CHAPTER ONE
Economics and Development Studies
Definition
Development :The process of improving the quality of all
human lives and capabilities by raising people’s levels of
living, self-esteem, and freedom.
Developing countries :Countries of Asia, Africa, the Middle
East, Latin America, eastern Europe that are presently
characterized by low levels of living and other development
deficits.
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The Nature of Development Economics
Traditional economics :An approach to economics that
emphasizes utility, profit maximization, market efficiency, and
determination of equilibrium.
it is concerned primarily with the efficient, least-cost allocation
of scarce productive resources and with the optimal growth of
these resources over time so as to produce an ever-expanding
range of goods and services.
It assumes economic “rationality” and a purely materialistic,
individualistic, self-interested orientation toward economic decision
making.
Political economy :The attempt to merge economic analysis with
practical politics—to view economic activity in its political context.
Development economics :The study of how economies are
transformed from stagnation to growth and from low income to
high-income status, and overcome problems of absolute poverty. It
has wider scope.
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The subject economic development is of recent origin.
It is one of the newest, most exciting, and most
challenging branches of the broader disciplines of
economics and political economy.
Throughout the world people live in different
circumstances.
Some people live in Comfortable house with many rooms,
They have, more than enough to eat, They are well
clothed, healthy
can look forward to reasonable degree of financial
security others
about 3/4 of the world population are much less
fortunate.
They have little or no shelter, inadequate food, their
healthy is poor.
They cannot read and write, unemployed.
These differences in living Conditions raise various issues.
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Why does affluence Co-exist with poverty across
different continents and across people with in a nation
and even with in the city.
How does traditional subsistent low productivity society
can be transformed in to modern, high productivity, high
income nations
To what extent are the development aspirations of the
poor nation helped or hindered by the condition of the
rich nations.
By what process and under what condition do the rural
substantial farmers in remote regions of sub-Saharan or
Asia evolves into successful commercial farms.
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The meaning of Economic growth and development
The term Economic Development is used interchangeably
with such terms as economic growth, economic welfare,
economic progress and secular change. However in strict
sense, these terms have different meaning and scope.
According to professor Bonne, Development requires and
involves some sort of direction, regulation and guidance to
generate the forces of expansion and maintain them.
According to Maddison, " The raising of income levels is
generally called economic growth, in rich countries, and in
poor ones it is called economic development".
Even though economic growth and development are
sometimes used synonymously in economic discourse,
economic growth refers to a rise in per capita GDP. Whereas
economic development is more than economic growth.
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Economic development implies(in addition to the rise in per
capita income) fundamental change in the structure of the
economy. That is,
a falling share of agriculture in GDP
a rising share of industry in GDP
rising share of population living in cities (urban areas) rather
than in rural areas.
Furthermore, Economic development also implies that the
country must participate in the process that brought the
major structural change or changes in income.
In general, Development embrace the major economic and
social objectives and values that societies strive for.
According to Todaro: DEV is “conceived as a multi dimensional
process involving major changes in social structures, popular
attitudes, and national institutions, as well as the acceleration
of economic growth, the reduction of inequality (and
unemployment), and the eradication of absolute poverty”.
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Therefore, development is hardly possible without growth, but
growth is possible without development.
A country may produce more of goods and services.
However, the benefits of this growth may exclusively be
appropriated by a privileged elite and small middle class. In this
case the vast majority of the country’s people may be completely
unaffected or worsened growth without development is not
sustainable.
In the oil rich countries, for example, their economies grow when
price of oil increases. Nevertheless, this growth is not sustainable,
as prices cannot be increased indefinitely.
But Development is sustainable b/c it is a change in the
structural & institutional factors, social attitudes & customs
accompanied with a secular rise in real income through a change
in output and occupational structure & improvement in the relative
contribution of inputs.
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Core values of development
Life-sustenance: life-sustenance is concerned with the
provision of basic needs.
No country can be regarded as fully developed if it cannot
provide its entire people with such basic needs as housing,
clothing, food and minimum education.
According to this approach when the basic needs (i.e. food,
shelter, health minimal education and protection) absent or in
a critical short supply we cannot say the country has fully
developed.
It implies that economic development is a necessary
condition to provide people with basic needs.
Self-esteem: this is concerned with the feeling of self-respect
and independence or not being used as a tool by others for
their own need.
no country can be regarded as fully developed if it is exploited
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by others.
Freedom from servitude:
Freedom is ability of people to determine their destiny.
It involves an expanded range of choices for societies and
their members together with a minimization of external
constraints in the pursuit of devolvement.
No man is free if she/he cannot choose; if she/he is
imprisoned by living on the margin of subsistence with no
education and no skills.
The Objectives of Development
A. To increase the availability of basic life-sustaining goods
like food, shelter, health and protection.
