ECONOMICS 103

Section Dd

LESSON 4: DATA OF MACROECONOMICS

Macroeconomics – studies behavior of economy as a whole. It concerns

to the overall performance of the economy.

Microeconomics – behavior of the small units of the economy. This

includes the buyers, sellers, household, firms, industries, etc.

Macroeconomic goals:

1. Rapid Growth of Output. To increase income.

2. Low Employment Rate
Unemployment Rate refers to the portion of unemployed to the
total labor force. It can be calculated by this formula:
Unemployment Rate = (Unemployed / Labor Force) x 100
Labor Force includes who work (employed) and doesn’t work
(unemployed) that has the capacity to work.
Unemployment refers to those who are looking for work but
couldn’t land on a job according to PSA.
3. Stable Prices
- Prices may rise or fall but the trend should not have big gap.
- Stabilizing prices are usually done by Bangko Sentral Pilipinas
(BSP). This includes printing money and controlling the total
supply of money. There are two ways of controlling supply of
money: Open-market Operations & Changing Interest Rates.
- Monitors inflation rate that targets 3-4% and avoids double digits
inflation rate.
Why printing a lot of money is not advisable?

Once you print a lot of money, it will lose its value. If people have a lot of
money, the purchasing power of the individuals will increase as they can afford
anything. This will lead to higher demands which it will lift the prices of such
products and services. Thus, increase of prices will lead to inflation. So, if P100
can buy 50 candies before, you can buy only 1 or 10 candies due to inflation
which shows that the value of P100 decreases.

Types of Macroeconomic Policy:

These policies are utilized to achieve macroeconomic goals. One of such is

the Policy Instrument. This instrument is an economic variable under the
control of government that can affect one or more of the macroeconomic goals.

Policy Instruments:

A. Fiscal Policy – refers to the government policy instrument used to affect

taxation and government spending.
2 Forms of Government Spending:
i. Government Purchases – this includes expenses such as
salaries, infrastructures, welfares, etc.
ii. Government Transfer Payments – this refers to the expenses
without performing service in exchange. Examples are 4Ps,
Senior Citizen Payment, PWD, Scholarships, Unemployment
Insurance, etc.
2 Ways on how Taxation affects overall economy:
i. Taxes affect people income – this includes Disposable
Income which refers to the income after paying taxes. The
higher the income, the higher the tax will be imposed.
ii. Taxes affect prices of goods and factors of production –
high tax imposed to such cost of materials will be discouraged
to produce goods. Lower tax encourages.
 Fiscal Policy (1) affects long-term economic growth through its impact on
national saving and investment, and (2) stimulating spending in deep or
sharp recession.

B. Monetary Policy - is the instrument used by the government to affect

money supply which the government conducts through managing the
nation’s money, credit, and banking system.

This also affects Interest Rates. Once the IR is high, it implies that
income will be generated more which is advantageous to overall economy.

MEASUREMENT OF MACROECONOMIC STATISTICS

A. Gross Domestic Product (GDP)

- is the market value of all final goods produced within a country
in each period.
- Covers expenditures and income. It also states that Expenditure
is equivalent to Income. This implies that whatever the buyer
paid would be the income of the seller.
- Calculates the Market Value = Price (P) x Quantity (Q)
- Encompasses within a country. It calculates all the goods or
products produced in a particular country even if the producer is
foreign.

Three Approaches:

1. Expenditure Approach – total expense on domestically produced

final goods and services.
2. Income Approach – total income earned.
3. Value Added - the value of its output minus the value of the
intermediate goods the firm used to produce that output.
 The value of the final goods already includes the value of the
intermediate goods, so including intermediate and final goods in
GDP would be double-counting.

Expenditure Components of GDP:

1. Consumption (C) - The value of all goods and services bought by

households. Also known as “personal consumption
expenditures”.
i. Durable Goods – lasts long time (cars, house)
ii. Non-durable Goods – lasts short time (foods, clothes)
iii. Services – work done for consumers
2. Investment (I) – Refers to the spending of the factor of production
on capital. It also refers to the spending on goods bought for use.
i. Business Fixed Investment – PPE
ii. Residential Fixed Investment – spending on housing
units
iii. Inventory Investment – change in the value of all
firms’ inventories
3. Government Spending (G) - includes all government spending on
goods and services and excludes transfer payments.
4. Net Exports (NX) – Exports less Imports.
Exports are goods that are produced domestically and sold
abroad.
Imports are are goods produced abroad and sold
domestically.

Summarize:

GDP (Y) = C + I + G + NX
Gross National Product (GNP) refers to the total income earned by the nation’s
factors of production, regardless of where located. Now term as Gross National
Income(GNI).

Gross Domestic Product (GDP) refers to total income earned by domestically-

located factors of production, regardless of nationality.

(GNP – GDP) = (factor payments from abroad) – (factor payments to abroad)

GDP per capita = (GDP divided / total population)

GDP Per Capita refers to the capacity of an individual to a country.

2 Types of GDP:

1. Real GDP- refers to the calculation of GDP based on constant price.

Solution:

(Pbase x Qd1) + (Pbase x Qd2) = Real GDP

2. Nominal GDP- refers to the calculation of GDP based on current price.

Solution:

(P1 x Qd1) + (P2 x Qd2) = Nominal GDP

Example:

(a) Calculate the Real GDP based on the year 2022.

(b) Calculate the Nominal GDP based on the given table.

Given:

Year Apple Orange

P Qd P Qd
2021 10 5 9 10
2022 11 6 10 11
2023 12 7 11 12
 (a) In calculating the Real GDP, the constant or base price will be the year
2022 which is 11 for Apple and 10 for orange. By using the Real GDP’s
formula, the following GDP as follows:

Year Apple Orange Real GDP

P Qd P Qd
2021 11 5 10 10 155
2022 11 6 10 11 176
2023 11 7 10 12 197

(b) In calculating the Nominal GDP, use the formula and calculate what
was given in the table.

Year Apple Orange Nominal

P Qs P Qs GDP
2021 10 5 9 10 140
2022 11 6 10 11 176
2023 12 7 11 12 216

Real GDP is more accurate than Nominal GDP in calculating the GDP
because remember that GDP is based on the “production”. In Real GDP, it
emphasizes the growth of production even the prices are all constant. Whereas
in Nominal GDP, both price and quantity can affect the GDP thus, even if the
price changes while the quantity remains constant, Nominal GDP increases. This
is the reason why Nominal GDP is not purely basis on accuracy of GDP because
it is not the price that will focus but rather the quantity or production.

GDP Deflator (GDPD) is a measurement to the level of price. It can be

calculated by Nominal GDP/Real GDP x 100.

Inflation Rate is the percentage increase in the overall level of prices.

 Inflation rate can be computed by this formula:

𝐺𝑃𝐷𝐷2 − 𝐺𝑃𝐷𝐷1
𝑥 100
𝐺𝑃𝐷𝐷1

Example:

B. Consumer Price Index (CPI)

- Measure of overall levels of prices.
- Published by the Bureau of Labor Statistics (BLS)
Uses:
• tracks changes in the typical household’s
cost of living
• adjusts many contracts for inflation
• allows comparisons of peso amounts over time

How to Calculate Inflation Rate using CPI:

1. Find the Basket. Identify the basic commodities per basket.

2. Find the Price. Determine the prices/costs of each product per basket.
3. Compute the Basket Cost. Calculate the total cost of the products.
4. Choose Base Year / Compute using CPI.

CPI = Cost of Basket in Current Period / Cost of Basket in Base Period) x 100

5. Compute Inflation Rate. The formula is as follows:

𝐶𝑃𝐼2 − 𝐶𝑃𝐼1
𝑥 100
𝐶𝑃𝐼1
Where CPI1 refers to the CPI of the previous year and CPI2 is the CPI of
the current year.

Example:

1. Find the Basket. In a basket, assume that the commodities include 4

hotdogs and 2 hamburgers.
 2. Find the Price.
Hotdogs Hamburgers
2001 $1 $2
2002 $2 $3
2003 $3 $4

3. Compute the Basket Cost.

Hotdogs Hamburgers Basket Cost
2001 $1 x 4 $2 x 2 $8
2002 $2 x 4 $3 x 2 $14
2003 $3 x 4 $4 x 2 $20
Note: Basket Cost = Cost of Hotdogs + Cost of Hamburgers

4. Compute using CPI. Assume that the base year is 2001.

CPI2001 = 8/8 X 100 = 100
CPI2002 = 14/8 X 100 = 175
CPI2003 = 20/8 X 100 = 250
5. Compute using Inflation Rate.
a. From 2001 to 2002
𝐶𝑃𝐼2 − 𝐶𝑃𝐼1 175 − 100
𝑥 100 => 𝑥 100 = 𝟕𝟓%
𝐶𝑃𝐼1 100

This implies that the inflation rate increases 75% from year 2001 to 2002.

b. From 2002 to 2003

𝐶𝑃𝐼2 − 𝐶𝑃𝐼1 250 − 175
𝑥 100 => 𝑥 100 = 𝟒𝟐. 𝟖% 𝒐𝒓 𝟒𝟑%
𝐶𝑃𝐼1 175

This implies that the inflation rate increases 43% from year 2002 to 2003.
 CONSUMER PRICE INDEX (CPI) vs GDP Deflator

Consumer Price GDP Deflator

Index
1. Price of Capital Goods Excluded Included
2. Price of Imported Included Excluded
Consumer Goods
3. Basket of Goods Fixed Dynamic

Reasons why CPI may overstate inflation:

1. Substitution bias: The CPI uses fixed weights, so it cannot reflect

consumers’ ability to substitute toward goods whose relative prices have
fallen.

2. Introduction of new goods: The introduction of new goods makes

consumers better off and, in effect, increases the real value of the dollar.
But it does not reduce the CPI, because the CPI uses fixed weights.

3. Unmeasured changes in quality: Quality improvements increase the

value of the dollar but are often not fully measured.

C. Unemployment Rate
That’s All
 CHAPTER 1: Introducing Economic Development: A Global Perspective

1.1 Introduction to Some of the World’s Biggest Questions

Development - The process of improving the quality of all human lives and capabilities by
raising people’s levels of living, self-esteem, and freedom.

1.2 How Living Levels Differ Around the World

Average living conditions - depends largely on where a person was born

Living standards strata - stylized sets of material living conditions
4-strata Schema - created by Hans Rosling

FOUR STYLISED STRATA OF LIVING STANDARDS

1) Bottom/Lowest Stratum (Extreme Poverty)
 more than one billion people live in extreme income poverty
 suffer acute multidimensional deprivations in areas such as nutrition, health, and primary
education, or both.
 A typical person living in such extreme income poverty subsists on about $1.40 per day.
 in 2018 the United Nations estimated in its ‘Multidimensional Poverty Index’ that
nearly 1.3 billion people live with acute deprivations.
 One of the poorest communities may live in a remote rural area in the eastern part of
Africa, where many clusters of small houses contain groups of extended families.
 Theirs is nearly a subsistence economy - an economy in which production is mainly for
personal consumption and the standard of living yields little more than basic necessities
of life—food, shelter, and clothing.
 In western Africa the geography, culture, and languages are different, but many of the
conditions of poverty are strikingly similar (Refer to page 2 and 3 to read more about
the conditions of poverty specifically in the eastern part of Africa)
 More than three quarters of the extreme poor live in rural areas.
2) Second-Lowest Stratum
 not officially classified as extremely poor
 a typical family in this stratum may live on about twice that line, $3.80 per day per
person
 Close to 3 billion people may be thought of as living in this stratum.
 They are almost as likely to live in an urban area (or nearby lower-income peri-urban
area) as in a rural area. (Refer to page 3 paragraph 2 to read more about the conditions
in this stratum)
 People suffer from one or more components of multidimensional poverty (Chapter 5),
though for at least 80% of them the number of their deprivations are not enough for
them to be officially classified by the UN as “multidimensionally poor”
3) Second-Highest Stratum
 may live on about $15 per person per day (considered solidly middle income by global
standards)
 More than two billion people may be thought of as living in this strata.
  Such families typically live in urban areas. (Refer to page 3 paragraph 3 to read more
about the conditions in this stratum)
 Their city is likely to exhibit very high inequality, with sharp contrasts in living
conditions from one section of this sprawling metropolis to another.
4) Highest Stratum (Rich)
 Close to a billion people live in here
 Most are certainly not millionaires, let alone ultra-rich; but they live very comfortably
 A family in this stratum living in North America, Western Europe, or Japan might live
on an income of perhaps $75 per person per day. (Refer to page 4 paragraph 2 to read
more about the conditions in this stratum)

 People at the lowest or second-lowest strata probably have some awareness of what life is
like on the higher strata, from the TV at the village centre if not at home.
 You can refer to Box 1.2 in page 6 to see the summary of some of the typical differences
across the four strata of living conditions.

