Barriers to economic growth and/or economic development

• Explain, using a poverty cycle diagram, how low incomes reproduce themselves and where a policy could break the cycle.
• Explain the causal chain from each economic barrier to slower growth or development, and the conditions under which it binds.
• Explain how weak legal, tax, banking and property institutions, gender inequality, poor governance and unequal political power act as barriers.
• Evaluate the relative significance of different barriers for a named country, using explicit criteria.

A Poverty trap, or poverty cycle, is a linked chain of conditions that starts and ends in poverty, in which each condition causes the next, so that poverty reproduces itself unless something from outside the chain breaks it. It is a description of a mechanism. It is not the benefit-withdrawal poverty trap of welfare economics, in which a worker loses benefits as earnings rise and so gains little from working more.

The cycle can operate in a single household, in a village or region, or in a whole economy, and it often runs across generations: children born into Absolute poverty are more likely to be poor as adults. Any linked combination of factors can form the cycle, so there is more than one correct version. The economy-wide version runs through saving and investment, and every link has a reason.

1. Low income leads to low saving, because almost all income has to be spent on food, shelter and other necessities. The same holds for the government: low incomes mean little tax revenue, so public saving is low too.
2. Low saving leads to low investment, because domestic saving is the main source of finance for investment where foreign finance is scarce and banks reach few people.
3. Low investment, in physical capital such as tools, machines and infrastructure, in human capital such as schooling and health, and in natural capital such as soil and water, leads to low labour productivity, because each worker has little capital, few skills and poor health to work with.
4. Low productivity leads to low income, because wages and profits are paid out of what is produced. The economy is back at low income, and the cycle repeats.

The human capital version works inside the household. Low income means children are undernourished, often ill, and leave school early to work. As adults they have little Human capital, so their productivity and earnings are low, and their own children face the same constraints. Two further versions are common. In the public revenue cycle, low incomes mean low tax revenue, so the government spends little on infrastructure, health and education, so productivity and incomes stay low. In the natural capital cycle, households with no other means of survival overuse land, forests and water, the degraded Natural capital yields less, and incomes fall further.

Three features make the cycle hard to escape by individual effort. The poor cannot borrow to invest in themselves, because they have no collateral, no credit record and no bank nearby. The returns to schooling and health arrive years later, while the need for food and shelter is immediate. And with no savings to fall back on, a single shock, such as an illness, a drought or the death of an earner, wipes out whatever progress has been made.

Breaking the cycle requires raising one stage independently of current income. Public provision of schooling and health care raises human capital even where families cannot pay; infrastructure raises the productivity of existing capital; access to credit and safe saving lets households invest; cash transfers, foreign aid and foreign direct investment add resources from outside the loop. These are the strategies of topic 4.10. The cycle describes a tendency, not a certainty: many households and countries have escaped poverty, and the diagram shows why escape is difficult, not that it is impossible.

A barrier to Economic growth limits the growth of an economy's real output or its productive capacity. A barrier to Economic development limits the improvement in people's lives: their income, health, education and choices. Many barriers do both, but not all. An economy can grow quickly on mineral exports while most people see little change, so for each barrier it matters which of the two it holds back, and for whom.

Rising economic inequality means that a growing share of income and wealth goes to the richest groups. The chain to slower growth runs through the poor: households with low incomes cannot pay for schooling, health care or a small business, and they have no assets to offer as security for a loan, so talent and effort that could have been productive are never used. Total investment in people is lower than it would be with the same national income more evenly spread, and growth is slower. Rising inequality also weakens the link between growth and development: when the gains go mostly to the top, a given rate of growth reduces poverty by less.

Inequality reinforces other barriers. The very rich are the group most able to move savings abroad (capital flight) and to buy political influence, so laws, taxes and public spending can come to favour them (unequal political power). Where inequality feeds resentment and conflict, the risk of disorder deters investment. The barrier binds most where the poor depend on their own income to pay for schooling and health, so it is weaker where the state provides them free. Indicators are the Gini coefficient and the gap between the HDI and the inequality-adjusted HDI (topic 4.8).

Infrastructure is the large-scale physical capital that all economic activity depends on: roads, railways and ports; electricity generation and grids; telecommunications and internet networks; clean water and sanitation. Without it, costs are high everywhere. Poor roads raise transport costs and spoil crops before they reach a market; unreliable power leaves machines idle and forces firms to run their own generators; no clean water or sanitation means water-borne disease, which keeps children out of school and adults out of work. Firms are less competitive, farmers are cut off from buyers, foreign investors go elsewhere, and output and incomes stay low.

Markets supply too little infrastructure. Networks have very high fixed costs and pay back over decades; many have features of a public good (a street light, a flood barrier) or of a natural monopoly (a power grid, a water network), so private firms cannot charge enough, or would charge monopoly prices if they could. Provision therefore falls to governments, and governments with a small tax base cannot afford it. The barrier binds hardest in rural areas and for small firms, which cannot build substitutes of their own.