B. To generate greater individual and national self-esteem.
C. To expand the range of economic and social choices
available to individuals and the nation.
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1.3. Current Interest in Development Economics
The focus to problems of under developed countries have
started recently, after the end of the II world War, aiming
of promoting development .
Before the war, there was little emphasis with the
economic and social problems of developing countries
Reason: that the poor countries were colonies.
The colonizers focused on depression and
unemployment of their countries.
The situation today is different.
The development of underdeveloped countries and
primarily the eradication of absolute poverty are now
regarded as one of the greatest social and economic
challenges facing humankind.
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A number of factors can be pointed out that account for
this change in attitude and upsurge of interests in the
economics of development and the economies of poor
nations is due to.
The factors are
Academic interest in development.
The awareness of developing countries about their
backwardness and their demand for a new international
economic order.
The awareness of the world in general and developed
countries in particular about the mutual interdependence
of the world economy.
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Measurement of Economic Growth and
Development
Having defined the concepts of growth and development and the
difference between them, it is necessary to measure them in some
quantitative terms.
One reason why the concepts of growth and development are too often
confused with each others is lack of proper indicators to measure them.
Often the same measures are used for calculating both growth and
development processes.
Measures of Growth and Development: Conventional
The dominant conventional measures of growth and development are the
Gross National Product (GNP) or Gross Domestic Product (GDP) and their
corresponding per capital values.
GNP/GDP have been used for the measurement of economic
development in several ways.
For a given country over two or more years, the absolute value of GDP/
GNP or PCI is compared for different years.
The difference between the values for various years then reflects the
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growth rate over the period
By economic growth we generally mean the rate at which the
national income is growing over a period of time.
This definition implies that economic growth can be measured in
terms of changes in the national income of a country.
The growth rate could be computed as:
g =(Yt –Yt-1) x 100%
Yt-1
Where, g = is the growth rate
Yt = is the national income in year t and
Y t-1 = is the national income in year t-1
In other words, economic growth is simply the ration of change in
national income to the previous level of income expressed in
percentage terms.
Example: The Ethiopian national income was estimated to be Birr
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372 million in 1999. If it has reached the income level of Birr 400
million in 2000 . Find the growth rate during 1999 – 2000?
Limitations of conventional income measures:
Aside from their defects as indicators of development, the
calculations of the GNP/GDP based measures suffer from a number
of shortcomings. Among these
The GNP/GDP measure excludes non-market activities,
transactions and subsistence production.
Since these occur to a significant degree in developing countries,;
sizeable part of economic activities are left unrecorded.
double counting of intermediate inputs;
underestimation and exclusion of unrecorded transactions, which
are rampant in developing countries, particularly across borders;
the statistical problems arising from the non quantifiability of
important economic variables and activities.
The less developed an economy, the more serious these problems
are likely to be.
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So, bear in mind these differences across countries, comparison is
meaningless
Another difficulty arises as a result of differences in the rate of
inflation among countries such that those with high rates of inflation
can post very high levels of national income.
National income deflators can moderate this problem if
appropriately applied.
problem of conversion of national incomes measured in national
currencies into the US dollar at the official exchange rate.
GDP/ GNP and PCI should be based on PPP principle
Alternative Development
Among the developed alternative indicators the major once are the
following:
Human Development Index (HDI) developed by UNDP, and
The Human Poverty Index,
Physical quality of life index
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The Human Development Index (HDI)
•Human Development Index (HDI) –is an index measuring
national socioeconomic development, based on measures of
life expectancy at birth, educational attainment, and adjusted
real per capita income.
It is used to distinguish whether the country is a developed, a
developing or an under-developed country,
From the definition of HDI we can have three components,
which are essential in the construction and refinement of a
Human Development Index. These include:
1. Longevity-measured by life expectancy at birth
2. Measure of educational attainment- knowledge as
measured by a weighted average of adult literacy
(two-thirds) and mean years schooling (one-third weight)
that is combination of primary, secondary and Tertiary level
enrollments.
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3. Standards of living: measured by real per capita GDP
HDI ranges from 0 to 1.
If the actual value is equal to maximum the index is one.
The HDI ranks countries into three groups:
a) low human development (0.0 to 0.49),
b) medium human development (0.50 to 0.79)
c) and high human development (0.80 to 1.00).
To construct the index, fixed minimum and maximum values
are taken for each of the variables.
a. For life expectancy at birth the range is 25-85 years.
b. For adult literacy, the range is 0 – 100 percent.
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c. For real per capita income the range is $100 – 40,000.
For any component of the HDI, the individual indices can
be computed according to the general formula of:
Index = Actual value – Minimum value
Maximum value – Minimum value
Life Expectancy Index =
Education Index =
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Adult Literacy Index (ALI) =
Gross Enrolment Index (GEI) =
CGER: Combined gross enrolment ratio
Income Index =
GDP pc: GDP per capita at PPP in USD
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Finally, each of the three components receives equal
(one third) weight to find HDI.
