CHAPTER ONE

CONCEPTS AND PRINCIPLES OF DEVELOPMENT

ECONOMICS

Unit Introduction

By studying development economics, you will have the opportunity

to apply the tools of economic analysis
_to the problems and challenges facing less-developed countries, and
_ To begin to understand why some countries have been able to go through a process of
economic and human development.
Although the central theme of this chapter is the concept of development, you should begin your
study of the economics of development.
‘Development’ and the narrower concept of ‘economic development’ are difficult to define
exactly. After exploring what is meant by these concepts, you should be able to offer a working
definition of development. There follows a note on the terminology used to describe different
groups or categories of countries.
In order to understand much development issues, and hence parts of this course, it is essential to
be able to understand the difference between economic growth and development, core values
and objectives of development, obstacles and basic requirement to development will be
discussed.
Lastly, measurement and comparability of per capita income, human development aspects, and
the issue of development gap are discussed.
Objectives: By the end of this unit and the relevant reading, you should be able to:
• Explain concepts and definitions of economic development
• Differentiate and understand economic growth and development
 Understand the core values and objectives of development.
 Explain human development, measurement and development gap
There is a huge gap between Developed and Developing countries. If so,
1. Why do you think about the causes for the gap between the rich and poor to exist in your
area?
2. How do you understand Development our country Ethiopia?

Unit Overview

1.1 Current interest in

Development Economics

1.2 Definition and nature of

Development Economics

1.3 The meaning of

Economic growth and
Development

1.4 Core values and Objectives

of Development

1.5 Human Development

1.6 Obstacles to Development

1.7 Basic Requirements for

Development

1.8 Development Gap

1.1 The Current Interest in Development Economics

One of the most outstanding/striking characteristics of the world economy in recent decades
has been the growing inequality in the distribution of resources between different parts of the
world. China, the most populous/crowded country in the world, has experienced economic
growth at an unprecedented rate, and India has also made substantial/large progress.

Development economics attempts to explore some of the economic challenges peculiar/odd to

some of the poorest countries in the world. We will investigate the factors that have led to this
global inequality, and analyze some of the forms of market and government failure that may
have contributed to the situation.

As part of this course, you will see the way in which economics can help our understanding
of some of the major challenges of the 21st century, including:

 How can less-developed countries achieve sustainable development?

 To what extent does rapid population growth help or hinder-/delay development?
 Is it necessary for economies to go through a process of structural transformation
- and how does this take place?
 How important is it for countries to engage in international trade in the context
of a globalizing economy?

Development economics faces up to these questions, and shows you how to apply economic
analysis in a variety of situations of global significance.

Development economics can draw on theory that you may have encountered in both micro and
macro modules, and combine this with evidence from poorer countries.

The subject is of recent/new origin; it was about five decades ago.

The public and political concern for the poor nations is only recently increasing. There were
factors which were not conducive for the emerging of the subject as a separate field of study
pre 1950s and there are some favourable circumstances. Some of them are explained here under.
Factors which were not favourable factors/not conducive /disadvantage for the development
of the subject pre 1950 period
 In the 1930s advanced countries were caught/wedged up in and fully engaged in ‘the great
economic depression’
 In the 1940s countries were fighting world war two(WWII)
 The developing countries (Africa, Latin America and Asia) were caught up with stagnation
and colonialism.
The favourable factors that helped the rise of the subject include:
 The recent renewed interest from academicians in the growth and development process
of developing countries;
 Recently poor countries became aware of their backwardness and developed the desire to
become strong through economic growth.
 The quest for New Economic Order (NOE) by these nations is a case in point. NEO is
based on equity/fairness, sovereignty, equality and common interest among all nations
and thus calls for:
 Terms of trade improvement,
 Access to markets of developed nations,
 Greater financial assistance and cancelling of past depts.,
 Reform on multinational financial institutions such as International
Monetary Fund (IMF) and World Bank (WB).
 Increasing mutual interdependence of the world economy through trade and finance

