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Module 3 in AE 12 (Economic
Development)
Characteristics and Institutions of Developing Countries
Module Objectives:
At the end of Module 3, students are expected to answer:
- What are some common characteristics of LDCs? Which of these characteristics are causes and which accompaniments of underdevelopment?
- How might today’s LDCs differ from those of the 1950s?
- How might a list of common characteristics of low-income countries vary from that of LDCs as a whole?
- How do production and labor force shares in agriculture, industry, and services change as GNP per capita increases?
Module Overview
This module surveys the characteristics of developing countries, with particular emphasis on low-income economies. It looks at income distribution, political framework, family system, relative size of agriculture and industry, technology and capital levels, saving rates, dualism, international trade dependence, export patterns, population growth, labor force growth, literacy, and skill levels, and the nature of economic and political institutions, including governance; democracy and dictatorship; transparency; social capital; the state bureaucracy; tax collecting capability; a legal and judicial system; property and use rights; statistical services and survey data; and land, capital, insurance, and foreign exchange markets. The last section examines rent seeking and corruption and their relationships to state weakness and failure. Subsequent chapters will expand on economic patterns of development.
Varying Income Inequality
As economic development proceeds, income inequality frequently follows an inverted U-shaped curve, first increasing (from low-to middle-income countries), and then decreasing (from middle-to high- income countries). Even so, the proportion of the population in poverty drops as per-capita income increases.
Political Framework
VARYING POLITICAL SYSTEMS
In 2000–01, Freedom House (2002) ranked about one-fourth, 34 of 137 LDCs, as free, that is, enjoying political rights and civil liberties. Political rights mean not just a formal electoral procedure but that “the voter [has] the chance to make a free choice among candidates... and candidates are chosen independently of the state.” Civil liberties implies having rights in practice, and not just a written constitutional guarantee of human rights. Freedom House (2002) designates Belize, Bolivia, Bulgaria, Cyprus, Dominican Republic, El Salvador, Ghana, Jamaica, Korea (South), Mali, Malta, Mauritius, Mexico, Mongolia, Panama, Peru, Namibia, Romania, South Africa, Suriname, Taiwan, Thailand, Uruguay, and the three Baltic countries as free in 2000–01 but Argentina, Bangladesh, Brazil, Kenya, Nigeria, Paraguay, Russia, Senegal, Tanzania, Turkey, Venezuela, and Zimbabwe as not. If we assume that Freedom House’s free countries are democracies, they comprise about 40 percent of LDCs’ 5 billion people, because democracies include populous India.
A SMALL POLITICAL ELITE
Unlike Western democracies, political control in LDCs tends to be held by a relatively small political elite. This group includes not only individuals who directly or indirectly play a considerable part in government – political leaders, traditional princes and chiefs, high-ranking military officers, senior civil servants and administrators, and executives in public corporations
- but also large landowners, major business people, and leading professionals. Even an authoritarian leader cannot rule without some consensus among this influential elite unless he or she uses police and military repression, perhaps with the support of a strong foreign power.
LOW POLITICAL INSTITUTIONALIZATION
For the political elite, economic modernization often poses a dilemma. Although achieving modernity breeds stability, the process of modernization breeds instability. Certainly modernization enhances the ability of a governing group to maintain order, resolve disputes, select leaders, and promote political community. But urbanization, industrialization, educational expansion, and so on, eventually involve previously inactive ethnic, religious, regional, or economic groups in politics. According to Samuel Huntington, the explosion of mass participation in politics relative to institutional capacity to absorb new participants leads to political instability. (Of course, civil conflict is not confined to newly modernizing countries, as Canada, Belgium, Spain, and the United Kingdom currently have ethnic, religious, or regional conflict.)
