Barriers to economic growth and/or economic development Paper 2

IBDP Economics  SL – The global economy – Barriers to economic growth and/or economic development -Paper 2  Exam Style Practice Questions

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Barriers to economic growth and/or economic development  Paper 2? 

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Chinese investment helps Peru to develop

  1. Over the past decade, Peru has been one of South America’s fastest-growing economies, with an average economic growth rate of 5.9 % and low average annual inflation of 2.9 %. This has been mostly due to a favourable external environment, sensible macroeconomic policies and reforms of environmental regulations designed to increase investment in Peru’s profitable mining sector. However, the deregulation in the mining sector has been opposed by environmental groups and trade unions, fearing increased pollution and poorer working conditions.
  2. Strong growth in employment and income has dramatically reduced poverty rates. Absolute poverty fell from 27.6 % in 2005 to 9 % in 2015.
  3. Gross domestic product (GDP) growth continued to accelerate in 2016, very much helped by higher mining export output as several new large mining projects entered into production and reached full capacity. Peru mines and exports many commodities, including copper, gold, lead, zinc, tin, iron ore, silver, and oil and petroleum products.
  4. China is Peru’s main trading partner, taking 22.1 % of Peru’s exports and supplying 22.7 % of their imports in 2016. Chinese companies are also significant suppliers of foreign direct investment (FDI) to Peru, recently investing over US$2 billion to purchase a hydroelectric power plant. The second main trading partner is the United States (US), taking 15.2 % of Peru’s exports and supplying 20.7 % of their imports in 2016.
  5. Peru’s current account deficit declined significantly from 4.9 % to 2.8 % of GDP in 2016, owing to increasing export growth and lower imports. Peru’s government continues to support a free trade policy; since 2006, Peru has signed trade deals with 17 different countries including the US, Canada, China and Japan. In addition, a trade deal has also been signed with the European Union.
  6. Real GDP growth is expected to slow slightly in 2017 due to an anticipated lower growth rate in the mining sector and weak private investment. To support the economy as mining production slows, the government is expected to increase public investment in 2017.
  7. Growth projections may not be achieved if any, or a combination, of the following occur: external shocks in commodities prices, a further deceleration of China’s economic growth, unpredictability in world capital markets and the threat of tight monetary policy in the US. Raising economic growth requires structural and fiscal reforms to improve productivity, reduce the size of the informal sector and improve the efficiency of public ser

Question

Using a poverty cycle diagram, explain how increased foreign direct investment might break the cycle (paragraph [4]).

▶️Answer/Explanation

For drawing a poverty cycle diagram (including investment), beginning and ending in an indicator of poverty AND an explanation of how FDI will break the cycle (by closing the savings gap which would increase the level of investment, by providing employment opportunities which raise income).

Pakistan and the International Monetary Fund

  1. Pakistan is a low-income country with a rapidly growing population and widespread poverty. As of 2019, it has a large budget deficit due to high levels of military spending and high costs of debt servicing (35 % of the deficit is interest payments). It is also experiencing a widening current account deficit and is heavily dependent on foreign aid.
  2. Pakistan’s government is negotiating a loan from the International Monetary Fund (IMF). Amongst its conditions, the IMF has said that the government must decrease private-sector regulation such as regulations on financial institutions. The government must also sell state-owned enterprises and government revenue must be raised by increasing indirect taxes and improving tax collection systems. Furthermore, the IMF insists that the government cuts its spending further.
  3. The government has stated that the IMF loan is essential to restore confidence in Pakistan’s economy. This would help to attract foreign direct investment (FDI) to encourage economic growth and help break out of the poverty cycle. High debt levels and slowing economic growth in 2018 discouraged FDI. The IMF loan is also needed to help persuade other multilateral lenders such as the World Bank and the Asian Development Bank to provide and extend loans.
  4. In the past, Pakistan has had 21 agreements with the IMF with limited success—any balance of payments or external debt improvement has been temporary. The IMF states that this is because Pakistan has not always met the conditions of the loans, while other stakeholders argue it was the lack of support given to Pakistan to implement the conditions and to allocate the loan funds appropriately.
  5. Economists say that there needs to be a focus on improving human capital to provide the large number of young people entering the labour force with the skills to grow businesses. The quality of education needs to improve and to be combined with an effort to provide girls with greater access to education—female participation in the labour force is the lowest in the region.
  6. The World Bank has financed education and infrastructure, such as renewable energy projects, in poor regions of Pakistan. However, critics of the World Bank argue that the projects are not making a significant difference and the construction of hydroelectric dams leads to environmental damage.
  7. The government believes that the macroeconomic concerns of the IMF should be addressed first, and poverty issues in Pakistan can be dealt with later.