1.2 Definition and Nature of Development Economics

Development certainly implies change or transformation but, when referring to a country, its
society or its economy, the concept of development can be interpreted very broadly.
It would include, in addition to certain economic changes and processes, other transformations
which would usually be regarded as political and/or social.
For the purpose of this lesson, you must confine your attention to Development economics
which is a branch of economics that systematically studies the economic development of the
third world nations of Africa, Asia (except Japan)& Latin America (including Caribbean nation).
Development economics is one of the newest/most recent and most challenging branches of the
broadest disciplines of economics and political economy and became a separate field of study in
economics especially after 1950’s.
Development economics draws on relevant principles and concepts from other branches of
economics such as Macroeconomics, Labour economics, Public finance, and
Microeconomics etc.
Development Economics can be defined as a branch of economics that studies the process of
transformation developing economies into a developed one. In other words, it studies how an
under developed economy could successfully be transform into a modern-developed economy.
It also studies the measurement problems of economic development; identify key variables
that matters to development and possibility of closing gap in living standards among peoples of
developed and underdeveloped countries.
Economic development is the prime objective of the developing countries, because their
economies are only in the early stages of transformation, currently operating below capacity and
didn’t satisfy the needs of their people.
Development economics as separate field of economics emerged very recently. After the second
WW (World War 2), many countries of Africa &Asia became independent with their under
developed or developing economies.
Economic Development: - is more than economic growth, it is broader and encompasses a
number of issues. It may define as a high level and uniformly accessible material wellbeing.
It is the degree of betterment as well as equity in distribution of material welfare among a
society.
That includes;
 falling share of agriculture and a rising share of non- agricultural sector ( such as industry) in
the GDP,

 rising share of population living in urban areas rather than in rural areas,

 increases in the rates of accumulation of capital;

 changes in demographic compositions

 Change in employment structure, etc.

 Economic Development also implies that the country must participate in the process that
brought major structural changes.
Economic Growth is only a necessary component of economic development but not a sufficient
condition. The happening of economic development associated with the overall improvement in
lives or welfare of the vast majority of the people such as; elimination of poverty, unemployment
and inequality, increased access to health care, education, etc

Development is actually more general and multi- dimensional process. It includes

– removal of poverty, malnutrition, access to clean water, raising life expectancy,
reduction in infant mortality, increased access to schooling, etc.
Economic development refers to a fundamental change in the structure of the economy.
Structural change refers to changes in the nature and relative importance of sectors in the
economy. Development is the transformation of the economy via changes that are the key
elements of the economy.
The nature of Development economics
is different from that of traditional economics and political economy. Let us see one by one.
 Traditional Economics
It is concerned with the least cost allocation of resources and the growth of these resources
overtime. It also deals with the advanced capitalist world of perfect market, consumer
sovereignty, marginal and individualistic based on decision making, market equilibrium etc.

 Political Economics
It goes beyond traditional economics and studies the social and institutional process through
which certain groups of economic and political elites dominate the allocation of resources.

 Development Economics
It deals with economic, social, political and institutional mechanisms necessary to bring rapid
and large scale improvement in living standards of the poverty stricken peoples of Africa, Asia
and Latin America.

Major Terminologies used in Development Economics

For the purpose of this course the following sets of terms, used to describe a country or groups of
countries, and are sometimes used synonymously:
• Less Developed Countries (LDCs), developing, underdeveloped, poor, backward, ‘Third
World’, ‘South’
• Developed Countries (DCs), more developed, industrial, industrialized, rich, advanced, ‘First
World’, ‘North’.
Some of these terminologies are incorrect when applied to some countries. It is, for example,
possible that a country is not developing, in a general sense. Others terminologies were more
relevant at some point in the past, but others are no longer appropriate. For example, North–
South division is an incorrect division since some of the major LDCs are in the North and
Australia and New Zealand are in the South. Similarly First World–Third World has a cold war
background and is no longer relevant. Specifically,

