Limits to Growth and Development Pack by Komilla Chadha

Limits to growth and development in

LDCsA2 Economics Unit 4

Komilla Chadha25 April 2011

www.a2withkomilla.blogspot.com Page 1

Contents Page

1. Population issues..........................................Page 32. Poor Infrastructure......................................Page 43. Capital Flight.................................................Page 54. Human Capital Inadequacies......................Page 65. Poor governance..........................................Page 76. Foreign currency gap..................................Page 87. Civil Wars......................................................Page 98. Primary Product Dependency....................Page 109. Geography.....................................................Page 1110.Savings gap and inadequate capital accumulation.............Page 1211.Debt.............................................................Page 1312.Corruption.................................................Page 14


1. Population IssuesWhat are the population issues in LDCs? In the past you might have come across a population pyramid, particularly if you have studied geography, they show the percentage of the population in each age group and gender group. LDCs are characterized with high birth rates (due to a belief that a large family can increase family income and the lack of availability, education and belief in contraception) and high death rates (due to lack of medical aid and information regarding healthy living). This results in a convex population pyramid as you can see below. This can have several issues, the most prominent one being there is a small economically active population (by Western standards).

How do they impact growth?Having such a large population pushes by in large most people into employment in the informal sector which does not improve a family’s income and prevents consumption from taking place. This is one way in which population issues impact AD. Furthermore, as the death rate and healthcare is poor it means productivity is not at its full potential hindering AS. As mentioned previously the economically active population isn’t exactely big and this is minised further by ‘brain drain’ which is where adequate labour moves to another place. This resuces labour market and results in a further decline of AS.

Case Study: Malawi

Something to think about...

The Maulthusian view is sometimes used to show why countries with these population issues could result in famine and poverty.


2010 infoBirth rate:41.28/1000 population (11th world ranking)Death rate 13.69/1000 population (21st world ranking)

2. Poor InfrastructureWhat are the infrastructure issues in LDCs? LDCs lack infrastructure structure such as electricity, reliable water supply, roads, training systems, monetary infrastructure, waste disposal, telecommunications and many others. This lack of infrastructure can be due to lack of government spending (for a variety of reasons such corruption, political interest, civil war etc) and international intervention e.g. from NGOs.

How do they impact growth?Firstly, if infrastructure is poor then nobody would wish to invest in the country because they will just incur extra costs. So these countries have a lack of FDI which means that the circular flow of income cannot be improved from overseas investment. Furthermore, lack of infrastructure means that AS cannot grow which hinders economic growth, especially for long term economic growth. Even the UK has to constantly improve infrastructure because it improves productivity and make a country competitive.

Case Study: IndiaIndia has one of the worst infrastructure in the world ranking 86th out of 139 for overall quality of infrastructure below China and Brazil. Economists have observed that unless this situation is improved India cannot reach growth above 9%.

Points to think about...This cannot apply to all countries because some countries such as Afghanistan are rich in raw materials. in these countries FDI will not be put of from the lack of infrastructure if the material in question is valuable e.g. oil. TNCs in fact are likely to bring infrastructure such as roads to the countries. Of course because of the war in Afghanistan this has not been the case.


3. Capital FlightWhat is Capital Flight? It is clear that the number of wealthy individuals in LDCs is very low. Their savings in their should help stop the savings gap cycle and increase investment. However, this is not the case, many of these countries suffer with what is known as Capital Flight. This is when wealthy individuals move their savings overseas in search of a better return which the poor institutions of the source country cannot offer.

How does it impact growth?This impacts economic growth through AS and AD. The potential for many firms to increase capital stock isn’t there because banks do not have the funding to lend. Lack or inefficiency of capital stock results in hinderance to long term economic growth. Of course, this lack of being able to get capital stock is also known as investment and is part of the AD formula. AD therefore is too affected, in an adverse way.

Case Study: Russia + Argentina (From Wikipedia)In the last quarter of the 20th century, capital flight was observed from countries that offer low or negative real interest rates like Russia and Argentina to countries that offer higher real interest rate like China.

Points to think about...Another point to think about is that if these individuals are putting their money in foreign banks (or assets or shares for that manner) not only are they affecting investment they are affecting government spending. The Government loses out on tax revenue it could have recieved if they used their money in the local money and this hence restricts how much the government can spend and AD falls further.


4. Human Capital Inadequacies

What do we mean by human capital indecencies? What we mean by human capital inadequacies is the lack of education and training which is given to the labour force. This means they are not specialized or informed of way to do different jobs. This means that labour force is not very productive in comparison to other countries.

