Economic Growth in the Developed and Developing Economies

Economic growth is the increase in the production of goods and services of a country, compared to one time and another. GDP and per capita GDP are common indicators economists employ in the measuring the standard of living and the rate of economic development. Therefore, economic growth is computed as a yearly change in the real GDP (or per capita GDP).

Developed and Developing Countries

Developed countries are countries whose per capita GDP is relatively high. Examples of such countries are the USA, Canada, Japan, and Australia. On the other hand, developing countries have lower per capita GDP compared to developed countries. However, their GDP grows at a higher rate than developed countries. Examples are the developing countries of Asia, Latin America, and Africa.

Essentially, economic growth is based on the role of capital, labor, and technology. In addition, developed and developing countries differ based on the absence and presence of suitable institutions that enhance growth. These are discussed below:

Institutions and Requirements for Growth

1. Savings and Investment

   A country amasses capital from both private and public sector investments. It is noteworthy that Investments are usually made from savings. Increasing the investment rate in developing countries is difficult because there is a lower disposable income for meaningful savings than in developed countries.

2. Financial Markets and Intermediaries

   Any financial market (such as banks)’s function is to direct savers’ funds toward viable projects leading to economic growth. The financial market achieves this by:

   1. Filtering those seeking funding while supervising those who have acquired funds to ensure that they indulge in projects that generate risk-adjusted returns.
   2. Promote savings and risk-taking by constructing viable investment instruments.
   3. Reduction of credit blocks that companies must surmount in financing capital investments.

   If a financial market fails its mandate, a decline in credit standards and increasing leverage will attract risk, undermining growth.

3. Political Stability, Rule of Law, and Property Rights

   Property rights are legal structures that protect private and intellectual property. In developed countries, the legal system is well established to protect these rights. The same might not be said about most developing countries.

   Political instability occasioned by such occurrences as war increases investment risk and cripples foreign investment and economic growth. Political instability is much more experienced in developing countries than in developed countries.

4. Education and Health Care Systems

   In most developing countries, the education system has not been well established compared with developed countries. Therefore, a large portion of the labor force is illiterate, with a small portion having the capacity to use the ever-changing technology. Moreover, there exists a brain drain in developing countries. Highly skilled citizens leave their developing countries for developed countries, further depriving their countries of the expertise they need for development. Therefore, improving the education system through formal schooling and informal job training works best for the economy.

   Due to the unavailability of top-grade health amenities in developing countries, the life expectancy in such countries is lower than in developed countries. For instance, diseases are more prevalent in African countries, worsened by the HIV/AIDS epidemic.

5. Free Trade and Unrestricted Capital Flows

   An open economy is where capital and trade flow freely. Since foreign investment is a source of funds, it can increase income, savings, and investments. Therefore, developing countries would benefit from the formulation of policies that attract external investment. Such policies include the removal of higher trade tariffs on imports and easing restrictions on all foreign investments. On the other hand, free trade boosts a country’s economy by availing more goods and services at lower prices.

6. Tax and Regulatory Systems

   Limited tax regulations catalyze business activities and the entry of new companies into a market, thus increasing the productivity levels of a country. In most developing countries, a tax regulatory system discourages foreign investors, worsening the state of their economy.

Factors Limiting Growth in Developing Countries

From the above discussions, the factors that limit economic growth in developing countries include:

1. Poor public education and health systems.
2. Political instability and lack of property rights.
3. Existence of tax and regulatory policies that discourage entrepreneurship.
4. Existence of restrictions on international trade and capital flows.
5. Corrupt and weak legal systems, coupled with the failure to enforce laws.
6. Existence of poorly developed financial markets.
7. Low rates of saving and investment activities.

It is worth noting that while these factors can be experienced in developed countries, they are more common in developing countries.

Question

The government of a developing country is working to stimulate economic growth. It allocates more funds to education, infrastructure, and healthcare. However, the ministry of trade discourages foreign investment. Moreover, the legal system and private ownership have been ignored in this country.

Which of the following is most likely true about this economy?

1. Economic growth is unlikely.
2. The economy will grow at a faster rate.
3. Difficult to determine.

Solution

The correct answer is A.

If the government of this country invests in infrastructure, its physical capital will increase, raising labor productivity and growth. Moreover, better education and healthcare will increase human capital, productivity, and growth.

However, since the legal system is ignored, property rights, transparency in international trade and foreign investment, and efficiency will be interfered with. Thus, improvement in economic growth is unlikely to happen.

Reading 9: Economic Growth

LOS 9 (a) Compare factors favoring and limiting economic growth in developed and developing economies.