Economic Development: An Overview

1. Lesson 1 Economic Development: An Overview

2. Preview • What is “economic development”? • The “level” and “distribution” of national income • Human Development • “Structural” characteristics of developing countries

3. What is “Economic Development”? • 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

4. Measuring Economic Development • 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 “level” of economic attainment • The “distribution” of economic attainment

5. Income and Growth Measurement Issues • 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?

6. Comparing Per-capita Incomes Across Countries • We need to convert per-capita incomes across countries into a common unit of measurement • Two methods of conversion: • The Exchange Rate Method • The Purchasing Power Parity (PPP) Method

7. The Exchange Rate Method • Convert each country’s income (reported in its local currency) to a 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)

8. Per-capita Income and PopulationSelected Countries

9. Problems with the Exchange Rate Method • 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

10. The Purchasing Power Parity (PPP) Measure • 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.

11. Comparison of PPP and Exchange Rate Estimates of Per-capita Income

12. PPP vs. Exchange Rate Measures of GDP

13. Problems with the PPP Measure • 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.

14. Some Stylized Facts • Over the last three decades, the world distribution of income has been stable • 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” within the world distribution of income • Rise of East Asia and BRIC (Brazil, Russia, India, and China) • Stagnation of sub-Saharan Africa and Latin America

15. The Power of “Compounding” • 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,

16. The Power of Compounding • 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

17. Changes in Income Relative to USA1960-85

18. The “Mobility” Matrix, 1962-84Danny Quah (1993)

19. What do we learn from the Mobility Matrix? • 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

20. The Distribution of Income Across the World

21. Facts About Inequality Across Countries • The richest 20% earn almost 50% of total per-capita income, while the poorest 40% earn only 15%: huge 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)

22. Inequality Across Countries

23. Human Development • 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

24. Sri Lanka vs. GuatemalaDistribution of Income

25. Sri Lanka vs. GuatemalaHuman Development

26. The Human Development Index(HDI) • The United Nations Development Program (UNDP) has reported the Human Development Index (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 ranking of countries according to the HDI is indicative of the state of development across countries

27. Per-capita Income and Human Development • So what should we look at: per-capita income or measures of human development? • Critical question: is per-capita income correlated with different measures of human development? • If the answer is “yes,” then per-capita income may be a good proxy for indicators of development

28. Per-capita Income and Life ExpectancyDeveloping Countries

29. Per-capita Income and Adult LiteracyDeveloping Countries

30. Per-capita Income and Infant MortalityDeveloping Countries

31. Per-capita income and Human 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

32. Structural Features of Developing Countries 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 young • 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)

33. Population Growth and Per-capita Income

34. Structural Features of Developing Countries 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

35. Fraction of Labor Force in Agriculture

36. Structural Features of Developing Countries 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

37. Non-agricultural Labor in Services

38. Percentage of Non-agricultural Labor Force in Services

39. Structural Features of Developing 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

40. Share of Primary Exports in Total Exports

41. International Trade • What determines the pattern and composition of world trade? • Theory of comparative 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

42. International Trade • 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 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

43. Changes in Terms of Trade1980-93