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					Sir Peter T. Bauer. “The Vicious Circle of Poverty.”

   - discusses the idea that „underdeveloped countries‟ are caught in a „vicious circle of
       poverty‟ (4)

   - these ideas are widespread, provide the basis of „important policy proposals and
       measures, notably for the suggestion that appreciable economic progress in poor
       countries requires drastic sacrifice at home, supplemented by large scale aid from
       abroad.‟ (4)

   - “The thesis states that poverty itself sets up well nigh unsurmountable obstacle to its
       own conquest.” (4)

    - Found in a number of diverse forms…”The most frequent is that “the low level
        of income renders saving impossible, thus preventing the capital accumulation
        necessary for an increase in income.”

    - “Others include the suggestion that the narrow markets of poor countries obstruct
        the emergence and extension of the specialization necessary for high incomes;
        that demand is too small to permit profitable and productive investment; that
        government revenues are insufficient for the establishment of effective public
        services; that malnutrition and poor health keep productivity low, which
        prevents a rise of income,….International private investment cannot alleviate the
        situation, since one aspect of the vicious circle is a lack of profitable private
        investment opportunities.” (4)

  - Note that one view development potential in underdeveloped areas, was propounded
      by The Center for International Studies at MIT: “…poverty itself makes it
      impossible to carry out the required saving and investment by a voluntary
      reduction in consumption.” [Domestic incomes are so low, all of it must go for
      consumption (C) and none is left over for saving (S) and investment (I).]

 - Similarly from Ragnar Nurkse [1953. Problems of Capital Formation in
      Underdeveloped Countries], “…one of the best known and influential writings in
      this field. Under the chapter heading, „Vicious Circle of Poverty,‟ he wrote: “In
      discussions of the problem of economic development, a phrase that crops up
      frequently is „the vicious circle of poverty…” (4 sq.)

    Bauer notes caustically, that this “…can be summed up by the trite proposition: „a
      country is poor because it is poor.‟” (5) He argues that: “The supply of capital is
      governed by the ability and willingness to save; the demand for capital is
      governed by the incentives to invest.” He then notes that: “A circular relationship
      exists on both sides of the problem of capital formation in the poverty-ridden
      areas of the world.” (5) Bauer, then, identifies the circular relationships that were
      identified by Nurkse (5):
In graphic form, Bauer‟s description of Nurkse‟s „vicious circle of poverty‟ is arranged
As follows:


                               Small Capacity to Save



       Low Level of Real            Supply Side           Lack of Capital
           Income



                                  Low Level of
                                  Productivity




                       Inducement to Invest is Low



 Small buying Power               Demand Side
    Of the People

                                                          Small Capacity to
                                                                Save

        Low Level of Real
                   Income

                                 Low Level of
                                 Productivity


He notes that Nurkse wrote: “The low level of real income, reflecting low productivity, is
a point that is common to both circles.” (6)

        Bauer explains that this „thesis‟ may be expressed as a model: “The model of the
vicious circle of poverty and underdevelopment is a particular model designed to explain
the continuation through time of a zero or negligible rate of economic growth. The
essential variables and relationships in most growth models are these: the growth of
income is a function of the rate of capital accumulation that is of investment; investment
depends on saving; and saving is a function of income. Hence the growth of income
depends on the growth of capital and the growth of capital depends on the growth
income. Thus the model behind the thesis of the vicious circle of poverty pivots on the
suggestion that the low level of income itself prevents the capital formation required to
raise income.” (6)

        Bauer continues, dismissively: “This thesis is demonstrably and indeed obviously
invalid. If it were valid, innumerable individuals, groups and communities could not have
risen from great poverty to riches as they have done throughout the world in both rich and
poor countries. This in itself should be sufficient to disprove the thesis as a general
proposition. The thesis is refuted also by the very existence of developed countries all of
which started poor, with low incomes per head and low levels of accumulated capital, i.e.
with the economic features which define underdeveloped countries today. Yet they have
advanced, usually without appreciable outside capital and invariably without external
grants. This would have been impossible on the arguments of the vicious circle of poverty
and stagnation. As the world is a closed system and clearly began in a state of
underdevelopment the thesis is indeed inconsistent with the phenomenon of development.
In a recent macroeconomics introductory textbook, N. Gregory Mankiw (2004),
Economic Advisor to President Bush, has written:

       Because capital is a produced factor of production, a society can change the amount of
       capital it has. If today the economy produces a large quantity of new capital goods, then
       tomorrow it will have a larger stock of capital and be able to produce more of all types
       of goods and services…one way to raise future productivity is to invest more current
       resources in the production of capital. (Principle of Macroeconomics, 3rd Ed., 249)

