Unit 4: The Global Economy - Economic Development
Beyond GDP: Measuring True Development! Economic development goes far beyond simply increasing GDP. While economic growth measures the expansion of output, economic development encompasses improvements in living standards, health, education, freedom, and overall quality of life. This unit explores how we measure development using both single indicators like GDP per capita and composite indicators like the Human Development Index (HDI). Understanding these measures—along with their strengths and limitations—is essential for analyzing development challenges and evaluating policies aimed at reducing poverty and improving human welfare globally.
1. Economic Growth vs. Economic Development
Economic Growth: An increase in the real output (Real GDP) of an economy over time. It's a quantitative measure focusing purely on the expansion of production.
Economic Development: A broader concept involving improvements in living standards, reduction in poverty, better health and education, greater freedom and choice, and overall enhancement in quality of life. It includes growth but extends to qualitative improvements in human welfare.
Key Distinctions
| Aspect | Economic Growth | Economic Development |
|---|---|---|
| Focus | Quantitative (numbers) | Qualitative and quantitative (welfare) |
| Measurement | GDP, Real GDP, GDP per capita | HDI, MPI, life expectancy, literacy, poverty rates |
| Scope | Narrow - just output | Broad - includes health, education, freedom, environment |
| Necessary? | Necessary but not sufficient for development | Requires growth plus equitable distribution and welfare improvements |
| Can have without the other? | Yes - can have growth without development (inequality) | Difficult to have development without growth (need resources) |
Relationship:
- Economic growth is a component of economic development
- Growth provides resources needed for development
- BUT growth alone doesn't guarantee development
- If growth benefits only wealthy, development may not occur
- Development requires growth PLUS equitable distribution, good governance, investment in human capital
Growth Without Development:
Development Requires Growth:
- Oil-rich countries with high GDP per capita but poor healthcare, education
- Example: Equatorial Guinea (high GDP per capita from oil, but low HDI)
- Wealth concentrated among elite, majority remain poor
Development Requires Growth:
- Development programs (schools, hospitals, infrastructure) need funding
- Growth generates tax revenue for social programs
- Without growth, difficult to improve living standards
2. Single Indicators of Economic Development
Single indicators use one metric to measure development or living standards. While simple and easy to compare, they provide an incomplete picture.
1. Gross Domestic Product (GDP) Per Capita
GDP Per Capita: Total GDP divided by population. It measures average income per person in a country.
GDP Per Capita Formula:
\[ \text{GDP Per Capita} = \frac{\text{Total GDP}}{\text{Population}} \]
Example:
Country with GDP = $500 billion, Population = 25 million \[ \text{GDP Per Capita} = \frac{\$500 \text{ billion}}{25 \text{ million}} = \$20,000 \]
Example:
Country with GDP = $500 billion, Population = 25 million \[ \text{GDP Per Capita} = \frac{\$500 \text{ billion}}{25 \text{ million}} = \$20,000 \]
Advantages of GDP Per Capita:
- Easy to calculate: Data widely available for most countries
- Easy to compare: Simple numerical comparison between countries
- Correlation with development: Generally, higher GDP per capita = higher living standards
- Indicator of productive capacity: Shows economic potential
- Useful for tracking over time: Shows economic progress
Limitations of GDP Per Capita:
1. Doesn't Measure Distribution (Inequality):
2. Ignores Non-Market Activities:
3. Doesn't Account for Informal/Hidden Economy:
4. Ignores Quality of Life Factors:
5. Exchange Rate Problems:
6. Composition of Output:
7. Negative Externalities Not Subtracted:
1. Doesn't Measure Distribution (Inequality):
- Average doesn't show how wealth is distributed
- Country could have high GDP per capita but most people poor
- Wealth concentrated among small elite
- Example: High-income oil states with extreme inequality
2. Ignores Non-Market Activities:
- Subsistence farming not counted (common in developing countries)
- Household work (childcare, cooking) not valued
- Barter economy excluded
- Underestimates true economic activity in developing countries
3. Doesn't Account for Informal/Hidden Economy:
- Underground economy not recorded
- Large in many developing countries
- GDP underestimated
4. Ignores Quality of Life Factors:
- Doesn't measure health, education, freedom
- No information on life expectancy, literacy
- Says nothing about happiness or well-being
- Environmental quality not considered
5. Exchange Rate Problems:
- Comparing GDP requires currency conversion
- Market exchange rates may not reflect true purchasing power
- Can distort comparisons (PPP adjustment needed)
6. Composition of Output:
- Doesn't distinguish between "goods" and "bads"
- Military spending, pollution cleanup add to GDP but don't improve welfare
- Natural disasters increase GDP (reconstruction) but reduce welfare
7. Negative Externalities Not Subtracted:
- Environmental damage not deducted
- Pollution, deforestation counted as growth
- Depleting resources increases current GDP but harms future
2. Gross National Income (GNI) Per Capita
GNI Per Capita: Total income earned by a country's residents (including income from abroad) divided by population. Similar to GDP per capita but includes net income from abroad.
