ECF340 – ECONOMICS OF

DEVELOPMENT
OUTLINE
 Objectives

 Learning outcomes
 Introduction
 Defining development economics
 Concepts of development and economic growth
 Measures of development
 Characteristics of underdevelopment
Objectives
The aims of this topic are to:
 Introduce the concepts of development and
economic growth
 Explain various ways of measuring development
 Explain the characteristics of underdevelopment
Learning Outcomes
At the end of this topic, you should be able to:
 Distinguish between development and
economic growth
 Explain and evaluate the various methods of
measuring development
 Explain and evaluate the characteristics of
underdevelopment
 Introduction
Defining Development Economics
 Study of the problems and processes of economic
development in developing countries; Africa,
Asia, Middle East, Latin America; it is more than
growth

 The study of how economies are transformed

from stagnation to growth and from low-income
to high-income status, and overcome problems of
poverty
The focus is on alleviating the conditions of
extreme poverty: poor health, poor nutrition,
and low education

In other words, development economics

focuses on the problems faced by developing
economies and possible solutions to such
problems.

It looks at both micro and macro levels

 At the micro level, the focus is on how markets in
these countries function in relation to
development

 At the macro level, the focus is on the differences

in economic levels among different countries

 The ultimate goal is to enact appropriate

development policies that will transform
developing countries into developed ones
 Concepts of Development and
Economic Growth
 Development
 The process of improving the quality of all human lives
and capabilities by raising people’s levels of living,
self-esteem, and freedom.

 Development could refer to conditions that identify the

quality of material life.

 In its simplest definition and perhaps in its common

usage, development can be considered as the objective
of moving to a state relatively better than what
previously existed.
 It could also refer to the processes of change and
improvement that raise living standards or
quality of life

 The improved quality of life involves

 higher incomes
 better education,
 higher standards of health and nutrition,
 less poverty, a cleaner environment,
 more equality of opportunities,
 greater individual freedom, and
 a richer cultural life.
Development is definitely not a pure economic
phenomenon

In other words, development is a multi-

dimensional process.

It does not only involve growth in incomes but

also improvements in other aspects of life;
social, political, cultural
 Economic Growth
 Refers to an increase in the amount of goods and
services produced in an economy over a period of time
OR

 An increase in the productive capacity of an economy

to produce goods compared from one period to another

 Thus, economic growth only focuses on the growth in

the productive capacity of an economy without
considering other aspects of development.

 This concept is a measure of income levels in an

economy
 Measures of Development
 In order to have an understanding of the relative
performance of countries, regions or individuals,
we need to measure development.

 As earlier stated, development is inevitably a

multidimensional phenomenon.

 You can think of many important aspects of

material well-being that indicate levels of
development.
 Economists have long focused on income and
income growth as measures of economic
development.

 This is, however, no longer the case.

 Many studies and international organisations

widely report other indices of development.

 In this section, we focus on GDP, GDP per capita,

GNP, GNP per capita and HDI as measures of
development
Gross Domestic Product (GDP)
Simply defined as the market value of all final
goods and services produced within a
country’s borders in a specific time period,
usually a year.

It thus measures the total income of everyone

in the economy or the total expenditure on the
economy’s output of goods and services
It includes household consumption (C),
government expenditure (G), investment (I)
and net exports (Exports-Imports)

Thus, GDP (Y) = C + I + G + NX

(expenditure approach)

GDP is commonly used as an indicator of the

economic well-being of a county and the
standards of living in a country
GDP Per Capita
 GDP per capita (GDP divided by population) is,
therefore, the primary measure of average
individual income in a given country.

 As income is spent on purchasing goods and

services, GDP per capita could be a measure of
living standards.

 Per capita GDP is mostly useful when comparing

one country to another because it shows the
relative performance of countries
 A rise in per capita GDP signals growth in the
economy and tends to be translated as an increase
in productivity

 Development is concerned about comparisons of

living standards over time and across countries.

 In order to make GDP comparable over time, we

need to account for inflation.

 As prices go up (inflation), the purchasing power

of income falls.
 By choosing a base year and using appropriate
price indices, you can convert nominal GDP to
real or constant GDP.

