Development Flashcards
Define the two types of poverty
There are 2 types of poverty, both linked to being unable to afford the ‘necessities’:
- Absolute Poverty: when people can’t afford the ‘necessities’ to survive (food, shelter etc). This is usually given as an income of less than $1.25 per day (PPP), although you may see it as $1/day or $2/day etc.
- Relative Poverty: when people can’t afford the ‘necessities’ that are normal within their country (ie in Spain: TV, mobile phone, food…). The common measure is if the household income is less than 60% of the median income of the country.
What types of inequality are there?
When considering inequality we should distinguish between ‘income inequality’ and ‘wealth inequality’(the value of assets) and we should distinguish between global inequality and inequality within a country.
How are the two types of inequality related?
Income inequality has a snowballing effect on the wealth distribution: top incomes are saved at high rates, pushing wealth concentration up; in turn, rising wealth inequality leads to rising capital income concentration, which contributes to further increasing top income and wealth shares.
How do we measure inequality?
We measure inequality using the Lorenz Curve and the Gini Index.
Lorenz Curve Diagram:
X-axis: Cumulative % of national income; Y-axis: Cumulative % of households (poor -> rich)
Straight 45 degree line - line of perfect equality.
A curve is drawn under that line, the further away it is (the more bowed the Lorenz Curve is) the greater the income inequality in the represented country.
Above the curve - area A, below - area B
We can calculate the Gini index from the curve. The Gini index is A/(A+B). So a Gini index of 0 = perfect equality and the higher the Gini index the more unequal a society is.
Is inequality bad? (3, 1)
Yes:
1. There is an inefficient use of a society’s resources. It prevents a “meritocracy”, where ‘the best people’ gain the best jobs. Children born in rich families can inherit wealth from their parents, get better education, more support from their parents. Children from poorer families may need to work after school, they attend worse schools, get less contacts. This means some people may end up becoming extremely rich without making more effort than someone from a poor background. Because of this, someone who may be very talented but was born in a poor family may never achieve their full potential.
- Income equality helps economic growth. It helps everyone become richer. In 2011 International Monetary Fund showed that greater income equality increased the duration of countries’ economies growth spells more than free trade, low government corruption, foreign investment, or low foreign debt.
- Income equality helps improve social factors linked to better standards of living. Crime rates are lower in more equal societies, even life expectancy of those in the richest groups is longer in more equal societies.
No:
- Clearly there will always be some inequality in a capitalist society. This could be argued as a positive: it is a reward for higher levels of productivity and a reward for taking (successful!) risks investing in businesses. The existence of a reward is important both as a reward itself and as an incentive.
Have we become more or less equal?
On a national level, in the developed world, inequality has increased. The Gini coefficient stood at an average of 0.29 in OECD countries in the mid-1980s. By the late 2000s, however, it had increased by almost 10% to 0.316. Significantly, it rose in 17 of the 22 OECD countries for which long-term data series are available.
However on a global scale we might say that inequality has been falling. Many LEDCs, particularly the BRIC economies have seen faster growth rates than the MEDCs, so the gap between the ‘developed’ and ‘developing’ world has narrowed.
From 2 humps to a single hump at 10$/day.
What are the causes of income & wealth inequality?(8)
- Labour Market explanations (1): Economic theory tells us that the wage rate a person earns should be equal to the marginal revenue they generate. The more skills/qualifications a job requires, the more revenue it generates, hence the workers get paid more. Skills/qualification depend on natural ability, but also on education level.
According to some recent economists (Rajan) the gap in education levels in technologically advanced countries has meant that those with a good education are able to use new technology/be very productive/earn high wages, while those with low skills see their jobs being outsourced and are facing unemployment. He used this to explain the massive growth in credit: income inequality has risen faster than consumption inequality, implying the poor are borrowing to spend, thus creating a debt-based bubble . - Labour Market explanations (2): More experienced workers may be paid more as their experience makes them more productive, older workers may gain promotions and earn more. Women earn less than men, in the UK, those who leave school at 16 earn 55% of male earnings, those leaving post 16 - around 50%.
- Labour Market explanations (3): A lack of AD/demand for labour condemns many to unemployment. The school leavers don’t get a job during a recession and when the economy picks up, employers prefer to employ ‘new’ school leavers, rather than those who have been unemployed for a couple of years.