GNI Formula:
\[ \text{GNI} = \text{GDP} + \text{Net Income from Abroad} \]
\[ \text{GNI Per Capita} = \frac{\text{Total GNI}}{\text{Population}} \]
\[ \text{GNI Per Capita} = \frac{\text{Total GNI}}{\text{Population}} \]
Difference from GDP:
When Different:
- GDP: Production within country's borders
- GNI: Income earned by country's residents (regardless of location)
- GNI includes income from investments abroad, remittances
- GNI subtracts income foreigners earn domestically
When Different:
- Countries with large foreign investments abroad: GNI > GDP
- Countries with many foreign-owned companies: GNI < GDP
- Example: Ireland has lower GNI than GDP (many foreign multinationals)
World Bank Classification:
Uses GNI per capita (Atlas method) to classify countries:
Uses GNI per capita (Atlas method) to classify countries:
- Low income: ≤ $1,135
- Lower-middle income: $1,136 - $4,465
- Upper-middle income: $4,466 - $13,845
- High income: ≥ $13,846
3. Purchasing Power Parity (PPP) Adjustment
Purchasing Power Parity (PPP): An adjustment that accounts for differences in price levels between countries. PPP-adjusted figures show what money can actually buy, not just nominal exchange rate conversions.
Why PPP Matters:
Example:
- Same income buys more in countries with lower prices
- $1,000/month goes much further in India than in Norway
- Market exchange rates don't reflect actual purchasing power
- PPP adjusts for cost of living differences
Example:
- Country A: GDP per capita = $10,000 at market exchange rates
- Country B: GDP per capita = $10,000 at market exchange rates
- BUT: Prices in Country A are half those in Country B
- Country A's PPP-adjusted GDP per capita = $20,000 equivalent
- Real living standards in A are higher than B
3. Composite Indicators of Economic Development
Composite indicators combine multiple measures to provide a more comprehensive picture of development. They recognize that development is multi-dimensional.
1. Human Development Index (HDI)
Human Development Index (HDI): A composite index created by the United Nations Development Programme (UNDP) that measures average achievement in three basic dimensions of human development: health, education, and standard of living.
Three Components of HDI:
1. Health (Longevity):
2. Education (Knowledge):
3. Standard of Living:
1. Health (Longevity):
- Measured by: Life expectancy at birth
- Reflects healthcare quality, nutrition, sanitation
- Indicator of overall population health
2. Education (Knowledge):
- Two sub-components:
- Mean years of schooling (average education of adults)
- Expected years of schooling (education children entering school can expect)
- Reflects access to and quality of education
- Human capital indicator
3. Standard of Living:
- Measured by: GNI per capita (PPP-adjusted)
- Reflects material well-being
- Command over resources
HDI Calculation:
For each dimension, calculate an index between 0 and 1: \[ \text{Dimension Index} = \frac{\text{Actual Value} - \text{Minimum Value}}{\text{Maximum Value} - \text{Minimum Value}} \]
Then take geometric mean: \[ \text{HDI} = (\text{Health Index} \times \text{Education Index} \times \text{Income Index})^{1/3} \]
HDI ranges from 0 to 1
For each dimension, calculate an index between 0 and 1: \[ \text{Dimension Index} = \frac{\text{Actual Value} - \text{Minimum Value}}{\text{Maximum Value} - \text{Minimum Value}} \]
Then take geometric mean: \[ \text{HDI} = (\text{Health Index} \times \text{Education Index} \times \text{Income Index})^{1/3} \]
HDI ranges from 0 to 1
- • 0 = lowest possible development
- • 1 = highest possible development
HDI Categories:
- Very High Human Development: HDI ≥ 0.800 (e.g., Norway 0.961, Switzerland 0.955, USA 0.921)
- High Human Development: 0.700 ≤ HDI < 0.800 (e.g., China 0.768, Brazil 0.754)
- Medium Human Development: 0.550 ≤ HDI < 0.700 (e.g., India 0.633, Bangladesh 0.661)
- Low Human Development: HDI < 0.550 (e.g., Chad 0.394, Niger 0.400)
Advantages of HDI:
- Broader measure: Captures health, education, and income
- Focus on people: Emphasizes human well-being, not just production
- Easy to understand: Single number (0-1), easy to compare and rank
- Widely used: International standard, published annually for ~190 countries
- Highlights disparities: Shows countries with high GDP but poor health/education
- Policy focus: Encourages investment in health and education
Limitations of HDI:
- Limited dimensions: Only three aspects; ignores inequality, freedom, environment, gender equity, happiness
- No inequality measure: Averages hide disparities within countries (IHDI addresses this)
- Data quality: Developing countries may have unreliable statistics
- Aggregation issues: Equal weighting may not reflect true priorities
- Doesn't show sustainability: Current development may be at expense of future
- Cultural bias: Western-centric view of development
- Still includes GDP: GNI per capita has all GDP limitations
2. Inequality-Adjusted HDI (IHDI)
Inequality-Adjusted HDI (IHDI): Adjusts the HDI for inequality in the distribution of each dimension (health, education, income). Shows actual level of human development accounting for inequality.
