4.3.2 Factors influencing growth and development Flashcards
Explain primary product dependency.
Typically, countries at an earlier stage of development tend to export a narrower range of products. Many developing
countries continue to have high dependence on extracting & exporting primary commodities. These economies are vulnerable to volatile global prices. There are significant risks from over-specialisation especially when the terms of trade from their main exports decline; as countries specialise more in primary commodities, it increases the supply of these commodities which, when coupled with relatively price inelastic demand for these goods, causes their price to fall quite significantly (and the revenue earned).
What is the core idea behind the Prebisch Singer Hypothesis?
- There is likely to be a long-term decline in real commodity prices
- In part this is because the income elasticity of demand for commodities is lower than for manufactured goods
- This then worsens the terms of trade for primary exporters over time
- In this situation, countries might be better off focusing on import substitution policies which encourage rapid industrialisation and improved export diversification designed to make a country more resilient to price shocks
However in reality, for many countries, how has the Prebisch Singer hypothesis not happened?
- Labour intensive manufactured goods are now significantly cheaper because of globalisation, technological
improvements and the exploitation of economies of scale - Rising global population and increasing per capita incomes have seen a hefty increase in the world prices of
many primary commodities. Consider for example the prices of rare earths used in manufacturing smart
phones - Many primary commodity exporters in developing countries have seen their terms of trade rise
Explain Dutch Disease
Dutch Disease refers to the adverse impact of a sudden discovery of natural resources on the national economy via
the appreciation of the real exchange rate and the decline in export competitiveness. If natural resources are found and extracted and if the world price of them is rising, then export revenues will increase and there will be increased investment into that sector. But the risk is that there is a corresponding loss of investment into other industries such as manufacturing businesses. And the surge in export incomes can cause an appreciation of the exchange rate which then makes other sectors trying to export less competitive in overseas markets. A worst-case scenario is when
manufacturing industries in developing countries start to shrink well before it has reached middle-income status. This
is known as premature de-industrialisation.
What are strategies for reducing Primary product dependency and price volatility?
- Better government – including more transparency & accountability to taxpayers so that it is clear how natural
resource revenues are being spent - Stabilisation Fund / Sovereign Wealth Fund – e.g. to fund human capital and infrastructure or to inject money
into an economy when aggregate demand dips - Higher taxes of natural resource profits (i.e. extracting resource rents and then reinvesting in the domestic
economy to increase a country’s supply-side capacity) - Buffer stock schemes – these are designed in principle to reduce some of the effects of price volatility although
most less developed countries have limited ability to influence the world prices of their key exports - Diversification – including shifting resources into processing, light manufacturing & tourism – giving higher value added and making the economy less susceptible to external shocks
Explain the savings gap
- Savings are needed to help finance capital investment
- Many rich countries have excess savings, whereas in smaller low-income countries, extreme poverty make it
almost impossible to generate sufficient savings to fund capital investment projects - Furthermore, the financial / banking sector may be extremely underdeveloped in developing economies, and there may no guarantees provided by governments for depositors to get their money back in case of bank
failure - This increases reliance on foreign aid or borrowing from overseas (leading to higher external debt)
- This problem is known as the savings gap
What is an example of the savings gap in Africa?
- In Sub Saharan Africa for example, savings rates of around 17 per cent of GDP compare to 31 per cent on
average for middle-income countries - Low savings rates and poorly developed or malfunctioning financial markets then make it more expensive for African public and private sectors to get the funds needed for capital investment
What does the Harrod-Domar model of growth say?
The rate of growth depends on:
* Level of national saving (S)
* The productivity of capital investment (capital-output ratio)
For example, if £100 worth of capital equipment produces each £10 of annual output, a capital-output ratio of 10 to 1 exists. When the quality of capital resources is high and when an economy can better apply capital inputs and appropriate technologies e.g. by using more advanced ideas, then the capital output ratio will be lower.
What is the role of higher savings?
An increase in national savings leads to an Increase in investment – which leads to a larger capital stock – which leads
to an increase in real GNI – which leads to increased factor incomes – which in turn allows more households to save
Why is capital investment important for developing countries?
- Injection of demand for capital goods industries
- Creates positive multiplier effects
- Increased capital stock can increase rural productivity and therefore per capita incomes and consumption in
rural areas - Investment in new machinery and factories supports economies of scale especially in new / infant industries
- It can help achieve export-led growth because of the increase in productive capacity
What happens in a foreign currency gap?
A foreign exchange gap happens when currency outflows exceed currency inflows.
