Economics (9708) | Economic development

Welcome to Economic Development!

Hello! This chapter is one of the most important and engaging topics in A Level Economics. It moves beyond just measuring money (GDP) and asks a fundamental question: "How do we genuinely improve human lives around the world?"

Don't worry if this topic feels complex—it deals with real-world problems. We will break down the differences between economic growth and true development, explore how to measure living standards, and analyze the major external factors (like aid, debt, and multinational companies) that help or hinder poorer nations.

11.3 Economic Development and Living Standards

11.3.1 Defining the Core Concepts

It is crucial to distinguish between Economic Growth and Economic Development. They are related, but not the same!

Economic Growth (The "Quantity" Concept)

Economic Growth refers to the increase in the real value of goods and services produced by an economy over time. This is usually measured by the increase in Real GDP or Real GNI.
Analogy: Economic growth is like getting a bigger paycheck every year.

Economic Development (The "Quality" Concept)

Economic Development is a wider, multi-dimensional concept involving improvements in standards of living, health, education, infrastructure, income equality, and access to opportunities.
Analogy: Economic development is using that bigger paycheck to afford better health insurance, send your kids to a better school, and live in a safer neighborhood.

Quick Takeaway: A country can experience growth without development (if the rich get richer and the environment suffers), but sustainable development usually requires sustained growth.

11.3.3 Indicators of Living Standards

How do we actually measure if a country is developing? We use indicators, which fall into two main categories: monetary and non-monetary/composite.

A. Monetary Indicators (National Income Statistics)

• Real GDP per capita: Total output divided by the population, adjusted for inflation.
• Real GNI per capita: Gross National Income (GDP plus net factor income from abroad) divided by population, adjusted for inflation.
• Real NNI per capita: Net National Income (GNI minus depreciation/capital consumption).

A Crucial Adjustment: Purchasing Power Parity (PPP)

PPP is essential for comparing income between countries. A dollar buys very different amounts of goods in New York compared to Nairobi.

• Definition of PPP: An exchange rate that equalizes the purchasing power of different currencies. It adjusts monetary statistics to show what the income can actually buy in terms of goods and services.
• Example: If the same basket of goods costs $100 in Country A and $200 in Country B, the PPP exchange rate suggests that Country A's currency has twice the purchasing power of Country B's.

B. Issues with Monetary Indicators (Why GDP isn't enough)

Using just GDP/GNI per capita can be misleading because these figures do not account for:

• Income Distribution: A high GDP per capita might mask extreme poverty if income is highly unequal.
• The Informal Economy: Unreported activities (like small, cash-only farming or services) are missed, which is a large factor in many LDCs.
• Negative Externalities: GDP treats pollution clean-up as output, but ignores the initial environmental damage (e.g., logging adds to GDP but destroys forests).
• Non-Marketed Goods: Activities like unpaid childcare or subsistence farming are vital but not included in GDP figures.
• Quality of Life Factors: Freedom, security, and human rights are ignored.

C. Non-Monetary and Composite Indicators

To get a better picture of true development, we look at non-income factors:

• Non-Monetary Indicators (Simple): Life expectancy at birth, adult literacy rate, infant mortality rate, access to clean water and sanitation.
• Composite Indicators (Combining factors):
  • Human Development Index (HDI): The most common composite index. It measures development based on three dimensions (The H-E-I Trick):
    1. Health (Life Expectancy)
    2. Education (Mean years of schooling)
    3. Income (GNI per capita, PPP adjusted)
  • Measure of Economic Welfare (MEW): Adjusts Net National Product (NNP) by subtracting 'bads' (like pollution costs) and adding 'goods' (like leisure time).
  • Multidimensional Poverty Index (MPI): Identifies non-monetary poverty, looking at deprivations in health, education, and living standards simultaneously. It shows the *intensity* of poverty.

11.3.3 The Kuznets Curve (Inequality)

The Kuznets Curve is a theoretical relationship that suggests that as a country moves through its development process (measured by per capita income), income inequality first rises and then falls, resembling an inverted 'U' shape.

