Constraints on Growth & Development

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A2 Macro Unit 4 - revision notes from tutor2u

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Constraints on Growth & Development

  1. 1. A2 Macro: Constraints on Growth and DevelopmentIn this chapter we will focus on the some of the major constraints on growth and development facing emergingcountries. Economic growth is not guaranteed and some countries struggle and sustain the minimum growth rateneeded to bring down poverty and sustain their chosen development path.Infrastructure Primary Export DependencyMacro Instability Conflict and CorruptionHuman Capital Weaknesses Savings and Foreign Exchange GapNatural Capital Depletion Inequality
  2. 2. What Factors Can Limit Growth and Development?In this section we will explore some of the many growthlimiters that a country may face1 / Infrastructure Infrastructure includes physical capital suchas energy, power and water supplies andtelecommunications & transport networks. Evidence shows that there is a strong positivecorrelation between a countrys developmentand the quality of its road network Poor infrastructure causes higher supplycosts and delays for businesses. It reduceslabour mobility and hurts the ability ofexporters to get their products to globalmarkets.Here are three examples of infrastructure deficiencies:1. India: India’s irrigation system is deficientand not properly managed and this has made it difficult to sustain food grain production when rainfall is lessthan expected – as was the case in 2012. This has led to a surge in food prices which hits the poorestcommunities hardest. For a few days in the summer of 2012, much of northern India was plunged intodarkness for two consecutive days. About 700 million people were left without power, a situation that affectedtransport, communication, healthcare, industries and farming. India needs an estimated $400bn investment inthe power sector if it is to meet its development goals.2. Brazil: Host for the 2014 World Cup and the 2016 Olympics. Brazil’s growth is constrained by infrastructureweaknesses: In 2011, only 14% of her roads were paved. The World Economic Forum ranks Brazil’s quality ofinfrastructure 104th out of 142 countries surveyed, behind China (69th), India (86th) and Russia (100th).3. Sub-Saharan Africa: The combined power generation capacity of the 48 countries of Sub-Saharan Africa is68 gig watts – no more than Spain’s. Excluding South Africa, this figure falls to 28 GW, equivalent to thecapacity of Argentina (except Argentina has a population of 40 million and Africa has 770 million.) Poor road,rail and harbour infrastructure adds 30-40% to the costs of goods traded among African countries. Thischronic shortage of energy - with firms and people facing acute shortages of power – is a major barrier togrowth and development.One limitation to infrastructure investment in developing countries is that tax revenues are low or come from anarrow base of businesses. For example, East African Breweries accounts for nearly 10% of the direct and indirect taxrevenues going to the Kenyan government.Many countries will need to increase their spending on infrastructure in the years ahead to adapt to and deal with theconsequences of climate change. There has been much interest in recent years concerning the investment ininfrastructure that businesses from emerging countries such as Brazil and China are making in the continent of Africa.China’s foreign direct investment in Africa has jumped from under $100 million in 2003 to more than $12 billion in2011.2 / Dependence on limited exports Many nations still relying on specializing in and exporting low value added primary commodities. Theprices of these goods can be volatile on world markets. When prices fall, an economy will see a sharp reduction in export incomes, an adverse movement in theirterms of trade, risks of a higher trade deficit and a danger that a nation will not be able to finance state-ledinvestment in education, healthcare and core infrastructure. Despite being rich in natural resources, for many countries this terms out to be a curse rather than a blessingExports of least-developed countries by major product, 2010(Percentage of total exports)2005 2010Others 14.6 19.4Textiles 1.4 1.3Other semi-manufactures 3.2 2.3
  3. 3. Raw materials 4.3 3.5Food 9.2 9.9Clothing 13.7 11.8Fuels 53.6 51.7Source: World Trade OrganisationHere are some examples of export dependence for a selection of countries in Sub-Saharan Africa: The data showsthe % of total exports in 2010: Angola: 97% oil Ghana: 39% gold, 26% oil, 17% cocoa Kenya: 19% tea, 12% horticulture Nigeria: 90% oil Senegal: 11% fish, 11% phosphate Tanzania: 37% gold Uganda: 18% coffee Zambia: 84% copperSub-Saharan Africa (SSA) is often cited as a region where primary sector dependence is high. SSA’s share in globalmanufacturing trade remains extremely low.3/ Vulnerability to External ShocksEvents in one part of the world can quickly affect many other countries. For example, the global financial crisis of2007-2010 brought about recession in many countries and deep financial distress in many regions. It also led to a fallin foreign direct investment flows into many poorer countries and pressure on governments in rich nations to cutoverseas aid budgets.If a resource rich country exports the resource, then it exposes itself to damaging volatility of its export earnings. In2010, economists Bruckner and Ciccone found that a 10% fall in income due to falling commodity prices raises thelikelihood of civil war in sub-Saharan Africa by around 12%.4/ Land locked countriesLand locked economies face particular challenges to integrate in global trade – without good infrastructure andefficient logistics businesses it can be difficult, costly and slow to get products to the countries of trade partners - butsome landlocked countries have been doing well especially when they achieve regional economic integration withother land-locked nations.
