Lesson 1

What is “economic development”?

The “level” and “distribution” of national income

Human Development

“Structural” characteristics of developing countries

Growth in per-capita GNP (Gross National Product)?

Growth in the “quality” of life? Increases in life expectancy Lower infant mortality Access to sanitation, drinking water, power Access to healthcare and education

Measures of “quality” of life are correlated with GNP

Economic development is a complex and multi-dimensional aspect of the evolution of societies

First step: understanding the income generation process in a country

Two issues that influence development: The “levellevel” of economic attainment The “distributiondistribution” of economic

attainment

Per-capita income and economic growth are good indicators of the “level” of economic attainment

Huge and persistent disparities in per-capita income across countries

But how do we measure these differences?

We need to convert per-capita incomes across countries into a common unit of measurement

Two methods of conversion: The Exchange Rate Exchange Rate Method The Purchasing Power Parity Purchasing Power Parity (PPP)

Method

Convert each country’s income (reported in its local currency) to a common benchmark common benchmark currency, such as the U.S. dollar, and then divide the result by the country’s population

Provides a measure of per-capita incomes across countries in terms of a common currency (US dollar)

Comparisons using this method are usually biased. Why? Under-reporting of income in developing

countries (inefficient tax collection systems, tax evasion, income generated for self-consumption, etc.)

Prices for many goods are not reflected in exchange rates (non-traded goods such as infrastructure, services, public goods, etc.)

Exchange rate method underestimates the real income of poor countries

Constructs international prices (in terms of a common currency) for baskets of goods and services across countries.

National income is then estimated by measuring the value of output at these constructed prices.

Construction of price indices require information about the market structures of the goods and services being considered (i.e., competitive or non-competitive), which are not always available

These estimates ignore costs that arise out of externalities such as pollution.

Over the last three decades, the world distribution of income has been stablestable The richest 5% nations had per-capita

incomes 29 times higher than that for the poorest 5%

However, there has been a lot of “mobility” withinwithin the world distribution of income Rise of East Asia and BRIC (Brazil, Russia,

India, and China) Stagnation of sub-Saharan Africa and Latin

America

Given a rate of growth, how long does it take for a country’s income to double?

A dollar invested at r % per year will grow to two dollars in T years, where

Taking logs,

21001 Tr

2ln100/1ln ee rT

Now,

Then,

A country growing at 5% per year will double its per-capita income every 14 years

A country growing at 1% per year will double its per-capita income every 70 years

xxx ee 1ln ,number small afor and 7.02ln

income of rategrowth theis where,/70 rrT

Middle income countries were the most mobile

Poor countries were the least mobile Several countries changed their

relative position: There are no “traps” to development But history seems to matter for the future

A history of extreme underdevelopment does put countries at a disadvantage

The richest 20% earn almost 50% of total per-capita income, while the poorest 40% earn only 15%: hugehuge disparity across countries

Majority of wealth is concentrated in the hands of the “minority”

Inequality seems to rise and then fall as per-capita income increases: “inverted U-hypothesis” (Kuznets, 1955)

Relying solely on per-capita GNP as an index of development is risky A fairly prosperous country with high

inequality may have low literacy, high infant mortality, low empowerment of women, etc

A fairly poor country might spend a lot of resources on health and education

The United Nations Development Program (UNDP) has reported the Human Development Index Human Development Index (HDI)(HDI) since 1990

The HDI for a country is the average of three components: Life expectancy at birth Measure of educational attainment Per-capita income

The HDI for each country takes a number between 0 and 1: the “fraction of ultimate development”

The rankingranking of countries according to the HDI is indicative of the state of development across countries

So what should we look at: per-capita income or measures of human development?

Critical question: is per-capita income correlatedcorrelated with different measures of human development?

If the answer is “yes,” then per-capita income may be a good proxyproxy for indicators of development

Even though understanding the HDI is important, per-capita income must be taken very seriously

Though relationship between per-capita income and indicators of development are strong, they are not perfect

Reflects roles played by social and cultural attitudes, government policy, institutions

Demographic Characteristics

Poor countries have high birth and death rates

With development, death rates fall, but birth rates remain high Leads to high population growth (for a while):

may have negative effects on growth Overall population is youngyoung A young population A young population can have two consequences:▪ Combined with poverty, can lead to child labor and low

education▪ If education is a priority, country can reap “demographic

dividend” (think of India and China)

Occupational and Production Structure

Agriculture accounts for a significant proportion of production (30% for low-income countries)

Share of labor force living in rural areas is very high (72% on average)

In developed countries, less than 20% of the labor force live in rural areas

Rural-Urban Migration

“Push” from agriculture: poverty and landlessness

“Pull” from urban sector: high wages and living standards

Between 1980-93, urban population growth was double that of overall population growth in developing countries

A large fraction of the urban labor force is in “services” When industrial jobs are scarce, an “informal” sector

develops in urban areas People shine shoes, petty retailers, middlemen, domestic

aids, etc This is different from the “service sector” in developed

countries

International Trade

Exports from developing countries: primary products (raw materials, cash crops), textiles, light manufactures

Exports from developed countries: manufactured goods (capital goods, consumer durables), technology

What determines the pattern and composition of world trade? Theory of comparative advantagecomparative advantage Countries specialize in exporting goods

in which they have a relative cost advantage (lower opportunity cost of production)

Developing countries have a relative abundance of unskilled labor; this is reflected in their exports

Emphasis on primary exports may be detrimental to developing countries Prices of primary products are volatile: creates

instability in export earnings Over time, such products become less important in

the consumption basket

Terms of tradeTerms of trade: ratio of the price of exports to the price of imports An increase in terms of trade is “good” and vice-

versa

Poor countries are more likely to face a decline in their terms of trade compared to rich countries