Example: a country has a population of 3,000,000 with GDP of
$6,000,000,000. The nation’s life expectancy is 70 years. The
adult literacy rate and gross enrollment rate of this nation are
65% and 60% relatively. Find HDI.
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Interpretation and Advantage
l HDI measures relative not absolute level of HD and
that its focus is on the ends of development
(longevity, educational achievement and standard
of living).
l Advantage: disaggregating the country’s overall HDI
into separate components to distinguish between
Man and Women, different social classes reflecting
skewed income distributions, and different regions
and ethnic groups.
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Example
Assume that the following Data is given for a certain
country;
Life Expectancy=73 Years
Adult Literacy = 85%
Combined Gross Enrolment = 82%
PCI($PPP) = 8,000
Compute HDI?
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Human Poverty Index ( HPI)
The Human Poverty Index (HPI) was an indication of the
standard of living in a country, developed by the United
Nations (UN).
It was first reported as part of the Human Development
Report in 1997. .
In 2010 it was supplanted/replaced by the UN's
Multidimensional Poverty Index.
MPI reveals a different pattern of poverty than
income; poverty as it illuminates a different set of
deprivations.
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It is a composite measure focuses on dimensions of
deprivations.
The HPI for developing countries is based on three main
indices:
a) The percentage of the population not expected to survive
to the age of 40 (P1)
b) The adult illiteracy rate (P2)
c) A deprivation index based on an average of three variables:
i. the percentage of the population without access to safe water;
ii. the percentage of population without access to health service; and
iii. the percentage of the underweight children under five years old
(P3)
The formula is given by:
HPI = [1/3(P13 + P23 + P33)]
1/3
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Physical Quality of Life Index (PQLI)
PQLI is an attempt to measure the quality of life
or well being of a country. The value is the
average of three statistics.
Basic literacy rate
Infant mortality
Life expectancy
All are equally weighted on a 0 to 100 scale.
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Steps to Calculate PQLI
1. Find percentage of the population that is literate (i.e.
literacy rate)
2. Find the infant mortality rate (out of 1000 births)
IMR = (166 – Infant Mortality)*0.625
3. Find the life expectancy
Life Expectancy = (average life expectancy – 42)*2.7
4. Find PQLI
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Obstacles to Development of
Africa
There are indeed two fundamental problems
which may explain why these economies are either
stagnant or in regression.
A)Internal Causes:
Inability to solve internal conflicts
Inter-state conflicts including boarder disputes
Administrative inefficiency
Inappropriate development models
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Unrealistic development strategies
Lack of viable institutions
Ethnicity and Political instability
The existence of governments without legitimacy
Financial bureaucratic and political corruption
Lack of transparency in public transactions and
lack of accountability in public action
Lack of trained people to educate and advise
farmers
Adverse weather conditions
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B) External Causes:
The disturbing effects of the oil price rises
Policies advocated by the WB and IMF
The burden of international debt and interest
rate
Lack of adequate capital flow and transfer of
technology
Erection of high tariff barriers
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The Basic Requirements for
Development
The African region contains the growing world’s
share of absolute poor with little power to influence
the allocation of resources.
a. Peace and Security:
Political terror has systematically undermined
both development and security.
Peace is one of the preconditions for economic
growth and economic development.
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b. Governance and Leadership:
In order for Africans to develop, they must be
part of the decision making process.
Good governance enhances democracy as well
as efficiency in the economy.
This is important so that African people should
claim ownership and inclusive participation in
globalization.
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c. Economic Growth:
Export led growth is a development strategy that has been employed
with remarkable success in some parts of the world, especially Asia.
d. Global Interdependence:
Globalization is a process of integrating economic decision making
such as the consumption, investment and saving process all across
the world.
It is a global market in which all nations are required to participate.
Thus, for Africa’s development and confronting
the 21 century, challenges must be ready and
st
prepared for globalization, the interdependence of states.
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Development gap
Development gap is a term used for defining the
differences between the most and least advanced
countries.
It is another way of referring to nations that enjoy
first, second and third world statuses.
You may question that what are the gaps? We can point out the
gaps by considering the following basic discriminatory concepts:
1. The real per capita Gross domestic product.
For example, in 2000 the real per capita GDP of
Developed Nations is $ 20,000
Developing Nations is $ 1,200
Ethiopia is $ 100
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2. Developing Countries have high Unemployment
compared to developed countries that is a gap in level
of Unemployment.
3. Level of Education-that is a difference in educational
attainment of nations
4. Unlike developed in developing Countries there is
poor infrastructure ,inadequate public service, high
level of corruption, and inefficient institutions
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These four development gaps mentioned above are too
broad and they will be properly addressed under the next
course Development economics II especially points
mentioned under 2,3&4. Therefore, now we try to discuss the
real per capita GDP gap.
