Factors That Impact Development in Developing Countries
As a purpose-led organization, improving country growth through good governance is the core company mandate at FreeBalance. As such, FreeBalance participates in governance, development, foreign aid, ICT for development and transparency discussions globally.
If it is true that economic growth by itself does not ensure development, hardly any development can be sustained without economic growth. Therefore, in order to catch up with developed nations, developing and emergent countries need to achieve and sustain higher than average economic growth rates. In order for this to happen, there are some pre-conditions that need to be verified.
One typical way of understanding whether a developing country is in the right path to succeed on its efforts to develop itself is to compare its fundamentals with the ones of countries with a similar level of development and to those of countries towards which we wish to converge.
With the World growing approximately 4% per year, any economic growth rate below that level can easily be considered insufficient to allow developing countries to catch up with the most developed ones.
1. Savings and Investment Levels
The desirable levels of savings and investment change throughout time. Most of this change is related to the fact that the capital intensity tends to increase in line with the relative development level of a nation. By this we mean that the more developed a country is (compared to the rest of the World), the greater the volume of savings and investment (measured in proportion of the GDP) it is required to produce to avoid having its rates of economic growth diminish. Also, any country who wishes to sustain fast growth rates for a long period of time should target gross investment and saving rates higher than 20% of its GDP. In fact, many developing and emerging nations are actually investing more than 30% of their GDP, which helps to explain why their average rate of economic growth is much higher than the one registered in developed nations.
2. Impact of Emigration
Emigration should be analyzed according to its opportunity cost. Emigration will tend to have a greater positive net impact when developing nations from which people are emigrating have a considerable amount of unemployed/underemployed labor. Also, it becomes more beneficial when externalities such networking through the Diasporas are leveraged, providing new ideas, technologies, skills and investments to developing nations.
3. Impact of Remittances
The impact of remittances is another important variable. The weight in percentage of the GDP of remittances varies considerably among developing nations. In fact, in certain countries, such as Philippines, remittances represent more than 10% of the GDP (The Economist, Feb 9 2010) more than the overall combined expenditure that this nation has on health care and education.
Two important downsides of emigration should always be mentioned. One is the fact that emigration reduces the stock of labor by reducing the active population as well as birth rates. Such decrease can limit not only the long run economic growth rate but also its ability to sustain its elderly population. One second important downside has to do with the “brain drain” effect than usually comes with emigration. Brain drain can threaten the development process of poor nations by leaving them without valuable skilled labor. Some evidence, though, has been found that an “optimal level” of brain drain actually exists (Lowell, B. Lindsay).
4. Trade Policy: Substantial Impact in the Development Process of a Country
There is evidence that, in line with what classic theory suggests, open markets can lead to greater prosperity by making it easier for countries to specialize themselves and capital to be allocated more efficiently. Despite this, a certain level of protectionism can help countries to foster their development and strengthen their bargaining power.
5. Foreign Aid: Different Impact Across Developing Nations
Opinions regarding the net impact of foreign aid (often referred to as development assistance) diverge substantially. Some believe that it does not have a positive impact on development, while others argue that it actually has some positive impact.
It is important to understand, though, that development assistance is attributed on a highly arbitrary basis. This type of assistance has different types of hidden political agendas and the amount of assistance is everything but homogeneous. Countries such as Liberia, receive large amounts of development assistance, to the point that this type of cash-flow surpasses the entire volume of fiscal revenues. Others, though, such as the Democratic Republic of Congo, get almost nothing.
The size of development assistance, the way it is implemented and the hidden agendas that come with it are crucial aspects that will determine the bottom line effect that assistance will have in the real economy.
6. Development Impact of Good Governance
Institutions such as the IMF and the World Bank have become more interested in finding ways to access the quality of the governance within countries and on how to improve it. Processes like the Public Expenditure and Financial Accountability (PEFA) framework is helping to focus governments on improving governance factors.
The reason why governance has become so important now-a-days has a lot to do with the change in the perception of costs and benefits related to corruption. For a long period of time, economic literature argued that corruption relaxed government-imposed rigidities, could increase commerce and allocate investment in a more efficient way. The dominant view, though, today is that corruption benefits mostly “rent seekers”, “is subject to increasing returns that perpetuate it” and creates an environment “that, in time, can lead to the collapse of political regimes” (Vito Tanzi & Hamid Reza, IMF Edition 2000-2182).
In addition to this, corruption can be perceived as an extra tax on the economy that further distorts its activity and introduces uncertainty (Shang-Jin Wei, Nov. 1997). Like almost any tax, this limits economic activity to a suboptimal level and tends to slow down economic growth.
Empirical evidence has been found that corruption not only depresses the long run economic growth of a nation but
also contributes to higher poverty rates and greater income distribution inequity.
Over the past twenty years, emerging and developing countries have managed to boost their growth and increase their weight in the overall world economy. In 1991, their share in the world GDP was as small as 31%. This year, 2011, they are expected to produce 49% of the world GDP (about half of the world income) and by 2013, the IMF expects emerging and developing economies to surpass the total amount of real income of the advanced economies.
Emerging and developing countries have been improving their public financial management, increasing public and private savings and shifting current account deficits towards the most developed nations. This has allowed them to improve in a consistent way their levels of development and improve their future economic outlook.
Despite all recent growth, there is still a long way to go. Advanced economies still have a GDP per capita six times the size of the rest of the world. Even so, twenty years from now, we will probably look back in time and describe these years as an historical growth period, in contemporary history, for most of the developing world.