Unit 4: The Global Economy - Promoting Economic Growth & Development
Understanding Barriers to Development and Strategies for Economic Growth
Introduction: The Development Challenge
Despite global economic growth, billions of people remain in poverty. Understanding why some countries develop while others remain poor is central to economics.
Key questions:
- Why do some countries remain trapped in poverty?
- What barriers prevent economic development?
- What strategies can promote sustainable growth?
- How can international community help?
1. Poverty Traps
What is a Poverty Trap?
Poverty trap is a self-reinforcing mechanism that causes poverty to persist. Poor countries remain poor because they are poor—poverty itself creates conditions that perpetuate poverty.
Vicious cycle: Low income → Low savings → Low investment → Low productivity → Low income...
The Basic Poverty Trap Cycle
Step-by-Step Mechanism
1. Low Income:
- People earn very little
- Barely enough to survive
2. Low Savings:
- All income spent on basic needs (food, shelter)
- Nothing left to save
- No funds for investment
3. Low Investment:
- Cannot invest in education (human capital)
- Cannot invest in tools, equipment (physical capital)
- Cannot start businesses
4. Low Productivity:
- Without education or tools, productivity remains low
- Labor is inefficient
- Output per worker minimal
5. Low Income (cycle repeats):
- Low productivity generates low income
- Cycle perpetuates across generations
Types of Poverty Traps
1. Savings/Investment Trap
Harrod-Domar Model:
\[ \text{Economic Growth Rate} = \frac{\text{Savings Rate}}{\text{Capital-Output Ratio}} \]- If savings rate is zero or very low → No growth
- Need minimum level of savings to break out
- Poor countries cannot reach this threshold
2. Demographic Trap
High population growth eats up economic gains:
- GDP grows but population grows faster
- GDP per capita stagnates or falls
- High birth rates common in poor countries (lack of education, contraception)
- More children → Greater dependency ratio → Less savings
Formula:
\[ \text{Growth in GDP per capita} = \text{GDP Growth Rate} - \text{Population Growth Rate} \]If GDP grows 3% but population grows 3%, GDP per capita doesn't increase!
3. Human Capital Trap
- Poor families cannot afford education
- Children work instead of attending school
- Uneducated adults have low productivity
- Earn low wages
- Their children also cannot afford education
- Intergenerational poverty
4. Health Trap
- Malnutrition, disease reduce productivity
- Sick workers cannot work effectively
- Medical costs drain savings
- Cannot afford healthcare
- Health problems worsen
- Productivity remains low
5. Infrastructure Trap
- Poor infrastructure (roads, electricity, water)
- High transport costs, unreliable power
- Businesses uncompetitive
- Low investment from domestic and foreign firms
- No tax revenue to build infrastructure
- Infrastructure remains poor
Breaking the Poverty Trap
The "Big Push" Theory (Rosenstein-Rodan):
Need large-scale coordinated investment across multiple sectors simultaneously to break out of poverty trap.
Why gradual change doesn't work:
- Small investments have small effects
- Easily absorbed by population growth or shocks
- Don't reach critical threshold
Why big push needed:
- Simultaneous investment in education, health, infrastructure
- Creates complementarities and spillovers
- Pushes economy past tipping point
- Self-sustaining growth begins
Source of funds:
- Foreign aid
- Foreign direct investment (FDI)
- International loans
- Domestic resource mobilization
2. Economic Barriers to Development
A. Lack of Physical Capital
B. Lack of Human Capital
C. Limited Access to Credit and Financial Services
D. Dependence on Primary Commodities
E. Debt Burden
F. Capital Flight
3. Political and Social Barriers to Development
A. Poor Governance and Corruption
B. Lack of Property Rights
C. Civil War and Conflict
D. Gender Inequality
E. Cultural and Social Factors
4. Economic Growth and Development Strategies
Overview of Strategy Types
Developing countries have tried various strategies to promote growth. Debate continues over which approaches work best.
Main categories:
- Market-oriented strategies: Rely on free markets, trade, private sector
- Interventionist strategies: Active government role in directing development
- Sustainable development approaches: Balance growth with environmental and social goals
A. Import Substitution Industrialization (ISI)
Strategy: Develop domestic industries to replace imports; reduce dependence on foreign goods
How it works:
- Protect infant industries with tariffs and quotas
- Government subsidizes domestic manufacturers
- Restrict imports of consumer goods
- Promote self-sufficiency
Historical context: Popular in Latin America, Africa, Asia (1950s-1980s)
ISI: Advantages
- Diversifies economy away from primary commodities
- Creates industrial jobs
- Develops domestic technological capacity
- Reduces vulnerability to external shocks
- Infant industries learn and eventually compete
ISI: Disadvantages and Failures
- Inefficiency: Protected industries never become competitive
- High costs: Consumers pay high prices for low-quality goods
- Rent-seeking: Businesses lobby for continued protection
- Slow growth: Lack of competition reduces innovation
- Balance of payments problems: Still need to import capital goods and technology
- Limited market: Small domestic market limits economies of scale
Verdict: Largely abandoned after poor results. East Asian export-oriented approach proved more successful.