Clearly, Mankiw is talking about what the Austrian School refers to as ‘the problem of
intertemporal resource allocation.’ A good example of this „problem‟ is discussed in
Stephen L. McDonald (1971) Petroleum Conservation in the United States: An Economic
Analysis (Resources for the Future). Note that it was published a couple years before the
„first energy crisis‟ in 1973/74. Chapter Five of this book, entitled, “The Optimum Time-
Distribution of Use”, provides a mathematical approach for the present-value-maximizing
conditions of a resource‟s utilization (77):

                                       (MNRt)
                      MNR0 = (1 + bt) -----------
                                        (1 + r)t
His approach takes into account:

       Marginal net revenue (MNR) or increment to net revenue resulting from a unit
              shift in production between periods (subscript 0 indicates the present;
              subscript t indicates any point in future time);

       b - is the fraction of a unit of production lost from ultimate recovery in the period
                 indicated as the result of producing the last unit at present;

       r - represents the rate of discount (i.e., rate of interest adjusted for risk and
                uncertainty). (77)
McDonald then provides an example:

Assume that MNR0 = 2.20; MNRt = 2.31; b = 0.048; r = 0.10; and t = 1. Then:

                                         (2.31)
                         2.20 = (1.048) --------- = 2.20
                                            (1.10)

       To shift a barrel of production between the present and one year from now (in either
       direction) would add nothing to net present value: the gain of present value would be
       2.20 and the sacrifice of present value would be 2.20. But if MNR0 were greater than
       2.20 (the other values given), it would pay to shift some production from a year from
       now to the present; or if MNR1 were greater than 2.31 (the others values given), it
       would pay to shift some production from the present to one year from now. (77)

McDonald develops a number of additional scenarios reflecting different assumptions,
e.g., if b = 0 (“no loss of recovery a year from now as a result of the last unit presently
produced.”) (77) He then lengthens the future time-horizon to n.

       Finally, Bauer writes that: “It [the „vicious circle of poverty‟ thesis] is also refuted
by the rapid economic advance of many underdeveloped countries in recent decades
which for obvious reasons is particularly relevant in this context.” (6)

         Bauer then cites the growth rates (GNP) and output/capita in various areas of the
world – ECLA (Economic Commission for Latin America): between 1935 and 1953 GNP
in Latin American countries rose by 4.2%/annum, while output/capita increased by 2%;
and over the 1945 – 1955 period, GNP increased at 4.9% per year and output/capita by
2.4% per year. (6-7) He notes that there has been „rapid and readily demonstrable
progress‟ in South East Asia and West Africa, reporting that while the per capita income
figures are “low by Western standards”, he notes parenthetically “the conventional
statistics much exaggerate the income differences between the developed and
underdeveloped countries”. He then reminds us, low as they are, “they nevertheless
reflect substantial advance since the beginning of the century, when these were
essentially subsistence economies.” (7) He then provides figures for South East Asia
supporting these conclusions (output of rubber and value of exports). Malaya for
example: in 1900, total exports were worth ₤ 8 million annually; in 1963, the value had
expanded to ₤ 300 million/year also noting share that was Asian owned. (7-8) This
“reflects largely the spread of the exchange economy in South East Asia.” (8, emphasis
added)

       He cites the progress in West Africa (Ghana and Nigeria): “…since the end of the
nineteenth century has been striking, rapid and well documented.” (8) He continues:

       There is ample evidence of this progress from sporadic national income figures and, more
       relevant and revealing, from the statistics of population growth, foreign trade, government
       revenue, literacy, health, infant mortality, and so on. The rapid progress of Ghana is reflected
       in statistics which are somewhat more reliable and meaningful than elsewhere in Africa or
       Asia. As already noted, by the early 1960‟s the national income per head was about ₤ 75;
       in real terms it had doubled since 1910 and quadrupled since 1890. The total population
       approximately quadrupled between 1890 and 1960, from about 1.6 million to about 6.5. (8)

In the Rostowian scheme, even in the early years of the nineteenth century, both South
East Asia and Africa regions, with but few exceptions, remained „traditional societies‟ –
“one whose structure is developed within limited production functions, based on pre-
Newtonian science and technology, and on pre-Newtonian attitudes toward the physical
world.” (1990. Stages of Economic Growth, 3rd Ed., 4) Somewhat later, he notes:

       …these societies, because of the limitation on productivity, had to devote a very high
       proportion of their resources to agriculture; and flowing from the agricultural system
       there was an hierarchical social structure, with relatively narrow scope – but some
       scope – for vertical mobility. (5)

