IB Economics/Development Economics/Barriers to Economic Growth

5.3 Barriers to Economic growth and/or Development

Poverty cycle

Low incomes --> Low savings --> Low investment --> Low productivity --> low income...

Absolute poverty: inability to just meet basic physical human necessities/needs of food/nutrition, clothing, health and shelter in order to survive

Because this is so difficult to measure accurately, many researchers simply estimate that 20% of the world’s population falls below this line
UNDP reports that most live in 10 countries, with the proportions falling below the poverty line in brackets: Bangladesh (80%), Ethiopia (60%), Vietnam (55%), Philippines (54%), Brazil (49%), India (40%), Nigeria (40%), Pakistan (29%),Indonesia (24%) and China (10%)
A characteristic of most LEDCs is the unequal distribution of income
What is interesting is the middle income LEDCs appear to have greater income inequality than very poor or high income countries
Income inequality is greatest in Latin American countries

Relative poverty: a poverty measure based on a poor standard of living/low income compared to the rest of society

Suggests that the lack of ACCESS to many goods and services expected by the rest of the respective society leads to social exclusion and damaging results for the individuals and families mired in relative poverty

Rural Poverty

Most poor people are found in rural areas: farmers with small holdings, landless peasants, artisans, fishermen, nomads and indigenous people - the poor are not idle, they work hard
Those with a traditional way of life are not necessarily poor - for thousands of years they adequately sustained themselves - it is only recently that they have become poor due to policies which have deprived them of the means of earning a living (land, fisheries, hunting ranges, forests)
Poverty in city slums is highly correlated with poverty in the countryside and is linked through migration
Women are often the poorest of the poor, as men control most of the land, capital and technology, and receive a better education in most countries - this can have a major impact on population control

Investments in infrastructure, social services, and technology in rural areas can go a long way to helping those mired in the poverty cycle

Human Suffering Index (HSI) has been developed which looks beyond HDI

Composite indicator, linking ten measures of human welfare - income (GDP/capita), inflation rate, life expectancy, demand for new jobs/urban population pressures, infant mortality/infant immunization, nutrition/daily calorie supply, access to clean water, energy use/telephones/1000 people, adult literacy/secondary school enrollment, and personal political freedom/civil rights
HSI numbers are worst in Mozambique (93), followed by Somalia, Afghanistan, Haiti, and Sudan. Most of these countries also have high population growth. The most comfortable countries are Denmark (1), the Netherlands, Belgium, Switzerland, and Canada, which have low population growth. Total scores of 75 or greater (extreme human suffering) occur in 37 countries (20 in Africa, 16 in Asia, and Haiti) with 8% of the world's population (432 million people) (2002)
It is estimated that 75% of the world’s population live in countries where the human suffering index is over 50%
It is estimated that 1 billion people live in desperate poverty
HSI numbers are comparatively worse off now than just five years ago

Case study: Kerala State in India This is a region with low income and yet a reasonably high standard of living because of the emphasis on human development:

The society is very international in its approach, and is not afraid of new ideas and methods of doing things
Women have a high status in the society due to the matrilineal system of passing property from mother to daughter rather than from father to son
With greater wealth and income in the hands of women, the child mortality rate is low, and spending on health, nutrition and education for children has been very high: the illiteracy rate is very low
There is a strong interest in community economic development and the institutions which promote community welfare such as cooperatives and community associations
The result is strong representation for labour in the workplace, excellent health standards and low prices on food which result in very little malnutrition

Reducing Poverty

The trickle down theory is associated with the concept that inequity is inevitably a part of economic growth, but after a period of rapid growth, greater equity and poverty reduction will occur
Studies have shown that income distribution does appear to worsen at first
However, the evidence indicates that rapid growth does not appear to have eradicated poverty which is surely the aim of growth in the first place
Furthermore, as income rises for the few who are lucky, their consumption pattern tends to dominate the location on the production possibility curve, more luxury goods rather than necessities are produced

