Issachui Academy MATHEMATICS & ECONOMICS
STUDY GUIDE IB Economics HL · First assessments 2022 · Reviewed calculations · Historical examples dated

IB ECONOMICS HL / STUDY GUIDE

Unit 4: The Global Economy

4.9 Barriers to economic growth and/or economic development

Poverty traps/poverty cycles

Poverty trap refers to the vicious cycle where poverty perpetuates through generations due to the prevailing low-income level leading to a low savings level, hence low level of investment and productivity, and back to a low level of income.

Table 4.9.1 Poverty cycle
Table 4.9.1 Poverty cycle

Economic barriers

Below are the economic barriers that hinder development in an economy.

Rising economic inequality

High income inequality is a barrier to growth and development in several ways:

  1. Where there are high levels of inequality, there tend to be lower levels of saving, as the poor have a very low marginal propensity to save. Low levels of saving means that investment is limited.
  2. The rich tends to dominate political and economic life, meaning that policies tend to be made in their favour.
  3. Capital flight is the movement of financial wealth abroad, often in response to economic or political risk. It can reduce funds available for domestic investment. Purchases of imported consumer goods are imports, not capital flight.
Lack of access to infrastructure and appropriate technology
Lack of access to infrastructure

Infrastructure includes essential facilities and services such as roads, airports, and sewage treatment that add to the capital stock of the economy and are necessary for economic activities. Improvements in infrastructure lead to higher levels of economic development; for example, better roads mean that producers can transport their goods to more parts of the country.

Lack of access to appropriate technology

In development economics, appropriate technology refers to the use of technology that makes use of existing local resources. For LEDCs, this often means technology that makes use of labour (due to the relative abundance of labour as opposed to capital) and locally available raw materials, and can be operated easily by the local populace.

An example of this is the Universal Nut Sheller originally used in Mali, which is a simple and inexpensive hand-operated machine for shelling varying sizes of peanuts.

Low levels of human capital

The presence of human capital determines the level of labour productivity, which in turn determines the level of economic output produced per person. Higher labour productivity is important in increasing per-person income levels that contribute to a higher standard of living.

The availability of education

Education is a positive externality; when the workforce is more educated, the economy is more efficient. Education also makes people more able to read and communicate, and therefore makes it more likely that attitudes about the role of women in society will improve. More educated people are also likely to be healthier, as they are more informed about health issues and how to avoid them.

Education therefore improves efficiency and productivity, thus helping the economy to achieve higher levels of growth and development.

The availability of healthcare

Better availability of healthcare is also likely to improve economic development; there is a strong correlation between healthcare and life expectancy. Healthcare might also improve economic growth, as the availability of healthcare means that workers have to take less time off work due to ill health.

Dependence on primary sector production

Countries which are dependent on a narrow range of goods, such as primary products, may suffer if the prices for those goods change on international markets, or if substitutes for those goods become available.

The price elasticity of demand and supply for commodities on the world market tend to be inelastic. This means that any change in demand or supply will lead to large fluctuations in price; this will in turn have a large impact on the export revenue of countries dependent on the sale of those commodities.

This price volatility also makes it hard for individuals, firms, and governments in developing countries to plan ahead; this limits investment and government planning for healthcare, education, and infrastructure, and thus also limits development.

Lack of access to international markets

Protectionist measures taken by developed countries may hinder the ability of developing countries to achieve economic growth; if developed countries adopt protectionist policies, developing countries will be prevented from using their comparative advantage and exporting to developed countries.

Protectionism is particularly harmful in primary product markets. For example, the US subsidises domestic cotton production heavily, damaging developing country producers. Such products are sold at lower prices than they would be without subsidies, so are ‘dumped’ in foreign markets.

There are other reasons why countries may have limited access to international markets:

  • Landlocked countries and countries with poor infrastructure may have limited physical access to international markets.
  • Developing countries might struggle to meet product standards required to trade on international markets.
  • Developing countries might have non-convertible currencies, which can only be used domestically and are therefore not accepted on foreign exchange markets. This makes trade riskier, and therefore less likely to happen.
Informal economy

The informal economy consists of activities that are not, or are insufficiently, covered by formal arrangements. Much of this production is within the national-accounts production boundary and should be included in GDP and related income measures. However, limited records and surveys can lead to under-recording. Being untaxed does not itself exclude output from GDP or GNI.

Jobs in the informal economy tend to have poor working conditions and no social protection or labour rights. Workers in the informal economy suffer from poor productivity, and difficulty in accessing investment. This means that the output of the informal economy is limited. Since firms in the informal economy do not pay tax, the government’s resources to fund economic development are also limited.

Capital flight

Capital flight refers to the movement of money out of a country due to political or economic instability. This restricts growth as that capital could have been used for spending or investment in the domestic economy. Capital flight also might cause depreciation of the country’s currency, as the supply of the currency on the international money market increases.

