BA2 – Economic Development

Lesson 2: Comparative Economic Development

Defining the developing world

The most common way to define the developing world is by per capita income. Several
international agencies, including the Organization for Economic Cooperation and
Development (OECD) and the United Nations, offer classifications of countries by their
economic status, but the best-known system is that of the International Bank for
Reconstruction and Development (IBRD), more commonly known as the World Bank.

World Bank - An organization known as an “international financial institution” that

provides development funds to developing countries in the form of interest-bearing
loans, grants, and technical assistance.

In the World Bank’s classification system, 213 economies with a population of at least
30,000 are ranked by their levels of gross national income (GNI) per capita. These
economies are then classified as low-income countries (LICs), lower-middle-income
countries (LMCs), upper- middle-income countries (UMCs), high-income OECD
countries, and other high-income countries. (Often, LMCs and UMCs are informally
grouped as the middle-income countries.)

Sometimes a special distinction is made among upper-middle-income or newly high-

income economies, designating some that have achieved relatively advanced
manufacturing sectors as newly industrializing countries (NICs).

Low-income countries (LICs) In the World Bank classification, countries with a GNI per
capita of less than $1,025 in 2011.

Middle-income countries In the World Bank classification, countries with a GNI per
capita between $1,025 and $12,475 in 2011.

Newly industrializing countries (NICs) Countries at a relatively advancedlevel of

economic develop- ment with a substantial and dynamic industrial sector and with close
links to the inter- national trade, finance, and investment system.

Least developed countries - A UN designation of countries with low income, low

human capital, and high economic vulnerability.

Human capital Productive investments in people, such as skills, values, and health
resulting from expenditures on education, on-the-job training programs, and medical
care.

Another way to classify the nations of the developing world is through their degree of
international indebtedness; the World Bank has classified countries as severely
indebted, moderately indebted, and less indebted. T he United Nations Development
Programme (UNDP) classifies countries according to their level of human development,
including health and education attainments as low, medium, high, and very high.

Another widely used classification is that of the least developed countries, a UN

designation that as of 2012 included 49 countries, 34 of them in Africa, 9 in Asia, 5
among Pacific Islands, plus Haiti. For inclusion, a country has to meet each of three
criteria: low income, low human capital, and high economic vulnerability.

Finally, the term emerging markets was introduced at the International Finance
Corporation to suggest progress avoiding the then-standard phrase Third World that
investors seemed to associate with stagnation.

Basic Indicators of Development

Real income and purchasing power parity

In accordance with the World Bank’s income-based country classification scheme,

gross national income (GNI) per capita, the most common measure of the overall level
of economic activity, is often used as a summary index of the relative economic well-
being of people in different nations. It is calculated as the total domestic and foreign
value added claimed by a country’s residents without making deductions for
depreciation (or wearing out) of the domestic capital stock. Gross domestic product
(GDP) measures the total value for final use of output produced by an economy, by both
residents and nonresidents. Thus, GNI comprises GDP plus the difference between the
income residents receive from abroad for factor services (labor and capital) less
payments made to nonresidents who contribute to the domestic economy

Purchasing power parity (PPP) - Calculation of GNI using a common set of

international prices for all goods and services, to provide more accurate comparisons of
living standards.

Health and Education

Life expectancy is the average number of years newborn children would live if subjected
to the mortality risks prevailing for their cohort at the time of their birth.

Undernourishment means consuming too little food to maintain normal levels of activity;
it is what is often called the problem of hunger. High fertility can be both a cause and a
consequence of underdevelopment, so the birth rate is reported as another basic
indicator.

Literacy is the fraction of adult males and females reported or estimated to have basic
abilities to read and write; functional literacy is generally lower than the reported
numbers.

Holistic Measures of Living Levels and Capabilities

Human Development Index (HDI)

An index measuring national socioeconomic development based on combining

measures of education, health, and adjusted real income per capita.

The New HDI ranks each country on a scale of 0 (lowest human development) to 1
(highest human development) based on three goals or end products of development: a
long and healthy life as measured by life expectancy at birth; knowledge as measured by
a combination of average schooling attained by adults and expected years of schooling
for school-age children; and a decent standard of living as measured by real per capita
gross domestic product adjusted for the differing purchasing power parity of each
country’s currency to reflect cost of living and for the assumption of diminishing marginal
utility of income.