Question

Define the term human capital indicated in bold in the text (paragraph [5]).

▶️Answer/Explanation

Any two of the following:

  • factor of production (labour)
  • skills
  • abilities
  • knowledge/qualifications
  • level of health (that make a labour force productive).

Economic growth in Laos

  1. The construction of the China–Laos railway is a major contributor to Laos’ economic growth. This landlocked country is projected to grow by 7 % this year, which is a good achievement for a country still experiencing low incomes and over-reliance on the agricultural sector.
  2. The 420 kilometre railway line will connect China to Laos and link Southeast Asian countries all the way to Singapore. The railway will improve the communication between resource-rich Laos and its neighbours, all of which have larger markets. This will increase both trade and tourism in the region. With the help of Chinese investment, the Lao government also plans to increase its hydroelectric power generation capacity in the next 12 years. This could mean a total of 429 dams on the Mekong River by 2030. However, environmentalists say that the excessive construction of dams could destroy the ecosystem.
  3. Five years ago, the Lao government introduced a policy to privatize state-owned property, designed to attract foreign direct investment (FDI). The privatization policy was especially appealing to Chinese investors and has succeeded in increasing FDI in Laos. The Lao government sold a share in its telecommunication industry to a Chinese firm, which helped launch Laos’ first satellite. This not only improved internet connection quality for communication purposes but also made health services and education more accessible in rural areas, where 61 % of the labour force work as farmers.
  4. The Lao government hopes that Chinese investment will not only introduce technological innovations but will also bring jobs that would help many of the citizens of Laos to break out of the poverty trap. Six Chinese construction companies are now carrying out construction along the entire railway track and are employing a total of 50000 workers, although these are mostly Chinese.
  5. Many are concerned that Laos may be heading for a debt crisis with so much investment financed through borrowing. The construction of the railway will cost an estimated US$6 billion, which will be 60 % funded by foreign investors. The governments of China and Laos will finance the remaining 40 %. Laos’ total commitment to the building of this infrastructure is US$840 million. Around US$500 million of that amount will come from loans from China. The remaining amount will be drawn from the government budget.

Question

Define the term poverty trap indicated in bold in the text (paragraph [4]).

▶️Answer/Explanation

An explanation that it is any one of the following:

  • any linked combination of factors which causes poverty to be self-perpetuating with low income/poverty as the cause
  • low incomes lead to low saving which leads to low investment which leads to low growth which leads to low income
  • low incomes lead to low levels of human capital that leads to low productivity that leads to low incomes.

Text D — Overview of Sierra Leone

  1. Sierra Leone is located on the west coast of Africa. Economic activity is concentrated on agriculture and mining, which together contribute 70 % of gross domestic product (GDP) and 77 % of export revenue.
  2. Economic growth rates fluctuated from +20.1 % in 2013 to −21.5 % in 2015. The economic slowdown in China contributed to a significant drop in mining activities and a fall in Sierra Leone’s export revenue. China is Sierra Leone’s largest market for exported minerals.
  3. Economic growth rates in Sierra Leone have improved in recent years due to increased activity in agriculture, mining and construction. Increased employment in these labour-intensive sectors could help reduce poverty, which remains widespread in the country. Sierra Leone’s ranking in the Inequality adjusted Human Development Index (IHDI) is very low.
  4. The fall in export revenue has led to a 50 % depreciation of the leone (Sierra Leone’s currency) over the past five years. Even recent increases in the price of commodities have not been sufficient to offset the high import expenditure on food, medication, cars and capital equipment.
  5. The depreciation of the leone has led to inflationary pressures. The removal of a fuel subsidy resulted in an increase in the price of fuel and pushed the inflation rate from 16.8 % in 2018 to 17.2 % in 2019.
  6. To make matters worse, access to essential, life-saving health care services in Sierra Leone is often disrupted by regional conflicts. Healthcare in Sierra Leone is generally charged for and is provided by a mixture of government, private and non-governmental organizations (NGOs). NGOs are relied on to protect the health and wellbeing of citizens. NGOs help to achieve this by distributing medicine and teaching families about hygiene and proper sanitation.
  7. Another area of concern is the government debt, which stood at 62 % of GDP in 2019. The government has reduced its budget deficit from 5.7 % to 3.4 % of GDP by minimizing non-payment of taxes and implementing cost-saving measures such as the automation of some government services.
  8. The newly elected government has made good progress in its fight against corruption, but it is facing many macroeconomic challenges. Foreign aid has been reduced, infrastructure is inadequate and many economic activities remain untaxed. Youth unemployment is also high due to low literacy rates and a lack of skills required in the job market.

