Limits to growth and

development in

LDCs
A2 Economics Unit 4

Komilla Chadha
25 April 2011

www.a2withkomilla.blogspot.com Page 1
 Contents Page

1. Population issues..........................................Page 3
2. Poor Infrastructure......................................Page 4
3. Capital Flight.................................................Page 5
4. Human Capital Inadequacies......................Page 6
5. Poor governance..........................................Page 7
6. Foreign currency gap..................................Page 8
7. Civil Wars......................................................Page 9
8. Primary Product Dependency....................Page 10
9. Geography.....................................................Page 11
10.Savings gap and inadequate capital accumulation.............Page 12
11.Debt.............................................................Page 13
12.Corruption.................................................Page 14

www.a2withkomilla.blogspot.com Page 2
 1. Population Issues
What are the population issues in LDCs?
In the past you might have come across a population pyramid, particularly if
you have studied geography, they show the percentage of the population in
each age group and gender group. LDCs are characterized with high birth
rates (due to a belief that a large family can increase family income and the
lack of availability, education and belief in contraception) and high death
rates (due to lack of medical aid and information regarding healthy living).
This results in a convex population pyramid as you can see below. This can
have several issues, the most prominent one being there is a small
economically active population (by Western standards).

How do they impact growth?

Having such a large population pushes by in large most people into
employment in the informal sector which does not improve a family’s income
and prevents consumption from taking place. This is one way in which
population issues impact AD. Furthermore, as the death rate and healthcare
is poor it means productivity is not at its full potential hindering AS. As
mentioned previously the economically active population isn’t exactely big
and this is minised further by ‘brain drain’ which is where adequate labour
moves to another place. This resuces labour market and results in a further
decline of AS.

Case Study: Malawi

2010 info
Birth rate:41.28/1000 population (11th world
ranking)
Death rate 13.69/1000 population (21st world
ranking)

Something to think about...

The Maulthusian view is sometimes used to show why countries with

these population issues could result in famine and poverty.

www.a2withkomilla.blogspot.com Page 3
 2. Poor Infrastructure
What are the infrastructure issues in LDCs?
LDCs lack infrastructure structure such as electricity, reliable water
supply, roads, training systems, monetary infrastructure, waste
disposal, telecommunications and many others. This lack of
infrastructure can be due to lack of government spending (for a variety
of reasons such corruption, political interest, civil war etc) and
international intervention e.g. from NGOs.

How do they impact growth?

Firstly, if infrastructure is poor then nobody would wish to invest in the
country because they will just incur extra costs. So these countries
have a lack of FDI which means that the circular flow of income cannot
be improved from overseas investment. Furthermore, lack of
infrastructure means that AS cannot grow which hinders economic
growth, especially for long term economic growth. Even the UK has to
constantly improve infrastructure because it improves productivity
and make a country competitive.

Case Study: India

India has one of the worst infrastructure
in the world ranking 86th out of 139 for
overall quality of infrastructure below
China and Brazil. Economists have
observed that unless this situation is
improved India cannot reach growth above 9%.

Points to think about...

This cannot apply to all countries because some countries such as
Afghanistan are rich in raw materials. in these countries FDI will not be
put of from the lack of infrastructure if the material in question is
valuable e.g. oil. TNCs in fact are likely to bring infrastructure such as
roads to the countries. Of course because of the war in Afghanistan this
has not been the case.
www.a2withkomilla.blogspot.com Page 4
 3. Capital Flight
What is Capital Flight?
It is clear that the number of wealthy individuals in LDCs is very low.
Their savings in their should help stop the savings gap cycle and
increase investment. However, this is not the case, many of these
countries suffer with what is known as Capital Flight. This is when
wealthy individuals move their savings overseas in search of a better
return which the poor institutions of the source country cannot offer.

How does it impact growth?

This impacts economic growth
through AS and AD. The potential for
many firms to increase capital stock
isn’t there because banks do not have
the funding to lend. Lack or
inefficiency of capital stock results in
hinderance to long term economic
growth. Of course, this lack of being
able to get capital stock is also known as investment and is part of the
AD formula. AD therefore is too affected, in an adverse way.

Case Study: Russia + Argentina (From Wikipedia)

In the last quarter of the 20th century, capital flight was observed from
countries that offer low or negative real interest rates like Russia and
Argentina to countries that offer higher real interest rate like China.

Points to think about...

Another point to think about is that if these individuals are putting
their money in foreign banks (or assets or shares for that manner) not
only are they affecting investment they are affecting government
spending. The Government loses out on tax revenue it could have
recieved if they used their money in the local money and this hence
restricts how much the government can spend and AD falls further.
www.a2withkomilla.blogspot.com Page 5
 4. Human Capital
Inadequacies
What do we mean by human capital indecencies?
What we mean by human capital inadequacies is the lack of education and
training which is given to the labour force. This means they are not
specialized or informed of way to do different jobs. This means that labour
force is not very productive in comparison to other countries.

How does it impact growth?

