Economic Life-Cycle of a Country (5 Steps)
Economic development is a dynamic process, often visualized as a cycle that progresses through various stages.
These stages are not merely a measure of income and wealth but also show up in terms of societal values, behaviors, and self-perception.
The economic life-cycle of a country, consisting of what might be viewed as five main stages, provides a roadmap to understanding this journey from being impoverished to affluence, and the eventual onset of decline.
This is a theme that we’ve seen throughout history.
Each stage is marked by distinctive economic behaviors and trends that reflect the country’s evolving mindset toward wealth and financial stability.
When you go through this list, you might think of where your own country is, or that of other countries might be.
Moreover, you might think of how this might impact trading and investing opportunities as well as global geopolitical influence down the line.
Key Takeaways – Economic Life-Cycle of a Country
- Economic development is a dynamic process that progresses through stages, reflecting societal values and behaviors, in addition to traditional markers of income, expenses, assets, and liabilities.
- Each stage of the economic life-cycle is characterized by distinctive economic behaviors and trends.
- Understanding the economic life-cycle can help countries navigate their development journey and adapt strategies for sustainable growth.
- It can also help traders/investors visualize what opportunities might be available going forward.
Stage One: Perception and Reality of Poverty
The first stage in the economic life-cycle of a country is characterized by the perception and reality of poverty.
These countries often have minimal income levels, with the majority of their population living a subsistence lifestyle.
Financial scarcity drives a deep value for money, resulting in little to no waste and negligible debt.
Typically, such countries find it challenging to attract lenders, mainly due to their minimal savings and undeveloped economic state.
Statistically, countries in this stage experience low Gross Domestic Product (GDP) per capita.
Stage Two: The Emergence of Wealth
The second stage sees countries getting richer rapidly, yet, the mindset from the first stage persists, still viewing themselves as poor.
This stage is marked by increased income and a consequent rise in savings and investment.
The previous generation’s frugality, work ethic, and financial cautiousness are still prevalent, manifesting in behaviors like increased work hours, export-led economies, pegged exchange rates, high saving rates, and efficient investment in infrastructure and reserve-currency countries’ bonds.
Their exchange rates are frequently tied to that of their largest export partner or that of the world’s reserve currency. Sometimes it’s both (e.g., the relationship between Vietnam and the US where the VND is pegged to the USD).
For instance, China, in the late 20th and early 21st century, saw immense economic growth but continued to uphold the values of frugality and hard work.
This reflected in its high savings rate, which in 2010 stood at a staggering 52% of GDP, and a strong emphasis on export-led growth.
Stage Three: The Shift to Affluence
In the third stage, countries not only become rich, but they also start perceiving themselves as such.
High per capita incomes, productivity gains from past investments in infrastructure, R&D, and capital goods, characterize this stage.
There’s a marked shift in the collective mindset from survival and saving to enjoying the fruits of economic prosperity.
This shift becomes evident as a new generation, who may not have lived through past hardships, comes to the forefront.
Statistics show a reduction in work hours and a spike in leisure and luxury goods expenditure.
For instance, countries like Germany and Sweden saw a decrease in average weekly work hours from around 41 hours in the 1980s to approximately 34 hours in the 2020s.
Meanwhile, the global luxury goods market, heavily influenced by rich economies, was projected to grow to approximately $1.45 trillion by 2040.
Stage Four: Perception Vs. Reality
The fourth stage is marked by a widening gap between perception and reality.
Countries begin to become poorer but continue to see themselves as rich.
This stage sees a surge in debt relative to income as countries become expensive due to high earning and spending levels.
Their balance sheets deteriorate, but the spending gives an illusion of wealth.
Investments in infrastructure, capital goods, and R&D are reduced, leading to a slowdown in productivity gains.
There’s often a higher military expenditure to protect global interests.
Countries like the US exemplify this stage, with its high national debt, unfunded obligations at many times the national debt figure, and high military expenditures leading to large deficits.
This, in turn, requires the issuance of debt. The debt load can become dangerous once there’s not the organic demand for it, which means it has to be monetized, which devalues the claims.
This can lead to problems like inflation and currency weakness.
Can this be reversed?
Ultimately, getting out of a highly indebted state will involve being more productive, working more, and spending less.
But that’s not easy to do.
It’s not easy to arrest a decline because of embedded behaviors and what’s already happened to make things the way they are.
Stage Five: Deleveraging and Relative Decline
The last stage in the cycle is characterized by deleveraging and relative decline, often hard for countries to accept.
Bubbles burst, and deleveraging leads to reduced private debt growth, private sector spending, asset values, and net worth.
As a countermeasure, government debt growth, deficits, and central bank money printing increase.
Consequently, these countries have to compete with cheaper countries in earlier development stages (e.g., their workers are less cost-competitive relative to those in cheaper countries). Their global power diminishes as economic and financial trends decline.
Japan, in the 1990s, experienced this phase, known as the “Lost Decade,” where asset price collapse led to economic stagnation and deflation.
Central bank interest rates were drastically reduced, and government spending was increased to combat the economic downturn.
What characterizes this stage?
Classically, there are fiscal deficits. This requires debt creation.
When there isn’t enough organic demand for the debt, money printing has to make up the remainder, known as debt monetization.
This leads to a devaluation of the currency and a devaluation of the financial claims denominated in that currency. It is bad for the holders of its cash and credit.