Text E — Sierra Leone’s new development plan

  1. In 2019, the government of Sierra Leone introduced a new five-year development plan. The plan includes policies aimed at increasing the welfare of Sierra Leone’s citizens by working towards the Sustainable Development Goals.
  2. The development plan ensures access to free primary and secondary education in all public schools. The cost of education is the main reason that many households are not sending their children, particularly girls, to school. For those paying private education fees, switching to public education would allow more of their household income to be spent on other essential services and farming equipment.
  3. The expected increase in human capital should facilitate economic activities and lead to investment. Schools now teach modern farming practices, such as those involving the use of farm machinery and fertilizers. These would benefit rice farmers and help achieve food security (ensuring people have access to enough food).
  4. The provision of technical education should not only increase agricultural output but also allow for the diversification of the economy. The manufacturing sector contributes only 2 % of the country’s GDP and could provide an alternative source of employment. The five-year plan also addresses the lack of infrastructure, in particular for electricity generation, which has so far restricted the development of the manufacturing sector.

Text F — Investment in Sierra Leone

  • The World Bank ranked Sierra Leone 160th among 190 countries in 2018 for the ease of doing business, citing difficulties in accessing electricity and in obtaining loans and business permits. Government borrowing from the banking sector has increased in recent years, resulting in high interest rates and limited credit availability for the private sector. Foreign investors, however, usually bring capital from abroad.
  • Despite the challenges, Sierra Leone offers significant opportunities for investment. Foreign investors are involved in the energy sector, infrastructure, agriculture, tourism, and natural resources. Reduced tax rates on corporate income are offered for investments in agriculture and tourism.

Question

Using a poverty cycle diagram, explain how the provision of free primary and secondary education may help households break the poverty cycle (Text E, paragraph [2]).

▶️Answer/Explanation

For drawing an appropriate poverty cycle diagram showing a linked combination of factors that perpetuate poverty, starting/ending with ‘low income’ and including ‘low investment’ or ‘low (human or physical) capital’ AND an explanation that either:
• The money not required for school fees may be spent on necessities (medicine/food) which could lead to higher productivity and higher income for households
OR
• The money not required for school fees may be spent on farming equipment which make household members more productive
OR
• More children will attend school, and this would increase human capital, leading to higher labour productivity and higher income for households.

Burundi

  1. Burundi is a small landlocked African country. Densely populated, it has a population of approximately 10.6 million inhabitants. The economy is dominated by subsistence agriculture, which employs 90 % of the population, though cultivatable land is extremely scarce. More than a decade of conflict led to the destruction of much of the country’s physical, social and human capital. However, substantial improvements have occurred since the conflict ended in 2006, thanks largely to the success of measures implemented to reduce the excessive control of the military.
  2. Even though Burundi is enjoying its first decade of sustained economic growth, poverty remains widespread. Burundi’s ranking on the Human Development Index (HDI) increased by 2.5 % per year between 2005 and 2013 as education and health outcomes have significantly improved over the period, yet the country still ranks low at 180th out of 187 countries in 2013. Per capita gross national income more than doubled between 2005 (US$130) and 2013 (US$280).
  3. Burundi is making the transition from a post-conflict economy to a stable and growing economy. Economic reforms and institution building are ongoing. After significant improvements to achieve peace and security, the country’s development program is shifting gradually towards modernizing public finance. However, the government has limited “fiscal space” because tax collection is very hard to carry out and tax receipts are low.
  4. With its limited resources, the government is attempting to strengthen basic social services and upgrade infrastructure and institutions, particularly in the energy, mining, and agricultural sectors. This has been accompanied by increasing participation of the private sector. The goal now is to grow a more stable, competitive and diversified economy with enhanced opportunities for employment and improved standards of living.
  5. Over the last decade, annual economic growth in Burundi has been between 4 % and 5 %. Inflation continues to decline reaching 3.9 % in July 2016, down from 24 % in March 2012, reflecting a careful monetary policy helped by a recent decrease in the prices of imports, especially oil, which is an essential commodity.
  6. Burundi’s main exports are agricultural; coffee and tea account for 90 % of foreign exchange earnings, and exports are a relatively small share of Gross Domestic Product (GDP).

