BARRIERS TO ECONOMIC GROWTH & ECONOMIC DEVELOPMENT

1. SECTION 5: DEVELOPMENT ECONOMICS BARRIERS TO ECONOMIC GROWTH & ECONOMIC DEVELOPMENT ECONOMICS – A COURSE COMPANION, p329-343 1

2. INSTITUTIONAL & POLITICAL BARRIERS There are a range of barriers to economic development: • Insufficient provision of education • Insufficient health care systems • Lack of Infrastructure • Weak Institutional Framework • Ineffective Tax Structure & Formal & Informal Markets • Political Instability & Corruption • Unequal distribution of income. 2

3. Insufficient Provision of Education Millennium Development Goals • One of the Millennium Development Goals is to ensure that by 2015, children everywhere, will be able to complete a full course of primary schooling. • While progress has been made in the provision of education, particularly primary education, there was still about 115 million children of primary school age who do not attend primary school, based on reports from 2005. • 80% of these children are in Africa or Southern Asia. 3

4. Insufficient Provision of Education • At the most basic level, the provision of education requires vast funding and this simply may not be available in sufficient quantities. • Within a country there may be large disparities between the provision of education, with urban areas receiving more of the education funds that rural areas. • There are also family economic conditions that prevent children from attending school: they may be needed to work within the home or farm, or they may be involved in external work as “child labourers”. 4

5. Insufficient Provision of Education • For most part it is children from poor households and from families where the mothers received no formal education, who do not attend school. • Enrolment in secondary schools tends to be far lower than primary schools, with the necessity of earning an income, the greatest obstacle to attending school. 5

6. Insufficient Health Care System • There has been much progress made by many developing countries in terms of the training of doctors and nurses and the building of hospitals and clinics, and the provision of public health services such as access to safe water. • Throughout the world, infant mortality rates have fallen and more children are immunized than every before. • However, there are still significant shortcomings, especially among the low income countries. 6

7. Lack of Infrastructure • One of the greatest drawbacks for developing countries is their lack of infrastructure, which is essential for growth. 7

8. Categories & Examples of Infrastructure 8

9. Lack of Infrastructure • The lack of any of these facilities will harm the ability to achieve economic growth. • If goods cannot be transported from one area of the country to another because of poor roads, or from one area of the country to a seaport, then trade and growth is restricted. • If power supplies are intermittent and unreliable then production is harmed. • If communication channels are poor on non-existent the ability to coordinate economic activity is severely limited. 9

10. Lack of Infrastructure • Lack of infrastructure also hinders development prospects. • Poor roads or public transport mean that it might be difficult to get to school to obtain an education • An underdeveloped radio and television network can make it difficult for people to find and participate in wider communities. • The availability of gas and electricity is important to households for activities such as cooking and food preservation, while sanitation and safe water are vital for health to improve. 10

11. Weak Institutional FrameworkThe Legal System • In many developing countries, the legal system does not function well. • Where this is the case, then there is no way to create and enhance contracts and there is no way to uphold property rights. • Social scientists consider property rights to be essentially a “basket” of legal rights. 11

12. Weak Institutional FrameworkThe Legal System Essential legal rights include: • The right to own assets, such as land or buildings. • The right to establish the use of our assets, such as adding to the building. • The right to benefit from our assets, such as renting out our assets. • The right to sell our assets. • The right to exclude others from using or taking over our assets. 12

13. Weak Institutional FrameworkThe Legal System • Property rights allow people to own and benefit from private property, so long as the law supports them. • If a person cannot guarantee his or her ownership of a property, then there is no incentive to improve that property, since it is possible that the property could be lost and the investment will have been wasted. • It there is no enforceable property rights, as is the case in many developing countries, then investment and growth will be very much reduced. 13

14. Weak Institutional FrameworkThe Financial System • Developed and independent financial institutions are essential if economic growth is to be achieved, and these are often underprovided in developing countries. • Most developing countries have dual financial markets. • The official markets are small and tend to be dominated by foreign commercial banks who often have an outward looking emphasis to their operations and restrict their lending to foreign businesses and the already established large manufacturing local businesses. 14

15. Weak Institutional FrameworkThe Financial System • The unofficial markets are not legally controlled. • Their main operations is to lend money, usually at very high interest rates, to those who are desperate and poor enough to have to borrow it. 15

16. Weak Institutional FrameworkThe Financial System • Savings are necessary to make funds available for investment and investment is necessary for economic growth. • Saving is difficult enough in countries where there are high levels of poverty, but it is even harder in there is nowhere to save money that is safe and will give a good return. • Where there are weak or untrustworthy financial institutions, people with investment income tend to buy assets, such as livestock or invest their money outside the country (capital flight) 16

17. Weak Institutional FrameworkThe Financial System • Financial services are necessary if low income people are to be able to manage their assets and to allow them to increase in value. • The difficulties associated with saving and borrowing money are a significant barrier to economic growth and development. • It makes it exceedingly difficult for low income people to raise themselves out of poverty. 17

