ECON 306: Development Economics

BSS (Honours) third year, Department of Economics, University of Dhaka

The Economics of Development

Lecture by: Dr. Rubaiya Murshed
PhD and MPhil, Faculty of Education (Economics of Education), University of Cambridge
Lecturer, Department of Economics, University of Dhaka
What is ‘development’?
• Achievement of a minimum physical quality of life
• “The process of improving the quality of all human lives and capabilities by raising people’s
levels of living, self-esteem and freedom” – Todaro and Smith (2009)
• Definition can go further: political rights and freedoms, intellectual and cultural
development, family stability, low crime rate, religious values
• Minimum material well-being is a prerequisite
• Across time and across nations – inter-temporal and international
• Distinction between ‘economic development’ and ‘human development’
 Economic development
Economic development means an improvement in the quality of life and living standards, e.g.
measures of literacy, life-expectancy and health-care.
 Economic growth
• Economic growth: Economic growth refers to an increase in the size of a country's economy
over a period of time. The size of an economy is typically measured by the total production
of goods and services in the economy, which is called gross domestic product (GDP).

GDP growth rate: Bangladesh

Relationship between economic development and economic growth
Economic growth is the sustained increase in the value of a country's real GDP over time.
Economic development includes economic growth, but also considers the quality of life and the planet.
Therefore, economic growth generally brings economic development alongside it, but this is not guaranteed.
Capitalism and economic growth
What kind of economic growth is good for the society?
The importance of balance
Inequality and economic growth

It suggests that as an economy develops from a low-

income agrarian society to a higher-income industrial
and then post-industrial society, income inequality
follows a specific pattern. The Kuznets curve is often
depicted as an inverted U-shaped curve.

Economic growth will reduce income inequality if:

Wages of the lowest paid rise faster than the average
wage. Government benefits, such as; unemployment
benefits, sickness benefits and pensions are increased in
line with average wages.
How do economists think of the growth and
development process?
• Definition: Economic growth is an increase in GDP per capita, the
value of goods and services in the economy
• Theories of economic growth (e.g. the Solow model) understand
the combination of circumstances that drive economic growth
• Economic development not just about growth
• Economic development an increase in GDP per capita coupled
with decrease in poverty and inequality
• Equally interested in the distribution of resources, incentives and
institutions
What indicators can we use to measure
development?
• Indicators of physical well-being
• Income indicators such as GDP, GNP, per capita income
• Useful for international comparisons
• ‘In 1994, GNP per capita in Switzerand was 286 times that in Ethiopia’
• Other indicators
• Literacy, infant mortality, life expectancy
• Indicators of psychological well-being
• Attitudes and values
• Happiness
Various indicators used by economists to
measure development
• Physical well-being - GDP, per capita income
• Productive well-being - literacy, infant mortality, life expectancy
• Psychological well-being - attitudes and values, or happiness
• Political well-being - political rights and civil liberties
Is there any correlation between different
measures of development?
• Figure 1
Correlation between income and literacy
• Figure 2
Correlation between income and life
expectancy
• Figure 3
One way to think about the development process
Endowments
• Countries begin with economic
endowments
• Endowments favour the emergence of
particular institutions
Institutions • Institutions plus endowments produce
outcomes
• Outcomes determine endowments for
the future