Question

Using information from the text/data and your knowledge of economics, evaluate the challenges to economic growth and economic development faced by Burundi.

▶️Answer/Explanation

Responses may include:

  • definition of economic growth
  • definition of economic development.

Discussion of factors affecting growth and/or development

  • Landlocked country (paragraph [1]) making access to markets difficult, and difficult to access resources.
  • High population density (paragraph [1]), affecting the quality of life.
  • Dependence on subsistence agriculture (paragraph [1]) leads to low incomes.
  • Scarcity of cultivatable land (paragraph [1]) limiting production of agricultural goods.
  • Destruction of capital (paragraph [1]) during conflict, expensive to rebuild from (limited) public funding.
  • Widespread poverty (paragraph [2]) and existence of the poverty trap.
  • Per capita gross national income is still very low (paragraph [2]), despite doubling over eight years.
  • Low tax receipts (paragraph [3]) limit the ability of the government to finance development objectives.
  • Over-specialization (paragraph [6]) on a narrow range of (agricultural) exports makes Burundi vulnerable to international price changes.
  • Low agricultural export revenue (paragraph [6]) with low income elasticities and high levels of global competition implies lower prospects for growth.
  • Possibility of debt (increasing) due to public spending and a narrow tax base (paragraph [3]).
  • It is likely that inequality is high, because poverty is widespread, which makes development more difficult to achieve (paragraph [2]).
  • However better prospects for growth because of lower import prices and use of government monetary and other policies (paragraphs [4] and [5]).

Pakistan and the International Monetary Fund

  1. Pakistan is a low-income country with a rapidly growing population and widespread poverty. As of 2019, it has a large budget deficit due to high levels of military spending and high costs of debt servicing (35 % of the deficit is interest payments). It is also experiencing a widening current account deficit and is heavily dependent on foreign aid.
  2. Pakistan’s government is negotiating a loan from the International Monetary Fund (IMF). Amongst its conditions, the IMF has said that the government must decrease private-sector regulation such as regulations on financial institutions. The government must also sell state-owned enterprises and government revenue must be raised by increasing indirect taxes and improving tax collection systems. Furthermore, the IMF insists that the government cuts its spending further.
  3. The government has stated that the IMF loan is essential to restore confidence in Pakistan’s economy. This would help to attract foreign direct investment (FDI) to encourage economic growth and help break out of the poverty cycle. High debt levels and slowing economic growth in 2018 discouraged FDI. The IMF loan is also needed to help persuade other multilateral lenders such as the World Bank and the Asian Development Bank to provide and extend loans.
  4. In the past, Pakistan has had 21 agreements with the IMF with limited success—any balance of payments or external debt improvement has been temporary. The IMF states that this is because Pakistan has not always met the conditions of the loans, while other stakeholders argue it was the lack of support given to Pakistan to implement the conditions and to allocate the loan funds appropriately.
  5. Economists say that there needs to be a focus on improving human capital to provide the large number of young people entering the labour force with the skills to grow businesses. The quality of education needs to improve and to be combined with an effort to provide girls with greater access to education—female participation in the labour force is the lowest in the region.
  6. The World Bank has financed education and infrastructure, such as renewable energy projects, in poor regions of Pakistan. However, critics of the World Bank argue that the projects are not making a significant difference and the construction of hydroelectric dams leads to environmental damage.
  7. The government believes that the macroeconomic concerns of the IMF should be addressed first, and poverty issues in Pakistan can be dealt with later.

Question

Using a poverty cycle diagram, explain how the government of Pakistan could intervene to “break out of the poverty cycle” (paragraph [3]).

