10/29/11

The catch up curve, will developing countries grow faster than developed countries?



Will developing countries catch up?
Economists have developed theories that show that countries with lower levels of per capita GDP should have higher per capita GDP growth rates.  It is a very basic theory, showing a negative relationship between the initial level of GDP per capita and Growth in real GDP per capita.  This hypothesis is very simple and easy to test, and the results show that it explains what is happening in a lot of countries, but not all of them.

The reasons for countries not being able to catch up go back to having proper governments and institutions in place.  For example, property rights need to be well established, and the rule of law must be solid.  Imagine a place where your property could be seized by the government any day, is that the proper incentive needed to create new investment or savings?


Why does GDP per capita remain low in developing countries?
Low rates of savings: low savings in developing countries means that the available amount of money available for investment is low as well.  Having low investment in a country means that capital levels will remain low and discourage growth.  Remember that capital is one of the biggest factors in encouraging high labor productivity which then leads to economic growth.

Poor public education and health:  without means to educate your people, human capital will remain low.  Remember that human capital is one of the factors that increase labor productivity which then leads to economic growth.  Bad healthcare also influences the economy because sick people are not as productive.  Not having adequate medicine or healthcare increases the number of people who cannot work, either because they are sick, or they are taking care of sick people.

Wars: fighting and wars suck economic resources away from sectors that could lead to increases in economic growth.  Wars fought on domestic soil can also destroy capital and/or technology which will decrease labor productivity and thus economic growth.

The good and bad of globalization:
Globalization leads to increases in both foreign direct investment (FDI) and foreign portfolio investment (FPI).  Both of these work to transfer money from rich nations to poorer nations, building up capital supplies in developing countries.  By having more capital, these nations increase their labor productivity which leads to increases in economic growth.

But globalization can also increase economic volatility in developing countries, especially small ones which depend largely on exports for GDP.  If a shock hits the global economy and sends export prices crashing, then GDP in these countries will fall sharply.  This makes them very dependent on other nations to purchase their products, and any changes in the number of sales, or sale price could hurt or help them immensely.  Large countries can also take advantage of this dependence by instituting policies that create more favorable outcomes for the large country at the expense of the smaller country.

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