How does it impact growth?This impacts growth through AS. If the labout is not educated and trained this means they cannot be used to their full potential and there is will be a lack of innovation in LDCs and this results in a long term hinderance to economic growth. FDI will also be reluctant to invest in such places as they will not be able to work at full productivity and training costs aren’t cheap. Government for the same reason cannot (or is not willing to) invest in education and training, costs are high and results can only be seen in the long-term which conflicts with short-term political interests.

Case Study: EthiopiaEthiopia had a 36% total adult literacy rate between 2005-2008 and the reason being that even though there are educational institutions (albeit limited ones) children are unable to utilise this. Parents cannot provide for their large families so children must go out to work and by doing this they miss out one all important education and remain illiterate. When they are older there is again no time to be educated as they begin their own family and the cycle continues.

Points to think about...Human Capital issues results in employment or subsistence farming as no-one wishes to invest to or recruit such workers. This has the multiplier effect as it pushes consumption down and subsequently AD. Another point to note in many of these countries the epidemic of HIV and AIDs mean that adults are sometimes unable to work and hence have to pull their children out of school and force them to work. So even though the opportunity to be educated is there many kids find themselves unable to benefit from it.


5. Poor GovernanceWhat kinds of issues are associated with poor governance? There are several issues associated with poor governance. These will be discussed in the following bullet points:★ Many LDCs have a dictatorial governance (this is obviously changing with the revolution in the Middle East) and this means that not always does the authority serve the people or is bothered about the economics impacts on people. We will discuss some of these points further in the corruption section.★ As a result, money is not spent wisely, they will spend it on whre their political interests lie e.g. they may spend the money on implementing regulations and laws which protect them and on the army. This means that TNCs and other investors will be put off from investing in such nations because of (i) ethics and more likely because (ii) they do not rust their political system.★This results in a misallocation of resources, so for example, education and training we have seen is such a key player in terms of growth but the government will spend money on the army and weapons resulting in a misallocation of resources.

How does it impact growth?The last point is probably the most crucial in understanding how this affects AS. The misallocation of resources means that AS cannot be extended. The governments need to spend serious money if they want AS to grow. Furthermore, if they are spending more one themself and or one their political party then this reuces all scope for government spending to increase AD.

Case Study: ZimbabweDue to the poor governance, Zimbabwe suffers with all issues with hinder growth and hyperinflation. This lack of stability ceases investors from investing, domestic firms from growing and obviously the government is so corrupt that all the government spending is spent on lavish lifestyle of Mr Mugabe.

Points to think about...I think it os important to point out one of the reason why these governments have poor performance is because many of hem are uneducated and probably don’t even what AS and AD is!


6. Foreign Currency GapWhat is the foreign currency gap? The foreign currency gap is a pretty simple concept. Essentially what it states is that many LDCs rely on the primary sector and we can se the Clarke-Fisher model to explain this too! However, the income from this sector is low because the have a low PED and are vulnerable to natural disasters etc. This means that export revenue is fairly low and LDCs cannot therefore finance imports.

How does it impact growth?You might think this is will benefit their Balance of Payments but it has a detrimental impact of AS. Much capital stock can be found in MEDCs so firms have to import it in order to grow and cause a shift in AS yet they are unable to do this because there is not enough export revenue to so. They only export revenue can go up is by increasing productivity which is only possible by purchasing capital stock so they are stuck!

Points to think about...Many of these countries do not have a proper monetary system in place and this means it is difficult to source finance. Another thing is that they do not have any property of legal infrastructure in play so to borrow from overseas bank wouldn’t work because they have nothing to secure their loan. Moreover, by importing less you push up the prices of imports (simple supply and demand) this results in a fall of standards of living as people cannot afford imports.


7. Civil WarsWhat is civil war? A civil war is when one or more groups have a war with one another. Quite often they can caused by political differences. In some senses the current situation in Libya is an example of civil war - pro Gaddafi supports fighting the rebels.

How does it impact growth?It has several impacts but the most important one being resources (which are as it is scarce in LDCs) being allocated to the war effort. This has a big opportunity cost because the same money and effort could be used to improve education etc. The adversely impacts AS and actually AD is affected too because people are forced to participate in war not

allowing them to earn and add to

consumption. A lot of human capital is lost in the bloodshed and whatever infrastructure was there becomes destroyed (again impacting long run AS).

Case Study: Congo(From Wikipedia)Specific information on the details of war is not required so to give you an example I have pasted the information from Wikipedia. The Republic of the Congo Civil War, lasting from June 1997 to December 1999, was fought between partisans of two presidential candidates, which ended in an invasion of Angolan forces and installation of Denis Sassou Nguesso to power.


8. Primary Product Dependency

What is PPD? LDCs are known to rely on the primary sector and quite often subsistence farming and as seen before one of the reason they are not able to free from this is because of capital flight. The value of such primary products is low therefore locals don’t make much money. This has many implications.

