Unit 4: The Global Economy - Economic Development
Understanding Development Indicators and the Difference Between Growth and Development
Introduction: Economic Growth vs. Economic Development
Economic Growth
Definition: An increase in real GDP or real GDP per capita over time.
- Quantitative measure
- Focuses on output/income
- Measured by GDP statistics
Economic Development
Definition: An improvement in living standards, well-being, and economic structure of a country.
- Qualitative and quantitative
- Broader concept than growth
- Includes health, education, freedoms, environmental sustainability
- Structural transformation of economy
Key insight: Growth is necessary but not sufficient for development. A country can have high GDP growth but poor development outcomes (inequality, environmental destruction, lack of freedoms).
1. Single Indicators of Economic Development
A. Gross Domestic Product (GDP)
GDP is the total market value of all final goods and services produced within a country in a given time period.
Three approaches to measure GDP:
- Expenditure: \(GDP = C + I + G + (X - M)\)
- Income: Sum of all incomes earned
- Output: Sum of value added by all industries
B. GDP per Capita
GDP per Capita Formula
\[ \text{GDP per capita} = \frac{\text{Total GDP}}{\text{Population}} \]Purpose: Measure average income/output per person
Advantage over total GDP: Accounts for population size, better indicator of individual living standards
Example:
- • Country A: GDP = $1 trillion, Population = 10 million
- • GDP per capita = $1,000,000,000,000 ÷ 10,000,000 = $100,000
C. Gross National Income (GNI)
GNI (formerly GNP) is the total income earned by a country's residents, regardless of where production occurs.
\[ GNI = GDP + \text{Net income from abroad} \]Difference from GDP:
- GDP: Production within borders (geographic concept)
- GNI: Income of nationals (nationality concept)
Example:
- Japanese company earns profits in US → Counts in US GDP, but Japan's GNI
- American worker earns salary in UK → Counts in UK GDP, but US GNI
D. GNI per Capita
GNI per Capita Formula
\[ \text{GNI per capita} = \frac{\text{Total GNI}}{\text{Population}} \]World Bank classification by GNI per capita (2024):
- Low income: ≤ $1,135
- Lower-middle income: $1,136 - $4,465
- Upper-middle income: $4,466 - $13,845
- High income: ≥ $13,846
Advantages of Single Economic Indicators (GDP/GNI)
- Widely available: Collected by most countries
- Standardized: Comparable across countries and time
- Simple to understand: Single number easy to communicate
- Correlates with development: Generally, higher GDP/GNI associated with better outcomes
- Useful for policy: Helps governments track economic progress
Limitations of Single Economic Indicators
Major Problems with GDP/GNI as Development Measures
1. Doesn't Show Distribution (Inequality):
- High average income doesn't mean everyone is well-off
- Extreme inequality can coexist with high GDP per capita
- Wealthy elite may hold most income
- Example: Oil-rich countries with high GDP but poverty for most citizens
2. Ignores Non-Market Activities:
- Household work (cooking, childcare, cleaning) not counted
- Volunteer work excluded
- Subsistence farming in developing countries underestimated
- Informal economy (unreported work) missed
3. Doesn't Reflect Quality of Life:
- Health outcomes not captured
- Education levels not included
- Life expectancy not reflected
- Freedom, human rights, happiness excluded
4. Environmental Degradation:
- Pollution, deforestation actually increase GDP (cleanup, healthcare costs)
- Resource depletion not subtracted
- Unsustainable growth treated as positive
5. Composition of Output:
- Doesn't distinguish military spending vs. education spending
- Both add to GDP but different welfare implications
6. Purchasing Power Differences:
- Nominal GDP misleading due to price level differences
- $1,000 buys more in India than Norway
- Need PPP adjustment (see below)
7. Updating and Accuracy Issues:
- Developing countries have weaker statistical systems
- Large informal sectors hard to measure
- Data may be outdated or inaccurate
Purchasing Power Parity (PPP)
Why PPP Matters
Problem: Using market exchange rates to compare incomes across countries is misleading because price levels differ.
Example:
- Person earning $50,000 in US vs. $10,000 in India
- Seems like US person is 5× richer
- But cost of living much lower in India
- $10,000 buys more in India than in US
Solution: PPP-adjusted GDP
Purchasing Power Parity (PPP) adjusts for price level differences to compare real purchasing power.
\[ \text{PPP-adjusted GDP per capita} = \frac{\text{GDP per capita at market rates}}{\text{Price level index}} \]Effect: Makes developing countries' incomes appear higher (their currencies undervalued in market rates)
Example comparison:
- India nominal GDP per capita: ~$2,500
- India PPP-adjusted GDP per capita: ~$9,000
- PPP better reflects actual living standards
2. Composite Indicators of Economic Development
Why Composite Indicators?
Single economic indicators (GDP, GNI) don't capture the multidimensional nature of development. Composite indicators combine multiple measures to provide a more comprehensive picture.
Advantages:
- Capture multiple dimensions of well-being
- Better reflect quality of life
- Highlight areas needing improvement
- More holistic measure of development
A. Human Development Index (HDI)
Human Development Index (HDI) is the most widely used composite measure, created by the United Nations Development Programme (UNDP).