1.3 How Countries Are Classified by Their Average Levels of Development: A First Look

Countries are often classified by:

a. levels of income
b. human development
and are also grouped by:
a. levels of poverty
b. quality of governance
c. and many other dimensions

Gross national income (GNI) - the total domestic and foreign output claimed by residents of a
country, consisting of gross domestic product (GDP) plus factor incomes earned by foreign
residents, minus income earned in the domestic economy by nonresidents.

The World Bank classifies countries according to four ranges of average national income:
a. Low-Income Country (LICs)
 In the World Bank classification, countries with a GNI per capita of less than $996
in 2018.
 About three-quarters-of-a-billion people—roughly 10% of the world’s population
live here
 A majority of these countries are located in sub-Saharan Africa, where population is
growing fastest.
b. Lower-middle income countries (LMCs)
 In the World Bank classification, countries with a GNI per capita incomes between
$996 and $3,895 in 2018.
c. Upper-Middle Income Countries (UMCs)
 In the World Bank classification, countries with a GNI per capita between $3,896
and $12,055 in 2018.
 More than 60% of the world’s people now live in “middle-income countries”
d. High-Income Countries (HICs)
  in 2018, about 16% of the world population live in high-income countries (HIC)
 In the World Bank classification, countries with a GNI per capita above $12,055 in
2018.
 Chile, Equatorial Guinea, and Hungary had average income that was only barely
enough to reach the HIC threshold
 the average person in an HIC lives very well by global standards.

Note: many people who live in a LIC are not poor; many who live in a LMC are poor; and some
who live in a UIC have incomes more typical of those in UMCs.

Least-Developed countries
 Similar to LICs
 a country has to meet criteria of low education and health, and high economic
vulnerability, as well as low income
 Just over a billion people live in these 49 countries.

Highest-income Developed Countries

 Are members of the Organization for Economic Cooperation and Development (OECD)
 primarily in West Europe and North America, plus Australia, New Zealand, Japan, and
South Korea.

Recognizing that well-being cannot be measured by income alone, the United Nations
Development Programme (UNDP) classifies countries taking account of their health and
education attainments in addition to income, in its Human Development Index (HDI)

Countries’ Average HDI (According to UNDP’s 2018 update):

Low HDI - sub-Saharan Africa
Medium HDI - South Asia and Arab States
High HDI - Latin American and East Asia
Very High HDI - OECD

1.4 Economics and Development Studies

1.4.1 Wider Scope of Study

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 extreme poverty.
 is largely an empirical research discipline.
 incorporates research in political economy and institutional, behavioural and
experimental economics
 must also address the economic, social, political, and institutional mechanisms, both
public and private, necessary to bring about rapid (at least by historical standards) and
large-scale improvements in levels of living.
  must be concerned with the economic, cultural, and political requirements for effecting
rapid structural and institutional transformations of entire societies in a manner that
brings the fruits of economic progress to all their populations.
 Geographic Scope of development studies is generally considered to be most of Asia;
sub-Saharan Africa, the Middle East and North Africa; Latin America and the
Caribbean; and often the formerly Communist transition economies of East and
Southeast Europe.
 A Dynamic Field - development economics must be eclectic and is a field on the crest of
a breaking wave, with new theories and new data constantly emerging
 Purpose of Development Economics: to help us understand how to improve the lives of
the global population.

1.4.2 The Central Role of Women

Globally, women tend to be poorer than men; they are also more deprived in health,
education and in freedoms in all its forms. These facts alone lead to the special focus on women
in development.

Women
 In developing countries have primary responsibility for child rearing, and the the resources
that they are able to bring to this task will determine how readily the cycle of transmission of
poverty from generation to generation can be broken
 mothers tend to spend a significantly higher fraction of income under their control for the
benefit of their children than fathers do
 transmit values to the next generation

Thus, To make the biggest impact on development, then, a society must empower and
invest in women.

Development
 a multidimensional process involving major changes in social structures, popular attitudes,
and national institutions, as well as acceleration of economic growth, reduction of inequality,
and poverty eradication
 represents the whole gamut of change by which a social system, tuned to the diverse basic
needs and evolving aspirations of individuals and social groups within that system, moves
away from a condition of life widely perceived as unsatisfactory toward a situation or
condition of life regarded as materially and spiritually better

Institutions - Constitutions, laws, regulations, social norms, rules of conduct, and generally
accepted ways of doing things.
Economic institutions - “humanly devised” constraints that shape human interactions, including
both informal and formal “rules of the game” of economic life in the widely used framework of
Douglass North.
Social system - The organisational and institutional structure of a society, including its values,
attitudes, power structure, and traditions.
1.5 The Meaning of Development: Amartya Sen’s “Capability” Approach

Amartya Sen
 leading thinker on the meaning of development
 winner of the 1998 Nobel Prize in economics
 argues that “capability to function” is what really matters for status as a poor or non-poor
person.
 “the expansion of commodity productions...are valued, ultimately, not for their own sake,
but as means to human welfare and freedom.”
 argues that poverty cannot be properly measured by income or even by utility as
conventionally understood; what matters fundamentally is what a person is, or can be,
and does, or can do.
 What matters for well-being is not just the characteristics of commodities consumed, as in
the utility approach, but what use the consumer can and does make of commodities.
(Example: a person with a parasitic disease will be less able to extract nourishment from a
given quantity of food than someone without parasites.)
 Functionings - What people do or can do with the commodities of given characteristics that
they come to possess or control.
 in Sen’s view, functionings that people have reason to value can range from being healthy,
being well nourished, and well clothed, to being mobile, having self-esteem, and “taking part
in the life of the community.

FUNCTIONING DEPENDS ALSO ON:

1) social conventions in force in the society in which the person lives,

2) the position of the person in the family and in the society,
3) the presence or absence of festivities such as marriages, seasonal festivals and other
occasions such as funerals,
4) the physical distance from the homes of friends and relatives.

5 SOURCES OF DISPARITY BETWEEN (MEASURED) REAL INCOMES AND

ACTUAL ADVANTAGES IDENTIFIED BY SEN:
1) personal heterogeneities - such as those connected with disability, illness, age, or gender;
2) environmental diversities - such as heating and clothing requirements in the cold or
infectious diseases in the tropics, or the impact of pollution;
3) variations in social climate- such as the prevalence of crime and violence, and “social
capital”;
4) distribution within the family - economic statistics measure incomes received in a family
because it is the basic unit of shared consumption, but family resources may be distributed
unevenly, as when girls get less medical attention or education than boys do; and
5) differences in relational perspectives - meaning that some goods are essential because of
local customs and conventions.

Thus, looking at real income levels or even the levels of consumption of specific
commodities cannot suffice as a measure of well-being.
Capabilities - The freedoms that people have, given their personal features and their command
over commodities.

 Real income is essential, but to convert the characteristics of commodities into functioning
in most important cases, surely requires health and education as well as income.
 For Sen, human well-being means being well in the basic means of being healthy,
well nourished, well-clothed, literate and long lived and more broadly, being able to take
part in the life of the community, being morale and having freedom of choice om what one
can become and can do.

3 OBJECTIVES OF DEVELOPMENT:
1. To increase the availability and wisdom and the distribution of basic life-sustaining goods
such as food, shelter, health, and protection.
2. To raise levels of living including, in addition to higher incomes, the provisions of more jobs,
better education and greater attention to cultural human
3. To expand the range of economic and social choices

1.6 Happiness and Development

Happiness - is part of human well-being, and greater happiness may in itself expand an
individual’s capability to function.
 In recent years, empirical studies have shown that the average level of happiness or
satisfaction increases with a country’s average income.
 Studies show that financial security is only one factor affecting happiness

7 FACTORS THAT AFFECT AVERAGE NATIONAL HAPPINESS (Richard Layard)

1. Family Relationships
2. Financial Situation
3. Work
4. Community and friends
5. Health
6. Personal freedom
7. Personal values

 The importance of these factors may shed light on why the percentage of people reporting
that they are not happy or satisfied varies so widely among developing countries with similar
incomes.
 Many people, throughout the world, from low- to high-income countries, hope that their
societies can gain the benefits of development without losing traditional strengths such as
moral values and trust in others, sometimes called social capital.
 The government of Bhutan attempts to make “gross national happiness” rather than “gross
national income” its measure of development progress.
 Happiness is not the only dimension of subjective well-being of importance.
 As the 2010 Stiglitz-Sen-Fitoussi Commission on the Measurement of Eco nomic
Performance and Social Progress put it: subjective well-being encompasses different aspects:
 1. cognitive evaluations of one’s life
2. Happiness
3. Satisfactio
4. Positive emotions such as joy and pride
5. Negative emotions such as pain and worry

1.7 The Sustainable Development Goals: A Shared Development Mission

1.7.1 Seventeen Goals

 In September 2015, the member countries of the United Nations adopted 17 Sustainable
Development Goals (SDGs), to be achieved by 2030, thereby commit ting to substantial
achievements in ending multidimensional poverty and improving the quality of life.
 Sustainable Development Goals (SDGs) - Successor to the earlier Millennium
Development Goals (MDGs), a set of 17 broad goals, among them to: end poverty and
hunger; ensure healthy lives, quality education, gender equality, water and sanitation, and
modern energy; promote inclusive growth, employment, resilient infrastructure,
industrialisation, innovation, and improved cities; reduce inequality; combat climate change
and environmental damage; and promote peace, justice, and global partnership
 The 17 goals span many, although not all, of the widely accepted goals of economic
development (Refer to page 17 Table 1.1 for the 17 Sustainable Development Goals)

Compared with previous SDGs, their three underlying principles are new:
1. The universality principle: The SDGs apply to every nation (with action encouraged from
every sector).
2. The integration principle: All the goals must be achieved; to do so it is nec essary to
account for their interrelationships.
3. The transformation principle: It is not sufficient to take “piecemeal” steps.

Sector - a subset (part) of an economy, with four usages in economic development:

technology (modern and traditional sectors); activity (industry or product sectors); trade (export
sector); and sphere (private, public, and nonprofit or citizen sectors)

1.7.2 The Millennium Development Goals, 2000–2015

 In 2000, the member countries of the United Nations adopted eight MDGs, committing
themselves to making substantial progress toward the eradication of poverty and achieving
other human development goals by 2015.
 Millennium Development Goals (MDGs) - Precursor to the SDGs adopted by the United
Nations in 2000

8 MDG GOALS:
1. to eradicate extreme poverty and hunger;
2. achieve universal primary education;
3. promote gender equality and empower women;
4. reduce child mortality;
5. improve maternal health;
6. combat HIV/AIDS, malaria, and other diseases;
7. ensure environmental sustainability;
8. and develop a global partnership for development.