By way of summary, Rostow concludes:

       In terms of history then, with the phrase „traditional society‟ we are grouping the whole
       pre-Newtonian world the dynasties in China; the civilization of the Middle East and the
       Mediterranean; the world of medieval Europe. And to them we add the post-Newtonian
       Societies which, for a time, remained untouched or unmoved by man‟s new capability for
       regularly manipulating his environment to his economic advantage. (5)

It is significant to observe what transpired after contact with the so-called Colonial
Powers – the populations in these areas grew rapidly, passing through what is known as
„demographic transition‟. The demographic transition model may be summarized as:

       Stage I – High birth rates offset by high and early death rates, population is
                      stable, traditional ways of viewing the physical world, limiting
                      productivity

       Stage II – Some change in economic/technological conditions, resulting in
                     suppression of the death rate as birth rates remain high,
                     population begins to grow rapidly

       Stage III – Social adjustments to high birth rates and growing population,
                      birth rates fall, coming back into conformity with the lowered
                      birth rates

       Stage IV – Lowered birth rates are associated with the lowered death rates,
                     population is stable

This pattern of demographic transition may be associated with each of the major bursts in
population outline by E. Deevey in his 1960s article, “Human Population”. It is
significant to reflect on the close parallel between contact by a „subsistence economy‟
[South East Asia and Africa] with a „commercial economy‟ [the colonial nations – Great
Britain, France, Spain, Portugal], changes in „production functions‟ [commercialization],
and „demographic transition‟.
         The colonial period, then, initiated what Rostow called the era characterized by
the creation of „the preconditions for take-off‟‟, i.e., “societies in the process of transition;
that is, the period when the preconditions for take-off are developed; for it takes time to
transform a traditional society in the ways necessary for it to exploit the fruits of modern
science, to fend off diminishing returns, and thus to enjoy the blessings and choices
opened up by the march of compound interest.” (Rostow, 1990, 6; emphasis added)
Unfortunately for developing countries, „modern science‟ and its fruits are undergoing
constant change – what Joseph Schumpeter has characterized as a “perennial gale of
creative destruction”. (1942. Capitalism, Socialism and Democracy, 3rd Ed., Chapter VII)
He has written:

        …the contents of the labourer‟s budget, say from 1760 to 1940, did not simply grow on
        unchanging lines but they underwent a process of qualitative change. Similarly, the history
        of the productive apparatus of a typical farm, … is a history of revolutions. So is the history
        of the productive apparatus of the iron and steel industry…, or the history of the apparatus of
        power production…, or the history of transportation. The opening up of new markets, foreign
        or domestic, and the organizational development from the craft shop and factory to such
        concerns as U.S. Steel illustrate the same process of industrial mutation – if I may use that term –
        that incessantly revolutionizes the economic structure from within, incessantly creating a new
        one. This process of Creative Destruction is the essential fact about capitalism. It is what
        capitalism consists in and what every capitalist concern has got to live in. (83, emphasis in the
        original)

In a footnote to this passage, Schumpeter wrote:

        Those revolutions are not strictly incessant; they occur in discrete rushes which are
        separated from each other by spans of comparative quiet. The process as a whole works
        incessantly however, in the sense that there is either revolution or absorption of the results
        of revolution, both together forming what are known as business cycles. (83)

Schumpeter has emphasized in viewing and judging the process of „creative destruction‟
“we must judge its performance over time, as it unfolds through decades or centuries.”
(83, emphasis added) He continues:

        …in capitalist reality as distinguished from its textbook picture, it is not that kind of com-
        petition which counts but the competition from the new commodity, the new technology,
        the new source of supply, the new type of organization (the large-scale unit of control for
        instance) – competition which commands a decisive cost or quality advantage and which
        strikes not at their foundations and their very lives…. It is hardly necessary to point out
        that the competition of the kind we now have in mind acts not only when in being but also
        when it is merely an ever-present threat. It disciplines before it attacks. The businessman
        feels himself to be in a competitive situation even if he is alone in his field or if, though
        not alone, he holds a position such that investigating government experts fail to see any
        effective competition between him and any other firms in the same or a neighboring field
        and in consequence conclude that his talk, under examination, about his competitive sor-
        rows is all make-believe. (84-5, emphasis added)

Even Rostow acknowledged that the pre-conditions for take-off were only attained in
Western Europe in the late seventeenth and early eighteenth century,

        …as the insights of modern science began to be translated into new production functions
       in both agriculture and in industry, in a setting given dynamism by the lateral expansion
       of world markets and the international competition for them. But all that lies behind
       the break-up of the Middle-Ages is relevant to the condition of the preconditions for take-
       off in Western Europe. (6)

Rostow makes a pregnant observation for the later development of other regions to which
economic development was to diffuse –
       The more general case in modern history, however, saw the stage of preconditions arise
       not endogenously but from some external intrusion by more advanced societies. These
       invasions – literal or figurative – shocked the traditional society and began or hastened its
       undoing; but they also set in motion ideas and sentiments which initiated the process by
       which a modern alternative to the traditional society was constructed out of the old culture.

