The Economics of Developing Countries
Bonus Web chapter thirty-nine
The Economics of Developing Countries
CHAPTER OVERVIEW
It is sometimes difficult for affluent Americans to realize that hunger, squalor, and disease are commonplace for most of the world’s population. The problem of raising the standard of living in these countries is the central issue of this chapter. The chapter begins by identifying the developing countries and discusses their characteristics. Then we discuss why these countries have such low standards of living emphasizing the obstacles to economic growth. Next, we examine the potentials and pitfalls of government’s role in economic development. We also examine private money flows from the advanced industrial countries (IACs) to the developing countries and assess the debt problem the developing countries face including a discussion of possible debt forgiveness. Finally, we distill a list of possible policies that might help developing countries increase their growth rates.
WHAT’S NEW
This chapter now appears on the website. It is fully supported by the supplements.
The data have been updated throughout. There is new data on “aid dependency ratios.” There are new references to the role of agricultural subsidies in IACs and their adverse impact on developing countries (DVCs).
INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to
1. Distinguish between IACs and two categories of DVCs.
2. Identify factors that characterize DVCs.
3. Describe the growth rates of IACs, middle-income DVCs, and low-income DVCs.
4. Enumerate some human implications of poverty in the DVCs.
5. State the two basic avenues for growth for a nation.
6. Describe the primary obstacles to growth in the DVCs.
7. Illustrate by diagram the vicious circle of poverty.
8. State five features of the positive role of government in development.
9. Explain the problems of public sector involvement in development.
10. Describe three aspects of the role of advanced nations in development assistance.
11. Describe the extent of DVC debt, consequences, and possible solutions including debt forgiveness.
12. List and describe nine policies for promoting economic growth in the DVCs.
13. Define and identify terms and concepts listed at the end of the chapter.
COMMENTS AND TEACHING SUGGESTIONS
1. Current data are important for the discussion of economic growth and underdevelopment. Good sources include the World Bank’s annual World Development Report, the World Bank Atlas, and the International Monetary Fund’s annual World Economic Outlook. Data can also be found in a free monthly publication, International Economic Conditions, which can be obtained from the Federal Reserve Bank of St. Louis, PO Box 442, St. Louis, MO 63166 and the periodical magazine, The Economist.
2. The world population problem is a challenging issue for most students and it can be explored by recalling the Malthusian model summarized in most texts on the history of economic thought. One such text is Robert Heilbroner’s The Worldly Philosophers, which has a chapter on Malthus.
STUMBLING BLOCKS
The material in this chapter is not difficult to understand, but students may have difficulty appreciating what poverty is and how it really affects people. Visits to a local homeless shelter or food bank may be illuminating. Another activity is to have a “global dinner” where meal sizes and composition are varied to reflect the wide disparities in global income distribution. In a group of 100 people, for example, one will get an extravagant meal, two or three will get a decent but unremarkable meal, and the remainder will receive something like a bowl of rice.
LECTURE NOTES
I. The Rich and the Poor
A. Industrially advanced countries (IACs) include the U.S., Canada, Australia, New Zealand, Japan, and most of Western Europe. They have developed market economies based on large stocks of capital goods, advanced technologies, and a welleducated labor force. They have a high per capita output, as seen in Figure 39W-1.
B. Developing countries (DVCs) are unindustrialized nations heavily committed to agriculture. They have low rates of literacy, high unemployment, rapid population growth, and their exports are largely agricultural or raw materials. Capital equipment is scarce, production technologies are primitive, and productivity is low. More than 60 percent of the world’s population lives in these nations, which can be divided into two groups (Figure 39W-1).
1. The first group consists of “middleincome” DVCs with an average annual per capita output in 2001 of $1,850, but with a range from $745 to $9,206 per capita.
2. The low-income group is the poorest with average output per capita of only $430 and a range to $745. Dominating this group are India, Indonesia, and the subSaharan African nations.