Indebtedness

Indebtedness refers to the amount of money that a country owes to other countries and/or international institutions. Developing countries incur debt whenever they borrow from abroad. This value of this debt (the principal) has to be repaid, along with any interest that is due on the debt. Money that is spent on servicing the debt leaves the economy, and thus slows economic growth as governments have less money to spend in the domestic economy. It also slows development as the government cannot provide essential services such as healthcare and education.

The servicing of international debt causes balance of payment problems, because export earnings are diverted into debt servicing instead of the purchasing of food and capital equipment imports. Spending is also foregone on investment that can help with development objectives, such as spending on healthcare and education.

Excessive foreign debt also causes debt overhang, where LEDCs cannot easily increase its borrowing due to its high level of debt, thus depriving them of the ability to invest in development projects.

Geography including landlocked countries

Landlocked countries tend to trade less and have slower growth rates, as they have to spend more money on and wait longer for transport of exports and imports. These transport costs add to the costs of their exports, and decrease their competitiveness.

Tropical climates and endemic diseases

Development of production technology in tropical climates has tended to be slower. This is because agricultural productivity is lower, leading to poor nutrition and poor health, and because the high incidence of diseases affects the quality of human resources.

Political and social barriers

Weak institutional framework
Legal system

A well-functioning legal system is essential for development; without it, there is no way to create and enforce contracts, and no way to uphold property rights. Property rights refers to the legal right to own property/assets, the right to sell property/assets, and the right to benefit from property/assets.

Property rights allow people to own and benefit from private property. If property rights are not enforced, there will be less investment and therefore limited growth. Property rights are important for three reasons:

  1. Property rights incentivise owners of property to use their skills to earn income from the property.
  2. Owning property gives people an incentive to improve the value of that property, as they know that when they sell it they will profit from the increased values.
  3. Property can be used as collateral, for example for a loan. The ability to get credit allows low-income families to, for example, set up businesses.
Ineffective taxation structures

Tax revenue is very important for governments; it allows governments to finance government spending, for example on public services such as healthcare and education.

Ineffective taxation structures in developing countries mean that governments earn less taxation revenue. This means that they have less money to spend on public services, and less money to spend on improving infrastructure. This limits economic growth.

Taxation structures in developing countries are ineffective because of:

  • Inefficient and corrupt administration, meaning that people are less incentivised to pay taxes and the taxes that are paid might not reach their intended destination;
  • A low level of corporate activity, leading to low corporate tax returns;
  • Although import and export tariffs are a major source of revenue for the governments of developing countries, countries are only able to gain significant tax revenue if they are involved heavily in foreign trade.
  • If a country has large informal markets, the government will not earn tax revenue on a large proportion of economic activity.
Banking system

Many developing countries have ‘dual’ financial markets; that is, there are both official financial markets, which tend to be dominated by foreign commercial banks, and unofficial financial markets, which are not legally controlled, and mainly exist to lend money at very high interest rates.

Functional banking systems are necessary for growth as saving is necessary to make funds available for investment. Financial systems also allow people to manage their assets and allow them to increase in value, thereby giving them more money to invest in their human capital.

Gender inequality

Achieving gender equality helps development for two reasons: it helps the women themselves achieve development, and it has external benefits.

For example:

  • The health and well-being of families improves as gender equality improves because better education means that women are better informed about healthcare, hygiene, and diet.
  • The education of children improves as women pass on their own education and see education as more valuable, meaning that they prioritise it for their own children. This leads to an improvement in the quality of the workforce.
  • Women have more control over contraception and marry later, meaning that family sizes are smaller and the rate of population growth is slower.
Lack of good governance/corruption

A lack of good governance leads to corruption, instability, and unequal power and status, thus threatening development.

Corruption, or the dishonest exploitation of power for personal gain, hinders growth and development because politicians act to further their own interests, not those of voters. Corruption leads to:

  • The legal system is becoming less effective.
  • Resource allocation is based on price, not need or efficiency, as resources are allocated to individuals who can bribe officials.
  • Bribes increase the cost of business, driving up costs of production.
  • Officials might divert investment into projects based on bribes.
  • Regulations are less stringently upheld.
Unequal political power and status

Political instability might limit growth and development because it reduces the likelihood of Foreign Direct Investment (FDI) and reduces the degree to which the government can plan and run the economy in the long-term. It also causes uncertainty, reducing investment.

Unequal power and status also limits growth and development. When the ownership of resources and income are concentrated among a small percentage of the population, the wealthy have a disproportionate say in government policy, and low income people are less likely to become involved in the political process. This lack of representation means that their interests are unlikely to be foregrounded in government.

Enlarged diagram