The elite may not contribute that much to growth
They often import luxury goods rather than invest domestically - this is very different from the historical pattern for the MEDCs
Often there is capital flight: elites may invest in overseas bank accounts, property or investment opportunities
Brain drain occurs when those in skilled positions (e.g., doctors, engineers, architects, university professors) leave and work abroad for higher pay/increased opportunities

Stimulating Growth while Reducing Poverty

Growth needs to be targeted at those sectors which will reduce poverty
Raising the income of the poor will lead to increased consumption of necessities which are produced within the country
This stimulates investment, incomes and jobs and leads to improved health and education which, in turn, increases productivity
R&D should be directed toward appropriate technology rather than to the transfer of labour saving technology from MEDCs

Institutional and political factors

Ineffective taxation structure

Taxation is often a difficult problem in LEDCs:

In many countries very little tax revenue is collected and government is forced to raise revenue by printing money or imposing export tariffs which inevitably reduces the incomes of rural people because most LEDCs export raw materials and agricultural products
A proper income tax system can provide the revenue for govt. and reduce inequality by making the wealthy pay a fair share for running the country
Greater tax revenue also allows the government to provide basic infrastructure for the poor such as better health care, better schools, provision of clean water, sanitation, and electricity and more reliable road systems (infrastructure)
Laffer Curve

Price Distortions

Prices are often distorted due to subsidies or a strong union sector which is able to extract high wages from foreign multi-nationals
A return to market prices is essential so that correct signals can be sent to allocate resources according to true scarcity: for example, lower wages would lead to greater employment
Government subsidizes capital through tax breaks, grants and low foreign exchange - this lowers the price of capital artificially and leads to substitution of capital for labour

Lack of property rights

And rule of law in general, including reasonable, predictable contract enforcement
No clear title to real property (land, houses) and high-value assets
Inheritance of property often cloudy
Capital gains from sales often subject to negotiation, thus not predictable

Political instability

Important to attract FDI
Important that the next government assume the debt obligations of outgoing government
Rule by the will of the people OR for the government in power - who is the government working for?

Corruption

An issue worldwide; many different forms; some quite subtle in nature
Most involving bribes for getting imports into a country or in bidding on government contracts
Transparency International

Unequal distribution of income

Redistribution of assets often does not happen or does not happen fairly (transparently)
If the most important cause of inequality is an unequal distribution of land, natural resources and capital, attempts must be made to redistribute at least some natural resources such as land
Land reform can often lead to a dramatic increase in farm productivity and incomes for the rural poor
Children of the elite have greater access to education and to the best jobs:

Policies to open access to education for the poor, to reduce absenteeism and improve the quality of education can lead to great increases in productivity

Gini coefficient/Lorenz Curve

Formal and informal markets

Percentage of population engaged in a money economy v. subsistence/barter economy
The less informal markets operating, the more grasp on the macroeconomy the government has

Lack of infrastructure

Important to attract FDI
Key to allow access to markets, schools, hospitals, wider world (even if just the capital city/urban area)

International trade barriers

overdependence on primary products
consequences of adverse terms of trade
consequences of a narrow range of exports
protectionism in international trade

International financial barriers

International finance & indebtedness

Economic development has been promoted since 1960 as the best route for LEDCs to follow, justifying borrowing from banks to spend on projects:

The risky nature of lending to LEDCs requires: higher interest rates, much more expensive than the rate charged by the World Bank or aid agencies
Stock of debt: the ratio of debts to exports has averaged 125% to 150%
Debt servicing flow: includes interest payments and repayments of principal, and often exceeds 40% of exports for certain poorer LEDCs

Causes of the Debt Crisis

In 1973 and 1979 OPEC increased the price of oil dramatically:

Oil rich countries looked for the highest rate of return on investments
The international banking community started lending this money to LEDCs
While the nominal interest rates charged were high, once inflation had been taken into account, the real interest rates were very low leading to an explosion in LEDC borrowing
Those LEDCs which did not have oil, were now faced with vastly higher costs for fuel, input costs rose dramatically hurting exports