Published annually: Human Development Report
Range: 0 to 1 (higher is better)
Components of HDI
HDI Calculation
HDI combines three dimensions with equal weighting:
\[ HDI = \sqrt[3]{\text{Health Index} \times \text{Education Index} \times \text{Income Index}} \]1. Health (Long and Healthy Life):
- Indicator: Life expectancy at birth
- Minimum: 20 years, Maximum: 85 years
- Reflects healthcare quality, nutrition, sanitation
2. Education (Knowledge):
- Two sub-indicators (equally weighted):
- a) Mean years of schooling (for adults 25+): Expected 0-15 years
- b) Expected years of schooling (for children): Expected 0-18 years
3. Income (Decent Standard of Living):
- Indicator: GNI per capita (PPP, in constant dollars)
- Minimum: $100, Maximum: $75,000
- Logarithmic scale (diminishing returns to income)
HDI Country Classification
- Very High Human Development: HDI ≥ 0.800 (e.g., Norway, Switzerland, Australia)
- High Human Development: 0.700 ≤ HDI < 0.800 (e.g., China, Brazil, Turkey)
- Medium Human Development: 0.550 ≤ HDI < 0.700 (e.g., India, Egypt, Philippines)
- Low Human Development: HDI < 0.550 (e.g., Niger, Central African Republic, Chad)
HDI Example Comparison
Country A (High HDI: 0.950):
- Life expectancy: 83 years
- Mean years of schooling: 13 years
- Expected years of schooling: 17 years
- GNI per capita (PPP): $55,000
Country B (Low HDI: 0.400):
- Life expectancy: 55 years
- Mean years of schooling: 3 years
- Expected years of schooling: 8 years
- GNI per capita (PPP): $2,000
Interpretation: Country A has much higher development across all dimensions.
Advantages of HDI
- Multidimensional: Captures health, education, income
- Simple to understand: Single number (0-1)
- Widely recognized: Used globally for comparisons
- Highlights development priorities: Shows weakest dimensions
- Better than GDP alone: Includes quality of life factors
- Tracks progress over time: Can monitor improvements
Limitations of HDI
- Limited dimensions: Only three (health, education, income)
- Doesn't measure inequality: Uses averages (rich and poor not distinguished)
- Ignores freedoms: Political rights, civil liberties excluded
- No environmental sustainability: Resource depletion, pollution not considered
- Doesn't capture happiness/life satisfaction: Subjective well-being ignored
- Equal weighting debatable: Why are three dimensions weighted equally?
- Data quality issues: Developing countries have poor statistics
- Snapshot measure: Doesn't show distribution within countries
B. Inequality-Adjusted HDI (IHDI)
IHDI adjusts HDI for inequality in distribution of health, education, and income.
How it works:
- Takes HDI components and adjusts downward based on inequality
- Greater inequality → Larger adjustment → Lower IHDI
- Perfect equality → IHDI = HDI
Example:
- Country has HDI = 0.800 but IHDI = 0.650
- Loss = (0.800 - 0.650) / 0.800 = 18.75%
- High inequality reduces human development by 18.75%
C. Gender Development Index (GDI) and Gender Inequality Index (GII)
GDI (Gender Development Index):
- Ratio of female HDI to male HDI
- Measures gender gaps in health, education, income
- Value close to 1 = gender equality
GII (Gender Inequality Index):
- Measures gender disparities in three dimensions:
- 1. Reproductive health: Maternal mortality, adolescent fertility
- 2. Empowerment: Parliamentary representation, secondary education
- 3. Labor market: Labor force participation rates
- Range: 0 (equality) to 1 (extreme inequality)
D. Multidimensional Poverty Index (MPI)
MPI identifies multiple deprivations at household level in health, education, and living standards.
Ten indicators across three dimensions:
1. Health (1/3 weight):
- Nutrition
- Child mortality
2. Education (1/3 weight):
- Years of schooling
- School attendance
3. Living Standards (1/3 weight):
- Cooking fuel
- Sanitation
- Drinking water
- Electricity
- Housing
- Assets
Person is multidimensionally poor if: Deprived in at least 1/3 of weighted indicators
E. Happy Planet Index (HPI)
HPI measures sustainable well-being by considering life expectancy, experienced well-being, and ecological footprint.
\[ HPI = \frac{\text{Well-being} \times \text{Life Expectancy}}{\text{Ecological Footprint}} \]- Well-being: Subjective life satisfaction (survey)
- Life expectancy: Years
- Ecological footprint: Environmental impact per capita
Goal: High well-being with low environmental cost
Top performers: Often middle-income countries (e.g., Costa Rica)
3. Economic Growth vs. Economic Development
The Relationship
Economic growth is necessary but not sufficient for economic development.
