Limits to growth and development

Economic growth is measured in terms of changes in real GDP. However, economic development cannot be defined so precisely. It is a multidimensional concept which refers to changes in living standards and welfare over time. Unlike economic growth, economic development is a normative concept dependant on value judgements. In order to provide some measure of development, various composite measures are used. The most common of these is the human development index (HDI), which includes GDP per head (measured at PPP), health (measured in terms of life expectancy) and education (measured in terms of school enrolment ratio and literacy rate). However, this is a narrow measure of development because it ignore a range of other indicators such as:

  • the proportion of the population with access to clean water
  • the proportion of the working population employed in agriculture
  • energy consumption per person
  • proportion of households with internet access
  • mobile phones per thousand of population

Constraints on growth an development

While all countries face restraints on growth and development, there is an enormous difference in the scale of the constraints affecting developed and developing countries. Further, the problems facing any particular developing or developed country vary considerably. It is important to have some knowledge of particular countries in order to give relevant examples. This article and the next will focus primarily on problems facing developing countries.

Primary product dependency

Primary products may be divided into hard commodities, such as copper, tin and iron ore and soft commodities, such as most agricultural crops – wheat, palm oil, rice and fruit. A range of issues face countries dependant on primary products, including the following:

  • Price fluctuations: given their price inelasticity of supply and demand, any demand side or supply side shock will cause a significant price change
  • Fluctuations in producers incomes and foreign exchange earnings: since demand is price inelastic, then a fall in price will cause total revenue to fall and in turn, the foreign currency earnings from exports to fall
  • Difficulty of planning investment and output: the price fluctuations cause uncertainty, which is a deterrent to investment
  • Natural disasters: extreme weather can cause severe disruption to primary products, especially soft agricultural ones
  • Protectionism by developed countries: for example, the huge subsidies given to US cotton farmers have created great difficulty for Indian cotton farmers, who are unable to compete; the EU’s Common Agricultural Policy has meant there is no free access to European markets for food from developing countries
  • Low income elasticity of demand for primary products: the Prebisch-Singer hypothesis states that the terms of trade between primary products and manufactured goods tend to deteriorate over time.

The Prebisch-Singer hypothesis

This theory suggests that countries that export commodities will be able to import less and less for a given level of exports. Prebisch and Singer examined data over a long period of time and found that the data suggested a decline in the terms of trade for primary commodity exporters. A common explanation for this is that the income elasticity of demand for manufactured goods is greater than that for primary products – especially food. Therefore, as incomes rise, the demand for manufactured goods in increases more rapidly than demand for primary products and so the prices of manufactured goods rise relative to the prices of primary products, so causing a decline in the terms of trade for countries dependant on the export of primary products due to increasing general incomes.

The theory may be criticised on the following grounds:

  • First, some countries have developed on the basis of their primary products (e.g. Botswana diamonds)
  • Second, if a developing country has a comparative advantage in a primary product, then its resources will be more effectively used by the specialisation of that product.
  • Third, primary products rose sharply until the middle of 2008 while the prices of many manufactured goods were falling.

Some economists argue that, in the case of food, prices are likely to increase as world population grows and incomes in China and India rise, so  causing higher demand for food more traditionally eaten by those in developed countries.

Similarly, the outlook for countries such as Bolivia is good. Nearly half the world’s known reserves of Lithium lie in Bolivia, which is used to make batteries for hybrid and electric vehicles. Given the decline in oil production and subsidies being given to electric car manufacturers, demand for lithium can be expected to rise sharply in the future.

In contrast, countries producing copper, such as Chile, were faced with a 50% price fall in the middle of 2008 and 2009.

Savings gap

The Harrod-Domar model suggests that that savings provide the funds which are borrowed for investment purposes. Therefore, economic growth depends on:

  • the level of saving and the savings ratio
  • the productivity of investment.
It suggests that economic growth depends on labour and capital. Developing countries have a large amount of labour, so it is a lack of physical capital that holds back economic growth and therefore development.
Therefore, economic growth requires policies that encourage saving or generate technological advances, which enhance the productivity of capital.
Human capital may also be as important as economic capital, but without investment to finance this growth cannot be achieved.
However, savings may be difficult to manipulate, as raising interest rates would make lending harder, and outweighing the benefit of savings in the short run, but perhaps is better solution in the long run. Also, an increase in exchange rates would increase currency value, making exports less competitive, and therefore further reducing marginal propensity to save due to a loss of income.