This impacts growth through AS. If the labout is not educated and trained
this means they cannot be used to their full potential and there is will be a
lack of innovation in LDCs and this results in a long term hinderance to
economic growth. FDI will also be reluctant to invest in such places as they
will not be able to work at full productivity and training costs aren’t cheap.
Government for the same reason cannot (or is not willing to) invest in
education and training, costs are high and results can only be seen in the
long-term which conflicts with short-term political interests.

Case Study: Ethiopia

Ethiopia had a 36% total adult literacy rate between 2005-2008 and the
reason being that even though there are educational institutions (albeit
limited ones) children are unable to utilise this. Parents cannot provide for
their large families so children must go out to work and by doing this they
miss out one all important education and remain illiterate. When they are
older there is again no time to be educated as they begin their own family and
the cycle continues.

Points to think about...

Human Capital issues results in employment or subsistence farming as no-
one wishes to invest to or recruit such workers. This has the multiplier effect
as it pushes consumption down and subsequently AD. Another point to note
in many of these countries the epidemic of HIV and AIDs mean that adults
are sometimes unable to work and hence have to pull their children out of
school and force them to work. So even though the opportunity to be
educated is there many kids find themselves unable to benefit from it.

www.a2withkomilla.blogspot.com Page 6
 5. Poor Governance
What kinds of issues are associated with poor governance?
There are several issues associated with poor governance. These will be
discussed in the following bullet points:
★ Many LDCs have a dictatorial governance (this is obviously changing with
the revolution in the Middle East) and this means that not always does the
authority serve the people or is bothered about the economics impacts on
people. We will discuss some of these points further in the corruption section.
★ As a result, money is not spent wisely, they will spend it on whre their
political interests lie e.g. they may spend the money on implementing
regulations and laws which protect them and on the army. This means that
TNCs and other investors will be put off from investing in such nations
because of (i) ethics and more likely because (ii) they do not rust their
political system.
★This results in a misallocation of resources, so for example, education and
training we have seen is such a key player in terms of growth but the
government will spend money on the army and weapons resulting in a
misallocation of resources.

How does it impact growth?

The last point is probably the most crucial in understanding how this affects
AS. The misallocation of resources means that AS cannot be extended. The
governments need to spend serious money if they want AS to grow.
Furthermore, if they are spending more one themself and or one their
political party then this reuces all scope for government spending to increase
AD.

Case Study: Zimbabwe

Due to the poor governance, Zimbabwe suffers with all issues with hinder
growth and hyperinflation. This lack of stability ceases investors from
investing, domestic firms from growing and obviously the government is so
corrupt that all the government spending is spent on lavish lifestyle of Mr
Mugabe.

Points to think about...

I think it os important to point out one of the reason why these governments
have poor performance is because many of hem are uneducated and probably
don’t even what AS and AD is!

www.a2withkomilla.blogspot.com Page 7
 6. Foreign Currency Gap
What is the foreign currency gap?
The foreign currency gap is a pretty simple concept. Essentially what it
states is that many LDCs rely on the primary sector and we can se the
Clarke-Fisher model to explain this too! However, the income from this
sector is low because the have a low PED and are vulnerable to natural
disasters etc. This means that export revenue is fairly low and LDCs
cannot therefore finance imports.

How does it impact growth?

You might think this is will
benefit their Balance of Payments
but it has a detrimental impact of
AS. Much capital stock can be
found in MEDCs so firms have to
import it in order to grow and
cause a shift in AS yet they are
unable to do this because there is
not enough export revenue to so.
They only export revenue can go
up is by increasing productivity
which is only possible by purchasing capital stock so they are stuck!

Points to think about...

Many of these countries do not have a proper monetary system in place
and this means it is difficult to source finance. Another thing is that
they do not have any property of legal infrastructure in play so to
borrow from overseas bank wouldn’t work because they have nothing to
secure their loan. Moreover, by importing less you push up the prices of
imports (simple supply and demand) this results in a fall of standards
of living as people cannot afford imports.

www.a2withkomilla.blogspot.com Page 8
 7. Civil Wars
What is civil war?
A civil war is when one or more groups have a war with one another.
Quite often they can caused by political differences. In some senses the
current situation in Libya is an example of civil war - pro Gaddafi
supports fighting the rebels.

How does it impact growth?

It has several impacts but the most important one being resources
(which are as it is scarce in LDCs) being allocated to the war effort. This
has a big opportunity cost because the same money and effort could be
used to improve education etc. The adversely impacts AS and actually
AD is affected too because people are forced to participate in war not

allowing them to earn and add to

consumption. A lot of human capital is

lost in the bloodshed and whatever
infrastructure was there becomes
destroyed (again impacting long run
AS).

Case Study: Congo(From Wikipedia)

Specific information on the details of war is not required so to give you
an example I have pasted the information from Wikipedia. The Republic
of the Congo Civil War, lasting from June 1997 to December 1999, was
fought between partisans of two presidential candidates, which ended
in an invasion of Angolan forces and installation of Denis Sassou
Nguesso to power.

www.a2withkomilla.blogspot.com Page 9
 8. Primary Product
Dependency
What is PPD?
LDCs are known to rely on the primary sector and quite often
subsistence farming and as seen before one of the reason they are not
able to free from this is because of capital flight. The value of such
primary products is low therefore locals don’t make much money. This
has many implications.