EXPERIENCE OF WESTERN DOMINATION
Except for Japan, in the past 200 years – and especially in the first half of the 20th century – most of Africa and Asia were Western-dominated colonies. Even countries such as Afghanistan and Thailand, which were never Western colonies, experienced Western penetration and hegemony. And although most of Latin America became independent in the 19th century, it has been subject to British and U.S. economic and political suzerainty since then. Thus, during the century or two of rapid economic growth in the Western countries, most LDCs have not had the political independence essential for economic modernization.
exceeded industry’s capacity to absorb labor. In addition, partly because of advanced technology and greater capital intensity, industry’s labor productivity is higher than agriculture’s. Thus, the output percentage in agriculture for low-income countries, 20–35 percent, is lower than the labor force percentage and higher in industry, 20–40 percent. Figure 4-1 indicates that although industry and agriculture accounted for equal shares of output at an income level of just under $700 per capita (in 1977 U.S. dollars), parity in labor force shares was not reached until income was more than twice that level. In high-income countries, less than 5 percent of production is in agriculture, 25–40 percent in industry, and more than half in services.
more, whereas LDCs increased their share. Manufacturing output has been increasingly disaggregated (divided) into numerous service-oriented stages of production with cheaper transport and communication and enhanced specialization. Bringing the stages together may involve services rendered at various geographical locations rather than mass production via an assembly line under one roof, as with Henry Ford’s Model T. The following is part of the explanation for the service sector’s rising share in the United States: A key feature of US trade is the decomposing of the production process into separable functions that can then be allocated around the world to countries that possess comparative advantage in that particular phase of the production process. The pieces are then brought together for final assembly and sale. Indeed, improved technology and increasing disaggregation have contributed to a reduced labor share in industry not only in DCs but world-wide.
Inadequate Technology and Capital
Output per worker in LDCs is low compared to developed countries because capital per worker is low. Lack of equipment, machinery, and other such capital and low levels of technology, at least throughout most of the economy, hinder production. Although output per unit of capital in LDCs compares favorably to that of rich countries, it is spread over many more workers. Production methods in most sectors are traditional. Many agricultural techniques, especially in low-income countries, date from biblical times. Wooden plows are used. Seed is sown by hand. Oxen thresh the grain by walking over it. Water is carried in jugs on the head, and the wind is used to separate wheat from straw. Generally, most manufacturing employment, although not output, is in the informal sector. These may be one-person enterprises, or at most, units with less than 10 workers, many of whom are apprentices or family workers. Production is labor intensive. Simple tools are used, and there is no mechanical power. Sustainable development refers to maintaining the productivity of natural, produced, and human assets (or wealth) over time. The World Bank uses a green national accounts system of environmental and economic accounts, measuring these changes in wealth as adjusted net savings. Low Saving Rates From gross domestic savings, the Bank subtracts not only the consumption of fixed capital but also energy depletion, mineral depletion, forest depletion, and carbon dioxide damage, while adding education spending, a proxy for human asset accumulation. This adjusted net savings (Figure 4-2) gives lower than traditional estimates for low- and middle-income countries, as resource depletion and environmental damage are a higher proportion of savings and education spending a lower proportion than those for high-income countries. (Figure 4-2 shows that high-income countries’ net savings after adjustment are a higher percentage of gross national savings than for developing countries.) Adjusted net savings as a percentage of GNI, 2001, is 6.6 percent for low-income countries, 9.3 percent for middle-income countries, and 13.7 percent for high-income countries.
model (Chapter 5), the dual economy grows only when the modern sector increases its output share relative to the traditional sector. In the 1950s and 1960s, this modern sector tended to be foreign owned and managed. Today, it is increasingly owned domestically, by either government or private capitalists, and sometimes jointly with foreign capital. Despite local majority ownership, operation of the modern sector often still depends on importing inputs, purchasing or leasing foreign patents and technology, and hiring foreign managers and technicians.
