Developing Economies

Types of economy:

 First World – highly developed and industrialized, e.g. Western Europe and USA

 Second World, e.g. Eastern Europe – living standards usually lower than First World, and higher
proportion of the economy is involved in agriculture; less developed service sector

 Third World – developing economies, e.g. several countries in Africa, Latin America Some have
developed quite fast e.g. Malaysia; others have yet to develop significantly

Developing economy: economies with low real income per capita, compared to developed economies
like USA, Canada and Japan. Usually have low life expectancy, low literacy, and a high agricultural
sector. However, there is a wide variety of developing countries – some very poor, e.g. Ethiopia; others
such as Korea, Taiwan, and Singapore have been very successful at raising living standards.

Main monetary indicator of the economic status of a country is GDP per capita and non monetary
indicators of the welfare of a country are life expectancy, adult literacy. The distribution of income and
wealth must always be considered.

Problems of less developed countries (LDCs)

 LDCs are often dependent on one or two commodities exported to foreign countries and economic
growth is dependent on exports earnings, which can lead to instability. This causes problems because:

1. These goods usually have price inelastic supply and demand – any shift in supply or demand can
have major effects on price.

2. Technological developments have reduced the need for some natural commodities produced by
LDCs

3. Income elasticity for these products is usually low-as economies grow, demand for, e.g.
foodstuffs, typically grows at a slower rate

4. Technological developments have improved yields of these products, which shifts supply to the
right and brings down the price, worsening terms of trade; a falling price of commodities means
that these countries’ exports buy less imports

 Rapid population growth

 High interest repayments due to high levels of borrowing

 Lack of appropriate technology

 Some countries have high spending on defense

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What causes growth?

 Natural resources – although many successful countries like Japan only have a few natural resources
 Capital – both human and physical; countries which grow fast have usually invested in better
education and nutrition
 Technology Good A

 Entrepreneurship Production possibility frontier

Economic growth

Polices to improve the LDC situation

Good B
 Imports substitution – countries but tariffs onto foreign goods to protect their own industries. The
problem is that protected industries may simply become inefficient. Often criticized as an ‘inward
looking strategy’

 More trade – this is an outward looking strategy; encourages foreign investment and seeks to export
(e.g. Singapore and Hong Kong)

Aid

 Often aid remains in the hands of a few and does not trickle down into the economy
 Often focuses on the cities not the country as a whole
 May reduce the incentive for the country to develop its own industry – may lead to reliance on aid.
 Governments in aid-giving countries often want to cut it when they need to reduce their own deficit –
LDCs cannot rely on it
 Banks often charge high interest rates – debt repayments can become a major burden
 May be better to concentrate on opening markets to trade to allow LDCs the opportunity to export

Economic reasons for aid

 By helping developing countries developed country is creating markets to export to in the future.
 Trickledown effect: the idea that the benefits of faster growth would work their way through the
economy so that all groups benefited – in reality, e.g. in Brazil, some groups benefit but others do
not gain so much.

Barriers to growth for LDCs

 Rapid population growth – if population grows at the same rate as income, the income per capita
stays constant. If population growth exceeds is the income growth, the income per person falls

 Human resources, e.g. if the workforce is untrained or poorly educated or in bad health; growth will
be more difficult.

 Poor natural resources, e.g. if a country has poor resources, growth can be more difficult. However, it
also depends on how these resources are maintained and used

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 Lack of an effective financial system financial institutions enable firms to invest. If however, people
are reluctant to save or no effective bank system exists, there will not be encourage savings to finance
investment.

 Cultural barriers, e.g. some people do not trust banks and so do not save

 Poor use of resources, e.g. labour is unemployed or firms have no incentive to be efficient because of
a lack of competition.

Policies to encourage growth in LDCs

 More investment in people, e.g. health care, better diets , education, training
 Policies to encourage trade
 Policies to encourage savings and investment
 Policies to encourage productive use of land, e.g. fertilizers, equipment, irrigation systems
 Polices to encourage entrepreneurship
 Improvements in appropriate technology
 Policies to encourage development of infrastructure, e.g. roads, railways, dams.

Growth and Economic Cycles

Growth: increase in national income during a specific period of time, normally one fiscal year is known
as economic growth. Percentage change in national income is known as growth rate.

The rate of growth of an economy depends on:

 Resources – the more resources that a country has, and the more effectively it users its natural
resources, the more it can grow

 Investment in people – the more that countries invest now, the more likely it is that they will grow in
the future, better training and better research, for example, may lead to future growth

 Technology – as technology improves, countries can use their existing resources more productively

 Capital goods – investment in capital goods increase productivity and leads to future growth

 Savings – savings enables investment by providing the funds for firms to invest

To help growth

 Promote saving, e.g. provide incentives for households to save

 Promote research and development
 Promote education, e.g. provided funds fro education, ensure qualifications are relevant to industry
 Promote mobility of factors of production between industries
 Promote supply side policies, e.g. remove barriers to labour market flexibility, cut taxes to increase
incentives, improve the amount and quality of information available

Argument against growth

 Causes external costs, e.g. pollution

 May reduce quality of life, e.g. more income growth may involves less leisure time, pollution,
movement away from the countryside towards the towns. The ‘zero growth proposal’ argues that
because of the external cost of growth, Governments should aim for 0 growths.
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Economic cycles (also called business or trade cycles)
Real GDP
Boom Long run trend

Recession

Recovery

Slump

Time

Term Characteristics
Slump or Heavy unemployment, low levels of aggregate demand
depression

Recovery Economy picks up; demand increasing firms being to invest

Boom More confidence in the economy, investment high but

beginning to be shortages of supply (e.g. of labour)

Recession Downswing of the economy: falling demand and rising stocks

of unsold goods; some firms will close and unemployment will
rise.

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