Development Economics definition and concepts: Chapter 1

Development Economics I
 Chapter 1: Economics of Development: Concepts And
Approaches
 Chapter 2: Structural Features and Characteristics of
Developing Countries
 Chapter 3: Growth Models and Theories of Development
 Chapter 4: Historic Growth and Contemporary
Development
 Chapter 5: Poverty, Inequality and Development
 Assessment: Mid 30%, Assignment 20%, & Final 50%
1

Chapter One: Economics of Development: Concepts and Approaches
1.1. Introduction: Basic Concepts and Definition of
Development Economics
 The study of economic development is one of the newest,
most exciting, and most challenging branches of the broader
discipline of economics and political economy.
 The majority of people found in North American and Western
Europe live in the first (luxury) type of life.
 Whereas most people who live in Africa, Asia and Latin
America live in the second (subsistence) type of life.
 Development Economics starts with Adam Smith, but
separate field is recognized some four decades ago; when
Novel prize were awarded in 1979 for two eminent
economists Arthur Lewis and Theodor Schultz (Chicago
University) for their pioneering studies of economic
development. 2

Cont….
Development Economics is a field of economics that is
rapidly evolving its own distinctive analytical and
methodological identity.
DE is not similar to the economics of advanced countries
(in which the economics of advanced countries is
Neoclassical).
It is the economics of poor and underdeveloped countries or
third world nations with varying ideological orientations and
diverse cultural background.
Development economics was basically designed to theorize
on economic backwardness of the less developed countries
(LDCs) and apply the theoretical knowledge to the
analysis of particular problems of underdevelopment, low
income and poverty, and to find ways and means to solve
these problems.
3

Definition of Development Economics:
Development Economics is a branch of economics that studies
systematically the economic development of third world nations.
Development Economics deal with economic, social, political
cultural and institutional mechanism both in public and private
sector necessary to bring about rapid and large scale
improvements in the levels of living of masses which are stricken
by poverty.
The three equally important aspects of development are;
1. Raising peoples living levels;
2. Creating conducive environment ; and
3.Increasing freedom of peoples by increasing varieties of consumer goods
and service.
Development Economics is therefore, the study of how economies
are transformed from stagnation to growth and from low –
income to high income status.
4

1.2. The Nature of Development Economics
Traditional Economics- is concerned with the efficient
least cost combination of resources and with the optimal
growth of these resources over time so as to produce an ever
expanding range of goods and services (Classical and Neo-
Classical economic thought).
It assumes economic rationality and a purely materialistic,
individualistic and self- interested orientation towards
economic decision making.
Political Economy:- goes beyond traditional economics
and studies the social and institutional process through
which certain group of economic and political elite dominate
the allocation of resources. Political economy is therefore,
concerned with the relationship between politics and
economics, with a special emphasis on the role of power in
economic decision making. 5

Cont….
Development Economics:- has an even greater scope.
 It deals with economic, social, political and institutional mechanisms
to bring rapid and large scale improvement in the living standard of
the mass of poverty stricken people living in poor countries of Africa,
Asia and Latin America.
 In development economics, a larger government role and some
degree of coordinated economic decision making are essential
components.
 Development must be sensitive to the uniqueness and diversity of the
third world.
 And we should be aware that there is no single development
economics in this world.
 Because of the heterogeneity of the developing world and the
complexity of the development process, development economics
must be eclectic, attempting to combine relevant concepts and
theories from traditional economic analysis along with new models.
6

1.3. Interests in and Evolution of Development Economics
The study of development economics as a recent and
separate subject is because of the increasing political and
public concern of the poor nations of the world.
A number of factors can be pointed out that account for this
change in attitude and upsurge of interests in the economics
of development.
These factors can broadly be classified into three:-
 i. Academic interest in development,
 ii. The awareness of developing countries about their
backwardness and their demand for a new international
economic order and
 iii. The awareness of the world in general and developed
countries in particular about the mutual interdependence of
the world economy
7

