4.3.2 Factors influencing growth and developement Flashcards
Impact of economics factors in different countries:
- primary product dependency
- volatility of commodity prices
- savings gap: Harrod-Domar model
- foreign currency gap
- capital flight
- demographic factors
- debt
- access to credit and banking
- infrastructure
- education/ skills
- absence of property rights
Primary Product Dependency PPD
Primary products include agriculture, mining etc.
A large amount of most developing countries economic activity is based of a primary product. These cause issues for a number of reasons:
● Natural disasters can wipe out production of the primary product and so means that farmers are left with no income. They are often non-renewable, which means the country will suffer when they run out of the product.
● They tend to have a low-income elasticity of demand, which means as people get wealthier, they don’t continue to increase the amount of primary products they buy whereas they are likely to increase their demand for manufactured goods. The Prebisch Singer Hypothesis suggests the long run price of primary goods declines in proportion to manufactured goods, which means those dependent on primary exports will see a fall in their terms of trade. However, in recent years, there has been a rise in the prices of some key commodities, such as food and a fall in prices of some manufactured goods due to the expansion to places like China.
● Another issue caused by this is the Dutch disease. This is when a country becomes a significant commodity producer in a short amount of time, causing an increase in demand for the currency (to enable people to buy the goods) which pushes its value up. This increases export prices and leads to a reduction in competitiveness of the economy, causing a fall in output in other areas. This occurred for the non-oil sectors in Venezuela and Nigeria.
● Some countries have been able to use primary products to develop, for example Saudi Arabia and oil. It is suggested that countries should use primary product revenue to invest in manufacturing etc.
● Not all primary products have a low income elasticity of demand, for example diamonds.
● One example of a country that suffers from this is Ghana. Gold, cocoa and oil account for 75% of their total exports and they had to ask the IMF for a loan in 2014 due to their unsustainable balance of payments deficit. (IMF website)
Volatility (of commodity prices)
Primary products tend to have inelastic demand and supply curves which means relatively small changes in demand or supply leads to huge fluctuations in price.
These large changes in price mean that producers’ income and the country’s earnings are also rapidly fluctuating, making it difficult to plan and carry out long term investment as well as meaning that producers can see their income fall very rapidly, causing poverty.
● When prices of commodities rise for a number of years, there tends to be over-investment in the production of the commodity causing long term risk when the price eventually falls.
Savings gap
● Developing countries have lower incomes and thus they save less. This means there is less money for banks to lend, reducing borrowing and thus reducing investment/consumption. A savings gap is the difference between actual savings and the level of savings needed to achieve a higher growth rate.
● The savings rate in Africa is around 17% of GDP compared to 31% on average for middle income countries (Tutor2u). India is another country with a low savings as a share of GDP.
● The Harrod-Domar model suggests savings provide the funds which are borrowed for investment purposes and that growth rates depend on the level of saving and the productivity of investment. It concludes that economic growth depends on the amount of labour and capital and that developing countries have a vast labour supply, so their problems are caused by capital. In order to improve capital, investment is necessary and investment requires savings.
● However, there are problems with this model. Economic growth is not the same as economic development. It is difficult for individuals to save when they have little income and borrowing from overseas causes problems with debt. It is possible that investment could be wasted
Foreign currency gap
● This is when exports from a developing country are too low compared to imports to finance the purchase of investment or other goods from overseas required for faster economic growth.
● One country which suffers from this is Ethiopia. In 2018, public debt was around 60% of GDP; most of it in foreign currency so it is possible that they will not have enough foreign currency to repay their debt. It is thought there are only enough currency reserves to pay for a month of imports. (The Economist)
Capital flight
● Large amounts of money are taken out of the country, rather than being left there for people to borrow and invest. If money was placed in banks within the country, then credit could be created by banks for consumers and businesses to spend.
● This can occur because of lack of confidence in the country’s stability, to hide it from government authorities or simply for profit repatriation.
● This caused the Argentine economic crisis in 2001.
Demographic factors
● Developing countries tend to have higher population growth, which limits development. If population grows by 5%, the economy needs to grow by 5% to even maintain living standards. This means developing countries need to have higher rates of growth to develop than more developed countries would do.
● The high population growth is caused by high birth rates, which increases the number of dependents within a country but does not immediately increase those of working age. It places strains on the education system and leads to youth unemployment.
● The population of Africa is expected to more than double by 2050, complicating efforts to reduce hunger.
Debt
● During the 1970s and 1980s, developing countries received vast loans from banks in the developed world. Now, they suffer from high levels of interest repayment; sometimes even higher than the loans and aid they receive from developed countries, meaning money is flowing from developing to developed countries.
● This means they have less money to spend on services for their population and they may need to raise taxes, which limits growth and development.
● Borrowing for growth makes sense, just as firms borrow to expand, but the problem occurs when governments take on too much debt and do not spend it well.
● Nigeria’s debt is 52% of GDP.
Access to credit and banking
● Developing countries have limited access to credit and banking compared to developed countries, who have complex systems. This means those in developing countries cannot access funds for investment and they struggle to save for the future.
● Some families may use loan sharks, who give high interest rates and leave individuals permanently in debt.
Infrastructure
● In a developed country, there is a complex network of buildings, roads, ports, railways, airports, utilities and electricity cables.
● Low levels of infrastructure make it hard for businesses to trade and set up within the country, for example if there are a lack of roads. It makes their services and production less reliable.
● However, the development of infrastructure can be expensive and tends to conflict with environmental goals.
● India is a good example of country suffering from poor infrastructure. For example, they saw power blackouts in 2012 and this damages their potential tourism industry. About half their roads are not paved and they need to invest around $400bn in the power sector. (Tutor2u)
Education/Skills
● Poor education within these countries means that workers are low skilled, sometimes unable to read and write, so have low levels of productivity.
● Countries like China and South Korea invested heavily in their human capital when they were developing, and this has benefitted them in the long term. Ethiopia suffers from high illiteracy rates at around only 49%. (Unesco)
● However, there is debate about what type of education is needed and problems concerning over-education i.e. if graduates are unable to find graduate level jobs.
Absence if property rights
● Property rights are where individuals are allowed to own and decide what happens to certain resources. A lack of rights mean that individuals and businesses cannot use the law to protect their assets, leading to reduced investment. They will be unwilling to buy machinery, build factories or establish brands.
● The loss of property rights in Zimbabwe led to economic collapse.
Impact of economics factors in countires
PPD’s costs
1) Natural disasters can wipe out production of the primary product, resulting in farmers left with no income: they are often non-renewable, meaning the country will suffer when they run out of the product.
2) Tend to have low-income elasticity of demand, meaning as people get wealthier they don’t increase the amount of primary products they buy whereas they are likely to increase their demand for manufactured goods.
3) The Dutch disease - when a country becomes a significant commodity producer in a short amount of time, causing an increase in demand for the currency (to enable people to buy the goods) which pushes its value up. This increases export prices and leads to a reduction in competitiveness of the economy, causing a fall in output in other areas. E.g. this occurred for the non-oil sectors in Venezuela and Nigeria.
Evaluation: not all primary products have a low income elasticity of demand e.g. diamonds.
Primary product dependency: Prebisch Singer Hypothesis and evaluation
The Prebisch Singer Hypothesis suggests the long run price of primary goods declines in proportion to manufactured goods, which means those dependent on primary exports will see a fall in their terms of trade.
However, in recent years there has been a rise in the price of some key commodities such as food and a fall in prices of some manufactured goods due to the expansion to places like China.
