Question

The theoretical growth models we covered so far, e.g., Solow, Romer or Schumpeter, all predict that countries have higher per capita income if they invest more into their physical and human capital stocks.
a. Given these straightforward predictions, why do so many countries struggle to replicate per capita income levels that we observe in the OECD or other rich economies? Explain.

Answer 1

Answer:

As Solow mentions in his theory of unconditional convergence, that countries with the same level of savings rate and population growth rate will eventually converge to a similar per capita level. Similarly, Schumpeter in his theory of economic development states that heavy investment is required to foster economic development.

However, in real-world economies, you will often witness that many underdeveloping nations do not end up with the same level of per capita income as other rich economies. Some of the reasons being:

1. High population growth rate - Most underdeveloped economies have large populations, with many living in drastic living conditions. In countries in Africa and Asia, 30-40% are often found malnourished and prone to mortal diseases. As a result, many of the working population is weak and unproductive and cannot earn enough income. The overall per capita is therefore low.
2. Lack of basic access to education - Most underdeveloped economies are agrarian economies. Families do not have enough income, especially in rural areas to send their children to school. Note that most of these families have a larger family size (more than 2 children), as compared to these developed OECD economies. These children are expected to help their parents on the farm. Therefore, with no education, these children are unable to get high-paying jobs when they grow older, and therefore this leads to overall low income in the country.
3. Lack of government funds - These nations do not have enough domestic investment or savings or even proper infrastructure since there exists a high level of corruption, lack of transparency, or just that there are not enough funds with the government of these countries to invest in physical and human capital. These countries are usually heavily endowed in debt, and most of their funds go in debt repayment. Additionally, these countries usually import more than they export and therefore not much of the funds are left to invest in essential human capital.
4. The vicious cycle of poverty - Low income in these countries leads to low savings which therefore leads to low investment, low demand for goods, lower productivity within workers and ultimately leads to low income. This leads to the irreversible cycle of poverty and therefore these countries are unable to breakthrough the poverty cycle.