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Economic Growth - Constraints

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

Introduction

Economic growth is not guaranteed and some countries struggle and sustain the minimum growth rate needed to bring down poverty and sustain their chosen development path.

What Factors Can Limit Growth and Development?

In this section we will explore some of the many growth limiters that a country may face

1 / Infrastructure

  • Infrastructure includes physical capital such as transport networks, energy, power and water supplies and telecommunications networks.
  • Evidence shows that there is a strong positive correlation between a country's economic development and the quality of its road network
  • Poor infrastructure hampers growth because it causes higher supply costs and delays for businesses. It reduces the mobility of labour and affects the ability of exporters to get their products to international markets.

Here are three examples of infrastructure deficiencies:

India: India’s irrigation system is deficient and not properly managed and this has made it very difficult to sustain food grain production when rainfall is less than expected – as was the case in 2012. This has led to a surge in food prices which hits the poorest communities hardest. For a few days in the summer of 2012, much of northern India was plunged into darkness for two consecutive days. About 700 million people were left without power, a situation that affected transport, communication, healthcare, industries and farming. India needs an estimated $400bn investment in the power sector if it is to meet its development goals.

Brazil: Host for the 2014 World Cup and the 2016 Olympics. Brazil’s growth is constrained by infrastructure weaknesses: In 2011, only 14% of her roads were paved. The World Economic Forum ranks Brazil’s quality of infrastructure 104th out of 142 countries surveyed, behind China (69th), India (86th) and Russia (100th). 

Sub-Saharan Africa: The combined power generation capacity of the 48 countries of Sub-Saharan Africa is 68 gig watts – no more than Spain’s. Excluding South Africa, this figure falls to 28 GW, equivalent to the capacity of Argentina (except Argentina has a population of 40 million and Africa has 770 million.) A recent report from the Infrastructure Consortium of Africa (ICA), found that poor road, rail and harbour infrastructure adds 30-40% to the costs of goods traded among African countries. This chronic shortage of energy - with firms and people facing acute shortages of power – is a major barrier to growth and development.

One key barrier to infrastructure investment in developing countries is that tax revenues are low or come from a narrow base of businesses. For example, East African Breweries accounts for nearly 10% of the direct and indirect tax revenues going to the Kenyan government.

Many countries will need to increase their spending on infrastructure in the years ahead to adapt to and deal with the consequences of climate change. There has been much interest in recent years concerning the investment in infrastructure that businesses from emerging countries such as Brazil and China are making in the continent of Africa. China’s foreign direct investment in Africa has jumped from under $100 million in 2003 to more than $12 billion in 2011.

2 / Dependence on limited exports

  • Many nations still relying on specializing in and exporting low value added primary commodities. The prices of these goods can be volatile on world markets.
  • When prices fall, an economy will see a sharp reduction in export incomes, an adverse movement in their terms of trade, risks of a higher trade deficit and a danger that a nation will not be able to finance state-led investment in education, healthcare and core infrastructure.

Exports of least-developed countries by major product, 2010

(Percentage of total exports)

2005

2010

Others

14.6

19.4

Textiles

1.4

1.3

Other semi-manufactures

3.2

2.3

Raw materials

4.3

3.5

Food

9.2

9.9

Clothing

13.7

11.8

Fuels

53.6

51.7

 Source: World Trade Organisation

Here are some examples of export dependence for a selection of countries in Sub-Saharan Africa: The data shows the % of total exports in 2010:

  • Angola: 97% oil
  • Ghana: 39% gold, 26% oil, 17% cocoa
  • Kenya: 19% tea, 12% horticulture
  • Nigeria: 90% oil
  • Senegal: 11% fish, 11% phosphate
  • Tanzania: 37% gold
  • Uganda: 18% coffee
  • Zambia: 84% copper

Sub-Saharan Africa (SSA) is often cited as a region where primary sector dependence is high. SSA’s share in global manufacturing trade remains extremely low.

3/ Vulnerability to external shocks

Events in one part of the world can quickly affect many other countries. For example, the global financial crisis of 2007-2010 brought about recession in many countries and deep financial distress in many regions. It also led to a fall in foreign direct investment flows into many poorer countries and pressure on governments in rich nations to cut overseas aid budgets.

If a resource rich country exports the resource, then it exposes itself to damaging volatility of its export earnings. In 2010, economists Bruckner and Ciccone found that a 10% fall in income due to falling commodity prices raises the likelihood of civil war in sub-Saharan Africa by around 12%.

