The poverty trap (cycle) and how to break it

B & D Pages 343-4

Learning Objective

Explain that in some countries there may be communities caught in a poverty trap (poverty cycle) where poor communities are unable to invest in physical, human and natural capital due to low or no savings; poverty is therefore transmitted from generation to generation, and there is a need for intervention to break out of the cycle.

How the poverty cycle is a trap

If people can only produce enough food to survive – live at the level of subsistence – then they cannot afford the luxury of saving.This is called absolute poverty.Often this is due to low levels of food productivity.No savings is the fundamental reason why extremely poor nations are trapped in poverty. No growth can really start (or no other solutions are really sustainable) without first breaking this fundamental barrier.

Why is lack of savings the barrier?

Savings is required for investment. Investment is required for increasing productivity. This leads to growth incomes. Draw the following diagram (refer to p.344):

1. Low productivity2. Low incomes 3. Low savings 4. Low investments

• No increase in productivity

Four ways this cycle-trap can be broken(without foreign intervention)

1. Reduce food consumption; save food to sell, buy more food-producing stock

2. Improve technology (through training and equipment) (for greater food productivity)

3. Switch to “cash crops” – grow export crops but import food sources (and thus develop trade industries as a bonus)

4. Reclaim previously unusable land (toxic, infested, poor drainage, dense forest). Now labour productivity increases.

4.5 Foreign Direct Investment

B & D 378-380

Learning Outcomes

1. Describe the nature of foreign direct investment (FDI) and multinational corporations (MNCs).

2. Explain the reasons why MNCs expand into economically less developed countries.

3. Describe the characteristics of economically less developed countries that attract FDI.

4. Evaluate the impact of foreign direct investment (FDI) for LDCs.

FDIs and MNCs

Foreign Direct Investment is capital investment owned and operated by a foreign entity.It is mainly the Multi National Corporations (MNCs) that undertake Foreign Direct Investment. MNCs have production lines in different countries, and their income and profit flows are part of foreign capital flows.

Production and Growth

• Productivity refers to the amount of goods and services produced for each hour of a worker’s time.

• A nation’s standard of living is determined by the productivity of its workers.

(a) Growth Rate 1960-1991 (b) Investment 1960-1991

South Korea

Singapore

Japan

IsraelCanada

Brazil

West Germany

MexicoUnited Kingdom

Nigeria

United States

IndiaBangladesh

Chile

Rwanda

Growth Rate (percent)0 1 2 3 4 5 6 7

South Korea

Singapore

Japan

IsraelCanada

Brazil

West Germany

MexicoUnited Kingdom

Nigeria

United States

IndiaBangladesh

Chile

Rwanda

Investment (percent of GDP)0 10 20 30 40

Growth and Investment

MNCs are attracted to LDCs for various reasons

Recall our 4 factors of production:• Physical capital – lacking in LDCs due to low

levels of saving• Technological knowledge – also lacking in LDCs

due to lack of investment in Research and Development

• Human capital – abundant in numbers in LDCs, making cost of labour must cheaper

• Natural resources – more available in LDCs due to less “exploitation” that requires expensive technology

Also note: MNCs like to be close to emerging markets

The pros and cons of FDI via MNCBenefits Disadvantages FDI AD/Y LRAS to right Multiplier process is started when I

is put into local economy:Ijobsincomespending

MNCs provide training and education (=human capital) passed on to others and other areas development

Contribution to tax which might be used to put into education

May contribute to local development programmes

Manager jobs often done by expatriates

Capital-intensive production does not reduce unemployment in LDC

MDCs are attracted to where the tax base the lowest

The have huge power and influence on domestic government

May result in widening inequalities within country

overspecialised and over-dependent = vulnerable!!