Home      limitstoecondev

Limits to Growth and Development

Poor Infrastructure – a lack of roads, bridges, airports, ports and other infrastructure can hold back growth as firms are reluctant to invest as productivity may be low as a result of this. Also domestic firms may find it hard to grow and export due to a lack of transport links, as well as amenities like electricity and clean water.

Debt – High government debt levels mean that the government cannot spend much nor invest in infrastructure hence not contributing to economic growth (government spending is a component of aggregate demand) and also holding back the economy due to poor infrastructure.

Inadequacies in Human Capital – If the labour force isn’t educated properly or posses the necessary skills that employers require then foreign firms won’t locate the production process to that country. Poorly educated workers also means that domestic firms will find it hard to recruit skilled workers and they may to pay a higher wage for the few workers that do possess these skills. Workers that are ill can also limit growth and development.

Savings Gap – A savings gap is where there is either more money to save than there are investment opportunities or vice versa.

Capital Flight – If investors worry about the credibility of a government to repay, or fear that a country may be on the brink of a recession then they may remove their money from the country and hence limit investments.

Corruption – Unscrupulous politicians and businessmen can funnel money out of the system for their own private purposes therefore removing money that could be used to invest in the economy or help poor citizens. Corruption may also involve giving contracts to companies that aren’t the most competitive and hence lead to inefficiencies.

Population Issues – In the West there is a growing issue of a high elderly population but a diminishing working population which causes problems for how the elderly are going to be cared for as well as pension deficit fears. In the developing world a small population can be an issue as there is not enough workers, similarly a large population may drive the wage rate down, which would perhaps lead to more FDI and employment but would mean poorer conditions and pay for citizens.

Poor Governance/Civil Wars – A bad government may be corrupt or just inept, a country which is experiencing civil wars will be to embroiled in that to worry about economic growth which would create jobs and long term prospects for the country.

Dependence on Primary Products

A problem for LDCs is that they depend heavily on the production of primary goods, particularly agriculture. The agricultural industry provides employment and income for a large percentage of a developing countries population. However agriculture has low labour productivity thus depressing incomes. The reason for low productivity in agriculture is as a result of the land sharing agreements (see Land Sharing Agreements) which are discussed below.

Due to the problem of low agricultural productivity and the trouble of improving it, many LDC countries are forced to rely on the production of primary goods in order to export. This is because they can’t develop a manufacturing industry, without – amongst other things – a rise in agricultural productivity allowing labour to be released to other industries.

In LDCs many small farmers are involved in the production of export foods; however they do not normally sell their produce directly to foreigners but to tradesmen who then sell the output on. The tradesmen offer the farmers a price but this is usually a lot lower than the market price. The farmer has little choice but to accept the deal as he is unaware of the true market price (due to lack of technology, resulting in asymmetric information, this is being ameliorated by the ascent of mobile phones), is not a major player (as he is not exploiting economies of scale) and because he may not be able to store his output and may not know when the next opportunity to sell his goods will be. This latter problem may be due to a lack of competition in the tradesmen industry, allowing them to reap large supernormal profits. All of these factors keep rural wages low and hence reduce productivity as farmers don’t have enough supernormal profit to invest in their land or agricultural techniques. If they could do so there would be excess labour, which according to the Lewis Model, would mean workers would be attracted by slightly higher urban wages, and would go and work in the industrial sector, allowing a country to grow.

The advantages of relying on primary products are; a comparative advantage in the production of the good, a source of export revenue which would generate taxes and could be used to invest in other sectors and as an important source of employment. Disadvantages of relying on primary products include; volatile prices (this makes it hard for producers to budget and save, and increases the risk of them investing, as their returns may be small in the future, or they may not have sufficient cash to operate as it is all invested), limited products – some primary products are non-renewable and will eventually be depleted. There is also a discouragement to invest in other sectors of the economy as all resources are being funnelled to extract or produce the primary good, this means there is little room for diversification. Further problems may arise if the primary product is a foodstuff; supply may be affected due to adverse weather conditions, additionally supply issues may affect the production of other primary products, and if a country is dependent on this for its output it would be severely affected by any disruptions. A diverse economy wouldn’t suffer as badly because it would still have over revenue streams to rely on for employment and taxes.


Land Sharing Agreements

Land Tenancy

In many developing countries land isn’t distributed equally and some land owners hire out areas of land to small farmers. One method that this is conducted under is share cropping. Under this system a landowner hires out an area of land to a smaller farmer and the two parties share the resulting crop. The farmer is the agent and the landowner the principal. The principal would want the agent to maximise output so that the principal can see the additional crop to increase his profit. However the agent would only want to produce enough crop to feed himself and his family, as long as he is fed there is no advantage to him of working harder – that just increases his workload! This is a principal agent problem, where there isn’t an incentive to the agent to supply the optimal amount for the principal. Therefore there is also an asymmetric information problem because the principal can’t easily monitor the amount of work that the agent is doing.

Tenants also don’t have much incentive to invest in improving production or on the state of the land, as part of the return would benefit the landlord and hence the tenant’s return on investment would be diminished.

An alternative structure may be for the landlord to charge a fixed rate on the land and hence the tenant will be more incentivised to produce more as they can receive all the profits (but also have increased costs). As well as this they also have more risk as they have to pay the fixed rent regardless of output (and hence revenue).

Land Ownership

In some LDCs land is passed down through the generations with the land being divided between the sons. Hence the land plot would be smaller through every generation. This reduces productivity, can cause inefficiencies and means that there are no benefits from economies of scale. There are also moral issues with this act as women may not be able to own land in some countries. Furthermore this could cause problems as women provide much of the labour in the agricultural sector.

Additionally over-farming of this ever decreasing land size can cause erosions of soil because the land isn’t allowed to retain its composure due to a lack of crop rotation. This can lead to less productive land over time. These problems make land less productive and hence perpetuate poverty. It is also fairly impossible for farmers to access and borrow money in order to invest in agricultural improvements (buying more land, machines and fertilisers) due to the lack of financial markets in LDCs, particularly in rural areas. The reason for this is that there are high costs for banks to operate in these remote areas and the return is low. Financial institutions also have scarce information on the credit worthiness of rural borrowers and hence the risk is un-quantified.
Page last updated on 15/04/14