How It Works:
Interpretation:
- Calculates HDI for each dimension
- Adjusts downward based on inequality in that dimension
- Higher inequality → bigger downward adjustment
- IHDI always ≤ HDI
- Loss: HDI - IHDI shows "loss" due to inequality
Interpretation:
- Countries with high inequality have large gap between HDI and IHDI
- Countries with low inequality have small gap
- Shows true development considering distribution
3. Multidimensional Poverty Index (MPI)
Multidimensional Poverty Index (MPI): Measures acute poverty by assessing deprivations across health, education, and living standards. Identifies who is poor and how they are poor.
Ten Indicators Across Three Dimensions:
Health (each weighted 1/6):
Education (each weighted 1/6):
Living Standards (each weighted 1/18):
Person is "multidimensionally poor" if deprived in ≥1/3 of weighted indicators
Health (each weighted 1/6):
- Nutrition (BMI, child malnutrition)
- Child mortality (death of child in family)
Education (each weighted 1/6):
- Years of schooling (no household member completed 6 years)
- School attendance (any school-age child not attending)
Living Standards (each weighted 1/18):
- Cooking fuel (uses dung, wood, charcoal)
- Sanitation (no improved toilet or shared)
- Drinking water (no access to safe water)
- Electricity (no electricity)
- Housing (floor is dirt, sand, dung)
- Assets (doesn't own car, truck, radio, TV, phone, bike, etc.)
Person is "multidimensionally poor" if deprived in ≥1/3 of weighted indicators
MPI Value:
\[ \text{MPI} = \text{Headcount Ratio} \times \text{Intensity of Poverty} \]
- Headcount Ratio: % of population multidimensionally poor
- Intensity: Average % of weighted indicators poor are deprived in
4. Gender Inequality Index (GII)
Gender Inequality Index (GII): Measures gender-based disadvantage in three dimensions: reproductive health, empowerment, and labor market participation. Ranges from 0 (perfect equality) to 1 (total inequality).
Three Dimensions:
- Reproductive Health: Maternal mortality ratio, adolescent birth rate
- Empowerment: Share of parliamentary seats held by women, educational attainment (secondary+)
- Economic Status: Labor force participation rate (female vs. male)
5. Happy Planet Index (HPI)
Happy Planet Index (HPI): Measures sustainable well-being. Combines life satisfaction, life expectancy, and ecological footprint to assess efficient use of resources to achieve well-being.