Criticisms against the MDG

 Some critics argued the MDG targets were not ambitious enough
 goals were not prioritised; for example, reducing hunger may leverage the achievement of
many of the other health and education targets.
 goals are presented and treated in reports as stand-alone objectives; in reality, the goals are
not substitutes for each other but complements, such as the close relationship between health
and education.
 when the MDGs measure poverty as the fraction of the population below the $1-a-day line,
this is arbitrary and fails to account for the intensity of poverty - that a given amount of extra
income to a family with a per capita income of, say, 70 cents a day makes a bigger impact on
poverty than to a family earning 90 cents per day.
 lack of goals on reducing rich-country agricultural subsidies, improving legal and human
rights of the poor, slowing climate change, expanding gender equality, and leveraging the
contribution of the private sector.

1.7.3 Implementing the Sustainable Development Goals

Sustainable Development Goals: Progress and Challenges

Progress reports toward achieving the SDGs - The United Nations issues annual reports on
progress and challenges toward achieving the SDGs. Each year, different sets of goals receive
the primary focus. The SDGs have been criticised as were the earlier MDGs, though at times for
somewhat different reasons:
 A common critique is that the goals are not prioritised; for example, reducing hunger may
leverage the achievement of many of the other health and education targets.
 Further, when the SDGs measure the end of poverty as no one living on less than $1.90 per
day, this avoids discussion about prioritising help for the poor.
 Even more, some have criticised the sheer number of 17 goals and many targets, in that one
cannot focus on everything, so in the end little if anything may get focused on at all.

Nonetheless, the SDGs are the current global framework for assessing key aspects of
development progress; and each are addressed, to varying degrees, in the coming chap
 Chapter 2: Comparative Economic Development

Chapter 2: Comparative Economic Development

Developing countries – primarily in Asia (not all, like Japan which is a developed
country), Africa, Middle East (Example: Saudi Arabia who is rich in oil but they face
economic development challenges)

Classifying Levels of National Economic Development

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.

classify these 216 countries/economies according to income and then rank them
according to their GNI per capita. They usually have annual ranges of income.
Note that it can change from one year to another, depending on the performance
of their economy.

4 World Bank Income Classifications

Low-income countries (LICs) - countries with a GNI per capita of less than $996 in
2018.

Lower-middle-income countries (LMCs) - countries with a GNI per capita

incomes between $994 and $3,895 in 2018.

Upper middle-income countries (UMCs) - countries with a GNI per capita

between $3,896 and $12,055 in 2018.

High-income countries (HICs) - countries with a GNI per capita above $12,055 in
2018

Conventional Comparisons of Average National Income

Though they have high income, when the government report that their country is
still developing, they are considered developing. (Example: Oil exporting country
such as Saudi Arabia)

Saudi Arabia is a rich country but heavily relying on its oil exports. Imagine if
there would be a financial crisis, such that they will not import oil from Saudi, then
their economy is highly susceptible to economic shocks. At one period, their
income would fall by too much, it will be unstable.
It doesn’t matter if the economy has high income because they are susceptible to
economic shocks. (Example: Covid19)

It might be misleading to just immediately compare income per capita of

countries by using the exchange rate conversion. So they adjust for PPP.

Purchasing Power Parity

Calculation of GNI using a common set of international prices for all goods and
services to provide accurate comparisons of standards of living. Rather than
converting automatically the income per capita using exchange rate, we will
adjust it to PPP. The cost of living and wage rates in a country differ.

Number of units of a foreign country's currency required to purchase the quantity

of goods and services in the local developing market as one dollar would buy in
the United States.

Other Common Country Classifications

The G7 and G20

Least-developed countries

Landlocked and small island countries

Heavily indebted poor countries (HIPCs)

Newly industrialising countries (NICs)

Examples: China, India, Malaysia, Philippines

Emerging Market

If an economy is said to be emerging if their economy can experience

considerable economic growth and possess some of the characteristic of a
developed economy. (Example: Philippines)

Human Development Level

presented by the United Nations Development Programme (organization that is

catering to development programs across the world)

is an index measuring national socioeconomic development, based on combining

measures of education, health, and adjusted real income per capita.
UNDP classifies countries/economies based on HDI.

Human Development Classification

Low: 0 - 0.549

Medium: 0.550 - 0.669

High: 0.7 - 0.799

Very High: 0.8 - 1

Although it is possible that higher income means higher HDI but it is not
true for all countries. When countries are grouped based on income, there is a
difference of HDI across income categories.

Empiricals show that higher income country has longer life expectancy at
birth. The notion is maybe because they have good medical care, better facilities,
they can invest for R&D. But if malaki yung crime rate or prone to wars, it is
possible their life expectancy is lower.

3 Dimensions of Development

Health: a long and healthy life as measured by life expectancy at birth

Education: knowledge as measured by a combination of average schooling

attained by adults and expected years of schooling for school-age children

Income: a decent standard of living as measured by real per capita gross domestic
income 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.

Key Similarities and Differences Among Developing Countries

Levels of income and productivity

If an individual is educated and healthy, he can produce more and work well.

Agriculture has the lowest productivity. Most of the developing countries heavily
relied on agricultural production in which productivity is relatively low or smaller
compared to industrial or manufacturing sector.

Human capital attainments

Investments in high developed countries have long term effects on productivity

and output of the economy.

Because the developing countries have low income, they can save less, invest less
and spend less on infrastructure projects.

Capital stock matters. It is a factor that could affect growth and development
because if a country invests on stock, it will make the country develop.

Inequality and absolute poverty

Population growth and age structure

Population growth in developing countries is higher and is faster to grow

compared in developed countries. (Example: China)

Population growth rates are determined by the difference between the birth rate
and the death rate (net of migration).

Crude birth rate - is the number of children born alive each year per 1,000
population (often shortened to birth rate).

A major implication of high birth rates is that the active labour 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 are supported financially by the country’s labour
force (typically defined as citizens between the ages of 15 and 64).

Arguments:

If malaki yung economic dependency burden (older who are over 64 and younger
who are under 15), mababa yung workforce (15-64) then mababa rin income. It
doesn’t necessarily follow na malaki yung population, malaki rin yung income.

If malaki yung population, marami yung pakainin because the economies have to
produce more goods, provide more services and spend more on infrastructures.

Rural Economy and Rural-to-Urban Migration

Rural areas are generally poorer and tend to suffer from missing markets, limited
information, and social stratification.

In developing countries, more than 2/3 of the population lives in the rural areas
and correspondingly fewer in urban areas.

Common in developing countries, people would migrate to urban areas because

they will find job opportunities there.

Example: Philippines

- malaki yung unemployment rate sa NCR, nearby regions. They

would go to Manila to find jobs and live in nearby areas where the
costs are cheaper.

Social Fractionalisation

Low-income countries more often have ethnic, linguistic, religious, and other
forms of social divisions, sometimes termed “fractionalisation.”

The greater the ethnic, linguistic, and religious diversity of a country, the more
likely it is that there will be internal strife and political instability, particularly if
inequality falls along these identity group lines.

Basically, the greater the fractionalization is of the citizens in a country/the

more na diverse, then malaki yung impact in growth and development.

Geography and Natural Resource Endowments

Many social scientists argue that geography must play some role in problems of
agriculture, public health, and comparative development more generally.

Landlocked economies, common in Africa, often have lower incomes than coastal
economies.

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.

Another dimension of geography is the extent of endowments of natural

resources such as minerals.
2.1. Introduction to Comparative Economic Development

This section highlights the wide gaps in income, life expectancy, and literacy rates
between countries, setting up the need for comparing and understanding these
disparities. It introduces Gross National Income (GNI) per capita as a standard
measure, with an example of the U.S. ($58,270 in 2017) compared to India ($1,800)
and the Democratic Republic of Congo ($460).

The idea is to illustrate why some countries are wealthier and healthier than
others, which leads into the various ways economists classify and study nations to
understand these differences.

2.2. Classifying Levels of National Economic Development

A. Gross National Income (GNI) per Capita

GNI per CAPITA is a primary measure for assessing a country’s wealth. The World
Bank classifies nations into four groups:

Low-income: GNI per capita of $1,045 or less.

Lower-middle-income: $1,046 - $4,095.

Upper-middle-income: $4,096 - $12,695.

High-income: $12,696 and above.

Example Calculation:

Imagine calculating the GNI per capita for a hypothetical country with a total
income of $200 billion and a population of 50 million.

GNI per Capita = Total GNI = 50,000,000 = 4,000

Population 200,000,000,000

This country would fall into the LOWER-MIDDLE-INCOME category.

B. Purchasing Power Parity (PPP)

PPP adjusts income for local purchasing power, making international income
comparisons more meaningful. For instance:

- In the U.S., $1 might buy a single item, but in India, $1 might buy two or three
items due to lower prices.

PPP Conversion Example:

If the cost of living in Country A is half of that in Country B, then $1 in Country A

would have the purchasing power of $2 in Country B.

This adjustment allows economists to calculate "PPP-adjusted GNI" for a more

realistic income comparison.

C. Additional Classifications

Organizations like the UN use Least Developed Countries (LDC) status for the
most vulnerable economies, defined by low income, human asset weakness, and
economic vulnerability.

2.3. Health, Education, and the Human Development Index (HDI)

GNI per capita doesn’t capture everything about well-being. This section
introduces health and education as key indicators for measuring development.

A. Health and Education Metrics

- Life Expectancy: Average number of years a person is expected to live, reflecting

health and living standards.

- Under-5 Mortality Rate: Deaths of children under five per 1,000 live births,
highlighting healthcare quality.

- Education: Enrollment rates, literacy rates, and average years of schooling are
used to assess a country’s educational level.

B. Human Development Index (HDI)

The HDI combines income, health, and education to offer a fuller picture of
development.

1. Health Index (based on life expectancy).

2. Education Index (based on mean and expected years of schooling).

3. Income Index (GNI per capita adjusted by the natural logarithm to show
diminishing returns).

The HDI is calculated as follows:

HDI=(H×E×I) 1/3

where:

𝐻 : Health index,

𝐸 : Education index,

𝐼 : Income index.

Example Calculation:

Suppose a country has:

- Life expectancy: 70 years,

- Mean schooling years: 8,

- Expected schooling years: 12,

- GNI per capita: $10,000.

Using the formulas provided for each component and the geometric mean, you
would calculate each index individually, then combine them for the HDI.

2.4. Key Similarities and Differences Among Developing Countries

This section discusses common characteristics in developing nations, though each

has unique challenges:

1. Low Income and Productivity: Productivity directly affects income. Developing

countries often face a "low productivity trap."

2. Human Capital Challenges: Health and education investments are essential but
often underfunded.

3. High Inequality and Poverty: Developing countries generally have higher

income inequality and poverty rates.
4. Rapid Population Growth: A younger demographic can be an advantage or a
challenge.

5. Rural Economies and Urban Migration: Agricultural reliance and rapid

urbanization create economic and social pressures.

6. Industrialization and Trade: Developing countries often rely on primary exports,

with less emphasis on manufacturing.

2.5. Living Standards Converging

This section tackles the idea of convergence, where poorer countries might close
the gap with richer ones over time.

A. The Great Divergence

The “Great Divergence” refers to increasing income disparities from the 19th to
the 20th century as industrialized nations grew wealthier.