4/ Landlocked countries

Land-locked economies face particular challenges to integrate in global trade – without good infrastructure and efficient logistics businesses it can be difficult, costly and slow to get products to the countries of trade partners - but some landlocked countries have been doing well especially when they achieve regional economic integration with other land-locked nations.

5/ Low national savings and low absolute savings

Savings are needed to provide finance for capital investment. In many smaller low-income countries, high levels of poverty make it almost impossible to generate sufficient savings to provide the funds needed to fund investment projects. This increases reliance on overseas borrowing or tied aid.  This problem is known as the savings gap. In Africa for example, savings rates of around 17 percent of GDP compare to 31 percent on average for middle income countries. Low savings rates and poorly developed or malfunctioning financial markets make it more expensive for African public and private sectors to get funds for investment. Higher borrowing costs impede capital investment.

Problems facing The Bottom Billion – Paul Collier’s 4 Development Traps

Professor Paul Collier finds that the living standards of the world's bottom billion have stagnated over the past forty to fifty years.

He identifies four “development traps” - they are conflict, reliance on natural resources, being landlocked with bad neighbours, and bad governance.


6/ Limited financial markets

Many of the least developed countries have limited financial markets such as banking, money and credit systems, insurance markets and stock markets.

Worldwide, approximately 2.5 billion people do not have a formal account at a financial institution. Access to affordable financial services is linked to overcoming poverty, reducing income disparities, and increasing economic growth

These are essential for providing long term capital for the private sector and helping to channel savings and provide funds for investment projects.

Some progress is being made in Sub-Saharan Africa – there are now 19 stock markets in operation – but most of these are very small by international standards.

The Nigerian stock market accounts for only 3% of Brazil’s or India’s stock market capitalization.

6/ Volatile incomes and employment

Income growth so much more volatile in poor countries than in rich ones:

Volatility can be disruptive to economic health. It increases the risks for businesses considering capital investment, it raises the chances of people falling into extreme poverty and it makes a nation’s finances more fragile perhaps lowering the scope for important investment in public goods.

7/ Weaknesses in business management

Few development textbooks give much emphasis to the complex roles for and effects of business management as a constraint on growth and subsequent development. A fundamental cause of poverty is low wages and poverty pay is linked to relatively low productivity (measured in different ways, one of which is the value of output per person employed).

Economists such as Nicholas Bloom from Stanford University have been studying the impact of weak management in some developing countries including India. Bloom has argued for example that “In India are badly managed: equipment is not looked after, materials are wasted, theft is common because inventory is not monitored, defects keep occurring, etc.  In a recent project with the World Bank, we found that giving management advice to Indian factories increased productivity by 20%.”

Weaker management may also help to explain why many poorer countries have not fully and intensively adopted new technologies. Economist Diego Comin finds that extensive adoption of new technologies has accelerated in recent years – witness the rapid expansion of mobile technology in many African countries – but that many of the least developed countries tend to use technologies less intensively - fewer people use less advanced computers less often.

8/ Capital flight

Capital flight is the uncertain and rapid movement of large sums of money out of a country. There could be several reasons - lack of confidence in a country's economy and/or its currency, political turmoil or fears that a government plans to take privately-owned assets under government control

Capital flight can lead to a loss of foreign currency reserves and put downward pressure on an exchange rate – driving the prices of essential imports of goods and services higher.

According to figures from Global Financial Integrity, developing countries lost $5.86 trillion in 2001-2010 to illicit financial flows

9/ Conflict, corruption and poor governance

Governance refers to how a country is run and whether the exercise of authority manages scarce resources well improving economic outcomes and the quality of life for a country’s people. High levels of corruption and bureaucratic delays can harm growth by inhibiting inward investment and making it likely that domestic businesses will invest overseas rather than at home.

Governments need a stable and effective legal framework to collect taxes to pay for public services. In India, there are 15 times more phone subscribers than taxpayers. If a legal system cannot protect private property rights then there will be less research and development & innovation.

Conflicts – there have been an estimated 150 conflicts since 1945 with 28 million deaths (this is twice the toll of WW1). Conflicts have huge collateral damage effects – for example, Angola has lost 80% of its farmland because of landmines. Most conflicts are intra-state i.e. civil war and reconstruction can take decades and many countries remain aid-dependent. About 1.5 billion people live in countries suffering repeated waves of political and criminal violence.