- Ownership of assets: An asset is something which generates a future flow of income, for example: renting out property or generating profits. In general only the rich can afford to buy assets, so they can get richer than the average, as not only their income rises, but they get an income from their ownership of assets. In the UK the wealth Gini is 0.67, far higher than the income Gini 0.33, showing a concentration of wealth among the richest.
This is the basis of Thomas Piketty’s work: that the return on capital (r) is greater than the growth in real national income (g), r>g, so those who own assets will become relatively richer than those who work, so income inequality increases. In addition, since some assets (such as property) tend to appreciate over time then wealth inequality is likely to grow. To work this out Piketty looked at empirical evidence, the only exception was 1930-1975 (the Great Depression, WWII, post-war period). - Pension rights: Those people who rely on pensions generally have a lower income than those in work. As the population of MEDCs ages this is becoming a significant factor in income inequality and especially affects the poor, who rely on a state pension since they were unable to save during their working life (see ownership of assets).
- Inheritance: Wealth can be directly inherited, so some people are wealthy because their parents (or great-grand parents) were wealthy. As above, the inheritance of assets also generates income. According to Forbes 400 list, 5 of the 10 wealthiest Americans inherited their wealth.
- Government tax policy: Some taxes are regressive, such as VAT and indirect taxation - the same tax rate no matter what the income is. They increase inequality, since they take a larger % of income from the poor than the rich. A high rate of a progressive tax (rate depends on the income, like income tax) may encourage tax avoidance (evasion), meaning the rich pay a smaller % of their incomes. This links to the idea of the Laffer Curve.
Laffer Curve Diagram:
Y-axis: Tax Revenue; X-axis: Tax Rate.
The curve is an upside down parabola, as tax rates increase, tax evasion occurs or the rich leave the country and hence tax revenue decreases. - Health problems: Many people in poor health are unable to work, and so end up on benefits/relying on family members. This is a huge problem in sub-Saharan Africa (AIDS) and means the whole households end up in poverty as there is a high dependency ratio (number of workers per “mouth to feed” in a household).
Evaluate the causes of inequality?(3)
- All education is not equal. Some education may be very academic and not really increase productivity, but can generate high pay (Boris Johnson studied Classics…). Similarly some vocational education can impact productivity, but work may end up lordly paid (nursing?).
- Government tax policy may in fact reduce inequality. Firstly Inheritance Tax can reduce the wealth that can be inherited. Secondly, progressive taxes(based on a percentage of income), like income tax will reduce income inequality.
- Assets may depreciate. Just as they may rise in value they may also fall as the post 2008 housing crash has shown.
What is the Kuznets Curve?
The basic argument was that, as countries begin to develop (and so GDP per capita begins to rise) there are investment opportunities for a few, to start up new industries and they quickly grow richer. These new businesses draw in rural labour and the incomes of the new urban workers grow quicker than rural wages. Thus inequality rises. However, beyond some point this process slows and reverses, as the urban workers start to demand higher wages (so catch up with the very rich), while rural incomes start to rise (as the rural workforce is now small) and catch up to the urban incomes.
It has also been suggested that this greater equality may be the result of government action - as the country becomes rich enough to generate a large tax base, workers educated enough to participate in democracy and ‘the rich’ become rich enough to accept progressive taxation then a welfare state is created! In this view capitalism itself does not reduce inequality!
There has been a lot of criticism of the Kuznets Curve, not least that it was based on relatively little empirical data, really the post-WWII-1954 period. Even Kuznets himself said his work was “perhaps 5% empirical information and 95% speculation, some of it possibly wishful thinking”.
Kuznets Curve Diagram:
Y-axis: Gini coefficient; X-axis: GDP per capita
The curve is an upside down parabola
The alternative view is Piketty & r>g
What policies can the government use to reduce inequality?(6)
- Increase Benefits: These payments help equalise the distribution of income. Since the rich pay most in taxes (in absolute terms at least and in % terms if most tax revenue is from progressive tax), then this is taking money from the rich and giving it to the poor.
BUT There are issues about reducing incentives to work if the benefit system is “too generous”, this links back to improves supply-side economics. - National Minimum Wage:A higher NMW (or what is called a ‘living wage’) would remove firms monopsony powers and raise incomes of those on the lowest incomes.
