► Distinction between Economic Growth and

Economic Development:
► Economic Growth refers to a rise in real NI per capita.
► It is an objective measure of economic capacity.
► Economic Development is a normative concept, Can
not be captured by any single measure or index.
► Most people would include in their definition increases
in the material well-being of individuals as well as
improvements in basic health and education.
► Others might add changes in the structure of production
(away from agriculture toward manufacturing and
services), improvement in the environment, greater
economic equality, or an increase in political freedom.
► Measuring Economic Growth:
► Economic growth refers to changes in per capita
income over time.
► Two basic measures of NI are employed:
1. GNP or GNI is the sum of the value of finished goods
and services produced by citizens of the country who live
inside and outside its borders during a given year.
► GNP excludes intermediate goods (goods used in the
production of other goods).
2. GDP is the sum of the value of finished goods and
services produced by citizens of the country or by resident
foreigners inside its borders during a given year.
► GNP or GDP divided by total population provides a
measure of per capita income.
► Measurement Problems of GDP:
1. Doesn't include Non-traded goods and services (e.g.
Housework and childcare)
► Therefore,GDP is usually underestimated in
developing countries.
2. Adding up the total value of goods and services that are
traded in markets requires using their market prices.
► Accurate price information may not be available or may
not be representative of market prices at the national level.
3. Doesn't account for the "bads" (e.g.pollution, crime,
congestion, depreciation and depletion of natural
resources).
► Although there are defects in GDP as a measure of NI,
it is a widely agreed approach, which facilitates
comparisons of nations' economic activity both over time
and relative to other countries which are essential to
understand 'the process of economic development.
Comparing GDP per capita across countries requires
having a standard measure in a common currency.
► To accomplish this goal the market exchange rate
between one currency, usually U.S. dollars, and each
national currency is used.
►Exchange Rate is the rate at which one country's
currency is exchanged for the currency of another country.

Exchange rate Conversion Problems:

► 1. Exchange rates, particularly of developing countries,
can be distorted.
► Trade restrictions or direct government intervention in
setting the exchange rate make it possible for an official
exchange rate to be different from a rate determined by a
competitive market for foreign exchange.
2.Exchange rates are determined by the flow of traded
goods and international capital and do not reflect the
relative prices of non-traded goods and services (goods
that do not enter into international trade, e.g. Haircuts,
Internal transportation, wholesale and retail trade,
elementary school education, Land, homes, and office
buildings.
►As a result, GDP converted to U.S. dollars by market
exchange rates gives misleading comparisons if the ratio
of prices of non-traded goods to prices of traded goods is
different in the countries being compared.
► Solution
► Purchasing Power Parity (PPP) a set of prices for all
goods and services prevailing in one of the countries to
value the goods and services of all countries being
compared.
►Table 2-1 presents a PPP conversion for two countries
using two goods.
► The task becomes more complicated in a world of tens
of thousands of goods and more than 200 nations.
► The International Comparison Program (ICP),
challenges this difficult task by deriving a set of
International Prices in a common currency.
► Detailed price data on a basket of hundreds of specific
goods have been collected periodically for an ever-
increasing number of nations.
► International prices are then derived by aggregating the
price data from the individual countries and are used to
determine the value of national output at these
standardized international prices.
►Estimates of NI in terms of PPP are reported in the
publication of the IMF, UNDP, World Bank, and other
multilateral agencies
► With differences of this magnitude, comparisons of per
capita income levels using market exchange rate
conversions can be misleading.
► Another way of making comparisons of GDP using
market exchange rates versus PPP is to think about
World GDP as a whole.
► World GDP is calculated by converting each nation's
GDP into a common currency using market exchange
rates.
► When world GDP is calculated the low- and middle-
income economies account for 29% of the world output.
On the other hand, when the calculation is based on PPP,
they account for 44 %.
►Accordingly, PPP allows for more valid comparisons of
real income levels across economies. But PPP has its
limits too.
► Problems of PPP:
1.Trade and capital flows are transacted at market
exchange rates and should be converted at those rates.
2. The ICP provides a consistent set of PPP estimates of
national income, but these are only estimates and critics
have pointed out errors in data collection and
methodology.
3. PPP conversions cannot correct for problems in the
measurement of GDP in a nation's own currency.
4. Variations in the quality of goods cloud cross-country
comparisons.
5. The specific price index constructed by the ICP gives
more weight to the goods consumed in rich nations and
tends to bias upward the GDP of poorer nations that
consume a different basket of goods.
What do we Mean by Economic Development ?
►As indicated previously, economic growth is a
necessary but not sufficient condition for improving the
living standards of people in countries with low levels of
GDP per capita.
► It is necessary because, if there is no growth,
individuals can become better off only through transfers of
income and assets from others.
► it is not sufficient for improving mass living standards
for several reasons:
1. Governments promote economic growth not just to
improve the welfare of their citizens but also to expand the
power of the state.
►Examples:
1. Governments in developing nations may use NI to
expand their militaries or construct elaborate capital city
complexes in deserts and jungles.
2. Political leaders may be corrupt and take income for
personal gain, whether for visible consumption at home or
the accumulation of wealth in overseas bank accounts and
property.
► Accordingly, when gains from growth are channeled in
such ways, they often provide little benefit to the country's
citizens.
2. Resources may be heavily invested in further growth,
with significant consumption gains delayed to a later date.
3. Income and consumption may increase, but those who
already are relatively well off may get all or most of the
benefits. The rich get richer, and the poor get poorer. .
► Four broad factors affect how weil income can be
converted into "the capability to live a minimally
acceptable life":
1. Personal heterogeneities: including age, proneness to
illness, and extent of disabilities.
2. Environmental diversities shelter, clothing, and fuel
required by climatic conditions.
3. Variations in social climate: such as the impact of crime,
civil unrest, and violence.
4. Differences in relative deprivation: the extent to which
being impoverished reduces one's capability to take part in
the life of the greater community.
►Accordingly, economic development requires alleviating
the sources of “capability deprivation" that prevent
people from having the freedom to live the lives they
desire.
 Measuring Economic Development
► There are two widely cited indicators of economic
development:

