Step 23: Economic Development
- Economic growth is a rise in real GDP. Economic development is a wider improvement in people’s lives: health, education, freedom and living standards.
- Development is measured with GNI per capita at PPP, the Human Development Index (HDI) and the Multidimensional Poverty Index (\( \text{MPI} = H \times A \)), plus other indicators.
- Poor countries face barriers such as poverty traps, weak infrastructure and institutions, debt and dependence on primary products.
- Strategies include trade, aid, FDI, microfinance, education and health spending and institutional reform. Exam marks come from evaluating each one, not just describing it.
Growth is not the same as development
Picture two towns. In the first, a new oil field doubles income, but the money goes to a few owners and the school still has no books. In the second, income rises slowly, but every child now finishes school and clean water reaches every home. The first has more growth; the second has more development.
Growth usually helps development, because it pays for schools, hospitals and roads, but it is not enough: it can be unequal, harm the environment or be spent on things that do not help most people.
Measuring development
GNI per capita at PPP
Gross national income (GNI) is the income earned by a country’s residents, including income from abroad. Divided by population, it gives average income per person. To compare countries fairly, it is converted at purchasing power parity (PPP) exchange rates, which reflect what money actually buys. A haircut or bus ride is much cheaper in many low-income countries, so market rates make them look poorer than they are.
For example, a country has GNI of 2,000 billion pesos and a population of 50 million. The market exchange rate is 20 pesos per US dollar, but a basket of goods costing $1 in the US costs only 8 pesos there (the PPP rate is 8 pesos per dollar). Find GNI per capita at market rates and at PPP.
At PPP, the average person can buy two and a half times as much as the market rate suggests.
Limits: an average hides inequality, and GNI ignores the informal economy, health, education and pollution.
The Human Development Index (HDI)
The United Nations Development Programme (UNDP) introduced the HDI in 1990 to measure development more broadly. It combines three dimensions, each turned into an index between 0 and 1:
- Health: life expectancy at birth.
- Education: mean years of schooling (adults) and expected years of schooling (children).
- Income: GNI per capita (PPP). Logarithms are used, because an extra $1,000 matters far more to a poor family than to a rich one.
The HDI is the geometric mean of the three indices:
Each index is worked out as \( \dfrac{\text{actual} – \text{minimum}}{\text{maximum} – \text{minimum}} \). For health the UNDP uses a minimum of 20 years and a maximum of 85 years.
For example, a country has life expectancy of 72 years, an education index of 0.70 and an income index of 0.70. Calculate its HDI.
The HDI is about 0.732. A geometric mean punishes a low score in one dimension more than a simple average would, so a country cannot make up for poor health just by being richer.
Limits of the HDI: it leaves out inequality, political freedom, the environment and the quality of schooling.
The Multidimensional Poverty Index (MPI) and other indicators
The MPI, published since 2010 by the UNDP and the Oxford Poverty and Human Development Initiative, looks at poverty household by household. It measures deprivations in health, education and living standards across ten indicators, such as nutrition, child mortality, schooling, clean water, sanitation and electricity. A person is multidimensionally poor if deprived in at least one third of the weighted indicators.
\( H \) (headcount ratio) is the share of people who are poor. \( A \) (intensity) is the average share of indicators in which poor people are deprived. For example, if 40% of people are poor and they are deprived in 50% of indicators on average, \( \text{MPI} = 0.4 \times 0.5 = 0.20 \).
Other indicators include the share below an income poverty line, the Gini coefficient, infant mortality, adult literacy and the share of jobs in agriculture.
What developing economies have in common
Developing countries differ hugely, but many share some of these features:
- Low income per head and high levels of absolute poverty.
- A large share of workers in agriculture and the informal sector, with low productivity.
- Rapid population growth and a young population, so a high dependency ratio.
- Lower life expectancy, higher infant mortality and lower literacy.
- Exports concentrated in a few primary products (crops, minerals, oil).
Barriers to development
The poverty trap (cycle of poverty). Low incomes mean households can save very little. Low savings mean little money for investment. Low investment means low productivity, which keeps incomes low. The circle repeats. The Harrod–Domar model puts this in a formula: the growth rate equals the savings ratio divided by the capital–output ratio, \( g = s / k \).
For example, a country saves 10% of its income and needs $4 of capital to produce $1 of output a year. Its population grows by 2.5% a year. What happens to income per head?
To escape, the country must raise saving (or attract outside funds such as aid or FDI) or use capital more productively (lower \( k \)).
Poor infrastructure. Bad roads and unreliable electricity raise firms’ costs and cut them off from markets.
Weak institutions. Corruption, insecure property rights and political instability discourage investment, because people fear losing the rewards.
Debt. Revenue spent on repaying foreign lenders cannot go on schools and hospitals, and foreign-currency debt gets harder to repay if the domestic currency falls.
Primary-product dependence. Commodity prices swing sharply, so export earnings and tax revenue are unstable, and primary prices have often fallen relative to manufactures over long periods, worsening the terms of trade. For example, if a country earns $10 billion from exports, $6 billion of it from coffee, a 25% fall in the coffee price (with volumes unchanged) cuts coffee earnings to $4.5 billion and total exports to $8.5 billion, a fall of 15%.
Other barriers include low human capital, rapid population growth, capital flight and conflict.