Outcomes
Endowments
• Geography (e.g. trade and disease)
• Physical capital
• Human capital
• Infrastructure
• Information flows
• Undiversified assets (e.g. land and labour)
• Inequality
• Ethnolinguistic fractionalisation
Institutions
• Household production and dualism (e.g. use of family labour,
formal-informal sectors)
• Exchange with kin
• Informal and segmented markets
• Interlinkages between factor markets
• Weak governance and civil society
Outcomes
• Low savings
• Low investment in physical capital
• High fertility
• Low human capital investment
• Poor information flows (e.g. small networks)
• Rent seeking and corruption
• High inequality
• Persistence of poor outcomes
Difference between GDP and GNP
• In economics, Gross Domestic Product (GDP) is used to calculate the total
value of the goods and services produced within a country’s borders
• Gross National Product (GNP) is used to calculate the total value of the
goods and services produced by the residents of a country, no matter their
location.
• Essentially, GDP looks for the amount of economic activity within a nation’s
economy, while GNP looks at the value of the economic activity generated
by the nation’s people.
• GNP will count the economic activities of expatriates and other citizens
outside the country’s borders but GDP will not, and that GDP will consider
the activities of non-citizens within those borders, but GNP will not.
What are the problems with using GDP to
measure development?
Problems with using GDP to measure development
• An increasing GDP is often seen as a measure of welfare and economic success.
However, it fails to account for the multi-dimensional nature of development or the
inherent short-comings of capitalism, which tends to concentrate income and, thus,
power.
• It is also important to understand what GDP cannot tell us.
• GDP is not a measure of the overall standard of living or well-being of a country.
• Although changes in the output of goods and services per person (GDP per capita)
are often used as a measure of whether the average citizen in a country is better or
worse off, it does not capture things that may be deemed important to general
well-being. So, for example, increased output may come at the cost of
environmental damage or other external costs such as noise. Or it might involve the
reduction of leisure time or the depletion of non-renewable natural resources.
Where did Gross Domestic Product come from?
• The idea of economic growth stems from classical economics where
growth in national income represents the growth in the wealth of a nation
– the classical hallmark of success.
• The concept of economic growth gained popularity during the industrial
revolution, when market economies flourished. In the 1930s, Nobel
laureate, Simon Kuznets wrote extensively about national statistics and
propagated the use of GDP as the measure of the national income of the
US. However, Kuznets took this measure with a pinch of salt.
• GDP was designed in the 1930s to provide information about the
impact of the Great Depression in the USA and subsequently how
much money could be raised for fighting the Second World War
IGC blog: https://www.theigc.org/blogs/gdp-adequate-measure-development
GDP has become the most important number in the world
• It is embedded in domestic and international structures: GDP is the basis for
government loan eligibility as well as within-country accounting.
• It provides useful economic information, helping governments to justify
public spending on interventions and infrastructure that contribute to GDP
growth.
• The core political narrative of the late 20th Century was ‘Growth is Good’:
economic growth has contributed to increases in living standards for many
since the end of the Second World War and funded public investment in
social goods
• It has communications power: it is one figure that signals improvement, the
faster and higher it grows the better things are.
• While other statistics can be debated and brushed off, the cumulative effect
of these factors is that increases and decreases in GDP create the core
narrative around which governments operate.
Limitations of GDP
• GDP isn’t a measure of assets: it is a measure of spending, not of wealth, and
does not fully reflect the assets of a country (including both financial assets
but also natural, human and social assets).
• GDP creates perverse incentives: an increase in GDP doesn’t necessarily
mean an increase in anything valuable - if we pay people to dig holes and fill
them in again, GDP will go up.
• GDP doesn’t automatically mean we can afford more public spending: an
increase in GDP doesn’t translate directly into an increase in taxable goods
and services - illegal activity is counted towards GDP, but it doesn’t bring in
tax revenue.
• GDP includes the profits gained from, but not the cost of, environmental
damage: Measuring economic activity using GDP incentivises
environmentally damaging practices like fossil fuel extraction, rather than
more sustainable development.
Limitations of GDP (continued)
• There are a number of things that GDP does not measure at all
which contribute significantly to how we live:
• Non-financial activities: such as the power of our communities, our trust
in institutions and governments and other types of social capital. It does
not include caring or domestic activities carried out within the family.
• Economic inequality: GDP does not tell us anything about how resources
are distributed within countries. GDP growth can reflect concentration of
wealth for the richest in society while median income does not increase or
even decreases in real terms.
• Costs of externalities: GDP does not measure costs to society caused by
activities that generate GDP, like the contribution of increased pollution to
poor health outcomes.
So, what alternative measures can we use to
measure development?
• Environmental indicators
• Social indicators
• ‘Physical Quality of Life’ Index: life expectancy at age 1, infant mortality and literacy
• Literacy, nutrition, social and community services
• Property rights
• Civil liberties and increase of freedoms
• Example: China and India – rapid socio-economic development but less freedom vs. cautious
economic development and greater political and civil liberties. Which would you consider more
‘developed’?
Unpacking the Example
• China: Very rapid economic growth (double-digit GDP growth for
decades), huge poverty reduction, infrastructure boom. But,
restrictions on political and civil liberties — limited press freedom,
censorship, one-party system.
• India: More cautious economic reforms, slower growth compared
to China, persistent inequality and poverty. But, strong
democratic institutions, free press, vibrant civil society, political
participation.
• So the tension is: Material prosperity vs. freedoms and rights.
Competing Views of “Development”
•Economic Growth View (Traditional/Neoclassical)
•Development = higher per-capita income, industrialization, better infrastructure.
•By this view → China looks “more developed”.

•Capabilities Approach (Amartya Sen)

•Development = expansion of human freedoms and capabilities (ability to live the life you value).
•Civil liberties, political participation, rights, and agency matter as much as income.
•By this view → India may look “more developed”, despite slower growth.

•Human Development Index (UNDP)

•Combines income, education, health.
•Both countries improved, but still differ: China ahead in life expectancy & income; India ahead in
democratic freedoms.