Appropriate technology is technology suited to the resources, skills and conditions of the people who use it. In an economy where labour is plentiful, capital is scarce and power is unreliable, that usually means simple, labour-using, low-cost equipment that can be repaired locally, such as a hand or solar water pump, an efficient cookstove or a service delivered through a basic mobile phone. Two problems hold growth back. Without access to any improved technology, productivity stays low. With inappropriate technology, imported capital-intensive machinery creates few jobs, depends on imported spare parts and foreign technicians, and stands idle when it breaks down, so the investment yields far less output than it should.

Human capital is the knowledge, skills and health embodied in people. Low levels of it are a barrier because labour productivity depends on it: workers with little schooling and poor health have fewer skills, less energy and more days off sick, so they produce less per hour and earn less. They are also less able to adopt new technology or to move into higher-value work in manufacturing and services. Access is limited by cost (fees, uniforms, transport and the earnings a child gives up by attending school), by distance, by quality (absent or untrained teachers, clinics without medicines) and by social norms that keep girls out of school. Indicators are life expectancy, child mortality, mean and expected years of schooling, and literacy rates (topic 4.8).

Education and health care are merit goods with positive externalities: a literate, healthy population benefits employers, neighbours and future generations, not only the person who is educated or treated. Households weigh only their own benefit and often cannot afford even that, so a free market provides too little of both. A further drain is emigration: when the most highly trained doctors, nurses and engineers leave for higher wages abroad, the country loses much of the return on what it spent educating them, although money they send home partly offsets the loss.

The Informal economy is economic activity that is not registered with, taxed or regulated by the government and is not recorded in official statistics: street trading, small family farms and workshops, casual day labour. Most of it is legal work that is simply unregistered. It is large in low-income countries because there are few formal jobs, because registering a business is slow and costly, because taxes seem high compared with the public services received, and because the rules are weakly enforced.

• Revenue chain: informal firms and workers pay little tax, so the tax base is narrow and government revenue is low, which leaves little money for infrastructure, schools and clinics.
• Workers chain: informal workers have no written contract, no legal protection, no safety standards and no social insurance, so their incomes are low and insecure and one illness or bad season can push a household back into poverty.
• Firms chain: an informal firm cannot get a bank loan without registered assets and accounts and cannot enforce a contract in court, so it stays small, invests little, trains no one and does not reach the economies of scale that would raise its productivity.

The informal economy is not only a barrier. Where formal jobs do not exist it provides livelihoods, and it absorbs workers who lose formal jobs in a downturn, so forcing it into the formal economy through penalties can destroy incomes. The policy problem is to make formality worth choosing, through simpler registration and services that firms value. Because informal output is not recorded, it also means that GDP understates the size of the economy (topic 4.8).

The Primary sector extracts or harvests natural resources: agriculture, mining, forestry and fishing. Many low-income countries earn most of their export revenue from a few primary products, such as cocoa, coffee, copper or crude oil. Dependence on primary production is a barrier through four chains.

1. Unstable prices. In the short run neither buyers nor producers of commodities respond much to price, so a shift in demand or supply (a drought, a new mine, a recession in a large importing economy) moves the world price a long way. Export revenue, farm incomes and government revenue rise and fall with it, which makes planning, investment and debt repayment difficult.
2. Slow growth of demand. Demand for food and many raw materials is income inelastic: as world incomes rise, spending on them rises less than proportionately, while spending on manufactures and services rises faster. Over time the prices a primary exporter receives for its exports tend to buy fewer of the manufactures it imports.
3. Little value added. Selling raw cocoa beans, cotton or ore leaves the processing, branding and retailing, where most of the value of the final product is created, to firms in other countries, along with the skilled jobs that go with them.
4. Over-specialisation. Land, labour and capital are tied to one or two products, so a crop disease, a change in climate or a synthetic substitute can hit the whole economy at once.

Lack of access to international markets is the second trade barrier. High-income countries protect their own producers, above all their farmers, with tariffs, quotas and subsidies (topic 4.2), so exporters in developing countries sell less and at lower prices; subsidised surpluses sold abroad also undercut farmers in poor countries in their own home markets. Tariff escalation makes this worse: tariffs that are low on raw cocoa beans but higher on cocoa paste and higher still on chocolate discourage a developing country from processing its own commodities, which blocks the move away from primary production. Product standards and paperwork that a large firm can absorb may be too costly for a small exporter. At home, high transport costs, poor ports and slow customs add to the cost of every sale abroad, and a country outside the main trading blocs (topic 4.4) faces the outside tariff in each of them.

