Role of Money in Economic Development

Role of Money in Economic Development of The Developing Countries –

Generally it is believed that the economic development of a country depends on the growth of real factors like capital accumulation, technological progress and increase in the quality and skills of the labour force. This type of view doesn’t express the role of money adequately in the process of economic development. It is said and mostly believed that money is a mere veil and intrinsically unimportant. What matters is the real goods and productive factors which money buys. But in the modern time this extreme view is not believed. Now in the modern economic time money is an important factor, without it the present complex economic system is impossible.

Money serves as a standard of value, store of value, standard for deferred payments and most importantly it serves as a medium of exchange.

A monetary economy is an economy in which goods are sold for money and money is used to buy goods.

1. Money promotes Productivity and Economic Growth –

Barter system was full of problems such as double coincidence of wants, lack of standard unit of account, impossibility of subdivision of goods etc. which were the hurdle in specialization or division of labour and were keeping the economy from growing. Division of labour or specialization increases the productivity which in turn promotes the economic growth. Money made the specialization possible which increases the productivity and promotes the economic growth.

2. Money promotes Savings and Investment –

In the barter system, the goods which were not consumed were the savings as well as investment, means, investment and savings were the same, which made investment depends on the savings. But in the modern economy this is not the case, money made the investment independent of the savings. In the modern economy individuals or households saves the money and the firms invests the money in capital goods, so, now investment is different from savings. In a monetary economy, investment can be greater than the savings, which is possible because the government or Central Bank of a country can print money and increase its supply in the economy. Which further leads to more employment, more output, more income, more consumption, more saving and more investment. And this accelerates the economic development.

3. Money Invested in Quick Yielding Projects –

It is mostly believed that any increase in money supply in the developing countries would lead to the rise in prices or cause inflation in the economy. But this is not always true. A reasonable or required amount of newly printed or created money helps the development of the economy by increasing the level of investment. In developing countries a lot of natural and human resources lie unutilized or underutilized which can be used for productive purposes. If the newly created money is used for investment in projects such as flood control, land reclamation, irrigation works and cottage industries which yields quick returns, then the problem of inflation will not be there. These projects will increase the production of essential consumer goods in the short run and will prevent the rise in the prices.

4. Money and Inflationary Financing of Economic Development –

According to Lewis, In an economy marked by scarcity of capital and abundance of labour and idle natural resources, creation of credit or bank money would lead to the increase in capital accumulation in the same way as does a more respectable source, that is, savings out of profits.

According to him, capital formation resulting from a net increase in the money supply would be accompanied by rise in prices. But it will be for a short time. When the modern sector expands by more capital formation and surplus labour employed in it is paid out of the created money, the immediate effect would be rise in prices. When the purchasing power in the hands of workers immediately increases, the output of the consumer goods remains constant for a time. But when the newly formed capital created by credit money is put to use, the output of consumer goods also increases. So, after a time lag output of consumer goods catches up with the increased purchasing power and the prices would start going down.

5. Monetization and Economic Growth –

It is well known that the most underdeveloped countries have a large non-monetized sector where production is for the purpose of subsistence only. To break this subsistence nature of the economy activity and promote economic growth, its monetization is required. Money helps the subsistence sector to connect with the modern sector, this connection helps the subsistence sector to expand its output. To obtain the products of the modern industrial sector the people engaged in the subsistence sector will make efforts to raise their output. So, a surplus of output over their self-consumption will be generated, which will break the subsistence nature. This is supported by the history, during the colonial period, the monetization of the peasant sector led to the expansion in exports in exchange for the imported industrial products.

The monetization of the subsistence sector also helps in raising the volume of savings. Monetization will connect the subsistence sector with the financial institutions, this provides the opportunities of earning more income through interest on saving and this also raises the propensity to save of the people in the subsistence sector.