Cont….
 i. Academic interest in development: There is a renewed interest from academician
in the growth and development process of developing countries. Adam Smith, D.
Ricardo, R. Malthus, and K. Marx studied about economic issues and their
consequences. For example, classical thinkers say that population growth with
diminishing return is one of the reason for economic stagnation.
 ii. International economic order: - Poor countries themselves are aware of their
backwardness which leads to a desire to grow and strength their political power
through economic growth. Example, developing countries ask the world for a new
economic order. The new economic order was originated by special session of the
United Nations (UN) assembly. The new international economic order calls for:-
Improve terms of trade for poor countries. Greater access to markets of
developed countries for manufacturing goods of developing countries. Greater
financial assistance for cancelling of past debts Reform of IMF and have a greater
say in decision making They ask international food program and They ask
greater assistance
 iii. The awareness of the world in general and developed countries in particular
about the mutual interdependence of the world economy: - The rich countries have
been compelled out of economic and political necessity to rethink their economic
relations with the poorer nations of the world.
8

1.4. Economic Growth Versus Economic Development
 Economic Growth: is defined as the increase in the value of
goods and services produced by every sector of the economy. It
is usually expressed in terms of the gross domestic product or GDP
of the country.
 Economic development: is more than economic growth.
 Economic development is a sustainable boost in the standards of living
of the people of a country.
 Economic development include in addition to a rise in per capita income,
a fundamental change in the structure of the economy.
 Economic Development also implies that the country must participate in
the process that brought the major structural change.
 Economic development is aimed at the overall well-being of the citizens
of a country, as they are the ultimate beneficiaries of the development of
the economy of their country.
 Note: Economic Growth is a necessary but not a sufficient condition
for Economic Development.
9

Distinction Between Economic Growth and Economic
Development
• Economic Growth – takes place when there is a
sustained increase in a country’s output (as
measured by GDP or GNP) or in the per capita
output (GDP or GNP per person)
• Economic Development–occurs when the standard
of living of a large majority of the population (rises)
improvement in well-being, including both income and
other dimensions like health and literacy
• Why is there a distinction? 10

1.5. Three Core Values of Development
Higher income is an important element of one’s well being. But, well
being of individuals also depends on their health, education,
geographical, social environment, and political system.
There are three core values of development: (i) sustenance, (ii) self-
esteem, and (iii) freedom.
 Sustenance (Ability to meet basic needs): Sustenance is the ability to
meet basic needs of people. All people have certain basic needs
without which life would be impossible. These basic needs include
food, shelter, health, and protection. People should have access to
these basic needs.
 Self-Esteem (to be a person): Sense of worth and self-respect and
feeling of not being marginalized are extremely important for
individual’s well being.
 Freedom from Servitude (to be able to choose): Human freedom,
the ability to choose, is essential for the well being of individuals.
Freedom involves an expanded range of choices for societies:
economic and political. 11

1.6. Measurement and International Comparison of Growth and Development
Methods of measuring development (indicators) and making international
comparisons are by the Income Measures, the Physical Quality of Life Index,
the Human Development Index, and the Human Poverty Index.
1.6.1. Conventional Measures of Development and their Limitations
Conventional Measures of Development: The dominant conventional
measures of growth and development are:
o The Gross National Product (GNP) or Gross Domestic Product (GDP) and their
corresponding per capital values.
o These national income (GNP/GDP) measures are used for the measurement of
economic development in several ways.
• The level of per capita income is taken as a measure of the average standard of
living of the population, while the growth rate measures improvements in the
standard of living.
• This income measure of development is also used to compare the economic
performance of different countries. Thus, the level of national income or per
capita income and their growth rates can be compared internationally.
• The poverty datum line, as the measure of the critical minimum level of per
capita income below which individuals are deemed to be living in absolute
poverty, is also derived from the income measure of development. 12

