hectic regarding tax evasion. All this leads to cumulate the ‘Black Money’ which is normally diverted in the unproductive fields. Such expenditures promote inflation and unequal income distribution in the economy. They hardly contribute to capital formation of the poor


10.       Market Imperfections. In case of LDCs the market imperfections and price distortions play an important role and the market mechanism becomes inefficient. The mobility of labor remains limited leading to raise the wage differentials between the wage earners. The labor are hardly aware of with the employment opportunities. In such situation the optimal factor combinations are hardly attained. The big firms get monopolies and they often outcompete the small firms. The failure to compete with the big firms on the part of small firms means the lagging industrial structure. In such situation, the UDCs will go on depending upon imports wasting the foreign exchange. Moreover, in the presence of market imperfections when the costs of production would be higher the exports would

remain low.

As a result of combined behaviour of all above mentioned factors the incomes, savings and capital formation remain low in UDCs.

 11. Problems Of Money Markets. For the sake of capital formation big funds are required which are often raised through money markets. The money market consists of central bank, commercial banks, specialized financial institutions, development finance institutions, cooperative banks and money lenders etc. But money markets in UDCs are classified into organized money market and unorganized money market. The organized money market is available in the urban centers, which advances loans and accepts the deposits from the urban people linked with business, commerce, industry and services. In such market the rate of interest is artificially kept low, and there is a greater use of cheques and drafts etc. But such all is for a limited segment of the society. On the other hand, the unorganised money market which is existing in the rural areas is comprised of Mahajans, money lenders, landlords, feudals, friends and relatives etc. In such market the rate of interest is higher. The payments of loans are also made in the form of grains. The transactions are often kept secret. The peasants and the small farmers are the main borrowers in such market who often borrow limited amounts. It means that there exists financial dualism in UDCs.’ The monetary policy becomes least successful. The financial institutions dominated by bureaucratic hold often bypass the rules and instructions given by central bank. The commercial banks are highly unionized and they prefer to advance loans for business and commerce, rather for manufacturing where the return is low and risk is high. The money lenders charge extra-ordinary high rate of interest, thus exploit the poor farmers. The political interference is often observed in case of lending activities. In such situation, the role of money market in capital formation remains pervasive and slow.


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