The Economics of Developing Countries

SPRING 2016.

1. How are countries classified based on income?

Countries can be classified into two main income groups. Industrially advanced countries (IACs) are
characterized by well-developed market economies based on large stocks of capital goods, advanced
technology for production, and well-educated workers. The high-income nations include the United
States, Canada, Japan, Australia, New Zealand, and most of the nations of western Europe. They had an
average per capita income of $26,710 in 2001. Developing countries (DVCs) are poor, not highly
industrialized, are heavily dependent on agriculture, have high population growth, and have low rates of
literacy. The middle-income countries have an average income per capita of $1,850. There are also lowincome countries with an average income per capita of $430. This group is dominated by India, and most
of the sub-Saharan nations of Africa.

2.It is stated that the avenues of economic growth are essentially the same for both industrially advanced
and developing nations. What are the two basic avenues?
First, resources need to be used more efficiently. This condition suggests that unemployment needs to
be eliminated and existing resources need to be allocated to their highest and best use. Second, the
stocks of productive resources natural resources, skilled labor, capital, and entrepreneurial ability need
to be increased. Technological advancement is also necessary. Increasing the stocks of resources and
technological improvement will increase a nations production possibilities.
3.Why do DVCs experience different rates of growth? What are some obstacles to growth?
The physical, human, and socioeconomic conditions in these nations are reasons why DVCs experience
different rates of economic growth. First, many DVCs possess inadequate natural resources. This
limited resource base is an obstacle to growth. Also, the agricultural products that DVCs typically
export are also subject to significant price variation on the world market creating variations in national
income.
Second, the circumstances for human resources in DVCs are difficult. DVCs tend to be overpopulated
and have high rates of population growth. These growing populations reduce the capacity of DVCs to
save, invest, and increase productivity. They also overuse land and natural resources and the migration
of rural workers to cities creates urban problems. DVCs often experience both unemployment and
underemployment, which waste labor resources. DVCs have low levels of labor productivity because
of insufficient physical capital and lack of investment in human capital.
Third, DVCs have an inadequate amount of capital goods and these countries find it difficult to
accumulate capital. Domestic capital formation occurs through saving and investing. The potential for
saving is low in many DVCs because the nations are too poor to save. There is also capital flight of
savings from DVCs to more stable IACs. The investment obstacles include a lack of investors and
entrepreneurs, and a lack of incentives to invest in DVC economies. The infrastructure is poor in many
DVCs.

Fourth, technological advance is slow in DVCs. Although these nations might adopt the
technologies of industrial nations, these technologies are not always appropriate for the resource
endowments of the DVCs, and they must learn to develop and use their own technologies.
Finally, it is difficult for DVCs to alter the social, cultural, and institutional factors to create a good
environment for achieving economic growth

4. Evaluate the statement: No nation can grow without a large natural resource base.
A small resource base is clearly an obstacle to economic growth as it has been for many DVCs. A
large resource base, however, is not an absolute requirement for economic growth because it only
helps make growth possible. Several major nations, such as Japan, the Netherlands, and Switzerland,
have small resource bases and yet are industrially advanced nations. These nations have been able to
focus on increasing or improving the stocks of other resources, such as labor or capital, or they have
made technological advances, all of which have allowed these nations to overcome the obstacle of a
small natural resource base. [39W: p. 4]
5.What are three major human resource problems in developing nations?
They are overpopulated. Unemployment and underemployment is widespread. The productivity of
the labor force is low.
6.Why do developing nations often have low labor productivity? Are the workers just lazy?
Laziness is a loaded term that explains little about low labor productivity. Labor productivity is
directly affected by the amount of physical capital available to workers and the level of human capital
(education, health) in the work force. DVCs lack both physical and human capital that enable
workers to produce more output per worker. Furthermore, highly skilled and productive workers may
opt to leave a DVC and seek employment in an IAC. This brain drain contributes to the productivity
problem inDVC
7.Economic development in DVCs often focuses on capital accumulation. Why?
First, the availability of capital goods affects labor productivity, which affects real incomes and the per
capita standard of living. Most DVCs are deficient in the tools, equipment, machinery, and factories
that would make the workers more productive. Second, the natural resource base is often limited in
DVCs, which means that other resources such as capital goods will be needed to substitute as an
avenue for economic growth. Third, there maybe cumulative effects from capital accumulation
because if capital accumulation increases output faster than the population grows, the savings
generated from rising real incomes can be reinvested to generate more capital formation and more
savings. [39W: pp. 7-8]
8. What are the prospects for domestic capital formation in DVCs?
The prospects are bleak. Domestic capital formation requires a reallocation of some production from
consumer goods to investment goods, and it requires a reallocation of incomes from consumption to
savings. The reallocation of production from consumer goods to investment goods may not occur
because there are few incentives for domestic capital formation in DVCs. The number of

entrepreneurs willing to take risks is few and the economic incentives in the form of expected profits
may not be sufficient to encourage much investment in capital goods. Furthermore, the lack of
infrastructure and public capital that complement and enhance private investment makes any private
domestic investment project more difficult or more likely to fail.
In addition, many citizens of DVCs are too poor to save much of their incomes, which means the pool
of savings for investment is small. Those richer citizens with higher incomes and savings may prefer
to invest those savings in IACs rather than risk losing the funds in a DVC. This capital flight problem
further reduces the pool of potential savings. [39W: p. 8]
9.What is the difference between capital-using and capital-saving technological advances? Give
examples.
When a technological change requires the use of a greater amount of capital to produce a certain level
of output, then it is capital-using. In contrast, when a technological advance permits more output to be
produced with the same amount of capital, or the same output to be produced with less capital, then the
advance is capital-saving.
Most technological advances are capital-using rather than capital-saving. Advances in production of
manufacturing goods often require new capital investment in plant, equipment, or machinery, and are
capital-using. Some technological advances, however, can save capital over the long term. Changes in
farming practices to incorporate contour plowing or crop rotation may extend the life of equipment
used in plowing or reduce the equipment needed for irrigation or soil management. [39W: p. 9]
10. Of what significance is the will to develop?
This is undoubtedly a most significant factor that can influence economic development. Countries
without vital natural resources like Japan have developed in spite of that obstacle because
individuals and society had the will to develop. On the other hand, countries endowed with great
natural resource supplies have not developed because of sociocultural impediments. Tribal
allegiances may take precedence over national identity; religious and philosophical beliefs may
restrict work habits and prevent population control; a class system may hinder mobility; and finally,
institutions such as school systems and land ownership patterns may inhibit growth and change.
[39W: p. 9]
11. Compare the problems in achieving growth in an advanced nation with those of a developing nation.
Do these problems differ in degree or in kind? Explain.
The problems differ in kind, but also in degree. The basic problem of the poor countries is poverty
itself. They have little ability or incentive to save, and therefore there is little available for investment
in physical or human capital. Lack of either form of investment inhibits change and the cycle of
poverty continues.
Achieving higher growth rates in advanced nations also requires more investment in both human and
physical capital in order to raise productivity. But the requirement is for an expansion of investment,
not for an entire transformation of society from the vicious circle of poverty. [39W: pp. 9-10]

12. Draw and explain a diagram that illustrates the vicious circle of poverty in DVCs.
Low per capita incomes make saving and investment difficult in DVCs and mean there is
a low level of demand. These conditions contribute to low levels of investment in physical and human
capital, thus contributing to low labor productivity. The low labor productivity leads to low per capita
incomes. Increasing population growth also keeps per capita incomes low. The cycle repeats itself.