Since 1935 most industrialized countries have been off the gold standard
Governments started inflating in the early 1960s until 1976 when inflation rates reached high levels in the MEDCs:

Loanable funds were available at low interest rates to lend around the world
LEDCs were accustomed to ‘soft’ loans from international agencies such as the World Bank which lent at low rates of interest
Commercial banks charged full market rates on 'hard' loans

By 1979 most OECD countries decided to stop inflating:

Interest rates rose dramatically, particularly on short term commercial paper
More than 50% of LEDC debt is short term in nature, the interest rates being charged to LEDCs reached crisis proportion
With the shortage of money, oil rich countries started taking their cash out of the bank to be used in their own countries
No more loans were available for anyone including LEDCs
As incomes in MEDCs fell so did imports from LEDCs worsening their balance of payments difficulties
Elite groups in LEDCs panicked and there was capital flight:

It is estimated that 30% of all borrowed funds, usually in a hard currency, ended up in bank accounts outside the borrowing country

Poor project evaluation

MEDC banks were only interested in securing loans through government guarantees, there was little checking of the projects the money was to be used for
Much of the borrowed money had been wasted on military arms or projects which did not have any hope of paying interest on the debt or ever repaying the principal
Many LEDCs printed money to cover the deficits which led to extremely high rates of inflation in some countries

Rescheduling & Restructuring

LEDCs were unable to service their debts and were forced to reschedule
Loans were renegotiated with lenders, extending the terms of repayment
LEDC governments have been forced to make major structural reforms under instruction from the IMF in order to qualify for rescheduling:

Market mechanisms: supply side measures increase output and investment
Devaluation of the currency: devaluation should lead to greater exports and fewer imports unless both domestic demand for imports and external demand for exports are inelastic
Deflation: tight monetary and fiscal policy reduce government deficits, inflation and eventually interest rates

LEDCs which are able to lower their debt servicing experience some benefits:

Lower inflation which stabilizes the exchange rate and creates enough confidence that the elite repatriate money lost through capital flight
Domestic interest rates fall leading to greater domestic investment and an improvement in the economy

Restructuring simply extends the length of the repayment problem, it does not eliminate the debt:

LEDCs simply lack the exports needed to earn the foreign exchange required to service the debt
The only hope of getting out of debt is for MEDC economies to expand rapidly leading to major increases in imports from LEDCs
Most of the debtor nations are faced with years of economic deprivation in order to meet their debt obligations
Domestic policies that lead to overvalued currencies encourage imports and discourage exports creating strong pressures to seek more loans to support the country until the next crisis
If the money had been invested in projects which earned a rate of return which could have paid the interest plus repaid the principal, there would have been few problems

Non-convertible currencies

Capital flight/brain drain

Social and cultural factors acting as barriers

religion
culture
tradition
gender issues

Periods of economic growth are associated with structural transformation and social and ideological changes. In the past, 1/3 of growth came from population increases and 2/3s from productivity increases
Productivity increased due to technological change in terms of capital and human skills, encouraging research and development which led to further growth
The rise in income led to increased consumption:

Demand for income elastic industrial products rose quickly
Demand for income inelastic agricultural goods grew only slowly
This led to a rapid rural-urban shift which often destroyed traditional values

Current Conditions facing LEDCs

Many LEDCs are not truly nations, they are artificial creations of former colonial powers

Have not had enough time to adapt to modern concepts such as science, individualism, economic mobility, and the work ethic

Political dependency has been replaced by economic dependency:

Technological transfer is controlled by MNCs and trade and finance are dominated by MEDCs
Many LEDC natural resource endowments require western capital and knowledge to exploit them
Populations are much larger, population densities greater, and education levels lower than they were for MDCs during their period of industrialization
The terms of trade have moved steadily against the LDCs because they export mainly raw materials with little value added

LEDCs have little scope to develop new products or techniques of production, the expertise in the MEDCs is overwhelming:

Most R&D is concentrated in MEDCs
Most technology is labour saving which may not be of great use in countries which have a large labour force looking for employment