BUT There are arguments that a higher NMW may lead to unemployment, via excess supply of labour or making firms less internationally competitive, so actually increase inequality. - Tax Policy (1): A shift from regressive taxes (like VAT) to progressive taxes (like income tax) should even out the distribution of income. Higher marginal rates of income tax should reduce inequality, especially if the money is used by the government to improve opportunities.
BUT There are difficulties - Laffer Curve and the impact on incentives again. - Tax Policy (2): Higher rates of Inheritance tax should reduce inherited wealth.
- Tax Policy (3): Introduce a ‘Wealth Tax’. This solution is promoted by Piketty, since he points to wealth as the prime cause of inequality. The idea would be a small % tax on people’s wealth.
BUT There are problems. Firstly some people are ‘wealthy’ but have low incomes, like elderly people who bought a house 50 years ago which has appreciated but they’re living on a pension. Secondly, it would need to be global, since wealth is easy to transfer out of a country (buy shares/house in a foreign country ). - Improving Education: A more skilled workforce, or at least more relevant skills, should make everyone more productive and so increase wages for all
BUT This is a long term policy and might make everyone richer but not narrow the distribution of income.
As with lots of thing balance is the key word: we don’t want a distribution of income which is too wide and condemns many to a life of poverty even as they are born, but at the same time we don’t want to lose the incentive effect that a distribution of income creates.
In general, the more developed countries are more equal. We could question cause/effect.
What are the limits to development? (12)
- Poverty Cycle
Capital shortage -> Low income per capita -> Low savings -> Low investment -> Capital shortage etc. - Lack of Infrastructure
Infrastructure is a country’s ‘internal skeleton’ it includes things like roads, rail, telecommunications, sewage/water, electricity grid, schools/hospitals, ports/airports…
Poor infrastructure causes:
- Difficulties in getting goods to market
- Increases the cost of goods
- Asymmetric information - rural sellers can’t contact urban consumers
- Discourages businesses to set up - especially FDI
- Has negative impact on other, non-wealth, aspects of development
Infrastructure is poor because: poor infrastructure - low incomes - low tax revenues for the gov - low spending on infrastructure - … - Human Capital
Human capital is Investment into people (labour). The objective is to improve productivity. It is mainly increased through improved education (improves skills) and through improved health care (allows people to work more)
Education allows people to use other sources of development more effectively and is linked to health care (awareness of sanitation).
Poor education/health - low incomes - low tax revenue - low spending on education/health - … - Primary Product Dependency (PPD)
Many LEDCs rely on exporting a limited range of primary products (hard or soft commodities). Problems with this include:
- Fluctuating prices: due to unstable nature of supply and low PED. This makes any sort of planning difficult, for both producers and government (tax revenues), producers are likely to hold their profits in cash in case they make a loss next year, so large investments are avoided.
- Falling prices: historically they have fallen (by 50% from 1980 to 1999). This is because of improved agricultural yields (better farming techniques, use of artificial fertilisation hybridisation, GM) and technology to access more remote raw materials, leading to increased supply and so falling prices. Also, YED of agricultural products is low, so as MEDCs get richer, the commodity producers become relatively poorer.
- PPD makes LEDCs reliant on richer countries: of economic growth in richer countries falls, so does the demand for commodities and this has a huge impact on the LEDC producer.
- Narrow range of commodity exports: increases dependency and vulnerability (weather conditions)
- Highly competitive world markets where the opportunity to create ‘added value’ is low (perfect competition), so very little profit.
- Productivity is very low in agriculture: needs workers during harvest, but not for the rest of the year.
- Sharecropping: where a landlord rents out a piece of land to a farmer. This reduces the incentive for the tenant to invest and to maximise output (as they only get a %), but also spreads risk
- Land ownership: the custom in many countries is to split the land between the sons when the father dies. This means each generation the plots get smaller (less EoS). Also encourage over-farming as small farmers cant afford to leave land ‘fallow’.
- Asymmetric information: farmers are often unaware of the actual market price and sell at the price offered by the traders. (Oxfam estimates a Ugandan coffee farmer gets about 2.5% of the UK retail price, whereas Nestle has over 25% profit margin on instant coffee) - Worsening Terms of Trade
Prebisch-Singer Hypothesis - ToT will fall for primary producers over time.
