Lesson 1

 What is “economic development”?  The “level” and “distribution” of national income  Human Development  “Structural” characteristics of developing countries

 Growth in per-capita GNP (Gross National Product)?  Growth in the “quality” of life?  Increases in life expectancy  Lower infant mortality  Access to sanitation, drinking water, power  Access to healthcare and education  Measures of “quality” of life are correlated with GNP

 Economic development is a complex and multi-dimensional aspect of the evolution of societies  First step: understanding the income generation process in a country  Two issues that influence development: level  The “level” of economic attainment distribution  The “distribution” of economic attainment

 Per-capita income and economic growth are good indicators of the “level” of economic attainment  Huge and persistent disparities in per-capita income across countries  But how do we measure these differences?

 We need to convert per-capita incomes across countries into a common unit of measurement  Two methods of conversion: Exchange Rate  The Exchange Rate Method Purchasing Power Parity  The Purchasing Power Parity (PPP) Method

common benchmark  Convert each country’s income (reported in its local currency) to a common benchmark currency, such as the U.S. dollar, and then divide the result by the country’s population  Provides a measure of per-capita incomes across countries in terms of a common currency (US dollar)

 Comparisons using this method are usually biased. Why?  Under-reporting of income in developing countries (inefficient tax collection systems, tax evasion, income generated for self-consumption, etc.)  Prices for many goods are not reflected in exchange rates (non-traded goods such as infrastructure, services, public goods, etc.)  Exchange rate method underestimates the real income of poor countries

 Constructs international prices (in terms of a common currency) for baskets of goods and services across countries.  National income is then estimated by measuring the value of output at these constructed prices.

 Construction of price indices require information about the market structures of the goods and services being considered (i.e., competitive or non-competitive), which are not always available  These estimates ignore costs that arise out of externalities such as pollution.

stable  Over the last three decades, the world distribution of income has been stable  The richest 5% nations had per-capita incomes 29 times higher than that for the poorest 5% within  However, there has been a lot of “mobility” within the world distribution of income  Rise of East Asia and BRIC (Brazil, Russia, India, and China)  Stagnation of sub-Saharan Africa and Latin America

 Given a rate of growth, how long does it take for a country’s income to double?  A dollar invested at r % per year will grow to two dollars in T years, where  Taking logs,

 Now,  Then,  A country growing at 5% per year will double its per-capita income every 14 years  A country growing at 1% per year will double its per-capita income every 70 years

 Middle income countries were the most mobile  Poor countries were the least mobile  Several countries changed their relative position:  There are no “traps” to development  But history seems to matter for the future  A history of extreme underdevelopment does put countries at a disadvantage

huge  The richest 20% earn almost 50% of total per- capita income, while the poorest 40% earn only 15%: huge disparity across countries  Majority of wealth is concentrated in the hands of the “minority”  Inequality seems to rise and then fall as per- capita income increases: “inverted U- hypothesis” (Kuznets, 1955)

 Relying solely on per-capita GNP as an index of development is risky  A fairly prosperous country with high inequality may have low literacy, high infant mortality, low empowerment of women, etc  A fairly poor country might spend a lot of resources on health and education

Human Development Index (HDI)  The United Nations Development Program (UNDP) has reported the Human Development Index (HDI) since 1990  The HDI for a country is the average of three components:  Life expectancy at birth  Measure of educational attainment  Per-capita income  The HDI for each country takes a number between 0 and 1: the “fraction of ultimate development” ranking  The ranking of countries according to the HDI is indicative of the state of development across countries

 So what should we look at: per-capita income or measures of human development? correlated  Critical question: is per-capita income correlated with different measures of human development? proxy  If the answer is “yes,” then per-capita income may be a good proxy for indicators of development

 Even though understanding the HDI is important, per-capita income must be taken very seriously  Though relationship between per-capita income and indicators of development are strong, they are not perfect  Reflects roles played by social and cultural attitudes, government policy, institutions

Demographic Characteristics  Poor countries have high birth and death rates  With development, death rates fall, but birth rates remain high  Leads to high population growth (for a while): may have negative effects on growth young  Overall population is young  A young population  A young population can have two consequences: ▪ Combined with poverty, can lead to child labor and low education ▪ If education is a priority, country can reap “demographic dividend” (think of India and China)

Occupational and Production Structure  Agriculture accounts for a significant proportion of production (30% for low-income countries)  Share of labor force living in rural areas is very high (72% on average)  In developed countries, less than 20% of the labor force live in rural areas

Rural-Urban Migration  “Push” from agriculture: poverty and landlessness  “Pull” from urban sector: high wages and living standards  Between , urban population growth was double that of overall population growth in developing countries  A large fraction of the urban labor force is in “services”  When industrial jobs are scarce, an “informal” sector develops in urban areas  People shine shoes, petty retailers, middlemen, domestic aids, etc  This is different from the “service sector” in developed countries

International Trade  Exports from developing countries: primary products (raw materials, cash crops), textiles, light manufactures  Exports from developed countries: manufactured goods (capital goods, consumer durables), technology

 What determines the pattern and composition of world trade? comparative advantage  Theory of comparative advantage  Countries specialize in exporting goods in which they have a relative cost advantage (lower opportunity cost of production)  Developing countries have a relative abundance of unskilled labor; this is reflected in their exports

 Emphasis on primary exports may be detrimental to developing countries  Prices of primary products are volatile: creates instability in export earnings  Over time, such products become less important in the consumption basket  Terms of trade  Terms of trade: ratio of the price of exports to the price of imports  An increase in terms of trade is “good” and vice-versa  Poor countries are more likely to face a decline in their terms of trade compared to rich countries