Varying Dependence on International Trade
The ratio of international trade to GNP varies with population size but not income per capita. Thus, the United States and India have low ratios and the Netherlands and Jamaica high ratios. Even so, a number of developing countries are highly dependent on international trade and subject to volatile export earnings. Several low-income countries and oil exporting countries depend a great deal on a few commodities or countries for export sales. For example, in 1992, primary commodity export concentration ratios, the three leading primary products (food, raw materials, minerals, and organic oils and fats) as a percentage of the total merchandise exports, were high for low- income sub-Saharan Africa, Central America, and a few other LDCs. Percentages included Nigeria (crude petroleum and petroleum products, cocoa) 96; Iran (crude petroleum, petroleum products, miscellaneous fruits) 94; Ethiopia (coffee; undressed hides, skins and furs; and crude vegetable materials) 87; Saudi Arabia (crude petroleum, fin fish, shellfish) 87; Venezuela (crude petroleum, petroleum products, gas) 81; Ecuador (crude petroleum, bananas, shellfish) 81; Zambia (copper, cotton, unmanufactured tobacco) 80; Uganda (coffee, cotton, undressed hides, skins, and furs) 79; Togo (natural phosphates, cotton, cocoa) 75; Papua New Guinea (copper, timber, coffee) 71; Cameroon (crude petroleum, cocoa, timber) 68; Myanmar or Burma (timber, vegetables, shellfish) 67; Honduras (bananas, coffee, shellfish) 64; Trinidad and Tobago (petroleum products, crude petroleum, gas) 64; Paraguay (cotton, soybeans, vegetable meal) 61; Panama (bananas, shellfish, sugar) 60; Cote d’Ivoire (cocoa, timber, coffee) 59; Chile (copper, timber, animal feeds) 55; Bolivia (zinc, gas, tin ore) 53; Nicaragua (coffee, beef and cattle, cotton) 52; Kenya (tea, coffee, dried preserved fruit) 52; Madagascar (spices, shellfish, coffee) 52; Central African Republic (coffee, timber, cotton) 52; and Syria (crude petroleum, petroleum products, shellfish) 51. But more diversified and industrially oriented South Korea had a percentage of 4, China 6, India 8, Turkey 10, the Philippines 11, Brazil 14, Thailand 14, and Pakistan 15. In 1985, six primary products accounted for more than 70 percent of sub-Saharan Africa’s export earnings. Furthermore, although 76 percent of the exports of developed countries is to other DCs and only 24 percent with LDCs; 75 percent of LDC trade is with DCs and only 25 percent with other LDCs (Table 4-3). Some trade between rich and poor states – very important to developing countries – is not nearly so essential to developed countries. For example, in the 1980s, one-third of Ghana’s exports was cocoa to Britain, corresponding to only a fraction of 1 percent of its imports. And one-third of 1 percent of an English firm’s sales comprised all the machinery bought by Ghana’s largest shoe manufacturer.
Rapid Population Growth
About 5.3 billion people, or 82 percent of the world’s 6.5 billion people in 2004, live in developing countries. Developing countries have a population density of 500 per arable square kilometer (63 per square kilometer or 162 per square mile) compared to 263 per arable square kilometer (23 per square kilometer) in the developed world. These figures contribute to a common myth that third-world people jostle each other for space. However, India, with 625 inhabitants per arable square kilometer, whereas more densely populated than Canada (67) and the United States (156), is less densely populated than Germany (714) and Britain (1,000). Moreover China (1,000) is not so dense as Japan (2,500), whereas both the Netherlands and Bangladesh have 1,667. The problem in LDCs is not population density but low productivity (low levels of technology and capital per worker) combined with rapid population growth. Between 1945 and 2004, death rates in developing countries were cut more than two-thirds by better public health, preventive medicine, and nutrition. Additionally, improved transport and communication made food shortages less likely. Whereas the population growth rate in industrialized countries was 0.1 percent in 2004, LDC birth rates remained at high levels, resulting in an annual growth of 1.6 percent (a rate doubling population in 44 years). High fertility means a high percentage of the population in dependent ages, 0–14, and the diversion of resources to food, shelter, and education for a large nonworking population. The lagged effect of even more rapid population growth in past decades has generated an LDC labor force growth estimated at 1.9 percent yearly in 2004 – a much faster labor force growth than that of industrialized Europe in the 19th century (which grew at less than 1 percent a year). Industrial employment’s demand growth lags behind this labor force growth, so that unemployment continues to rise in developing countries, especially in urban areas.
