These are countries that have low income per capita. They experience low standards of living. Mainly, they are characterized by high population growth, high mortality rates, primitive production methods, low levels of technology and also extreme inequality of wealth and income. The Vicious circle of poverty: This is a circular effect of forces acting and reacting upon each other in a way that keeps a country in a state of poverty. In a nutshell, it creates a circular effect whose beginning is poverty and ends in poverty. A country is poor because it’s poor. It begins from a negative factor of low income and high population growth rate. These countries are highly dependent on subsistence farming. Farming leads to low levels of production and by extension, low agricultural surpluses are experienced. As a result, there is low purchasing power which brings about low demand for industrial goods. This eventually leads to low industrialization as there is no motivation for investments. Also, they experience low levels of income per capita which leads to low rates of savings that translate to low investments rates or low capital formation. This further extends to low productivity and in the end, low income per capita, and the circle goes on and on (Rangarajan & Baku, 1979). Solutions for economic growth: Increased savings. Savings should be increased and the amounts saved should be invested in production. This requires cutting unnecessary expenditure. The government should introduce fiscal policies which will encourage savings.
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High taxes on luxury goods and higher direct taxes on rental income can bring the consumption expenditure down. The government can also mobilize savings by introducing schemes like compulsory deposits and compulsory loans schemes.
They should include both short-term and long-term investments which are well planned and coordinated. In the short term, investments in agriculture and other related activities like consumer goods industries, fertilizers, and other agricultural inputs and also irrigation should be undertaken. This will provide the necessities of life in reasonably enough quantities and favorable prices. Also, production efficiency will be increased. In the long term, basic industries like chemical industries, steel and iron industries should be set up. To encourage investments, appropriate monetary and banking policies should be introduced. This will facilitate sufficient incentives and facilities to affect the savings. Foreign capital can also be acquired to supplement the domestic capital.
Theories of growth
It is also referred to as the iron law of wages. It suggests that if wages are raised more than enough to cater for subsistence, the population will grow at a higher rate than food and other necessities. This will increase the number of job seekers and the increased labour supply will make the wages go down to subsistence levels. Therefore, improving wages can only be temporary hence the conclusion that wages are fixed by demand and supply.
In underdeveloped countries, the theory can still be valid until development causes a higher productivity growth than the population growth rate.
The application of the theory in underdeveloped countries is doubtful. First of all, land which is a major factor in developing countries is excluded from the theory’s function. Given the nature of the financial mechanisms in these countries, the neo-classical solution will be difficult to achieve. Even if equality may be achieved, it will only be relevant to organized markets which are usually found in urban sectors leaving out the unorganized rural sector. It is also difficult to define the nature of capital in poor economies considering the problem of heterogeneity of capital.
This theory helps in eradicating the circle from the demand side. To induce investors, market sizes should be extended. The theory suggests that all sectors of an economy should be invested. That is transport, industries, agriculture to mention but a few. This theory creates and increases the demand as the production of one sector is demanded by the other. However, some economists prefer the theory of unbalanced growth as they argue that it is more practical and brings more benefits (Fidelis 1996).
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The less developed countries need to set up structures and implement policies that encourage savings and investments as there can never be any growth unless capital is accumulated. The government institutions should be streamlined for efficiency and also fight to reduce rampant corruption, as it hampers economic growth. The foreign aid acquired should be used appropriately.
- Fidelis, H 1979, principles of macroeconomics, Tata McGraw-Hill, New Delhi
- Ingham, B 2003, international Economics: A European Focus, Hall, Germany