Economics: Growth in Emerging Economies

This lesson has not been reviewed.

Please purchase the lesson to review.

Why do some countries become rich while others remains stuck in poverty? This is a central question of development economics. In this lesson, we will look at a model that explains how a country might become mired in poverty and the ways in which it might escape, and apply that model to two cases from the modern world economy.
Development economists believe that poverty might persist due to the following vicious cycle. Let's define poverty as very low GDP per capita, not much money per person in an economy. In an economy like that, people aren't inclined to save much because they have to spend all of what they make for basic necessities. On top of that, in many poor countries, the financial institutions are poorly developed so there is not much reward on savings anyway. With little savings, there isn't much money for businesses to borrow to build factories or for the government to borrow for schools and public health facilities. All of this infrastructure can make an economy richer, but without the savings, the investment doesn't happen. Meanwhile, with people not spending much money, there is a little incentive for businesses to expand and grow. As a result, there aren't many good jobs and because there isn't much capital, the tools people have to work with are often poor and they don't make much money. Therefore, the cycle persists and poverty remains.
How can you break out of such a cycle? Anything that interrupts the story can become the key to progress. For instance, suppose the institutions for savings are improved. With modern financial institutions and financial liberalization, people get better rewards for saving money. That might incline people, even poor people, as we have seen empirically across the world, to save more money than they are already saving. And even small increases in savings will be enough to encourage investment and spur some economic growth. Also what can happen is technological progress increases the productivity of existing tools. If people get smarter because of new technical know-how and they can use existing tools better, that will increase the output they can produce, and increases in output may lead to more savings, more investment, and economic progress.
Of course, the government can get directly involved in this story. Not only can the government foster financial institutions that pay higher rates of interest, but the government could also directly stimulate demand. Stimulating demand gives local businesses an incentive to produce more, so they will hire more workers, create more income, in the typical Keynesian story. Moreover, the government might borrow money, perhaps from lenders abroad or from financial institutions like the International Monetary Fund or the World Bank, and use these loans to invest in schools, public health, or even build industrial facilities to increase the economic capacity. In that case, we get the stimulation of infrastructure development, which increases jobs in the country and also increases the productive capacity of the economy. So technological progress, government action, financial liberalization--all of these can spark economic growth.
Moreover some governments have actually gone so far as to try to encourage a reduction in population growth, so that the existing wealth is spread over fewer people. Coercive policies to try to prevent people from having children are typically ineffective and highly controversial because of the ethical concerns we have about them. But we have noticed that when economies grow richer, people typically will have fewer children. Poor people will have more children in developing countries because they are their only insurance policy against being poor in their old age. And as financial institutions develop and people have other opportunities for saving and ensuring their well-being in old age, people typically do have fewer children. That is, the birth rates are correlated with economic progress.
Let's look now at how this model can help us understand what's happened in two remarkable cases in the modern world economy. A third of the world's people live in the rapidly growing economies of China and India. The emergence of this economic power on the world scene is comparable to the development of the United States in the early 20^th Century or that of Germany in the 19^th. It's going to change everything about the world economy. Looking beneath the news, the differences between China and India can shed some light on how economic development works. Let's take a look at that. Economic growth in both China and India has been remarkable. The growth rate in China however has been faster. Per capita gross domestic product in China has increased at an annual rate of 8.5% over the last 20 years. The annual growth rate in India on the other hand has been 4%. By comparison, per capita GDP in the United States has been increasing at an annual rate of only 2%. Why has China been growing faster than India? To get a clue in a story that's kind of oversimplified, focus on the difference in their economy. China has been producing manufacturing goods for export, while India is experiencing rapid growth in the export of services--engineering services, software design, and call centers for the modern tech economy. Look now at how this gap might have developed. China made a very intentional set of investments in the late 1970s in public health and education at a time when it was experiencing a very, very large bulge in its youth population. Then in the early 1990s, China began to explicitly target manufacturing output, subsidizing factories that produced manufacturing goods. This at a point when the global economy was developing a remarkable supply chain, where companies in developing countries were looking for the absolute cheapest labor and the best factories for producing tech products like computers, electronics, and all kinds of manufacturing goods. China became the destination of choice and as a result economic growth in China took off. In India, however, as technology began to develop for communications over long distances, the large population of well-educated English-speaking people suddenly became available to companies looking for folks to provide services, what we call back-office services--data processing, other kinds of information tech management, and call services. In this particular case, as soon as this communications technology made the off-shoring of these jobs economically profitable, they began to move to India at a rapid rate and we saw the remarkable development of cities like Bangalore and Hyderabad with new tech industries. India then benefitted from technological progress of a different kind than that of China--India, principally communications to enhance services; China, manufacturing in the global supply chain. Now, with China then, we can see that their economic development may be on a faster footing simply because they started earlier. The government made those investments earlier and the global supply chain became economic reality earlier in history than did the ability to provide services over long distances. Communications technology came after the manufacturing transportation technology that was the global supply chain's foundation. In the 1970s, the per capita gross domestic product in India was twice that of China, but as a result of some good policies and a lot of good luck, the gross domestic product of China per capita is now twice that of India. And along with this prosperity come a whole lot of human benefits. The life expectancy in China is now longer, the infant mortality rate is lower, the literacy rates are higher. A lot of good progress makes life better for people in China as the per capita income goes up.
This is the big economic story of our time and the happy ending is far from assured. All of the things that happened in China and India to break them out of a low level cycle, all of that good luck and good choice could be reversed. And they are facing huge challenges--unemployment, the transition of farmers from agricultural life to industrial life, as well as challenges from their neighbors and political tensions. Any of these things could derail economic progress. On top of that, economic progress itself comes with costs, huge environmental challenges in China and India. China is now home to 20 of the world's 30 most polluted cities. On top of that, there are public health problems. At a time when China is having to cut back its large government-funded public health system, they are facing an epidemic, an underreported epidemic, of HIV, as is India. All of these problems are challenging.
If you are going to bet on who is going to be more successful at the middle of this century, you would have to know a lot of things. First of all, does the economy look better for manufacturing outsourcing or for the growth of services outsourcing? Is it possible that China might jump the barrier that India has managed to erect with English language and get into the services business, or might India be able to build out the infrastructure that would allow it to capture some of the manufacturing business from China? Another element that helps handicap the prospects is the demographic element. Notice that India's population is much younger; there is a bulge of young people coming up through the pipeline, while China is growing older rapidly. This is going to create social as well as economic problems for China as the middle of the century approaches.
This is a big story, because these are the folks that you will be competing with in the international economy and their markets are the opportunity for you and the companies that you will work for. We all have a stake in the success of India and China, and the health of the global economy depends on it.
Productivity and Growth
Emerging Economies
Growth in Emerging Economies Page [2 of 2]