Capital flight is the large-scale movement of money and other financial assets out of a country to places its owners regard as safer. It is caused by political instability, fear of a devaluation or of confiscation, high inflation, high or arbitrary taxation, and the wish to hide income from corruption or tax evasion. The chain to slower growth: savings that could have financed domestic investment are held abroad, so investment is lower; income earned on assets abroad is not taxed at home, so the tax base shrinks; and selling the domestic currency to buy foreign assets puts downward pressure on the exchange rate and drains foreign reserves, which weakens confidence and encourages more flight. Capital flight is not the same as foreign direct investment leaving or a government repaying debt. It is usually carried out by the richest residents, so it is closely linked to inequality and corruption.

Indebtedness is a high level of debt relative to a country's income or export earnings, so that servicing it, paying the interest and the repayments that fall due, uses a large share of its resources. The chain: the larger the debt and the higher the interest rate, the more export earnings and tax revenue go to creditors, and the less is left for schools, clinics and roads. The opportunity cost of debt service is the investment in human and physical capital that would break the poverty cycle. Debt also binds through three further routes. Much of it is in foreign currency, so a depreciation raises the cost of servicing it in domestic currency. Heavy debt makes new borrowing dearer or impossible. And investors who expect taxes to rise in future to pay the debt hold back now, so private investment falls as well.

Debt is not a barrier in itself. Borrowing that finances a road or a power station that raises output and tax revenue can pay for itself. Debt becomes a barrier when the interest rate is higher than the growth of the income that has to service it, or when the money financed consumption, prestige projects or projects that never earned foreign currency, or when commodity prices fell or world interest rates rose after the loans were taken. The policy response, debt relief, is part of topic 4.10.

A Landlocked country has no coastline, so all of its sea-borne trade must cross at least one other country. The chain: goods travel further by road or rail to reach a port, wait at one or more borders, and depend on a neighbour's roads, ports, customs and political stability. Transport costs are higher and delivery times longer and less predictable, so exports are less competitive abroad and imported machinery, fuel and fertiliser cost more at home. Firms that need reliable supply chains, including foreign investors, choose coastal locations instead, so landlocked countries trade less and attract less investment. UNCTAD reports that more than 80% of landlocked developing countries are commodity dependent, which is consistent with high transport costs shutting them out of manufacturing for export.

Other features of geography raise costs in similar ways: distance from large markets; small island economies, with tiny home markets, high shipping costs and exposure to storms and sea-level rise; mountainous or arid terrain that makes roads and farming expensive; and frequent earthquakes, floods or droughts that destroy capital. Geography is a barrier, not a destiny. Its effect is smaller where transport corridors, regional trade agreements and good relations with neighbours keep the route to the sea open, and where a country produces goods of high value per tonne, such as services or diamonds, for which transport costs matter little.

An Endemic disease is one that is constantly present in a region or population, such as malaria, dengue, tuberculosis and parasitic infections in many tropical areas. The chain: frequent illness and early death mean lost working days and lower productivity; children who are ill miss school and learn less, so human capital is lower in the next generation; households spend scarce income on treatment and lose earners; high child mortality encourages families to have more children, which spreads household income more thinly; and the risk of disease deters investors and tourists. Each link lowers growth and human development.

Tropical climates also make farming harder: fragile soils, pests, crop and livestock diseases and very variable rainfall mean yields are lower and riskier, and most of the poor in low-income tropical countries work in farming. Climate change adds heat stress, drought and flooding, which fall hardest on these countries. The barrier is weakened by public health measures and research: vaccination, insecticide-treated bed nets, clean water and drought-resistant crops reduce its effect, which is why health programmes appear among the strategies in topic 4.10.

Institutions are the laws, rules and organisations that shape economic behaviour: they decide whether a promise can be enforced, whether a farmer will keep the crop she grows, and whether taxes are collected fairly. Markets and governments both work through them, so when they are weak, every other part of the economy works badly. Four kinds matter most.

The legal system. Where courts are slow, unpredictable or open to bribes, contracts cannot be enforced and disputes cannot be settled fairly. People then trade only with those they know and trust, avoid long-term agreements and keep firms small and within the family. Specialisation, investment and foreign direct investment, all of which depend on agreements between strangers that last for years, are lower, so productivity and growth are lower.

Ineffective taxation structures. A large informal economy, weak tax administration, evasion by wealthy individuals and firms, and reliance on taxes on trade and spending mean that tax revenue is low relative to GDP, and that what is collected falls heavily on the poor. A government with low revenue cannot finance infrastructure, schools and clinics, so it depends on borrowing, which adds to indebtedness, or on aid, which can be withdrawn. A narrow tax base is therefore a barrier to development as well as to growth.

