Briefly discuss the challenges developing countries face in capital and labor markets.

Question

What will be an ideal response?

Answer 1

POSSIBLE RESPONSE: Capital and labor markets work less efficiently in developing countries than in developed countries. In lower-income countries there are more barriers to loans for capital investments. Good capital investment projects must therefore overcome a higher cost of capital than the rate at which capital is available to less-promising sectors. An underlying reason is that property rights are less clearly defined and enforced, which discourages investment in new plant capital and equipment. Similarly, labor markets work less efficiently in developing countries. Wage gaps between expanding and declining sectors are greater than those in developed countries. The wider wage gaps are an indication that labor is not free to move to its most productive use. The lack of efficient capital and labor markets in developing countries present challenges for the government. If the government cannot quickly eliminate the barriers to efficient capital and labor markets, it would be faced with choosing which sectors to protect, or subsidize, or give cheap loans to. The government would also have to decide whether it is realistic to try to change the nation's comparative advantage. For instance, increasing its investment in education and healthcare would lead to expansion in the country's endowment of human skills.