 Modern Vs backward countries; this terminology is not however commonly used

because of its negative connotation,
 Developed Vs underdeveloped( developing) ; this way of classification is most popular,
 Most developed Vs least developed countries; this terminology or way of classification
is also commonly used to differentiate rich nations from poor nations,
 High, middle and low income countries; this classification is based on the level of income
of countries. It has been later redefined by the World Bank as follows based on specific
per capita income (PCI) ranges,
 Low income countries = are economies with Per Capita Income (PCI) less than $ 755 in
the year 2000’s constant prices,
 Middle income economies are countries with PCI $ 755 to $9265 in the year 2000’s
constant price. Middle-income countries may be further divided in to two these are lower
middle income countries and upper middle income countries.

 Lower middle income countries refers to economies with PCI of $755

to $2995 in the year 2000’s constant prices,
 Upper middle income countries refer to economies with PCI of $2995 to
$9265 in the year 2000’s constant prices.

 High-income economies= are economies with PCI greater than $ 9265 in the year 2000’s
constant prices.
 N.B: Both the low and middle-income economies are categorized as developing
economies. In this subject guide mostly we use the distinction Developed countries
(DCs) and Less Developing Countries (LDCs).

1.3 Economic Growth and Development

The term economic development is used interchangeably with such terms as economic growth,
economic welfare/, economic progress and secular change.
However, the term economic development has its own distinctive meanings and hence differs
from terms such as economic growth.
Economic Growth is the process by which the productive capacity of an economy increases
over time to bring about rising levels of national output and income. It refers basically to the rise
in the value of the goods and services produced by an economy. It is conventionally measured as
the percentage increase in real Gross Domestic Product (GDP) or Gross National Income (GNI).

Economic growth is a mere quantitative expansion of the economy without structural changes.
There can be economic growth without economic development. There are several countries that
have achieved higher rates of economic growth without improvement in the income distribution
and standards of living. For example some oil exporting countries have achieved highest rates of
national income (GDP) but without qualitative changes in their economy.

Economic Development on the other hand is a multi-dimensional process involving changes in

individual behaviours, social structures, popular attitudes and national institutions.
It is a process that includes the organization of economic, political and social systems. Simply
stated, development refers to the process of improving the quality of life of all human lives. It
is also a process that deals with the economic, social, political and institutional mechanisms, both
public and private, as well as with improvements in levels of living for the poverty-stricken,
malnourished, and illiterate. Overall, successful development requires both a skilful and
judicious balancing of market forces, and intelligent and equity-oriented government
intervention in areas where market forces would lead to undesirable economic and political
outcomes. Therefore, because of its multidisciplinary characteristics, development may mean
different things to different people.
Economic development refers to the problems of underdeveloped countries and economic
growth to those of advanced countries.

Different scholars explain development differently. Some of them are discussed here under.
According to Schumpeter,”
Development is a discontinuous and spontaneous change in the stationary state, which forever
alters and displaces the equilibrium state previously existing; while
Growth is a gradual and steady change in the long run which comes about by a general increase
in the rate of saving and population.”

According to Mrs. Ursula Hicks, the problem of underdeveloped countries are concerned with
the development of unused resources, even though their uses are well known, while those
advanced countries are related to economic growth most of their resources being already known
and developed to a considerable extent.

According to Kindle Berger, Economic development should include…. the eradication of mass
poverty with its correlates of illiteracy, disease and early death; changes in the composition of
input and output that generally include shifts in the underlying structure of production away from
agricultural towards industrial activities, the organization of the economy in such a way that
productive employment is general among working age population rather than the situation of the
privileged minority; and the correspondingly greater participation of the broad groups in making
decisions about the directions of economic and other activities to improve their welfare.

Economic development implies growth plus structural transformation. Economic growth can be
attained in several ways but to have development there are limited ways.

Before the 1970 economic growth was considered to be equal to development because it was
assumed that a gain in overall GDP would trickle down to the poor. During this period
development was defined in terms of reduction and elimination of poverty, inequality and
underemployment.

