Introduction

Ch 01
 Outline

• Stylized facts

• Development and equity

• Poverty-growth-inequality triangle

• Development gap and income distribution

• Poverty-weighted growth rates

 Introduction
• Why development economics as a separate field of study?

• Many markets missing: labour, financial, insurance

• Institutions and public infrastructure missing: property rights, laws, transportation

• Development taking place when there is a developed world elsewhere: aid dependency, technology transfer

• Speed of development differs from European experience

• History of colonialism
GDP per capita in year 2000, USD, PPP
exchange rates
 Measuring Development
• What do we mean by development?
 Development can be seen…..as a process if expanding the real freedoms that people enjoy (Amartya Sen)
 Higher income, ceteris paribus, allows wider set of choices
 Role of political freedom
 Process of improving the quality of all human lives and capabilities by raising people’s levels of living, self-
esteem, and freedom
• Millennium Development Goals (MDGs) by United Nations
 Eradicate extreme poverty and hunger; universal primary education; gender equality; reduce child mortality
• Human Development Index (HDI) is based on three measures
 Life expectancy at birth (index of long and healthy life)
 Literacy rate and secondary and tertiary gross enrolment ration (index of knowledge)
 GDP per capita (index of decent standard of living)
 Normative Framework For Development
• Normative concerns lie at heart of development analysis and policy

• Development policies are normative when they involve value judgements about what should be done

 Should public policy aim at increasing economic growth?

• When development is a matter of analysing empirically existing situations then it is referred to as a positive
approach

• Others endeavour to predict how a situation could change in certain ways

 How many households will be below poverty line if economy annually grows at 5%?

 Normative, positive, and predictive approaches are all interconnected

• But, normative approaches are central to shaping development policies but are not sufficient to create it

 Poverty due to lack of income vs. poverty due to unmet basic needs

 Public policies to reduce poverty will be different depending on how poverty is conceptualized
 Normative Framework For Development
• All normative recommendations for development wrestle with common core issues

 Of uncertainty; of difficulties in predictions; of evaluating of trade-offs

 How can one take action on climate change?

 Should a country invest in wind turbines, solar panels, or nuclear energy?

• Policymaking often involves trade-offs between pursuit of two valuable objectives

• Different ways of understanding what development should improve lead to different policies and consequences
 Examining assumptions of economic growth on
human flourishing
• Economic growth is a necessary component of development
although required growth rate is debatable
• In many circumstances this is true but not always necessary
• Assumption 1: A high GDP Per Capita is Necessary for Human
Flourishing
 Morocco has a higher GDP per capita than Vietnam, its
illiteracy and infant mortality rates are much higher
 Uruguay has a much lower GDP per capita than Saudi
Arabia, yet people live longer
 When countries are arranged according to HDI
 Wealthier countries (GDP per capita) are not
necessarily wealthier in human dimensions
 Assumption 2: Families With A Good Income Will
Not Be Deprived In Other Dimensions

• Comparing different conceptualizations

of poverty in Peru and India, Ruggieri,
Saith and Stewart (2003) concluded
 poor (in income) were not
necessarily poor in education or
nutrition
• Having an income, or belonging to a
‘non-poor’ household, does not
guarantee of avoiding malnutrition or
receiving education
 Assumption 3: Economic Growth Will Reduce
Other Kinds Of Poverty, Such As Malnutrition
• Chinese growth rate is responsible of halving proportion of people living on under USD 1 a day

• Disconcerting truth is that, expected spill-overs is scarce on several key variables