▶️Answer/Explanation

A poverty cycle diagram AND an explanation of one of:

  • government may (collect more tax and) spend on investment projects such as education/infrastructure to increase level of human and physical capital and therefore break the cycle 
  • government may attract FDI which may supplement low savings as it could increase incomes and therefore break the cycle
  • any valid government policy which would attract FDI and/or encourage economic growth.

Text A — Bangladesh: the economic role of women

  1. Bangladesh is a densely populated country in Asia. Its currency is the Bangladeshi taka (BDT). The annual rate of growth of gross domestic product (GDP) has steadily increased from 5.6% in 2010 to 8.1% in 2019. Absolute poverty has declined, but inequality has risen, partly due to higher unemployment rates for women than men. Moreover, the labour force participation rate for women is much lower than the rate for men. Over 80% of the women’s jobs are in the informal economy, and these jobs are low paid and insecure. Women need regular paid work, which not only raises household income but also improves economic well-being in terms of education and health.
  2. The structure of the economy is changing. The growth of cities is due to the expansion of the manufacturing sector, which now contributes a larger share to GDP than the agricultural sector. These changes have increased the number of women in the labour force. In particular, the growth of the ready-made garments (RMG) industry (mass-produced clothing) has given women the opportunity to move into formal employment. The RMG industry provides jobs for almost 4 million low-skilled and semi-skilled workers, accounting for over 40% of total manufacturing employment. The majority of these jobs are being filled by women, with the result that the gap between the wages of men and women is gradually being reduced.
  3. There are concerns about working and safety conditions in the RMG factories. After an accident in a factory in 2013, reforms are being implemented, partly in response to criticisms from overseas retailers and consumers who purchase the garments. The minimum wage has been increased, inspections are carried out, and there are fewer small, unsafe factories.
  4. While working conditions are improving, such reforms raise the costs of manufacturing garments. Furthermore, the international garment market is becoming more competitive, putting pressure on Bangladeshi factories to reduce costs.
  5. The overseas demand for Bangladeshi garments had been rising strongly until 2019. However, demand has recently fallen, reducing firms’ revenue. The reduction in revenue and the need to lower costs have forced certain firms to reduce the size of their labour force by dismissing some of their female workers.
  6. The number of ethically and environmentally concerned consumers is increasing globally. Rather than trying to lower costs, firms can be more successful if they produce “green ready-made garments” by implementing sustainable practices. About 100 garment factories in Bangladesh have already been certified as producers that meet specified environmental standards. In addition, global retailers and fashion brands are supporting recycling initiatives through the Circular Fashion Partnership.


Text B — Trade prospects for exports of ready-made garments (RMG)

  1. Exports of RMG account for over 84% of Bangladesh’s total exports. At present, Bangladesh is the world’s second largest garment exporter after China. Bangladeshi exports could further increase as Chinese garments become more expensive due to rising wages in China.
  2. Bangladesh is designated as an Economically Least Developed Country (ELDC) and is therefore able to sell goods in Europe and China without any quotas or tariffs being imposed. However, Bangladesh will graduate from ELDC status by 2026 and will then no longer be eligible for preferential trade agreements. Moreover, the USA, which is the largest export market for Bangladeshi garments, has applied a 15% tariff on imports from Bangladesh since 2013, citing concerns about working conditions in factories.


Text C — Role of foreign direct investment in the RMG sector

  1. Vietnam and Myanmar have significantly increased their garment exports to China due to foreign direct investment (FDI) from China. Chinese investors have set up factories that import raw materials from China and re-export the finished goods back to China.
  2. Consequently, to compete successfully in the huge Chinese market, Bangladesh needs to attract more FDI from China. Bangladesh is developing the required infrastructure, such as transport links. It is also necessary to diversify into expensive high-end fashion, market more aggressively, and use branding strategies.
  3. The funds from additional FDI would be helpful, because the relative contribution of Official Development Assistance (ODA) to Bangladesh’s budget is declining. Furthermore, the foreign exchange obtained from foreign investors assists in financing the current account deficit.

Question

Define the term informal economy indicated in bold in the text (Text A, paragraph [1]).

▶️Answer/Explanation

An understanding that it is two of the following:

  • economic activity that is not officially recorded 
  • economic activity that is not regulated 
  • economic activity that is not taxed
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