9 Barriers to Development and Growth | Economics notes

Barriers to development or growth are issues that reduce the rate of development or economic growth for a country.

Development refers to improvements in the standard of living.

Key barriers to entry covered here include:

Low levels of education / training

Low levels of education mean the human capital level of workers remains low, keeping labour productivity low. So the LRAS does not shift right, reducing the extent of economic growth.

Lower education levels mean workers have a lower marginal revenue product of labour. So they are paid less, increasing poverty.

Poor quality of healthcare

Poor healthcare standards means people are more likely to be ill, lowering quality of life.

Workers may miss more days off work or be less productive, so productivity remains low. So the LRAS does not shift right, reducing the extent of economic growth.

Poor quality infrastructure

Poor quality infrastructure can mean poor quality roads, public transport or internet connectivity. Poor quality roads for example means it takes longer to get to work, leaving workers with less leisure time and thus reducing quality of life. It also means workers are more geographically immobile – there are fewer jobs they can reach. This means there is a worse match between workers and the jobs that suit their skills, reducing overall productivity. So the LRAS shifts left if infrastructure worsens, reducing the degree of economic growth.

Aggregate demand is lower due to low government spending on infrastructure (AD=C+I+G+X-M). This further reduces growth.

Note the effects of all the above on wages. Reducing worker productivity lowers the marginal revenue product of labour. This lowers wages. That is likely to result in lower consumption.

Low savings

The Harrod-Domar model predicts that low savings lead to low economic growth. This is because low savings mean reduced funds for investment. Reduced investment means capital May depreciate if investment does not now cover capital depreciation costs. This reduces productivity, so this shifts LRAS left, reducing real GDP. Lower investment also means reduced aggregate demand (AD=C+I+G+X-M), so AD shifts left, further reducing the economic growth rate.

Access to credit / high interest rates

It may be difficult to access loans in developing economies. Potential borrowers are less likely to have a credit record, less likely to have collateral (assets the lender can take if the borrower fails to repay) and are likely harder to track down if not repaying loans. Because of this higher risk of lending, there will be a reduced supply of loanable funds and any supply of loans is likely to come with a higher interest rate, to incentivise lenders to take this extra risk. That reduces demand for loans.

So lending falls, reducing the amount of borrowing to fund consumption and investment. This shifts aggregate demand left, as C and I are components of AD (AD=C+I+G+X-M). Lower investment also means reduced productivity growth as capital is more likely to wear off, so LRAS shifts left. Altogether this means reduced real GDP.

Corruption

Corruption also means often rich businessmen influence policies in their favour. For example making the tax regime less progressive. This may increase income inequality.

Corruption may lead to misallocation of government spending. For example too much government spending may be wasted on projects with low returns.

Wasted government spending may raise government borrowing, increasing the amount of debt interest paid. This means higher taxes may be needed in future to pay off debt interest. Higher taxes are likely to reduce aggregate demand and long-run aggregate supply, reducing future growth and real incomes.

Alternatively if the government continues to borrow, there could be a debt crisis if interest payments cannot be met. The government would default on its debt, which would significantly harm its future ability to borrow and attract funds from abroad.

Lack of property rights and other lacking institutions

Lack of property rights means land, business assets, property or intellectual property may not be protected from theft. This reduces the rate of return from investments, as there is a greater chance that the entrepreneur’s rewards or assets may get stolen without repercussions. This reduces the amount of investment including lower foreign direct investment. As explained with the access to credit point made above, this shifts AD left and LRAS left, reducing the rate of economic growth.

“Institutions”, in this context, refer to legal and administrative rules that may support development. For example, not just property rights but also an independent judiciary that can fairly resolve disputes and enforce property rights.

Primary product dependency

Volatility of revenues

Primary products include commodities like oil and rare earth metals, as well as agricultural products.

These products have price inelastic demand, as they are often necessities. They also have price inelastic supply, as it can take time to discover new resources.

So, for any given shift in demand or supply, price fluctuations are much larger. This price volatility makes revenues less certain. This reduces the extent to which producers can plan for the future. Indeed producers are likely to reduce investment as they cannot predict future prices.

Prebisch-Singer hypothesis

The Prebisch-Singer hypothesis states that the price of primary commodities falls over time, relative to the price of manufactured goods. This means poorer countries, that rely on primary commodities, will see reduced net exports over time, preventing growth and development.

One explanation is primary commodities are usually necessities, with an income elasticity of demand (YED) near zero. But manufactured goods have a higher YED. The YED for services is even higher still. So as global incomes rise, demand for manufactured goods and services rises significantly. But demand for primary commodities only rises a little.

Resource curse

A particular type of “resource curse” can occur through currency markets. Suppose one country exports oil as its primary product and increases oil exports. This boosts demand for its currency, as people need its currency to buy the oil. So the value of the currency increases. This appreciation makes exports dearer, reducing the competitiveness of other exports. So, other exports see a fall in demand.

In other words, the country cannot diversify easily into other exports because of its dependency on oil.

Conflict and natural disasters

Conflict and natural disasters worsen the quality of life. Such events directly lower well-being and cause injury and deaths. It can also worsen the other development barriers, such as worsening infrastructure or healthcare provision.

These events also reduce the rate of return to any investment, as there is a risk of machinery or output (E.g. housing) being destroyed. This is likely to reduce investment.

If a country is missing a generation of workers as a result, that will also reduce productive potential.

Example – Ethiopia

Ethiopia has life expectancy at birth of 68.7 years. While this is up from about 50 in 2000, it is still far below Ethiopia’s Sustainable Development Goal.

The literacy rate for 15-24 year olds is 72.8%

Government spending on health and education is 5.8% of GDP, half of the rate required to achieve Ethiopia’s Sustainable Development Goals 

35% of adults have an account at a financial institution, such as a bank.

24% of the population use the internet.

Ethiopia has faced civil war in the northern Tigray region. The civil war has displaced 5 million people as of 2021 and Tigray faces difficulties accessing clean water and medical aid. In November 2022 there was agreement to cease hostilities. 

Ethiopia is prone to droughts. 12 million people are estimated to suffer from food insecurity in the most drought-affected areas of the country.

Sources: SDG report 

Evaluation points for barriers to development

The extent to which the points above are barriers to development depends on:

• The true direction of causation. In fact, it could be that these points are just “consequences” rather than “causes” of poor development. A poor country is unlikely to have the necessary tax revenue to invest in state education, for example.
• For primary product dependency, whether the country has a fixed exchange rate regime. If the exchange rate is fixed, then higher exports of natural resources cannot lead to an appreciation and reduce demand for other exports. This prevents the “resource curse”.
• For poor education, healthcare and infrastructure, the extent of aid and NGO help (NGO = non-governmental organisation). Aid may help fund these issues, rendering them less of a barrier.
• Regarding access to credit, the influence of microfinance matters. Microfinance *In countries where there is widespread use of microfinance, this may make access to credit easier.
• More generally, the more solutions are in place, the lesser the barrier to development becomes.

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