A recent example of the cost of conflict comes from the Ivory Coast. After a disputed presidential election in late 2010 violence erupted and the country descended into a four-month civil war that killed an estimated 3000 and displaced around a million people. The war could only be ended by a French intervention in April 2011. Since then the new government under President Ouattara has struggled to re-establish security but raids against army and policy installations still threaten stability.

Corruption has long been a barrier to sustained growth and development in Africa. Conflict has had terrible consequences; over one third of economies in Africa have suffered some kind of warfare from Rwanda, Sierra Leone, Eritrea, Uganda, and Somalia.

That said encouraging progress has been made in building democratic institutions in many African countries.

Economic growth can collapse and go into reverse when states fail – there are numerous reasons why chronic government failure can hamper growth and development:

  • Failures to protect property rights and provide sufficient incentives for new businesses to flourish
  • Forced labour, caste labour and other forms of discrimination –  all of which waste scarce human resources not least limiting the roles that women can play in labour markets and – over the long term - holding back innovation and technological progress (two key drivers of growth)
  • Power elites controlling an economy - using their power to create monopolies and blocking new technologies
  • Stateless areas - large parts of the world are still dominated by stateless societies where the rule of law barely exists
  • Public goods - chronic failures to provide basic and effective public services such as education, health and transport. Many of the world’s least developed countries have not built effective tax systems and so their revenue base is inadequate for much needed capital investment and the annual revenues required to provide public health and education programmes
  • Conflicts – there have been many conflicts over natural resources e.g. in Sierra Leone

10/ Population decline and / or an ageing population

  • In some countries the size of the population is declining as a result of net outward migration
  • If a nation loses younger workers, this can have a damaging effect on growth
  • The changing age-structure of a population also matters, leading to a fall in the ratio of workers to dependants

Demographic change is important to many of the fast growing countries in Asia.

  • Most countries in East Asia are expected to experience a decline the portion of their working age population (15-64 years) to total population from now until 2025
  • Seven countries are expected to see declines of 10 percent or more (including China, Japan, Thailand and Vietnam) while three will see declines of over 20 percent (Hong Kong SAR China, Korea and Singapore)
  • Countries such as Indonesia, Mongolia, Myanmar and Vietnam are forecast to see a decline in their population size due to a combination of emigration and demographics

Declining populations in Eastern Europe

Many countries in Eastern Europe must face the challenges of continued population decline. Only two out of twelve countries will experience population growth according to recent estimates.

The relationship between demographic trends, per-capita income and economic growth is complex. Lower per-capita income should lead to higher growth, but it also has a negative impact on labour supply. Eastern Europe will have to rely on capital accumulation and productivity growth rather than labour force growth to generate economic growth.

One of the BRIC countries – Russia – is experiencing a sustained decline in their population and their active labour force. High levels of net migration, rising death rates linked to exceptionally high accident rates and the effects of alcohol abuse have all contributed to a fall in population to below 150 million.

Globally the world’s population is ageing. Within next 10 years, there will be 1 billion older people worldwide. By 2050 nearly one in five people in developing countries will be over 60

11/ Rising inflation

Fast growing countries may experience an accelerating rate of inflation which can have damaging economic consequences.

Two effects in particular can hit growth, namely falling real incomes and profits together with higher costs and also reduced competitiveness in international markets.

12/ Persistent trade deficits due to rising imports

Some countries may experience large deficits on the current account of their balance of payments. This means that the value of imported goods and services is greater than the value of exports and net investment incomes leading to an outflow of money from their economy.

High trade deficits might have to be covered by foreign borrowing (increasing external debt) or a reliance on inflows of capital investment from overseas multinationals

Large trade gaps can eventually lead to a currency crisis and possible loss of investor confidence.

13/ Over-extraction of the natural resource base

Natural resources provide an important source of wealth for many lower-income countries and when world prices are high, there is an incentive to increase extraction rates to boost export earnings.

This might lead to an excessive rate of extraction that damages growth potential

Deforestation and rapid extraction of oceanic fish stocks are two good examples of this.

A report from the OECD published in 2012 found that there is a growing need to improve the sustainable use of available land, water, marine ecosystems, fish stocks, forests, and biodiversity. Some 25% of all agricultural land is highly degraded.