The banking system. Where banks have few branches outside the cities, require high minimum balances and lend only against registered collateral, most poor households and small firms have no account. They cannot save safely, so savings are kept as cash or livestock, and they can borrow only from moneylenders at very high interest. Savings are not channelled to the firms that could invest them productively, small firms cannot grow, and households cannot borrow to get through an illness or a bad harvest, so one shock can undo years of progress. A weakly regulated banking system also risks crises and tends to lend to the politically connected.

Property rights are the legal rights to own, use and sell an asset. Where land, homes and businesses have no secure, registered title, three things follow. The owner cannot use the asset as collateral, so cannot borrow to improve it. The owner fears eviction or seizure, so has little reason to invest in irrigation, fencing or a better building whose benefit could be taken away. And the asset is hard to sell or rent to someone who could use it more productively. Investment and productivity are lower as a result. The barrier binds most for the rural poor, whose main asset is land held by custom without any title.

Gender inequality is unequal access for women and men to education, health care, income, assets and decision-making. The first chain runs through today's economy: when girls receive less schooling and women face barriers to owning land, opening accounts, borrowing and working in the formal sector, the skills and effort of half the population are under-used, so output is lower than it could be. The second chain runs through the next generation: mothers with less education and less control over household income tend to have more children and are less able to secure their nutrition, health care and schooling, so the human capital cycle continues. The usual indicator is the Gender Inequality Index (topic 4.8), which combines reproductive health, empowerment and labour-market participation.

Governance is the way public power is exercised: whether the government is accountable, transparent, competent and bound by the rule of law. Corruption is the abuse of public office for private gain. Poor governance and corruption hold back growth and development through several chains. Public money is diverted from services, so schools lack teachers and roads are paid for but not built. Bribes act as an unpredictable tax on business, so fewer firms start and less foreign investment arrives. Licences and contracts go to the best connected, not the most efficient, so resources are misallocated. Citizens who see taxes stolen are less willing to pay them, which narrows the tax base further. Aid is wasted, so donors reduce it.

Corruption differs from most other barriers in that it weakens every policy meant to remove the others. A government that is building infrastructure, expanding schools or reforming land titles achieves less of each where funds and decisions are captured along the way. That is why it is often treated as a barrier of unusually wide reach.

Unequal political power and status means that political influence is concentrated in an elite, an ethnic or religious group, a region, a caste or one gender. The chain: laws, public spending and public jobs are shaped to favour that group, so other groups are excluded from land, credit, education and public services, and Economic discrimination in hiring and lending goes unchallenged. Their productive potential is wasted, so growth is lower, and grievances build. In the worst case they turn into violent conflict, which destroys physical and human capital and deters investment for years. Low social status can exclude people whatever the law says: a minority, a lower caste or indigenous people may have equal legal rights and still be unable to use them.

The key question is how significant each barrier is. A barrier is significant for a country when removing it would raise growth or development by a large amount, and when nothing else would immediately take its place as the binding constraint. That depends on the country and the time, so a judgement is always about a named barrier in a named country. Five criteria make the comparison precise.

1. Reach: how many other barriers does it cause or worsen? Poor governance weakens taxation, infrastructure, the legal system and the use of debt; low human capital feeds every version of the poverty cycle. A barrier with wide reach matters more.
2. Bindingness: would removing it alone raise growth, or would another constraint take over at once? A new road does little where there is nothing to sell or the border is closed, so the road was not the binding barrier.
3. Controllability: can domestic policy change it, as with education, property law or tax administration, or is it largely fixed or external, as with location, climate or rich countries' trade barriers? An external or fixed barrier needs outside action or must be worked around.
4. Time: institutions and human capital take decades to change, while debt relief or a trade preference can take effect within a year. A barrier that is slow to remove matters more in the long run but cannot be the explanation of a sudden change.
5. Evidence: have countries that faced the same barrier grown or developed anyway? If they have, the barrier is not decisive on its own.

Four positions can be weighed against these criteria. The institutions view holds that with secure property rights, honest government and courts that enforce contracts, investment and public services follow, and that without them, aid, natural resources and market access are wasted. The geography view holds that location, climate and disease constrain some countries regardless of policy and need outside support. The poverty-trap view holds that low income itself prevents the saving and investment that would end it, so an external injection is needed. The external view holds that commodity dependence, rich countries' protection and debt limit what good domestic policy can achieve.

• Poverty cycle: low income, low savings, low investment (physical, human and natural capital), low productivity, low income. Each link has a reason, and the loop is closed.
• Economic barriers: rising inequality; infrastructure and appropriate technology; low human capital; primary-sector dependence; lack of access to international markets; the informal economy; capital flight; indebtedness; geography, including landlocked countries; tropical climates and endemic disease.
• Political and social barriers: a weak legal system, ineffective taxation, a weak banking system and insecure property rights; gender inequality; poor governance and corruption; unequal political power and status.
• Significance: judge reach, bindingness, controllability, time and evidence, for a named country.