Constraints on growth and development

Commodity prices and primary product dependency

• Volatile commodity prices: demand and supply of primary products are price inelastic, so small shifts cause big price swings; export earnings and tax revenue become unpredictable, making planning and investment hard.
• Primary product dependency and the Prebisch-Singer hypothesis: the prices of primary products tend to fall over the long run relative to manufactured goods, because demand for primary products is income inelastic (as world incomes rise, spending shifts to manufactures and services) while productivity gains in primary production raise supply. So the terms of trade of primary product exporters deteriorate, and they must export more to buy the same imports.

Savings gap: the Harrod-Domar model

Growth depends on investment, financed by savings. g = s / k, where s is the savings ratio (savings as a share of GDP) and k is the capital-output ratio (units of capital needed for one unit of output).

Low incomes mean low savings, so low investment and slow growth: a savings gap. Filling it requires domestic saving (banking), FDI, aid or borrowing.

Criticisms: investment does not guarantee growth (it may be wasted, or lack skilled workers and infrastructure); k may change; it ignores technology and human capital.

Harrod-Domar examples

Other economic constraints

• Foreign currency gap: not enough export earnings to pay for imported capital goods and debt repayments.
• Capital flight: wealthy residents move money abroad (fear of instability, devaluation or taxation).
• Demographic factors: rapid population growth spreads output over more people; a high dependency ratio; emigration of skilled workers (brain drain), though remittances help.
• Debt: household debt and overseas debt; servicing debt in foreign currency uses export earnings.
• Access to credit and banking: many people lack bank accounts, so saving and borrowing for business are hard.
• Infrastructure: poor roads, ports, power and internet raise costs.
• Education and skills: low human capital limits productivity.

Non-economic constraints

• Corruption: diverts resources, deters investment, raises costs.
• Poor governance: weak property rights and rule of law.
• Civil wars: destroy capital and displace people.
• Migration: loss of skilled workers.
• Terrorism: deters tourism and investment, diverts spending to security.

Worked example

A country saves 18% of GDP and has a capital-output ratio of 4. It wants to grow at 6% a year. Using Harrod-Domar, find its growth rate and the savings ratio needed.

1. g = 18 / 4 = 4.5%
2. Needed s = g x k = 6 x 4 = 24%
3. Savings gap = 24 - 18 = 6% of GDP

Answer: Growth 4.5%; a savings ratio of 24% is needed, a gap of 6% of GDP to be filled by FDI, aid or borrowing.

Check yourself

1. The savings ratio is 20% and the capital-output ratio is 4. Calculate the growth rate using the Harrod-Domar model.
   Show answer

   5 %. g = 20 / 4 = 5%.

2. The capital-output ratio is 3 and the target growth rate is 7%. Calculate the savings ratio needed.
   Show answer

   21 %. s = g x k = 7 x 3 = 21%.

3. A country saves 12% of GDP and has a capital-output ratio of 3. By how many percentage points would the savings ratio need to rise to reach 6% growth?
   Show answer

   6 percentage points. Needed s = 6 x 3 = 18%, so a rise of 6 percentage points.

4. The Prebisch-Singer hypothesis predicts that, over the long run, the terms of trade of primary product exporters will
   • improve
   • remain constant
   • deteriorate
   • become perfectly elastic
   Show answer

   deteriorate. Primary product prices tend to fall relative to manufactures.

5. Explain why the demand for primary products tends to grow more slowly than demand for manufactured goods as world incomes rise.
   Show answer

   Primary products such as food have a low income elasticity of demand, so as incomes rise people spend a smaller proportion on them and more on manufactures and services.. Income elasticity of demand explains Prebisch-Singer.

6. A foreign currency gap means a country
   • has too much foreign currency
   • uses a foreign currency instead of its own
   • cannot earn enough foreign currency to pay for necessary imports and debt service
   • has a current account surplus
   Show answer

   cannot earn enough foreign currency to pay for necessary imports and debt service. Export earnings fall short of import and debt needs.

7. Explain how corruption can constrain economic growth.
   Show answer

   Corruption diverts public money away from investment in infrastructure and services, raises costs for firms through bribes and uncertainty, and deters FDI, so investment and growth are lower.. Corruption reduces investment.

8. Why are commodity prices often volatile?
   • Commodities are always in excess supply
   • Demand and supply are price inelastic, so small shifts cause large price changes
   • Governments fix commodity prices
   • Demand for commodities is perfectly elastic
   Show answer

   Demand and supply are price inelastic, so small shifts cause large price changes. Inelastic curves mean shifts move price a lot.

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Sources

• Pearson Edexcel International Advanced Level in Economics specification (issue 2)

Last updated 8 November 2026. Spotted a mistake? Tell us.