Unit 9 Uneven development on a global scale

9.6 Barriers to growth

A key difference between a typical country with a high level of per capita income and a typical country with a low level is that workers in the former have more capital to work with—in the form of machinery, equipment, and infrastructure (electricity, transport, and communications), and better technology. The data shows that their average level of education is also higher.

Infrastructure and education

external effect, externality

An external effect occurs when a person’s action confers a benefit or imposes a cost on others and this cost or benefit is not taken into account by the individual taking the action. External effects are also called externalities.

Why are infrastructure and education inadequate in low-income countries? Infrastructure and education have positive external effects, which means they will be under-provided by the private sector. Adam Smith pointed out in the Wealth of Nations that as a consequence, the government would have to be involved in funding transportation infrastructure, for example, and schooling. When governments are unwilling or unable to raise the necessary revenue from taxes and domestic borrowing, or to efficiently manage large-scale infrastructure projects and organizations such as school systems, growth will be constrained.

One important example of infrastructure is an electricity grid with the capacity to provide reliable electricity on the scale that is required. For households, electricity makes a big difference for living standards because, for example, it makes it much easier to have light after the sun goes down, and to use appliances such as a refrigerator. Lack of access to reliable electricity is a major barrier to the growth of firms and therefore to economic growth in low-income countries. Imagine running a restaurant when your fridge may turn off at any moment, an accounting firm where you cannot use desktop computers, or a garment factory where outages repeatedly interrupt the production line. Although businesses compensate by buying generators and providing their own power, this is expensive and diverts funds that could go towards other investments and growing the business. Reliable, low-cost energy for firms is linked with productivity, profitability, and job creation.

Figure 9.13 shows that there is a strong positive correlation between electricity consumption and per capita GDP. The causality works in both directions: higher-income countries demand more electricity, and greater consumption of electricity facilitates increased production and higher incomes.

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Figure 9.13 Scatterplot of electricity consumption and GDP per capita, 2023.

US Energy Information Administration. 2025. Global Electricity Consumption.; World Bank Group. 2025. World Development Indicators. Note: The countries labelled in red are discussed in more detail in Sections 9.9 and 9.10.

Coordination problems that hinder growth

Low public investment in infrastructure and education and low private investment in new technology may reinforce each other. Imagine an economy in which most production takes place using small-scale and low-productivity traditional technologies, requiring locally available inputs. Most workers have low levels of education and skills.

Highly productive modern technologies are available. Will entrepreneurs invest in new technology, leading to growth in output, income, and profits? Figure 9.14a shows how a coordination problem may leave the economy in a low-technology equilibrium, despite the potential benefits of adopting more modern methods.

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Figure 9.14a Low-technology equilibrium: investing in new technology is not profitable because no other entrepreneurs are investing.

This ‘vicious cycle’ is an example of a positive feedback loop, a concept that you can read more about in Section 8.2.

The ‘vicious circle’ in Figure 9.14a illustrates a situation in which no individual entrepreneur finds it profitable to adopt a modern technology. All production takes place in the traditional sector, for which the existing electricity network is adequate. Moreover, since few employers demand high-level skills, workers have little incentive to undertake education. An entrepreneur considering entering the modern sector would face high costs of electricity generation, and of attracting or training skilled workers, resulting in low or negative returns to investment. Continuing to operate in the traditional sector remains preferable.

There is another equilibrium in this economy, in which many entrepreneurs have adopted new technologies, as illustrated in Figure 9.14b. Demand for skills from the modern sector is now high—workers have incentives to improve their skills. The government responds to the modern sector’s demand for power by extending and modernizing the electricity network and improving access to education. In this equilibrium, success breeds success and more entrepreneurs invest in more advanced technologies. Output, wages, and profits grow.

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Figure 9.14b High-technology equilibrium: if many entrepreneurs adopt new technologies, entering the modern sector is profitable.

This economy faces a coordination problem similar to the investment coordination problem in Section 3.11 of the macroeconomics volume. If the government supplies the missing input (electricity and education in this case), this strengthens the incentive for each firm to invest in the modern sector, which in turn creates demand for acquiring higher skills and for further private sector investment complementary to the modern sector. While everyone would benefit if the whole economy moved from the low-technology equilibrium to the high-technology one, individual entrepreneurs cannot coordinate their investments so they choose to remain in the traditional sector.

developmental state

A government that takes a leading role in promoting the process of economic development through its public investments, subsidies of particular industries, education, and other public policies.

Government policy could solve the coordination problem by a combination of state-directed investment in infrastructure and education and export subsidies, for example. The developmental states in Japan, South Korea, and Taiwan are credited with using such policies in the 1960s.

Coordination problems restrict access by domestic firms and entrepreneurs to potentially high-return investment projects and associated new technology, which the model of the production function suggests should exist. These weaknesses will also dissuade foreign firms from investing even if wages are much lower than at home (Figure 9.9 shows the concentration of foreign direct investment by US companies in high-wage countries). In Unit 10, we address the question of why governments that divert tax revenues into gains for themselves or other members of the elite rather than into spending on infrastructure and education are able to stay in power.

There is some good news for people in countries where governments have not been able to solve coordination problems by providing key infrastructure: new technologies themselves are reducing some of the barriers to growth. For example, the development of mobile phone networks led by the private sector has reduced the need for hardware-based telecommunications infrastructure.

India, Ghana, and Nigeria are good examples of countries that have almost skipped the adoption of landlines entirely. Mobile telephony also means that in countries without branch banking infrastructure, rural populations have access to banking services using mobile phones. The decentralized production of electricity through solar panels is another example of a reduction in the need for large-scale infrastructure.