Growth in less developed countries: benefits, costs and constraints

Overview

Benefits of economic growth for a less developed country, foreign exchange gap and why it constrains development and how dependence on primary commodity exports can hold back development.

What you need to know

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Questions from this subtopic

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1. 1

   Analyse the benefits of economic growth for a less developed country.

   Model answer

   Growth raises average incomes, which reduces absolute poverty where the growth reaches the sectors in which poor people work, and it creates wage employment that is usually more secure and better paid than subsistence work. It widens the tax base, giving the government the revenue to fund health, education, sanitation and infrastructure, which raise development directly. Higher incomes permit higher saving and investment, so growth can become self-sustaining, and rising output can relieve the foreign exchange constraint by supporting exports. It also makes a country a more attractive destination for investment and technology.

2. 2

   Analyse the costs and risks of rapid economic growth for a less developed country.

   Model answer

   Growth is frequently accompanied by widening inequality, because the returns accrue first to those with capital, land or education, so the poorest may see little benefit for a long time. It brings environmental damage in the form of pollution, deforestation and resource depletion, which falls hardest on poor households dependent on land and water. Rapid urbanisation strains housing, sanitation and transport, producing slums and congestion. Traditional livelihoods and social structures are disrupted, and where growth depends on volatile commodity exports or on borrowed foreign capital, it can be reversed abruptly, leaving the country with debts contracted in better times.

3. 3

   Evaluate whether the benefits of growth in less developed countries outweigh the costs.

   Model answer

   The benefits are hard to dispute in the long run, since no country has escaped mass poverty without sustained growth and the fall in extreme poverty in fast-growing economies has been extremely large. The costs are real but are mostly consequences of the pattern of growth rather than of growth itself: inequality, pollution and displacement can be moderated by taxation, regulation, environmental pricing and public provision. The strongest qualification is that some growth genuinely does not help, notably enclave extraction that employs few people and remits profits abroad while damaging the environment. The reasonable judgement is that growth is necessary and generally beneficial, but that its composition and the policies accompanying it determine whether it delivers development.

4. 4

   Explain the savings gap as a constraint on growth in a low-income economy, and how it might be closed.

   Model answer

   Investment must be financed by saving, but where incomes are close to subsistence households cannot save much, so domestic saving is too small to fund the investment the economy needs, and low investment keeps productivity and therefore incomes low. The gap can be closed by attracting foreign saving through direct investment, borrowing or aid, by developing banks and mobile financial services so that the saving that does occur is channelled into investment rather than held as cash or livestock, and by raising government saving through improved tax collection. Each route has costs, since borrowing creates debt service and foreign investment creates profit repatriation.

5. 5

   Explain the foreign exchange gap and why it constrains development.

   Model answer

   A developing economy needs to import capital equipment, fuel, fertiliser and medicines that it cannot produce itself, and these must be paid for in foreign currency earned from exports, borrowed, or received as aid or investment. If export earnings are small and volatile because they depend on a few primary commodities, the country cannot buy the imports its development requires, and investment projects stall for want of equipment. This is why export diversification, and access to foreign markets, matter for development quite apart from the income the exports generate.

6. 6

   Analyse how dependence on primary commodity exports can hold back development.

   Model answer

   Demand for primary commodities is income inelastic, so as world incomes rise, demand for them grows more slowly than demand for manufactures and services, and their relative price tends to drift downwards over time. Both demand and supply are price inelastic in the short run, so any shift in either produces violent price swings, making export earnings, tax revenue and the exchange rate unstable and long-term planning impossible. Primary production also offers limited scope for productivity growth and few linkages to the rest of the economy, and a commodity boom can raise the exchange rate enough to destroy the manufacturing sector that would have provided the alternative.

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