ECO 2: ECONOMIC DEVELOPMENT

Comparative Economic Development

Common Characteristics of Developing Countries

● These features in common are on average and with great diversity, in
comparison with developed countries:

– Lower levels of living and productivity

– Lower levels of human capital

– Higher levels of inequality and absolute poverty

– Higher population growth rates

– Greater social fractionalization

– Larger rural population - rapid migration to cities

– Lower levels of industrialization and manufactured exports

– Adverse geography

– Underdeveloped financial and other markets

– Colonial Legacies - poor institutions etc.

Defining the Developing World

World Bank Scheme- ranks countries on GNI/capita

Human Development Index

● Recent efforts have tried to come up with an indicator that summarizes

several different “dimensions” of welfare

● The most well-known example is the Human Development Index (HDI),

developed by the United Nations Development Program (UNDP)
● The HDI combines measures of income, education (enrollment ratio
and literacy), and health (life expectancy), into a single measure

● The HDI is a relative index: the value for each country is between 0
and 1; it conveys the relative position of a given country in the overall
development schedule

● For example, a country with income per capita equal to $9,000, life
expectancy at birth equal to 71, adult literacy equal to 75%, and
enrollment ratio equal to 98% would have an HDI equal to 78

● Countries are classified into different “development groups” according

to the value of their HDI
 Overall Indicators of Development

● Non-economists (and some economists) usually reject the idea that

welfare and poverty should be measured by income alone

● Although income makes people live better, there are other dimensions
of people’s lives that are also important for welfare

● A large array of Social Indicators try to measure these different

dimensions

● Health variables: child mortality, life expectancy, malnutrition, number

of hospital beds per inhabitants, etc

● Education indicators: illiteracy, enrollment rates, average educational

achievement in the population, etc

● Access to service/information indicators: radios or TV’s per inhabitants,

circulation of newspapers, % of households with access to safe water,
etc

Can you think of other indicators?

Limitations of the HDI

● The weights given to health, education and income in the HDI are
arbitrary

● In an economic index, the weights should reflect the relative value of

the three variables for the population being analyzed: the marginal
rate of substitution between them; this is not the case in the HDI
● Nevertheless, changes in education and life expectancy have not
always been followed by changes in income

● In other works, part of the changes in life expectancy and education

are not correlated with changes in income ➔ the HDI can help to
account for the welfare implication of these changes

● How is it possible?

At any point in time, there is a close relation between life expectancy (or
education) and income; but this relation has been shifting
Human Development Index

GNP and
GDP

Once Again

● GNP – focused on nationality

● Sum of value of finished (or final) goods and services (as

opposed to intermediate outputs) produced by a country’s
economic agents (firms and households) during one year,
regardless of whether production takes place within or outside
the country.

● GDP – geographically focused

● Sum of value of finished (not intermediate) goods and services
produced in a country during one year, regardless of whether
foreigners or that country’s economic agents are doing the
production.

● Alternative definition of GDP (or GNP) – national income

● Instead of determining the size of the economy by counting up

the value of all finished goods and services, one can estimate
GDP by summing value added, industry/sector by industry/sector.
The single industry’s value-added is distributed as income to the
suppliers of labor, capital, and other factors of production.
Accordingly, the summation of all value added in an economy
equals national income.
 Looking at Purchasing Power Parity (PPP)

Purchasing power parity (PPP) is a theory which states that exchange

rates between currencies are in equilibrium when their purchasing power is
the same in each of the two countries. This means that the exchange rate
between two countries should equal the ratio of the two countries' price level
of a fixed basket of goods and services. When a country's domestic price
level is increasing (i.e., a country experiences inflation), that country's
exchange rate must depreciated in order to return to PPP. The basis for PPP is
the "law of one price". In the absence of transportation and other transaction
costs, competitive markets will equalize the price of an identical good in two
countries when the prices are expressed in the same currency.

PPP example:

A particular TV set that sells for 750 Canadian Dollars [CAD] in Vancouver
should cost 500 US Dollars [USD] in Seattle when the exchange rate between
Canada and the US is 1.50 CAD/USD. If the price of the TV in Vancouver was
only 700 CAD, consumers in Seattle would prefer buying the TV set in
Vancouver. If this process is carried out at a large scale, the US consumers
buying Canadian goods will bid up the value of the Canadian Dollar, thus
making Canadian goods more costly to them. This process continues until
the goods have again the same price. But there are three things to take into
consideration with this law of one price. (1) As mentioned above,
transportation costs, barriers to trade, and other transaction costs, can be
significant. (2) There must be competitive markets for the goods and
services in both countries. (3) The law of one price only applies to tradeable
goods; immobile goods such as houses, and many services that are local, are
of course not traded between countries.

Exchange Rate Conversion

● Many services (e.g., haircuts) and more than a few finished goods tend
not to be traded internationally. This complicates the task of comparing
per-capita GDP in one country with that of another country, as is
required for the systematic analysis of economic development.

