The Economics of Developing Countries In this chapter we will begin by distinguishing between industrially advanced countries and developing countries. We will look at the differences in incomes and GDP and the impact of poverty on humanity. Developing countries often face large obstacles to growth, so we will investigate these obstacles. Lastly we will discuss the role of government in the developing countries’ economies as well as the role of the industrially advanced economies. Chapter 25W The Economics of Developing Countries Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Classifications Industrially advanced countries High income nations Well-developed market economies Per capita income $38,745 in 2010 Developing countries Middle income nations Low income nations Wide variation in income per capita The World Bank classifies countries into high-income, middle-income, and low-income brackets. The high-income nations are referred to as industrially advanced countries (IACs), the middle- and low-income nations are classified as developing countries (DVCs). The middle-income countries averaged a per capita income of $3,723 in 2010, and in the low-income countries, the per capita income averages only $1005 or less. The sub-Saharan African nations dominate the low-income group. LO1

Classifications This figure shows groups of economies. The world’s nations are grouped into industrially advanced countries (IACs) and developing countries (DVCs). The IACs (shown in gold) are high-income countries. The DVCs are middle-income and low-income countries (shown respectively in green and in purple). LO1

Comparisons U.S. GDP $14.6 trillion Combined GDP of DVCs $20 trillion U.S. has 4.5% of population but produces 23.1% of world’s output U.S. per capita GDP is 127 times that of Democratic Republic of the Congo Walmart’s annual revenue is greater than all but 23 nations’ GDP In 2010, we can clearly see the gap between an IAC such as the U.S. and the DVCs. The Democratic Republic of the Congo is considered to be one of the world’s poorest nations and has just a small fraction of the GDP of the U.S. The U.S.’s GDP almost matches the combined GDP of all of the DVCs (144 countries in 2010). Even a business such as Walmart, with its annual world revenues of $405 billion, beat all but the national incomes of 23 nations. LO1

Growth, Decline and Income Gaps Some developing countries have grown considerably China, Malaysia, Chile, Thailand Some developing countries have become high-income Singapore, Greece, Hong Kong Income gap has widened Developing countries must grow faster to reduce the gap Despite the fact that some countries have demonstrated considerable growth, even achieving IAC status, the gap between the IACs and the DVCs continues to widen. To close the gap, the DVCs need to experience higher growth rates than the IACs. LO1

Human Realities of Poverty Selected Socioeconomic Indicators of Development This table exemplifies the human impacts of poverty. Poverty contributes to lower life expectancies, greater mortality for children under 5, greater illiteracy rates, and less access to technology and energy. LO1

Obstacles to Development The path to economic development Use existing resources more efficiently Expand available supplies of resources Simple generalizations are not possible There is no one simple fix to the problem developing nations face in trying to grow. The same tasks are also faced by the IACs: the need to ensure that they use existing resources as efficiently as possible and that they expand their supplies of resources. Unfortunately, in the past, the path most nations seemed to have had to take to expand their available supplies of resources has frequently been a violent one as they sought to take the resources from others. LO2

Obstacles to Development Natural Resources Shortage of land, resources, power Tropical climates hinder labor, lead to disease Difficult to solve While some DVCs do have natural resources, others lack mineral deposits, have little land suitable for farming, and have few sources of power. Most of these countries are also located in areas with tropical climates which can hinder productive labor, lead to diseases among people, crops, and livestock and just make living difficult. The tremendous overpopulation of DVCs also causes tremendous problems. LO2

Obstacles to Development Human resources Large populations Reduced standard of living Less saving and investment Lower productivity Overuse of land resources Urban problems Qualifications Unemployment and underemployment It is projected that over the next 15 years 9 out of every 10 people born will be born in a DVC. These high birth rates cause a drain on the DVC’s income growth and can even cause their per capita income to stagnate or decline. The expense of raising large families decreases the capacity of the family to save and invest. When investment fails to keep pace with capital needs, productivity usually declines as workers do not have the tools or equipment needed. Since most DVCs are heavily dependent on agriculture, the rapid population growth can quickly deplete the land resource available as the land is over-farmed to produce more and more food. And finally, the increasingly dense populations in urban areas aggravates problems such as substandard housing, pollution, and congestion. Most authorities agree that the best way for DVCs to improve their position is to control the birth rate; however, that is fraught with political, societal, and religious implications not easy to overcome. Of course, not everyone agrees that reducing population growth is the best way to increase per capita GDP. There are also countries with large population densities that are extremely successful. LO2

Obstacles to Development This table compares the population of IACs with DVCs. LO2

Obstacles to Development This graph compares population growth of the IACs and the DVCs. The figure clearly shows that developing countries tend to have much higher population growth rates than IACs. LO2

Obstacles to Development Capital accumulation This is key for economic development Domestic capital formation Savings potential Capital flight Investment obstacles Lack of infrastructure Even with high savings rates, the low per capita incomes in DVCs means that there is just not enough there to provide significant capital investment. DVCs also suffer from capital flight as those citizens who do have available savings to invest choose to invest abroad because they can earn a higher return. The lack of infrastructure in DVCs continues to be a major obstacle to investment. If businesses cannot get their product to market, or even be sure that the lights will come on when needed, what incentive is there to invest? It takes a concerted effort by the government to ensure that the development of infrastructure remains a priority for the nation. LO2