 This will then capture the real change in living

standards relative to the base year for a given
country

 To compare living standards across countries we

need to convert GDP figures into a common
currency (e.g. US $).
But what is the exchange rate for this
conversion?

One option is to simply use the average

exchange rates from currency markets in a
given year.

There are certain problems with this method.

Most importantly, exchange rates are affected
by tradeable goods and services, while GDP
includes both tradeable and non-tradeable
goods and services.

If non-tradable goods and services are

‘cheaper’ in developing countries, using an
exchange rate conversion GDP would
overstate the income gap (i.e. developing
countries would appear to be poorer than they
actually are).
 One way to overcome this problem is to use physical
quantities produced in each country and aggregate them
using the set of relative prices in a given country (e.g.
the USA).

 In other words, this method calculates how much more

material is produced in a country if goods have a
relative value similar to the USA.

 Data on quantities is hard to come by.

 Therefore, this idea is usually implemented by

adjusting existing GDP figures using an appropriate
price index (PPP) – Reading assignment
 Once you have made GDP figures comparable
across time and countries, you can start looking at
income gaps between developing and developed
countries.

 You should get a clear idea about the income gap

between the rich and the poor countries to
appreciate the role of development economics

 Even with PPP conversions, GDP differences

across developed and developing countries could
overstate the real gap in living standards.
 There are two reasons for this.

 First, home production may account for a larger part of

production (and consumption) in developing countries.

 For example, childcare is a service which the majority

of families purchase from a provider in developed
countries but in developing countries children stay at
home and either siblings or parents look after them.

 Although in both cases a utility generating service is

delivered, in one case it is transacted in the market and
hence included in GDP, while in the other it is home
production and not included in national accounts.
Gross National Product (GNP)
The monetary value of all final goods and
services produced by nationals of a particular
country in a given period of time, usually a
year.

It thus counts production by citizens ( and

more importantly, companies) of a nation even
if this production occurs in another country
GNP per capita
Shows the average value of goods and services
produced by each person each year

It is simply GNP divided by the total

population of a nation
 Human Development Index
 The ultimate goal of development is to increase
material well-being and life satisfaction but so far
we have focused on income.

 The central question is whether income is a good

measure of human well-being and living
standards.

 In other words, does an increase in income lead to

an improvement in various aspects of well-being?
 It is useful if we distinguish between subjective
and objective well-being.

 When you ask individuals whether they are

satisfied with their lives, you are measuring
subjective well-being.

 On the other hand, when you measure things like

life expectancy, infant mortality or years of
education, you are choosing a set of objective
variables and hence looking at objective well-
being.
In an effort to quantify societal objective well-
being, in 1990 the United Nations
Development Programme (UNDP) started to
report a composite index known as HDI
(Human Development Index).

This Index combines the three elements of life

expectancy, education and income and comes
up with an objective measure of societal well-
being across countries of the world
 Using the HDI, countries are ranked on a scale of
0 (lowest human development) to 1 (highest
human development) based on three components:

1. Life expectancy at birth (proxy for health)

2. Knowledge, as measured by mean years of
school and expected years of schooling
3. Standard of living, as measured by real per
capita GNI adjusted for the differing PPP of each
country’s currency to reflect cost of living and
for the assumption of diminishing marginal
utility income
The HDI ranks countries into four groups as
follows;
a) Low Human Development - 0.0 to 0.54
b) Medium Human Development – 0.55 to 0.699
c) High Human Development – 0.70 to 0.799
d) Very High Human development – 0.80 to 1.
Calculating HDI

 Three Indices: Income, Health (Life Expectancy)

and Education
 Income Index: first calculate the adjusted
national income by taking the of current
national income

 Then subtract the log of 100 from log of current

income on the assumption that real per capita
income cannot be less than $100
$100 PPP is the minimum national income
that a nation can have

The maximum expected national income has

been set at $75, 000 PPP and gives the amount
a developing nation aspires to achieve in the
future generation

Subtract the log of 100 from the log of

expected income.
 Divide the difference between the log of current
income and log of 100 by the difference between
the maximum expected income and the log of
100.
 We obtain each country an index number ranging
from 0 to 1; Thus,

ln 𝑒𝑠𝑡. 𝑖𝑛𝑐𝑜𝑚𝑒 − ln(𝑚𝑖𝑛. 𝑖𝑛𝑐𝑜𝑚𝑒)