• Consider child malnutrition

 India experienced 15 years of boundless economic growth

 Yet, 46 percent of all children under 3 remain malnourished in 2005-06

 Even in China, impressive growth has been accompanied by health inequities and deprivations
 Assumption 4: Data for Income and Expenditure
Are Better Than Other Poverty Data
• Critics of non-monetary indicators of development argue that income and expenditure data are most reliable
indicators of development
• Income and consumption or expenditure data are subject to a number of serious difficulties
 Income data in developing countries are often considered less accurate than consumption data
 Both consumption and income data have to be gathered item by item with varying recall periods
 Much consumption may be from non-market sources, and imputation of prices is not straightforward
 Other challenges include purchasing power parity rates across rural–urban areas or countries
• Another assumption is that non-monetary indicators are of weak quality
 Coverage and quality of non-monetary data has in fact improved tremendously in last two decades
 Analyses of poverty and deprivation increasingly draw on non-income variables as well as assets, consumption
or income
 Relationship Between Economic Growth and
Human Development
• There is no automatic link between economic growth and human flourishing
• Economic growth provide resources to sustain improvements in human development but only if it is
accompanied by other things
• Four factors that influence extent to economic growth contributes to human flourishing
 Households’ propensity to spend their after-tax income on food, water, education, and health
 Income distribution and generating employment for low-income groups
 Level of government activity like public expenditure, social spending
 Role of NGOs
• But relationship is bi-directional
 Improvements in human flourishing contribute to greater economic growth
Human Development and Economic Growth
Performance: Cross-Country Evidence
 Relationship Between Economic Growth and
Human Development
• Economic growth is essential to human development
• It depends on strength of existing mechanisms for translating growth into human development
• Without appropriate public policies, economic growth can end up being
 jobless without increased employment opportunities
 ruthless with benefits mainly to rich
 voiceless without an expansion of empowerment and political engagements
 rootless by stifling cultural diversity
 futureless by depleting natural resources
Poverty-Growth-Inequality Triangle
 How Does Growth Affect Poverty and Inequality?

• Rising tide lifts all boats

• Impact of growth on poverty and inequality depends

on how growth is distributed across rich and poor
 Channels From Growth To Poverty and Inequality
• Government
 Public goods and services
 As countries become richer, government can raise more fiscal revenue and increase spending on public
goods and services (Wagner’s Law)
 Redistribution
 As national incomes rise, countries engage in more redistribution

Income Redistribution by Country Group, 1980s–2010s

(difference in Gini points before and after taxes and transfers)

Tax Revenues and Spending on Health and Education, by

Country Group (percent of GDP, 2010-19 average)
 Channels From Growth To Poverty and Inequality
• Factors and markets
 Employment of factors
 Economic volatility is associated with both lower growth and higher inequality
 Another reason for unemployed or underemployed factors could be poverty traps
 Labour supply response
 Economic growth can result in a lower fertility rate, which reduces labor supply and thus increases return
to labor
 Average adult worker in a low-income country works 50 percent more hours than adult workers in high-
income countries
 Differentiated labour
 Rising wage skill premium has increased inequality of labor income
• Markets
 At high levels of markups and profitability, increase in market concentration leads to lower investment and
lower wages, which directly influence income distribution and growth
 Channels From Growth To Poverty and Inequality
• Unbalanced growth
 Different sectors, industries, regions, and firms may grow at different rates
 When some sectors boom but others lag, growth is not likely to raise incomes proportionately
 Kuznets (1955) postulated that inequality evolves as an inverted “U” shape function
• Sectoral composition
 Sectoral composition of growth is important in determining poverty reduction
• Capital intensity
 If growth is generated in capital or innovative skill intensive sectors, then capital returns would be higher
 Piketty (2015) provides evidence that 𝑟 − 𝑔 has effect of amplifying wealth inequality over time
 Channels From Growth To Poverty and Inequality
• Technology and innovation
 Prospect of obtaining rents from new products drives innovation, and innovation contributes to growth
 Rents created by successful innovations lead to a rising share of top 1 percent of distribution
• Trade
 Trade liberalization will lead to lower inequality in developing countries and higher inequality in advanced
economies
 In practice, skill premium has increased in both advanced and developing countries, mainly due to skill-
biased technological change
• Financial liberalization
 Higher global financial integration can improve financial intermediation and help poor by providing funds to
accumulate human and physical capital
 Capital account liberalization might increase frequency of financial crises
 Financial crisis disproportionately affect poor and raise inequality
 How Does Poverty And Inequality Affect
Growth?

