Why are some countries poor? It’s a simple question, but one with many possible answers. In the realm of political economics, there are a couple theories that seek to answer this question.
Geographical Advantage Theory:
I bet you can guess this one. The bigger a country is and the richer the territory is in natural resources, the better off the economy will be. Thus, any disparity in development is a product of geographical circumstance. This seems legitimate, but it’s not the best determinant of modern development. Also, it ignores the problem of the “resource curse”: an economy’s dependence on a key resource and consequent vulnerability to price changes of said resource. This ‘boom-bust’ cycle due to the resource curse can lead to great instability and little development.
But the U.S. is a big country and a rich country. So is Australia, and Brazil… and you’re right, in terms of GDP. But in measures of wealth more pertinent to a country’s standard of living, like median income, income per capita, and gini indexes, you’re wrong. For example, Scandinavian countries, relatively small, resource sparse countries, have some of the highest standards of living. So, there is a very weak correlation of geographic size to development.
This was the predominant theory of economic development from the ’50’s to ’60’s. It’s fairly straight forward. Quite literally, it’s a linear theory of development. According to the modernization theory, economic development follows a linear sequence of steps.
- Traditional economy: an agricultural based economy prone to the ‘boom bust’ cycle
- Transitional stage: introduction of new industries in economy
- Take-off stage: further diversification of economy
- Drive to maturity: diversified economy
- High mass consumption: highly diversified economy characterized by mass production and consumption
If this seems a bit vague, you’re right. The theory stays vague to generalize the basic steps of development. Essentially, according to the theory, any country can achieve high development by following these steps. But… if everyone can be a winner, why are there poor countries? Critics of this theory point out that countries that start development earlier have an undeniable advantage over those that start this process later. If country A starts developing their mining industry, country B’s mining industry will be at a disadvantage if it starts 50 years later. This is because it’s more difficult to enter a market that is already dominated by powerhouse industries, even in a macroeconomic sense. The dependency theory seeks to explain this problem of late blooming economies.
There are two kinds of economies: core and periphery. Core economies are rich, developed countries. Periphery countries are poor, underdeveloped countries. But we know there are rich and poor countries. We are trying to understand why. The dependency theory states that periphery economies are dependent on core economies. Periphery economies focus on exporting resources to core economies. That exported resource is unlikely to keep its initial value. Over time, peripheral economies will be trapped in a trade imbalance. This trend is called declining terms of trade: the diminishing returns of exporting raw resources.
It’s a cycle. Once an economy becomes peripheral, it’s very difficult to transition into a core economy. They depend on a key export for economic survival and there is no incentive for the wealthy, those who benefit from control of the resource, to diversify the economy. This explains why most former colonies, peripheral economies, are typically underdeveloped. However, this doesn’t explain why economies that are not export based are poor. That leads us into the next theory.
Institutional Design Theory:
Instead of two different kinds of economies, there are two different kinds of economic policy: extractive and inclusive. Extractive policy takes from the economy, inclusive policy protects it. Extractive policies are exemplified by colonial governments and predatory states; these are meant to deplete resources unsustainably for the benefit of the state or the elite. Inclusive institutions protect participation in an economy through contract laws, protection for private property, and government subsidies for new businesses. So, why not just have inclusive policy? Well, economic policy is determined by political institutions. If a country has authoritarian or colonial political roots, it will most likely have extractive policies. If a country has democratic political institutions, it will most likely have inclusive policy.