Where LEDCs try to add value to raw materials they are faced with high tariff barriers in the MEDCs which are trying to preserve jobs
Growth does not necessarily proceed without interruption. It requires social legitimacy:

When Argentina took off, Juan Peron carried out measures that were popular with his constituents, such as price control of food grains and enlarged military expenditures, but that stifled growth and divided society into sharply contending classes
Iran's oil wealth, far from being a source of stability, increased the alienation of the great majority of the people who felt that the nation's wealth was being monopolized by a corrupt few

Population Birth and Death Rates

The natural increase in population is the birth rate minus the death rate
The pre-industrial era was characterized by high birth and high death rates leading to a slow growing population

Birth rates in LEDCs are much higher than in MEDCs during the comparable period of development: a larger proportion of women marry and do so at a younger age (leads to larger families)
For many developing countries the birth rate remains high while the death rate falls - studies suggest that developing countries today are moving through this phase more rapidly than MEDCs
Eventually the birth rate also declines, until low birth and death rates lead to low and stable population growth again
For MEDCs population growth rate is 0.5% and for LEDCs it is 2% (2003)
Studies indicate that more even income distribution contributes to a more rapid fall in the birth rate
In those LEDCs with high poverty levels, birth rates have remained much higher than for MEDCs: there is a correlation between high birth rates and low GDP per capita

Death rate: as countries develop the death rate drops very quickly due to:

Sanitation: there is a reduction in infant mortality due to better sanitation, cleaner water and basic health knowledge
Health care: there is a reduction in mortality from disease because of better health care systems
Agricultural production: as food production increases deaths resulting directly or indirectly from malnutrition fall

Survival rate: as the survival rate for children increases there is a rapid increase in children as a proportion of the population, savings and investment rates fall:

This increases dependency rates within families, per capita income falls as unproductive children are housed and fed
Children under 15 form 25% of MEDC population and 50% of the LEDC population which leads to a high dependency ratio of non-workers to workers
Because of the young population, fertility rates are very high and birth rates increase yet again: healthier, better fed women have a greater capacity to give birth to a healthy child

Population: Policy Options

After the last ice age, 13,000 years ago, world population was 100 million
By 1790 this had increased to 1.7 billion, and current estimates place world population at 6 billion - the latest findings show a very rapid decrease in population growth rates to the point where it is now expected that population will stabilize at about 7.5 billion by 2040, much lower than original estimates of 12 billion by the year 2075

Optimal Population Levels

Sub-optimal levels: there is not enough labour to utilize the available resources to the maximum potential
Above optimal levels: diminishing returns set in as there is too much labour
However, natural resource discoveries and increases in productivity: will increase the optimal population level
Preference for additional children depends on the number of surviving children and the costs and benefits of those extra children
Costs are dependent on feeding, clothing and education, plus the opportunity cost of the mother’s time
Benefits include the need for children to help with the farm or small family business, the security in old age, and particularly during periods of prolonged sickness

Slower population growth: can be achieved through family planning by women:

Social security: if there are pensions and support during illness, there is less need for a large family
Effective birth control: whether through chemical or mechanical means or through birth spacing through extended breast feeding
Higher female employment and greater schooling for both men and women leads to lower fertility rates
Meaningful work for women: women have an alternative way of achieving fulfillment other than having children

Financial costs of having children:

There are reduced opportunities for children to earn income in urban settings due to enforced schooling and fewer less skilled jobs, plus the opportunity costs of the parent's time rises
Higher incomes seem to encourage fewer children with more invested in each child
Mass sterilization: created much hatred and severe backlash

Slower population growth is better:

Savings rates rise: families save more and govts. spend less on social services
People invest more in human capital: it is more worthwhile if there are fewer children and they are likely to live longer
There is more investment in infrastructure
There is less deforestation and erosion of soil

Ecological Footprint

The US with 6% of the population in the world uses 40% of the world’s resources, and India with 17% of the population uses 4% of the world’s resources
Population densities: Are very low in most African and South American countries, and are very high in many developed countries
If MEDC populations are adjusted to include their ecological footprint, the real populations and population densities are even higher:

