5.3 Barriers to growth

February 11, 2010 annay17

Biggest Barrier: Corruption? (Mobutu and his wife)

The cycle to development

The most obvious indicator of lack of development is POVERTY.

1.2 billion people live below the absolute poverty line, and they go through the POVERTY CYCLE

Poverty Cycle

Low income –> low savings –> low investment –> low incomes

INSTITUTIONAL AND POLITICAL BARRIERS

Ineffective taxation structure: Direct Taxation (profit and income tax)

• Informal markets: much of the economic activity is probably in an informal market, which are unaccounted for by the government. As most of this income is parallel to the official markets, the tax base will be difficult to calculate.
• Low profit tax: governments set low profit tax to incent domestic firms to facilitate inflow of FDI. Foreign fimrs are offered tax holidays to attract FDI.
• Ways to evade tax: Multinationals evatde taxes by overpricing intermediate goods which are purchased form subsidaries in ow tax countries outside the LDC.

Furthermore, implementing a proper tax system increases cost.

Why is this a problem?

Taxes are needed to provide merit and public goods such as education and roads, as well as welfare systems such as social security and pension funds. The lack of tax causes governments of developing countries to overspend and run up deficits. Also, it means that existing taxes are often regressive, since flat rate taxation will mean less as a proportion of income for the rich than for the poor.

LACK OF PROPERTY RIGHTS

Property rights means that ownership or legal rights of use have been established by law. It enables people to use property right is a means of securing an income and also as collateral to take loans.

The problem with the lack of property rights is that business activity will suffer from the lack of investment, since povety cannot be used for collateral. It also lowers entrepreneurial incentives and reduces the propensity of farmers living on costmanry land. Just working on land that is not yours is a disincentive for improving land and enhancing capital.  The poor therefore do not a have acess to secure resources.

POLITICAL INSTABILITY

Weak governments are amongst the most oppresive since force is needed to hodl down the general population and favoritism is used to court favour of the powerful. Political instability often arises due to the absence of one or all of the following:

Rule of Law: A good system is one where the rules apply equally and to all. It provides tability and reliability since citizens will be able to reply on fair treatment in the system. This is particularly important in matters concerning the protection of property rights and competition: both are needed for economic growth.

Legal institutions: Police (where they act on authority limited by law), judicial (case are tried and rulings are based upon law) and penal system are needed.

Democratic institutions: People who have the right to elect a leader commonly become better citizens, as they feel it is easier to abide. Ideally, bad rulers do not survive elections in a democracy.

The results of political instability.

Political instability -> low level of investment and low FDI from abroad -> low output and growth and low level of tax receipts -> poverty and social conflict -> Political instability        ie. a cycle.

DRC has suffered a domestic war that has devastated the country. It is in the midst of recovery, but it is harder to recover, due to the corruption.

CORRUPTION

When people acting in an official capacity of trust and responsibility misuse their position for private gain.

Corruption is both the cause and the effect of poor governance and corruption levels are higher in developing countries than in developed.

Effect of corrption

• Corruption discourages investment and growth. Foreign companies tend to avoid countries where the costs of doing business are high and risky due to corruption.
• When firms are committed to doing business by bribery there is going to be a larger degree of bookkeeping and tax evasion.
• When countries are run by dictatorship, government contracts and loans go to family members and trusted friends of the dictators only. i.e. highly inneffcient use of government funds.
• Skews public funds away from areas rendering general social benefits. Highly corrupt countries tend to under spend in human capital goods such as education and health care.
• Environmental issues arrise.
• Distrust and sceptism towards government agencies.
• Country can suffer from an increase in the burden of debt.

DRC is infamous for the incredibly corrupt government officials.

INFORMAL MARKETS

The informal sector, or the unofficial economy is composed of two parts in developing economies:

a.)   substinence agriculture and manufacturing of tools ans clothing

b.)  parallel markets for goods.

In many developing countries, informal markets are the most important element for creating jobs and output.

Results of informal markets:

• los of income/output in the economy. The formal economy will have dificulty in growing due to competition from the informal market.
• Provides poor tax base
• People working in the informal sector have little social security or social welfare.

LACK OF INFRASTRUCTURE

• Difficulty in getting the goods to central markets
• Pay a higher price for goods in the village which has incurred transport costs
• Goods which villagers cannot bring to market themselves will be sold at lower prices to wholesalers who will be advantaged by the villagers’ lack of knowledgte of market prices
• The effort of bringing the good to the village to sell could be wasted if to good is not needed or wanted at the moment. Calling the market could have saved the trouble.

Problems

• Lack of airports, seaports, transportation network.
• Urbanization creates inner-city problems in many countries as people flock to the city. Burdens water supply sewage system and roads.
• Lack of access to basic education.

DRC has a good potential, as it has a lot of natural endowments. If the infrastructure is improved, then the country could be more efficient in production.

Entry Filed under: Section 5

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