       The idea spreads not merely that economic progress is possible, but that economic progress
       is a necessary condition for some other purpose, judged to be good: be it national dignity,
       private profit, the general welfare, or a better life for the children.

Clearly, change in these regions was exogenous in origin, and was not the product of
endogenous factors since they had become mired down in a subsistence existence.

        During the Colonial period, both the South East Asian and African regions, and
the Americas, as well, were affected by their contacts with the colonial powers – induced
to change from subsistence to commercial economies and pulled inexorably into the
international marketplace. This movement required searches for what Robert Baldwin
and Douglass North have called an export base – rubber in Brazil, logwood in Belize,
cacao, vanilla beans, or chicle in Mesoamerica, teak in South East Asia or mahogany in
Meso- and South American rainforests. These initial commodity exports were low-value
added goods and commanded relatively low prices in international markets. When
consumers in these regions bought finished goods, with higher value added (skilled labor,
capital and entrepreneurship), than could be produced domestically, they paid free-market
prices.

        As time passed, and as risk capital was accumulated (usually by the more
successful and entrepreneurial citizens, it became feasible and economic desirable to
partially process the raw export commodities, i.e., adding additional capital and
entrepreneurship value to the goods, commanding higher prices in global markets. A
good example of this process is the shift from exporting „raw‟ logs to shipping either
squared-off forms or lumber, which required domestic investment in saw mills. As
household incomes rise, based on exports, local demand for consumer goods stimulates
investment in domestic production of consumer (residentiary) items (soap, beer, rough
furniture, printed materials). Further specialized production for the international market
provides additional opportunities to increase the export base, e.g., exploitation of marine
products which are perishable, inducing construction of processing facilities which
provide additional employment opportunities to the local labor force.

Developments in Africa

       Bauer has written:
       Statistics of foreign trade are of particular interest for West Africa because well over
       99½% of the population is African [as opposed to East Africa with its large Indian
       population]: all agricultural exports (the bulk of all exports) are produced by them and
       practically all imports are destined for their use. To take Ghana-Gold Coast first. In
       1890 there were no exports (or production) of cocoa; by the mid-1930’s these were
       about 300,000 tons annually, and by the early 1960’s they were over 400,000 tons, all
       from farms established, owned and operated by Africans; there are no foreign-owned
       cocoa farms. (8, emphasis added)

These observations are telling…so, where is the „colonial/capitalist exploitation‟ so
consistently articulated by Marxists, socialists and „dependendistas‟? In terms of the
„socio-economics‟, Bauer notes:

       In the early 1890‟s there were about 3,000 children at school; by the mid-1950‟s there
       were over half a million. In the 1890‟s there were neither railways nor roads, but only a
       few jungle paths, and transport of goods was entirely by human porterage and by canoe.
       By the 1930‟s there was a substantial railway mileage and a good road system; by then
       journeys by road required fewer hours than they has required days in 1890.

       Substantially the same applies to Nigeria. (8)

       The economic development of West Africa is only the most striking instance of a more
       general experience in Africa since the end of the nineteenth century. There has been
       substantial material advance in many parts of the continent, those parts with which the
       developed world has established contact…. By Western standards, sub-Saharan Africa
       was materially almost unimaginably backward in the third quarter of the nineteenth
       century. For instance, there were no schools and no man-made communications in the
       interior (with the irrelevant exception of a few primitive paths chiefly cut by slave traders
       or raiders).

       In many areas this progress has meant the suppression of slavery and tribal warfare and this
       disappearance of famine and of the worst epidemic and endemic diseases. It has meant the
       development of communications, the replacement of local self-sufficiency by the possibilities
       of exchange and the emergence and growth of cities…. In West Africa slave raiding and
       slavery were still widespread at the end of the nineteenth century; in 1900 the towns in
       Northern Nigeria, which are now centers of the groundnut trade, were important slave markets.
       (9, emphasis added)



Bauer then discusses the founding and development of Hong Kong and its evolution into
a world-class manufacturing centre…, noting ironically,

       Throughout the Western world This rapid severe barriers have come to be erected against
        imports from Hong Kong to protect the domestic industries of the United States, Great Britain,
       Germany and France from the unsubsidized competition of the industries of Hong Kong, an
       underdeveloped country, 8,000 or more miles away. This rapid progress has occurred in spite
       of the presence of three features often said to reinforce the vicious circle of poverty, namely
       lack of natural resources, extremely severe population pressure, and a very restricted domestic
       market.

