The following points highlight the three main factors that check capital absorption in under-developed countries.
Factor # 1. Lack of Complementary Factors of Production:
In an economy, production is the result of various inputs like land, labour, capital and entrepreneur.
Under-developed countries generally lack in latest technology, skilled labour and entrepreneurial ability.
The scarcity of these factors tends to decline in the marginal productivity.
If capital accumulation takes place, the supply of complementary factors of production starts increasing simultaneously. Therefore, if any factor which puts any limit to the capital absorption capacity, is the lack of complementary factors of production in backward and under-developed countries.
Factor # 2. Inflationary Forces:
The absorption of capital is also hindered by the inflationary forces in an under-developed country. Generally, these countries are more prone to inflation than the developed countries. Whenever a light dose of investment is made either out of corporate savings or credit creation it is likely to lead to inflation.
The governments of these countries find it difficult to control inflation as they do not resist the growing pressure of demand for more social welfare services. Again, market imperfections also add fuel to the inflationary forces.
Sometimes, it is felt that moderate degree of inflation is desirable but once it starts, it becomes difficult to limit it to a moderate amount. Inflation breeds inefficiency in production and misdirects the resources from productive channel towards unproductive channels.
Factor # 3. Maintenance of Balance of Payment Equilibrium:
The development process of an under-developed country involves the need of foreign exchange to pay for their heavy imports. In other words, the rate of economic development depends largely on the extent of export and import capacity of a country.
If imports exceed exports, it upsets the balance of payment equilibrium, thus making it unfavourable. Besides, unfavourable balance of trade causes much scarce supply of foreign exchange needed for capital imports to be dissipated on luxury imports to the disadvantage of the development programmes. This is not the end. Sometimes, rapid rate of production of exporting goods.
This discussion confirms that less developed countries possessed limited capital absorption capacity. However, in the opinion of ‘Meier’ and ‘Baldwin’, the rate of development must be influenced by consideration of maintaining a balanced relationship between the creation of exports plus the receipt of foreign investment and the requirement of imports plus the saving of foreign investments.
Therefore, the country should tend to encounter balance of payment problems.