𝐼. 𝐼 =
ln 𝑚𝑎𝑥. 𝑖𝑛𝑐𝑜𝑚𝑒 − ln(𝑚𝑖𝑛. 𝑖𝑛𝑐𝑜𝑚𝑒)

Where I.I = income index

 Life Expectancy (health proxy) Index: calculated by subtracting
20 years from the current life expectancy at birth

 20 years is the minimum life expectancy that could have been in any
country over the previous generation

 This is then divided by 85-20years years where 20 is the minimum

life expectancy expected

 That is, 85 years is the maximum life expectancy that a country

expects to achieve over the next generations. Thus,

𝑒𝑠𝑡. 𝑙𝑖𝑓𝑒 𝑒𝑥𝑝𝑒𝑐𝑡𝑎𝑛𝑐𝑦 − 𝑚𝑖𝑛. 𝑙𝑖𝑓𝑒 𝑒𝑥𝑝𝑒𝑐𝑡𝑎𝑛𝑐𝑦

𝐿𝐸𝐼 =
𝑚𝑎𝑥. 𝑙𝑖𝑓𝑒 𝑒𝑥𝑝𝑒𝑐𝑡𝑎𝑛𝑐𝑦 − 𝑚𝑖𝑛. 𝑙𝑖𝑓𝑒 𝑒𝑥𝑝𝑒𝑐𝑡𝑎𝑛𝑐𝑦
Where LEI represents life expectancy index
 Education index: has two components; mean years of schooling and
expected years of schooling

 Mean years of schooling (MYS) has a min. of 0 and max. of 15

 Expected years of schooling (EYS) has a min. of 0 and max. of 15

𝑒𝑠𝑡. 𝑀𝑌𝑆 − 𝑚𝑖𝑛. 𝑀𝑌𝑆

𝑀𝑌𝑆 =
𝑚𝑎𝑥. 𝑀𝑌𝑆 − 𝑚𝑖𝑛. 𝑀𝑌𝑆

𝑒𝑠𝑡. 𝐸𝑌𝑆 − 𝑚𝑖𝑛. 𝐸𝑌𝑆

𝐸𝑌𝑆 =
𝑚𝑎𝑥. 𝐸𝑌𝑆 − 𝑚𝑖𝑛. 𝐸𝑌𝑆

Therefore, Education index= (MYS+EYS)/2

Where MYS=mean years of schooling, GER=expected years of schooling

Class Activity
1. Consider a country with an estimated per
capita GNI PPP of $6,353, life expectancy of
68.8 years, mean years of schooling of 6.4
and expected years of schooling of 12.3.
Calculate and interpret the HDI for this
country.
2. Compare and contrast the new (post 2010)
and old (1990-2010) ways of computing HDI
Advantages of HDI
 It accounts for other dimensions of development
such as health and education which play a vital
role in development process as components of
human capital (productive investments in people
such as skills, values, and health resulting from
expenditures on education, on-the-job training
programs, and medical care

 It points out that differences in income are greater

than differences on other indicators of
development, at least health and education
Disadvantages
It gives an equal weight to it’s components; the
equal weight has some value judgement behind
it, but it is difficult to determine what this
value is

The values of the various components are

measured in different units, thus the meaning
of ‘equal weight’ cannot be easily determined
 The measures for health and education where
chosen partly on the criterion that sufficient data
must be available to include as many countries as
possible.

 However, there is a possibility of better proxies.

 HDI has a strong tendency to rise with per capita

income, as wealthier countries can invest more in
education and health, and this added to human
capital raises productivity
Characteristics of underdevelopment
1. Lower per capita income

2. Low levels of human capital/productivity

3. High levels of inequality and absolute poverty

4. Low levels of industrialization and

manufactured exports

5. Dominance of informal sector

6. Low level of urbanization but rapid rural-to-urban
migration

7. Lower levels of industrialization and manufactured

Exports (dependence of agriculture and primary
products)

8. Poor institutions and dominance, dependence and

vulnerability in international relations

9. Brain drain

10. High unemployment levels

~THE END~