Understanding Economic Development

Sustainable Development

Sustainable development: development that meets the needs of the present without compromising the
ability of future generations to meet their own needs.

Economic development: a process that leads to improved living standards for a population as a whole,
including increased access to goods and services that satisfy basic needs (food, shelter, sanitation,
edu, healthcare), reduction in poverty, greater employment opportunities and reduction in serious
income, wealth and gender inequalities.

Sustainable Development Goals (SDG) – 17 Goals

The first two are zero hunger and no poverty.

The Relationship between Sustainability and Poverty (HL)

Poverty reduces sustainability:

- cannot afford inputs that preserve soil’s fertility (eg, fertilizer)
- high birth rate and population growth rate → need to open up new lands for agriculture
- lack of modern energy sources → cut down forests to obtain firewood
- lack of technology that would reduce or reverse environmental degradation

Measuring Development

Single indicators:

(i) income indicators

- GDP or GNI per capita
- GDP or GNI per capita, USD PPP

(ii) health indicators

- life expectancy at birth
- infant mortality rate (per 1,000 live births)
- maternal mortality rate (per 100,000 live births)

(iii) education indicators

- adult literacy rate (people aged 15 and above)
- primary/secondary school enrolment

(iv) economic inequality indicators

- Lorenz curve and Gini coefficients
- poverty lines
- minimum income standards

(v) social inequality indicators

- inequality in education
- inequality in life expectancy
Composite indicators:

(i) Human Development Index (HDI) – the higher the better

3 dimensions:
- income: GNI per capita, USD PPP
- healthcare: life expectancy at birth
- edu: mean years of schooling + expected years of schooling

HDI is between 0 and 1

0: lowest level of economic development
1: highest level of economic development

Limitations of the HDI:

- income, gender and wealth inequalities
- quality of life factors (freedom, crime, voting rights, stress, etc)
- environment
- extent of poverty
- unemployment

(ii) Inequality-adjusted Human Development Index (IHDI) – the higher the better
- IHDI = HDI when there are no inequalities in income, education and healthcare.
- IHDI < HDI when there are inequalities in income, education and healthcare.
- better than HDI

(iii) Gender Inequality Index – the lower the better

3 dimensions:
- reproductive health: maternal mortality rate + adolescent birth rate
- empowerment (eg, the share of parliamentary seats held by women)
- female labour force participation

(iv) Happy Planet Index (HPI) – the higher the better

HPI = (well-being * life expectancy * inequality of outcomes) / ecological footprint

Pros: it takes into account sustainability which is a key element of sustainable development
Cons: inaccurate as countries with high living standards or high HDI might score low in HPI (eg,
Australia and Singapore) due to high ecological footprint.

Evaluating Measures of Economic Development

(i) since economic development is a complex and multidimensional process, it cannot be accurately
represented by any one measure.
(ii) the measures could be inconsistent and conflict with each other (eg, HDI and HPI).
(iii) data collection and statistical error:
- definitions of variables or methods used may vary from country to country
- limited capacity for statistical data collection
- where data are missing, estimates are used → not so accurate
Relationship between Economic Growth and Economic Development

Diagram: PPC (merit goods and capital goods)

How growth leads to development:

(i) real GDP rises → more output → more access to goods and services (food, shelter, sanitation,
healthcare, edu)
(ii) real GDP rises → more output → greater demand for labour → greater employment opportunities
(iii) real GDP rises → tax revenues should rise → could be spent on poverty alleviation
(iv) real GDP rises → possibly less social problems + greater political stability

How growth may not lead to development (or may harm development):
(i) environmental degradation and resource depletion → unsustainability
(ii) more demerit goods are produced
(iii) more capital goods are produced (may still raise development in the future as PPC will shift
outwards in the future)
(iv) more exports are produced
(v) income and wealth inequalities may worsen
(vi) growth may not create more jobs (eg, capital-intensive production method) and may create more
unemployment (structural)
Barriers to Economic Growth and Economic Development

Poverty Cycle

Diagram: poverty cycle.

How to break the poverty cycle?

- poverty cycle in a family/community: the government can help
- poverty cycle in an economy as a whole: foreign aid and inward FDIs

Economic Barriers

(i) Economic inequality (income and wealth)

Problems:
- low domestic spending as the rich spend a lower fraction of their income (they also import a lot)
- the savings (by the rich) usually leave the country due to a poor domestic banking system
- corruption
- low living standards (lack of access to health care and education)
- inability to borrow (access to credit)
- poverty and social problems

(ii) Limited access to infrastructure

Problems:
- financing (low tax revenues + forced to charge a P below cost to make them affordable) → low
quality
- limited access by the poor (rural areas may get neglected)
- environment destroyed due to lack of proper planning

(iii) Limited access to technology

Capital intensive VS labour intensive.