Cont…
 Limitations of conventional income measures: Development is
much broader term than economic performance, although the
latter is essentially a part of it. In essence, development ultimately
refers to the quality of life and of human welfare. Thus, in essence
income indictors are incomplete and limiting measures of
development.
 It can be argued that gross domestic product does not actually do a
good job of what we most often use it to display.
 GDP and/or GNP is reasonably accurate and extremely useful of
measure of social and economic wellbeing and level of economic
performances.
 Problems in measuring GDP or GNP: -
 Wealth distribution,
 Real income distribution,
 Omission of some transaction,
 Underground economy and
 GDP ignores the side effect of Economic Growth on Env’t & welfare of society.
13

1.6.2. Alternative measures of level of development
The side effect of measuring Income encountered due
to: -
 The failure of the GNP/GDP measures to reflect the
impact of growth on the pattern of income distribution
 The inability of the GNP/GDP measures to reflect the
welfare impact of the goods and services produced as
well as the likely costs to society of certain patterns of
growth.
 The invalidity of the GNP/GDP indicator as a measure
of well being in situations where growth has actually
deepened poverty and income inequalities, increased
unemployment and affected the environment
adversely.
14

Cont….
Some of glaring (evident) omissions of GNP/GDP measurements
are: -
• environmental impact,
• health conditions, and
• activities in the non-monetized sector, etc.
 Among the developed alternative indicators; the major are the
physical quality of life index (PQLI) developed by Morris (1979),
the Human Development Index (HDI) developed by UNDP, and
the Human Poverty Index. These are to be discussed one by one
below.
a. Physical Quality of Life Index (PQLI):
This composite index is based on three simple indicators: -
 Infant mortality (IM),
 life expectancy (LE), and
 literacy (read and Write) (L). 15

Cont….
PQLI = f (IM, LE, L); This measure gives equal weight to each of the three
indictors.
For each indicator, the performances of individual countries are rated on a
scale of 1 to 100, where 1 represents the worst performance and 100 the best
performance.
 Example: In 1973 Sweden achieved 77 years LE, Guinea Bissau in 1950 got lowest 28
years of life expectancy and 66.60 years for Ethiopia (WB, 2019).
 For infant mortality, the upper limit was 9 per 1000 for Sweden in 1973 and the lower
limit was 229 per 1000 for Gabon in 1950 and also 36.5 deaths per 1,000 live births for
Ethiopia (WB, 2019).
 Infant Mortality is the occurrence of death of very young children under one year.
 Literacy rates measured as percentages from 1 to 100 provide their own direct scale.
 The PQLI of each country is given by the following formula.
PQLI = (IMI + LEI + LI) / 3
Where: IMI is an index of IM, LEI is an index of LE.
The PQLI indirectly reflects the effects on human development of investment
in health service, water and sewage systems, quality of food and nutrition,
education, housing, and changes in income distribution. and LI is an index of
L. 16

Cont….
However, the PQLI has been criticized as an indicator of
social development in relation to both the choice of
indicators as well as the weight assigned to the different
indicators.
It is handicapped by the limited data availability
It gives disproportionate weight to longevity as two
of the three indicators, infant mortality and life
expectancy are related to it.
It gives equal weight to each indicator arbitrarily
without obvious rationale
It treats economic and social indictors separately,
instead of combining them in a composite index.
17

b. Human Development Index (HDI):
 The Human Development Index (HDI) is a statistical tool used to
measure a country's overall achievement in its social and
economic dimensions.
 HDI is ranking various countries with the success of human
development of their population.
 UNDP is offering the HDI as an alternative to the GNP for
measuring the relative socio-economic progress of nations.
 HDI has also attempted to take account of some of the limitations
of the PQLI.
 HDI is based on three variables: -
 Longevity:- as measured by life expectancy at birth
 Educational attainment:- as measured by a condition of adult literacy (two
third weight) and a combined primary, secondary, and tertiary school enrollment
ratios (one third weight)
 Standard of living measured by real per capita income at purchasing power
parity (PPP): The marginal value of money income above the world average
threshold of $5120 real GDP per capita is assumed to be rapidly diminishing.
18