• From poverty to growth

 Negative impact of poverty on growth depends

on initial level of poverty

 High poverty rate is associated with lower

growth in subsequent decade

Growth in GDP per capita vs Initial Poverty, 1960–2010

 How Does Poverty And Inequality Affect
Growth?
Inequality in 1970 vs GDP per capita Growth in next 50 years
• From inequality to growth
 Countries that started with lower levels of inequality
experienced higher rates of economic growth
 Mixed evidence of impact of inequality on growth
 Effect of inequality on growth may depend on
 level of development
 time horizon of growth spells
 whether a study uses a cross-country or panel data
approach
Key Channels in Growth-Poverty-Nexus
From Growth To Poverty and Inequality
Key Channels in Growth-Poverty-Nexus
From Poverty and Inequality to Growth
 GNP Growth vs. Social Welfare Growth
• Consider a developing economy in which total population is divided into five equal-sized groups (quintiles)

• Bottom, or poorest, 20% of population receives only 5% of national income

• Remaining four quintile groups receive 9, 13, 22, and 51%, respectively
• We can approximate growth in aggregate social welfare by using a weighted sum of growth of income in
each income class
 Generalized Welfare Index
• 𝑊 = 𝑤1 𝑔1 + 𝑤2 𝑔2 + ⋯ + 𝑤𝑛 𝑔𝑛 , where
 𝑊 = a weighted index of growth in aggregate economic welfare of a nation over a given period of time (in %)
 𝑔𝑖 = percentage growth rate of income in the 𝑖𝑡ℎ income group, where groups of equal size are ranked from
lowest to highest in terms of average income per person
 𝑤𝑖 = social "welfare weight" attached to income in 𝑖𝑡ℎ group
• As long as 𝑤𝑖 ’s add up to unity and are non-negative, 𝑊 must fall somewhere between maximum and minimum
income growth rates of various income groups
• Distinguish among three broad types of welfare weight approaches, each of which reflects a different philosophy
of development
 Traditional GNP index
 "poverty weights" index
 "equal weights" index
 GNP Index
• Traditional GNP index of development uses prevailing size distribution of income as actual welfare weights

• Welfare index growth would be identical with calculated growth rate of GNP
 𝑊 = 0.05𝑔1 + 0.09𝑔2 + 0.13𝑔3 + 0.22𝑔4 + 0.51𝑔5
• If average per person family income grew by 10% in each quintile, both GNP and 𝑊 would improve by 10%
• If, however, income in bottom 40% showed no growth at all while 𝑔3 , 𝑔4 , and 𝑔5 were 5, 10, and 20% respectively,
both GNP and 𝑊 would show a very healthy 13% improvement
• And yet, bottom 40% of population would be no better off than before in absolute terms and much worse off in
relative terms
 Poverty Weights Index
• Alternative measures to raise levels of living for so-called “bottom 40%”
• May consider a set of welfare weights that give greater emphasis to raising incomes among bottom 40% than
among top 60% of population
 𝑊 = 0.40𝑔1 + 0.30𝑔2 + 0.15𝑔3 + 0.10𝑔4 + 0.05𝑔5
 Where 𝑤𝑖 ’s are policy welfare weights attached to income growth in each quintile
• Development performance would be largely evaluated by effects of public policy on maximizing income growth
among two lowest income classes
• Poverty-weighted index will differ from GNP index, and performance by latter criterion will not correlate with
success by former
• Countries that are "growing" in terms of GNP may not be "developing" in terms of providing basic needs for vast
number of their very poor
 Equal Weights Index
• Between two extremes of GNP and poverty weights index, one might also wish to construct an "equal weights"
index
• An equal weights index income growth in each of 𝑛 income classes is afforded an identical weight
1
 𝑊 = 𝑤1 𝑔1 + 𝑤2 𝑔2 + ⋯ + 𝑤𝑛 𝑔𝑛 , where 𝑤1 = 𝑤2 = ⋯ = 𝑤𝑛 =
𝑛

• Such a welfare index would not be biased toward either upper or lower income groups
• More unequal "size" distribution of income, greater divergences among three indexes of development
 Income Distribution and Growth
• Economic performance as measured by "equal" and
"poverty" weighted indexes is notably poor in some high
GNP growth countries like Brazil, Mexico, and Panama

• In five countries (Colombia, Costa Rica, El Salvador, Sri

Lanka, and Taiwan), the "equal" and "poverty" indexes
show a better development performance than GNP
growth as a result of improved income distribution

• In four countries (Korea, Peru, Philippines, and Yugoslavia),

little change in income distribution resulted in little
variation between GNP measure and two alternatively
weighted indexes of social welfare