•So, "Development” is multidimensional.

Alternate measures of development
• Human Development Index
• Human Capital Index
• Social Progress Index
What is the Human Development Index (HDI)?
• Mahbub Ul Haq and Amartya Sen developed the index, which is better suited to track the
progress, not only of rich, but also of poor nations.
• HDI has 3 components: Life expectancy at birth, Education (average of literacy and enrolment rates),
Weighted measure of per capita income
• HDI defines each country’s achievement in each of the 3 components relative to the minimum and
maximum observed world-wide. e.g. if life expectancy at birth in country X is 55, the world minimum is
45, and world maximum is 85, then the index for country X is (55-45)/(85-45) = 10/40 = 0.25
• HDI does this for all three components, and then averages them
• Each country is given a number between 0 and 1: ‘the fraction of ultimate development’
• It incorporates the traditional approach to measuring economic growth, as well as education and health,
which are crucial variables in determining how developed a society is.
What are the criticisms of the HDI?
• A composite from fundamentally different indicators such as life expectancy and literacy
• If life expectancy of the lowest country in the sample increases, then the HDI of all other
countries declines
• Very questionable to compare absolute size of the HDI
• HDI leaves out political and civil liberties
• But, instructive to compare rankings of countries
New method of calculating the HDI from 2010
• In its 2010 Human Development Report, the UNDP began using a new method of calculating
the HDI. The following three indices are used:
• Life Expectancy Index is a way to measure how long people in a country are expected to live
compared to a set range.
• Lowest value (0): If average life expectancy at birth is 20 years, the index is 0 (the worst possible score).
• Highest value (1): If average life expectancy at birth is 85 years, the index is 1 (the best possible score).
• In between: Most countries fall somewhere between 20 and 85 years. Their score is calculated by seeing how far
along they are in this range.
• Composite Education Index which includes
• Mean Years of Schooling Index. Fifteen is the projected maximum of this indicator for
2025.
• Expected Years of Schooling Index. Eighteen is equivalent to achieving a master’s degree
in most countries.
• Income Index is 1 when GNI per capita is $75,000 and 0 when GNI per capita is $100.
• The HDI is calculated as the geometric mean of the three normalized indices.
Human capital index
• On 11th October 2018, The World Bank launched the Human Capital Index
(HCI). This newly created index ranks 157 countries’ performances on a set
of four health and education indicators according to an estimate of the
economic productivity lost due to poor social outcomes. The main benefit
is that it focuses on outcomes analogously to the Social Progress Index (SPI)
and unlike GDP. For example, educational quality as measured by actual
adjusted learning is weighted more appropriately against years of
schooling.
• It is expected that mainly developing countries will make use of the HCI in
order to quantify the results of social sector investments, thus increasing
spending on human development (health, education, social security, etc.),
which the World Bank argues have been forgotten at the expense of
infrastructure and institutional development.
Social Progress Index
• The SPI was developed by the non-profit, Social Progress Imperative. It is one of
the outcomes of the Commission on the Measurement of Economic Performance
and Social Progress – or simply, Stiglitz-Sen-Fitoussi, after its leaders. The main
objective of the Commission was to investigate how the wealth and social
development of countries could be measured beyond the uni-dimensional GDP
measure. It is still a relatively new indicator, with data only for four years,
however it covers a wide span of more than 130 countries.
• The SPI is a refinement of the HDI because it expands the number of composite
indicators from only four to fifty-four in a wide array of areas, including basic
human needs, foundations of well-being, and opportunities to progress.
Therefore, this index is capable of synthesising the most relevant aspects that
determine development. For example, access to water and sanitation,
educational and health outcomes, public criminality, housing, access to
information, and communication.
Food for thought: What is the best
way to measure development?
• GDP still useful as an indicator for domestic
policy-makers
• For international comparisons, use social
indicators, but they too have problems in that
they cannot be aggregated easily
• Other factors affect the level of development a
country is achieving: income distribution,
government policy, public demand for policy,
institutions, culture, history
“The test of our progress is not whether we add more to
the abundance of those who have much; it is whether
we provide enough for those who have little.”

- Franklin D. Roosevelt
Useful Reading
• Michael Todaro and Stephen Smith (2009), Economic
Development, Pearson Education, Chapters 1 and 2.
• Amartya Sen, ‘The Concept of Development’, in H.
Chenery and T. N. Srinivasan (eds.) Handbook of
Development Economics (1988), pp. 232-237.
• Partha Dasgupta and Martin Weale, ‘On Measuring the
Quality of Life’, World Development 20 (1992), pp. 119-
131.