For people residing in Europe or North America, it is difficult to imagine the widespread poverty that exists in certain poor African and Asian countries. These countries are developing countries, otherwise known as Less Developed Countries (LDC). Per capita GDP (Gross Domestic Product divided by the population) in some countries can be under $500 per year, compared to over $40,000 in the U.S. and certain European countries. Living conditions are poor beyond belief. Goods and even rudimentary services like fresh water are not available. The only way to overcome such conditions is through economic growth, or rise in GDP faster than the population. But there are certain features of these developing countries that form severe obstacles to growth in output and income per capita – output and income are of identical magnitudes.
First, in some countries, population growth is so rapid (three to four times the rate of industrial countries) that GDP per capita can’t catch up. Attempts to slow it down, such as China’s old policy that allowed couples to have no more than one child or various family planning programs in other countries often fall short of yielding spectacular results.
Second, a rise in real output requires an increase in productivity (output per worker) which, in turn, requires an increase in machines and structures, otherwise known as “capital formation.” Yet these countries are lacking in such capital. For developing countries, savings and investments are necessarily meager, so they are caught in a vicious circle. Because poor countries with low incomes can’t afford to save, they cannot invest and accumulate capital. Hence productivity remains low and real GDP fails to grow. And as income fails to grow; savings remain meager. In turn, wealthy developing countries, such as oil producers, sometimes channel their savings to foreign banks rather than invest them in their own countries. Foreign technical and economic assistance with direct foreign investments (establishing factories), transferred from wealthy to poor countries, can be helpful. And yet, some developing countries restrict incoming foreign direct investment, such as factories owned by foreign multinationals, partly because they wish to minimize the influence of foreign companies on their economies.
Third, limited availability of skilled labor is often an obstacle to both domestic and incoming foreign investment.
Fourth, inadequate infrastructure can be a serious problem. For example, in developed economies we take for granted the existence of road, rail, and air transport to move materials, parts, and final goods from one part of the country to another. Imagine if this is lacking and goods are stuck in place. The same is true for health and water facilities or institutions designed to train workers in various skills.
Last, but not least, is the absence of modern or even semi-modern technology and the instruments to produce and introduce. In many cases corruption of government, and restrictions on the smooth function of markets (even the labor market) imposed by the government also hinder growth.
Fortunately, certain developing countries in Asia and Latin America, such as Thailand and Columbia have succeeded in overcoming some, or all, of these obstacles and have now reached output/income of several thousand dollars per capita. As these countries continue to grow they face several policy questions, which are not always easy to resolve. Many times the proper resolution is counter-intuitive. For example; often when a country attempts to develop through a policy called “import substitution.” Namely, it surrounds itself by a wall of protection from imports, through high import tariffs or restrictive import quotas, and develops internal industries that are substitute for imports. Such a policy was common in Latin America and some Asian countries in the last century. But despite its appeal, it failed time and again to spur growth.
In doing so, the country failed to exploit its own comparative advantage. The alternative policy that proved successful, more often than not, is to concentrate on industries in which the country has a comparative advantage and foster the country’s exports. For developing countries well-endowed with unskilled labor (such as India) and lacking in advanced technology, these would be labor-intensive, technologically unsophisticated industries such as textiles, footwear, lumber goods and sometimes agriculture. In such sectors these countries can integrate themselves into the global economy and grow. Only at a later stage can they move into capital-intensive and then later into technologically advanced sectors. The successful post-WWII examples of Japan, South Korea and Hong Kong point to a desirable move in that direction. Countries that succeeded in promoting such growth are now called “emerging markets.” Once growth begins, it becomes easier for a country to save and invest, as well attract foreign capital to propel itself forward.