How does it impact growth?Aggregate demand is effected in two way by this, the first is straight forward as people are poor and tend to rely on subsistence farming they spend less in the local economy reducing consumption. To understand the second, it is important to look back at the cobweb theory (on Youtube PajHolden has a great video tutorial of this), cobweb theory provides one explanation of why prices fluctuate in the agricultural market. This fluctuation and instability makes it unlikely that farmers will invest pushing aggregate demand further down. Low PED of such goods further exacerbates the effects of the cobweb theory. AS is also affected though, the risk of natural disasters impacting such industries can easily push AS down.

Case Study: MozambiqueMozambique relies on sugar production for much

of its trade and development and wants to focus on this to grow further. However, the detrimental floods of 2000 spoilt nearly all the crops and contracted AS significantly.


9.GeographyWhat are some of the geographical elements that can impact growth? ★ Natural disasters e.g. floods, droughts, earthquakes, tsunamis etc.★ Brain Drain★Access to raw materials★Proximately to economic core★Coastal issues e.g. coastal erosion★Fertility of land and animals★Is the country landlocked?

How do they impact growth?This factors are particularly important to the primary sector and as discussed in the primary product dependency section are extremely important. However, the other factors are also very important e.g. if a country is land locked it is difficult to trade internationally making a country lack the economic injections it would have once got. The proximity to economic core denotes whether there will slums and shanty towns created. Brain drain occurs in places like rural indian villages where people are trying to search for different high earning jobs. These migrants go to the economic core and there tends to be a lack of jobs and shelter because of the influx of migrants and this results in the creation of slums. This means the government has to spend money trying to solve this problem rather than spending on infrastructure, education etc.

Points to think about...Another way to demonstrate the problem that the economic core faces with an influx of brain drain migrants is that it is an opportunity cost for the government.


10. Savings gap and inadequate capital

accumulation What is the savings growth? The savings gap in many LDCs starts off with the understanding that many LDCs are reliant on low value primary sector production. This starts of a negative wealth cycle as one can see below.

How is it relevant to economic growth?This cycle is relevant to economic growth because it basically shows why firms (more likely farmers) are not able to invest and increase their income and subsequently increase consumption. Both aggregate demand and supply are left at a low value because of this problem.


Low income (from ppd)

Low savings as they don’t earn much

If they don’t saving much they cannot (i) invest much and (ii) borrow to invest

Low capital accumulation as they can’t afford it

11. DebtWhat are the issues surrounding debt? Debt provides several problems for developing one the primary one being financing the debt and debt interest. They borrow at times of low interest to find that some years down the line the interest has increased significantly. The other issues which branch of the problem of debt include, not making as much money as projected (governments may have invested the money into a type of export which at that time was a high earned which by the time the moneys impact can be seen that export is now not worth much), increase in oil prices (prices of everything else rises but value of debt does not), fall in the value of currency making imports expensive and exports cheap to trading partners hence unable to source funding for debt and debt from money being used on the military.

How does it impact growth?This impacts growth in several way, the first is AD is affected because government spending falls, investment falls as there is less trust in the government and as the result of the first two consumption falls. FDI too falls and if tax is increased to raise funds for debt then short run AS falls. Obviously, no need to expound on this but with debt the opportunity cost is huge!

Case Study: IMFThe IMF cancelled one third of all debt because of pressure groups such as Live8 and Jubilee 2000 who argued that debt is only ruining people’s lives in LDCs.

Points to think about...There are many disputes regarding who is responsible for this situation the country being questioned at hand or the IMF who monitors such transactions. Is it fair to charge countries anyway?


12. CorruptionWhat are the issues surrounding corruption? When we talk about corruption we are talking about political parties or beings who are not fulfilling their role to serve the people but in fact are using the role to live lavish lifestyles and benefit themselves. Some of the issues surrounding corruption are bribery, extortion (illegally obtaining property, funds or other assets), inequality and fraud.

How does it impact growth?They essentially impact growth by misallocating resources. Corruption ensures that the elite have a great life and the ordinary layman suffers for the happiness for the elite. AD is obviously affected, as people suffer in poverty consumption is impacted, lack of faith in the government means investment is near to nothing the use of the money means the government is not spending money for the people. AS is too affected because there is a lack of investment and implementation of supply-side policies in such places.

Case Study: Zimbabwe Robert Mugabe, if you look him up, you will find he is basically the face of corruption. The devastating economic situation in Zimbabwe has a lot do with his corrupt nature. Yet this is not only found in Zimbabwe many other LDCs have to face this too.


Thank you for reading!


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Limits to Growth and Development Pack by Komilla Chadha