Factors Influencing Growth and Development

Economic Factors

Every country has its own unique history and combination of cultural, political and economic factors that determine its development. There is no single theoretical model which accounts for all economic development, but we can identify the factors that are likely to influential in particular countries. We can divide them into economic and non-economic factors.

Primary product dependency – Primary products (or commodities) include agricultural products and minerals (eg fossil fuels, metals and diamonds). A high dependency on these products may hinder development. Dependency is measured by the % of exports accounted for by primary products, or the percentage of GDP. It can also be measured by the % of the population employed in these industries. Much of sub-saharan Africa is heavily dependent on agricultural products and minerals, and a number of countries in the Middle East rely heavily on oil and gas deposits.

Primary product dependency can hinder development for the following reasons:

Low price elasticity of demand – Commodities tend to be basic or essential goods (eg food and energy) which low PED. This can result in very volatile prices if there are unplanned changes in supply, such as a crop failure or (particularly in the case of oil and gas) the discovery of new deposits or interruptions to supply because of political problems.

Big swings in commodities prices can mean that a country’s GDP can grow or fall rapidly and make it difficult to plan ahead. This discourages investment, and consequently impedes development.

Low income elasticity of demand – These goods also tend to have a low IED. Over the long term, this is likely to mean that the demand for these goods grows more slowly than for manufactured goods and services, so that countries dependent on primary products are likely to develop more slowly than countries with larger manufacturing and services sectors.

Resource curse – A number of countries with generous endowments of natural resources (especially minerals and fossil fuels) have tended to develop more slowly than countries without such endowments. Nigeria and Venezuela (both with huge oil reserves) and Angola (diamonds) have lagged far behind the likes of Japan, Hong Kong or South Korea, all of which have to import most of their energy and other primary products. There is a number of reasons for the ‘resource curse’:

Civil war – Mineral deposits are usually found in only a few parts of a country. This can give rise to conflict between inhabitants of resource rich and resource poor regions, particularly if there are strong regional identities which are tribal or religious.

Appreciation of the exchange rate – Sometimes the exports of minerals may drive up the exchange rate, if those exports create a large current account surplus. The higher exchange rate then makes other sectors of the economy (manufacturing and services) less internationally competitive. This can affect developed countries too; both the U.K. and the Netherlands experienced this problem in the 1970s and 1980s as a result of the discovery of the North Sea oil and gas fields. The problem became known as the ‘Dutch disease’.

limited investment in other sectors – An abundance of natural resources may result in the neglect of investment in manufacturing and services; reliance on income from primary products becomes an easy option. It may also lead to the neglect of training and education, as the economy is not competing on the basis of its skills and technology.

Monopoly power – A lot of the world’s mineral deposits are controlled by a small number of big multinational companies who buy up the rights to these deposits (often by making corrupt payments to politicians). They pay little in local taxes and take most of the profits out of the country, so that the local population get little benefit from this natural wealth. These giant companies also have a degree of monopsony power and are able to pay very low wages to the local workforce.

It should be noted however that not all countries with large endowments of natural resources are held back by it. Much depends on how well the country is governed. Australia is a good example of a country with a high degree of dependency on primary products, but a very high level of development. Much of the income from this natural wealth generates tax revenues which are invested by the government in education, health care and infrastructure. Norway is another example.

_Infrastructure _– The network of roads, rail, air and sea ports, telecommunications, water and power supply are all vital to development. The most developed countries tend to have much better infrastructure than less developed ones.

_Human capital and technology _– Countries that have an educated and skilled workforce (high levels of human capital) will be better placed to develop and make use of advanced technologies which can boost productivity and living standards.