  4. 4. 5/ Low national savings and low absolute savingsSavings are needed to provide finance for capitalinvestment. In many smaller low-income countries, high levelsof poverty make it almost impossible to generate sufficientsavings to provide the funds needed to fund investmentprojects. This increases reliance on overseas borrowing ortied aid. This problem is known as the savings gap. In Africafor example, savings rates of around 17 percent of GDPcompare to 31 percent on average for middle incomecountries. Low savings rates and poorly developed ormalfunctioning financial markets make it more expensive forAfrican public and private sectors to get funds for investment.Higher borrowing costs impede capital investment.6/ Limited scale and efficiency of financial markets Many of the least developed countries have limited financial markets such as banking, money and creditsystems, insurance markets and stock markets. Worldwide, approximately 2.5 billion people do not have a formal account at a financial institution. Access toaffordable financial services is linked to overcoming poverty, reducing income disparities, and increasingeconomic growth These are essential for providing long term capital for the private sector and helping to channel savings andprovide funds for investment projects. Some progress is being made in Sub-Saharan Africa – there are now 19 stock markets in operation – butmost of these are very small by international standards. The Nigerian stock market accounts for only 3% of Brazil’s or India’s stock market capitalization.6/ Volatile incomes and employmentIncome growth so much more volatile in poor countries than in rich onesVolatility can be disruptive to economic health. It increases the risks for businesses considering capital investment, itraises the chances of people falling into extreme poverty and it makes a nation’s finances more fragile perhapslowering the scope for important investment in public goods.Poor countries specialize in fewer and more volatile sectorsThey tend to be smaller economies who cannot influence world pricesPoor countries tend to experience more frequent external shocksThese external shocks tend to be severe and affect millionsFewer countries have extensive social security safety netsJust 28 % of Africas labour force has stable wage-paying jobsProblems facing The BottomBillion – Paul Collier’s 4Development TrapsProfessor Paul Collier finds that theliving standards of the worldsbottom billion have stagnated overthe past forty to fifty years.He identifies four “developmenttraps” - they are conflict, reliance onnatural resources, being landlockedwith bad neighbours, and badgovernance.
  5. 5. 7/ Weaknesses in management Few development textbooks give much emphasis to the complex roles for and effects of businessmanagement as a constraint on growth and subsequent development. A fundamental cause of poverty is lowwages and poverty pay is linked to relatively low productivity (measured in different ways, one of which isthe value of output per person employed). Economists such as Nicholas Bloom from Stanford University have been studying the impact of weakmanagement in some developing countries including India. Bloom has argued for example that “In India arebadly managed: equipment is not looked after, materials are wasted, theft is common because inventory is notmonitored, defects keep occurring, etc. In a recent project with the World Bank, we found that givingmanagement advice to Indian factories increased productivity by 20%.” Weaker management may also help to explain why many poorer countries have not fully and intensivelyadopted new technologies. Economist Diego Comin finds that extensive adoption of new technologies hasaccelerated in recent years – witness the rapid expansion of mobile technology in many African countries –but that many of the least developed countries tend to use technologies less intensively - fewer people useless advanced computers less often.8/ Capital Flight Capital flight is the uncertain and rapid movement of large sums of money out of a country. There could beseveral reasons - lack of confidence in a countrys economy and/or its currency, political turmoil or fears that agovernment plans to take privately-owned assets under government control Capital flight can lead to a loss of foreign currency reserves and put downward pressure on an exchange rate– driving the prices of essential imports of goods and services higher. According to figures from Global Financial Integrity, developing countries lost $5.86 trillion in 2001-2010 toillicit financial flows9/ Conflict, corruption and poor governance Governance refers to how a country is run and whether the exercise of authority manages scarce resourceswell improving economic outcomes and the quality of life for a country’s people. High levels of corruption andbureaucratic delays can harm growth by inhibiting inward investment and making it likely that domesticbusinesses will invest overseas rather than at home.