If the exchange rate is fixed this means the gov needs to run a C&FA surplus (gov borrowing) or reduce imports (bad in LR). The lower export earnings means the country will struggle to generate foreign currency in which may be needed to pay off debt or will have to sell of its foreign currency reserves to buy the domestic currency.
The alternative is to devalue, or allow the currency to float, causing a
depreciation, pushing up import prices so worsening ToT again.
Worsening profits encourage farmers to switch to illegal crops. These are then in the hidden economy, so reduce tax revenues and are associated with rising crimes and corruption levels.
BUT In recent years the commodity prices have been rising due to growth in demand from China. But the prices can fall again. Also new crop varieties (high yielding varieties) helped increase farmers incomes. But to make the full use of these requires basic education. - The Savings Gap
Without savings there are no funds for investment. The Harrod-Domar Model is often used here. This assumes a closed economy (no international trade) and the absence of a gov sector. This means savings equal investment. Growth rate of an economy = s/k (savings ratio - percentage of incomes saved/capital output ratio - how much capital is required (in $ terms) to produce $1 of output).
LEDCs have low savings ratios (because they are so poor) and so there is little investment and so economic growth will be low!
The implications are clear - unless capital is becoming more productive, then a lack of savings will mean low GDP growth (see poverty cycle) - Foreign Currency Gap
LEDCs need capital and to buy it they need foreign currency. To get foreign currency they need to sell their own currency. Who wants to buy the currency of an LEDC?
Some LEDC have a ‘non-convertible’ currency: the gov fixes it at an artificially high rate, or so little of a currency is required in rich countries that no one wants to buy it at any price. - Capital Flight
When firms, governments or individuals transfer money abroad in order to avoid the currency risks and low rate of returns on domestic savings/investment. This is because LEDCs are inherently risky and because of corruption and lack of control. Those who have stolen gov funds can’t have them taken away if the money is moved abroad.
Around 80% of all lending to Africa (1970-1996) was placed abroad the same year it was lent. Therefore no investment, no infrastructure, more debt and increased reluctance of international donors/aid agencies to provide future funds. - Corruption
Corruption leads to uncertainty and so less investment (especially FDI), lower tax revenues (bribes aren’t taxed), inefficient industries, increased costs to firms, less trade, distrust, criminality. - Population Growth
More people means a lower GDP per capita. This is particularly damaging when the population increase occurs in the very young or old, as this increase the ‘dependency ratio’, the number of ‘mouths’ each working person has to feed.
However, a boom in the young working population may be a source of growth: India has a large % of 20-30 year olds, all entering work/starting up businesses which could provide a boost to growth. - Debt
Most of the LEDC debt is in $ (currency gap) and the borrowing had not been well invested - often going on show projects or simply disappearing in corruption/capital flight.
Many LEDCs found themselves Ina debt cycle, having to borrow to pay off interest on older debts, but this increased total debt, so future interest payments were even higher, so more borrowing was required. By 1990, for example Uganda had debt servicing payments (interest, not actual debt) of around 80% of its exports (ie foreign currency earnings).
Debt causes many problems: opportunity cost (health/education), in SR the gov has to cut back on its spending, reducing AD/growth. This is especially true if it needs to continue to borrow money as lenders may insist on harsh conditions (Greece). The IMF calls this “stabilisation policies” to “structural adjustment policies” (SAP). - Poor Governance/Institution and War
A gov needs to be able to collect tax revenue. In many LEDCs much economic activity is in the ‘informal markets’ (ie cash in hand), while taxes on company profits are very low (to help gov friends or to encourage TNCs). Direct taxes which require records of income kept, are difficult to collect, so govs rely on indirect tax (VAT) and import duties.
Another problem is the lack of “property rights” - legal ownership of property. In some African countries less than 10% of land is formally owned, sometimes it is owned by the state (who can redistribute it) or isn’t owned at all and just farmed by one family because their parents farmed there. Property rights allow people to use the property to get an income or use as collateral on a loan. Similarly a lack of property rights disencourages investment for future output.
Giving greater property rights to women would also help as they are more likely to save/invest in the family.