This can occur when:
o A country is running a persistent current account deficit
o There is an outflow of capital from investors in money & capital markets (this is known as capital
flight)
o There is a fall in the value of inflows of remittances from nationals living and working overseas
What is a key consequence of a foreign currency gap?
A key consequence of a foreign currency gap can be that a nation does not have enough foreign currency to pay for essential imports such as medicines, foodstuffs and critical raw materials and replacement component parts for machinery. In this way, a foreign currency shortage can severely hamper short run economic growth and also hurt development outcomes.
What are options for developing countries wanting to attract external finance?
Developing economies can draw on a range of external sources of finance, including FDI, portfolio equity flows, longterm and short-term loans (both private and public), overseas aid, and also remittances from migrants living and working overseas. Foreign direct investment remains the largest external source of finance for developing economies. It makes up nearly 40 percent of total incoming finance in developing economies as a group, but less than a quarter in the least developed nations, with a declining trend since 2012.
What is capital flight?
Capital flight is the uncertain and rapid movement of large sums of money out of a country.
What are the reasons for capital flight linked to a lack of investor confidence?
- Political turmoil / unrest / risk of civil conflict
- Fears that a government plans to take assets under state control
- Exchange rate uncertainty e.g. ahead of a possible devaluation
- Fears over the stability of a country’s financial system
What is a key consequence of capital flight?
Many billions of US$s each year are taken out of a country illegally especially in countries with persistently high levels
of corruption. Capital flight can undermine the stability of the financial system and also lead to a weaker currency
which in turn then increases the prices of essential imported goods such as components and food and it also makes
it harder (more expensive) for a country to finance their external debts.
What countries do we associate capital flight with?
We tend to associate capital flight with countries where there are deep-rooted economic and political difficulties such
as Russia, Pakistan, Nigeria and countries troubled by civil war. One policy to limit the amount of capital flight is for government to introduce capital controls which control how much money people can take out of a country. However, illegal capital outflows are much harder to stop
What demographic factors have changed and will keep changing?
- Working age population will grow to 552m in low-middle income countries, decrease by 40m in high income countries
- Rising life expectancy, risen by seven years globally.
- Population growth is slowing down. In Japan, an ageing population combined with low female participation and low net inward migration is causing a contraction in the size of their active labour force
What will happen with an ageing population in OECD countries?
the ageing of the population in OECD countries, which is expected to continue in the next
decades, may contribute to reduced innovation, reduced output growth and reduced real interest rates across OECD economies
What are possible microeconomic effects of population growth?
- Changing patterns of consumer demand in markets / affecting profits of businesses in particular sectors
- Impact on government welfare spending and tax revenues e.g. health care for the elderly, treatment of chronic
illness - Impact on housing market e.g. if people can live in their own homes for longer
What are possible macroeconomic effects of population growth?
- Impact on the rate of growth of productivity and long-term GDP growth - for example if there is an increase
in the age-dependency ratio - Impact on business competitiveness if the median age continues to rise rapidly
- Increased demand for state-funded health care including social care and a possible reduction in tax revenues
if the active labour force contracts
How can rising per capita incomes actually cause an increase in population
growth, in many lower and middle income countries?
This is because higher incomes and consumption leads to improved access to health care and leads both to
higher fertility and to lower infant and child mortality.
What are opportunities from rapid population growth?
- A young median age and fast natural population growth contributes to an expanding population of working
age which can increase long-run aggregate supply (LRAS) causing an outward shift of the PPF. - Providing per capita incomes are rising, then population growth increases the size of domestic markets - encouraging economies of scale and increased capital investment spending by businesses
- More people in work leads to a widening of the tax base to help government finances
- Population growth and urbanization tend to go together - population growth increases density and, alongside
rural-urban migration can lead to benefits from agglomeration economies. Urbanisation has been linked to
stronger innovation and it also stimulates demand for new infrastructure which in turn creates jobs and creates positive multiplier effects - The challenge of feeding a growing population can be a catalyst for research and development and
innovation in farming designed to increase crop yields
What are the risks and drawbacks from rapid population growth?
- A large number of young people entering the labour market creates challenges - not least in providing
sufficient jobs in the formal economy to prevent a large increase in youth unemployment. - Fast-growing population holds back the annual growth of per capita incomes. Income is spread more thinly
across large households which makes it harder to satisfy everyone’s basic needs and wants and can lead to
rising malnutrition - Rapid population growth puts increasing pressure on the natural environment including demand for water
and energy and can also threaten bio-diversity - High rates of rural-urban migration can lead to problems associated with urban density such as crime, the
spread of disease and increased inequalities of income and wealth.