1. Human Development Index (HDI).

2. Millennium Development Goals (MDGs)

 1. Human Development Index (HDI)

► The UNDP published its first human development

report in 1990.
► Although the terminology is different, human
development and economic development are the same
idea.
►The UNDP attempted to quantify the essential
determinants of human development: to live a long and
healthy life, acquire knowledge, and have access to
the resources needed for a decent standard of living.
► For each of these elements, a specific measure was
constructed and aggregated into an index, the Human
Development Index (HDI). ,
► Because the HDI combines outcomes with different
units of measurement-years of life expectancy, years of
schooling, and dollars of income-each outcome must be
converted into an index number to permit aggregation into
a composite measure.
1. As a proxy for living a long and healthy life, the HDI
employs a nation's life expectancy at birth and compares
progress on this measure relative to other nations.
► The goalposts for assessing life expectancy are a
minimum value of 20 years and a maximum of 83.2.
► Twenty years represents the minimum life expectancy
that permits a society to sustain itself.
► The maximum value of 83.2 years is what Japan
achieved in 2010.
►A country's score is a measure of its populations life
expectancy compared to the maximum and minimum
scores.
Example:
In 2010, El Salvador had life expectancy at
birth of 72 years. El Salvador's HDI life expectancy index
is calculated as:
(72 - 20) / (83.2 - 20) = 0.82

► Therefore, El Salvador has attained 82% of the

potential range in life expectancy.

2. As a proxy for acquiring knowledge, the HDI includes

two variables:
a. The mean years of schooling achieved by the adult
population, those 25 years and older.
b. Expected years of schooling for children of school-going
ages.
► The goalposts of the adult schooling variable are 0 and
13.2 (the United States).
► For expected years of schooling, the goalposts are 0
and 20.6 (Australia).
► Example:
El Salvador's mean years of schooling among
adults is 7.7 years (58%), While, for expected years of
schooling it is 12.1 years (59%).