B. Export-Oriented Industrialization (EOI) / Export Promotion
Strategy: Develop industries focused on exporting to world markets
How it works:
- Integrate into global economy through trade
- Specialize in labor-intensive manufacturing (comparative advantage)
- Attract FDI for export industries
- Invest in infrastructure and education
- Maintain competitive exchange rate
Examples: South Korea, Taiwan, Singapore, Hong Kong (Asian Tigers), later China, Vietnam
EOI: Advantages
- Large markets: Can export to entire world, not just small domestic market
- Economies of scale: Mass production lowers costs
- Competition drives efficiency: Must be competitive to export
- Technology transfer: Foreign firms bring know-how
- Foreign exchange earnings: Can import necessary capital goods
- Rapid growth: East Asian miracle demonstrated success
EOI: Disadvantages
- Vulnerability to global recessions: Dependent on foreign demand
- Terms of trade: Face tariffs in developed country markets
- Race to bottom: Competition may lower wages and standards
- Environmental damage: Rapid industrialization causes pollution
- Inequality: Export sector prospers while rural areas lag
C. Diversification
Strategy: Reduce dependence on narrow range of products; develop multiple sectors
Why needed:
- Countries reliant on few commodities vulnerable to price shocks
- Example: Oil exporters suffer when oil prices collapse
How to diversify:
- Develop manufacturing alongside agriculture
- Promote tourism
- Invest in services (finance, IT)
- Add value to primary products (processing)
- Develop multiple export crops
Benefits:
- Reduces risk
- Stabilizes export earnings
- Creates broader employment base
D. Structural Change and Industrialization
Lewis Model of structural transformation:
Development involves labor moving from low-productivity agriculture to high-productivity industry.
Process:
- Stage 1: Surplus labor in agriculture (disguised unemployment)
- Stage 2: Industry emerges, offers higher wages
- Stage 3: Labor migrates to cities for factory jobs
- Stage 4: Agriculture modernizes (mechanizes)
- Stage 5: Economy becomes industrial, then service-based
Government role:
- Invest in infrastructure
- Provide education and training
- Create stable macroeconomic environment
- Support key industries (industrial policy)
E. Foreign Direct Investment (FDI)
Strategy: Attract multinational corporations to invest in productive capacity
Benefits of FDI:
- Capital inflow: Funds investment without borrowing
- Technology transfer: Modern equipment and techniques
- Management expertise: Learn best practices
- Employment creation: Jobs for local workers
- Export opportunities: Multinationals provide access to global markets
- Linkages: Domestic suppliers develop
How to attract FDI:
- Political stability and good governance
- Infrastructure development
- Skilled labor force
- Tax incentives
- Special Economic Zones (SEZs)
- Protect property rights
FDI: Potential Problems
- Profit repatriation: Profits sent back to home country
- Limited linkages: May import all inputs (no benefits to local suppliers)
- Exploitation: Low wages, poor working conditions
- Environmental damage: Lax regulations exploited
- Volatility: Can leave suddenly during crises
F. Official Development Assistance (ODA) / Foreign Aid
Definition: Financial assistance from developed countries and international organizations to developing countries
Types:
- Bilateral aid: Country-to-country (often tied to political alliances)
- Multilateral aid: Through international organizations (World Bank, UN agencies)
- Humanitarian aid: Emergency relief (disasters, famines, conflicts)
- Development aid: Long-term projects (infrastructure, education, health)
Aid: Potential Benefits
- Finances projects poor countries cannot afford
- Fills savings gap
- Builds infrastructure (roads, schools, hospitals)
- Provides technical expertise
- Emergency relief saves lives
Aid: Criticisms and Problems
- Corruption: Aid funds stolen or misused
- Dependency: Creates reliance, reduces incentive for self-sufficiency
- Tied aid: Must be spent on donor country goods (less effective)
- Political conditions: Serves donor interests, not recipient needs
- Undermines local producers: Free food aid harms domestic farmers
- Poor coordination: Donors fund pet projects, not priorities
- Limited effectiveness: Some studies show weak growth impact
Debate: Aid works vs. Aid is harmful
G. Fair Trade
Definition: Movement to ensure producers in developing countries receive fair prices and decent working conditions
How it works:
- Certification schemes (Fair Trade label)
- Guaranteed minimum prices above market rate
- Direct relationships between producers and buyers
- Social premium for community projects
- Labor standards enforced
Products: Coffee, tea, cocoa, bananas, cotton
Fair Trade: Benefits
- Higher incomes for small farmers
- Price stability (protects against market swings)
- Community development funds
- Better working conditions
- Environmental sustainability (organic practices promoted)