Labour-intensive technology is more suitable for countries with large quantities of labour relative to
capital (most LEDC), because:
- creates more jobs (reduce rural unemployment)
- reduce income inequality

(iv) Low levels of human capital (education and healthcare)

Barriers to education:
- insufficient funding
- insufficient resources (teachers, classrooms, teaching materials)
- gender discrimination
- distance from home
- hunger and malnutrition

Barriers to achieving good heath:

- insufficient funding
- insufficient resources (doctors, medical facilities, medical supplies)
- distance from home
- insufficient access to clean water and sanitation
(v) Dependence of production and exports on the primary sector

Main issue: price volatility of primary commodities (low PED and PES)

Consequences of overdependence:
- farmer’s incomes fluctuate greatly → affecting the ability to plan and invest
- employment fluctuates greatly
- export earnings fluctuate greatly→ affecting the country’s ability to import
- fluctuating government revenues → could not plan for growth/development

(vi) Limited access to international market

Issues:
- tariff
- agricultural support by rich countries (price floors and subsidies)

Problems:
- lower export earnings for LEDC (less job creation) → BOPs issue + increased debt burdens
- increased poverty among affected farmers (due to lower prices)

(vii) The informal economy

Problems:
- low wages
- long hours
- no pensions
- unsafe working environment
- lower tax revenues to the govt

(viii) Capital flights (a large scale of transfer of privately-owned financial capital to another country)

Reasons: when wealth and income are threatened

- sudden increases in taxes
- political instability
- a sharp currency devaluation/depreciation

Problems:
- outflows of $ → a downward pressure on the EXR → imported inflation + more capital flights
- savings leaving a country → reduced I in the future
- a financial crisis → reduced economic growth

(ix) Indebtedness

Problems:
- debt servicing costs → opp cost
- poor credit ratings → reduced ability to borrow in the future (forced to raise IR)
- it may need to raise T and cut G (esp if the debt is owed by the govt) → contractionary FP → lower
econ growth
- lower private I due to uncertainty → lower econ growth
- possibility of a debt trap (the borrowing government has to keep borrowing more and more to pay
back its old debts)
Political and Social Barriers

(i) Weak institutional framework – poor legal system

Problems of a poor legal system:

- corruption
- discrimination
- crime
- reduced economic activities as contracts cannot be enforced

(ii) Weak institutional framework – ineffective taxation structures

Problems:
- tax evasion (corruption)
- inefficiencies in tax collection (complicated bureaucratic procedures and complex tax legislation)
- high dependence on indirect taxes → regressive → income inequality
- the rich can influence the government tax policies to reduce their tax burdens

(iii) Weak institutional framework – poor banking system

Importance:
- provides firms with credit to run/expand businesses → econ growth + more jobs
- provides individuals with credit for I in human capital → higher labour productivity + break poverty
cycle

Problems:
- exclusion of the poor from access to credit (no stable income + lack collateral) → may need to rely
on informal sources of credit (loan sharks)
- higher interest rates are charged to the poor if any loans are provided, due to their high-risk nature &
lack of collateral
- banking system not well developed + not reliable → the rich prefer saving abroad → I falls → lower
growth

(iv) Weak institutional framework – lack of property rights (laws that define rights to ownership, use
and transfer of property)

Importance:
- when property rights are secured → more investments → economic growth + job creation
- the property can be used as collateral → improved access to credit
- more tax revenues to the government (through property taxes or privatising the land ownership)

(v) Gender inequality

Problems:
- gender inequalities in health and education (because girls in LEDC are often not intended to seek
work in the labour market)
- gender inequalities in the labour market (lower pay + fewer employment opportunities)
- gender inequalities in inheritance rights
- gender inequalities in access to credit (low income + lack of collateral)
(vi) Inappropriate governance

Features of good governance include:

- efficiency
- fairness
- accountability
- transparency

Good governance also promotes political stability which fosters economic growth.