18. Ineffective Tax Structures • Tax revenues provide governments with the means to finance necessary public services, such as education and health care, and to generally improve the infrastructure of the country. • However, this is very difficult to do if governments do not receive a great deal of tax revenue. • It is very difficult for governments to collect tax revenue in developing countries 18

19. Ineffective Tax Structures • As a result of tax exemptions and inefficient or corrupt administration, it is estimated that less than 3% of the population in developing countries pay income tax, as opposed to the 60-80% in developed countries. • Corporate tax revenues tend to be low, since there is relatively little corporate activity in developing countries (although it is growing) and developing countries often offer large tax incentives to in order to attract FDI. 19

20. Ineffective Tax Structures • The main source of tax revenue in developing countries are export, import and excise (customs) duties. These taxes are relatively easy to collect as they are paid when the goods pass through the country’s border posts. However, it is only possible to gain significant tax revenue if the country is heavily involved in foreign trade. 20

21. Ineffective Tax Structures Tax – Summary • Developing countries have problems with the administration of their tax systems in terms of inefficiency, lack of information and corruption. • These elements when combined often mean that people are able to evade paying taxes that they owe. 21

22. Formal & Informal Markets • The size or informal markets as a percentage of GDP in developing countries is far greater than in developed countries. • It would also appear that informal markets are growing in almost all countries in the world. • Large informal markets once again lead to much lower tax revenues for governments in developing countries. 22

23. Formal & Informal Markets • If the incomes of people are not recorded because they are earned on informal markets, then there will be no tax paid on such income. • Lower tax revenues make it difficult for governments to promote growth an achieve development objectives. • Furthermore workers, tend to be unprotected in the informal markets and very poorly paid with little job security, poor working conditions and no social care. 23

24. Formal & Informal Markets • Productivity in the informal markets also tends to be very low, workers are often low-skilled migrants from rural areas, with little education and low human capital. 24

25. Political Instability • Political instability causes uncertainty and, at its most extreme, complete economic breakdown. • Sudan in Africa is a relevant case. • Civil Wars from 1955 to 1972 and from 1983 to 2005, together with ongoing conflict in the western region of Darfur and caused significant loss of life and displacement of the population. • Such extreme political instability is likely to lead to very poor economic performance, high levels of poverty and low standards of living. • The likelihood of attracting foreign investment or even aid becomes much smaller. 25

26. Political Instability • A number of developing countries are experiencing civil wars as a result of ethnic and or religious conflict or border conflict. • The loss of life, damage to infrastructure, loss of investment and sometimes aid, has undoubtedly affected economic growth and development in these countries. 26

27. Corruption • Corruption is defined here as the dishonest exploitation of power for personal gain. • It tends to be most prevalent where: 27

28. Corruption is most prevalent where: • Governments are not accountable to the people, especially military governments. • Governments spend large amounts on large scale capital investment projects. • Official accounting practices are not well formulated or controlled. • Government officials are not well paid. • Political elections are not well controlled or are non existent –there is no democracy. • The legal structure is weak. • Freedom of speech is lacking. 28

29. Different Types of Corruption • There are many different forms of corruption including bribery, extortion, fraud, patronage and nepotism. • The effects of corruption are likely to hinder growth and development with a number of causative factors. 29

30. The Effects of Corruption • Electoral corruptionmeans that the wishes of the people are not heeded. This will put a government in place that has not been voted for by the majority. It is likely that such a government will not adopt policies to benefit the electorate. • Corruption of any sort reduces the effectiveness of the legal system. It people can `buy` there way out of prison or punishment there may be an incentive to act illegally. 30

31. The Effects of Corruption 3. Corruption leads to an unfair allocation of resources. If contracts go to the highest bidder, as opposed to the most efficient producer, then there is market failure and resources are being misallocated. If often sustains inefficient producers by shielding them from competition. 31

32. The Effects of Corruption 4. Bribes increase the costs for businesses, in cash terms and in terms of management negotiation times. This invariably leads to higher prices. 5. Corruptions reduces trust in an economy. As a result countries may find it harder to attract foreign investment, which is often diverted to less corrupt countries. 32

33. The Effects of Corruption • Corruption increases the risks of contracts not being honored and this, in turn, acts as a serious deterrent to investment, both internal and external. • Corruption means that officials will often divert public investment into capital projects where bribes are more likely. This reduces the quality of government services for the population. 33

34. The Effects of Corruption • Corruption often means that officials turn a blind eye to regulations, such as those regarding construction or the environment. They can have a damaging effect on individuals and the country as a whole. • The monetary gains from corruption are often moved out of the country. This is a form of capital flight and it reduces the capital available for internal • The costs paying of small bribes reduces the economic well-being of the ordinary citizen. 34

35. Unequal Distribution of Income • Although every country in the world has income inequality, it is fair to say that the gap between rich and poor in developing countries is generally greater than in developed countries. • High income inequality can be a barrier to growth for a number of reasons. • First, there tend to be low levels of saving, because the poor save a very small proportion of their income. • Low saving means low investment and so low growth. 35