_Debt _– Development in many poorer countries has been hampered by unsustainable debt, particularly in the 1980s and 1990s. They borrowed large sums, in dollars at favourable rates of interest. Much of the borrowing was from banks in rich countries who believed the loans and interest could be repaid from the fruits of growth and the fact that many of these countries had valuable mineral deposits. A number of factors resulted in the debts spiralling out of control:

  1. a rise in the value of the dollar and interest rates in the 1980s (repayment of the debt and interest therefore rose in local currency terms)
  2. a collapse in some commodity prices
  3. corruption and mis-management, resulting in the borrowed money not getting invested in productive uses

For a number of countries in Africa and South America, this resulted in debt and interest payments exceeding the value of aid and new loans, and taking up a huge proportion of the value of their exports. Although debt relief programmes and strong growth in the world economy have helped to solve the debt crisis, some countries, such as Argentina have not fully recovered from it.

_Access to banking and credit _– In many poorer countries there is only a limited network of banks that can provide loans to households and businesses, particularly in rural areas (where many people live in poorer countries). This can hold back development as it is difficult for small businesses to raise capital. The growth of __microfinance __(very small loans provided by charities and some commercial organisations) in some countries has helped to solve this problem, but interest rates on these very small loans can be prohibitive and can force people into further poverty and debt if they default. The growth of mobile phone banking services has also helped to overcome the problem of an absence of a physical branch network.

Property rights – A legal system that establishes and protects the rights of ownership of land, buildings and businesses is essential for economic development. If property can be easily confiscated by the state, or it is impossible to prove ownership, individuals and businesses will be reluctant to invest and may struggle to raise capital. Equally it is important that business contracts are legally enforceable. In some developing countries property rights are not properly protected and consequently the growth of businesses is impeded.

_Savings _– Investment, which is essential for long term growth and development is financed by saving. Countries with low levels of saving may therefore struggle to grow and develop.

Growth also depends on the Capital-Output Ratio. This is defined as the amount of capital needed to produce a given quantity of GDP. For instance, if it required £500 of spending on capital to produce an extra £100 of output, the capital-output ratio would be 5. The lower the ratio the better. This depends on factors such as the level of skill and education of the workforce and the level of technology a country has access to.

It can be seen from this that growth and development will be improved by a combination of higher saving and a lowering of the capital-output ratio.

The Harrod Domar Growth Model uses the following formula to explain how the growth rate of an economy is determined:

Growth rate = Savings Ratio/Capital-Output Ratio

EXAMPLE: Suppose the savings ratio, also called the average propensity to save is 10% and the capital-output ratio is 5. The model would then suggest that the annual growth rate is likely to be about 2%.

The policy implications for a government that wants to raise the growth rate are clear:

  1. Policies to encourage saving (such as tax incentives)
  2. Policies to improve the capital-output ratio (such as improvements in education)

The problem for many developing countries is that they are trapped in a vicious circle of low income, leading to low saving, which in turn leads to low growth. The circle can be broken by foreign aid, which, in effect uses the savings of other countries to finance investment and fill the savings gap to create a virtuous circle of rising income and saving.

Foreign aid can also be used to fill the foreign currency gap, the shortage of foreign exchange that may be a problem for some developing countries if they have chronic current account deficits.

_Demographic factors _– Rich countries tend to have an ageing population, which can mean a smaller % of the population in work and slower growth. On the other hand, many developing countries have a very high birth rate, leading to much unemployment amongst young workers and insufficient resources to provide the mall with a good education. This can perpetuate low incomes and impede development. A fall in the birth rate can help a country to achieve a higher level of development.

Non-economic Factors

Corruption and poor governance occur in all countries to some extent, but this is a much bigger problem in poorer countries, particularly if they are not democracies and don’t have a free press and independent judiciary. This makes it easy for a culture of bribery to develop, resulting in inefficient economic outcomes and very often capital flight, which is when richer people and businesses take much of their income and wealth out of the country, either to hide it, or because they do not think it is safe to keep it in the country. This deprives the country of savings and therefore investment.

Explain why a country that has substantial natural resources might develop more slowly than a country that has to import most of its natural resources.
Your answer should include: resource curse / primary product dependency / volatile prices / price volatility / price elasticity of demand / income elasticity of demand / Dutch disease / multi-national companies