(vii) Corruption

Problems:
- corruption works like a tax, which makes private I more costly → lower econ growth
- corruption reduces competition in the market since firms must pay bribes to start businesses
- bribes result in tax evasion → less $ available to be spent on the provision of merit goods
- if the bribe amount is fixed, it is regressive
- corruption makes government policies such as regulations ineffective
- possible political instability as corruption damages people’s trust
Strategies to Promote Economic Growth and Economic Development
Trade Strategies

(i) Import substitution (a growth and trade strategy where a country begins to manufacture simple
consumer goods for the domestic market to promote its domestic industry)

Policies involved may include:

- trade protection
- overvalued currencies (to make imported capital cheaper)
- greater use of capital

Advantages:
- some diversification (some industrialisation)
- infant industry argument
- economies of scale
- reduced dependence on foreign countries → BOPs may improve
- use of better capital → econ growth

Problems:
- high levels of protection → inefficiency + global resource misallocation
- reduced export competitiveness (due to overvalued currencies) → BOPs problem
- wrong technology (capital-intensive) was imported → income inequality + unemployment + poverty
- limited economic growth (due to serious inefficiencies)

(ii) Export promotion (a growth and trade strategy where a country attempts to achieve economic
growth by expanding exports)

Policies involved may include:

- targeting of export industries (investment grants, tax exemptions, subsidies)
- large government spending in key areas such as education, skills, etc
- undervalued currencies (to encourage exports while making imports more expensive)
- encouragement of R&D in appropriate technology (eg, labour-intensive)

Advantages:
- expansion into foreign markets → more job opportunities + EOS
- CA and BOPs improve
- emphasis on diversification
- the use of appropriate technology creates jobs, reducing poverty and income inequality

Problems:
- become overly dependent on exports (vulnerable to external shocks, such as recessions)
- lead to trade protection by the trading partners having serious trade deficits
- maybe forced to keep wages low to maintain export competitiveness → low living standards

(iii) Economic integration

refer to previous notes for the advantages and disadvantages of economic integration

(iv) Trade liberalisation

refer to previous notes for advantages and disadvantages of trade liberalisation

Diversification (reallocation of resources into new activities that broaden the range of goods and
services produced)

Advantages:
- prevent overspecialisation → more sectors can create jobs
- reduced vulnerability to short-term price volatility
- use of domestic primary commodities → production costs may be lower
- development of technological capabilities and skills
- “value-added” allows the goods to be exported at a higher price

Disadvantages:
- time lags
- need trade protection initially (too much trade protection can be harmful)
- lose the benefits of specialisation
- produce goods in which the country has no comparative advantage

Market-based Policies

(i) Trade liberalisation

- reduce barriers to trade (eg, tariffs)

(ii) Privatisation

(iii) Deregulation
- reduce barriers to entry (eg, environmental regulation)
- reduce minimum wages
- reduce unemployment benefits

Advantages:
- higher economic growth (LRAS & SRAS rises) → more job opportunities
- greater competition → efficiency
- lower inflation (when firms cut costs to be efficient)
- better product quality and greater choice (more competition)
- improved government budget (privatisation) → can be spent on merit goods
- more inward FDIs (deregulation)
- reduced corruption (less government intervention)

Disadvantages:
- possibility of a lower economic growth (imports may rise for trade liberalisation)
- structural unemployment (trade liberalisation)
- pollution (deregulation)
- higher price in the short term (privatisation)
- time lags
- more poverty (reduced minimum wages and unemployment benefits)
Interventionist Policies:

(i) Tax policies

- increase the progressivity of taxation:
raise direct taxes on real estate, land, capital gains and profits
raise indirect taxes on luxury goods
take measures to reduce tax evasion
- imposition of taxes on goods that create negative externalities (cigarettes, pollution, etc)

(ii) Transfer payments (cash transfers and benefits in kind)

(iii) Minimum wages

Advantages:
- possibility of greater tax revenues (tax policies) → more money to be spent on transfer payments
- improved income distribution (tax policies + transfer payments + minimum wages)
- reduced exploitation (minimum wages) → higher wages → higher living standards
- less negative externalities

Disadvantages:
- reduced incentive to work (transfer payments)
- transfer payments are costly
- more unemployment and inflation (if minimum wages are set too high)
- inward FDIs are discouraged (if taxes and minimum wages are set too high)
- growth may be harmed (tax policies + too high minimum wages)

Provision of Merit Goods

(i) Education
(ii) Healthcare
(iii) Infrastructure (energy, transport, telecommunications and sanitation)

Advantages:
- improved human capital → higher labour productivity → higher econ growth → more job creation
- break poverty cycle (edu + healthcare + infra) → reduced poverty
- more inward FDIs (edu + healthcare + infra)
- promote women empowerment (when edu and healthcare are provided also to women)
- reduced informal market (edu) as opportunities in formal market have increased
- more tax revenues to the govt in the long term
- greater political stability

Disadvantages:
- costly to the government → opp cost + need to raise taxes / cut down other spending
- limited effects if the quality is low → waste of $
- time lags
- ineffective (edu + healthcare) if the workers choose to work abroad
Foreign Direct Investment

Advantages:
- finance CA -ve
- create more jobs
- promote local industry
- improve skills and the level of technology
- lead to greater tax revenues
- more investment → higher economic growth