C. Comparisons highlight income disparities.
1. U.S. 2001 GDP (almost $10 trillion) was more than the total output of all of the DVCs combined ($6 trillion).
2. The U.S. has 5 percent of the population but produces 31 percent of the world’s output.
3. U.S. per capita GDP is almost 250 times greater than that of Sierra Leone, one of the world’s poorest nations.
4. The largest U.S. corporations have sales greater than most DVC nations’ output. General Motors had sales greater than the output value of all but 21 nations of the world.
D. Growth, Decline, and Income Gaps
1. DVCs such as China, Malaysia, Chile, and Thailand have achieved high annual growth rates in their GDPs in recent decades. Several previous DVCs, such as South Korea, Singapore, and Hong Kong have achieved IAC status. But many DVCs, such as those in sub-Saharan Africa, have experienced declining GDPs per capita.
2. The absolute income gap between rich and poor nations has been widening. For example, if per capita income is $400 a year in a DVC, a 2% growth rate means an $8 increase in income. Where per capita income is $20,000 per year in an IAC, the same 2% growth rate translates into a $400 increase in income.
E. Human realities are difficult. Implications are great in terms of poverty and the human condition as dramatized by the excerpt from Michael Todaro’s book in the text. Table 39W1 highlights other socioeconomic differences.
II. Obstacles to Economic Development
A. Natural resources must be used more efficiently and their supplies expanded. Resource distribution is very uneven as is evidenced by the wealth of the OPEC countries. Often ownership of natural resources is an issue if they belong to corporations in industrially advanced countries. However, weak resource bases are not necessarily impossible to overcome, as Switzerland, Israel, and Japan have shown.
B. Human resources in DVCs have three characteristics.
1. Overpopulation is the rule. An annual population growth of approximately 1.5 percent in these countries means that their populations double approximately every 47 years. This compares to an average 0.7 percent rate of population growth in advanced countries. It means that economic growth must be very rapid to make any gain on population; DVC per capita incomes are lagging behind the IACs (see Table 39W2).
a. Population growth accelerates with economic growth as better living conditions extend life.
b. Birth rates remain high as medical care and sanitation cut infant mortality.
c. Population growth hinders development because large families create obstacles to development. They reduce the ability of households to save, more investment is required to keep up with increases in the labor force, an overuse of agricultural land may occur, and massive urban problems are generated.
d. Other reasons exist to explain why expansion hinders development.
e. Possible solutions include China’s “onechild” program, but many nations have religious and sociocultural reasons to oppose contraception or birth control.
f. Three additional points are worth noting.
i. The relationship between population and economic growth is not as clear as it seems. Japan and Hong Kong are densely populated, but wealthy. Did the wealth come before or after population growth rates declined?
ii. Population growth rates for the DVCs in general have declined in recent decades.
iii. The traditional view is that reduction in population growth leads to economic development. But the “demographic transition” theory maintains that rising incomes lead to slower population growth. Children are viewed more as economic liabilities as the wealth of a country becomes greater. (Key Question 6)
2. High unemployment and underemployment are characteristics of DVCs, with rates in the vicinity of 15 to 20 percent. This may become worse as rural populations migrate to cities in the hope of finding jobs that are not there. Underemployment occurs when workers are employed less time than desired or at jobs that do not fully utilize their skills.
3. Low labor productivity occurs because there has not been enough investment in physical or human capital. Furthermore, often there is no entrepreneurial class. Higher education is often oriented toward the humanities rather than technical areas, and some of the best workers have migrated from their home countries, causing what is called the “brain drain.”
C. Capital accumulation is an important focus.
1. All DVCs suffer from a lack of capital goods—factories, machinery and equipment, public utilities, etc. Better equipped workers would improve productivity.
2. Increasing the stock of capital goods is crucial because of the very limited possibility of increasing the supply of arable land.
3. Once begun, the accumulation of capital may be cumulative if it can raise output faster than the population grows.
4. Domestic capital formation must come as a result of domestic saving. A nation cannot consume everything it produces if it wants to invest in the future.