  6. 6. Governments need a stable and effectivelegal framework to collect taxes to pay forpublic services. In India, there are 15 timesmore phone subscribers than taxpayers. Ifa legal system cannot protect privateproperty rights then there will be lessresearch and development & innovation.Conflicts – there have been an estimated150 conflicts since 1945 with 28 milliondeaths (this is twice the toll of WW1).Conflicts have huge collateral damageeffects – for example, Angola has lost 80%of its farmland because of landmines. Mostconflicts are intra-state i.e. civil war andreconstruction can take decades andmany countries remain aid-dependent.About 1.5 billion people live in countriessuffering repeated waves of political andcriminal violence.A recent example of the cost of conflictcomes from the Ivory Coast. After a disputed presidential election in late 2010 violence erupted and the countrydescended into a four-month civil war that killed an estimated 3000 and displaced around a million people. The warcould only be ended by a French intervention in April 2011. Since then the new government under President Ouattarahas struggled to re-establish security but raids against army and policy installations still threaten stability.Keeping track ofelection promisesLow transparencyof where taxrevenues comefromHow is statemoney spent andon whom?CorruptionIs thegovernmentdelivering keypublic services?How is thismoney spent?Does it delivergood outcomesper $ spent?Is spendingeffective inpromoting longrun growth?ImpactCan people trustgovernment andinstitutions?How free ofcorruption is thegovernment?Is the distributionof spendingequitable?Fairness
  7. 7. Corruption damages markets, investmentand growthCorruption undermines human developmentand democracy. It reduces access to publicservices by diverting public resources for privategain. Corruption hinders economic developmentby distorting markets and damaging privatesector integrity. Corruption can cost a countryup to 17 Percent of its GDP(Source: Asian Development Bank)Corruption has long been a barrier to sustained growth anddevelopment in Africa. Conflict has had terribleconsequences; over one third of economies in Africa havesuffered some kind of warfare from Rwanda, Sierra Leone,Eritrea, Uganda, and Somalia.That said encouraging progress has been made in buildingdemocratic institutions in many African countries.Economic growth can collapse and go into reverse whenstates fail – there are numerous reasons why chronicgovernment failure can hamper growth and development: Failures to protect property rights and provide sufficient incentives for new businesses to flourish Forced labour, caste labour and other forms of discrimination – all of which waste scarce humanresources not least limiting the roles that women can play in labour markets and – over the long term - holdingback innovation and technological progress (two key drivers of growth) Power elites controlling an economy - using their power to create monopolies and blocking newtechnologies Stateless areas - large parts of the world are still dominated by stateless societies where the rule of lawbarely exists Public goods - chronic failures to provide basic and effective public services such as education, health andtransport. Many of the world’s least developed countries have not built effective tax systems and so theirrevenue base is inadequate for much needed capital investment and the annual revenues required to providepublic health and education programmes Conflicts – there have been many conflicts over natural resources e.g. in Sierra LeoneLow rule of law scores
  8. 8. 10/ Population decline and / or an ageing population In some countries the size of the population is declining as a result of net outward migration If a nation loses younger workers, this can have a damaging effect on growth The changing age-structure of a population also matters, leading to a fall in the ratio of workers to dependantsDemographic change is important to many of the fast growing countries in Asia. Most countries in East Asia are expected to experience a decline the portion of their working age population(15-64 years) to total population from now until 2025 Seven countries are expected to see declines of 10 percent or more (including China, Japan, Thailand andVietnam) while three will see declines of over 20 percent (Hong Kong SAR China, Korea and Singapore) Countries such as Indonesia, Mongolia, Myanmar and Vietnam are forecast to see a decline in theirpopulation size due to a combination of emigration and demographicsDeclining populations in Eastern EuropeMany countries in Eastern Europe must face the challenges of continued population decline. Only two out of twelvecountries will experience population growth according to recent estimates.The relationship between demographic trends, per-capita income and economic growth is complex. Lower per-capitaincome should lead to higher growth, but it also has a negative impact on labour supply. Eastern Europe will have torely on capital accumulation and productivity growth rather than labour force growth to generate economic growth.One of the BRIC countries – Russia – is experiencing a sustained decline in their population and their active labourforce. High levels of net migration, rising death rates linked to exceptionally high accident rates and the effects ofalcohol abuse have all contributed to a fall in population to below 150 million.Globally the world’s population is ageing. Within next 10 years, there will be 1 billion older people worldwide. By 2050nearly one in five people in developing countries will be over 6011/ Rising inflation Fast growing countries may experience an accelerating rate of inflation which can have damaging economicconsequences. Two effects of high inflation in particular can hit growtho Falling real incomes and profits together with higher costso Reduced competitiveness in international markets.