B. Convergence Theory

Convergence theory proposes that poorer nations should grow faster than
wealthier ones, allowing them to catch up economically under the right conditions.

C. Types of Convergence

1. Relative Convergence: Shrinking income ratio.

2. Absolute Convergence: Reduction in absolute income differences.

Graphical Model: Figures in the text show that while some countries have
converged in relative terms, absolute differences remain large, especially when
accounting for varying starting points.

2.6. Long-Run Causes of Comparative Development

Long-term influences, such as geography, history, and institutions, affect current

development levels.

A. Geographic and Historical Factors

- Geography: Physical resources, climate, and location impact trade and

agriculture.

- Colonial Legacy: Colonies established extractive economies that left lasting

economic structures, often hindering sustainable development.

B. Institutional Quality

Strong institutions (rule of law, anti-corruption measures) promote stability and

growth. Weak institutions can perpetuate cycles of poverty and inequality.
 Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

3.1 Classical Theories of Economic Development: Four Approaches

The classical literature on economic development stemming from the second half of the 20 th century has
been:
1. The linear-stages-of-growth model (3.2)
➢ It viewed underdevelopment in terms of international and domestic power relationships,
institutional and structural economic rigidities, and the resulting proliferation of dual economies
and dual societies both within and among the nations of the world.
2. Theories and patterns of structural change (3.3)
3. The International-dependence revolution (3.4)
➢ It tended to emphasize external and internal institutional and political constraints on economic
development.
➢ Emphasis was placed on the need for major new policies to eradicate poverty, to provide more
diversified employment opportunities, and to reduce income inequalities.
4. The neoclassical, free-market counter revolution (3.5)
➢ It emphasized the beneficial role of free markets, open economies, and the privatization of
inefficient public enterprises.
➢ Failure to develop was primarily the result of too much government intervention and regulation
of the economy.
Theorists of the 1950s and 1960s viewed the process of development as a series of successive stages of
economic growth through which all countries must pass.
❖ It was primarily an economic theory of development in which the right quantity and mixture of
saving, investment, and foreign aid were all that was necessary to enable developing nations to
proceed along an economic growth path that had historically been followed by the more developed
countries.

3.2 Development as Growth and the Linear-Stages Theories

It is often dubbed as Capital Fundamentalism because of its emphasis on the central role of accelerated
physical capital accumulation.

ROSTOW’S STAGES OF GROWTH

❖ Walt W. Rostow – the most influential American economic historian and outspoken advocate of the
Stage-of-Growth Model.
➢ It is a theory of economic development; It states that the transition from underdevelopment to
development can be described in terms of a series of steps or stages through which all countries
must proceed.
❖ It is possible to identify all societies, in their economic dimensions, as lying within one of five
categories/stages of growth:
1. Traditional society
2. Pre-conditions for takeoff into self-sustaining growth
➢ The stage where a society begins to experience productive changes that lay the groundwork
for future development.
3. Take-off
4. Drive to maturity
5. Age of high mass consumption
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❖ Arguments:
1. The advanced countries had all passed the stage of “takeoff into self-sustaining growth”
2. The underdeveloped countries that were still in either the Stage 1 or Stage 2.
❖ One of the principal strategies of development necessary for any takeoff was the mobilization of
domestic and foreign saving in order to generate sufficient investment to accelerate economic
growth.

HARROD-DOMAR GROWTH MODEL / AK MODEL

❖ By Roy F. Harrod and Evsey Domar
❖ It is often referred to as the AK model because it is based on a linear production function with
output given by the capital stock K times a constant, often labelled A.
❖ It states that the rate of growth of GDP (Δ𝑌/𝑌) is determined jointly by the net national savings
ratio and the national capital-output ratio.
∆𝑌 𝑠
( )=
𝑌 𝑐
➢ Capital-output ratio, c: units of capital required to produce a unit of output over a given period
of time.
➢ Net savings ratio, s: Savings expressed as a proportion of disposable income over some period
of time.
❖ For the economy to grow and develop, it has to save more of its income so that it can invest more.
The amount of savings depends on the amount of national income.
❖ It often expressed in terms of gross savings, sG, in which it implies that to grow, economies must
save and invest a certain proportion of their GDP. In simpler words, the more they can save and
invest, the faster they can grow.
➢ The lower the value of c that an economy can attain, the greater the output that can be gained
from additional investment.
∆𝑌 𝑠𝐺 δ is the rate of capital depreciation.
( )= −𝛿
𝑌 𝑐

❖ It says that in the absence of government, the growth rate of national income will be directly or
positively related to the savings ratio (i.e., the more an economy is able to save—and invest—out
of a given GDP, the greater the growth of that GDP will be).
❖ It also says that growth rate of national income will be inversely or negatively related to the
economy’s capital-output ratio (↑c, ↓GDP growth rate)
❖ Components of economic growth:
1. Investment
2. Labor force rate
➢ Not explained explicitly because labor is assumed to be abundant in a developing-country
context and can be hired as needed in a given proportion to capital investments
3. Technological progress
➢ It can be expressed as a decrease in the required capital-output ratio, giving more growth for
a given level of investment.
 Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

❖ Obstacles & constraints:

➢ One of the most fundamental strategies of economic growth is simply to increase the proportion
of national income saved (not consumed), based on the Harrod-Domar Growth Model. If we
can increase s (new savings ratio), we can increase Δ𝑌/𝑌 (rate of GDP growth).
➢ The main obstacle to or constraint on development, according to this theory, is the relatively low
level of new capital formation in most poor countries.

SOME CRITISIMS OF THE STAGES MODEL

❖ Necessary versus Sufficient Conditions
➢ The mechanisms of development embodied in the theory of stages of growth did not always
work.
• Reason: It is not sufficient condition. (It is not because more saving and investment isn’t a
necessary condition for accelerated rates of economic growth)
• Necessary condition: must be present, although it need not be in itself sufficient, for an
event to occur.
• Sufficient condition: when present causes or guarantees that an event will or can occur; a
condition that logically requires that a statement must be true (or a result must hold) given
other assumptions.
➢ The Marshall Plan worked for Europe because the European countries receiving aid possessed
the necessary structural, institutional, and attitudinal condition to convert new capital effectively
into higher levels of output.
➢ The Rostow and Harrod-Domar models implicitly assume the existence of these same attitudes
and arrangements in underdeveloped nations.

3.3 Structural-Change Models

STRUCTURAL-CHANGE THEORY
❖ Underdevelopment is due to underutilization of resources arising from structural or institutional
factors that have their origins in both domestic and international dualism. Development therefore
requires more than just accelerated capital formation.
❖ It focuses on the mechanism by which underdeveloped economies transform their domestic
economic structures from a heavy emphasis on traditional subsistence agriculture to a more
modern, more urbanized, and more industrially diverse manufacturing and service economy.

LEWIS TWO-SECTOR MODEL

❖ It was formulated by Nobel laureate W. Arthur Lewis in the mid-1950s and later modified,
formalized, and extended by John Fei and Gustav Ranis.
❖ It is a theory of economic development in which surplus labor from the traditional agricultural sector
is transferred to the modern industrial sector, the growth of which absorbs the surplus labor,
promotes industrialization, and stimulates sustained development.
➢ Surplus labor: The excess supply of labor over and above the quantity demanded at the going
free-market wage rate; refers to the portion of the rural labor force whose marginal productivity
is zero or negative.
 Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

❖ According to Lewis, in order for the economy to grow and develop, it must transition from
traditional (agriculture) to a modern sector.
❖ One of the best-known early theoretical models of development that focused on the structural
transformation of a primarily subsistence economy.
➢ Structural transformation: The process of transforming an economy in such a way that the
contribution to national income by the manufacturing sector eventually surpasses the
contribution by the agricultural sector.
❖ It became the general theory of the development process in surplus-labor developing nations during
most of the 1960s and early 1970s, and it is sometimes still applied, particularly to study the recent
growth experience in China and labor markets in other developing countries.
❖ The underdeveloped economy consists of two sectors:
1. Traditional, overpopulated, rural subsistence sector
➢ It is characterized by zero marginal labor productivity
• a situation that permits Lewis to classify this as surplus labor in the sense that it can be
withdrawn from the traditional agricultural sector without any loss of output
2. High-productivity modern, urban industrial sector
❖ The primary focus of the model is on both the process of labor transfer and the growth of output
and employment in the modern sector (include modern agriculture).
❖ Lewis assumed that the level of wages in the urban industrial sector was constant, determined as
a given premium over a fixed average subsistence level of wages in the traditional agricultural
sector.
❖ The structural transformation of the economy will have taken place, with the balance of economic
activity shifting from traditional rural agriculture to modern urban industry.
❖ Criticisms/Questionable Assumptions:
1. It assumes that the rate of labor transfer and employment creation in the modern sector is
proportional to the rate of modern-sector capital accumulation.
➢ The faster the rate of capital accumulation, the higher the growth rate of the modern sector
and the faster the rate of new job creation.
2. The surplus labor exists in rural areas while there is full employment in the urban areas.
➢ This is questionable because in reality, it is possible that there’s no surplus labor in rural areas.
3. A competitive modern-sector labor market that guarantees the continued existence of constant
real urban wages up to the point where the supply of rural surplus labor is exhausted.
➢ This is questionable because in reality, there is a possibility that the wage rate decreases if
there is a higher number of workers in modern sector.
4. Diminishing returns in the modern industrial sector.
5. It assumes away the significance of also accounting for the importance of human capital
(education, skills and also health) in productivity.
❖ This is widely considered relevant to recent experiences in China, where labor has been steadily
absorbed from farming into manufacturing, and to a few other countries with similar growth
patterns.
 Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

❖ The Lewis two-sector model of structural change underlines the importance of transfers of resources
from low-productivity to high-productivity activities in the process of economic development,
attempting to analyze the many linkages between traditional agriculture and modern industry, and
clarifying recent growth experiences such as that of China.

STRUCTURAL CHANGE MODEL AND PATTERNS OF DEVELOPMENT

❖ the patterns-of-development analysis of structural change focuses on the sequential process
through which the economic, industrial, and institutional structure of an underdeveloped economy
is transformed over time to permit new industries to replace traditional agriculture as the engine of
economic growth.
➢ In contrast to the Lewis model and the Original Stages View of Development, increased savings
and investment are perceived by patterns-of-development analysts as necessary but not
sufficient conditions for economic growth.
➢ It believed that domestic factors were not the only factors that could affect the economic growth
and development, but also international factors (investment from abroad, etc.)
❖ Empirical structural-change analysts emphasize both domestic and international constraints on
development.
➢ Domestic constraints include economic constraints such as a country’s resource endowment and
its physical and population size, as well as institutional constraints such as government policies
and objectives.
➢ International constraints on development include access to external capital, technology, and
international trade.
• It is the international constraints that make the transition of currently developing countries
differ from that of now-industrialized countries.
❖ The Structural-Change Model recognizes the fact that developing countries are part of an
integrated international system that can promote (as well as hinder) their development.
➢ Major hypothesis: development is an identifiable process of growth and change, whose main
features are similar in all countries.
➢ It recognizes that differences can arise among countries in the pace and pattern of development,
depending on their particular set of circumstances. Factors influencing the development process
include a country’s resource endowment and size, its government’s policies and objectives, the
availability of external capital and technology, and the international trade environment.
➢ Empirical studies on the process of structural change led to the conclusion that the pace and
pattern of development can vary according to both domestic and international factors, many
of which lie beyond the control of an individual developing nation.
 Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

3.4 The International-Dependence Revolution

INTERNATIONAL-DEPENDENCE MODELS
❖ They view developing countries as affected by institutional, political, and economic rigidities, both
domestic and international, and caught up in a dependence and dominance relationship with rich
countries.
➢ Dependence: The reliance of developing countries on developed-country economic policies to
stimulate their own economic growth.
• The developing countries adopt developed-country education systems, technology,
economic and political systems, attitudes, consumption patterns, dress, and so on.
➢ Dominance: A situation in which the developed countries have much greater power than the
less-developed countries in decisions affecting important international economic issues.
❖ It explains how some countries become dependent on other countries, and how this dependency
leads to a power imbalance that affects international politics.
❖ During the 1970s, International-Dependence Models gained increasing support, especially among
developing-country intellectuals, as a result of growing disenchantment with both the stages and
structural-change models.
❖ 3 major streams of thought:
1. NEOCOLONIAL DEPENDENCE MODEL
➢ Main Proposition: Underdevelopment exists in developing countries because of continuing
exploitative economic, political, and cultural policies of former colonial rulers toward less-
developed countries.
➢ It attributes the existence and continuance of underdevelopment primarily to the historical
evolution of a highly unequal international capitalist system of rich country–poor country
relationships.
• Underemployment: An economic situation characterized by persistent low levels of
living.
➢ The coexistence of rich and poor nations in an international system dominated by such
unequal power relationships between the center (the developed countries) and the
periphery (the developing countries) renders attempts by poor nations to be self-reliant and
independent difficult and sometimes even impossible.
➢ Neocolonial view of underdevelopment attributes a large part of the developing world’s
continuing poverty to the existence and policies of the industrial capitalist countries of the
northern hemisphere and their extensions in the form of small but powerful elite or
comprador groups (local elites who act as fronts for foreign investors) in the less-developed
countries.
➢ According to Theotonio Dos Santos, dependency is based upon an international division of
labor which allows industrial development to take place in some countries while restricting
it in others, whose growth is conditioned by and subjected to the power centers of the world.
 Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

2. FALSE-PARADIGM MODEL
➢ Main Proposition: Developing countries have failed to develop because their development
strategies have been based on an incorrect/inappropriate model of development.
➢ It attributes underdevelopment to faulty and inappropriate advice provided by well-meaning
but often uninformed, biased, and ethnocentric international “expert” advisers from
developed-country assistance agencies and multinational donor organizations.
• These experts are said to offer complex but ultimately misleading models of
development that often lead to inappropriate or incorrect policies.
➢ According to this model, leading university intellectuals, trade unionists, high-level
government economists, and other civil servants all get their training in developed-country
institutions where they are unwittingly served an unhealthy dose of alien concepts and
elegant but inapplicable theoretical models.
➢ Example: The Implementation of K-12 Curriculum in the Philippines is not effective
compared to the other countries.
3. DUALISTIC-DEVELOPMENT THESIS
➢ Dualism is the existence and persistence of substantial and even increasing divergences
between rich and poor nations and rich and poor peoples on various levels.
• The coexistence of two situations or phenomena (one desirable and the other not) that
are mutually exclusive to different groups of society.
➢ 4 key arguments:
a. Different sets of conditions, of which some are “superior” and others “inferior,” can
coexist in a given space.
Example: The coexistence of wealthy, highly educated elites with masses of
illiterate poor people
b. This coexistence is chronic and not merely transitional.
c. Not only do the degrees of superiority or inferiority fail to show any signs of diminishing,
but they even have an inherent tendency to increase.
Example: The productivity gap between workers in developed countries and
their counterparts in most developing countries seems to widen
d. The interrelations between the superior and inferior elements are such that the existence
of the superior elements does little or nothing to pull up the inferior element, let alone
“trickle down” to it.
❖ The three models place more emphasis on international power imbalances and on needed
fundamental economic, political, and institutional reforms, both domestic and worldwide. They also
reject the claim that there are well-defined empirical patterns of development that should be pursued
by most poor countries.
❖ 2 major weaknesses of dependence theories:
1. Although these theories offer an appealing explanation of why many poor countries remain
underdeveloped, they give little insight into how countries initiate and sustain development.
2. The actual economic experience of developing countries that have pursued revolutionary
campaigns of industrial nationalization and state-run production has been mostly negative.
 Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

❖ If we are to take dependence theory at face value, we would conclude that the best course for
developing countries is to become entangled as little as possible with the developed countries and
instead pursue a policy of autarky (A closed economy that attempts to be completely self-reliant),
or inwardly directed development, or at most trade only with other developing countries.

3.5 The Neoclassical Counter-Revolution: Market Fundamentalism

NEOCLASSICAL COUNTER-REVOLUTION
❖ Central Argument: Underdevelopment results from poor resource allocation due to incorrect pricing
policies and too much state intervention by overly active developing-nation governments.
❖ Contrary to the claims of the dependence theorists, the neoclassical counterrevolutionaries argue
that the developing world is underdeveloped, not because of the predatory activities of the
developed world and the international agencies that it controls, but rather because of the heavy hand
of the state and the corruption, inefficiency, and lack of economic incentives that permeate the
economies of developing nations.
❖ Neoclassicists obtained controlling votes on the boards of the world’s two most powerful
international financial agencies—the World Bank and the International Monetary Fund.
❖ What is needed is simply a matter of promoting free markets and laissez-faire economics within the
context of permissive governments.
➢ Free markets The system whereby prices of commodities or services freely rise or fall when
the buyer’s demand for them rises or falls or the seller’s supply of them decreases or increases.
❖ 3 component approaches:
1. FREE-MARKET ANALYSIS
➢ A theoretical analysis of the properties of an economic system operating with free markets,
often under the assumption that an unregulated market performs better than one with
government regulation.
➢ It argues that markets alone are efficient—product markets provide the best signals for
investments in new activities; labor markets respond to these new industries in appropriate
ways; producers know best what to produce and how to produce it efficiently; and product
and factor prices reflect accurate scarcity values of goods and resources now and in the
future.
➢ Any government intervention in the economy is by definition distortionary and
counterproductive.
➢ Free-market development economists have tended to assume that developing-world markets
are efficient and that whatever imperfections exist are of little consequence.
➢ Weakness: If the government won’t intervene in the firms, then the economy will be polluted.
The firms will produce products in order to earn profit, without considering its effects on the
environment.
2. PUBLIC-CHOICE THEORY or NEW POLITICAL ECONOMY APPROACH
➢ It states that self-interest guides all individual behavior and that governments are inefficient
and corrupt because people use government to pursue their own agendas. It argues that
governments can do nothing right.
• It assumes that politicians, bureaucrats, citizens, and states act solely from a self-
interested perspective, using their power and the authority of government for their own
 Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

selfish ends. The net result is not only a misallocation of resources but also a general
reduction in individual freedoms
▪ Citizens use political influence to obtain special benefits (called “rents”) from
government policies that restrict access to important resources.
▪ Politicians use government resources to consolidate and maintain positions of power
and authority.
▪ Bureaucrats and public officials use their positions to extract bribes from rent-
seeking citizens and to operate protected businesses on the side.
▪ States use their power to confiscate private property from individuals.
➢ Conclusion: Minimal government is the best government.

3. MARKET-FRIENDLY APPROACH
➢ This was promulgated by the World Bank that successful development policy requires
governments to create an environment in which markets can operate efficiently and to
intervene only selectively in the economy in areas where the market is inefficient.
➢ It recognizes that there are many imperfections in developing-country product and factor
markets and that governments do have a key role to play in facilitating the operation of
markets through nonselective (market-friendly) interventions.
• Example: Investing in physical and social infrastructure, health care facilities,
and educational institutions
➢ It differs from the first two approaches by accepting the notion that market failures are more
widespread in developing countries in areas such as investment coordination and
environmental outcomes.
• Market failure: Market’s inability to deliver its theoretical benefits due to the existence
of market imperfections. It often provides the justification for government intervention
to alter the working of the free market.

TRADITIONAL NEOCLASSICAL GROWTH THEORY

❖ Another cornerstone of the neoclassical free-market argument is the assertion that liberalization of
national markets draws additional domestic and foreign investment and thus increases the rate
of capital accumulation.
❖ SOLOW NEOCLASSICAL GROWTH MODEL
➢ By Robert Solow
➢ Aside from labor, the technology also affects the production and the growth and development of
economy.
➢ It implies that economies will converge to the same level of income per worker conditionally.
➢ It differed from the Harrod-Domar formulation by adding a second factor, labor, and introducing
a third independent variable, technology, to the growth equation.
➢ It exhibited diminishing returns to labor and capital separately and constant returns to both
factors jointly.
❖ Output growth results from one or more of three factors:
1. Increases in labor quantity and quality (through population growth and education)
2. Increases in capital (through saving and investment)
3. Improvements in technology
 Chapter 3
CLASSIC THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT

❖ Closed economies (those with no foreign trade transactions or external activities) with lower
savings rates grow more slowly in the short run than those with high savings rates and tend to
converge to lower per capita income levels.
❖ Open economies (those with trade, foreign investment, etc.) experience income convergence at
higher levels as capital flows from rich countries to poor countries where capital–labor ratios are
lower and thus returns on investments are higher.
➢ Income convergence is when countries with lower incomes catch up to those with higher
incomes. It can also refer to a reduction in the income gap between countries.
➢ Openness is said to encourage greater access to foreign production ideas that can raise the rate
of technological progress.
➢ According to this theory, by impeding the inflow of foreign investment, the heavy-handedness
of many developing countries’ governments will slow down the growth in the economies of the
developing world.
CHAPTER 5: POVERTY, INEQUALITY AND DEVELOPMENT
5.1. Measuring Inequality
1. Size or Personal Distribution
o Definition: Size or personal distribution of income looks at how total income is
distributed among individuals or households, disregarding the source or factors of
production.
o Purpose/Function: This approach helps in understanding the distributional
outcomes of income and wealth within a population, highlighting disparities in
wealth and income.
o Simple Example: If in a country of 100 people, 10 people earn 50% of the total
income while the other 90 earn the remaining 50%, this indicates a high level of
inequality.
o Limitation/Disadvantage: Personal distribution does not explain the reasons
behind income inequality or account for how income is earned (like labor vs.
capital).
Quintile - A 20% proportion of any numerical quantity. A population divided into quintiles
would be divided into five groups of equal size.
Decile - A 10% portion of any numerical quantity. A population divided into deciles would
be divided into ten equal numerical groups.
Kuznets ratio, after Nobel laureate Simon Kuznets, has often been used as a measure of
the degree of inequality between high- and low-income groups in a country.
This can be solved by dividing the highest to the lowest share of income. The lower ratio,
the lesser degree of inequality.
2. Lorenz Curve
o Definition: It shows the actual quantitative relationship between the percentage of
income recipients and the percentage of the total income they did in fact receive
during, say, a given year.
o Formula: The Lorenz Curve is plotted with cumulative population on the x-axis
and cumulative income on the y-axis.
o Purpose/Function: The Lorenz Curve helps visualize inequality by comparing it
to a 45-degree line, which represents perfect equality.
o Simple Example: A Lorenz Curve that lies closer to the 45-degree line indicates a
more equal distribution, while a curve further away signifies greater inequality.
 o Limitation/Disadvantage: It can’t provide a precise numerical measure of
inequality on its own.
3. Gini Coefficient
o Definition: A measure derived from the Lorenz Curve that quantifies inequality,
with values ranging from 0 (perfect equality) to 1 (maximum inequality).
o Formula: It is measured graphically by dividing the area between the perfect
equality line and the Lorenz curve by the total area lying to the right of the equality
line in a Lorenz diagram.
o Purpose/Function: It provides a single, comparable measure of inequality within
or across populations as compared to Lorenz Curve.
o Simple Example: A Gini coefficient of 0.3 suggests moderate inequality, while a
value of 0.7 indicates high inequality.
o Limitation/Disadvantage: The Gini coefficient doesn’t show the specifics of
income distribution and is sensitive to changes in the middle of the distribution
more than the extremes.
Desirable Properties for Measuring Inequality:
1. Anonymity: A measure should not depend on who has higher income.
2. Scale independence: Inequality measures should not depend on size of the economy.
3. Population independence principle: An inequality measure should not be based on the number
of income recipients.
4. Transfer principle - If transfer income from a richer to a poorer person (not so much that the
poorer person is now richer than the originally rich person), resulting new income distribution is
more equal.
4. Functional Distribution
o Definition: Functional distribution examines the division of income among factors
of production, like wages (labor), rents (land), and profits (capital).
o Purpose/Function: This approach helps in understanding how income generated
by different economic sectors contributes to inequality.
o Simple Example: If labor income constitutes 60% of national income and capital
income 40%, it provides insights into how labor and capital contribute to income
distribution.
o Limitation/Disadvantage: Functional distribution does not account for how
income is distributed across individuals or households.
5.2. Measuring Poverty
1. Headcount Index
o Definition: The proportion of the population living below the poverty line.
o Formula: H/N where the number, or “headcount” H, of those whose incomes fall
below the absolute poverty line over the total population, N.
o Purpose/Function: It gives a straightforward measure of poverty incidence.
o Simple Example: If 20 out of 100 people are below the poverty line, the Headcount
Index is 0.2 or 20%.
o Limitation/Disadvantage: It does not measure the depth or severity of poverty.
2. Total Poverty Gap or Ratio
o Definition: Measures the total amount of income necessary to raise everyone who
is below the poverty line up to that line.
o Formula:
o Purpose/Function: It helps to quantify the resources needed to bring everyone to
the poverty line.
o Simple Example: If three individuals fall $2, $3, and $5 below the poverty line,
the total poverty gap is $10.
o Limitation/Disadvantage: It doesn’t differentiate between the poverty levels of
different individuals.
3. Average Poverty Gap
o Definition: The average income shortfall from the poverty line among the poor,
indicating the severity of poverty.
o Formula: APG = TPG / N; On a per capita basis, the average poverty gap (APG)
is found by dividing the TPG by the total population, N.
o Purpose/Function: This provides the average gap for individuals in poverty,
showing the intensity of poverty.
o Simple Example: If the total poverty gap is $10 for 5 individuals, the Average
Poverty Gap is $2.
o Limitation/Disadvantage: It doesn’t consider the total population, only those
below the poverty line.
4. Normalized Poverty Gap
o Definition: Measures the average poverty gap as a proportion of the poverty line.
 o Formula: NPG = APG / Yp
o Purpose/Function: It normalizes the poverty gap, allowing comparison across
different poverty lines or regions.
o Simple Example: With a poverty line of $10, if the Average Poverty Gap is $2, the
Normalized Poverty Gap is 0.2.
o Limitation/Disadvantage: It still only captures the intensity but not the depth of
poverty.
5. Foster-Greer-Thorbecke (FGT) Index
o Definition: A class of poverty measures that includes incidence, depth, and severity
of poverty.
o Formula:
o Purpose/Function: Different values of α\alphaα provide measures for poverty
headcount (α=0), poverty gap (α=1), and severity (α=2).
o Limitation/Disadvantage: It can be difficult to interpret for large datasets and
requires setting an appropriate α\alphaα parameter.
Desirable Properties for Measuring Poverty:
1. Anonymity: The measure should not depend on who has higher income.
2. Population independence principle: An inequality measure should not be based on the number
of income recipients.
3. The monotonicity principle: This means that if you add income to someone below the poverty
line, all other incomes held constant, poverty can be no greater than it was.
4. The distributional sensitivity principle: If you transfer income from a poor person to a richer
person, the resulting economy should be deemed strictly poorer.
6. Person-Equivalent Headcount
o Definition: Adjusts the headcount index to reflect both the number and the severity
of poverty.
o Purpose/Function: To capture a more comprehensive picture by accounting for
people’s proximity to the poverty line.
o Simple Example: A higher person-equivalent headcount indicates that more
individuals are far below the poverty line.
o Limitation/Disadvantage: It’s more complex and less intuitive than simple
headcount measures.
 7. Multidimensional Poverty Measurement
o Definition: Measures poverty across multiple dimensions (such as health,
education, and living standards) rather than just income.
Dimension Cutoffs: Establish specific cutoff levels for each dimension of poverty (e.g.,
education, health, living standards).
Deprivation Count: Determine how many dimensions a person must be deprived in to be
classified as multidimensionally poor.
o Formula: Counts individuals as poor if they fall below thresholds in a minimum
number of indicators.
o Purpose/Function: Provides a broader understanding of poverty that reflects
diverse deprivations.
o Simple Example: A household might be considered poor if they lack access to
adequate education, healthcare, and housing.
o Limitation/Disadvantage: It requires extensive data across multiple indicators and
may vary in definitions across contexts.
Dimension Monotonicity: If the average number of deprivations increases, the measure
of multidimensional poverty should also increase. This ensures that as people experience
more deprivation, the overall assessment of poverty reflects that worsening situation.
Overall:
▪ Inequality refers to the unequal distribution of resources, opportunities, and privileges
among individuals or groups within a society.
▪ Poverty is the condition of not having enough financial resources to meet basic living
needs, such as food, shelter, and clothing.
▪ Absolute Poverty is the number of people who are unable to command sufficient
resources to satisfy basic needs. They are counted as the total number living below a
specified minimum level of real income—an international poverty line.

5.3 POVERTY, INEQUALITY, AND SOCIAL WELFARE

What’s So Bad about Extreme Inequality?

➢ First, extreme income inequality leads to economic inefficiency.

➢ Second, extreme income disparities undermine social stability and solidarity.
➢ Finally, extreme inequality is generally viewed as unfair.
For all these reasons, for this part of the analysis we will write welfare, W, as

W = W (Y, I, P)

Where Y is income per capita and enters our welfare function positively, I is inequality and enters
negatively, and P is absolute poverty and also enters negatively.

Dualistic Development and Shifting Lorenz Curves: Some Stylized Typologies

As introduced by Gary Fields, Lorenz curves may be used to analyze three limiting cases of
dualistic development:

1. The modern-sector enlargement growth typology, in which the two-sector economy

develops by enlarging the size of its modern sector while maintaining constant wages in
both sectors.

Example: Before, people moved from farms (traditional sector) to cities to work in factories
(modern sector). Initially, inequality rose because factory workers earned more than farmers,
but overtime, as more people moved to the cities, inequality decreased, and poverty fell. This
is an example of more people benefiting from growth as the modern sector expanded.

2. The modern-sector enrichment growth typology, in which the economy grows but such
growth is limited to a fixed number of people in the modern sector, with both the numbers
of workers and their wages held constant in the traditional sector.

Example: Oil rich countries like Niger or Venezuela has greatly enriched a small portion of
the population involved in the oil industry (modern sector), while most of the population,
particularly in rural areas (traditional sector), remains poor. This growth is limited to a few,
causing inequality to rise as the wealth is not spread across the broader population.

3. The traditional-sector enrichment growth typology, in which all of the benefits of growth
are divided among traditional-sector workers, with little or no growth occurring in the
modern sector.

Example: Cuba, while not experiencing much growth in the modern sector focused more on
improving living conditions in the traditional sector by improving healthcare and education for
poor. This helped reduce inequality and poverty, even though the economy did not grow
rapidly.
 These three typologies offer different predictions about what will happen to inequality
during economic growth. With modern-sector enrichment, inequality rises steadily, while under
traditional-sector enrichment, inequality falls steadily because it results in higher income which
leads to relative distribution of income.

Under modern-sector enlargement, inequality first rises and then falls. Absolute incomes
rise and absolute poverty is reduced, but the Lorenz curves will always cross, indicating that we
cannot make any unambiguous statement about changes in relative inequality: it may improve or
worsen.

Kuznets’s Inverted-U Hypothesis

Kuznets curve- A graph reflecting the relationship between a country’s income per capita and its
inequality of income distribution.

Explanations as to why inequality might worsen during the early stages of economic
growth before eventually improving are numerous. They almost always relate to the nature of
structural change.

It suggests that inequality rises in the early stages of economic growth as wealth
concentrates in the modern sector, but it falls later as more people gain access to better jobs and
education. But this pattern isn’t universal as some countries like South Korea (after the war, they
implemented strategic policies focused on industrialization, education, and export-led growth)
have reduced inequality from the start. The outcome depends heavily on the nature of the
development process and policies in place.

Growth and Inequality

➢ During the 1960s and 1990s, per capita growth in East Asia averaged 5.5% while that of
Africa declined by 0.2%, yet both Gini coefficients remained essentially unchanged. Once
again, it is not just the rate but also the character of economic growth (how it is achieved,
who participates, which sectors are given priority, what institutional arrangements are
designed and emphasized, etc.) that determines the degree to which that growth is or is not
reflected in improved living standards for the poor. Clearly, it is not necessary for
inequality to increase for higher growth to be sustained.

Character of economic growth- The distributive implications of economic growth as

reflected in such factors as participation in the growth process and asset ownership.
5.4 ABSOLUTE POVERTY: EXTENT AND MAGNITUDE
It is extremely difficult to arrive at a tight estimate of the extent of global poverty at
any point in time. Major World Bank reports issued within a couple of years of each other have
provided estimates of the dollar-a-day headcount that differ by tens of millions of people. This
reflects the difficulty of the task.
Another difficulty is determining the most appropriate cutoff income for extreme
poverty. The $1-a-day line was first set in 1987 dollars, and for years the standard was $1.08 in
1993 US Purchasing Power Parity.
The incidence of extreme poverty is very uneven around the developing world. Household
survey-based estimate is regarded as the most accurate ways to estimate poverty incidence.
There are questions about whether the response of poverty reduction to average incomes
can be increased; and the extent to which gains of growth and poverty reduction will be extended
to countries so far mostly left out or continue in countries facing commodity price declines and
renewed concerns over rising debt levels.
Multidimensional Poverty Index (MPI)
- A poverty measure that identifies the poor using dual cutoffs for levels and numbers of
deprivations, and then multiplies the percentage of people living in poverty times the
percentage of weighted indicators for which poor households are deprived on average.
Three dimensions:
1. Health – This includes factors like nutrition and child mortality
2. Education – This includes factors like school attainment and school attendance
3. Wealth – This includes factors like access to electricity, safe drinking water, sanitation,
housing quality, cooking fuel, and other assets.

- These 10 factors/indicators are used to calculate the MPI value.

- Each indicator in Health and education is equivalent to 1/6, while in wealth, it is equivalent
to 1/7.
- The MPI has provided a new and fundamentally important way to measure poverty, to help
us understand how poverty levels differ across and within countries, and also how the
dimensions (or composition) of poverty can differ greatly in different settings.
Chronic Poverty
- Particularly concerned with individuals or families who experience long-term deprivation,
often due to structural factors that limit their ability to escape poverty over time.
5.5 ECONOMIC CHARACTERISTICS OF HIGH-POVERTY GROUPS
Children and Poverty
- Poverty disproportionally affects children, with half of those in multidimensional poverty
being children.
Women and Poverty
- Women represents the majority of the world’s poor and experience the harshest forms of
deprivation, as women typically earn less than men. This is especially true in rural and
urban where women are restricted to low paying. They are more likely to be poor and
malnourished and less likely to receive medical services, clean water, sanitation, and other
benefits.
Ethnic Minorities, Indigenous people, and Poverty
- Poverty disproportionally affects minority ethnic groups and indigenous people. Recent
years, domestic conflicts and even civil wars have arisen out of ethnic groups’ perceptions
that they are losing out in the competition for limited resources and job opportunities.
Rural Poverty – A majority of the poor live in rural areas, primarily working in agriculture
and resource- based jobs.
Poor countries – Poverty is prevalent in poor countries, but higher national income can help
reduce it.

5.6 GROWTH AND POVERTY

Are the reduction of poverty and the acceleration of growth in conflict? Or are they
complementary?
The relationship between poverty reduction and economic growth has been a subject of
ongoing debate for decades. Traditionally, body of opinion held that rapid growth is bad for the
poor because they would be bypassed and marginalized by the structural changes of modern
growth. However, a growing body of evidence suggests that poverty reduction and economic
growth are not necessarily in conflict but can be complementary.
There are at least 5 reasons why policies focused toward reducing poverty levels that
doesn’t lead to a slower rate of growth but rather, it could help to accelerate growth.
1. First, widespread poverty creates conditions in which the poor have no access to credit.
2. Second, a wealth of empirical data bears witness to the fact that, unlike the historical
experience of the now-developed countries.
3. Third, the low incomes and low levels of living for the poor, which are manifested in poor
health, nutrition, and education, can lower their economic productivity, and thereby lead
directly and indirectly to a slower-growing economy.
 4. Fourth, raising the income levels of the poor will stimulate an overall increase in the
demand for locally produced necessity products such as food and clothing.
5. Fifth, a reduction of mass poverty can stimulate healthy economic expansion by acting as
a powerful material and psychological incentive to widespread public participation in the
development process.
That dramatic reductions in poverty need not be incompatible with high growth is seen
both in case studies and in the cross-national comparisons of data. Countries where poverty has
been reduced the most tend to have had sustained growth; at the same time, growth does not
guarantee poverty reduction. From 1980–2005, China experienced the highest growth rate in the
world and also the most dramatic reductions in poverty. The headcount of the poor in China fell
from 634 million in 1981 to 128 million in 2004, with the corresponding headcount ratio falling
from 64% to 10%.

5.7 LABOUR THE FUNCTIONAL DISTRIBUTION OF INCOME AND INCLUDIVE

DEVELOPMENT
The Functional Distribution
It is based on the share of total national income that each of the factors of production (land,
labour, and capital) receives. Instead of looking at individuals as separate entities, the theory of
functional income distribution enquires into the percentage that labour receives as a whole and
compares this with the percentages of total income distributed in the form of rent, interest, and
profit
For example, if a large part of the income goes to capital owners and less to workers, this
could indicate growing inequality, as people who own assets (such as businesses or stocks) are
getting richer compared to those who rely only on wages.
Traditional Neoclassical Approach
The neoclassical theory of functional income distribution explains how income is divided
among the factors of production (like labor and capital) based on their contribution to the
economy. It assumes that the prices of these factors like wages for workers are determined by
supply and demand.
In essence, functional distribution offers a structural or factor-based analysis, while the
neoclassical approach focuses on the individual's role in determining income distribution based
on productivity. Both have unique perspectives on the causes of income disparities and the methods
to address them.
Labour And Inclusive Development
Inclusive development is a concept that emphasizes the importance of ensuring that
everyone benefits from economic growth and progress. It goes beyond simply increasing a
country's GDP and focuses on creating a society where all individuals can participate, contribute,
and thrive.
In Summary, Labor and Inclusive Development are connected because providing fair job
opportunities to all people is a key part of making sure that economic growth benefits everyone,
not just a few groups.

5.8 POLICY OPTIONS ON INCOME INEQUALITY AND POVERTY: SOME BASIC

CONSIDERATION
Four Broad Areas of possible Government Policy Intervention:
1. Altering the functional distribution
- the returns to labor, land, and capital as determined by factor prices, utilization levels, and
the consequent shares of national income that accrue to the owners of each factor.
2. Mitigating the size distribution
- the functional income distribution of an economy translated into a size distribution by
knowledge of how ownership and control over productive assets and labor skills are
concentrated and distributed throughout the population.
3. Moderating (reducing) the size distribution at the upper levels
- through progressive taxation of personal income and wealth.
- Such taxation increases government revenues, which decrease the share of disposable income
of the very rich—revenues that can, with good policies, be invested in human capital and rural
and other lagging infrastructure needs, thereby promoting inclusive growth.
Disposable Income -is the income that is available to households for spending and saving
after personal income taxes have been deducted.
4. Moderating (increasing) the size distribution at the lower levels through public
expenditures of tax revenues to raise the incomes of the poor either directly or indirectly.
Altering the Functional Distribution of Income through Relative Factor Prices
Altering the functional distribution is a traditional economic approach. It is argued that as
a result of institutional constraints and faulty government policies, the relative price of labor in the
formal, modern, urban sector is higher than what would be determined by the free interplay of the
forces of supply and demand.
 However, in recent years, some scholars and practitioners, particularly from the developing
world, argue that the impact of minimum wages on poverty is more nuanced in theory and
practice, particularly when the possibility of income sharing among the poor is accounted for.
Modifying the Size Distribution through Increasing Assets of the Poor
Given correct resource prices and utilization levels for each type of productive factor
(labor, land, and capital), we can arrive at estimates for the total earnings of each asset. But to
translate this functional income into personal income, we segment of the population.
Here we come to what is probably the most important fact about the determination of
income distribution within an economy: The ultimate cause of the unequal distribution of personal
incomes in most developing countries is the:
1. Unequal and highly concentrated patterns of asset ownership (wealth) in these
countries.
Asset ownership- The ownership of land, physical capital (factories, buildings,
machinery, etc.), human, and financial resources that generate income for owners.
2. Focus directly on reducing the concentrated control of assets, the unequal
distribution of power, and the unequal access to educational and income-earning
opportunities that characterize many developing countries
Redistribution policies- Policies geared to reducing income inequality and
expanding economic opportunities in order to promote development, including income tax
policies, rural development policies, and publicly financed services.
Land reform- A deliberate attempt to reorganize and transform existing agrarian
systems with the intention of improving the distribution of agricultural incomes and thus
fostering rural development.
Progressive Income and Wealth Taxes
Direct progressive income - personal and corporate income
Regressive Taxes - middle income groups often end up paying proportionally larger share than
higher income groups
Indirect Taxes - poor are taxed at the source of their income or expenditure
Direct Transfer Payments and the Public Provisions of Goods and Services
The direct provision of tax - financed public consumption goods and services to the very poor is
another potentially important instrument of a comprehensive policy designed to eradicate poverty.
Public consumption - All current expenditures for purchases of goods and services by all levels of
government, including capital expenditures on national defense and security.
 Chapter 6
Population Growth and Economic Development: Causes,
Consequences, and Controversies

In 2017, the world’s population reached about 7.6 billion people. In that year, the United
Nations Population Division projected that population would rise to about 8.6 billion in
2030, 9.8 billion by 2050, and 11.2 billion in 2100.
The overwhelming majority of that population will inhabit the developing world.
Population and economic development policies in Rwanda and Burundi, sometimes
described as “twins”

6.2.1 World Population Growth Throughout History

• When people first started to cultivate food through agriculture some 12,000 years ago,
the estimated world population was no more than 5 million.
• From year 1 on our calendar to the beginning of the Industrial Revolution around 1750,
it tripled to 728 million people.
• Turning from absolute numbers to percentage growth rates, for almost the whole of
human existence on earth until approximately 300 years ago, population grew at an
annual rate not much greater than zero (0.002%, or 20 per million).

The relationship between annual percentage increases and the time it takes for a
population to double in size, or doubling time, can be calculated from the annual
percentage increase
Doubling time: Period that a given population or other quantity takes to increase by its
present size.
Before 1650, it took nearly 36,000 years, or about 1,400 generations, for the world
population to double.
Sudden change in overall population trends results from: famine, disease, malnutrition,
plague, and war—conditions that resulted in high and fluctuating death rates.

In the twentieth century, there was a decline in mortality due to rapid technological
advances in modern medicine, improved nutrition, and the spread of modern
sanitation measures throughout the world which resulted in the increases in world
population growth especially in developing countries.
6.2.2 Structure of the World’s Population
GEOGRAPHIC REGION
More than three-quarters of the world’s people live in developing countries; fewer than
one person in four lives in an economically developed nation.

FERTILITY AND MORTALITY TRENDS

• The rate of population increase is quantitatively measured as the percentage yearly
net relative increase (or decrease, in which case it is negative) in population size due
to natural increase and net international migration.
• Natural increase simply measures the excess of births over deaths or, in more
technical terms, the difference between fertility and mortality.
• Population increases in developing countries therefore depend almost entirely on the
difference between their crude birth rates (or simply birth rates) and death rates.

Rate of population Increase: The growth rate of a population, calculated as the natural
increase after adjusting for immigration and emigration.
Natural increase: The difference between the birth rate and the death rate of a given
Population.
Net international migration: The excess of persons migrating into a country over those
who emigrate from that country.
Crude birth rate: The number of children born alive each year per 1,000 population
(often shortened to birth rate).
Death rate: The number of deaths each year per 1,000 population.
Total fertility Rate (TFR): The number of children that would be born to a woman if she
were to live to the end of her childbearing years and bear children in accordance with the
prevailing age-specific fertility rates.
• Modern vaccination campaigns, public health facilities, clean water supplies,
improved nutrition, and public education have all worked together over the past
three decades to lower death rates by as much as 50% in parts of Asia and Latin
America and by over 30% in much of Africa and the Middle East.
• Death rates have fallen for all age groups
• Average life span remains about 12 years greater in the developed countries.
This progress reduced the under-5 mortality rate. Under-5 mortality rate (Deaths among
children between birth and 5 years of age per 1,000 live births)

High-income countries have higher mortality rates - even though most children live into
adulthood - simply because majority of their populations are elderly.
Life expectancy at birth: The number of years a newborn child would live if subjected to
the mortality risks prevailing for the population at the time of the child’s birth.

AGE STRUCTURE AND DEPENDENCY BURDENS

Population is relatively youthful in the developing world.
Youth dependency ratio: The proportion of young people under age 15 to the working
population aged 16 to 64 in a country.

Developing countries have high youth dependency so the workforce in developing

countries must support almost twice as many children as it does in the wealthier countries.

The more rapid the population growth rate, the greater the proportion of dependent
children in the total population and the more difficult it is for people who are working to
support those who are not.

This phenomenon of youth dependency also leads to an important concept, the hidden
momentum of population growth.

Hidden momentum of population growth: The phenomenon whereby population

continues to increase even after a fall in birth rates because the large existing youthful
population expands the population’s base of potential parents.

6.2.3 Demographic Structure and the Hidden Momentum of Population Growth

The least-understood aspect of population growth is its tendency to continue even after
birth rates have declined substantially.
Reason:
• High birth rates cannot be altered substantially overnight.
 • Hidden momentum of population growth relates to the population age structure of
most low-income countries and some middle income countries.
The population age structure presented in population pyramids:
• Vertical axis: Age cohorts
• Horizontal Axis: population shares or population numbers of each cohort
• Numbers of males (LEFT) and females (RIGHT)
• A “steep” pyramid means that cohorts are of similar size, predicting relative
population stability.

Demographic dividend
- The high economic growth that can be achieved during the demographic transition
when the working-age population share is significantly greater than the non-
working-age population share, with much of the labour force in their prime
productive years.
- a period in which there are fewer children to support, a larger fraction of women
join or remain in the workforce for longer periods of time, and there are more
available resources to invest in human capital.

Fraction of people of working age is falling as a result of population ageing, the

resources needed for old-age support are increasing (a challenge for most high-income
countries). Thus, higher savings rate is required and allowing more immigration can be
helpful.

6.3 Demographic Structure and the Demographic Transition

Demographic transition: The phasing-out process of population growth rates from a
virtually stagnant growth stage, characterized by high birth rates and death rates through
a rapid-growth stage with high birth rates and low death rates to a stable, low-growth
stage in which both birth and death rates are low.
Demographic Transition: the transition from stable or slow-growing populations first to
rapidly increasing numbers and then to declining rates
- attempts to explain why all contemporary developed nations have more or less
passed through the same three stages of modern population history.
Stage 1
- high birth rates
- high death rates.

Stage 2: Beginning of Demographic Transition

Began when modernization (better public health methods, healthier diets, higher incomes,
and other improvements)
- decreasing mortality rate
- increasing population growth
- increasing life expectancy (under 40 years to over 60 years)

Stage 3
- Fertility decline
- falling birth rates
- lower death rates
- little or no population growth.

Replacement fertility: The number of births per woman that would result in stable
population levels.
- about 2.05 to 2.1 births per woman - developed countries.
- over 3 births per woman (lower survival rates) developing countries

Many developing countries today have higher birth rates than they were in pre-industrial
western Europe. This is because women tend to marry at an earlier age. As a result, there
are both more families for a given population size and more years in which to have
children.

6.4 The Causes of High Fertility in Developing Countries: The

Malthusian and Household Models

Thomas Malthus “father of the modern birth control”

movement. focused on the relationship between population growth and economic
development. 1798 Essay on the Principle of Population
Malthusian population trap: The threshold population level anticipated by Thomas
Malthus (1766–1834) at which population increase was bound to stop because life-
sustaining resources (increase at an arithmetic rate) would be insufficient to support
human population (increase at a geometric rate)
The growth in food supplies could not keep pace with the burgeoning population, per
capita incomes (defined in an agrarian society simply as per capita food production)
would have a tendency to fall so low as to lead to a stable population existing barely at or
slightly above the subsistence level. To avoid this, people have to practice “moral
restraint”

According to modern-day neo-malthusians poor nations will never be able to rise much
above their subsistence levels of per capita income unless:
- They initiate Preventive checks (birth control) on their population growth or
Malthusian positive checks (starvation, disease, wars) on population growth
- Achieving technological progress that shifts the income growth rate curve up at
any level of per capita income and achieve changes in economic institutions and
culture (“social progress”)

6.4.2 Criticisms of the Malthusian Model

1. technological advancements improve food production

2. focuses on its assumption that national rates of population increase are directly
(positively) related to the level of national per capita income.

6.4.3 The Microeconomic Household Theory of Fertility

The conventional theory of consumer behaviour assumes that an individual with a
given set of tastes or preferences for a range of goods (a “utility function”) tries to
maximise the satisfaction derived from consuming these goods subject to his or her own
income constraint and the relative prices of all goods.

Note: Children - special kind of consumption (in developing countries, investment)

Cd - the demand for surviving children (an important consideration in low-income

societies where infant mortality rates are high), is a function of the given level of
household income (Y).
Pc -the “net” price of children (the difference between anticipated costs, mostly the
opportunity cost of a mother’s time, and benefits, potential child income and old-age
support
Px - the prices of all other goods
Tx - the tastes for goods relative to children

• The higher the household income, the greater the demand for children.
• The higher the net price of children, the lower the quantity demanded.
• The higher the prices of all other goods relative to children, the greater the quantity of
children demanded.
• The greater the strength of tastes for goods relative to children, the fewer children
demanded.

6.4.4 The Demand for Children in Developing Countries

Economic theory of fertility assumes that the household demand for children is
determined:
• by family preferences for a certain number of surviving (usually male) children
• by the price or “opportunity cost” of rearing these children
• by levels of family income.

Note: in regions of high mortality, parents may produce more children than they actually
desire in the expectation that some will not survive).
Children in poor societies are economic investment goods in that there is an expected
return in the form of both child labour and the provision of financial support for parents in
old age.

Son Preference: The preference for sons over daughters is particularly prevalent in
South Asia and East Asia.
3 Reasons:
• Daughters marry outside their village and move to husband's place.
• Sons are viewed as having higher lifetime earnings potential.
• Dowry payments by the parents of the bride to the groom's family is a financial
burden.
Some Empirical evidence: high female employment opportunities outside the home and
greater female school attendance are associated with significantly lower levels of fertility
6.4.4 Implications for Development and Fertility
Birth rates among the very poor are likely to fall where the following socioeconomic
changes come to pass:
1. An increase in the education of women and a consequent improvement in
their role and status.
2. An increase in female nonagricultural wage employment opportunities,
which raises the price or cost of their traditional child-rearing activities.
3. A rise in family income levels through the increased direct employment and
earnings of a husband and wife or through the redistribution of income and
assets from rich to poor.
4. A reduction in infant mortality through expanded public health programmes
and better nutritional status for both mother and child, and better medical
care.
5. The development of old-age and other social security systems outside the
extended family network to lessen the economic dependence of parents,
especially women, on their offspring.
6. Expanded schooling opportunities so that parents can better substitute child
“quality” for large numbers of children.

Family-planning programmes: Public programmes designed to help parents plan and

regulate their family size.

6.5 The Consequences of High Fertility: Some Conflicting Perspectives

6.5.1 It’s Not a Real Problem

General arguments on the part of people who assert that population growth is not a cause
for concern:
• The problem is not population growth but other issues.
• Population growth is a false issue deliberately created by dominant rich-country
agencies and institutions to keep developing countries in their dependent condition.
• For many developing countries and regions, population growth is in fact desirable.

Other issues:
• Underdevelopment. If correct strategies are pursued and lead to higher levels of
living, greater self-esteem, and expanded freedom, population will take care of
itself.
Underdevelopment is the real problem, and development should be the only goal.

• World Resource Depletion and Environmental Destruction. Population can

only be an economic problem in relation to the availability and utilization of scarce
natural and material resources.
Developed nations should curtail their excessively high consumption standards
instead of asking less-developed nations to restrict their population growth.

• Population Distribution. It is not the number of people per se that is causing

population problems but their distribution in space.

• Subordination of Women. Their inferior roles, low status, and restricted access
to birth control are manifested in their high fertility.

6.5.2 It’s a Deliberately Contrived False Issue

The second main line of argument denying the significance of population growth as a
major development problem is closely allied to the neocolonial dependence theory of
underdevelopment.
Rich nations are concerned with the population growth of poor nations because they want
to hold down the development of the poor nations in order to maintain an international
status quo that is favorable to the rich nations’ self-interests.
A radical neo-Marxist version of this argument views population control efforts by rich
countries and their allied international agencies as racist or genocidal attempts who
may some day pose a serious threat to the welfare of the rich, predominantly white
societies.
6.5.3 It’s a Desirable Phenomenon
• free markets and human ingenuity (Julian Simon’s “genius” as the “ultimate
resource”) will solve any and all problems arising from population growth.
• many rural regions in developing countries are in reality underpopulated in the
sense that much unused but arable land could yield large increases in agricultural
output if only more people were available to cultivate it.

Three other noneconomic arguments complete the “population growth is desirable”:

• Many countries claim a need for population growth to protect currently
underpopulated border regions against the expansionist intentions of neighbouring
nations.
• There are many ethnic, racial, and religious groups in less-developed countries
whose attitudes favouring large family size have to be protected for both moral and
political reasons.
• Military and political power are often seen as dependent on a large and youthful
population.

6.5.4 It Is a Real Problem

The Extremist Argument: Population and Global Crisis The extreme version of the
population-as-problem position attempts to attribute almost all of the world’s economic
and social evils to excessive population growth.
Unrestrained population increase as the principal cause of poverty, low levels of living,
malnutrition, ill health, environmental degradation, and a wide array of other
social problems. Value-laden and incendiary terms such as population bomb
and population explosion are tossed around.

The Theoretical Argument: Population–Poverty Cycles and the Need for

Family-Planning Programmes
The population–poverty cycle theory is the main argument advanced by economists
who hold that too rapid population growth yields negative economic consequences.
Population growth intensifies and exacerbates the economic, social, and psychological
problems associated with the condition of underdevelopment.
Population growth is believed to retard the prospects for a better life for the already born
by reducing savings rates at the household and national levels.
Simple Model - A basic model that economists use to demonstrate these adverse
consequences of rapid population growth is a simplification of the standard Solow-type
neoclassical growth equation. Using the standard production function, Y = f (K,L,R,T)—
that is, output is a function of capital, labour, resources, and technology—and holding the
resource base fixed.
Equation 6.2 simply states that the rate of per capita income growth (y – l) is directly
proportional to the rate of growth of the capital–labour ratio (k – l) plus the residual
effects of technological progress (including improved human and physical capital).

Other Empirical Arguments: Seven Negative Consequences of Population

Growth
1. Economic Growth. Rapid population growth lowers per capita income growth in
most developing countries, especially those that are already poor, dependent on
agriculture, and experiencing pressures on land and natural resources.
2. Poverty and Inequality. The negative consequences of rapid population growth
fall most heavily on the poor because they are the ones who are made landless,
suffer first from cuts in government health and education programmes.
3. Education. Large family size and low incomes restrict the opportunities of parents
to educate all their children. Educational expenditures spread more thinly, lowering
quality for the sake of quantity.
4. Health. High fertility harms the health of mothers and children.
5. Food. Feeding the world’s population is made more difficult by rapid population
growth—a large fraction of developing-country food requirements are the result of
population increases. New technologies of production must be introduced more
rapidly, as the best lands have already been cultivated.
6. Environment. Environmental degradation
7. International Migration. One of the major consequences of developing countries’
population growth. Some of the economic and social costs of international
migration fall on recipient countries, increasingly in the developed world.

6.5.5 Goals and Objectives: Toward a Consensus

The following three propositions constitute the essential components of this
intermediate or consensus opinion:
1. Population growth is not the main cause of poverty, inequality, or limited freedom in
developing countries. The real causes lie in the poverty of families, especially women,
and poor development policies—both domestic and international.

2. The issue with population growth is not just numbers; it’s about the quality of life. We
need to consider the population of developing countries alongside the affluence and
consumption patterns of developed countries, especially when thinking about the world’s
resources.

3. Rapid population growth can make development harder and delay progress, but it’s
only a contributing factor, not the main cause of underdevelopment. Even with fertility
control, developing countries will likely see population growth due to existing momentum.

3 Policy goals:
1. Any strategy to limit population growth should also focus on improving poverty,
inequality, unemployment (especially for women), education, nutrition, and health. These
factors are key to allowing people the freedom to choose smaller families.

2. Support family-planning programs that provide education and technology to help

people control their fertility if they choose to.

3. Developed nations should assist developing countries in reducing fertility and mortality
by providing resources for family planning, but also by reducing their own excessive use
of global resources.

6.6 Some Policy Approaches

Three areas of policy can have important direct and indirect influences on the well-being
of present and future world populations:
1. General and specific policies that developing-country governments can initiate to
influence and perhaps even control their population growth and distribution.
2. General and specific policies that developed country governments can initiate in
their own countries to lessen their disproportionate consumption of limited world
resources and promote a more equitable distribution of the benefits of global economic
progress.
3. General and specific policies that developed-country governments and international
assistance agencies can initiate to help developing countries achieve their population
objectives.