Diminishing marginal utility - The concept that the subjective value of additional
consumption lessens as total consumption becomes higher.

Lower Levels of Living and Productivity

the wide disparity in income largely corresponds to the large gaps in output per worker
between developing and developed countries.

At very low income levels, in fact, a vicious circle may set in, whereby low income leads
to low investment in education and health as well as plant and equipment and
infrastructure, which in turn leads to low productivity and economic stagnation. This is
known as a poverty trap or what Nobel laureate Gunnar Myrdal called “circular and
cumulative causation.

One common misperception is that low incomes result from a country’s being too small
to be self-sufficient or too large to overcome economic inertia. However, there is no
necessary correlation between country size in population or area and economic
development (in part because each has different advantages and disadvantages that
can offset each other).

Higher Levels of Inequality and Absolute Poverty

Globally, the poorest 20% of people receive just 1.5% of world income. The lowest 20%
now roughly corresponds to the approximately 1.2 billion people living in extreme
poverty on less than $1.25 per day at purchasing power parity. Bringing the incomes of
those living on less than $1.25 per day up to this minimal poverty line would require less
than 2% of the incomes of the world’s wealthiest 10%. Thus, the scale of global
inequality is also immense.

But the enormous gap in per capita incomes between rich and poor nations is not the
only manifestation of the huge global economic disparities. To appreciate the breadth
and depth of deprivation in developing countries, it is also necessary to look at the gap
between rich and poor within individual developing countries. Very high levels of
inequality—extremes in the relative incomes of higher- and lower-income citizens—are
found in many middle-income countries, partly because Latin American countries
historically tend to be both middle-income and highly unequal

Corresponding to their low average income levels, a large majority of the extreme poor
live in the low-income developing countries of sub-Saharan Africa and South Asia.
Extreme poverty is due in part to low human capital but also to social and political
exclusion and other deprivations. Great progress has already been made in reducing the
fraction of the developing world’s population living on less than $1.25 per day and raising
the incomes of those still below that level, but much remains to be done,

Development economists use the concept of absolute poverty to represent a specific

minimum level of income needed to satisfy the basic physical needs of food, clothing,
and shelter in order to ensure continued survival. A problem, however, arises when one
recognizes that these minimum subsistence levels will vary from country to country and
region to region, reflecting different physiological as well as social and economic
requirements. Economists have therefore tended to make conservative estimates of
world poverty in order to avoid unintended exaggeration of the problem.

Absolute poverty - The situation of being unable or only barely able to meet the
subsistence essentials of food, clothing, shelter, and basic health care.

Higher Population Growth Rates

Global population has skyrocketed since the beginning of the industrial era, from just
under 1 billion in 1800 to 1.65 billion in 1900 and to over 6 billion by 2000. World
population topped 7 billion by 2012. Rapid population growth began in Europe and other
now developed countries. But in recent decades, most population growth has been
centered in the developing world. Com- pared with the developed countries, which often
have birth rates near or even below replacement (zero population growth) levels, the
low-income developing countries have very high birth rates.

A major implication of high birth rates is that the active labor force has to support
proportionally almost twice as many children as it does in richer countries. By contrast,
the proportion of people over the age of 65 is much greater in the developed nations.
Both older people and children are often referred to as an economic dependency burden
in the sense that they must be supported financially by the country’s labor force (usually
defined as citizens between the ages of 15 and 64).

Dependency burden - The proportion of the total population aged 0 to 15 and 65+,
which is considered economically unproductive and there- fore not counted in the labor
force.

Greater Social Fractionalization

Low-income countries often have ethnic, linguistic, and other forms of social divisions,
sometimes known as fractionalization. This is sometimes associated with civil strife
and even violent conflict, which can lead developing societies to divert considerable
energies to working for political accommodations if not national consolidation. It is one of
a variety of governance challenges many developing nations face.

Fractionalization - Significant ethnic, linguistic, and other social divisions within a

country.

Conflict can derail what had otherwise been relatively positive development progress. If
development is about improving human lives and providing a widening range of choice
to all peoples, racial, ethnic, caste, or religious discrimination is pernicious.

