4.3.2 Factors influencing growth and development

Question 1

Explain primary product dependency.

Answer 1

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).

Question 2

What is the core idea behind the Prebisch Singer Hypothesis?

Answer 2

• 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

Question 3

However in reality, for many countries, how has the Prebisch Singer hypothesis not happened?

Answer 3

• 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

Question 4

Explain Dutch Disease

Answer 4

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.

Question 5

What are strategies for reducing Primary product dependency and price volatility?

Answer 5

1. Better government – including more transparency & accountability to taxpayers so that it is clear how natural
   resource revenues are being spent
2. Stabilisation Fund / Sovereign Wealth Fund – e.g. to fund human capital and infrastructure or to inject money
   into an economy when aggregate demand dips
3. 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)
4. 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
5. Diversification – including shifting resources into processing, light manufacturing & tourism – giving higher value added and making the economy less susceptible to external shocks

Question 6

Explain the savings gap

Answer 6

• 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

Question 7

What is an example of the savings gap in Africa?

Answer 7

• 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

Question 8

What does the Harrod-Domar model of growth say?

Answer 8

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.

Question 9

What is the role of higher savings?

Answer 9

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

Question 10

Why is capital investment important for developing countries?

Answer 10

• 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

Question 11

What happens in a foreign currency gap?

Answer 11

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

Question 12

What is a key consequence of a foreign currency gap?

Answer 12

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.

Question 13

What are options for developing countries wanting to attract external finance?

Answer 13

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.

Question 14

What is capital flight?

Answer 14

Capital flight is the uncertain and rapid movement of large sums of money out of a country.

Question 15

What are the reasons for capital flight linked to a lack of investor confidence?

Answer 15

1. Political turmoil / unrest / risk of civil conflict
2. Fears that a government plans to take assets under state control
3. Exchange rate uncertainty e.g. ahead of a possible devaluation
4. Fears over the stability of a country’s financial system

Question 16

What is a key consequence of capital flight?

Answer 16

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.

Question 17

What countries do we associate capital flight with?

Answer 17

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

Question 18

What demographic factors have changed and will keep changing?

Answer 18

• 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

Question 19

What will happen with an ageing population in OECD countries?

Answer 19

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

Question 20

What are possible microeconomic effects of population growth?

Answer 20

1. Changing patterns of consumer demand in markets / affecting profits of businesses in particular sectors
2. Impact on government welfare spending and tax revenues e.g. health care for the elderly, treatment of chronic
   illness
3. Impact on housing market e.g. if people can live in their own homes for longer

Question 21

What are possible macroeconomic effects of population growth?

Answer 21

1. 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
2. Impact on business competitiveness if the median age continues to rise rapidly
3. Increased demand for state-funded health care including social care and a possible reduction in tax revenues
   if the active labour force contracts

Question 22

How can rising per capita incomes actually cause an increase in population
growth, in many lower and middle income countries?

Answer 22

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.

Question 23

What are opportunities from rapid population growth?

Answer 23

1. 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.
2. 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
3. More people in work leads to a widening of the tax base to help government finances
4. 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
5. The challenge of feeding a growing population can be a catalyst for research and development and
   innovation in farming designed to increase crop yields

Question 24

What are the risks and drawbacks from rapid population growth?

Answer 24

1. 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.
2. 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
3. Rapid population growth puts increasing pressure on the natural environment including demand for water
   and energy and can also threaten bio-diversity
4. 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.

Question 25

What is brain drain?

Answer 25

Some countries experience a brain drain effect which describes the movement of highly skilled or professional people
from their own country to another country where they can earn more money. Brain drains can lead to de-population. E.g Latvia’s population is forecast to contract by 200,000 people between 2017 and 2030, a fall of over 10%.

Question 26

What are the disadvantages of brain drain?

Answer 26

1. Loss of human capital – this damages long-run supply-side potential and is a barrier to development
2. Loss of enterprising younger workers who might have started up businesses at home
3. Skills shortages affect HDI outcomes e.g. the emigration of skilled doctors, teachers & engineers
4. Risk of a fall in aggregate demand because of a smaller population
5. Depopulation make the country less attractive to inflows of foreign investment

Question 27

What are the possible advantages of brain drain?

Answer 27

1. Remittances from emigrants flow back to increase a nation’s gross national income (GNI)
2. People living overseas (the diaspora) may be able to help finance private sector capital projects in the future
3. Acquisition of human capital by working & studying in other countries e.g. learning languages, earning
   degrees – possibly leading to brain gains if they return to their country of origin
4. May help to offset the risks from rapid natural growth of population such as higher inflation and pressure on
   the built environment and natural resources

Question 28

What is external debt?

Answer 28

External debt is owed to external
(overseas) creditors and examples of debt includes government bonds sold to foreign investors and private sector
credit borrowed from foreign banks. The scale of external debt is usually measured as a % of a country’s GNI.