• Initial Stage: When a country industrializes (moving from agriculture to manufacturing), investment focuses in urban areas, leading to high profits and skilled wages. Inequality rises sharply.
• Later Stage: As development matures, the government can redistribute wealth (through taxes/transfers), education spreads, and better job opportunities equalize wages. Inequality falls.

Caution: This is a hypothesis, not a rule. Many developing countries today have high inequality that has not yet started to fall.

11.4 Characteristics of Countries at Different Levels of Development

Countries categorized as Low-Income or Developing Countries (LDCs) often share common structural and demographic characteristics that hinder their development.

11.4.1 Population Growth and Structure

• High Dependency Ratio: LDCs typically have high birth rates, meaning a large proportion of the population is under 15 (dependents). This drains resources away from productive investment (like factories) and towards immediate consumption (like schools and infant healthcare).
• High Rates of Population Growth: Rapid growth can negate the benefits of economic growth; even if GDP grows, GDP per capita may not rise significantly.
• Level of Urbanisation: Rapid, unplanned migration from rural areas to cities creates massive strain on urban infrastructure, housing, and job markets, leading to shanty towns and high unemployment.
• Optimum Population: The level of population where output per head is maximized. Many LDCs are considered overpopulated relative to their capital stock and resource base, leading to diminishing returns on labor.

11.4.2 Income Distribution (Inequality)

High inequality is a defining characteristic. This is typically measured using the Lorenz Curve and the Gini Coefficient.

• Lorenz Curve: A graph plotting the cumulative percentage of the population against the cumulative percentage of income they earn. The closer the curve is to the 45-degree line (the line of perfect equality), the more equal the income distribution.
• Gini Coefficient: A numerical measure (ranging from 0 to 1, or 0% to 100%) derived from the Lorenz Curve. A Gini of 0 means perfect equality (everyone earns the same); a Gini of 1 means perfect inequality (one person earns everything). LDCs typically have high Gini coefficients (e.g., above 0.5).

11.4.3 Economic Structure

• Employment Composition: LDCs usually have a high proportion of employment and output derived from the Primary Sector (e.g., agriculture, mining, fishing). Developed economies focus more on the Secondary Sector (manufacturing) and especially the Tertiary Sector (services, finance).
• Pattern of Trade: LDCs often specialize in exporting primary commodities. These goods are vulnerable to:
  
  • Volatile Prices: Prices fluctuate heavily, making planning difficult.
  • Low Income Elasticity of Demand (YED): As global incomes rise, the demand for basic commodities rises slowly compared to manufactured or luxury goods.
  • Declining Terms of Trade: Over time, the price of primary exports may fall relative to the price of manufactured imports, making the country poorer.

11.5 Relationship between Countries at Different Levels of Development

External factors play a massive role in a country's development journey. These include aid, international investment, and debt burdens.

11.5.1 International Aid

International Aid is the voluntary transfer of resources from one country or institution to another, aiming to promote development and welfare.

Forms of Aid:

• Bilateral Aid: Given directly from one country to another (e.g., US to Ghana).
• Multilateral Aid: Given through an international institution (e.g., UK contribution to the UN or World Bank).
• Tied Aid: Aid given on the condition that the recipient spends it on goods/services provided by the donor country (often reduces the value to the recipient).

Reasons for Giving Aid:

Reasons are mixed, combining humanitarian and political motives:

• Filling resource gaps: Aid provides capital (saving gap) and foreign currency (foreign exchange gap).
• Relief and development: Humanitarian reasons (disaster relief) or long-term structural development (building schools).
• Political and Strategic Influence: Donors may use aid to gain political favour or access to resources.

Effects/Evaluation of Aid:

• Positive: Can fund critical infrastructure (roads, power), improve human capital (health/education), and stimulate investment.
• Negative: Can create dependency, lead to corruption (misallocation of funds), or distort local markets by providing subsidized goods.