Disadvantages:
- CA -ve occurs when profits are repatriated
- may not improve skills and the level of technology
- may not promote local industry
- may not create more jobs
- may not lead to greater tax revenues
- exploitation of workers
- environmental degradation
- the govt may be forced to provide more infrastructure needed by MNCs

Foreign Aid (the transfer of funds or goods & services to LEDCs to improve their economic, social or
political conditions)

Characteristics (conditions):
- concessional
- non-commercial

Forms:
- transfer of funds (grants, loans)
- transfer of goods and services (food, water, medicine)
- debt relief
- technical assistance (advice)

Types:
- humanitarian aid
- development aid

Who offers?
- ODA (govt)
- NGOs

Advantages of aid:
- break the poverty cycle
- provision of basic services
- improved income distribution
- economic growth
- SDGs can be achieved
- stop a debt trap (tax relief)
Disadvantages of ODA:
- conditional aid
- tied aid (another form of conditional aid)
- aid volatility and unpredictability
- uncoordinated donors
- aid may not reach those most in need
- corruption
- the quantity of aid may not be sufficient

Advantages of NGOs:
- only grants → no loans that need to be repaid → will not create a debt trap
- work closely with project beneficiaries

Disadvantages of NGOs:
- small size
- possible loss of independence due to growing reliance on govts and aid agencies for funding

Multilateral Development Assistance

(i) World Bank

Functions: extend long-term loans to LEDC govts to promote economic development and structural
change.

Advantages:
- funds can be used by the government → to break poverty cycle or to provide infrastructure, etc
- provides debt relief → stops a debt trap
- reduced corruption (due to market-oriented policies)
- benefits of market-oriented policies (eg. competition, etc)

Problems:
- loans have to be repaid (interest rates are determined in the market + not necessarily on concessional
terms)
- conditional loans (structural adjustment loans) → the conditions may include:
removal of price controls
trade liberalisation
reducing restrictions to new FDIs
privatisation
deregulation
cuts in government spending
- excessive interference in domestic affairs
- there are conditions for a country to qualify for debt reliefs
- excessive focus on market-based policies → inadequate attention to poverty alleviation (cuts in govt
spending + removal of price controls)
- some projects may destroy the environment
- World Bank governance dominated by rich countries → decisions are made without due regard for
the needs and wishes of LEDCs
(ii) International Monetary Fund (IMF)

Functions:
- oversee the global financial system
- help countries experiencing difficulties making international payments by providing short-term loans
- promote international monetary cooperation
- promote exchange rate stability

Advantages:
- reduced inflation (stabilisation policies + more stable currencies)
- provides debt relief → stops a debt trap
- may reduce the risk of the occurrence of another financial crisis in the future

Problems:
- loans have to be repaid (interest rates are determined in the market + not necessarily on concessional
terms)
- conditional loans (must adopt stabilisation policies)
- stabilisation policies may include:
contractionary monetary policy
contractionary fiscal policy
cuts in real wage
liberalisation policies (trade liberalisation + removing price control)
- excessive interference in domestic affairs
- stabilisation policies have damaging effects → low economic growth and more poverty
- there are conditions for a country to qualify for debt reliefs
- IMF governance dominated by rich countries → decisions are made without due regard for the needs
and wishes of LEDCs

Institutional Change

(i) Improved access to banking (including microfinance and mobile banking)

Advantages of microfinance (loans in small amounts to those who ordinarily do not have access to
credit)
- microfinance may not require collateral
- promote women empowerment (as it lends also to women)
- increased access to education and healthcare → break the poverty cycle
- allow more small businesses to start up → create jobs

Disadvantages of microfinance:
- microfinance interest rates can be higher
- microfinance contribute to the growth of the informal economy
- unskilled people may be harmed by microfinance
- limited impact on poverty alleviation if microfinance is too small (eg, not many organisations
provide microfinance due to high risks)

Advantages of mobile banking (the use of mobile phones to receive or send money or to pay bills):
- ease of making payments (save time) → efficiency
- reduce costs of transferring $
- reduce the risks of $ being stolen
- easier to get loans → more I
Disadvantages of mobile banking:
- network problems → causing delays
- cost of the services
- inability of some older people to use
- possibility of scams

(ii) Increasing women’s empowerment (creating conditions of equality of opportunities for women)

Advantages:
- improvements in child health and education → higher productivity → break the poverty cycle
- lower fertility → reduced population growth → income per capita rises
- women empowerment → reduced discrimination → less poverty and income inequality
(iii) Reducing corruption

refer to previous notes for problems associated with corruption

(iv) Property rights

refer to previous notes for the importance of property rights