For the US using 6.7 times the world average of resources per person: 1,900 million people
For India using 0.25 times the world average of resources per person: 212 million people

Malthusian approach: the law of diminishing returns suggests that the world will run out of resources in the face of the rapid increase in population
Demographers find that the big increase in population is over - while the long term effects will lead to increased populations in the future, the growth rate has already started to stabilize and will reach replacement level by the year 2050
While resources have been fixed, the gains from specialization, economies of scale and learning by doing have more than outweighed diminishing returns in the last 100 years
There does not appear to be a clear correlation between birth rates and per capita income - death rates have fallen quite independently of incomes
It appears that a more equitable distribution of income, greater literacy for women, and more job opportunities for women results in a lower population growth rate

Agriculture & Rural Urban Migration

It is estimated that in MEDCs, 27% of the population lives in the rural sector with possibly as much as 5% involved in agriculture
In LEDCs the figure is 66% living in rural areas, with nearly 70% involved in agriculture
Many of the most severe development problems arise from a weak agricultural sector - growth through the agriculture sector has not led to increases in per capita income
On the demand side:

The growth potential in the agricultural sector is limited because income elasticity of demand for food is close to zero, growth is much more rapid for industrial goods and services.
Primary exports form the major source of foreign exchange earnings for LDCs, and yet the proportion of primary sector goods in total world trade has fallen from 33% in 1950 to 21% in 1995.

On the supply side productivity in agriculture is very low:

Increased use of machinery and new methods of raising crops have made it possible for an individual farmer in the US to produce enough food to feed 50 families
Farmers in LEDCs are hard pressed to support one other family beside their own
Severe droughts and famines occur on a regular basis
The oil crisis led to a large increase in energy costs raising the cost of food, while poor people in urban areas spending 80% of their incomes on food could not afford a 100% increase in price
Government often imposes price controls which help the urban poor but hurt the farmers

The potential for growth through industrialization is much greater, so governments invest in infrastructure in cities and subsidized capital
As a result, food processing can be done much more cheaply by shipping unprocessed food to the cities: even less value added is left in rural areas

Unemployment & Rural Urban Migration

As government pours money into urban housing, education, food subsidies, health care, and infrastructure, people migrate to the cities, and then government pours even more money into the cities to prevent rioting
The official unemployment rate in LEDCs tends to be higher than for MEDCs; however, if disguised unemployment and underemployment figures are included, there is a very serious unemployment problem in LEDCs
Disguised unemployment: people are working but producing very little (marginal product is close to zero), each member of the family is trying to share in the total output but has very little to add to production
Underemployment occurs where people who would like to work full time only work part time each week, or for only a few months each year (or work in a job in which they are overqualified)

Urban Employment

If investment has been concentrated in industry, enough capacity may be created to absorb labour which is surplus to the agricultural sector
Rural wages equal the average product of farm labour in the farm household, this is at subsistence level because there is a great deal of surplus labour and much underemployment
The supply curve of labour to industry is elastic up to the point at which the withdrawal of labour can no longer be accomplished without a decline in agricultural productivity: all the surplus labour has been removed
Industry only has to pay slightly more than subsistence level to attract labour to manufacturing jobs in the cities
A large part of the population can leave without any reduction in farm output
The problem occurs if the urban sector is small relative to the large rural sector and there is not enough capacity to absorb the surplus labour
Often investment has been capital intensive (labour saving) which means there are few jobs available, particularly for the unskilled rural worker
Even if there is only a 20% chance of getting work, or if there is only part time work available for 20% of the year, young people are still attracted to the city if the urban wage is five times the rural wage
If a rural area suffers from drought every few years, the lifetime income expected from staying on a farm could be less despite the prospect of many years of being only partially employed in the city
Studies indicate that most migrants do find work within 2 months of reaching the city: most are young with better education which enhances the prospect of finding employment in the city