● Suppose, for example, that a haircut in Hanoi, Vietnam costs 60,000

dong and the price of the same haircut in Baltimore is $20.
Converting the former price using the exchange rate of 20, 000 dong
yields $3. Obviously, this discounts the value of nontraded services
produced and consumed in Hanoi (or, equivalently, exaggerates the
value of the same services produced and consumed in Baltimore).

● Purchasing-power parity estimates of GDP correct for this distortion.

● Standard measure of dollar-equivalent GDP: Multiply GDP, as

expressed in local currency, by exchange rate.
 ● Purchasing-power parity measure: Evaluate all finished goods
and services using U.S. prices.

Measures of Living Levels and Capabilities

• Health

• Life Expectancy

• Education

• HDI as a holistic measure of living levels

• HDI can be calculated for groups and regions in a country

● HDI varies among groups within countries

● HDI varies across regions in a country
● HDI varies between rural and urban areas
Table 2.3 Commonality and Diversity: Some Basic Indicators
 What is new in the New HDI?
1. Calculating with a geometric mean

● Probably most consequential: The index is now computed with a

geometric mean, instead of an arithmetic mean

● A geometric mean is also used to build up the overall education index

from its two components

● Traditional HDI added the three components and divided by 3

● New HDI takes the cube root of the product of the three component
indexes

● The traditional HDI calculation assumed one component traded off

against another as perfect substitutes, a strong assumption

● The reformulation now allows for imperfect substitutability. See:

http://mathforum.org/library/drmath/view/52804.html

What is new in the New HDI?

2. Other key changes:

● Gross national income per capita replaces gross domestic product per
capita

● Revised education components: now using the average actual

educational attainment of the whole population, and the expected
attainment of today’s children

● The maximum values in each dimension have been increased to the

observed maximum rather than given a predefined cutoff

● The lower goalpost for income has been reduced due to new evidence
on lower possible income levels
Table 2.6 The 2010 New Human Development Index (NHDI), 2008
Data

Characteristics of the Developing World: Diversity within

Commonality

Lower levels of living and productivity

2. Lower levels of human capital (health, education, skills)

3. Higher Levels of Inequality and Absolute Poverty

● Absolute Poverty

● World Poverty

4. Higher Population Growth Rates

● Crude Birth rates

Table 2.7 The 12 Most and Least Populated Countries and Their Per
Capita Income, 2008
 Figure 2.5 Under-5 Mortality Rates,
1990 and 2005

Table 2.8 Primary School Enrollment and Pupil-Teacher Ratios, 2010

 Figure 2.6 Correlation between Under-5 Mortality and
Mother’s Education
Table 2.9 Crude Birth Rates Around the World, 2009

CRUDE BIRTH RATE is the number of resident live births for a specified
geographic area (nation, etc.) during a specified period (year) divided by the
total population (estimated) for that area and multiplied by 1,000.

2. Calculation: (Number of resident live births / Number of total population) x

1,000

3. Examples: 180,000 live births in calendar year among nation residents-

2,300,000 estimated population in calendar year

(180,000/12,300,000) x 1,000 = 14.6 live births per 1,000 residents in given

year
 Characteristics of the Developing World: Diversity within
Commonality

5. Greater Social Fractionalization

6. Larger Rural Populations but Rapid Rural-to-Urban Migration

7. Lower Levels of Industrialization and Manufactured Exports

8. Adverse Geography

● Resource endowments

Table 2.10 The Urban Population in Developed Countries and

Developing Regions
Table 2.11 Share of the Population Employed in the Industrial
Sector in Selected Countries, 2004-2008 (%)

Characteristics of the Developing World: Diversity within

Commonality
9. Underdeveloped Financial and Other markets

● Imperfect markets

● Incomplete information

10. Colonial Legacy and External Dependence

● Institutions

● Private property

● Personal taxation

● Taxes in cash rather than in kind

How Low-Income Countries Today Differ from Developed Countries in

Their Earlier Stages

● Eight differences

● Physical and human resource endowments

● Per capita incomes and levels of GDP in relation to the rest of the
world

● Climate

● Population size, distribution, and growth

● Historic role of international migration

● International trade benefits

● Basic scientific/technological research and development

capabilities

● Efficacy of domestic institutions

Are Living Standards of Developing and Developed Nations

Converging?

● Evidence of unconditional convergence is hard to find

● But there is increasing evidence of “per capita income convergence,”

weighting changes in per capita income by population size
Figure 2.8 Relative Country Convergence: World, Developing
Countries and Developed Countries
Nature and Role of Economic Institutions

● Institutions provide “rules of the game” of economic life

● Provide underpinning of a market economy

● Include property rights; contract enforcement

● Can work for improving coordination,

● Restricting coercive, fraudulent and anti-competitive behavior

● Providing access to opportunities for the broad population-

● Constraining the power of elites, and managing conflict

● Provision of social insurance

● Provision of predictable macroeconomic stability