5. Savings potential is not promising in the poorest countries and may require foreign investment.
6. Another concern has been capital flight, which occurs when citizens who have been able to save transfer their savings to the IACs for safety and higher returns. This is a quantitatively significant problem.
7. Obstacles to investment include the lack of investors but also the lack of incentive to invest. Education and skilled workers as well as an adequate infrastructure are needed to encourage private investment.
8. One potential bright spot is inkind or nonfinancial investment in the form of surplus labor working on the improvement of the infrastructure and other capital improvements.
D. Technological advance is a somewhat separate process from capital formation. In some cases DVCs are able to transfer new technologies that are capital saving. Technological borrowing has aided the rapid growth of Pacific Rim region; OPEC nations have benefited in similar ways and the former Soviet bloc countries and republics are seeking western technology. On the other hand, DVCs often require technology appropriate to their resource mixes and must develop their own.
E. Sociocultural and institutional factors: One intangible ingredient is the “will to develop.”
1. Sociocultural obstacles to growth exist.
a. Tribal allegiances may take precedence over national identity.
b. Religious beliefs and observances may restrict the length of the productive workday. The “capricious universe view” may keep some from productive activity as it is seen as pointless in the end.
c. A caste system may allocate labor inefficiently.
2. Institutional obstacles also exist, especially the problem of land reform in these predominantly agricultural countries.
III. The Vicious Circle of Poverty (Figure 39W-2)
A. Poverty makes it difficult to grow. The obstacles to development listed in this chapter seem to arise from poverty. How can a country break the cycle of poverty?
B. Increasing the rate of capital accumulation may help, but only if the rate of population growth is somehow slowed at the same time. (Key Question 12)
IV. The Role of Government
A. A positive role exists for government, according to one perspective.
1. Government provides law and order.
2. The absence of entrepreneurship means that government may have to substitute in spearheading investment.
3. The infrastructure (like education, highways, and other government services) depends on adequate public investment in these projects.
4. Forced saving and investment may also require government intervention.
a. Increasing taxes is one alternative.
b. Government can cause inflation by creating and spending new money on public projects and by selling bonds to banks and spending the proceeds. The resulting inflation is like an arbitrary tax on the economy, but there are objections to creating investment in this way.
5. Socialinstitutional problems like land ownership and population growth can be alleviated by government policy.
B. Public sector problems exist in the DVCs.
1. Entrepreneurial ability is lacking in the public sector, too.
2. Many DVCs have histories of government corruption and poor administration and much of these economies is state owned or state controlled. (See Global Perspective 39W-1.)
V. Role of the Advanced Nations
A. Expanding trade may be the simplest way to benefit DVCs, and IACs can lower trade barriers against DVC products. However, many countries need basic capital and assistance to produce export.
B. Foreign aid can take several forms.
1. Public loans and grants from governments: In the last decade, U.S. aid has averaged about $10 to 14 billion per year, mostly administered by the Agency for International Development (AID). Total IAC aid in 2000 was $61 billion. (See Global Perspective 39W-2.)
2. The World Bank Group, supported by about 184 member nations including the U.S., lends out capital funds to DVC governments and also sells bonds and guarantees and insures private loans.
a. The World Bank is a “last-resort” lending agency whose loans are limited to productive projects for which private funds are not available.
b. Many World Bank loans are for basic development projects, such as infrastructure that is needed to attract private capital.
c. The World Bank also provides technical assistance.
d. Two World Bank affiliates supplement the Bank’s activities: The International Finance Corp. invests in private corporations in the DVCs; The International Development Association (IDA) makes “soft loans” to the poorest DVCs on more liberal terms than the World Bank.
C. Criticism of foreign aid to DVCs takes several forms.
1. A basic charge is that foreign aid, like welfare programs, creates dependency.
2. The recipients of much foreign aid end up being the bureaucracy and centralized governments of the receiving country.