Larger Rural Populations but Rapid Rural-to-Urban Migration

One of the hallmarks of economic development is a shift from agriculture to

manufacturing and services. In developing countries, a much higher share of the
population lives in rural areas, and correspondingly fewer in urban areas.
Although modernizing in many regions, rural areas are poorer and tend to suffer from
missing markets, limited information, and social stratification. A massive population shift
is also under way as hundreds of millions of people are moving from rural to urban
areas, fueling rapid urbanization, with its own attendant problems.

Lower Levels of Industrialization and Manufactured Exports

Industrialization is associated with high productivity and incomes and has been a
hallmark of modernization and national economic power. It is no accident that most
developing-country governments have made industrialization a high national priority,
with a number of prominent success stories in Asia.

the share of employment in industry in many developed countries is smaller now than in
some developing countries, particularly among women, as developed countries continue
their secular trend to switch to from industry to service sector employment. However,
many developed- country industrial jobs require high skills and pay high wages.

Along with lower industrialization, developing nations tended to have a higher

dependence on primary exports. Most developing countries have diversified away from
agricultural and mineral exports to some degree. The middle- income countries are
rapidly catching up with the developed world in the share of manufactured goods in their
exports, even if these goods are typically less advanced in their skill and technology
content. However, the low-income countries, particularly those in Africa, remain highly
dependent on a relatively small number of agricultural and mineral exports.

Adverse Geography

Many analysts argue that geography must play some role in problems of agriculture,
public health, and comparative development more generally. Land-locked economies,
common in Africa, often have lower incomes than coastal economies. As can be
observed on the map on the inside cover, developing countries are primarily tropical or
subtropical, and this has meant that they suffer more from tropical pests and parasites,
endemic diseases such as malaria, water resource constraints, and extremes of heat. To
add to this, global warming and climate change has become a threat and concern more
to developing nations.

Underdeveloped Markets

Imperfect markets and incomplete information are far more prevalent in developing
countries, with the result that domestic markets, notably but not only financial markets,
have worked less efficiently. In many developing countries, legal and institutional
foundations for markets are extremely weak.

Some aspects of market underdevelopment are that they often lack:

 a legal system that enforces contracts and validates property rights;

 a stable and trustworthy currency;
 an infrastructure of roads and utilities that results in low transport and
communication costs so as to facilitate interregional trade;
 a well-developed and efficiently regulated system of banking and insurance, with
broad access and with formal credit markets that select projects and allocate
 loanable funds on the basis of relative economic profit- ability and enforce rules
of repayment;
 substantial market information for consumers and producers about prices,
quantities, and qualities of products and resources as well as the
creditworthiness of potential borrowers; and
 social norms that facilitate successful long-term business relationships.

Infrastructure - Facilities that enable economic activity and markets, such as

transportation, communication and distribution networks, utilities, water, sewer, and
energy supply systems.

Lingering Colonial Impacts and Unequal International Relations

Colonial Legacy

Most developing countries were once colonies of Europe or otherwise dominated by

European or other foreign powers, and institutions created during the colonial period
often had pernicious effects on development that in many cases have persisted to the
present day. Despite important variations that proved consequential, colonial era
institutions often favored extractors of wealth rather than creators of wealth, harming
development then and now. Both domestically and internationally, developing countries
have more often lacked institutions and formal organizations of the type that have
benefited the developed world: Domestically, on average, property rights have been less
secure, constraints on elites have been weak, and a smaller segment of society has
been able to gain access to and take advantage of economic opportunities.

External Dependence

Developing countries have also been less well organized and influential in international
relations, with sometimes-adverse consequences for development. More generally,
developing nations have weaker bargaining positions than developed nations in
international economic relations. Developing nations often also voice great concern over
various forms of cultural dependence, from news and entertainment to business
practices, lifestyles, and social values.

How Low-Income Countries Today Differ from

Developed Countries in Their Earlier Stages

 Physical and human resource endowments

 Per-capita incomes and levels of GDP in relation to the rest of the world
 Climate
 Population size, distribution, and growth
 Historical role of international migration
 International trade benefits
 Basic scientific and technological research and development capabilities
 Efficacy of domestic institutions

Physical and Human Resource Endowments

Some developing nations are blessed with abundant supplies of petroleum, minerals,
and raw materials for which world demand is growing; most less developed countries,
however— especially in Asia, where more than half of the world’s population resides—
are poorly endowed with natural resources.