Political instability also forms a barrier to development, making enforcement of legal rights, like ownership, difficult. In the case of war, growth and development are very hard as people and capital/infrastructure are destroyed, no one invest, money for healthcare/education is diverted to weapons from abroad so using up foreign currency and then the death of crops in a war zone.
What are some growth and development strategies?(10)
- Harrod-Domar/Filling the Savings Gap
- Industrialisation
- Aid and Debt Relief
- Inward looking strategies
- Outward looking strategies
- Free Market Approach
- Government Led Approach
- Foreign Direct Investment
- Commercial Loans and Microfinance
- Fair Trade
Describe filling the savings gap
Harrod-Domar/Filling the Savings Gap
According to the H-D model the reason for low growth in LEDCs is a lack of domestic savings to fund investment. The 2 possible sources to fill this gap are from the government (which means either government borrowing to running a budget deficit, to provide funds for investment) or from abroad (in other words surplus on the C&FA = money saved by foreigners or provided for a particular investment (FDI), but could also include aid).
The H-D model says that this increased ‘savings’ increase growth, at first as I is part of AD and then it the LR because a greater capital stock is an increase in AS.
BUT:
- The assumption that more I = GDP growth ignores the importance of other factors (human capital to operate investment - lack of education).
- A lot of savings/money from abroad may be subject to capital flight and so there will be no increase in I.
- S=I? For this to happen the savings need to be turned into investment and this usually means banks and other financial institutions, but these often don’t exist in LEDCs.
- There are negatives in increased gov borrowing and running a CA deficit (= a C&FA surplus) so the solutions create their own problems.
Describe industrialisation
Industrialisation
This is known as the Structural Transformation or Lewis Model. This model blamed PPD for lack of growth. The solution would be to develop the modern, manufacturing sector. This leads to growth since productivity in the primary sector is low, if these people move into cities and worked in factories there would be higher labour productivity, with no loss in rural output.
BUT: mass migration into cities - urban unemployment (model assumes demand for products produced in cities), problems with living conditions/lack of infrastructure (water, schools etc) as cities grow and big differences between the urban and rural areas.
Some countries have decided to ‘jump’ the industrialisation phase and move directly to services - tourism. It is highYED, large multiplier, attracts FDI, provides foreign currency, generates tax revenues etc.
BUT: tourists may demand goods which cannot be locally made so it can increase imports and it is questionable whether it is sustainable: the growth of tourism may damage the natural beauty of many areas - less tourism in LR. It may encourage ‘unsavoury’ industries (prostitution, alcohol, drugs, gambling). Also a danger of dual economy: the tourist zones become relatively rich while the outside remain poor. This can have a knock on effect, in 1990s a Cuban doctor could make more money working as a waiter - not the best use of resources.
Describe aid and debt relief
Aid and Debt Relief
There are various types of aid: emergency aid (ie famine relief), official aid (like a gift from a government or a charity, often called “overseas development assistance”, ODA), soft loans(loans at 0% or below market interest rates), tied aid (aid given in return for some condition, often political) and debt relief (cancelling previous debt). The basic purpose is to fill the savings gap.
In favour of aid:
- Aid can allow greater gov spending. This is good in itself (G part of AD), but also allows the gov to target crucial public/merit goods (education, health, infrastructure).
- Aid can increase investment. I part of AD, good for LR growth (H-D). May need to involve technical expertise from abroad so can help develop human capital as well.
- No need to repay. An advantage over borrowing is the low cost to the receiver!
- Aid can be given to a specific project, so this ensures its effective use
Against aid:
- Much of the aid money may be used inefficiently (capital flight, corruption, show projects or administration costs of UNESCO, FAO etc)
- Aid diminishes local investment (crowding out), can lead to increase M, and destroy local markets (ie food if food is given)
- Who controls the money? The donor will want a say in how their money is spent, but the local country will want to spend it in a way they see fit
- Aid doesn’t reach the neediest. The UNDP thinks that 20% poorest rarely see the effects of aid, which tends to be targeted at specific areas
- Debt relief creates a “moral hazard” - if debt is written off are we rewarding “poor behaviour”? Will this encourage poor use of future lending in the belied it will be written off?
- Depends on the type of aid. How ‘soft’ are soft loans? What are the conditions attached to tied aid or debt relief?