Low Literacy and School Enrollment Rates
When compared to developed countries, literacy and written communication are low in developing countries. Low-income countries have an adult literacy rate of 61 percent; middle-income countries, 90 percent; and high-income countries, (rounded up to) 100 percent. Among world regions, South Asia has a literacy rate of 59 percent; sub-Saharan Africa, 65 percent; East Asia, 90 percent; the Middle East, 69 percent; and Latin America, 89 percent (cover table). Although LDC literacy rates are low
increased by more than one-third. Moreover, in the United States, the number of white-collar workers rose from 17 percent in 1900 to 45 percent in 1960, whereas the share of manual laborers declined sharply from 71 percent to 45 percent. Another characteristic of low-income countries is a small middle class of business people, professionals, and civil servants. As economic development takes place and the social structure becomes more fluid, the size of this middle class increases.
Poorly Developed Economic and Political Institutions
INSTITUTIONS
Economic policies are no better than the institutions that design, implement, and monitor them. Institution building takes time, evolving locally by trial and error. Figure 4-3 shows that the development of institutions is highly correlated with GDP per capita. Here institutional development measures “the quality of governance, including the degree of corruption, political rights, public sector efficiency, and regulatory burdens.” Moreover, the protection of property rights and the limits on the power of the executive are both highly correlated with income per capita. History, geography, and law influence institutional development. History includes the legacy of 17th- to 19th-century European colonization, including enforcement of law, insurance of property rights, and, negatively, the extraction of natural resources (as in much of sub- Saharan Africa and Latin America). Another difference is that between Latin America, where institutions concentrated economic power in an elite, compared to North America, where institutions permitted broader participation in economic and political life.
Macroeconomic stabilization and adjustment programs, foreign aid, and foreign investment are not likely to be effective in spurring a country’s economic development if economic and political institutions are poorly developed. Building institutions and investing in infrastructure are essential to spur investment by nationals and foreigners in directly productive investment projects. Low-income countries and other vulnerable countries need to develop a legal system; monetary and fiscal institutions; capital, land, and exchange markets; a statistical system; and a civil society independent of the state (for example, private and nongovernmental entities such as labor unions, religious organizations, educational and scientific communities, and the media) to achieve economic development. Neopatrimonial or predatory rulers may not be interested in reform emphasizing rule of law, as it would eliminate an important source of patronage. But a political elite interested in accelerating growth should put a priority on legal and bureaucratic reform. In most low-income countries, land, capital and credit, insurance, and forward and other exchange-rate markets are poorly developed. As discussed later, land markets should assign property rights to cultivators, but without undermining usufruct rights for traditional community or village land- rights systems. Exchange markets that increase the efficiency of transactions enhance growth and external adjustment.
INSUFFICIENT STATE TAX COLLECTIONS AND PROVISION OF BASIC SERVICES
One important institutional capability is the capacity to raise revenue and provide basic services. In several failed low-income countries, such as Sierra Leone, Liberia, Sudan, and Somalia, the state has failed to provide minimal functions such as defense, law and order, property rights, public health (potable water and sewage disposal), macroeconomic stability, and protection of the destitute, to say nothing of intermediate functions such as basic education, transport and communication, pollution control, pensions, family allowances, and health, life, and unemployment insurance (World Bank 1997i). A vicious circle of declining legitimacy, fiscal mismanagement, and the further erosion of legitimacy from a decline in public services can contribute to a country’s economic incapability and political instability. Examples include Mengistu Haile Mariam’s Ethiopia revolutionary socialist government (1974–91), Russia, Georgia, and Tajikistan. Governments need to maintain or reestablish a social compact with all their citizens, including the poor, in which some basic needs are met in return for tax contributions according to the ability to pay. One way to increase legitimacy and raise tax revenue is to replace widely evaded direct taxes, such as personal income taxes, with indirect taxes. One example of such tax is the value-added tax (VAT), which is simpler, more uniform, and less distortive than a simple sales tax, and has a high-income elasticity of revenue generation. Still, the VAT can face administrative problems, especially among the numerous small industrial firms and traders in low-income countries. Thus, the major point is that building economic institutions and infrastructure, including a tax system that raises enough revenue for basic services, is essential for spurring investment to increase economic growth and stability.