11.5.3 & 11.5.4 Multinational Companies (MNCs) and Foreign Direct Investment (FDI)

An MNC (Multinational Company) is a firm that owns or controls productive assets in more than one country. FDI (Foreign Direct Investment) is the investment made by an MNC into a foreign economy.

Consequences of MNC/FDI (A balanced view is essential for evaluation):

Benefits for the Host LDC:

• Job creation and income generation.
• Technology and skills transfer (improving human capital).
• Increase in tax revenue for the government.
• Improvement in infrastructure (MNCs often build roads and power supplies needed for their operations).

Drawbacks for the Host LDC:

• Repatriation of Profits: MNCs send profits back to their home country, acting as a leakage from the host economy's circular flow.
• Exploitation: May use local lack of regulation to pay low wages or pollute the environment.
• Political Influence: Large MNCs can pressure governments for favorable policies (e.g., tax holidays).
• Crowding out: May crowd out local small businesses that cannot compete with global scale.

11.5.5 External Debt

External Debt is the total amount of money owed by a country's government, firms, and residents to foreign creditors (governments, banks, or international organizations).

• Causes of Debt: Often accumulated due to persistent balance of payments deficits, high borrowing costs (interest rates), corruption, and poor investment decisions (e.g., 'white elephant' projects that yield no return).
• Consequences of Debt: Leads to massive debt servicing (repaying principal plus interest). This diverts scarce government revenue away from essential spending on health, education, and infrastructure, crippling long-term development efforts.

11.5.6 & 11.5.7 Role of the IMF and World Bank

These two Bretton Woods institutions play distinct, but related, roles in global development.

• International Monetary Fund (IMF):
  Focuses on macroeconomic stability and dealing with short-term balance of payments crises. The IMF offers short-term loans, often conditional on the recipient country adopting Structural Adjustment Programs (SAPs), which usually require spending cuts and market liberalization.
• The World Bank:
  Focuses on long-term development and poverty reduction. It provides loans and grants for specific projects like building dams, schools, hospitals, or sanitation systems.

11.6 Globalisation and International Trade Blocs

11.6.1 Meaning and Consequences of Globalisation

Globalisation describes the increasing economic, political, and cultural interdependence between countries worldwide, primarily driven by rapid decreases in transport and communication costs, and reduced trade barriers.

Consequences of Globalisation (Mixed Impact on Development):

• Positive: Increased market access, specialization and efficiency, rapid spread of technology, lower consumer prices.
• Negative for LDCs: Increased vulnerability to global shocks (e.g., financial crises), greater pressure to compete on low wages (the 'race to the bottom'), and potential loss of local culture/identity.

11.6.2 Trade Blocs (Stages of Economic Integration)

Countries often group together into trade blocs to gain benefits from closer economic ties.

1. Free Trade Area (FTA): Members eliminate tariffs/quotas among themselves, but each member maintains its own independent trade policy against non-members (e.g., NAFTA/USMCA).
2. Customs Union: Members form an FTA plus adopt a common external tariff (CET) against non-members. (e.g., the Gulf Cooperation Council).
3. Monetary Union: Members form an economic union plus adopt a common currency and central monetary policy (e.g., the Eurozone).
4. Full Economic Union: Involves complete harmonization of all economic policies (fiscal, monetary, trade, and exchange rate).

11.6.3 Trade Creation and Trade Diversion

When forming a trade bloc (especially a Customs Union or higher), economists evaluate the outcome based on two effects:

Trade Creation (Good for efficiency)

This occurs when high-cost domestic production within a member country is replaced by lower-cost imports from a more efficient producer within the trade bloc.
Result: Resources are shifted to more efficient producers, increasing global welfare.

Trade Diversion (Bad for efficiency)

This occurs when lower-cost imports from a non-member country are replaced by higher-cost imports from a less efficient producer within the trade bloc.
Reason: The non-member's low cost is cancelled out by the common external tariff.
Result: Trade diversion reduces global welfare as trade is diverted away from the lowest cost producer.

Evaluation Tip: For a trade bloc to benefit its members and the global economy, the volume of Trade Creation must outweigh the volume of Trade Diversion.