Many developing countries have a low GDP per capita and consequently they hold inadequate savings to finance the investment seen as essential to achieve economic growth.

Low incomes means low propensity to save, low savings means low investment, low investment means low capital accumulation, which in turn leads to low incomes.

Foreign exchange gap

Associated with the savings gap, many developing countries face a shortage of foreign exchange. This is when a country’s balance of payments on current account deficit is greater than the value of capital inflows. This may be the result of:

  • dependence on export earnings from primary products
  • dependence on imports of capital goods and other manufactured goods
  • servicing debt
  • capital flight

Capital flight

This occurs when individuals or companies decide to place cash deposits in foreign banks or buy shares or other assets from foreign countries. This has serious implications, for example:

  • it contributes the savings and foreign exchange gap, and consequently:
  • it restricts economic growth
  • it reduces the tax base because the country looses any tax payable on these assets

Debt

Many developing countries borrowed money at times of low interest rates, only to find that they are struggling to service the debt some years later. Debt has become a problem for a variety of reasons, including:

  • risky decisions to borrow money to finance major investment projects at a time when the world economy was strong and/or the prices of goods which they were exporting were high
  • an increase in oil prices
  • a fall in the value of currencies of developing countries, which increased the burden of foreign debt
  • loans taken out to finance expenditure on military equipment

Corruption, poor governance and civil wars

Corruption is usually defined as the use of power for personal gain. It may take a variety of forms including bribery, extortion and diversion of resources to the governing elite. Corruption acts as a constraint on development when it causes an inefficient allocaiton of resources.

Poor governance implies that the rulers of a country have adopted policies that result in the country’s resources being allocated inefficiently. Government failure (where government intervention creates a net welfare loss) might also be evident as part of poor governance.

Civil wars, such as those which have occurred in Sudan and the Democratic Republic of the Congo, disrupt growth and development. Indeed, in so far as they actually cause destruction of infrastructure and the death of many people, they may in fact negate any progress made in previous years.

All the above issues can deter both domestic investment and foreign direct investment and so limit the possibilities for growth and development.

Population issues

Population growth is particularly rapid in some of the poorest countries in the world. Meanwhile, population is falling in some developed countries.

Population growth may be analysed in relation to the views of Thomas Malthus, who predicted at the end of the eighteenth century that famine was inevitable because population grows at an exponential rate, whereas food production grows at an linear rate. Although his predictions were proved to be incorrect for Britain in the nineteenth century, some economists believe that they are still relevant for some of the poorest developing countries. In these countries, population growth is faster than GDP growth, with the result that GDP per capita is falling

Human capital inadequacies

A country where education standards are poor and where there is low school enrolment is likely to experience a low rate of economic growth due to low productivity. It will also act as a deterrent to transnational companies to invest in the country due to the costs involved in educating and training workers.

A particular problem for some countries is the prevalence of HIV and AIDS; when an adult develops AIDS, he or she will be forced to give up work. This means that the children might be withdrawn from school, either because the school fees can no longer be afforded, or they are required to work to support the family. A further problem arises if teachers contract work, forcing them to give up work. The training of workers may also be disrupted by AIDS, particularly if a transnational  country is involved and decides that it it no longer profitable to operate in the country. The combined effect of these problems is to reduce the quality and quantity of education and training.

Poor infrastructure

Infrastructure covers the whole range of structures that are essential for an economy to operate smoothly. Infrastructure includes the following:

  • transport
  • telecommunications
  • energy supply
  • water supply
  • waste disposal

Clearly, poor infrastructure will make it difficult to attract domestic and foreign investment and thus present a significant obstacle to growth and development. On the other hand, a country rich in a natural resource demanded by other countries might benefit from FDI; a transnational company might provide some infrastructure to the country in order to facilitate its business development. For example, new roads to transport goods from production areas to international links, which would benefit the entire country.

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