HPI Formula:
\[ \text{HPI} = \frac{\text{Well-being} \times \text{Life Expectancy}}{\text{Ecological Footprint}} \]
4. Characteristics of Developing Countries
Common Features (Not Universal):
Economic Characteristics:
Social Characteristics:
Structural Characteristics:
Economic Characteristics:
- Low GDP/GNI per capita: Low average incomes
- High poverty rates: Large proportion living below poverty line
- Large informal sector: Much economic activity unrecorded
- Primary sector dominance: Agriculture, mining; low industrialization
- Low productivity: Limited capital, technology
- High unemployment/underemployment: Limited job opportunities
- Dependence on primary exports: Vulnerable to commodity price shocks
- Weak financial systems: Limited access to credit
Social Characteristics:
- Low life expectancy: Poor healthcare, nutrition, sanitation
- High infant and maternal mortality: Limited medical care
- Low literacy rates: Limited access to education
- Poor health indicators: Malnutrition, disease prevalence
- High population growth: High birth rates
- Gender inequality: Women disadvantaged in education, employment, rights
- Income inequality: Large wealth gap
Structural Characteristics:
- Poor infrastructure: Roads, electricity, water, sanitation inadequate
- Weak institutions: Corruption, poor governance, weak rule of law
- Political instability: Conflict, weak democracy
- Limited human capital: Low education, skills
- Brain drain: Educated workers emigrate
- Foreign debt burden: Heavy external debt
- Aid dependency: Reliance on foreign aid
5. Barriers to Economic Development
1. Poverty Trap (Vicious Cycle):
- Low income → low savings → low investment → low productivity → low income
- Can't escape without external help
- Families too poor to invest in children's education
- Malnutrition reduces productivity
- Self-perpetuating cycle
2. Lack of Access to Credit:
- Poor can't get loans (no collateral)
- Can't start businesses or invest
- Banks prefer lending to wealthy/urban areas
- High interest rates from informal lenders
- Microfinance attempts to address this
3. Poor Infrastructure:
- Bad roads increase transport costs
- Unreliable electricity limits production
- Poor water/sanitation causes disease
- Lack of internet limits information access
- Deters foreign investment
4. Limited Human Capital:
- Low education limits productivity
- Poor health reduces work capacity
- Brain drain: Educated emigrate
- Intergenerational transmission of poverty
5. Political and Institutional Factors:
- Corruption: Diverts resources, discourages investment
- Weak property rights: No incentive to invest if can be seized
- Poor governance: Inefficient public services
- Political instability/conflict: Destroys infrastructure, discourages investment
- Lack of rule of law: Contracts not enforced
6. Dependency on Primary Products:
- Prices volatile (commodity price shocks)
- Declining terms of trade (Prebisch-Singer hypothesis)
- Low value-added
- Prevents diversification
7. Foreign Debt Burden:
- Large portion of budget goes to debt service
- Less available for development spending
- Debt crisis can force austerity
8. Geography and Climate:
- Landlocked countries face higher trade costs
- Tropical diseases (malaria) reduce productivity
- Climate change disproportionately affects poor countries
- Natural disasters more devastating
9. Population Growth:
- Rapid growth strains resources
- More dependents relative to workers
- Investment spread thin (more schools, hospitals needed)
- BUT: Demographic dividend possible if invest in youth
6. IB Economics Exam Skills
Key Exam Question Types
Question Type 1: Calculate Indicators [4 marks]
Example: "A country has GDP of $600 billion and population of 30 million. Calculate GDP per capita."
Answer Structure:
Example: "A country has GDP of $600 billion and population of 30 million. Calculate GDP per capita."
Answer Structure:
- State formula: GDP per capita = Total GDP / Population
- Substitute values: = $600 billion / 30 million
- Calculate: = $20,000
- Interpret: Average income per person is $20,000
Question Type 2: Explain Limitations [6 marks]
Example: "Explain why GDP per capita may not accurately reflect living standards."
Answer Structure:
Example: "Explain why GDP per capita may not accurately reflect living standards."
Answer Structure:
- Inequality: Average doesn't show distribution; wealth may be concentrated
- Non-market activities: Subsistence farming, household work excluded
- Quality of life: Ignores health, education, environment, freedom
- Composition: Military spending adds to GDP but doesn't improve welfare
- Informal economy: Unreported activity excluded
- Examples: Equatorial Guinea high GDP per capita but low development
Question Type 3: Compare Indicators [8 marks]
Example: "Compare GDP per capita and HDI as measures of economic development."
Answer Structure:
Example: "Compare GDP per capita and HDI as measures of economic development."
Answer Structure:
- GDP per capita:
- Single indicator - just income
- Advantages: Easy to calculate, widely available, comparable
- Limitations: Ignores distribution, health, education, quality of life
- HDI:
- Composite indicator - health, education, income
- Advantages: Broader measure, focuses on people, highlights disparities
- Limitations: Still limited dimensions, no inequality measure (unless IHDI)
- Comparison:
- HDI more comprehensive than GDP per capita
- HDI better reflects true development
- Can have high GDP per capita but low HDI (oil states)
- Both have limitations; best to use multiple indicators
Question Type 4: Distinguish Economic Terms [4 marks]
Example: "Distinguish between economic growth and economic development."
Answer Structure:
Example: "Distinguish between economic growth and economic development."
Answer Structure:
- Economic growth: Increase in real GDP; quantitative measure; just output expansion; measured by GDP growth rate
- Economic development: Improvements in living standards, health, education, freedom; qualitative and quantitative; broader concept; measured by HDI, MPI
- Key difference: Growth is necessary but not sufficient for development; development requires growth plus equitable distribution and welfare improvements
- Example: Can have growth without development (inequality); difficult to have development without growth
Question Type 5: Evaluate Development Strategy [10 marks]
Example: "Evaluate the use of HDI as a measure of economic development."