Obstacles to Development Technological advance Borrowed technology Socio-cultural obstacles Institutional obstacles Land reform Technological advances also present challenges. In this area, at least the DVCs can benefit from the efforts of the IACs that have the capital to do research and development. Many DVCs adopt the technological advances made in the IACs. Socio-cultural obstacles also exist in the DVCs. Tribal and ethnic allegiances frequently take precedence over national allegiance. Labor may be allocated based upon a caste system rather than skill or merit. Religious beliefs can also restrict the workday. Working around and through the obstacles takes time and education. Institutional obstacles present a final challenge. Political corruption and bribery are common, and schools are inefficient and ineptly administered. Land reform is necessary in many DVCs but again faces many obstacles. LO2

The Vicious Circle of Poverty LOW PER CAPITA INCOME LOW PRODUCTIVITY RAPID POPULATION GROWTH LOW LEVEL OF SAVING LOW LEVEL OF DEMAND The vicious circle of poverty can be difficult to break. The key is the low per capita income. A poor family has little incentive or ability to save. They must consume everything they produce just in order to survive. They have no disposable income to spend to create a demand. Population control is considered the key to increasing per capita income. If there were fewer mouths to feed, families might have more income to spend and time to spend it. LOW LEVELS OF INVESTMENT IN PHYSICAL AND HUMAN CAPITAL LO3

Role of Government A positive role Establishing the rule of law Building infrastructure Embracing globalization Building human capital Promoting entrepreneurship Developing credit systems Controlling population growth Making peace with neighbors Governments are key in stimulating economic growth and development. They need to provide law and order in the nation so people feel safe and know their property will be protected. They must build infrastructure and encourage entrepreneurship and new businesses. Government policies that encourage savings and investment are needed. A stable and viable banking system is also needed to handle the savings and investments. Maintaining a state of peace is also key as the costs of war are high and draining on a country’s resources. LO4

Role of Government Public sector problems Misadministration Bribery Corruption The problem of corruption in the governments of DVCs needs also to be addressed. DVCs are fraught with corrupt governments that are then ineffective in helping a country develop. In these cases, the government can often become an obstacle to development. LO4

Role of Government The Global Perspective highlights the amount of perceived corruption in the governments of these countries. A higher index value indicates that the country is perceived to have very little corruption. LO4

Role of Advanced Nations Expanding trade Admitting temporary workers Discouraging arms sales Foreign aid Direct aid The World Bank group The IACs have a vested interest in helping the DVCs grow. Remember that a rising tide raises all boats. If we can help others, we in effect are helping ourselves. There are several different ways the IACs can help. They can expand trade with the DVCs, buying products that they produce and reducing trade barriers that may inhibit trade. The large agricultural subsidies in IACs are also a problem as they create artificially low prices that the DVCs cannot match. IACs can help the DVCs by allowing temporary workers from the DVCs. The wages these workers earn can then be sent back home to help their families; this also provides an outlet for the excess DVC labor. The IACs can also discourage the sale of arms to the DVCs which can divert expenditures needed for infrastructure and education. Foreign aid is also another route. IACs can provide loans or grants to the DVCs to encourage infrastructure development. This can be done through direct aid or through the World Bank, whose major goal is helping DVCs achieve economic growth. LO5

Role of Advanced Nations Foreign harm? Dependency and incentives Bureaucracy and centralized government Corruption and misuse Current level of foreign aid Flows of private capital Foreign aid must be managed carefully to avoid causing more harm than good. The old story of giving a man a fish and feeding him for a day, or teaching a man to fish and feeding him for a lifetime applies. Some critics argue that foreign aid creates a dependency rather than self-sustaining growth. After a while, people may just expect someone else to come along and solve their problems rather than trying to solve them themselves. Much aid may not actually reach the intended recipients due to government corruption, bureaucracy, and misuse. You can see examples of this problem after natural disasters when aid pours into a country but we see pictures of food and supplies sitting unused and rotting in warehouses. IACs can also help through private investment by firms. Unfortunately, the recent recession greatly reduced the amount of private capital being invested everywhere, including the DVCs. It may take several years for it to recover. LO5

Role of Advanced Nations We can compare the amount of foreign aid that countries provide relative to their GDP. The United States provided the largest dollar amount of development assistance, but since the U.S. has the largest GDP, the aid as a percentage of GDP is much smaller relative to other countries’ assistance. LO5

Famine in Africa Root causes – natural and human Droughts – Lack of rainfall Civil strife – Rebellions and civil wars Population growth Ecological degradation Public policies External debt The continued problem of famine in the African sub-Saharan nations continues with no end in sight. The causes of these famines are both natural and human. This geographical area suffers from long periods of drought which leads to crop failures, meaning the country is unable to produce enough food on its own to feed its populace. Civil strife also creates problems when people are forced from their land into refugee camps. These wars also inhibit aid from reaching the people who need it as the warring factions divert the aid for their purposes. The rapid population growth puts tremendous stress on the ecological resources of the nation, leading to over-farmed land and polluted waterways. Many African nations continue to spend more on buying arms than on building the infrastructure needed to maintain a thriving economy, and all is made even more complex by the external debt these countries owe to the IACs. The World Bank has initiated a program to encourage debt forgiveness with the conditions that the nations receiving the forgiveness end warfare and use the savings to help ease the plight of their populations.