4.3.2 Factors Influencing Growth & Development

Economic Factors That Influence Growth & Development

Data shows that economic growth has a very positive impact on economic development
In most cases growth precedes development, but his is not always true e.g. Bangladesh used a range of strategies (including micro-finance) to transform the quality of life for many households
In some cases (usually in developing countries) economic growth is tied to one industry & generates so many negative externalities of production that the standard of living decreases for many even as growth increases

Economic factors That Influence Growth & Development

Factor

Explanation

Primary product dependency

In 2022 copper exports from Zambia accounted for 70% of their total exports & primary products in excess of 90%. They are suffering from over-specialisation
Primary products tend to have a very low-income elasticity of demand (YED). As world income rises, there is a less than proportional increase in demand
- This means that there is limited scope to continue increasing demand
Primary products have very little added value
- Exporting manufactured products raises the added value, incomes & profits

Volatility of commodity prices

Due to the inelastic nature of both the demand & supply of commodities, small changes in demand or supply can lead to large changes in price
In 2020, 25% of Bolivia's GDP was generated by exports. Commodities accounted for 60% of its exports
- When commodity prices rise, GDP rises - & vice versa
A more diversified range of exports prevents this

The savings gap: Harrod-Domar model

In the 1950's two economists identified the savings gap as a major constraint on growth
The Harrod-Domar model identified the following benefits of increased savings
- Increased savings → increased investment → higher capital stock → higher economic growth → increased savings
Based on this, any intervention (foreign or governmental) to increase the capital stock in an economy will lead to growth
There are many criticisms of the model including
- It does not account for many other factors such as labour productivity, corruption, technological innovation
- It was created based on data from wealthier industrialising nations as opposed to very poor undeveloped countries
- It focused only on physical investment & ignored other types such as investment in human capital (labour)

The foreign currency gaps

Foreign currency gaps develop for a number of reasons
- Oil importing countries have to pay more (reserves decrease) when world oil prices rise whereas oil exporting countries receive less (less flowing in) when world oil prices fall
- Large international debt payments may require continual outflows of currency
- Capital flight due to uncertainty or sanctions
This means that central banks are forced to use their reserves to buy vital imports
Developing a diversified, healthy export market prevents foreign currency gaps from developing

Capital flight

Occurs when money or assets rapidly leave a country
This may happen due to political upheaval, economic sanctions, war, or changes to government policy (e.g. interest rates)
- Sanctions applied to Russia in 2022 resulted in $75 billions of capital outflows
Capital flight reduces the money available for investment, reducing growth & development

Demographic factors

If the dependency ratio is high it means there is less money available for savings & investment
Many developing countries have high dependency ratios

Access to credit & banking

Financial institutions enable individuals & firms to borrow money which can be used for investment or to generate growth
A lack of financial institutions prevents this from happening

Infrastructure

Good infrastructure reduces business costs & attracts foreign direct investment
Some developing countries have such poor infrastructure that it makes it difficult to generate economic activity
- This is one reason why China has invested so heavily in infrastructure projects in Asia & Africa as it unlocks economic potential

Education & skills

Investing in this supply-side policy increases the potential output of the country (shifts the production possibility frontier outwards)
Higher education/skill levels → higher human capital → increased productivity → higher output → higher income

Absence of property rights

In many countries, property is the main household asset which can be used to secure loans or generate income
A lack of property rights in some developing countries prevents this from happening

Aside from the economic factors discussed above, a range of non-economic factors can have significant influences on economic growth & development

Corruption: this is a major problem in many countries. Often money intended for investment is siphoned off by corrupt politicians resulting in a lower level of investment. Corruption also diverts funds to certain groups who have bribed or lobbied officials (e.g. multinational firms) resulting in projects that deliver a low level of growth & development
Poor Governance: leads to inefficient use of resources & poor decision-making. It may also result in laws/regulation which directly inhibit growth & development
Wars: conflict destroys infrastructure, disrupts supply chains & often reduces the post war supply of labour. Conflict shifts the production possibility curve inwards
Political instability: if governments keep changing, it results in constantly changing policies & priorities. It also reduces confidence in the economy & international investors are slower to invest as they are fearful of losing their investment
Geography: it is harder for landlocked countries to generate economic growth. Often transportation & administration costs are higher than those with access to ports, which increases the costs of production & decreases international competitiveness. Natural terrain can also be a limiting factor e.g the arid, mountainous terrain of Pakistan