The Vicious Circle of Poverty

For poor countries, there is a point of view that they are destined to remain poor. The rationale behind the above statement is that, for poor countries, taking resources out of the production of consumer goods is very difficult because they are living so close to subsistence levels and the lack of saving can make it difficult for them to accumulate capital and grow.

That is called the vicious circle of poverty, which illustrates that the poor counties will remain poor if not poorer, while rich countries will grow even richer following the same circle. This essay will analyze the two types of countries, more specifically, the rich ones—the developed countries—such as the US and the European countries and the poor ones—the developing countries like China, India and most of the African countries. It will also examine how they function differently during the process of accumulating capital and grow. Further, this essay will explore ways as well as evaluating their feasibility for developing countries to break the vicious circle of poverty. Finally, this essay will draw some conclusion based on the overall analysis and give suggestions for the sustainable development of developing countries.

Comparison of developed countries and developing countries
First and perhaps the most important, is that in order for capital goods to be accumulated to produce greater quantities of consumer goods in the future, consumer goods have to be given up in the present. This can be illustrated using the production possibilities frontiers (PPF) model (see graphic 1). It shows the combinations of output that the economy can possibly produce given the available labor and resources as well as the available production technology with the two axis being the consumption goods and capital goods(). Given the limitation of resources and technology, if the country uses up more good for consumption, then it will leave fewer capital goods for investment (Mankiw, 2007).

Figure 1: PPF model of economic allocation

Second, apply the same model to the two different types of countries—developed and developing counties, and compare the choices by them. The two major differences between the two types of countries are the resources and technology. More often than not, developed countries are always having both more resources and much better technology than their developing counterparts. As a result, a developed country’s PPF curve will be much larger relative to its population. Graphic 2 illustrates the comparison of two countries, one developed and one developing, which both have similar population. As shown in the graphic, the developing country has a much smaller PPF curve than the developed country, which reflects its fewer resources and lower level of technology. What is worse, in the real cases, developing countries are always having much greater number of people as well as greater population growth rates.

Figure 2: comparison of PPF model in a developed country and a developing country

Third, consider the relationship between investment and consumption and see how it works differently in developed and developing countries. Assume the replacement level of investment represents the threshold level of investment (Ir as shown in figure 3)—the level of production that would just exactly replace the capital is worn out in the current period. Similarly, assume the subsistence level of consumption (Cs as shown in figure 3) equals that level of the production of consumption goods just sufficient to feed a country’s population without starvation.

Figure 3: Comparison of PPF model of economic growth

As seen from figure 3, the developed country has the ability to both feed its population at or above the substance level, and at the meantime, replace or expand its stock of capital. For example, the country can choose its production pattern on the PPF curve where shaded. In this area, it can feed its population and expand its production possibilities in the future.

While people in the developing country are living so close to subsistence levels and the country is lack of savings. So the choice for it becomes an “either or” question. It can choose between either feeding its population or expanding its production possibilities. Unfortunately, it cannot do both as in the shaded area, which is obviously beyond its production limit.

Finally, figure 4 illustrates how the vicious circle of poverty comes into being. If the developing country, for instance, decides to feed its population at the expenses of replacing worn out capital, the country must produce less than the replacement level of investment. As a result, in the future its production ability will further decrease and its PPF curve will shift back, making the decision even worse. At that moment, feeding its population would require an even lower level of production for capital goods, which will in turn lead to an even more serve shift back in its PPF curve. Consequently, if the country continues to choose to feed its population, the PPF curve will shift back to a point that it will be unable to either replace its capital or feed its population. Figure 4 illustrates these sequences by the movement over time from production possibility frontier P0 to production possibility frontier P1 and P2.

Figure 4: PPF model of vicious circle of poverty in a developing country

Ways to beak the vicious circle
While on a theoretical basis, the above analysis justify that the statement for poor countries, taking resources out of the production of consumer goods is very difficult because they are living so close to subsistence levels and the lack of saving can make it difficult for them to accumulate capital and grow. It seems that the poor counties are destined to remain poor, if not poorer. Supposedly, a poor country cannot get the capital investment to improve industry. Of course, that statement begs the question: how did any country ever get out of poverty? How did the first country get out of poverty? Clearly, there are ways that poor countries can lift themselves out of their “vicious circle of poverty.” Normally, there are three ways to break the vicious circle, to set the threshold of investment higher than required, to starve some of the population at the present in trade for the sustainable development in the future, and to get foreign aid from developed countries.

First of all, one of the solutions is for the developing country to decide to set its production of investment at more than the replacement level (that is higher than Ir shown in figure 3). From the perspective of the future, this choice has two advantages. First, it will expand the country’s PPF curve in the future (rightward to the new Ir level), reducing the poverty problem in the future. In fact, eventually the PPF will shift out enough so that the developing country will eventually be able to both feed its population and expand its production possibilities in the future (Goff, 2003).

Second, choosing to allow some of their population to starve will also move the country in the direction of being able to both feed its population and increase its PPF curve. Although it is not the ideal choice for a county, it is the only internal choice that may result in fewest deaths and the most future productive growth. This is true because some people will die through starvation, presumably those who are least productive. In the future, since the population is lower, the subsistence level of consumption will fall. Because it is the least productive who will starve, their deaths will not have a large adverse effect upon the PPF curve.

Finally, there is another more palatable solution exists, which is through foreign investment into developing countries. The vicious circle of poverty can be avoided if the country either has more resources or better technology. Foreign aid from developed countries can give developing countries either or both of these, allowing them to avoid the unpalatable choices discussed above and increase their PPF curves outward. Moreover, helping a developing country develop will also develop markets for the goods and services from developed countries, gaining economic benefits for them (World Bank, 2006).

From the analysis above, the economic growth and development refer to the expansion of economic choices, i.e., rightward or outward shifts in the PPF. For poor countries, there are limited resources and inferior technology, it is difficult for them to accumulate capital and grow.

While poor countries cannot afford to divert resources away from the production of consumption goods, they can escape from this situation with additional investment in capital from foreign aid. In absence of foreign investment, poor countries can also set its investment threshold higher than necessary or sacrifice few people in exchange of the sustainability of its economy, though not that favorable.
Goff, Peter. “Factors affecting economic growth in developing countries”, Development Economics Web Guide, Issue 1, May 2003

Mankiw, N.G. (2007) “Principles of Economics”, 4th edition, Harcourt College Publishers

World Bank, (2006) “The Economics of Developing Countries”, CHAPTER 16W.