► These values are then aggregated to form one

composite index for education.
3. Access to resources is measured by transforming GNI
per capita (PPP in US$).
►The goalposts are $163 (Zimbabwe in 2008) and
$108,211 (United Arab Emirates in 1980).
► The HDI uses the logarithm of income per capita
rather than the level of income per capita in determining
the importance of incomes in a country's human
development.
► The transformation into logarithms decreases the
significance of income gains as income increases.
►Example:
Assume that two nations have incomes of 10
and 100, respectively.
► Using these values implies a 10-fold importance to the
higher income because 100 is 10 times as large as 10.
► What if we use logarithms instead?
► If we use base 10 logarithms, we can easily see how
the relative importance of the higher income is reduced.
► The logarithm of 100 in base 10 is 2, because 10 raised
to the second power is 100.
► While, the logarithm of 10 in base 10 is 1, because 10
raised to the first power is 10.
► Accordingly, using logarithms in this case reduced the
relative importance of the higher income from a factor of
10 to a factor of only 2.
► This reflects the conclusions made by all the human
development reports that there are diminishing returns
to income as a means of securing a decent standard of
living (or, alternatively, that the marginal utility of an extra
dollar of income falls as income rises).
► El Salvador, with an estimated 2010 GNI per capita of
$6,498 falls 57% between the logarithm-adjusted income
goalposts.
► All three dimensions of the HDI are expressed in terms
of a percentage, solving the problem of different units of
measurement.
► How to aggregate the three dimensions?
► Up until 2010, this was done by giving the index of each
dimension an equal weight of one third and computing
the arithmetic mean of the three.
► In 2010, the three dimensions still have equal weight
but now a geometric mean of the three percentages is
computed.
► Reason for this change
► Using an arithmetic mean implied "perfect
substitutability" among the three components of HDI. If a
nation lost, 10% on its schooling measure this could be
compensated by a 10% improvement in income and the
HDI would remain unchanged.
► The geometric mean does not have this property. Low
achievement in one dimension is no longer linearly
compensated by high achievement in another dimension.
► The level of each index matters, creating a situation of
imperfect substitutability across the HDI's three
dimensions.
► Criticisms against the HDI:
1. Limiting the index to only three dimensions.
2. Assuming diminishing returns to income only but not to
either life expectancy or schooling.
3. The introduction of a geometric mean to aggregate the
three dimensions.
► Geometric means are sensitive to low values; in the
extreme, if one index equaled zero then the HDI would
equal zero too. The same applies if one index is close to
zero.
► How much of an improvement the HDI is over NI per
capita?
Figure 2-2 presents a comparison of HDI values and
levels of GNI per capita.
► The figure indicates that rising incomes raise the HDI.
This is expected because incomes are a component of the
HDI, and health and schooling also rise with incomes.
► According to the trend line, income alone explains 90%
of the variation in the HDI.
► But the scatter diagram also indicates variance around
this trend.
►Examples:
1. Angola and Georgia have similar levels of per capita
GNI but Angola has much lower life expectancy than does
Georgia (48 versus 72 years). There is also an almost
eight-year gap in schooling between the two nations.
Despite identical per capita incomes, there is low human
development in Angola, with an HDI of 0.403, and high
human development in Georgia, with an HDI of 0.698.
2. Mozambique and Togo have similar per capita incomes,
but life expectancy and schooling are much higher in
Togo, raising its HDI value.
► In terms of HDI values, Angola and Mozambique lay
well below the trend line while, Georgia and Togo lay well
above it.
► Conclusion
► Alternative measures of economic development are not
perfectly connected with levels of income.
► Therefore, with economic growth, increasing levels of
income can predict a lot about economic development. But
improved health and education depend on factors other
than income.
 2. Millennium Development Goals (MDGs)
► Defining economic development is difficult. As with any
normative concept, people have different opinions as to
what should be included in the definition and on what
weight to give to different goals.
► But even without a commonly agreed on definition,
policy makers need specific targets.
►One such set of targets is known as the Millennium
Development Goals (MDGs).
►In September 2000, 189 nations adopted the "United
Nations Millennium Declaration,”
► The declaration specifies a set of eight goals consistent
with this commitment:
1. Eradicate extreme poverty and hunger.
2. Achieve universal primary education.
3. Promote gender equality and empower women.
4. Reduce child mortality.
5. Improve maternal health.
6. Combat HIV/AIDS, malaria, and other diseases.
7. Ensure environmental sustainability.
8. Develop a global partnership for development.

► To more fully define these goals,, a panel of experts

developed a comprehensive set of targets and indicators
for each of the MDGs.
► The eight MDGs contain 21 targets, which correspond
to 60 indicators.
► This combination of multiple goals, targets, and
indicators is an articulation of what most of the world's
governments believe should be achieved to make
"development a reality for everyone”.
► The millennium declaration even suggests ways in
which this development agenda might be financed.
► But none of these recommendations is obligatory.
►Evaluating progress toward achieving the MDGs
requires carefulness.
► Relative success and failure at meeting the MDGs
varies not only among specific targets but also by region.
► Criticisms against the MDGs :
1. Including too much and setting targets that may be
either too high or too low.
2. Fail to address the fundamental economic problem of
trade-offs and priorities.
3. The 21 targets must be fulfilled simultaneously,
because economic development involves all' these goals.