Answer Structure:
Example: "Evaluate the use of HDI as a measure of economic development."
Answer Structure:
- Introduction: Define HDI (health, education, income)
- Advantages:
- Broader than GDP per capita (three dimensions)
- Focuses on people, not just production
- Easy to understand and compare (0-1 scale)
- Widely used international standard
- Highlights countries with high income but poor health/education
- Encourages policy focus on human capital
- Limitations:
- Still limited (only three dimensions)
- Ignores inequality (averages), environment, freedom, happiness
- Data quality issues in developing countries
- Equal weighting may not reflect priorities
- Doesn't show sustainability
- IHDI, MPI, GII address some gaps but add complexity
- Evaluation:
- Better than GDP per capita alone but not complete
- Best to use multiple indicators (HDI, IHDI, MPI, GII)
- Context matters: different priorities for different countries
- Useful tool but recognize limitations
- Judgment: HDI is valuable improvement over single indicators but should complement other measures
7. Real-World Examples
Growth Without Development: Equatorial Guinea
Situation:
BUT:
Lesson: High GDP per capita doesn't guarantee development without equitable distribution
- Oil discovery in 1990s caused GDP per capita to skyrocket
- Now one of highest GDP per capita in Africa (~$8,000)
BUT:
- HDI remains low (0.596 - medium human development)
- Most people still poor (wealth concentrated with elite)
- Life expectancy only 59 years
- High infant mortality
- Limited access to education
Lesson: High GDP per capita doesn't guarantee development without equitable distribution
Development Success: Costa Rica
Characteristics:
Success Factors:
Lesson: Strategic investment in human capital and institutions can achieve high development without extreme wealth
- Upper-middle income country
- GDP per capita ~$12,000
- HDI 0.809 (very high human development)
Success Factors:
- Abolished military (1949) - redirected spending to education, healthcare
- Universal healthcare and education
- Life expectancy 80 years (higher than USA!)
- High literacy (97%)
- Political stability and democracy
- Environmental protection (ecotourism)
Lesson: Strategic investment in human capital and institutions can achieve high development without extreme wealth
Rapid Development: South Korea
Transformation:
Key Policies:
Lesson: Strategic development policies can achieve rapid growth and development
- 1960: Low-income, war-torn, HDI similar to developing countries
- 2024: High-income, HDI 0.925 (very high), OECD member
Key Policies:
- Massive investment in education (now 100% literacy)
- Export-oriented industrialization
- Investment in technology and R&D
- Land reform
- Strong government industrial policy
Lesson: Strategic development policies can achieve rapid growth and development
Conclusion
Economic development encompasses far more than economic growth alone. While growth is necessary—providing resources for development—it's not sufficient. True development requires improvements in health, education, equality, freedom, and overall quality of life. Single indicators like GDP per capita are useful but incomplete, ignoring distribution and non-economic welfare dimensions. Composite indicators like HDI provide a broader picture by incorporating health and education alongside income, though they too have limitations. Understanding both types of measures—their strengths, limitations, and what they reveal about different countries—is essential for analyzing development challenges and evaluating policies aimed at improving human welfare globally.
Key Takeaways for IB Success:
- Distinguish clearly between economic growth (GDP increase) and economic development (welfare improvement)
- Know single indicators: GDP per capita, GNI per capita—advantages and limitations
- Master HDI: three components (health, education, income), how calculated, interpretation
- Understand other composite indicators: IHDI, MPI, GII
- Recognize that no single indicator is perfect—each has trade-offs
- Know characteristics of developing countries (economic, social, structural)
- Understand barriers to development: poverty trap, poor infrastructure, weak institutions
- Use real examples: Equatorial Guinea (growth without development), Costa Rica (efficient development), South Korea (rapid transformation)
- For evaluation: present balanced view of different indicators
Exam Success Checklist:
- ✓ For calculations: Show formula, substitute values, calculate, interpret
- ✓ For "limitations" questions: Provide multiple distinct limitations with explanations
- ✓ For "compare" questions: Explain both, then highlight key differences
- ✓ Always distinguish growth from development when relevant
- ✓ Remember GDP per capita ignores distribution, non-market activity, quality of life
- ✓ Remember HDI = health + education + income (three components)
- ✓ Use specific country examples to illustrate points
- ✓ For evaluation: advantages, disadvantages, context, judgment
- ✓ Mention PPP adjustment when comparing countries
- ✓ Acknowledge that multiple indicators provide better picture than any single measure