Critical water scarcity in agriculture is a fact for many countries

Extreme weather events are becoming more frequent and climatic patterns are changing in many parts of the world. The damaging effects of these extreme climatic events tend to fall most heavily on the poorest and most vulnerable communities in developed and developing countries.

14/ Inadequate investment in human capital

To sustain growth requires improvements in productivity, research & development and innovation. Whilst physical capital such as factories and technology plays a role, so too does the quality of the human input into production.

Economic growth might be limited by skills shortages as businesses seek to expand which forces up average wages and labour costs.

High level skills and qualifications are also needed to help businesses to move up the value chain and supply products that can be sold for higher prices in the world economy.

In many of the least developed countries there are acute shortages of human capital. Although primary enrolment rates have risen, secondary enrolment and teacher quality is poor and the tertiary education sector is tiny and low-quality. Some countries lose some of its limited skilled workforce to other countries. Gender inequality can have a hugely negative effect on human capital development.

15/ High levels of inequality of income and wealth

Although two decades or more of globalisation has strengthened average growth rates in many lower and middle-income countries, it has brought an increase in inequalities of income and wealth.

When the gap between rich and poorer communities gets bigger there are many possible dangers not least the costs of social tension and conflict and increasing spending on insurance, law and order systems and government welfare bills.

Recent theoretical work finds a negative correlation between income inequality and economic growth. One book that supports this view is The Spirit Level (Pickett and Wilkinson) which finds evidence that unequal societies may become less competitive over time.

16/ Gender inequality and discrimination

In many countries women are subject to deep-rooted cultural norms that prevent them playing a full and active role in their economy.

  • According to the World Bank, 232 million women live in economies where they can't get a job without their husband's permission
  • Less than 10% of credit for small farmers in Africa is directed to women

Some progress is being made, from 2009 through to 2011, 39 developing countries made legal changes towards gender parity – but only 38 out of 141 nations set the same legal rights for men and women in their own labour markets

Economic and social dangers from rising inequality

17/ Malnutrition and limits to growth and development

High rates of malnutrition can severely impair development and bring untold human misery. Poor nutrition can have serious negative effects on development prospects:

  • It impairs brain development among the young – nearly one in five children aged under five in the developing world is under-weight
  • It is responsible for half of all child deaths – 38% of under-five children in the poorest 20% of families in developing countries are underweight compared to 14% of under-fives in the wealthiest 20%
  • It increases the risks of HIV infection and cuts the numbers who survive outbreaks of malaria
  • Malnourished children are more likely to drop out of school and suffer reductions in their lifetime incomes
  • According to the World Bank, “the effects of this early damage on health, brain development, educability, and productivity caused by malnutrition are largely irreversible.”
  • The surge in global food prices has had a terrible effect on the risk of malnutrition in many of the world’s poorest countries. It has certainly led to a sharp rise in premature deaths and severe illnesses linked to poor nutrition in countries such as India.

Here is the 2011 data for the % of people who are undernourished:

  • Sub-Saharan Africa: 27% (equivalent to 231 million)
  • Southern Asia: 20%
  • Developing regions: 15%
  • Rural children in developing countries: 32%
  • Urban children in developing countries: 17%

There has been progress in reducing malnutrition but high prices for basic foods in recent years have curbed this trend.

Prevalence of undernourishment (% of population)

Country

Data is from 2008

Eritrea

65

Burundi

62

Haiti

57

Zambia

44

North Korea

35

Kenya

33

Low income countries

29

Least developed countries

29

Heavily indebted poor countries (HIPC)

28

Sub-Saharan Africa (all income levels)

22

India

19

Low & middle income countries

14

World

13

Middle income

13

China

10

European Union

5

Policies to reduce malnutrition

  • Schemes to promote health and nutrition education plus direct provision of micro-nutrient supplements and fortified foods
  • Growth monitoring schemes for the newly born and infants supplemented with vitamin provision from community organisations
  • Targeting cultural norms – in some countries, young girls are often allowed to eat only after their brothers
  • Cash transfers – i.e. consumer subsidies that can be spent on certain foods
  • Government subsidies for grain prices and export bans on domestically produced foods
  • Better food prices paid to small-scale farmers
  • Opening up retail markets to international supermarkets where food prices might come down through economies of scale and increased competition
Infrastructure spending to improve access to and improved quality of sanitation and clean water supplies





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