Question 29

When does external debt tend to rise?

Answer 29

1. A government is running a budget deficit and finances this by selling government bonds to overseas creditors
2. A country is running a sizeable current account deficit which is partly funded by borrowing from overseas
   institutions such as the IMF
3. Households and businesses borrow money in a foreign currency including mortgages and corporate bonds

Question 30

How can debt not be a problem?

Answer 30

Debt in itself is not necessarily a problem if the borrowing is being used to help fund capital investment projects which will ultimately increase a nation’s productive potential and increase trend economic growth.

Question 31

What are risks with a developing country increasing the scale of external debt?

Answer 31

• Returns on investment might fall short of expectations especially if investment goes on projects not subject
  to a proper cost-benefit analysis
• If a country experiences a depreciation/devaluation of their exchange rate, the real value of the debt will increase making it harder to repay
• A recession can make it harder to meet the interest payments on debt since government tax revenues shrink
• If international investors become nervous about the ability of a government to repay external debt, then a country may suffer a credit-rating downgrade which will increase the interest rate needed to finance new
  loans

Question 32

How does financial access benefit a country?

Answer 32

Financial access connects people into the formal financial system, making day-to-day living easier and allowing them to build assets, mitigate shocks related to emergencies, illness, or injury, and make productive investments. It also makes it easier for a government to measure economic activity and collect in tax revenues needed to pay for public services.

Question 33

What does infrastructure consist of?

Answer 33

Infrastructure consists of a spectrum of public, semi-public, and private goods. Public goods include access to safe
drinking water and sanitation. Semi-public goods include networks providing electricity, roads, ports, and airports

Question 34

Why should infrastructure be robust?

Answer 34

Infrastructure needs to be robust to cope with the effects of rapid urbanisation and climate change. According to the
World Bank, over the next 35 years, urban populations are estimated to expand by an additional 2.5 billion people — this is almost double the population of China. For the first time in history, more people now live in cities than in rural areas. There is growing need for renewable energy infrastructure to build resilience to the effects of climate change._

Question 35

How can infrastructure gaps can limit economic growth and development?

Answer 35

• Increase supply costs for businesses – this causes higher prices – therefore hitting real incomes for consumers
• Reduces geographical mobility of labour causing higher structural unemployment (a labour market failure)
• Damages export competitiveness and limits intra-regional trade (trade within a cluster of countries)
• Can make a country less attractive to foreign direct investment (FDI) which might then slow economic growth
• Makes an economy vulnerable to climate change / natural disasters such as flooding and earthquakes
• Contributes to gender inequality
• Have a direct impact on basic human development – e.g. having access to basic water and sanitation services

Question 36

How does the quality of education differ strongly between and within different countries?

Answer 36

Globally, more than 260 million
children and youth are not in school and nearly 60 percent of primary school children in developing countries fail to achieve minimum proficiency in learning.

Question 36

What is human capital?

Answer 36

Human capital is the skill, knowledge, talent, experience and ability of workers. Human capital can be increased through investment in education & training.

Question 37

What is the effect of poor human capital?

Answer 37

Poor human capital hits labour productivity and ability to harness/adapt to new technologies. Low productivity keeps wages down. Human capital deficiencies are closely linked to malnutrition.

Question 38

How can you improve poor human capital?

Answer 38

Better basic health care and nutrition helps to unlock improved human capital by avoiding brain impairment and the effects of stunted growth.

Question 39

Why are property rights important for development?

Answer 39

1. Rights to own land and to establish businesses are seen as crucial for wealth creation e.g. private plots to farm
2. Protection of property rights is a major barrier to corruption
3. Property rights are important to tackle gender inequalities
4. Community ownership / husbandry of natural resources can help overcome threats to eco-systems
5. Laws on patents are important to secure investment in research industries
6. Common rules encourage trade & investment between countries by reducing trade friction costs

Question 40

What is corruption?

Answer 40

Corruption is defined broadly as the misuse of public power for private benefit

Question 41

List how high levels of corruption damages long term growth & development in a number of ways

Answer 41

• Deters foreign direct investment by increasing the cost of doing business
• Leads to allocative inefficiency / i.e. diverting public resources for private gain, there are numerous extreme
  examples of extravagant wealth in economically less developed countries
• Government decisions are often unduly influenced by lobbying
• Contributes to income & wealth inequality and reduced progress in cutting the incidence of extreme poverty
• Causes a loss of trust - i.e. a breakdown of social capital
• Leads to poorer development outcomes because governments are not collecting sufficient tax revenues

Question 42

What are non-economic factors that can affect development?

Answer 42

Almost anything can affect development levels in an economy. Non-economic factors might include:
* Poor governance
* Degree of corruption
* Civil war and political unrest
* The geography of a country e.g. landlocked, mountainous etc