Transcript Chapter 2:Comparative Economic Development Commonalities & Diversity Common Characteristics of developing countries 1.

Chapter 2:Comparative Economic Development
Commonalities & Diversity
Common Characteristics of developing countries
1. Lower levels of living and productivity
2. Lower levels of human capital
3. Higher levels of inequality and absolute poverty
4. Higher population growth rates
5. Greater social fractionalization
6. Larger rural population- rapid migration to cities
7. Lower levels of industrialization and manufactured exports
8. Adverse geography
9. Underdeveloped financial and other markets
10. Colonial legacies- poor institutions etc.
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Defining the Developing World
World Bank Scheme- ranks countries on GNP/capita LIC, LMC, UMC, OECD (see
Table 2.1 and Figure 2.1) where LIC = Low-Income Countries, LMCs= Lower-MiddleIncome Countries, UMCs= Upper-Middle-Income Countries; (LMCs + UMCs) = MiddleIncome Countries
Table 2.1 Classification of Economies by Region and Income, 2007
(Latin America and the Caribbean)
(Sub-Saharan Africa)
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Table 2.1 Classification of Economies by Region and
Income, 2007 (continued)
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Figure 2.1: Nations of the World, Classified by GNI Per Capita
(=GNI/Population)
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Measuring Development for Quantitative Comparison
across Countries
 Gross National Income (GNI)
 Gross Domestic Product (GDP)
 PPP method instead of exchange rates as conversion factors (see Figure 2.2)
Figure 2.2 Income Per Capita in Selected Countries
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GNI and PPP
GNI (Gross National Income)
The Gross national income (GNI) consists of: the personal consumption expenditures, the gross
private investment, the government consumption expenditures, the net income from assets abroad
(net income receipts), and the gross exports of goods and services, after deducting two
components: the gross imports of goods and services, and the indirect business taxes. The GNI is
similar to the gross national product (GNP), except that in measuring the GNP one does not
deduct the indirect business taxes.
PPP
Purchasing power parity (PPP) is a theory which states that exchange rates between currencies
are in equilibrium when their purchasing power is the same in each of the two countries. This
means that the exchange rate between two countries should equal the ratio of the two countries'
price level of a fixed basket of goods and services. When a country's domestic price level is
increasing (i.e., a country experiences inflation), that country's exchange rate must depreciated in
order to return to PPP. Note: PH = E*PF or E=PH/PF
Need for adjustments to GDP
1.The exchange rate reflects transaction values for traded goods between countries in contrast to
non-traded goods, that is, goods produced for home-country use. Also, currencies are traded for
purposes other than trade in goods and services, e.g., to buy capital assets whose prices vary
more than those of physical goods. Also, different interest rates, speculation, hedging or
interventions by Central Banks can influence the foreign exchange market.
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Using PPP to adjust GDP
The PPP method is used as an alternative to correct for possible statistical bias. The
Penn World table is a widely cited source of PPP adjustments, and the so-called Penn
Effect reflects such a systematic bias in using exchange rates to outputs among
countries.
2. For example, if the value of the Mexican peso falls by half compared to the US
dollar, the Mexican Gross Domestic Product measured in dollars will also halve.
However, this exchange rate results from international trade and financial markets. It
does not necessarily mean that Mexicans are poorer by a half; if incomes and prices
measured in pesos stay the same, they will be no worse off assuming that imported
goods are not essential to the quality of life of individuals. Measuring income in
different countries using PPP exchange rates helps to avoid this problem.
3. PPP exchange rates are especially useful when official exchange rates are
artificially manipulated by governments. Countries with strong government control of
the economy sometimes enforce official exchange rates that make their own currency
artificially strong. By contrast, the currency's black market exchange rate is artificially
weak. In such cases, a PPP exchange rate is likely the most realistic basis for
economic comparison.
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Table 2.2 A Comparison of Per Capita GNI, 2005
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Some Basic Indicators of Development
 Health
 Life Expectancy
 Education
 HDI as a holistic measure of living levels
– HDI also varies for groups within countries
– HDI also varies by region in a country
– HDI also reflects rural-urban differences
 The HDI was created to emphasize that people and their capabilities should be the
ultimate criteria for assessing the development of a country, not economic growth alone.
 The HDI can also be used to question national policy choices, asking how two countries
with the same level of GNI per capita can end up with such different human development
outcomes. For example, the Bahamas and New Zealand have similar levels of income
per person, but life expectancy and expected years of schooling differ greatly between
the two countries, resulting in New Zealand having a much higher HDI value than the
Bahamas. These striking contrasts can stimulate debate about government policy
priorities.
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 The HDI sets a minimum and a maximum for each dimension, called goalposts, and then shows where each
country stands in relation to these goalposts, expressed as a value between 0 and 1.