LACK OF TRANSPARENCY
Transparency , political accountability, and knowledge transmission are key ingredients in effective development strategy (World Bank, 2002f:v–23). Yet as the 2001 Nobel Prize economist Joseph Stiglitz explains, there are natural asymmetries of information between governing elites and citizens.
RENT SEEKING
Economic rent is the payment above the minimum essential to attract the resource to the market. Rents “include not just monopoly profits, but also subsidies and transfers organized through the political mechanism, illegal transfers organized by private mafias, short-term super-profits made by innovators before competitor imitate their innovations, and so on.” Rent seeking is unproductive activity to obtain private benefit from public action and resources. This activity ranges from legal activity, such as lobbying and advertising, to illegal bribes or coercion (ibid.). The waste to society includes not only resource misallocation but also the costs of working to get the monopoly or special privilege, costs that are a substantial proportion of national income in many LDCs. All societies are subject to illegal and corrupt behavior. Wraith and Simpkins use the 19th- century United States and United Kingdom as case studies in their book, Corruption in Developing Countries. Even today, Western polities encounter companies contributing money and favors to skew policies, use of the state to favor powerful economic interests or destroy political opponents, efforts to cover up illicit use of government resources, and so forth.
INSECURE PROPERTY RIGHTS
A major institution associated with development is laws and mores pertaining to the rights of property owners and users. By providing insights to this truth, Hernando de Soto, Director, the Institute of Liberty and Democracy, Lima, Peru, who “has scarcely published an article in an academic journal, has had a major impact on development economics.” De Soto’s Mystery of Capital attributes the success of the West during the last 100 years and Japan in the last 50 years to legally enforceable property titling, based on painstaking accrual of law written by legislatures and consistent with the social contract, that is, the laws and principles of political right that people live by.10 “One of the most important things a formal property system [similar to that of the West] does is transform assets from a less accessible condition to a more accessible condition, so that they can do additional work. ... By uncoupling the economic features of an asset from their rigid, physical state, a representation makes the asset ‘fungible’ – able to be fashioned to suit practically any transaction.” Whereas an asset such as a factory may be indivisible, the concept of formal property enables Western citizens to “split most of their assets into shares, each of which can be owned by different persons, with different rights, to carry out different functions [so that] a single factory can be held by countless investors.” In LDCs, however, de Soto indicates, most potential capital assets are dead capital, unusable under the legal property system, and inaccessible as collateral for loans or to secure bonds. Formal credit markets do not exist for most LDC business owners and residents. De Soto estimates dead (or informal) capital in the five-sixths of the world without well-established property rights as $9.34 trillion, about $4,100 for every LDC citizen. Even the critic Christopher Woodruff’s conservative estimate of $3. trillion represents substantial capital that could be “unlocked” by clear property rights. Inadequate property and use rights for traditional systems. Property rights usually assign the rights to and rewards from using resources to individuals, thus providing incentives to invest in resources and use them efficiently. Given the high cost of supervising agricultural wage labor, clearly allocating land rights to owner-operators generally increases the efficiency of farm production. Private property rights may not always produce the most efficient farming arrangements where information costs are high and markets for finance and insurance imperfect. References Anderson, Anthony B. “Smokestacks in the rainforest: Industrial development and deforestation in the Amazon basin.” World Development 18 (2019) Anderson, Anthony B., ed. Alternatives to Deforestation. New York: Columbia University Press, 2019. Assunção, Juliano, “Land Reform and Landholdings in Brazil,” UNU-WIDER Research Paper No. 2006/137, November 2017. Baer, Werner. The Brazilian Economy: Growth and Development. Boulder, Colo.: Rienner, 2018. Bank Information Center. Funding Ecological and Social Destruction: The World Bank and the IMF. Washington, D.C.: Bank Information Center, 2020.