When holders of it start selling because they’re getting poor real returns, the combination of:
- the selling from existing holders and
- selling from governments (due to their deficits)…
…into inadequate demand forces:
- higher interest rates or
- the central bank printing money to soak up the excess
Neither is good.
Higher interest rates create economic weakness and money printing devalues money and credit.
What the decline looks like historically
Because the interest rate received on the money and debt aren’t on par with the rate the currency is declining due to the underlying capital flow (money moving into other currencies and things/stores of value that give better prospective returns).
That’s why governments often ban gold or impose foreign exchange controls to control the outflow. Sometimes they’ll impose wage and price controls, though they tend to just create distortions and aren’t very effective.
The devaluation goes on until a new balance of payments equilibrium is established.
This means you get a large enough level of forced selling of real and financial assets and enough reduced buying of them by domestic entities to the point where they can be paid for with less debt.
This is the point that entails the loss of reserve status. And the loss of reserve status effectively means forced budget controls – or further currency depreciation and the bad effects of that if overspending continues.
It means domestic entities can no longer spend as much, so the social and political consequences are bad. And once you get to that point, there’s nothing policymakers can do about it.
It’s simply a self-correcting mechanism from the excessive spending patterns of the past. You can’t spend beyond your means forever.
It’s true for any individual or collection of individuals (company or government).
How much any entity can spend beyond its means in the short run depends on its creditworthiness and whether the debt is being deployed effectively to obtain a positive ROI to benefit it in the future.
Reserve currency status is traditionally the last thing to go when an empire declines.
FAQs – Economic Life-Cycle of a Country (5 Steps)
What are the 5 stages in the economic life-cycle of a country?
The economic life-cycle of a country is generally broken down into five stages:
- Stage of Poverty: Countries are poor and know they’re poor. They have low incomes, people live a subsistence lifestyle, they value money, and don’t have significant debts. This is the undeveloped stage.
- Stage of Rapid Growth: Countries are getting richer quickly but still think they’re poor. They start to save and invest more, have export-led economies, and invest efficiently in their means of production.
- Stage of Wealth: Countries are rich and see themselves as rich. They work less, spend more on leisure and luxury goods, and their infrastructure and investments start to pay off with increased productivity.
- Stage of Overconfidence: Countries are becoming poorer but still think they’re rich. They start to accumulate debts, cut corners, and spend heavily on the military. The infrastructure becomes older and less efficient.
- Stage of Deleveraging and Decline: Countries go through a phase of deleveraging and relative decline, which they’re slow to accept. Central banks and governments step in to alleviate the debt burdens, their currencies depreciate, and they begin to lose global power.
What behaviors characterize a country in the first stage of the economic life-cycle?
In the first stage of the economic life-cycle, countries are aware of their poverty and behave accordingly.
This means they have very low incomes, and most people lead subsistence lifestyles, using their incomes primarily to meet their basic needs.
Because money is scarce and highly valued, these countries do not accrue much debt; savings are minimal and lending is uncommon due to the high risk.
Overall, the country’s economy is undeveloped, with a lack of significant investment in infrastructure, technology, or industry.
How does a country transition from the first stage to the second stage of the economic life-cycle?
A country transitions from the first to the second stage of the economic life-cycle when they start to experience rapid economic growth.
This is usually due to increased productivity, whether from the discovery/exploitation of natural resources, the establishment of a strong manufacturing sector, or significant advancements in technology.
However, due to memories of past poverty, these countries often continue to behave cautiously, with a focus on saving, investing, and improving their export economies.
Why do countries in the third stage of the economic life-cycle start to work less and spend more on leisure and luxury goods?
Countries in the third stage of the economic life-cycle start to work less and spend more on leisure and luxury goods due to a change in mindset and economic circumstances.
With rising income levels and a new generation that hasn’t experienced the harsh conditions of poverty, the emphasis shifts from saving and working to enjoying the fruits of economic prosperity.
As a result, there’s a decline in average work hours and an increase in expenditures on non-essential items like leisure and luxury goods.
Why does the fourth stage of the economic life-cycle lead to an accumulation of debt and deterioration of infrastructure?
In the fourth stage of the economic life-cycle, countries still see themselves as rich despite beginning to become poorer.
This overconfidence leads to a reduction in savings, increased debt, and decreased investment in infrastructure and research and development.
Spending rises faster than income and liabilities start to rise faster than assets.
Since the countries are unwilling to adjust their spending habits according to their reduced income growth, they start to cut corners and accrue more debt, resulting in aging and less efficient infrastructure.
How do countries typically react to the last stage of the economic life-cycle?
In the final stage of the economic life-cycle, countries experience deleveraging and relative decline.
The reaction to this stage is often slow due to denial and overconfidence from the previous stage.
To combat the decline, central banks and governments increase their debt and print more money to stimulate the economy, leading to lower real interest rates and a depreciating currency.
Consequently, these countries start to lose their global power due to the weak economy and poor financial conditions.
The economic life-cycle of a country serves as a mirror reflecting its journey of economic development and the corresponding societal transformations.
However, these are not rigid phases but fluid stages, with countries can:
- stay in one phase permanently (i.e., stage 1, like many African countries)
- be a blend of more than one stage
- transitioning back and forth with structural changes made, or
- even skip stages depending on various factors like governance, wars, pandemics/floods/natural disasters, and global influence
Therefore, while this cycle offers insights, it’s equally important for countries to realize their unique contexts and adapt their strategies accordingly.