  9. 9. 12/ Persistent trade deficits due to rising imports Some countries may experience large deficits on the currentaccount of their balance of payments. This means that thevalue of imported goods and services is greater than the valueof exports and net investment incomes leading to an outflow ofmoney from their economy. High trade deficits might have to be covered by foreignborrowing (increasing external debt) or a reliance on inflowsof capital investment from overseas multinationals Large trade gaps can eventually lead to a currency crisis andpossible loss of investor confidence.13/ Over-extraction of the natural resource base Natural resources provide an important source of wealth formany lower-income countries and when world prices are high,there is an incentive to increase extraction rates to boostshort-term export earnings. This might lead to an excessive rate of extraction thatdamages growth potential Deforestation and rapid extraction of oceanic fish stocksthreaten development. The World Bank finds that 350 millionjobs are linked to the health of the oceans and 1 billion of thepoorest people in the world depend on fish as their majorsource of protein Critical water scarcity in agriculture is a major problem. TheMDG for drinking water was met in 2010, yet 1 billion still lackaccess to clean water. The number of people living in nations,regions with water scarcity is expected to rise to 2.8 billion by2025 Extreme weather events are becoming more frequent. Thedamaging effects of these extreme climatic events fall mostheavily on the poorest and most vulnerable communities indeveloped and developing countries.14/ Inadequate investment in human capital To sustain growth requires improvements in productivity,research & development and innovation. Whilst physical capital such as factories and technology playsa role, so too does the quality of the human input intoproduction. Economic growth might be limited by skills shortages asbusinesses seek to expand which forces up average wagesand labour costs. High level skills and qualifications are also needed to helpbusinesses to move up the value chain and supply productsthat will get higher prices in the world economy. In many countries there are acute shortages of human capital.Although primary enrolment rates have risen, secondaryenrolment and teacher quality is poor and the tertiaryeducation sector is tiny and low-quality. Some countries lose some of its limited skilled workforce toother countries through a brain drainThe saving gap and the foreignexchange gapThese two gaps have long held tobe important in the developmenteconomics debate. In short:i) Many poorer countries do nothave sufficient domestic savingsto be able to finance the requiredrate of capital investment topromote economic growthii) Many developing countriessuffer from a shortage of foreignexchange that can be used tofinance imports of consumergoods and services, raw materialsand components and new capitalinputsDeriving the savings gap andthe foreign exchange gapsThinking back to introductorynational income accountingY is total output produced in agiven year (GDP)C is private consumptionI stands for total investmentG is government consumptionX denotes exportsM represents importsS is savingsT stands for total government taxrevenueWe know thatY (GDP) = C+I+G+X-MY is also the sum of C + S + TRearrangingC+I+G+X-M = C+ S + TThereforeS-I = (X-M) + (G-T)This gives us an equationexplaining total resource gap ofan economy into internal balance(i.e. the government budget) andexternal gap (balance of trade)
  10. 10. 15/ High levels of inequality of income and wealthSource: World Bank Report on China, published March 2012 Although two decades or more of globalisation has strengthened average growth rates in many lower andmiddle-income countries, it has brought an increase in inequalities of income and wealth. When the gap between rich and poorer communities gets bigger there are many possible dangers not leastthe costs of social tension and conflict and increasing spending on insurance, law and order systems andgovernment welfare bills. Recent theoretical work finds a negative correlation between income inequality and economic growth. Onebook that supports this view is The Spirit Level (Pickett and Wilkinson) which finds evidence that unequalsocieties may become less competitive over time.16/ Gender inequality and discrimination1) Just over half of the world’s female population aged 15-64 is in employment, compared to more than 8 out of10 men. But the proportion of economically active women has declined in the last 20 years2) In many countries women are subject to deep-rooted cultural norms that prevent them playing a full and activerole in their economy.a. According to the World Bank, 232 million women live in economies where they cant get a job withouttheir husbands permissionb. Less than 10% of credit for small farmers in Africa is directed to women3) Some progress is being made, from 2009 through to 2011, 39 developing countries made legal changestowards gender parity – but only 38 out of 141 nations set the same legal rights for men and women in theirown labour markets4) Women in many countries have a substantial role in the informal economy, working in family businesses,doing domestic work and producing goods for self-consumption. This type of work generally offers low,irregular or no remuneration and little or no access to social security or legal protection.