According to world development report (1991) “the challenges of development is to improve the
quality of life in the world’s poor countries. A better quality of requires:
 Higher income,
 Better education,
 Higher standards of health and nutrition,
 Less poverty,
 Cleaner environment,
 More equality and opportunity,
 Greater individual freedom,
 Richer cultural life.

1.4 Core Values and Objectives of Development

According to Professor Goulet (1971), Development has three core values. These are: life
sustenance, self esteem, and freedom from servitude.
I. Life sustenance
It refers to the ability to meet the basic needs such as food, shelter, health minimal education and
protection. In a condition where the basic needs are not met, we cannot say the country its fully
developed despite its high GDP or income level.

Efforts to meet these basic needs are known as the basic need approaches to development, which
was initiated by World Bank.
II. Self esteem
It is concerned with the feeling of self-respect and independence or not being used as a tool by
others. No country could be regarded as fully developed if others exploit it and does not have the
power and influence to conduct relation on equal terms.
III. Freedom from servitude (to be able to choose)
It refers to the freedom from ignorance/alawaq and poverty. Nobody is free if he /she cannot
choose and is imprisoned by living at the margin of subsistence with no education and skill.
Freedom also refers to political freedom including personal security, the rule of laws, freedom of
expression and political participation on equal footing.
Similarly, the Professor explained that there are three major objective of
development .These are:
 To increase the availability and widen the distribution of basic life sustaining goods,
 To raise the level of living including more jobs, better education, greater attention to
cultural and humanistic values and all of which serve to generate individual and national
self esteem,
 To expand the range of economic and social choice available to individuals and nations
by freeing them from servitude.

1.5 Major Obstacles to Economic Development

At present there are more than 6 billion people living in the world. Out of these75% (4.2
billion) persons are living in developing countries.
The per capita income in these countries is very low whereas the per capital incomes in
developed countries is very high.
Why the economic growth in developing countries is low?
What stops these countries from developing economically?
The answer to these questions is not simple. However, the main obstacles which the under
developed countries, including Ethiopia are generally facing for promoting development can be
identified as under.

A. Vicious Circle of poverty

It implies a circular association of forces tending to act and react up on one another in such a
way so as to keep a poor country in a state of poverty. It is the biggest obstacle in the way of
economic development. Ranger Nurkse in ''Problems of Capital Formation in Underdeveloped
Countries'' describes 'vicious circle of poverty as the basic cause of under-development of poor
countries. According to him, a country is poor because it is poor. Vicious circle of poverty would be
explained more from demand side and from the supply side which is discussed here under with
the help of diagram.
 On the side of demand when people have low real income the demand for goods is bound to be
small. In the small size of market, there is no incentive of invest in real or human capital. When
the rate of investment is low, the productivity of the factors of production is bound to be low.
Low productivity leads to low per capital income which is rapidly absorbed by the rising
population growth. The country, therefore, remained poor.

From the Supply side vicious circle of poverty, low level of real income contributes to low rate
of saving and this leads to low rate of investment. The low level of investment leads to low level
of productivity. When the productivity per worker is low, the real income will obviously be low
and so there poverty and vicious circle is complete.
Diagrammatically,