Fair Trade: Criticisms
- Limited scale: Helps only small percentage of farmers
- Higher consumer prices: Reduces demand
- Inefficiency: Keeps marginal producers in business
- Bureaucracy: Certification costs
- Questionable impact: Benefits may not reach poorest
H. Sustainable Development
Definition: Development that meets present needs without compromising future generations' ability to meet their needs
Triple bottom line:
- Economic: Growth and employment
- Social: Equity, health, education
- Environmental: Protect ecosystems, biodiversity, climate
UN Sustainable Development Goals (SDGs) - 17 goals including:
- No poverty
- Zero hunger
- Quality education
- Gender equality
- Clean water and sanitation
- Affordable clean energy
- Climate action
Sustainable Development Strategies
- Renewable energy: Solar, wind instead of fossil fuels
- Sustainable agriculture: Organic farming, agroforestry
- Circular economy: Recycling, waste reduction
- Green technology: Clean production methods
- Conservation: Protected areas, sustainable resource use
- Climate adaptation: Prepare for climate change impacts
Comparison of Development Strategies
| Strategy | Main Approach | Examples | Success Rate |
|---|---|---|---|
| ISI | Protect domestic industries from imports | Latin America 1950s-80s | Generally failed |
| EOI | Export-oriented manufacturing | East Asian Tigers, China | Very successful |
| FDI-led | Attract foreign investment | China, Vietnam, Ireland | Generally successful |
| Aid-dependent | Rely on foreign assistance | Many African countries | Mixed results |
| Resource-based | Export oil/minerals | Gulf states, Botswana | Variable (often poor) |
| Sustainable development | Balance growth with environment | Costa Rica, Bhutan | Promising but limited scale |
IB Economics Exam Tips
Key Concepts to Master
- Poverty trap mechanism: Low income → Low savings → Low investment → Low productivity → Low income
- Big Push theory: Need coordinated large-scale investment
- Barriers: Economic (capital, credit, debt) vs. Political/Social (governance, conflict, gender)
- ISI vs. EOI: Know differences and why EOI more successful
Essay Structure for Development Strategy Questions
Introduction:
- Define economic development
- Outline barriers preventing development
Body - Barriers:
- Discuss poverty traps and vicious cycles
- Economic barriers (capital, credit, debt, primary commodity dependence)
- Political/social barriers (governance, conflict, inequality)
Body - Strategies:
- Market-oriented (EOI, FDI, trade liberalization)
- Interventionist (ISI, government-led industrialization)
- International support (aid, debt relief, fair trade)
- Sustainable approaches
Evaluation:
- No one-size-fits-all (context matters)
- Trade-offs (growth vs. environment, efficiency vs. equity)
- Time horizons (short vs. long term)
- Evidence from real countries
- Combination of strategies often best
Common Mistakes to Avoid
- Oversimplifying: Development complex, multiple factors interact
- Blaming culture: Poverty often causes behaviors, not vice versa
- Ignoring success stories: East Asia shows development possible
- One-sided on aid: Both benefits and problems exist
- Not using examples: Specific countries make arguments credible
- Forgetting sustainability: Growth at any cost problematic
Real-World Examples to Use
- Success: South Korea - From aid recipient to developed economy via EOI
- Success: China - Rapid growth through export-led industrialization and FDI
- Success: Botswana - Diamond wealth managed well, good governance
- Failure: Venezuela - Oil dependence, corruption, economic collapse
- Failure: Zimbabwe - Poor governance destroyed once-prosperous economy
- Challenge: Sub-Saharan Africa - Multiple barriers, slow progress
- Alternative: Costa Rica - Sustainable development model
✓ Growth & Development Strategies Checkpoint
You should now understand poverty traps as self-reinforcing cycles (low income → low savings → low investment → low productivity → low income) requiring big push interventions; economic barriers including lack of physical and human capital, limited credit access, primary commodity dependence, debt burdens, and capital flight; political and social barriers encompassing poor governance, corruption, weak property rights, conflict, gender inequality, and social factors; and development strategies ranging from import substitution (ISI, generally failed) to export-oriented industrialization (EOI, successful in East Asia), FDI attraction, foreign aid (controversial effectiveness), fair trade, and sustainable development approaches. Remember no single strategy fits all contexts—successful development typically requires combinations of strategies adapted to local conditions, with East Asian export-led growth proving most successful historically but raising sustainability concerns. Always evaluate strategies with real-world examples and consider trade-offs between growth, equity, and environmental protection for IB Economics SL exams.
