Financing Development from Domestic Resources

Real capital formation from domestic resources requires investment and a commensurate increase in the volume of real saving. In the absence of international trade and foreign borrowing, capital formation is only possible through abstinence from present consumption and when society produces a surplus of consumer goods sufficient to meet the needs of labour engaged in producing capital. In a subsistence (Robinson Crusoe) economy, saving and investment are simultaneous acts, in the sense that if a producer is to develop the means of production he must sacrifice time and resources which would otherwise be used for consumption purposes. In a money exchange economy, savings and investment may be undertaken by different groups, and the process of capital formation is likely to require some form of finance and credit mechanism to ‘redistribute’ resources from savers to investors. In fact, in the early stages of development savings may not be the major barrier to capital formation but rather the unwillingness or inability to invest. The unwillingness to invest may stem from cultural attitudes or simply from a realistic assessment of the risks involved. The inability to invest, on the other hand, may result from shortages of factors of production and supplies necessary for particular types of capital formation that would be profitable. In short, in the transition from the subsistence to the money economy, the main obstacle to capital formation may not be a shortage of saving but bottlenecks in the productive system which do not permit investment or make it too risky. One of the ways of overcoming these bottlenecks is through international trade and foreign borrowing.