 The education component of the HDI is now measured by mean of years of schooling for adults aged 25
years and expected years of schooling for children of school entering age. (a).Mean years of schooling is
estimated based on educational attainment data from censuses and surveys available in the UNESCO
Institute for Statistics database and Barro and Lee (2010) methodology. (b). Expected years of schooling
estimates are based on enrolment by age at all levels of education and population of official school age for
each level of education. Expected years of schooling is capped at 18 years. The indicators are normalized
using a minimum value of zero and maximum values are set to the actual observed maximum value of mean
years of schooling from the countries in the time series.
 The life expectancy at birth component of the HDI is calculated using a minimum value of 20 years and
maximum value of 83.4 years. This is the observed maximum value of the indicators from the countries in
the time series, 1980–2010. Thus, the longevity component for a country where life expectancy birth is 55
years would be 0.552. That is, (55 – 20)/(83.2 – 20) = 35/63.2 = 0.552
 For the wealth component, the goalpost for minimum income is $100 (PPP) and the maximum is $107,721
(PPP), both estimated during the same period, 1980-2011.
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Goalposts for the Human Development Index in this Report
Dimension
Observed Maximum
Minimum
Life Expectancy
Mean Years of Schooling
Expected Years of Schooling
Combined Education Index
Per Capita Income (PPPs)
83.2 (Japan,2010)
13.2 (US, 2000)
20.6 (Australia, 2002)
0.951 (NZ, 2010)
108,211 (UAE, 1980)
20
0
0
0
163 (Zimbabwe, 2008)
Having defined the minimum and maximum values, the sub-indices are calculated as
follows:
Dimension index
Actual Index  MinimumValue
MaximumValue  MinimumValue
For education, the equation is applied to each of the two subcomponents, then a
geometric mean of the resulting indices is created and finally, the equation is
reapplied to the geometric mean of the indices, using 0 as the minimum and the
highest geometric mean of the resulting indices for the time period under
consideration as the maximum.
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Human Development Index
The HDI is the geometric mean of the three dimension indices:  I
1
3
LIFE
xI
1
3
Education
xI
1
3
INCOME
The expression above embodies imperfect substitutability across all HDI dimensions. It thus addresses one of
the most serious criticisms of the linear aggregation formula, which allowed for perfect substitution across
dimensions. Some substitutability is inherent in the definition of any index that increases with the values of its
components.
Example: China
Indicator
Value
Life expectancy at birth (years) = 73.5
Mean years of schooling (years) = 7.5
Expected years of schooling (years) = 11.4
GNI per capita (PPP US$)
= 7,263
Note: Values are rounded.
Life expectancy index =(73.5 – 20)/(83.2 – 20) = 0.847
(a) Mean years of schooling index = (7.5 – 0)/(13.2 – 0) = 0.568
(b) Expected years of schooling index = (11.4 – 0)/(20.6 – 0) = 0.553
Education index = 0.568 x 0.553  0  0.589
0.951  0
Income index =
ln(7,263)  ln(163)
 0.584
ln(108,211)  ln(163)
Human Development Index (HDI) =
3
0.847 x 0.589 x 0.584  0.663
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Table 2.3 Commonality and Diversity: Some Basic Indicators
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Figure 2.3 Human Development Disparities within Selected
Countries
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Table 2.4 Human Development for 23 Selected Countries
(2004 Data)
Note: (1). a positive ve number shows how much a country’s relative ranking rises when HDI is
used instead of GDP per capita.
(2). 0 implies that the use of HDI has no impact on rating by GDP per capita
.
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Table 2.5 Human Development Index Variations for Similar
Incomes (2004 Data)
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10 Characteristics of the Developing World: Diversity
within Commonality
1. Lower levels of living and productivity
2. Lower levels of human capital (health, education, skills)
3. Higher Levels of Inequality and Absolute Poverty
– Absolute Poverty
– World Poverty
4. Higher Population Growth Rates
– Crude Birth rates
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Figure 2.4: Shares of Global Income, 2005
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Table 2.6: The 12 Most and Least Populated Countries and
Their Per Capita Income, 2005
1.
2.
Low incomes have nothing to do with size (measured by population), i.e. no
causality between country size and economic development
China – large size but still a developing economy; St Kitts and Nevis – small but
wealthy.
