4.3.2 - Factors influencing growth and development

Commodity Dependence and Volatile Exports

Many developing countries depend heavily on a narrow range of primary products such as cocoa, coffee, copper, oil or other minerals. That can generate export income, but it also makes the whole economy more exposed to shocks.

Primary product dependency is risky for several reasons. Agricultural exports can be hit by drought, floods, pests or disease. Mineral and oil exports depend on finite reserves, so a country that relies too heavily on them may face trouble once output falls. Demand is also often weak in the long run. As incomes rise globally, demand for many basic commodities grows more slowly than demand for manufactured goods and services, because they have a low income elasticity of demand, so export earnings may not keep up with the cost of imported machinery, fuel and technology.

This is where the Prebisch-Singer argument matters. It suggests that, over time, the prices of many primary products tend to rise more slowly than the prices of manufactured imports. If that happens, the terms of trade deteriorate, meaning the country has to export more just to afford the same quantity of imports.

Short-run volatility is another problem. Commodity markets often have inelastic demand and inelastic supply, so even a small shift in harvest conditions or world demand can cause a large swing in price. In 2024, for example, poor harvests in Ghana and Côte d'Ivoire pushed world cocoa prices above $10,000 a tonne for the first time, more than three times their level a year earlier. That makes export revenue unpredictable. Governments then find it harder to plan spending, businesses delay long-term investment, and producers may over-expand during booms only to be trapped by losses when prices fall back.

Primary product booms can also damage other sectors through Dutch Disease. If a country discovers oil or experiences a sharp rise in commodity export revenue, demand for its currency may rise. The exchange rate appreciates, other exports become less competitive, and manufacturing or tourism may be squeezed out. Oil exporters such as Nigeria and, more dramatically, Venezuela are often discussed in this context.

None of this means commodity exports are always a curse. Some countries have used resource income well by stabilising revenue, investing in infrastructure and education, and diversifying into other sectors. Not every primary product has the same demand conditions either: premium foods or scarce minerals may be less vulnerable than basic commodities. The real problem is dependence on a narrow export base, not the mere existence of primary production.

Savings, Foreign Exchange and Finance

Even when labour is plentiful, development is difficult if an economy cannot finance investment. Poor countries often need more machines, roads, power systems and technology, but these require saving, foreign currency and a financial system that can turn funds into productive investment.

The intuition is simple. If households and firms save little, there is less finance available for investment. With less investment, the capital stock grows slowly. That means workers have fewer tools, productivity rises slowly, and output grows slowly too. Low output keeps incomes low, which then keeps savings low. The savings gap is the difference between what the economy actually saves and the saving needed to achieve a target growth rate, so it becomes part of a vicious cycle of poverty.

A quick example shows the logic. If a country saves 12% of national income and needs 4 units of capital to produce 1 extra unit of output, Harrod-Domar implies growth of 3%. If the savings ratio falls to 6% with the same capital-output ratio, implied growth falls to 1.5%. Rearranging the formula gives the saving needed for a target: s = g × sigma. To grow at 4% with a capital-output ratio of 4, the country would need to save 16% of national income, so a country saving 12% has a savings gap of 4 percentage points. Growth can also rise if capital is used more productively, lowering the capital-output ratio. The model is simple, but it shows why very low saving can be such a powerful brake on growth.

The model also has limits. Growth is not the same as development, because a country can raise GDP without improving health or education much. Very poor households may be unable to save in the first place. Investment can be wasted through corruption or poor project choice, and the model underplays productivity improvements that come from skills, technology or better institutions.

A second constraint is the foreign currency gap. A country may want to invest, but still be unable to import the machinery, spare parts, fuel, raw materials, medicine, essential consumer goods or technology it needs because export earnings are too low. If that happens, it must run down reserves or borrow in foreign currency. That can solve the problem temporarily, but it also raises debt.

Debt is not automatically harmful. Borrowing can support development if the money is used for productive investment that raises future output. The problem comes when debt becomes too large, interest rates rise, export revenue weakens, or the borrowed money is wasted. Then debt-service payments crowd out spending on schools, healthcare and infrastructure, and governments may even have to raise taxes to keep up with repayments.

Capital flight makes the situation worse. Money that could have stayed in domestic banks is moved abroad because of political instability, fear of inflation or currency collapse, tax avoidance, or corruption. A related leakage happens when profits are repatriated rather than reinvested locally. Weak banking systems deepen the problem because entrepreneurs cannot borrow easily, households cannot save securely, informal lenders may charge exploitative interest, and the lack of insurance leaves families exposed to one bad harvest or illness.