The difference in skilled human resource endowments is even more pronounced. The
ability of a country to exploit its natural resources and to initiate and sustain long-term
economic growth is dependent on, among other things, the ingenuity and the managerial
and technical skills of its people and its access to critical market and product information
at minimal cost.

Relative Levels of Per Capita Income and GDP

The people living in low-income countries have, on average, a lower level of real per
capita income than their developed-country counterparts had in the nineteenth century.

at the beginning of their modern growth era, today’s developed nations were
economically in advance of the rest of the world. They could therefore take advantage of
their relatively strong financial position to widen the income gaps between themselves
and less fortunate countries in a long period of income divergence.

Climatic Differences

Almost all developing countries are situated in tropical or subtropical climatic zones. It
has been observed that the economically most successful countries are located in the
temperate zone. Although social inequality and institutional factors are widely believed to
be of greater importance, the dichotomy is more than coincidence. Colonialists
apparently created unhelpful “extractive” institutions where they found it uncomfortable
to settle. But also, the extremes of heat and humidity in most poor countries contribute to
deteriorating soil quality and the rapid depreciation of many natural goods. They also
contribute to the low productivity of certain crops, the weakened regenerative growth of
forests, and the poor health of animals. Extremes of heat and humidity not only cause
discomfort to workers but can also weaken their health, reduce their desire to engage in
strenuous physical work, and generally lower their levels of productivity and efficiency.

Population Size, Distribution, and Growth

it is sufficient to note that population size, density, and growth constitute another
important difference between less developed and developed countries. Before and
during their early growth years, Western nations experienced a very slow rise in
population growth. As industrialization proceeded, population growth rates increased
primarily as a result of falling death rates but also because of slowly rising birth rates. By
contrast, the populations of many developing countries have been increasing at annual
rates in excess of 2.5% in recent decades, and some are still rising that fast today.
Moreover, the concentration of these large and growing populations in a few areas
means that many developing countries have considerably higher person-to-land ratios
than the European countries did in their early growth years. Finally, in terms of
comparative absolute size, no country that embarked on a long-term period of
successful economic growth approached the present-day population size.

The Historical Role of International Migration

Brain Drain - The emigration of highly educated and skilled professionals and
technicians from the developing countries to the developed world.

The Growth Stimulus of International Trade

International free trade has been called the “engine of growth” that propelled the
development of today’s economically advanced nations during the nineteenth and early
twentieth centuries. Rapidly expanding export markets provided an additional stimulus to
growing local demands that led to the establishment of large-scale manufacturing
industries. Together with a relatively stable political structure and flexible social
institutions, these increased export earnings enabled the developing countries of the
nineteenth century to borrow funds in the international capital market at very low interest
rates.

Free Trade - Trade in which goods can be imported and exported without any barriers in
the forms of tariffs, quotas, or other restrictions.

Terms of Trade - The ratio of a country’s average export price to its average import
price.

Basic Scientific and Technological Research and Development Capabilities

Basic scientific research and technological development have played a crucial role in the
modern economic growth experience of contemporary developed countries. Their high
rates of growth have been sustained by the interplay between mass applications of
many new technological innovations based on a rapid advancement in the stock of
scientific knowledge and further additions to that stock of knowledge made possible by
growing surplus wealth. And even today, the process of scientific and technological
advance in all its stages, from basic research to product development, is heavily
concentrated in the rich nations, despite the emergence of China and India as
destinations for research and development (R&D) activities of multinational
corporations.

Research and Development (R&D) - Scientific investigation with a view toward

improving the existing quality of human life, products, profits, factors of production, or
knowledge.

Efficacy of Domestic Institutions

Another difference between most developing countries and most developed countries at
the time of their early stages of economic development lies in the efficacy of domestic
economic, political, and social institutions. By the time of their early industrialization,
many developed countries, notably the United Kingdom, the United States, and Canada,
had economic rules in place that provided relatively broad access to opportunity for
individuals with entrepreneurial drive.