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Figure 2.5 Under-5 Mortality Rates, 1990 and 2005
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Table 2.7: Primary School
Enrollment and Pupil-Teacher
Ratios
Figure 2.6: Correlation between
Under-5 Mortality and Mother’s
Education
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Figure 2.7: People Living in Poverty, 1981-2002
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Table 2.8: Crude Birth Rates Around the World, 2005
10. Characteristics of the Developing World: Diversity within
Commonality
5. Greater Social Fractionalization
6. larger Rural Populations but Rapid Rural-to-Urban Migration
7. Lower levels of Industrialization and Manufactured Exports
8. Adverse Geography
-Resource endowments
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Table 2.9: The Urban
Population in Developed
Countries and Developing
Regions
Table 2.10: Share of the
Population Employed in the
Industrial Sector in Selected
Countries, 2000-2005 (%)
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10 Characteristics of the Developing World: Diversity within
Commonality
9. Underdeveloped Financial and Other markets
– Imperfect markets
– Incomplete information
10. Colonial Legacy and external dependence
– Institutions
– Private property
– Personal taxation
– Taxes in cash rather than in kind
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Low Income Countries Today And Developed Countries Then
Eight differences
–
–
–
–
–
–
–
–
Physical and human resource endowments
Per capita incomes and levels of GDP
Climate
Population size, distribution, and growth
Historic role of international migration
International trade benefits
Scientific/technological research
Efficacy of domestic institutions
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Figure 2.8 Convergence among OECD Countries but
Divergence in the World as a Whole
Convergence?
-Evidence of unconditional convergence is hard to find
-Per capita income convergence?
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Figure 2.9 Per Capita GDP
Growth in 125 Developing
Countries, 1995-2005
Figure 2.10 Growth Convergence
and Absolute Income Convergence
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Long-Run causes of Comparative Development
Schematic Representation
–
–
–
–
–
–
Geography
Institutional quality- colonial and post-colonial
Colonial legacy- pre colonial comparative advantage
Evolution and timing of European development
Inequality- human capital
Type of colonial regime
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Figure 2.11: Schematic Representation of Leading Theories
of Comparative Development
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Role of Institutions
1. Acemoglu, Johnson, and Robinson’s: “reversal of fortune”
and extractive institutions
2. Bannerjee and Iyer’s:“property rights institutions”.
Landlords versus cultivators
Will hand out a Lecture on Institutions
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Chapter 3: Classic Theories of Economic Growth and
Development
 Earlier Theories
Classic Theories of Economic Development – Four Approaches
1. Linear stages of growth model
2. Theories and Patterns of structural change
3. International-dependence revolution
4. Neoclassical, free market counterrevolution
Development as Growth and Linear-Stages Theories
1. Rostow’s Stages of Growth
2. Harrod Domar Growth Model
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Earlier Theories: Growth Theory + Development = Growth and
Development Economics
Adam Smith (as quoted in a1976 revision): “Great nations are never
impoverished by private, though they sometimes are publick prodigality
and misconduct.”
Thomas Malthus (1817): “The practical question then for our consideration
is, what are the most immediate and effective stimulants to the creation
and progress of wealth?
W. Arthur Lewis (1955): “The proximate causes of economic growth are the
effort to economize, the accumulation of knowledge, and the
accumulation of capital.”
Robert Solow (1956): To change the rate of growth of real output per head (=
GDP/Population) you have to change the rate of technical progress.
Paul Krugman (1995): Why did development economics fade away? -- the
leading development economists failed to turn their intuitive insights into
clear-cut models that could serve as the core of an enduring discipline.
The First Revolution: Adam Smith;1
1.
2.
3.
4.
5.
Link between division of labor, efficiency, and the size of the market
as central in his theory of wealth creation, public policy and
economic growth.
Like Hume, he regarded saving and investment as by-products and
precursors of domestic and foreign trade; as a means of enlarging
the market and increasing the division of labor and thus efficiency.
High saving and investment stimulate growth directly and indirectly.
Directly --- accumulation of capital on output. Indirectly --- effects
on labor productivity + interaction with exchange and trade.
Trade (domestic and foreign) stimulates growth: smaller countries
have higher trade (Belgium and Sweden, 143% and 77%
respectively in 1995) whereas for the USA and Japan, 24% and 17%
respectively.
By Smith, anything that increases division of labor and hence
specialization increases efficiency and wealth, and thus economic
growth.
Adam Smith ;2
6. Thus, anything that increases efficiency of labor (L), capital (K) should have the same effect
on output and hence economic growth.
7. Smith’s view on education, efficiency and growth follows from his distinction between the
quantity and quality of labor. Viewed inferior education as not contributing to increased
labor productivity or efficiency. Advocated improved education for the ‘common people.’
Thought education could be improved by more private-sector involvement aided by
public sector expenditure - need for government tax revenue.
8. In sum, Adam Smith attributed economic growth to:
a. an increase in the quantity and quality of the 3 main inputs; labor (L), capital (K), and
land (N). Modern-day growth accounting attempts to determine empirically the
proportions in which economic growth can be traced to these proximate causes. In
practice, we have as determinants; the increased quantity of capital through saving and
investment AND improved quality of labor, capital, and land as sources of economic
growth.