Can the present developing countries catch-up the
developed countries in per capita income? That is can the gap
in per capita income be eliminated?
To answer this we need to see the absolute gap and relative
gap. For instance to eliminate the absolute income gap
between developed countries and poor countries growth rate
of income of poor countries has to be higher than that of rich
countries.
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In actual the growth rate of rich countries is higher than
the growth rate of poor countries. Therefore it will be a real
challenge for poor countries to fill the per capita Gross
domestic gap.
To have a clear idea of the per capita income (GDP) gap
and challenge of poor countries, Let us answer the
following four questions based on the data given following
the four questions.
1. Given the recent growth rate experience of the poor
countries how long it takes them to reach the current
average level of per capita income in the industrialized
countries. (That is years needed to equalize per capita
income of poor countries with current average level of per
capita income of rich countries).
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2. Given the recent growth rate experience of the poor
countries relative to the industrialized countries how
many years it takes the per-capita income gap to be
eliminated? (That is year need to eliminate the absolute
income gap)
3. Given the rate of growth of the industrialized countries
from now (year 2000) until the year (2020) how fast the
poor countries have to grow for the per capita income
to be equalized by year 2020.
4. Given the rate of growth of the industrialized countries
how fast would the poor countries have to grow to
prevent the absolute per capita income gap between
rich and poor countries from being any wider in the year
2020.
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Hypothetical data
Given:
The current i.e. year 2000 level of per capita income (PCI) of
the industrialized (rich countries) countries is $
20,000. Represented by YD.
i.e. YD = $ 20,000
rD= the per capita income growth rate of the industrialized
Countries is 3% (that is the growth rate from year 2000
to 2020) i.e. rD = 3%
YDC - the current year 2000 level of per capita income (PCI)
of least developed Countries (poor Countries) is $ 1,200
i.e. YDC= $ 1,200
rDC- the per capita growth rate of LDCs is 2% i.e. rDc = 2%
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To proceed with the calculations of the four questions we use the simple Arithmetic
formula:
Compound-interest formula
S = P (1 +r)n
Where S = future sum
P = Principal
r = interest rate and
n = number of years
If we contextualize this formula in to our analysis it will be:
Y = Y (1 +r)
0
n
Where Y = per capita income after n years
Y = Current per capita income at time n
o
r = growth rate in per capita income
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n = number of years
Can't
Now we can start to solve the questions listed above
Y *= the per capita income of industrialized Countries in
D
2020
Calculated as: Y *= 20,000 (1+0.03) = $ 36,000
D
20
Where Y = $ 20,000 = per capita income at year 2000
D
r =3% = = 0.03 = growth rate of developed
D
(industrialized Countries.
n = 20 , after 20 years i.e in 2020
r *= represent growth rate of per capita income of the
D
LDCs.
Solution 1 Y = Y (1+r ) equation 1
D DC Dc
n
Given Y , Y , r and we are asked to find n
D DC DC
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Therefore Given the recent growth rate experience of the
poor countries (i.e. r = 2%) and percapita income of $ Dc
1,2000 of poor Countries, Poor countries need at least 142 years to reach the
current level of per capita income
(i.e. Y = 20,000) of industrialized countries.
D
For the next question we need the equality equation given:
Y (1+r ) = Y (1+r ) …………. Equation (1)
D D
n
Dc Dc
n
The equality equation implies the elimination of the absolute income gap.
Y (1+r ) = Y (1+r ) = 0
D D
n
DC Dc
n
The Given data are: Y , r , Y , r and again we are D D Dc Dc
required to determine n?
Taking the natural logarithm of both sides of Equation 1
l y (1+r ) = l y (1+r ) …………. Equation 2
n D D
n
n Dc Dc
n
l Y +l (1+r ) = l y + l (1 +r ) Equation 3
n D n D
n
n Dc n Dc
n
(Multiplication rule of logarithms
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At this step we can substitute the hypothetical data given above in Equation 5. However,
you have to note that we must take a developing country (Poor nation), which have a
current year i.e. 2000 growth rate of greater than the current
growth rate of industrialized
countries or developed national (i.e. greater than 3% in our case) unless it will be
unrealistic.
For example let us take South Korea and let us further assume that the growth rate of
South Korea in 2000 is 7% and the per
pita
caincome of South Korea in 2000 is $ 5000.
20, 000
ln
5, 000
Therefore, n= = 36 years
ln1 0.07 ln1 0.03
From our calculation South Korea at least need 36 years to eliminate the absolute incom
gap.
You can exercise Question 3 and 4 by yourself. Approximately you may get 18% and
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14% respectively.