Cont….
For life expectancy at birth the range is from 25-85
years. For adult literacy, the range is b/n 0-100. For real
per capita income the range is b/n $100 – 40,000$.
For any component of the HDI, the individual indices
can be computed according to the general formula of:
o Index: (Actual Value – Minimum Value) / (Max Value – Min Value)
 Life Expectancy Index = (LE–25) / (85-25)
o Adult Literacy Index (ALI) = (ALR – 0) / (100-0)
o Gross Enrolment Index (GEI) = (CGER – 0) / (100-0)
o Education Index = 2/3 x ALI + 1/3 x GEI
o GDP Index = [log(GDPpc) – log(100)] / [log(40000) – log(100)]
 Where: LE: Life expectancy, ALR: Adult literacy rate, CGER:
Combined gross enrolment ratio and GDPpc: GDP per capita
at PPP in USD. 19

Numerical Examples
 Calculating the life Expectancy Index
1. Turkey has life expectancy of 71.4 years in 2005, then, calculate life
expectancy index for Turkey?
Life Expectancy Index =
2. Turkey has adult literacy rate of 87.4% in 2005 and a combined gross enrolment ratio of
68.7% in 2005, then calculate ALI, GEI and Education Index for Turkey?
• Adult literacy index = (87.4 – 0) / (100-0) = 0.874
• Gross enrolment Index = (68.7 – 0) / (100 – 0) = 0.687
• Education Index = 2/3(Adult literacy index) + 1/3(Gross enrolment Index)
= 2/3 (0.874) + 1/3 (0.687) = 0.812
3. For Turkey, with GDP per capital of 8,407$ in 2005, the GDP index is
 log(8,407) – Log(100)/Log(40,000) – Log(100) = 0.74
4. Calculating the HDI
 Determining the HDI is straight forward. It is a simple average of the three
dimensions indexes.
 HDI = 1/3 [(life expe. Index + Education Index + GDP index)]
 1/3 (0.773 + 0.812 + 0.74) = 0.775 20

Cont….
The index thus ranges from 0 to 1. If the actual
value is equal to maximum the index is one.
The HDI ranks countries into three groups:
 low human development (0.0 to 0.50),
 medium human development (0.51 to 0.79) and
 high human development (0.80 to 1.00).
The HDI allows nations to take a broader
measure of their development performance,
both relatively and absolutely and thus to focus
their social and economic policies more directly
on those areas in need of improvement.
21

Cont….
Nevertheless, HDI has been criticized on grounds such
as: -
 It does not include non-quantitative elements of
human development such as human freedom, the
existence of civil liberties and the degree of political
participation.
 It is biased in the choice of indications,
 Its assumption of the rapidly diminishing marginal
value of money income above the world average
threshold of $ 5120 real GDP per capita distorts some
HDI estimates and limits its applicability.
 Its statistical methodology may also be compromised
by insufficient or inaccurate data. 22

c. Human Poverty Index (HPI)
The United Nations has constructed human poverty
indices for developing countries. The composite
measure focuses on dimensions of deprivations. The
HPI for developing countries is based on three main
indices:
 The percentage of the population not expected to survive to the
age of 40 (P1),
 The adult illiteracy rate (P2) and
 A deprivation index based on an average of three variables: the
percentage of the population without access to safe water; the
percentage of population without access to health service; and
the percentage of the underweight children under five years
old (P3).
The formula is: HPI =
23
1/3

1.7. Development Gap
 Eliminating the development gap between rich and poor
countries is the prime objective of the new economic
order. But what are the gaps?
 1. Real per capita GDP,
 2. Developing countries have higher unemployment,
 3. Level of educational attainment,
 4. In developing countries there is poor infrastructure,
inadequate public service, high level of corruption, and
inefficient institutions.
 Thus, the implications of differing conditions in
development in developed and developing countries can
perhaps be most intensely seen in tests for economic
convergence across countries.
24

Development Economics definition and concepts: Chapter 1

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