Explain a constraint to economic development and offer a policy prescription

Countries who are dependent on primary products often are constrained in achieving economic development. Such a dependency offers two distinct issues. Firstly, as demand and supply for commodities are price inelastic, small external shocks, such as a drought, will have considerable price effects. This will in turn lead to fluctuations in producer's incomes as well as foreign exchange earnings. Price volatility has the consequence of limiting private investment and hence growth, Van der Ploeg and Poelhekke (2009) found economic growth declined with volatility of unanticipated output growth. Secondly, as argued by the Prebisch-Singer hypothesis, long term primary product dependency will cause a terms of trade deterioration over time. Primary products have a low income elasticity of demand, whereas manufactured goods have higher YED's, hence as incomes increase over time the price of manufactured goods rises faster than commodities. Consequently, over time prices of imports (manufactured goods) rises faster than that of exports (commodities). This not only reduces producer incomes and hence tax receipts, but also caps welfare as people cannot afford exports over time. To bypass the constraint of primary product dependency, a state run industrialisation strategy must be employed. The Ricardian theory of comparative advantage would suggest that in the absence of state intervention, self interested producers will supply that which they have a comparative advantage in (lower opportunity cost) and demand, via exports, that which they do not. This will only lead to the issue at hand - primary product dependency. Industrial policy therefore must incorporate ideas of dynamic comparative advantage, altering incentives to harbour new competitive industries. This is crucial for economic development, as no country has achieved modern economic growth without industrialisation, only Switzerland has industrialised without active state intervention and this was because the country was at the 'frontier' at the time (Chang). The USA from 1830-1940 was the most protectionist country in the world, only when it had achieved economic hegemony did it liberalise trade. Further evidence of the success of strong industrial policy can be found in east Asia. Japan virtually banned FDI until the late 1980s and invested heavily into education and as a consequence achieved growth of 8% p.c. from 1950-73. This can also be seen in Singapore, who also used SOEs to achieve growth (producing 22% of the country's GDP). Investment into education, specifically secondary education, has the effect increasing productivity through developing transferable skills, hence reducing occupational immobilities. Transferable skills lead to a workforce more willing to accept the dynamic changes of industrialisation - mainly mechanisation. To conclude, primary product dependency is a constraint to economic development. This can be overcome via a strategy of industrialisation to move away from primary products with diminishing returns to the secondary and tertiary sector.