Strategies for development, and how well they work
| Strategy | How it helps | Evaluation |
|---|---|---|
| Trade-led growth (export promotion, trade liberalisation) | Access to world markets; specialisation by comparative advantage; economies of scale; foreign currency for capital goods | Worked for several East Asian economies, but depends on world demand and market access; infant industries may be wiped out |
| Foreign aid (grants, concessional loans, technical help) | Fills the savings gap; funds health, education and emergency relief | Can create dependency or be lost to corruption; tied aid must be spent on the donor’s goods; works best with good governance |
| Foreign direct investment (FDI) | Brings capital, technology, management skills and jobs; tax revenue | Profits may be sent home; transfer pricing can avoid tax; few links to local firms |
| Microfinance | Small loans to poor people, often women, with no collateral, to start small businesses | Grameen Bank in Bangladesh, founded by Muhammad Yunus, is the famous example (Nobel Peace Prize 2006); but interest rates can be high, and evidence of large effects on poverty is mixed |
| Investment in education and health | Raises human capital and productivity; lowers birth rates over time; directly improves HDI | Long time lag before benefits show; needs funding; risk of “brain drain” as skilled workers emigrate |
| Institutional reform | Secure property rights, less corruption and fair courts build the trust investment needs | Slow; depends on political will; reforms imposed from outside often fail |
No single strategy works alone. Successful developers usually combine market-led growth with state investment in people and infrastructure, and with sound institutions.
Sustainable development and the SDGs
Sustainable development means development that meets the needs of the present without compromising the ability of future generations to meet their own needs. In 2015 the United Nations adopted 17 Sustainable Development Goals (SDGs), with a target date of 2030. They replaced the eight Millennium Development Goals (2000–2015). The SDGs include ending poverty and hunger, good health, quality education, gender equality, clean water, affordable clean energy, decent work and climate action.
Critics argue that 17 goals, with many more targets, are too many to prioritise and hard to measure.
Practise: 6 questions
Try each one on paper first, then check the worked answer.
EasyQ1. Distinguish between economic growth and economic development, with an example of growth without development. Show worked answer
Example: a country discovers oil and real GDP rises fast, but the revenue goes to a small elite, so life expectancy, schooling and poverty do not improve for most people.
EasyQ2. A country has GNI of 900 billion rupees and a population of 30 million. The market exchange rate is 75 rupees per dollar and the PPP rate is 25 rupees per dollar. Calculate GNI per capita at market rates and at PPP. Show worked answer
Market rate: \( 30{,}000 \div 75 = \$400 \).
PPP: \( 30{,}000 \div 25 = \$1{,}200 \).
Living standards are three times higher than the market-rate figure suggests, because prices are lower in this country.
MediumQ3. A country’s health index is 0.6, its education index is 0.5 and its income index is 0.8. Calculate its HDI and compare it with the simple average. Show worked answer
HDI \( = 0.24^{1/3} \approx 0.621 \).
Simple average \( = (0.6 + 0.5 + 0.8) \div 3 \approx 0.633 \).
The HDI is lower because the geometric mean penalises the weak education score; high income cannot fully make up for it.
MediumQ4. In a region, 30% of people are multidimensionally poor, and on average they are deprived in 45% of the weighted indicators. Calculate the MPI and explain one advantage of the MPI over an income poverty line. Show worked answer
Advantage: it shows what people lack (for example, clean water or schooling), so governments can target specific deprivations, and it captures how intense poverty is.
MediumQ5. Using \( g = s/k \), a country saves 18% of income and has a capital–output ratio of 3. Population grows at 2% a year. Find the growth rate of GDP and the approximate growth rate of income per head. Using the rule of 70, how long will income per head take to double? Show worked answer
Growth per head \( \approx 6\% – 2\% = 4\% \).
Doubling time \( \approx 70 \div 4 = 17.5 \) years.
ExamQ6. Evaluate whether foreign aid is more effective than trade in promoting economic development. [12 marks] Show worked answer
Analysis (up to 4): aid fills the savings gap in a poverty trap (Harrod–Domar: higher investment raises \( g = s/k \)) and can fund health and education directly, raising HDI. Trade lets the country specialise by comparative advantage, earn foreign exchange, gain economies of scale and attract technology; export earnings are self-sustaining and do not need repayment.
Evaluation (up to 5): aid may cause dependency, be tied or lost to corruption; humanitarian aid is vital after disasters. Trade gains depend on access to rich-country markets, the type of export (volatile primary prices, worsening terms of trade) and whether gains are shared. Conclusion: the poorest countries may need well-targeted aid first to build human capital; in the long run trade is more sustainable. They work best as complements, and the deciding factor is the quality of institutions.
Check yourself
1. The three dimensions of the HDI are:
2. Why is GNI per capita converted at PPP rather than market exchange rates?
3. Which is the clearest example of a poverty trap?
Your score: 0 out of 3
The short version
- Growth is a rise in real GDP; development is a wider rise in wellbeing, including health, education and lower poverty.
- Measures: GNI per capita at PPP (income only), HDI (geometric mean of health, education and income) and MPI (\( H \times A \), household deprivations).
- Barriers include poverty traps, weak infrastructure and institutions, debt and dependence on volatile primary exports.
- Trade, aid, FDI, microfinance, human capital investment and institutional reform all help, but each has limits; success usually depends on good governance.
- The 17 UN Sustainable Development Goals (2015–2030) set development targets that include inequality and the environment.
Further reading on EconTutorials
Older in-depth articles on this topic from our blog: