Advanced Development Economics

(DeEc 5021)

Haramaya University
College of Business and Economics
Department of Economics

Temesgen K. Belissa (Ph.D.)

Asst. Prof. of Development Economics
 Chapter 1

Concepts and Measurement in Economic

Development

This chapter discusses

 Concepts of growth and development
 Objectives and basic goals of development
 Human development indicators
 Development measurement and common
characteristics of developing countries
 Sustainable development
Economic growth
 Economic growth is traditionally equated with
increases in GDP/GNP
 GDP is total output for final use produced by
residents and non-residents of a country.
 GDP doesn‘t include deductions for depreciation
of physical capital or depletion/degradation of
natural resources
 GNP is GDP + net factor income from abroad
which is income residents receive from abroad for
factor services less payments to non-residents
who contribute to the domestic economy.
Economic Growth (cont’d)

 Hence we could speak of :

 Positive (increasing) rates of economic growth –
if GDP increased from one period to another
 Negative (decreasing) rates of economic growth
- if GDP decreased from one period to another
 Constant rates of economic growth – if GDP
remained the same from one period to another
Benefits and costs of Economic
Growth
Benefits
Benefits
 Increases in economic growth should enable
more of everything to be produced
 Increases possibility of providing consumer
goods for all
 More consumer goods, etc. could be equated
with an increase in living standards
 Wealth generated may eventually ‗trickle
down‘ to those who are poor by means of
income distribution – taxes and benefits, etc.
Benefits  Improved standards of living
associated with increase in the
availability of luxury goods:
 TVs
 Fridges and freezers
 Swimming pools, etc .
 In addition:
 Infrastructure – roads, rail,
energy, water, communication
networks
 Health and education
provision
 All associated with a ‗decent‘
standard of living.
Costs of economic growth
 Economic growth means an increase in real GDP
– an increase real incomes. This is usually
considered beneficial, but there are also potential
costs of economic growth such as:
o Inflation
o Boom and bust economic cycles
o Current account deficit
o Environmental costs – pollution, loss of non-
renewable resources
o Congestion
o Potential of widening inequality.
Costs and benefits of economic
growth
From Economic Growth to Economic
Development

 Amartya Sen (the Nobel laureate in economics)

formally defined development as the ‗process of
expanding the real freedoms that people enjoy‘.
 Aristotle, ―Wealth is evidently not the good we
are seeking for it is merely useful for the sake of
something else‖
 ED can be thought of as beginning where EG
ends that is, at the heart of ED is the notion of
human well being… how do we use economic
performance, measured by EG, to enhance
people‘s lives? To improve their well being?
 What Do We Mean by Development?

 Have you ever visited a foreign (developed

country)?
 How does life differ in LDCs as compared to in
developed countries?
 What does development mean to you personally?
 Development can be seen . . . as a process of
expanding the real freedoms that people enjoy.
—Amartya Sen, Nobel laureate in economics
 Traditional Economic Measures
– Gross National Income (GNI)
– Income per capita
– Utility of that income?
 The New Economic View of Development
– Leads to improvement in wellbeing, more broadly
understood
 Amartya Sen’s “Capability” Approach
– Functionings as an achievement
– Capabilities as freedoms enjoyed in terms of
functionings
– Development and happiness
– Well being in terms of being well and having
freedoms of choice
– ―Beings and Doings‖:
 In capability to function, ―Beings‖ and ―Doings‖
includes being able to live long, well-nourished
 It also includes being healthy, literate, well-
clothed, mobile, able to take part in the life of the
community and being happy
 Based on this we currently study the economics
of hope, aspiration, happiness, freedom of
movement.
 Many Definitions of Development

 Gross National Income (GNI) Growth

o Generating and sustaining an annual increase in GNI
(5-7%)
 Income Per Capita (GP) Growth
o Generating and sustaining an annual increase in GNI
per person (GNI/POP)
o This accounts for the fact that population may grow
faster than the economy
o So ―development‖ may not occur even if GNI is
growing when the population is growing even faster.
Real Economic Development
 Growth of per capita income in excess of
inflation (π):
Growth in GDPpc - π > 0
=> Growth in GDPpc = ΔGDPpc /GDPpc
=> π = ΔPrice/Price
If π > Growth in GDPpc then purchasing power is
falling even when income is increasing.
 So ―development‖ may not occur even if
GDPpc is growing when inflation growing
even faster.
Structural Change

 Development defined to occur when the structure of

production and employment changes so that
agriculture‘s share of both decline and that of
manufacturing and service industries increase.
“New” Economic View of Development

 Development defined as a multidimensional process

involving major changes in:
- Social structures,
- Popular attitudes,
- National institutions,
- Acceleration of economic growth,
- The reduction of inequality,
- Eradication of extreme poverty.
 If income is increasing in a country but poverty,
unemployment, and/or inequality worsen ―it would be
strange to call the result ‗development‘‖
Three Basic Goals of Development

1. Sustenance: The ability to meet basic

needs
2. Self-esteem: A sense of self-worth, self-
respect, and dignity
3. Freedom of choice
Remember Sen’s definition of development
Development can be seen . . . as a
process of expanding the real freedoms
that people enjoy.
Three Objectives of Development to Achieve
the Basic Goals

1. To increase the availability and widen the

distribution of basic life-sustaining goods
(food, shelter, health, protection)
2. To raise the levels of living (higher incomes,
more jobs, better education, etc.)
3. To expand the range of economic and social
choices available
Development as freedom

 Development consists of the removal

of various types of lack of freedom that
leave people with little choice and little
opportunity for exercising their
reasoned agency
 Human freedom tends to promote
freedoms of other kinds: many
different interconnections between
distinct instrumental freedoms
Development as freedom

 Economic and political freedoms help to

reinforce one another (Although some
argue the opposite)
 Social opportunities in the fields of heath
care and education – which require public
action – complement individual
opportunities for economic and political
participation.
 Thus – intrinsic importance of human
freedoms
Human Development
 The basic purpose of development is to
enlarge people's choices.
 In principle, these choices can be infinite and
can change over time.
 People often value achievements that do not
show up at all, or not immediately, in income
or growth figures
Human development

 Human development is also greater access

to knowledge, better nutrition and health
services, more secure livelihoods, security
against crime and physical violence,
satisfying leisure hours, political and cultural
freedoms and sense of participation in
community activities.
Objectives of development

 Mahbub ul Haq argues that the objective of

development is to create an enabling
environment for people to enjoy long, healthy
and creative lives.
 Development … creating conditions for the
realisation of human personality
 Development.. .based on three criteria:
whether there has been a reduction in
poverty, unemployment and inequality
Development: which way now

 The process of Economic development has

to be concerned with what people can and
cannot do e.g. whether they can live long,
escape avoidable morbidity, be well
nourished, be able to read and write and
communicate, take part in literary and
scientific pursuits etc.
Indicators of Development
 Adequate Educational Levels
 Freedom of Speech
 Citizenship of a country that is truly
independent (both economically and
politically)
 Others conditions – sense of security;
freedom of worship etc…
 Understanding Indices to measure
development

 What is an index?
 An index is a composite of indicators that
produces a single calculation which can then
be ranked.
 The Human Development Index (HDI)
 …is the best known composite index of social
and economic well-being…
How the UNDP Measures Human
Development
 The HDI consists of three equally weighted
components:

(1) ―A long and healthy life‖ (Health)

(2) ―Knowledge‖ (Education)
(3) ―A decent standard of living‖ (Wealth)
Deconstructing Each Measure

 Each component of the HDI is measured in

the following way:
 Health
 Measured by life expectancy at birth.
 Education
 Measured as a combination of adult
literacy (with two-thirds weight) and gross
enrollment (with one-third weight).
 Wealth
 Measured by GDP per capita.
Three Issues to Consider When Evaluating
Indexes Like the HDI

1) Validity
2) Reliability
3) Parsimony
 Validity

 What is the index supposed to measure?

 What indicators make up the index?

 Are these the best indicators for this index?

 How are the indicators calculated?

 Are there better ways to calculate these indicators?

 In short, how well does the index actually measure

what it is supposed to be measuring?
 Reliability

 Who or what organization collected the data?

 How were the data collected?
 In short, if you or someone else were to try to
replicate the index would you end up with
more or less the same results?
 Parsimony

 The whole point of an index is to simplify the

measurement of a particular phenomenon.
 In short, does the index rely upon as few
indicators as reasonably possible without
undermining its validity?
Human Development Index (HDI)

 UNDP ranks countries using ―human development‖

which is based on:
1. Life expectancy at birth;
2. Average adult literacy
3. Mean years of schooling;
4. Real per capita incomes
 Countries are ranked into three groups:
1. Low human development (index of 0.0 – 0.499)
2. Medium human development (index of 0.5 – 0.799);
3. High human development (index of 0.80 – 1.0.)
Human Development Index (HDI)
 Life expectancy index (LEI)
CLE - LLE
LEI 
RLE

 CLE= current life expectancy in years

 LLE= the lowest life expectancy as observed
over the past generations in any country (25
years)
 RLE: Range of life expectancies expected over
the previous and next generations (65 years)
Human Development Index (HDI)
log(CI) - log( LPCI)
- NI 
log(MPCI - log(LPCI)

 Where CI = current income

 LPCI = the lowest per capita income as observed over
the past generations in any country
 MPCI = maximum per capita income that a country
could reasonably aspire to have over the coming
generation
 According to UNDP,
- LPCI = 100 PPP and
- MPCI = 40000 PPP
Holistic measures of living levels and
capabilities
 Health
 Life Expectancy
 Education
 Human Development Index

 Basic Index= (Actual – Min)/(Max- Min)

 Must lie between 0 and 1
 HDI as a holistic measure of Quality of Life
Human Development Index (HDI)
 Adult Literacy (ALI)
Current adult literacy
ALI 
100

Gross enrollment index (GEI):

Percentage of primary, secondary and tertiary

age population enrolled in school
GEI 
100

2 1
EI  (ALI)  (GEI)
3 3

1 1 1
HDI  (IE)  (LEI)  (EI)
3 3 3
Human Development Index (HDI)

 Suppose that country X‘s 2017 PPP income

per capita was $800; and the country‘s life
expectancy was 52 during the same year. If
adult literacy rate was 70% and 55 percent of
the country‘s primary, secondary, and tertiary
age populations were enrolled in school,
calculate the country‘s HDI in 2021.
Is the HDI Enough to Measure a Country’s
Level of Development?

 According to the UNDP, the answer is:

 ―Not at all.‖
 ―The concept of human development is much
broader than what can be captured in the HDI, or
any other composite indices…‖
 ―The HDI and the other composite indices can only
offer a broad proxy on some of the key the issues of
human development…‖
 ―A fuller picture of a country's level of human
development requires analysis of other human
development indicators and information.‖
Other indicators of Development
 Reduction in poverty. How do we measure if
someone is poor?

 Head count ratio… proportion of population below

the poverty line

 Income gap ratio…measures the depth of poverty by

the extent of the gap between the poverty line and
average income of the poor as a proportion of the
poverty line
Key definitions
 Poverty Line …. The percentage of the
population living below the specified poverty
line. * $11 a day (per person for a family of
three)—at 1994 international prices, adjusted
for purchasing power parity.
Other composite measures used to
describe development
 HDI … human development index
 GDI.. Gender Development Index
 GEM … Gender Empowerment Index
 HPI.. Human Poverty Index
 A-WEAI.. Abbreviated women empowerment in
agriculture index
Development Indices
 HDI… measures average achievement of a
country in basic human capabilities, health,
income distribution, education
Development Indices
 GDI… measures achievements in same
capabilities as HDI but takes account of
inequalities between women and men.
 GDI can be thought of as a discounted HDI
Development Indices

 Gender Empowerment Measure (GEM)…

examines whether women and men are able to
actively participate in economic and political life
and take part in decision making.
Development Indices
 Human Poverty Index (HPI)…focuses on the
way the poor and deprived fare in each
community. Uses the same indicators as HDI
but combines elements of ―deprivation‖ to
provide an aggregate judgement on the extent of
poverty.
Development Indices
 HPI..
– Longevity: HPI uses the % of people expected to die
before age 40;
– Knowledge: HPI uses the rate of illiteracy
– Lack of a decent standard of living : a composite
index which includes % of people with access to
health service and safe water; % of malnourished
children <5yrs old
Defining the Developing World

 Various grouping schemes: Best known is World

Bank’s System
 Categorizes countries based on their per capita
income levels into 5 groups:
1. Low-income countries
2. Lower-middle-income countries
3. Upper-middle-income countries
4. High-income OECD countries
5. Other high income countries
Common Characteristics of Developing
Countries
 These features in common are on average and with great
diversity, in comparison with developed countries:
– Lower levels of living and productivity
– Lower levels of human capital
– Higher levels of inequality and absolute poverty
– Higher population growth rates
– Greater social fractionalization
– Larger rural population - rapid migration to cities
– Lower levels of industrialization and manufactured exports
– Adverse geography
– Underdeveloped financial and other markets
– Colonial Legacies - poor institutions etc.
Characteristics of the Developing World: Diversity
within Commonality

 Underdeveloped Financial and Other markets

– Imperfect markets
– Incomplete information
 Colonial Legacy and External Dependence
– Institutions
– Private property
– Personal taxation
– Taxes in cash rather than in kind
Common Characteristics of Developing
Countries
1. Low levels of living
 Low total and per capita incomes relative to DCs
 Widespread poverty given low incomes and poor
distribution of income.
 Poor health and education
 High infant mortality
 Low levels of literacy, significant school dropouts,
inadequate and often irrelevant educational curricula
and facilities.
Common Characteristics of Developing
Countries
2. Low levels of labor productivity : some explanations:
1. In some LDCs, poor attitudes towards self-
improvement, manual labor, discipline, low
levels of adaptability, work ethic, and general
drive to innovate and experiment due to very
poor property right.
2. Poor health and nutrition levels
Common Characteristics of Developing
Countries
 High levels of population growth and dependency
burdens (older people and children)
 Substantial dependence on agricultural production and
primary-product exports
 Most LDCs oriented to production and export of primary
products rather than manufactured goods or services.
 Why? What is the implication of this to economic
development?
Common Characteristics of Developing
Countries

1. Prevalence of imperfect markets and incomplete

information
 Markets do not efficiently function to equilibrate supply and
demand and determine prices.
 Limited access to necessary information to make informed
economic decisions - production, consumption, marketing, etc.
Common Characteristics of Developing
Countries
1. Dependence and vulnerability in international
relations
 Many are small countries with little global economic or
political power.
 Price-takers in world markets.
 Subject to ―Westernization‖ pressures (education,
cultural and moral values, food diets and habits).
Why might this be a problem?
 Dependent on imports of food, fuel, and other critical
materials making LDCs vulnerable and being held
economic hostage by developed countries as well as
rich dominating groups within LDCs
World development patterns and disparities

 Why have some countries achieved a higher level of

living and well-being while many others are largely
trapped in poverty?
 There are many more Less Developed Countries
(LDCs) than Developed Countries (DCs) in the world.
 A few DCs (black) produces larger proportion of the
world‘s goods (GDP) while many more LDCs (dark
gray) with larger proportion of the world‘s population
produce only smaller proportion of the world‘s GDP.
Other Ways of Characterizing Countries

 Physical size and population

 Historical background
 Physical and human resources
 Ethnic and religious composition
 Relative importance of the public and private
sectors- the economic system
[Link]
A Sampling of other Development Indexes

• The Economist’s ―Quality of Life‖ Index

• UNICEF’s ―Child-Welfare‖ Index
• The ―Happy Planet‖ Index
• The UNDP’s ―Human Poverty Index‖
• The UNDP’s ―Gender Empowerment Measure‖
• International Living’s ―Quality of Life‖ Index
• The ―Global Peace Index‖
• Freedom House’s ―Freedom Rankings‖
Sustainable Development

 What do we mean by sustainable

development?

 Based on Seers‘ definition of ―development‖

i.e. to be concerned with ―…creating
conditions for the realisation of human
personality…‖
Sustainability of Development
 Sustainability … a characteristic of a process
or a state that can be maintained indefinitely.
 Why be concerned with sustainable
economic development?
 Sustainability therefore refers to a process or
a state that is not constrained by time or
space
Meaning of Sustainable Development

 ―Development that meets the needs of the present

generation without compromising the ability of future
generations to meet their own needs.
 SD is not a fixed state of harmony but rather a
process of change in which the exploitation of
resources, the direction of investments … are made
consistent with future as well as present needs.‖
Sustainable Development versus
Economic Development

 Exploitation of resources can either be

―responsible‖ (and leave something for future
generations) or ―irresponsible (use it up
now!!)
What is Unsustainable Development?

 Development which compromises future

development possibilities either
a. via excessive resource depletion and waste
generation or
b. imposing too heavy a burden of environmental
degradation or clean-up
c. not ensuring that the rents that accrue from
current exploitation are invested so that future
generations can share
 Economic Growth (GDP)
Increases in Material Output

Economic Development
Greater emphasis on social objectives
e.g. poverty, education, health,

Sustainable Economic Development

Recognising the need for environmental
Protection, inter- and intra-generational
equity.
Sustainable Development and
Economic development
 Sustainable development adds to our
understanding of economic development by:
– Providing an explicit recognition that development
and the environment are not mutually exclusive
– Integrating environmental concerns into traditional
development economics
– Incorporating social and environmental concerns into
economic decision-making
– Seeking to ensure the economically efficient
management of natural resources
Trade-offs among the Three Main objectives
of Sustainable Development

Economic Efficiency

Social Equity Preservation of the

Environment
The Economics of Sustainable
Development

 The economic goal is: ―… to maximize the

net welfare of economic activities while
maintaining or increasing the stock of
economic, ecological and sociocultural
assets over time…. and providing a safety
net to meet basic needs and protect the
poor.
 Figure : Interface between the economy
and the environment
The Sink Function of the
The Source Function of Environment from waste
the Environment. from production and
The Economy consumption
E.g. Minerals, Soils
and Biodiversity i.e. solid,
liquid, gaseous,
Toxic waste

Natural Events / Disasters Interface

-Stormsl Hurricanes/Flooding
-Earthquakes
-Volcanoes
-Viruses (HIV/ AIDS,SARS)
 Chapter 2

Poverty and Inequality

This chapter discusses

 Poverty and its measurement
 Inequality and its measurement
 Poverty-inequality- growth nexus
What is poverty ?
 The poor are those who do not have enough
income or consumption to put them above
some adequate minimum threshold.
 This view sees poverty largely in monetary
terms.
 In-ability to obtain a specific type of
consumption good
 People could be house poor or food poor or
health poor.
 These dimensions of poverty often can
be measured directly, for instance, by
measuring malnutrition or literacy.
 In-capability to function in society
(Amartya Sen, 1987)- broadest approach
 Poor people often lack key capabilities;
they may have inadequate income or
education, or be in poor health, or feel
powerless, or lack political freedoms.
1. Poverty and its Measurement
 Poverty is viewed as encompassing both
income and non-income dimensions of
deprivation, lack of empowerment, and
extreme vulnerability to external shocks
 According to the World Bank (2000),
―poverty is pronounced deprivation in
wellbeing.‖
Who are the poor?
 Demographic characteristics (age, gender,
ethnicity, family size, dependency ratio);
 Asset possession (land, education, social capital);
 Activity (choice of crops, type of employment);
 Location (rural-urban, region, neighbourhood
effects e.g., what other households in the same
social network do);
 Access to public services (health, school, social
protection programs);
 Access to market (distance, financial services).
Measuring Poverty

 Why Measure Poverty? There are four reasons

to measure poverty:
 To keep poor people on the agenda
 To be able to identify poor people and so to be
able to target appropriate interventions
 To monitor and evaluate projects and policy
interventions geared to poor people
 To evaluate the effectiveness of institutions
whose goal is to help poor people.
Steps in Measuring Poverty

 Three steps need to be taken in measuring poverty

i. Defining an indicator of welfare
ii. Setting the poverty line:
 establishing a minimum acceptable standard
indicator that separates the poor from the non-poor
iii. Generating a summary statistic:
 to aggregate the information from the distribution of
this welfare indicator relative to the poverty line.
I. Choosing an Indicator of Welfare:

 Monetary measures are often used to value

household welfare.
 The two most obvious candidates are income and
expenditure.
Candidate 1: Income
 What is income? (Controversial)
 The most generally accepted measure of income is
the one formulated by Haig and Simons
Income = Consumption + change in wealth
Cont.…

 Problems with this definition:

1. it is not clear what time period is
appropriate
2. Measurement: some income
components are not easy to measure:
 it is likely to be hard to get an accurate
measure of farm income; or of the value
of housing services; or of capital gains
Cont.…
3. income tends to be seriously understated
 People may forget: when asked in a single interview,
about items they may have sold, or money they may
have received, up to a year before.
 Fear: they may be reluctant to disclose
– the full extent of their income, lest the tax collector.
– income earned illegally: from smuggling, from
usury, corruption, or prostitution.
 Practical difficulty: Some parts of income are difficult
to calculate, for example, the extent to which the
family oxen has risen in value.
Cont.…
 Candidate 2: Consumption Expenditure
 It includes both goods and services that are
purchased and those that are provided from one‘s
own production (in-kind).
 In considering consumption approach, take care of the
following:
 Value of Durable Goods
 Value of Housing Services
 Wedding and funeral expenditures
 Household composition
Cont.…
 Income or Expenditure?
 Most rich countries use income, while most poor
countries use expenditure.
 There is a logic to this;
 in rich countries, income is comparatively easy to
measure (much of it comes from wages and salaries),
while expenditure is complex and hard to quantify.
 in less-developed countries income is hard to measure
(much of it comes from self employment), while
expenditure is more straightforward and hence easier
to estimate.
 Income is likely to be underestimated in LDCs
Cont.…
 Neither income nor expenditure would be an ideal
measure of household well-being, even if they were
measured perfectly.
 Neither measure puts a value on the leisure time
enjoyed by the household;
 Neither measures the value of publicly provided
goods (such as education, or public health
services); and
 Neither values intangibles such as peace and
security.
Setting the poverty line

 Poverty line is a cut of point that distinguishes

poor and non-poor households.
 For instance, if our measure of household
wellbeing is expenditure, households whose
consumption expenditure falls below this line are
considered poor.
 The poverty line defines the level of
consumption (or income) needed for a
household to escape poverty.
Cont.…

 The Concept: The poverty line for a household, zi,

may be defined as the minimum spending or
consumption (or income, or other measure)
needed to achieve at least the minimum utility
level uz, given the level of prices (p) and the
demographic characteristics of the household (x),
so
zi= e(p, x, uz).
Cont.…

 This implies that the analyst need to compute a

poverty line for each household.
 This gives a different poverty line for each
household.
 In practice, we cannot measure uz , or even e(·),
so a more pragmatic solution is needed.
 Construct one per capita poverty line for all
individuals
 With this approach, it is easier to talk of ―the
poverty line‖ and present it as a single number.
Cont.….

 Absolute vs Relative poverty line

 Poverty is often measured as absolute poverty or
relative poverty
 Absolute poverty :The situation of being unable
or only barely able to meet the subsistence
essentials of food, clothing, and shelter.
 Relative poverty: the wellbeing of an individual
relative to his community or other people
 Thus, a poverty line can be constructed in either
absolute or relative sense.
 POVERTY MEASURES

Relative

Monetary

Absolute

Objective
Basic Needs
Approach
Poverty Non-monetary
Anthropometric
needs
Subjective Direct surveys
Cont.…

 Issues in Choosing an Absolute Poverty Line

– Decide the Standard of Living
– In practice, almost all absolute poverty lines
are set by measuring the cost of buying a
basket of goods (the ―commodity-based
poverty line,‖).
– Pick an appropriate level to serve as a
poverty line
Cont.…

 Two ways of estimating the absolute

poverty lines:
 Objective poverty lines:
 The cost of basic needs method
 The food energy intake method
 Subjective poverty line
 Self declared poverty line
The Cost of Basic Needs Method

 The most satisfactory approach

 Procedures:
 Specify a consumption bundle that is
deemed to be adequate, with both
food and nonfood components.
 Estimate the cost of the bundle
 The basic needs poverty line is given by:
PLBN=CF+CNF
Food Energy Intake Method

 The basic needs approach requires information

on the prices of the goods that the poor
consume.
 When price data are not available, a number of
researchers have used an alternative method
to construct the poverty line—the food energy
intake method.
Goal: to find the level of consumption
expenditure (or income) that allows the
household to obtain enough food to meet its
energy requirements.
Cont.…

 Even underfed households typically

consume some clothing, shelter, and
food
 At the margin these ―basic needs‖ must
be as valuable as additional food.
Cont.…

 Unfortunately, the food energy intake method is

seriously flawed, and should not be used for
comparisons across time, or across regions, or
between urban and rural areas, unless the
alternatives are infeasible. Why?
 According to Ravallion and Bidani (1994), there
are two main reasons:
– The Urban-Rural Problem:
– The Relative Price Problem.
The Urban-Rural Problem:
 Rural households can obtain food more cheaply.
– Food is typically less expensive in rural areas
– Rural people are more willing to consume foodstuffs that
are cheaper per calorie (such as potato rather than
bread);
 Urban consumers are more likely to buy higher quality
foodstuffs, which raises the cost per calorie.
 This implies that the calorie income function for rural hhs
will typically be higher than that for urban hhs. Thus, for a
given level of food energy intake, the poverty line in the
rural area will be lower than that of urban area, as figure
below makes clear.
Cont...
Fig.2: Calorie Income Functions for Urban and Rural
The relative price problem:

 With the rise of price, food became relatively

much more expensive.
 for a given (real) income, households would
buy less food now than before.
 Thus, the food expenditure function shifted
down which implies a rise of poverty line.
Cont...
Fig.3: CPI of in 1993 and 1998
Subjective Poverty Lines
 Asking people to define a poverty line, and using this to
measure the extent of poverty. For instance, in a
survey one might ask
– What income level do you personally consider to be
absolutely minimal?
– The answers will vary from person to person (and by
size of household), but they could be plotted, and a
line fitted through them, to get a subjective poverty
line such as z* in figure below.
Cont...
Fig.4: Estimating a Subjective Poverty Line
3. Construct summary statistics:

 These are statistics used to measure the extent of

poverty.
 The most commonly used statistics are
– Headcount Index (P0)
– Poverty Gap Index (P1)
– Poverty Severity Index (P2)
– Foster, Greer, and Thorbecke (1984),
Poverty Measures: Human versus monetary indicators
 UNDP‘s Human Poverty Index:
– Probability of not surviving to ages 40

– Share of adults who are illiterate

– Share of population w/o access improved water source, and
share of children under weight for age
 Foster-Greer-Thorbecke class of poverty indices:
– Head-count index (incidence), Percentage of people below
poverty line
– Poverty gap (average depth), Average distance of poor from
poverty line
– Squared poverty gap (individual depth): Inequality amongst
persons below a poverty line
Poverty Measures: Human versus monetary indicators

General formula: 
k
 z  yi 
P    
1

N i 1  z 

Head-count index (incidence): α = 0: k

P0 
N

1 k
z  yi
Poverty gap (average depth): α = 1:
P1 
N
 z
i 1
 z  yi 
k 2
1
Squared poverty gap (individual depth): α = 2: P2 
N
 
i 1  z 


𝒚𝒊 : income/expenditure of individual i (adult equivalents) -- z: poverty

line –
N: total population -- k: number of poor people -- α: parameter showing
the degree of aversion to inequality among the poor.
 Headcount Index (P0)

 It is most widely used measure

 It measures the proportion of the population
that is counted as poor.
 Poverty Gap Index (p1)

 Adds up the extent to which individuals on average fall

below the poverty line, and expresses it as a
percentage of the poverty line.
1st: compute poverty gap (Gi) as the poverty line (z) less
actual income (Yi) for poor individuals; the gap is
considered to be zero for everyone else. i.e.,
2nd: compute the index as follows:
 z  Yi , if the individual is poor
Gi  
 0, otherwise
 Poverty Severity Index (P2)
 It is a measure of poverty that takes into account
inequality among the poor
 It is weighted sum of poverty gaps (as a proportion of
the poverty line),
– the weights are the proportionate poverty gaps
themselves; this is in contrast with the poverty gap
index, where the gaps are weighted equally.
 Hence, by squaring the poverty gap index, the
measure implicitly puts more weight on observations that
fall well below the poverty line. Formally,
Cont.…
 Foster, Greer, and Thorbecke (1984),
 This is the general (familiar) class of poverty indexes.
Formula:

where
o α is ‗poverty aversion‘ parameter
o a measure of the sensitivity of the index to poverty
o The larger α is, the greater the weight placed on the very
poorest people.
o Others are as defined earlier.
Cont.…

Notice that

 When α=0, Pα=P0,

 This is simply the headcount index.
 When α=1, Pα=P1,
 This is the poverty gap index
when α=2, Pα=P2,
 This is the poverty severity index.
Dynamics of Poverty

 This is about capturing the mobility in and out of

poverty.
 It is distinguishing categories of poor on the basis of
the dynamics of poverty.
1. Never Poor- on average above a poverty line and
never in poverty.
2. Transient poor-on average above poverty line, but
sometimes in poverty.
3. Chronic poor- on average below poverty line, but
sometimes out of poverty.
4. Persistent poor- always in poverty.
Multidimensional poverty

 Poverty cannot be adequately measured with

income, as Amartya Sen‘s capability framework
 Income is imperfectly measured, but even more
important, the advantages provided by a given
amount of income greatly differ, depending on
circumstances.
 To capture this idea the UNDP used its Human
Poverty Index from 1997 to 2009.
 In 2010, the UNDP replaced the HPI with its new
Multidimensional Poverty Index (MPI);
Multidimensional poverty
 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 percent of
weighted indicators for which poor
households are deprived on average.
 How is MPI Calculated?
 12 steps for the measurement of multidimensional
poverty
 Step 1: Choose Unit of Analysis : individual or household
but could also be a community, school, clinic, firm, district, or
other unit.
 Step 2: Choose Dimensions. Five means of selection, either
alone or in combination:
– Ongoing deliberative participatory exercises that elicit the
values and perspectives of stakeholders
– A list that has achieved a degree of legitimacy through public
consensus, such as the universal declaration of human rights,
the MDGs, or similar lists at national and local levels.
– Implicit or explicit assumptions about what people do value or
should value.
– They are drawn from convention, social or psychological theory,
or philosophy.
How is MPI Calculated?

 Step 2: Choose Dimensions. Five means of selection,

either alone or in combination:
– Convenience or a convention that is taken to be authoritative or
used because these are the only data available that have the
required characteristics.
– Empirical evidence regarding people‘s values, data on
consumer preferences and behaviors, or studies of what values
are most conducive to people‘s mental health or social benefit
 Step 3: Choose Indicators for each dimension on the principles of
accuracy and parsimony.
 Statistical properties are often relevant—for example, when
possible and reasonable, it is best to choose indicators that are not
highly correlated.
How is MPI Calculated?

 Step 4: Set Deprivation Cut-Off for each

indicator. Every person can then be identified as
deprived or non-deprived with respect to each
indicator. For example, if the dimension is
schooling (‗How many years of schooling have
you completed?‘), ‗6 years or more‘ might identify
non-deprivation, while ‗1–5 years‘ might identify
deprivation in the indicator.
How is MPI Calculated?

 Step 5: Apply Poverty Lines. This step replaces

the person‘s achievement with his or her status
with respect to each cutoff; for example, in the
dimension of health, when the indicators are
‗access to health clinic‘ and ‗self-reported
morbidity body mass index,‘ people are identified
as being deprived or nondeprived for each
indicator
How is MPI Calculated?

 Step 6: Count the Number of Deprivations for

Each Person. This step is demonstrated in the
last column of Table 1. (Equal weights among
indicators are assumed for simplicity. General
weights can be applied, however, in which case
the weighted sum is calculated.)
Table 1 Example of application of privation
lines
How is MPI Calculated?

 Step 7: Set the Second Cutoff. Assuming equal weights

for simplicity, set a second identification cutoff, k, which
gives the number of indicators in which a person must
be deprived in order to be considered multi-dimensionally
poor.
 In the example in Table 1, k is set to 4 and the persons
whose data are shaded are identified as poor.
 Step 8: Apply Cutoff k to Obtain the Set of Poor Persons
and Censor All Non-poor Data. The focus is now on the
profile of the poor and the dimensions in which they are
deprived. All information on the non-poor is replaced
with zeros (0). This step is shown in Table 2
Example of application of privation lines
How is MPI Calculated?

 Step 9: Calculate the Headcount, H. Divide the

number of poor people by the total number of
people. In our example, when k = 4, the headcount
is merely the proportion of people who are poor in at
least 4 of indicators. For example, as seen in Tables
1 and 2, two of the four people were identified as
poor, so H = 2/4 = 50 per cent. The multidimensional
headcount is a useful measure, but it does not
increase if poor people become more deprived, nor
can it be broken down by dimension to analyze how
poverty differs among groups. For that reason we
need a different set of measures.
How is MPI Calculated?

 Step 10: Calculate the Average Poverty Gap, A. A is the

average number of deprivations a poor person suffers. It
is calculated by adding up the proportion of total
deprivations each person suffers (for example, in Table
2, Person 1 suffers 4 out of 6 deprivations and Person 4
suffers 6 out of 6) and dividing by the total number of
poor persons. A = (4/6 + 6/6)/2 = 5/6.
How is MPI Calculated?

 Step 11: Calculate the Adjusted Headcount, M0. If the

data are binary or ordinal, multidimensional poverty is
measured by the adjusted headcount, M0, which is
calculated as H times A. Headcount poverty is multiplied
by the ‗average‘ number of dimensions in which all poor
people are deprived to reflect the breadth of
deprivations. In our example, HA = 2/4 × 5/6 = 5/12.
 Step 12: Set weight
 In this society, 5/6= 83.3 % of people are MPI poor. So, they are in
acute poverty. They are deprived at least either a) all the indicators
of a single dimension or b) a combination across dimensions
 We also learn that—on average—the poor here are deprived in
(5/6)*2/4 = 42 per cent of the weighted indicators
3. Inequality

 Inequality is a broader concept than poverty in that

it is defined over the entire population, not just for
the portion of the population below a certain poverty
line.
 Inequality measures are often calculated for
distributions other than expenditure—for instance, for
income, land, assets, tax payments, and many other
continuous and cardinal variables.
 ―We know that equality of individual ability has never
existed and never will, but we do insist that equality of
opportunity still must be sought,‖ Franklin D. Roosevelt
Measures of Inequality

 Decile Dispersion Ratio

 It presents the ratio of the average consumption (or income)
of the richest 10 percent of the population to the average
consumption (or income) of the poorest 10 percent.
 It calculated for other percentiles (e.g., dividing the average
consumption of the richest 5 percent, the 95th percentile, by
that of the poorest 5 percent, the 5th percentile).
 Limitation: it ignores information about incomes in the
middle of the income distribution, and does not even use
information about the distribution of income within the top
and bottom deciles.
Gini Coefficient of Inequality

 The most widely used single measure of inequality is

the Gini coefficient.
 It is based on the Lorenz curve (LC)
 LC is a cumulative frequency curve that compares
the actual distribution e.g. income with the
uniform distribution that represents equality.
 To construct the Gini coefficient, graph the cumulative
percentage of households (from poor to rich) on the
horizontal axis and the cumulative percentage of
expenditure (or income) on the vertical axis.
 Fig.5: the Lorenz curve

.
 Cont.….
 The diagonal line represents perfect equality.
 The Gini coefficient is defined as A/(A + B), where A
and B are the areas shown in the figure.
 If A = 0, the Gini coefficient becomes 0, which means
perfect equality,
 if B = 0, the Gini coefficient becomes 1, which means
complete inequality.
 Some users, including the World Bank, multiply this
number by 100
Gini Coefficient – Comparison of individual countries
Cont.…

 Income is more unequally distributed than

expenditure.
 This is a consequence of household efforts to smooth
consumption over time.
 It follows that when comparing inequality across
countries it is important to compare either Gini
coefficients based on expenditure, or Gini coefficients
based on income, but not mix the two.
Generalized Entropy Measures
 The family of generalized entropy (GE)
inequality measures given by

where
𝑦 is the mean income or per capita expenditure.
 α represents the weight given to distances
between incomes at different parts of the income
distribution, and can take any real value.
Cont.….

 The values of GE measures vary between zero and

infinity, with zero representing an equal distribution
and higher values representing higher levels of
inequality.
 In the Generalized Entropy measure, α can take any
real value.
 But the most common values of α used are 0, 1, and 2.
Cont.…

 GE(0), also known as Theil‘s L, and sometimes

referred to as the mean log deviation measure,
is given by

 GE(1) is Theil‘s T index, which may be written

as
Cont.…

 Atkinson’s Inequality Measures

– Atkinson (1970) has proposed another class of
inequality measures given by

– This class also has a weighting parameter ε (which

measures aversion to inequality).
Cont.…

 Criteria of a good measure of inequality:

 Mean independence. If all incomes were doubled,
the measure should not change. The Gini satisfies
this.
 Population size independence. If the population were
to change, the measure of inequality should not
change, all else equal. The Gini satisfies this, too.
 Symmetry. If any two people swap incomes, there
should be no change in the measure of inequality.
The Gini satisfies this.
Cont.….

Pigou-Dalton Transfer sensitivity. Under this criterion, the

transfer of income from rich to poor reduces measured
inequality. The Gini satisfies this, too.
 Decomposability. Inequality may be broken down by
population groups or income sources or in other
dimensions. The Gini index is not easily
decomposable or additive across groups. That is, the
total Gini of society is not equal to the sum of the
Gini coefficients of its subgroups.
 Statistical testability. One should be able to test for
the significance of changes in the index over time.
This is less of a problem than it used to be because
confidence intervals can typically be generated using
bootstrap techniques.
Income Distribution Dynamics

 What would happen to inequality when

economy grows?
 There is a longstanding, debate about the links
between income distribution and economic
growth.
Cont.…

 Simon Kuznets (1966), believed that in the course of

economic development, inequality first rises and then
falls.
 Bourguignon, Ferreira, and Lustig (2005) argue that
changes in income distribution are largely due to three
―fundamental forces‖:
1. Changes in the distribution of assets and the personal
characteristics of the population (for example,
educational levels, gender, ethnicity, capital
accumulation)— the endowment effects
Cont.…

2. Changes in the returns to these assets and characteristics

(for example, the wage rate, or profit rate)—the price
effects
3. Changes in how people deploy their assets, especially in the
labor market (for example, whether they work, and if they
do, in what kind of job)—the occupational choice effects.
 To these three one might also add demographic effects;

o Eg. if households have fewer children, the earnings of

working members will stretch further, and measured income
per capita will rise.
The simple arithmetic of poverty, inequality
and growth
 A change in the distribution of income can be
decomposed into two effects.
 First, there is the effect of a proportional change
in all incomes that leaves the distribution of
relative income unchanged, i.e. a growth effect
 Second, there is the effect of a change in the
distribution of relative incomes which, by
definition, is independent of the mean, i.e. a
distributional effect
The simple arithmetic of poverty, inequality
and growth
The simple arithmetic of poverty, inequality
and growth

 A change in poverty can be shown to be a

function of growth, distribution and the change
in distribution.
 Change in Poverty ≡ F(growth, distribution,
change in distribution)
Effects of inequality on the rate of growth
 First, credit market imperfections may explain
that redistributing capital from capital-rich
enterprises or individuals to capital-poor and
credit constrained people increases efficiency,
investment and growth
 Inequality is not a final outcome of growth but
plays a central role in determining the rate and
pattern of growth.
 Initial inequality seemed to be empirically
associated with lower growth rates.
Effects of inequality on the rate of growth

 Progressive redistribution may be growth-

enhancing
 Too much inequality in a redistributive
democracy leads to more redistribution and less
capital accumulation.
 Too much inequality may lead to social tension
expressed through collectively organized or
individually-led violent
 Chapter 3

Contemporary Issues in Development

Economics

This chapter discusses

 The Millennium Development Goals
 The Sustainable Development Goals
 The role of international community
 Inclusive Growth and Green Growth Strategies
 Framework for Sustainable Development
Millennium Development Goals (MDGs)

 The MDGs are eight goals planned to be achieved by

2015 that responded to the world's main development
challenges.

 The MDGs are based on the targets contained in the

Millennium Declaration adopted by 189 nations and
signed by 147 heads of government during the UN
Millennium Summit in September 2000.
Millennium Development Goals (MDGs)
From MDGs…
 The greatest triumph of the MDGs was to mobilize
broad support for a global development agenda
 While there was progress on many of the MDGs in
certain areas, the global promise went unfulfilled by
2015
 Three major criticisms of the MDGs are
(1) It was developed by a small group of experts and was
not member state driven
(2) It is too aid focused/donor driven and
(3) It completely overlooked the issue of inequality
Cont.…

 The UN intergovernmental process planned to begin in

September 2014 to agree the successor framework to
the MDGs which were set to expire in 2015
 The Post 2015 SDGs go beyond aid and addresses
three pillars of Sustainable Development: Economic,
Social, Environmental.
 There are currently 17 focus areas that serve as the
foundation from which the SDG recommendations will
be prioritized
What is Sustainable Development?
 Sustainable Development meets the needs of the present
generation without comprising the ability of future
generations to meet their own needs.
 The relationship between development and environment
has given birth to the sustainable development concept.
 Sustainable development
– is that global ecosystems and humanity itself can be
threatened by neglecting the environment.
– involves maximizing the net benefits of economic
development, subject to maintaining the services & quality
of natural resources over time
– Concerned with balancing the objectives of economic
growth and attending to environmental considerations.
What is Sustainable Development?
 As an individual, what is the ultimate goal?
 More money?
 Answer: Happiness of individual (personal well-
being)
 As a nation, what is the ultimate goal?
 Large GDP? high income per capita?
 Answer: Happiness of the people (national
welfare or sustainable development)
What is Sustainable Development?

 A nation's welfare can increase when the following

conditions are met.
1. Economic growth (Y): Increase in paid consumption
of goods and services:
2. Environmental protection (E): Increase in unpaid
consumption of environmental services:
3. Social equity (S): Decrease in desire (Increase in
income equity)
 i.e. Welfare is a function of YES (W = Y*E*S)S =
social equity.
1. What is Sustainable Development?
 The concept of UN‘s Sustainable Development has

“The achievement of sustainable development requires the

integration of its economic, environmental and social components
at all levels.” (United Nations Division for Sustainable
Development)
The SDGs are …

 A set of 17 goals for the world‘s future,

through 2030
 Backed up by a set of 169 detailed
Targets
 Negotiated over a two-year period at the
United Nations
 Agreed to by nearly all the world‘s
nations, on 25 Sept 2015
What is new and different about the 17
SDGs?
Universality, Integration and transformation
 First, and most important, these goals apply to
every nation … and every sector.
 Cities, businesses, schools, organizations, all are
challenged to act.
 This is called Universality
 Second, it is recognized that the goals are all
inter-connected, in a system.
 The aim is not to achieve just one goal.
 We must achieve them all.
 This is called Integration
 And finally, it is widely recognized that achieving
these goals involves making very big,
fundamental changes in how we live on Earth.
 This is called Transformation
Leave No One Behind (LNOB) in the 2030 Agenda

 ―As we embark on this collective journey, we pledge that no

one will be left behind.‖
 ―We will endeavour to reach the furthest behind first.‖
 ―People who are vulnerable must be empowered.
 For instance, all children, youth, persons with disabilities,
people living with HIV/AIDS, older persons, indigenous
peoples, refugees and internally displaced persons and
migrants.‖
Leave No One Behind (LNOB) in the 2030 Agenda

 ―Quality, accessible, timely and reliable disaggregated data

will be needed to help with the measurement of progress
and to ensure that no one is left behind.
 Such data is key to decision-making.‖

 The most poor, the most disadvantaged in all countries

 Progress for them should be prioritized and occur faster

than those better off
Sustainable Development Goals (SDGs)
Each
goal is
important
in itself
…
Each
And they
goal is
are all
important connected
in itself
…
How do we measure sustainable
development?
 There are no internationally agreed sustainable
development indicator, but
 Happiness Index (Sustainable Development Solutions
Network, Happiness Foundation)
 Better Life Index (OECD), Happy Planet Index (New
Economics Foundation), Gross National Happiness
Index.
 Human Development Index (UNDP)
Need for a development of SD index
Also need for a development of measurements of
SDGs
Three key differences between SDGs
and the MDGs
 Universal across all countries

 The whole-of-government approach

 The focus on inequality or to ‗leave no one

behind‘
Trade-offs and interactions between SDGs

 Between different SDGs

 Between the three dimensions of sustainable

development: economic, social and environmental

 Between international and domestic priorities

 Between short-term and long term goals

Ranking of Happiness Index 2012-2014

Helliwell, J. R. Layard and J. Sachs eds., World Happiness report

Income and Happiness: Comparing Countries
3. How do we measure sustainable development?
 Social Inequality
 Income inequality
- Gini Coefficient, Theil Index, General Enthropy Index,
etc.
- Rate of return on capital vs. rate of economic growth
 Gender inequality
- Gender Gap Index (World Economic Forum)
- Gender Inequality Index (UNDP‘s Human
Development Reports)
3. How do we measure sustainable
development?
 The UN has pursued sustainable development (SD), but without much
success.

World‘s ecological footprint has been rapidly increasing, thus degrading

environmental sustainability.

In many countries, economic growth has contributed to a decline in the

poverty, it has also been accompanied by rising income inequalities.
4. Key Concepts of Inclusive Growth and Green Growth

 Traditionally, the three pillars of SD have been thought

separately and policies have not been designed and
implemented synthetically.
 Also, the three pillars of SD have been often viewed as
contradictory, or environmental sustainability and social
equity have been viewed as residual outcomes of
economic growth,
 Accordingly, in many countries, economic growth was
taken up as the first goal and environmental protection
and social development were dealt with as secondary
goals.
4. Key Concepts of Inclusive Growth and Green
Growth

 But, the three pillars can be enhanced via

synergy creating policies.
 i.e., while pursuing economic growth, social
equity and environmental sustainability can be
enhanced.
4. Key Concepts of Inclusive Growth and Green
Growth
A. Inclusive growth
 Socially equitable growth
 i.e., Economic growth that allows people to contribute
to and benefit from economic growth.
 Socially equitable growth has been termed as ―shared
growth‖, ―pro-poor growth‖, ―broad-based growth‖ and
more recently ―inclusive growth‖.

28
4. Key Concepts of Inclusive Growth and Green
Growth

B. Green Growth
 Environmentally sustainable growth
 i.e., Economic growth which is consistent with
environmental sustainability.
 Environmentally sustainable growth has been termed
as ―sustainable growth‖, ―clean growth‖, and more
recently ―green growth.‖

29
4. Key Concepts of Inclusive Growth and Green
Growth
 The Green Growth Initiative and Inclusive Growth Initiative
should constitute two important ―strategies‖ to achieve the
ultimate, long-term goal of Sustainable Development.
 Chapter 4

Theories of Economic Development and

Growth Models

This chapter discusses

 Theories in development economics
 Linear stages of growth model
 Structural change theories
o Lewis two-sector surplus labor theory
o Patterns of development theory
 International–dependence revolution
 Neoclassical theory (Free market
counterrevolution)
Theories of economic development

 Theory is a systematic explanation of

interrelationships among economic
variables.
 Its purpose is to explain causal
relationships among these variables, to
understand world better and provide basis
for policy.
Main theories
 Classical theory of development
 Marx‘s historical materialism
 Rostow‘s stages of growth
 Vicious circle theory
 Balanced v. unbalanced growth
 Coordination failure (O-ring theory)
 Lewis-Fei-Ranis model
 Baran‘s Neo-Marxism
 Dependency theory
 Neoclassicism (Washington Consensus)
 Solow‘s neoclassical (Mankiw-Romer-Weil human
capital variable)
 New (endogenous) growth theory
Classical theory
 Classical theory of development is the 19th
century British model
 Classical theory puts that natural order
determines price, rent and economic affairs.
 Competitive economy promotes public
interest.
 Freedom from government restriction.
 Institutions to supply money.
Classical theory…
 Capital accumulation (savings) – output
– wages.
 Division of labor – related to market size.
 Free trade.
 Diminishing returns.
 Iron law of wages.
 Formulated amid scientific discoveries &
technical change.
 Major flaws – population theory & lack of
technological change.
Marxism
 Historical dialectic – examines where society
was, is going, and its change process.
 Movement from feudalism to capitalism to
socialism – based on changes in ruling &
oppressed classes & their relationship to
each other.
 Reserve army of unemployed.
 Can socialism be introduced through
parliamentary democracy?
Critique of Marxism
 Discussion of socialism not well
developed.
 Worker revolt is weakest link.
 Overlooked possibility that workers‘ and
capitalists‘ interests don‘t conflict.
Why didn’t Western workers overthrow
capitalism?

Marxist explanation
 Divide and rule.
 Exploitation of LDC workers.
 Media, education, religion support
capitalist ideology.
 Powerful legal, police, military and
administrative machinery.
 Marxism & its variants

 Yet Marxism remains rallying point for

discontented people.
 Class antagonism threat to rulers of
any economic system.
Legal, institutional & political framework,
social consciousness
Economic Relations of
structure of production
society (material
forces of  Appropriation of human
production) labor product
 Social contradictions
 Existing rationality, under which production
science & takes place
technology  Principles of distribution
 Mode of  Modes of thought,
organization of ideology, and
production Weltanschauung
 Degree of
development of
people
Marx’s economic interpretation of history
Rostow’s stages of economic growth

 Traditional society
 Preconditions for takeoff
 Takeoff
 Drive to maturity
 Age of high-mass consumption
Rostow’s traditional society

 Pre-Newtonian or 18th century.

 Lumps past economies, DCs 19th
century, & LDCs today together.
 Neglects dualism of many low-income
countries today.
Rostow’s preconditions stage and
radical change outside industry

 Increased transport investment – enlarge

market & specialization.
 Agricultural revolution to feed urban
population.
 Expansion of imports (especially capital),
perhaps financed by exporting natural
resources.
Rostow’s central stage, takeoff

 Decisive expansion 2-3 decades.

 Radically transforms economy & society.
 Barriers to steady growth overcome.
 Late 18th-century Britain, pre-civil war US,
late-19th-century Germany, post-Meiji (1868)
Japan, pre-1917 Russia, post-independence
India & post-1949 China.
Rostow’s 3 conditions for takeoff

 I/NNP increases sharply, say 5 to 10%.

 Leading manufacturing sector stimulates
growth through linkages.
 Political, social, & institutional framework to
exploit modern expansion: entrepreneurship,
retained earnings, banks & capital markets,
foreign investment.
Rostow’s drive to maturity

 Growth regular, expected & self-

sustained.
 Urban, skilled, less individualistic, more
bureaucratic labor force.
 State provides more economic security.
Age of high mass consumption

 Alternative: welfare state, military power.