       The level of income in underdeveloped countries is by definition low, but this is compatible
       with advance, indeed even rapid advance, if that advance has begun only recently, and has
       started from a very low level. This is the position in many underdeveloped countries.
       The thesis of the vicious circle of poverty postulates that low average levels entail zero
       rates of change, which is readily refuted by observation; or alternatively, the thesis
       identifies a low level with a zero rate of change, which is a simple error in logic. It is
       remarkable that such a crude notion should have been so widely accepted. (10,
       emphasis added)

He reports that these comments should not be construed to mean that:
       …there has been material progress throughout the underdeveloped world. There are
       substantial groups and large areas in the underdeveloped world which have progressed
        little in recent times…These are areas largely of subsistence agriculture. There is
       nothing abnormal or unexpected even in extreme material poverty in these circumstances.
       In particular, it has nothing to do with a generally operative vicious circle of poverty.
       There is no general rule or prescriptive right ensuring that all countries or regions should
       reach the same level of economic attainment or the same rate of progress at any given
       time or over any given time or over any given period. Economic progress and achieve-
       ment depends very largely on human qualities and attitudes, on social and political
       institutions, which derive from these, on historical experience and also on natural resources
       and of various other factors. (10-1, emphasis added)

Transformation of a subsistence economy into a market economy and its integration into
the global marketplace creates tremendous problems, e.g., “Problems of changes in land
tenure arrangements and property rights and inheritance, personal and social problems
arising from detribalization and from the transformation of a subsistence into a money
economy….the insistence on the vicious circle of poverty has served to obscure these
other real problems, and to divert attention and energy from attempts to deal with them.”
(11)

       Bauer records the observations of traveler to Africa at the end on the nineteenth
century, noting the conflicts between cultures. Mary Kingsley had written:

       If you will try Science [i.e., anthropology], all the evils of the clash between the two culture
       periods could be avoided, and you could assist these West Africans in their thirteenth century
       state to rise into their nineteenth century state without their having the hard fight for it that you
       yourself had. (1901. West African Studies, 2)

In many regards this is a similar argument to the one made by Alexander Gerschenkron
in his work on the „economic advantages of backwardness‟.He continues by quoting from
the book, The Economic Revolution in British West Africa (1926), written by Allan
McPhee:

       In fact, the process since the „Nineties of the last century has been the superimposition
       of the twentieth century after Christ on the twentieth century before Christ, and a large
       part of the problem of native policy is concerned with the natives during the difficulties
       of transition…The transition has been from the growth of subsistence crops and the
       collection of sylvan produce to the cultivation of exchange crops, with the necessary
       implication of a transition from a „Natural‟ economy to a „Monetary‟ economy, and the
       innumerable important reactions from the latter phase. (3)

One of the more vexing problems in this transition is to be found in the creation of
individual property rights. He writes:
       The problem of policy were particularly baffling in the context of land tenure (though
       by no means confined to it), notably whether individual rights in the cultivation and
       ownership of land should be permitted to replace communal or tribal tenure wholly or
       in part, again a problem which would not arise in a static or stagnant society. (13)

Communal or common ownership of any resource creates conditions most favorable for
its economically inefficient use. The problem has been described as „the tragedy of the
common‟ – the commons belong to no one but may be used by everyone. This results in
„overuse‟ and resource degradation. In private hands the land would be cared for since
the owner, and his/her descendants expect to use the resource over an extended period of
time. On a common, the first to get to the resource can capture the „best‟ – say a
grassland, first owner to arrive gets the best grass for his animals, so there is intense
competition for the use of the best land and a decided tendency for overgrazing to occur.
Extensive periods of overgrazing may permanently destroy the grassland, converting it
into a desert (see: the Sahal in Africa, south of the Sahara)

      Bauer cites the following passage from S. Herbert Frankel‟s (1960) article (“The
Tyranny of Economic Paternalism in Africa: A Study of Frontier Mentality, 1860-1960,”
Optima, 7):

       Looking back from the vantage point of our own times, it is clear that the root cause of
       the economic backwardness of various African territories

				
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