36. Unequal Distribution of Income • The rich tend to dominate both politics and the economy. • The tends to mean that policies are followed which are more in their favor and so we do not have pro-poor growth. Pro-poor growth • Pro-poor growth occurs when economic growth leads to a fall in some agreed measure of poverty. 36

37. Unequal Distribution of Income • High income inequality in developing countries tends to be marked by the rich moving large amounts of funds out of the economy (capital flight). • Also a large proportion of the goods purchased by the rich are foreign-produced and so their consumption does not help the domestic economy. 37

38. INTERNATIONAL TRADE BARRIERSOverdependence on primary products • While the share of manufactured goods produced by developing countries as a percentage of total world trade is growing, a number of developing countries are dependent on primary commodities for a significant share of their export revenues. 38

39. INTERNATIONAL TRADE BARRIERSOverdependence on primary products Rising Commodity Prices • When commodity prices are rising, this may be beneficial to these countries. • It will increase their rate of economic growth and if the revenues are used to finance spending on education, health care and infrastructure this can set off a positive cycle in terms of development and future growth. 39

40. INTERNATIONAL TRADE BARRIERSOverdependence on primary products Falling Commodity Prices • If prices fall then the economies experience deteriorating terms of trade. • Current accounts deficits will increase and it will be very difficult for countries to finance current expenditure and the necessary imports. • Unless they can change the pattern of their export trade, those countries that are dependent on a narrow range of primary products will find it difficult to gain much growth through international trade. 40

41. A Narrow Range of Exports:A Danger for Developing Countries • Regardless of the types of goods exported – commodities, manufactured goods or services like tourism, if a country is dependent on a narrow range of exports, then it faces great vulnerability and uncertainty. • Eg: Economic growth in a tropical country that is reliant on tourism revenues will be limited if the global tourist trade is damaged as result of terrorism. It is also vulnerable to other forces outside of its control such as tsunamis and other environmental factors. 41

42. A Narrow Range of Exports:A Danger for Developing Countries Example • Countries that were dependent on the export of a small range of low-skilled manufactured goods including textiles were damaged when China joined the WTO and sharply increased the supply on textiles on world markets, driving down their prices. 42

43. Protectionism in International Trade • As you already know, Protectionism is any economic policy that is aimed at supporting domestic producers at the expense of foreign producers. • Protectionist measures by developed countries against the exports of developing countries may be very harmful. • If the measures prevent developing countries from utilizing their comparative advantages and exporting to developed countries, then developing countries will be limited in their ability to earn foreign exchange. 43

44. Protectionism in International Trade • Protectionism in any market is damaging for developing countries, but it is especially the case in primary product markets. Case Study - US Cotton Farmers • 25,000 cotton farmers in the US share almost $4 billion in government subsidies every year. • This encourages farmers to produce more, forcing down the world price and exporting their surplus to developing countries that do not have the benefit of subsidies. • This immensely damaging for the developing country producers. The US does the same with maize, rice and diary products. 44

45. Protectionism in International Trade Case Study – EU Farmers • Protected EU farmers overproduce and export sugar, cereals and diary produce, lowering world prices and damaging markets and local suppliers in developing countries. • As these products are sold at lower prices than would be the case without subsidies, it is argued that they are “dumped” in foreign markets. • Small-scale farmers in developing countries are effectively deprived of their ability to earn a living, which is clearly a significant barrier to development. 45

46. Protectionism in International Trade The Value or Rich World Subsidies • According to Oxfam, the rich worlds spends $1 billion a day subsidizing its agricultural industries. 46

47. Protectionism in International Trade Tariff Escalation • Many developed countries engage in a policy of tariff escalation - the more a good is processed (from a developing country) the greater the increase in the tariff rate. • An importing country therefore protects its processing and manufacturing industries by putting lower tariffs on imports of raw materials and components and higher tariffs on processed and finished products. 47

48. Protectionism in International Trade Tariff Escalation • Tariffs escalation creates a significant problem for developing countries in terms of their access to markets. • There is little incentive to diversify away from producing raw materials, as higher tariffs will make their processed goods uncompetitive. • Effectively it can trap them as suppliers of raw materials. • Tariff escalation is widely observed in the agricultural markets of meat, sugar, fruit, coffee, cocoa and tobacco. 48

49. INTERNATIONAL FINANCIAL BARRIERSIndebtedness • Indebtedness is a major barrier to growth and development for many developing countries. • “Third world debt” as it has been known and the huge annual debt repayments are a massive problem for many developing countries. • This examined in more detail in future lessons. 49

50. INTERNATIONAL FINANCIAL BARRIERSCapital Flight • Capital Flight occurs when money and other assets flow out of a country to seek a “safe haven” in another country. • Developing countries have suffered greatly from this process ever since the 1970s. • There are three main causes of capital flight: • Questions about the safety of domestic Financial Institutions • Corruption • Currency Instability. 50