Demand side
Supply side
Low productivity Low productivity

Capital
deficiency Low Low
income Capital income
deficiency

Low Low demand

investment
Low Low saving
investment
B. Political Instability

In most of the developing countries, the governments are not stable. A new government comes
into power overnight; either through coup defeat/ adima mashenef or army takes over. The new
government introduces a new system of rules for the operation of business which causes
frustration/disturbance and discontentment among the people. How political instability affect
growth does is discussed in brief below.
(i) Influence of political instability. When there is lack of political stability in the country, it
directly affects economic growth. It closes off sources of internal and external investments.
(ii) The external investors. The external investors do not invest in a country where there is
political instability. The flow of investment in countries where there is civil war coups, army
take over etc. is either negligible or zero.
(iii) Internal investment. Political instability also limits internal investment. The wealthy class
in developing countries have enough income to spare.
They can invest their savings in profitable projects.
Generally, they avoid investing founds in their own country for fear of nationalization of their
projects, large scale interference by militant trade unions, harsh and exploitative attitude of the
various govt. agencies involved in the setting and operation of the projects etc.
The well off people including the politicians in developing countries prefers to take their money
outside the country or channel their investment out of their own country. The developing
countries are therefore, deprived of investment funds which adversely affect economic growth.
C. Corruption
Corruption is another obstacle to economic development in developing countries. Example, The
bribery or gift of money has becomes institutionalized. The govt. officials think bribery is built
into their pay structure. The businessmen, if they are to stay in business, have to pay bribes to
different departments of the govt. The employees give gift of money to their superiors. When
bribery is an acceptable practice, it then becomes difficult for businessmen and industrialists to
take part stay and grow in business. Bribery thus limits economic development
D. Lack of investment
For an economy to grow, it must have investment. The funds for investment can come either
from domestic savings or from abroad. Both these sources of investment funds have their own
peculiar problems which in brief are discussed as under.
(i) Investment funding by domestic savings. For economic growth we must give up
unnecessary expenditure so that the economy can achieve even greater consumption in the
future. In developing countries, the people with per capita incomes of as low as $ 600 per year
hardly meet the bare necessities of life. They have little to put into savings. The middle class
persons do save for their old age, marriage of children etc and put their money in saving banks.
The rich people prefer to invest their savings abroad. The overall result is that domestic savings
in most of the developing countries is as low around 13% of GDP; whereas it should not be less
than 25% of GDP to promote growth.
(ii) Investment funding from abroad. Another way to generate funds for investment is to
obtain from foreign loans, foreign private investment or from both. The foreign loans or the
foreign private investment has their own peculiar problems. For financing development of the
less developed countries (LDC's) the flow of capital comes from individual national
governments, multinational assistance organizations and from multinational companies.

The individual national governments give financial assistance to LDC's mainly for their own
economic and political interests. So long as the developing country is protecting the interest of
the donor countries, the flow of capital counties. It is stopped or very much slowed down when
the recipient country is of no benefit to them. A developing country, therefore, cannot rely on
such foreign aid for economic growth.

Same is the position now of the multinational assistance organizations like the Word Bank and
International Monetary Fund (IMF). These organizations which are mainly funded by the
developed capitalist’s countries of the world are also using these organizations to promote their
own economic and political interests. All the developing countries including Ethiopia are now
knee deep in debts of these organizations. The problem of debt servicing, rescheduling has
adversely affected economic growth of the poor countries.

As regards the flow of capital from multinational companies, they make investment in those
countries where infrastructure facilities such as transportation, power, cheap labour force, raw
material etc. are available. As these companies do not generally help in establishing
infrastructure in poor countries, therefore they do not contribute much to economic growth of the
LDC's. The problem of lack of proper investment, therefore, remains in developing countries.

E. Socio - Cultural Obstacles

LDCs (least developed countries) have social institutions and attitudes, which are not conducive
or suitable to development.
According to the UN’s report on the process’s and problems of industrialization in LDCs, there
are unfavourable factors or elements of social resistance to economic change in LDCs, which
include institutional factors like
 Rigid stratification of occupations reinforced by traditional beliefs and values
 Attitudes involving inferior valuation attached to business roles
 Backward social attitudes
 Unfavourable political conditions
 Stratification and classification based on class, religious groups, caste system, ethnic
groups. Etc

F. International Forces

Apart from local problems, international problems are also basic causes of poverty. To begin
with historical factors such as colonialism and neo colonialism have played a significant role in
hindering the development of many poor African nations.