Why growth helps development:
- Higher incomes enable better nutrition, healthcare, education
- Government tax revenues increase → Can fund social services
- Creates employment opportunities
- Resources available for infrastructure
Why growth alone is insufficient:
- Benefits may not be distributed equitably (inequality)
- Growth can harm environment (unsustainable)
- May not improve health/education if government doesn't invest
- Quality of life involves more than income
Examples of Growth Without Development
Case 1: Resource-Rich Countries
Example: Some oil-producing nations in Middle East and Africa
- High GDP per capita from oil exports
- But wealth concentrated in elite
- Poor education and healthcare for majority
- Low human development despite high income
Case 2: Environmental Destruction
Example: Rapid industrialization causing severe pollution
- GDP increases from industrial output
- But air/water quality deteriorates
- Health problems increase
- Quality of life falls despite income growth
Case 3: Inequality
Example: High average growth but rising inequality
- GDP per capita increases
- But bottom 50% see stagnant incomes
- Top 1% capture most gains
- Poverty persists despite national growth
Examples of Development With Moderate Growth
Case: Costa Rica
- Moderate GDP per capita (~$20,000 PPP)
- But very high HDI (0.809) - comparable to much richer countries
- Universal healthcare system
- High life expectancy (80 years)
- High literacy rates
- Strong environmental protection
Lesson: Smart policies can achieve high development without extreme wealth
Structural Transformation in Development
Economic development typically involves structural transformation - shift from agriculture to industry to services.
Three-sector model:
Stage 1: Agricultural Economy (Low-income countries)
- Most labor in agriculture (subsistence farming)
- Low productivity
- Low incomes
Stage 2: Industrializing Economy (Middle-income countries)
- Labor shifts to manufacturing
- Urbanization increases
- Productivity rises
- Incomes grow
Stage 3: Service Economy (High-income countries)
- Most labor in services (finance, healthcare, education, technology)
- High productivity
- High incomes
- Knowledge-based economy
Comparison: Development Indicators
| Indicator | What It Measures | Advantages | Limitations |
|---|---|---|---|
| GDP per capita | Average income/output per person | Simple, widely available, comparable | Ignores inequality, quality of life, environment |
| GNI per capita | Average income of nationals | Includes income from abroad | Same as GDP limitations |
| HDI | Health, education, income | Multidimensional, holistic, simple | Limited dimensions, ignores inequality/environment |
| IHDI | HDI adjusted for inequality | Shows distribution, more accurate | More complex, less data available |
| GII | Gender inequality | Highlights gender gaps | Narrow focus |
| MPI | Multiple deprivations (poverty) | Household-level, comprehensive | Complex, data-intensive |
| HPI | Well-being per environmental cost | Includes sustainability | Subjective well-being hard to measure |
IB Economics Exam Tips
Key Formulas to Remember
- \(\text{GDP per capita} = \frac{\text{GDP}}{\text{Population}}\)
- \(\text{GNI} = \text{GDP} + \text{Net income from abroad}\)
- \(\text{HDI} = \sqrt[3]{\text{Health Index} \times \text{Education Index} \times \text{Income Index}}\)
Common Mistakes to Avoid
- Confusing growth and development: Growth = increase in GDP; Development = broader improvements in well-being
- Saying GDP is always accurate: Has many limitations (inequality, non-market activities, environment)
- Forgetting PPP adjustment: Nominal comparisons misleading; must adjust for price levels
- Not explaining HDI components: Must mention health (life expectancy), education (years of schooling), income (GNI per capita PPP)
- Ignoring context: High GDP with high inequality vs. lower GDP with equality
Essay Structure for Development Questions
Introduction:
- Define economic development vs. growth
- State which indicators you'll discuss
Body - Single Indicators:
- GDP/GNI per capita: advantages and limitations
- Use specific examples
Body - Composite Indicators:
- HDI components and calculation
- Other indices (IHDI, GII, MPI)
- Advantages over single indicators
Evaluation:
- No single indicator perfect
- Context matters (inequality, sustainability)
- Trade-offs between measures
- Need multiple indicators for full picture
- Real-world examples (Costa Rica, oil-rich countries)
Real-World Examples to Use
- Norway: Very high HDI (0.961), high GDP, excellent health/education
- Qatar: Very high GDP per capita but lower HDI (inequality, migrant workers)
- Cuba: Low GDP per capita but relatively high HDI (strong healthcare/education)
- China: Rapid GDP growth but environmental costs, inequality
- Costa Rica: Development without extreme wealth
- Sub-Saharan Africa: Low HDI despite some GDP growth
✓ Economic Development Checkpoint
You should now understand the crucial distinction between economic growth (quantitative GDP increase) and economic development (qualitative improvements in well-being); the major single indicators including GDP per capita and GNI per capita with their advantages (simple, comparable) and severe limitations (ignore inequality, quality of life, environment, non-market activities); the importance of PPP adjustment for international comparisons; and composite indicators especially HDI with its three components (health/life expectancy, education/years of schooling, income/GNI per capita PPP) that provide a more holistic but still imperfect measure of development. Remember to always evaluate indicators critically, use specific country examples, and recognize that no single measure captures all dimensions of development. For IB Economics SL exams, clearly distinguish growth from development and explain why composite indicators like HDI are superior to GDP alone while acknowledging their limitations.