  11. 11. Economic and Social Costs from Rising Inequality16/ Malnutrition and limits to growth and developmentHigh rates of malnutrition can severely impair development and bring untold human misery. Poor nutrition can haveserious negative effects on development prospects: It impairs brain development among the young – nearly one in five children aged under five in the developingworld is under-weight It is responsible for half of all child deaths – 38% ofunder-five children in the poorest 20% of families indeveloping countries are underweight compared to 14%of under-fives in the wealthiest 20% It increases the risks of HIV infection and cuts thenumbers who survive outbreaks of malaria Malnourished children are more likely to drop out ofschool and suffer reductions in their lifetime incomes According to the World Bank, “the effects of this earlydamage on health, brain development, educability, andproductivity caused by malnutrition are largelyirreversible.” The surge in global food prices has had a terrible effecton the risk of malnutrition in many of the world’s poorestcountries. It has certainly led to a sharp rise in prematuredeaths and severe illnesses linked to poor nutrition incountries such as India.Here is the 2011 data for the % of people who are undernourished: Sub-Saharan Africa: 27% (equivalent to 231 million) Southern Asia: 20% Developing regions: 15% Rural children in developing countries: 32% Urban children in developing countries: 17%There has been progress in reducing malnutrition but high prices for basic foods in recent years have become a majorproblem in the fight against endemic malnutrition. Another effect if that high food prices make substitution of unhealthycalories more likely, contributing to global obesity level.•Low income families spend a higher % of their incomes -inequalities depress consumer demand•Investment skewed towards preferences of the richConsumption and mis-allocation ofresources•Incentives are undoubtedly needed for enterprise•But excessive compensation can encourage too muchrisk-taking especially in financial marketsRisk-taking•High inequality deprives many people of access toeducation limiting human capital growth•Many of the poorest pay more for their debtMarketfailures•Structural unemployment and vulnerable employmentincreases the burden on the state•Low employment damages social capitalUnemploymentand socialcohesion / upheavalTackling malnutrition in AfricaSub-Saharan Africa cannot sustainits present economic resurgenceunless it eliminates the hunger thataffects nearly a quarter of itspeople. More than one in fourAfricans - close to 218 millionpeople - is undernourished, Africangovernments spend between 5-10% of their budgets on agriculture,well below the 20% average thatAsian governments devoted to thesector during the green revolutionthere.”Source: African HumanDevelopment Report, 2012
  12. 12. Prevalence of undernourishment (% of population)Country Data is from 2008Eritrea 65Burundi 62Haiti 57Zambia 44North Korea 35Kenya 33Low income countries 29Least developed countries 29Sub-Saharan Africa (all income levels) 22India 19World 13Middle income 13China 10European Union 5Policies to reduce malnutrition1. Schemes to promote health and nutrition education plus direct provision of micro-nutrient supplementsand fortified foods2. Growth monitoring schemes for the newly born and infants supplemented with vitamin provision fromcommunity organisations3. Targeting cultural norms – in some countries, young girls are often allowed to eat only after theirbrothers4. Cash transfers – i.e. consumer subsidies that can be spent on certain foods5. Government subsidies for grain prices and export bans on domestically produced foods6. Better food prices paid to small-scale farmers7. Opening up retail markets to international supermarkets where food prices might come down througheconomies of scale and increased competition8. Infrastructure spending to improve access to and improved quality of sanitation and clean watersupplies

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