 US 1920s, Western Europe 1950s.
 Autos, suburbs, innumerable durable
consumer goods & gadgets.
Critique of Rostow
 Lack of empirical evidence (increase
investment rates).
 No historical evidence of abruptness.
 Difficult to test.
 Stages define not explain.
 Stages not unique.
 Dualism (not just pre-science & technology).
 How does an economy move to next stage?
 Does self-sustained growth imply
effortlessness? Are obstacles to growth
removed?
 Is this Western (or US) model in disguise?
Vicious circle theory
 Supply side - Because incomes are low,
low propensity to save for capital
formation, which results in low productivity
per person, which perpetuates low levels
of income.
 Demand side – Because incomes are low,
market size is too small to spur
investment.
Critique of vicious circle

 Saving depends on relative income.

 Personal savings small percentage of total
savings.
 Large-scale economies overrated. Market
is ample for most goods. Economies of
experience important.
Balanced growth advocates
 Meaning of balance.
 Balanced growth – synchronized
application of capital to wide range of
different industries.
 Big push needed because of
indivisibilities – of infrastructure &
demand.
Critique of balanced growth
 Agricultural investment needed.
 Infrastructure not so indivisible.
 Economy that can undertake balanced
growth is not underdeveloped - capital, skills,
materials needed are immense.
 Not starting from scratch.
 Growth in 1960s & 1970s without massive
investments.
Hirschman’s strategy of unbalance
 Major shortage is investment by
entrepreneurs & risk takers.
 Need development strategy to spur
investment decisions.
 Need to consider how investment affects
profitability of other sectors.
 Spur investment decisions through linkages –
backward to sales of inputs & forward to
purchases of inputs.
Critique of unbalanced growth

 Too little emphasis on agriculture –

contributes to industry through food, foreign
exchange, labor, capital & larger markets.
 Imbalances should have ultimate balance in
mind.
O-ring theory of Economic Development -
Kremer

 Based on 1986 shuttle Challenger.

 All of thousand components must work
for the Challenger to function.
 Taiwan & Korean governments
intervened to provide coordination.
 Human capital is important.
Lewis model

 Explains how economic growth gets

started through structural change –
increase in size of the industrial sector
relative to subsistence agricultural sector.
 Lewis concerned about labor shortages
in expanding industrial sector.
Lewis model (cont)
 Assumes MPLAG = 0.
 Wages low but positive.
 wK higher includes inducement.
 Capitalist hires to MRPL = wK
 Surplus above wage is saved & reinvested.
 Increases productivity; more workers hired.
 When labor no longer available, wT
 Growth from structural change & savings.
Critique of Lewis model
 MRP of labor in agriculture.
 Unlimited supply of labor in agriculture.
 As labor migrates, constant output divided
among less claimants.
 Food prices increase from more demand from
urban sector.
 Increased wages sooner than Lewis
assumption.
 Not realistic to assume only urban sector
saves.
Fei-Ranis modification
 wk institutional wage.
 When MRPLag = w, commercialization point
& industry pays market rate.
 Each migrating worker takes subsistence to
industrial sector – unrealistic.
 19th-century Meiji Japan - paid less than
subsistence wage.
 Eventually wk had to be increased to cover
increased demand for labor & increased
food price.
 Lewis-Ranis-Fei

 Supply curve for labor is not infinitely

elastic.
 To get more labor, you need to pay a
higher wage.
 Baran’s Neo-Marxist Thesis
 Application of Marxism to Africa, Asia, & Latin
America.
 Western economic & political domination
unfavorable.
 Western monopolistic business transferred to
LDCs.
 Bourgeoisie in LDCs too weak to accumulate
capital & provide institutional change.
 Baran - coalitions in LDCs

 Bourgeoisie ally with moderate leaders of

workers & peasants.
 Form New Deal coalition – democratic,
antifeudal, anti-imperialist, supportive of
indigenous capitalists.
 Indigenous middle & capitalist classes
unwilling or unable to reduce poverty and
provide economic development for masses.
 Baran’s dynamics
 Bourgeoisie frightened & forced into alliance with
landed interests & foreign capitalists.
 Government supported by foreign economic & military
assistance.
 Progressive coalition breaks down.
 Overriding interest in preventing socialism.
 Needed: progressive income tax; landlords invest
productively, public investment where private capital
does not venture or where monopolies or where
infrastructure required.
 Impossible – populist forces further polarization,
radicalism & revolt.
 Impasse broken by expropriation & ethos of collective
effort.
Critique of Baran
 Potential conflict of interest between local &
foreign capital.
 Nationalism & decline of colonial economic
ties.
 Couldn‘t revolution just transfer from one elite
to another, e.g. USSR?
 USSR is Baran‘s model – collectivism not
market socialism.
 Is transition of squalor, workers‘ poverty &
other human costs inevitable?
 Class interests under socialism.
Dependency theory - Frank
 Increased productivity & new consumption
patterns in peripheral countries benefit
small ruling class & allies.
 Underdevelopment means penetration of
modern capitalism & archaic economic
structures of third world.
 Economic development of DCs contributes
to underdevelopment of poor countries.
 Satellite development in LDCs
 Interior Brazil dependent on Sao Paulo & Rio
de Janeiro, dependent on Western capitalist
economies.
 Satellites develop most when least
dependent on DCs.
 Global subsidiary companies, unskilled labor
in factories & plantations, education for
colonial administration, foreign-dominated
urban complexes, trade & investment from
DCs contribute to underdevelopment.
 Should withdraw from world capitalist
system.
Critique of Frank

 Colonial development not self-directed,

although some infrastructure development.
 Would LDCs have been better off without
foreign domination? Afghanistan & Ethiopia.
 Taiwan, South Korea, Puerto Rico, Canada,
 Belgium.
 Need greater selectivity in dealing with
capitalist DCs.
 Dependence defined in circular manner.
Neoclassical counterrevolution
 1980s‘ economically conservative governments.
 View dominant in World Bank & IMF.
 Neoclassicals: slow growth from poor resource allocation
from nonmarket prices & excessive LDC state
intervention.
 Promoting free markets, privatizing public firms, free
trade, liberalizing exchange, encourage foreign direct
investment (FDI), reward savings, reduce government
spending & monetary expansion, remove price
distortions & regulations.
 Korea, Taiwan, Singapore, Hong Kong, Malaysia,
Thailand & Indonesia – free market approach.
Neoclassicism’s Washington
consensus
 Domestic savings
 Foreign direct investment
 Privatization
 Deregulation
 Property rights
―Universal consensus‖
―Big bang‖ or ―shock therapy‖
Neoclassicism’s Washington
consensus

 Price decontrol
 Fiscal discipline
 Reduce public spending
 Tax reform
 Financial liberalization
 Competitive exchange rates
 Trade liberalization cont….
Criticism of neoclassicism
 Neoclassicism concerned with operation of
markets, not with how markets develop or
with policies to induce development (North,
112 in text).
 Stiglitz – Washington Consensus benefits
few at expense of many, rich relative to
poor.
 Income distribution & capital controls.
 Much of focus of book on neoclassicism.
Neoclassical growth theory

 Solow: Y = TKα Lβ

 α- Elasticity of output with respect to capital.

 However, Solow model predictions are not
plausible.
 Mankiw, Romer & Weil add human capital to
model –predicts better.
 New endogenous growth theory, with T
variable, does even better with prediction.
 Critique
 Neoclassical model poor in predicting;
convergence doesn‘t take place.
 Assumption of perfect competition,
technological change exogenous (outside
model), technology same throughout
world, does not incorporate decisions by
people, firms, & governments.
New endogenous growth theory
 T varies, explaining more of growth.
 Technological discoveries are not global
public goods, as neoclassicists assume, but
subject to state technology policy.
 Innovator receives (at least temporary)
monopoly profits from discovery.