How does it impact growth?

Aggregate demand is effected in two way by this, the first is straight
forward as people are poor and tend to rely on subsistence farming they
spend less in the local economy reducing consumption. To understand
the second, it is important to look back at the cobweb theory (on
Youtube PajHolden has a great video tutorial of this), cobweb theory
provides one explanation of why prices fluctuate in the agricultural
market. This fluctuation and instability makes it unlikely that farmers
will invest pushing aggregate demand further down. Low PED of such
goods further exacerbates the effects of the cobweb theory. AS is also
affected though, the risk of natural disasters impacting such industries
can easily push AS down.

Case Study: Mozambique

Mozambique relies on sugar production for much

of its trade and development and wants to focus on

this to grow further. However, the detrimental
floods of 2000 spoilt nearly all the crops and
contracted AS significantly.

www.a2withkomilla.blogspot.com Page 10
 9.Geography
What are some of the geographical elements that can impact
growth?
★ Natural disasters e.g. floods, droughts, earthquakes, tsunamis etc.
★ Brain Drain
★Access to raw materials
★Proximately to economic core
★Coastal issues e.g. coastal erosion
★Fertility of land and animals
★Is the country landlocked?

How do they impact growth?

This factors are particularly important to the primary sector and as
discussed in the primary product dependency section are extremely
important. However, the other factors are also very important e.g. if a
country is land locked it is difficult to trade internationally making a
country lack the economic injections it would have once got. The
proximity to economic core denotes whether there will slums and
shanty towns created. Brain drain occurs in places like rural indian
villages where people are trying to search for different high earning
jobs. These migrants go to the economic core and there tends to be a
lack of jobs and shelter because of the influx of migrants and this
results in the creation of slums. This means the government has to
spend money trying to solve this problem rather than spending on
infrastructure, education etc.

Points to think about...

Another way to demonstrate the problem that the economic core faces
with an influx of brain drain migrants is that it is an opportunity cost
for the government.

www.a2withkomilla.blogspot.com Page 11
 10. Savings gap and
inadequate capital
accumulation
What is the savings growth?
The savings gap in many LDCs starts off with the understanding that
many LDCs are reliant on low value primary sector production. This
starts of a negative wealth cycle as one can see below.

Low income Low savings as they

(from ppd) don’t earn much

If they don’t saving much they cannot

Low capital
(i) invest much and (ii) borrow to invest
accumulation as they
can’t afford it

How is it relevant to economic growth?

This cycle is relevant to economic growth because it basically shows
why firms (more likely farmers) are not able to invest and increase
their income and subsequently increase consumption. Both aggregate
demand and supply are left at a low value because of this problem.

www.a2withkomilla.blogspot.com Page 12
 11. Debt
What are the issues surrounding debt?
Debt provides several problems for developing one the primary one
being financing the debt and debt interest. They borrow at times of low
interest to find that some years down the line the interest has increased
significantly. The other issues which branch of the problem of debt
include, not making as much money as projected (governments may
have invested the money into a type of export which at that time was a
high earned which by the time the moneys impact can be seen that
export is now not worth much), increase in oil prices (prices of
everything else rises but value of debt does not), fall in the value of
currency making imports expensive and exports cheap to trading
partners hence unable to source funding for debt and debt from money
being used on the military.

How does it impact growth?

This impacts growth in several way, the first is AD is affected because
government spending falls, investment falls as there is less trust in the
government and as the result of the first two consumption falls. FDI too
falls and if tax is increased to raise funds for debt then short run AS
falls. Obviously, no need to expound on this but with debt the
opportunity cost is huge!

Case Study: IMF

The IMF cancelled one third of all debt because of pressure groups such
as Live8 and Jubilee 2000 who argued that debt is only ruining people’s
lives in LDCs.

Points to think about...

There are many disputes regarding who is responsible for this situation
the country being questioned at hand or the IMF who monitors such
transactions. Is it fair to charge countries anyway?

www.a2withkomilla.blogspot.com Page 13
 12. Corruption
What are the issues surrounding corruption?
When we talk about corruption we are talking about political parties or
beings who are not fulfilling their role to serve the people but in fact are
using the role to live lavish lifestyles and benefit themselves. Some of
the issues surrounding corruption are bribery, extortion (illegally
obtaining property, funds or other assets), inequality and fraud.

How does it impact growth?

They essentially impact growth by misallocating resources. Corruption
ensures that the elite have a great life and the ordinary layman suffers
for the happiness for the elite. AD is obviously affected, as people suffer
in poverty consumption is impacted, lack of faith in the government
means investment is near to nothing the use of the money means the
government is not spending money for the people. AS is too affected
because there is a lack of investment and implementation of supply-side
policies in such places.

Case Study: Zimbabwe

Robert Mugabe, if you look him up, you will find he is basically the face
of corruption. The devastating economic situation in Zimbabwe has a lot
do with his corrupt nature. Yet this is not only found in Zimbabwe many
other LDCs have to face this too.

Thank you for reading!

www.a2withkomilla.blogspot.com Page 14
www.a2withkomilla.blogspot.com Page 15