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3 Major Causes of Vicious Circle of Poverty (With Diagram)

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Different economists have different opinions about the vicious circle of poverty.

According to Prof. Nurkse, “The main reason of vicious circle of poverty is the lack of capital formation.”

Similarly, Kindleberger opined that vicious circle of poverty takes place due to the small size of the market.

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However, the reasons of vicious circle of poverty can be classified into three groups:

(a) Supply side of vicious circle.

(b) Demand side of vicious circle.

(c) Vicious Circle of Market Imperfections.

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A. Supply Side of Vicious Circle:

Supply side of vicious circle indicates that in underdeveloped countries, productivity is so low that it is not enough for capital formation. According to Samuelson, “The backward nations cannot get their heads above water because their production is so low that they can spare nothing for capital formation by which their standard of living could be raised.”

In the words of Prof. Nurkse on the supply side there is small capacity to save resulting from low level of national income. The low real income is a reflection of low productivity, which in turn is due largely to the lack of capital. The lack of capital is a result of the small capacity to save and so the circle is complete.

Low Income → Low Saving → Low Investment → Low Production → Low Income

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The supply side of vicious circle can be illustrated with the help of a fig .1

Supply Side of Vicious Circle

Reflects the UDCs are poor. In these countries poverty refers to low real income .Real income remains low due to low level of capital and capital is low because of low level of saving. The reason of low saving is low level of income. Those, it becomes clear from the above analysis, that the main reason of low level of poverty and income is the low level of saving. Consequently, investment is not possible in production channels. A man can save only when his real income exceeds consumption. Generally, in UDC, society is divided into two groups viz.; rich and poor.

In such countries, majority of farmers are from poor groups. Their income is very low because they are engaged in subsistence farming. The methods of cultivation are old and unskilled. The productivity of labour is low due to unskilled labour, disguised unemployment and immobility of labour. Under such situation, a huge chunck of national product is consumed on consumption purposes. In this way, they lack in saving, investment and so the capital formation.

Although, the rich group of the society is in a position to save. But, they spend their saving on luxurious goods instead of saving. They gave preference to foreign products. Thus, their demand does not enlarge the size of the market. Basically, in an economy, investment does not depend only on saving, but also on ability to invest and willingness to invest. These countries lacks in investment facilities due to low level of demand.

The quantity of investment depends on able entrepreneurs. Able entrepreneurs have to take risk and put hard work to set up a new industry. The social atmosphere of the rich class is such that they do not dare to take risk. They prefer to put some labourers on work. Moreover, in UDCs, there exist medium income group who prefer to work in trade, services etc. instead of capital formation. The main reasons responsible for this are lack of capital for investment in industries, lack of industrial finance, lack of skilled labour, lack of transportation and social overhead etc.

B. Demand Side of Vicious Circle:

According to Prof. Nurkse, “On the demand side, the inducement of invest may he low because of the small purchasing power of the people, which is due to the small real income, which is again due to loco productivity. The level of productivity however, is the result of the small amount of capital used in production which in turn may be caused or at least partly caused by small inducement to invest.

Low Income → Low Demand Low Investment → Low Productivity → Low Income

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Fig. 2 shows that low income leads to low demand which in turn results in low investment and so the low level of capital which again leads to low productivity and low income. The main reason of the poverty in these countries is the low level of demand. Consequently, the size of market remain low. The small size of the market becomes a hurdle in the path of inducement to invest.

Demand Side of Vicious Circle

Thus, the investors do not establish industries on large scale and productivity remains low and so the income. In order to prove this, Prof. Nurkse has cited many examples. For instance, an entrepreneur will not establish a modern shoe factory in a country where the people are poverty ridden and unable to purchase shoes. Similarly, iron and steel industry in Chile will produce so much iron and steel in three hours that the entire demand of the country can be fulfilled. Thus, according to Nurkse, “In underdeveloped countries, on demand side, low purchasing power of the people results in low productivity.”

C. Vicious Circle of Market Imperfections:

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Meier and Baldwin have described a third vicious circle based on capital deficiency due to market imperfections. In underdeveloped countries, resources are underdeveloped and people are economically backward. Existence of market imperfections prevents optimum allocation and utilization of natural resources and the result is underdevelopment and this, in turn, leads to economic backwardness.

The development of natural resources depends upon the character of human resources. But due to lack of skill and low level of knowledge, natural resources will remain unutilized, under-utilized and misutilised. In the words of Meier and Baldwin, “Underdeveloped resources are, therefore, both a consequence and cause of the backward people… The more economically backward are the people, the less developed will be natural resources, lesser the development of natural resources more the people are economically backward.” The vicious circle caused by Market Imperfections is shown as under.

Vicious Circle of Market Imperfections

The vicious circle of poverty is a result of the various vicious circles which were on the sides of supply of and demand for capital. As a result capital formation remains low productivity and low real incomes. Thus, the country is caught in vicious circles of poverty which are mutually aggravating and it is very difficult to break them.

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