Does Economic Growth Alleviate Poverty in Developing Countries?

overty alleviation has implied an important goal for developing countries and policy-makers throughout the last century. Recently, organisations such as the United Nations and the World Bank have reported an increasing necessity for centring efforts on facing determinant factors of poverty growth in such countries.

In light of this claim, the Organisation for Economic Co-operation and Development has reminded the paramount role of the economic growth as a powerful factor for reducing poverty in developing countries. Incidentally, this positive effect can be drawn from empirical evidence such as the unprecedented poverty reduction associated with economic growth in the India since 1980, the poverty reduction—from 69% to 54%—in Mozambique caused by a 62% economic growth between 1996 and 2002, or the Chinese’s economic growth, which have lifted 450 million of people out of poverty since 1979.

Since back in time, a set of growth models have tried to address the complex mechanics of economic growth. Albeit started with a neo-Keynesian focus on savings (Harrod’s model in 1939 and 1948; and Domar’s model in 1946 and 1947), the dominant economic-growth strand over time has been that based on the exogenous Solow-Swan’s model, of 1956 and 1957, and the endogenous model proposed by Paul Romer and Robert Lucas, in 1986 and 1988, respectively. Solow-Swan’s states the capital accumulation—allowing for slow-down returns in capital and labour as it continues—as the main factor for boosting economic growth, which leads to a steady-state where, without technological progress, a country’s economic growth does stop. As that neo-classical model exogenously assumes the technological advance, this deficiency led economists Paul Romer and Robert Lucas to calibrate the economic growth theory by mathematically demonstrating the endogeneity of technological progress, which assumes the human capital and the technological change (i.e. investment in Research & Development) as main causal determinants.

Subsequently, traditional policy recommendations towards increasing economic growth have been aligned with the aforesaid factors drawn from such models, i.e. foreign direct investment, international trade, fiscal measures, etc. Nevertheless, since recent evidence drawn from the seminal work of Dani Rodrik, which points to the undervaluation of a country’s currency as a robust, determinant factor for boosting economic growth, his consistent real-exchange-rate-based endogenous model has brought much of the aforesaid traditional literature into disrepute. Incidentally, the real exchange rate not only achieves to accelerate economic growth but also has a positive impact boosting export flows.

In order to put this mechanics into context, let us reflect upon the undervaluation (also called real-depreciation) of a country’s currency within an international arena. In such context, if a country’s currency becomes undervalued/real-depreciated, the international arbitrage does play a crucial role that results in boosting economic growth. This hypothetical prediction associates the misallocation of an economy’s resources—when taxes on tradable goods are higher than those on non-tradable goods—with a suboptimal economic growth—which is a consequence of the resulting small dimensions of the economy’s tradable sector—setting a set of conditions for real-depreciations to boost economic growth if considering the comparative advantage that it might result for international arbitrage.

In short, the calibration of Dani Rodrik demonstrates that real-depreciations can boost economic growth under the assumption that taxes on tradable goods are higher than those on non-tradable goods, which also increases profits on the tradable sector.

In light of the common claims in research, such as that by Anna Buchanan in her paper “Impact and knowledge mobilisation: what I have learnt as Chair of the Economic and Social Research Council Evaluation Committee”, it can be identified a paramount necessity for economic policies to be based on empirical evidence, which is suggested by the governments’ particular inclination for this type of policy recommendations. Such preferences can be understood as the evidence-based policies are more likely to succeed and have a real impact on the target issue, which contributes to avoid eventual risks and difficulties that may arise from well-intentioned policies without a scientific root.

The conclusion arising from this article is the following. First, there exist an obvious empirical linkage between poverty alleviation and economic growth. Second, since back in time, traditional models have sown the seeds of a theoretical controversy and hence of a controversial effectiveness of the economic growth in fighting poverty. Third, Rodrik’s proposed misallocation of economy’s resources has implied an answer for disentangling theory from pragmatism. To sum up, Rodrik’s well-managed real exchange rate might imply an excellent evidence-based tool for future, powerful measures aimed at effectively alleviating countries’ poverty with such particular characteristics, which might allow public policies to go beyond traditional paradigms.

Enrique Muñoz-Salido

MSc Candidate in Economics and Finance, University of Brighton. Master's Specialisation Student in Mixed Methods Research, OUDCE, University of Oxford. University of Brighton Santander Scholar. Co-Founder and Secretary of the Brighton University Economics Society.


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