The gains from trade have also gone mainly to the developed countries (DCs). Further the
development of the export sector only made other sectors to neglected i.e. most of the poor
nations are basically concerned towards developing exportable agricultural commodities rather
than being concerned about the overall development of their domestic economy. Apart from this
too much dependence on exports has exposed many LDCs’ economies to international
fluctuations in the demand for and prices of their products. Hence the development efforts of
many poor nations were negative.

Foreign investment in most African nations has been mainly directed towards increasing
exportable goods. It has, however, tended to affect the economy adversely because the levels of
productivity, incomes living standards have not risen in the primary sector. Even in the export
sector, the level of real wages of unskilled labor has remained low. The foreigners have been
draining out large amounts of money in the name of profit and wages of management.

G. Inadequate Infrastructure Facilities

The under developed countries suffer from lack of basic infrastructure such as transport and
communication system, power supply, banking and other financial facilities. The provision of
inadequate infrastructure facilities stands in the way of economic development of the poor
countries.
1.6 Basic Requirements for Development

Development is a multidimensional in nature. Different countries have experienced different

approaches to economic development. However, there are some common requirements for
development that poor nations must fulfil. These are:
A. An Indigenous Base
For a poor country to be developed a strong domestic economic base has to be created. This will
happen if there is an internal motivation for the growth process being firmly rooted within the
domestic economy.
B. Removing Market Imperfections
Market imperfections lead to factor immobility and restrict sectoral expansion and development.
To avoid the problems associated with market imperfections the following measures have to be
taken
 Improving the existing socio-economic institutions or replacing them with
new ones
 Expanding capital and money market
 Making Cheap credit facilities available to traders and small businessmen

C. Structural Changes
It implies the transformation from a traditional agricultural society to a modern society or
industrial economy involving a radical transformation of existing institutions, social attitudes and
motivations.
It transfers population from primary to secondary and territory sectors. It is also the development
of new social systems, which would replace the old social systems, which are simply based on
class, caste and religious differentials.
D. Capital Formation
It related to the process of developing investible funds and directing them to investment areas. It
involves three interdependent stages

i. An increase in the volume of real saving

ii. The existence of credit and financial institutions to mobilize these savings for
converting them in to investible funds.
iii. The use of these savings for the purpose of investment in capital goods

E. Following suitable investment criterion

In the process of bringing growth and development, any developing economy is supposed to
follow suitable policies of investment but there is no well-defined single criterion, rather a set of
suitable criterion.
i. Social and Economic Overheads
Investment should aim at developing the growing points in the economy. In the beginning,
particular growing points should be developed which intern will set chain reactions and
influence the entire economy.
ii. Balanced Growth
Investment should be based on the principle of balanced growth i.e. an all round and
simultaneous development of the different sectors of the economy where there is a
harmonious growth of sectors so that no sector lags behind or moves ahead of the others.

iii. Choice of Techniques

Economic planners must always make their decisions based on broad development objectives
in the process of adopting a particular technique of production. That is a feasible production
technique needs to consider various aspects of the economy apart from achieving its direct
objectives. E.g. feasible production techniques in Ethiopia should make use of
 Unskilled labor (labor intensive production technique)
  Local inputs and raw materials
 Land and environmental favour abilities etc.
E.g. investments in the agricultural sector

iv. Capital-Output Ratio (K/Y)

While making a choice among investment projects and in determining priorities, capital-
output (K/Y) ratio of different projects must be compared. The lower the capital-output
(K/Y) ratio, the higher is the growth rate of the economy. For example, project A has 3:1
capital-output ratio while the second project B has 4:1 capital-output ratio. So from these
projects, Project A would be selected because K/Y ratio is small for the first one.
Project1 => K/Y = 3/1
Project2 => K/Y=4/1
F. Socio-Cultural Requirements
To bring development it requires changing people’s attitudes from backward and primitive
thinking to modern thinking and in this process education has to be used as a great tool of
enlightenment.
G. Administrative Requirements
The existence of a strong, competent and uncorrupt administration is crucial for economic
development. Government has to a strong one, capable of maintaining law and order and
defending the country against external aggression. In the absence of stable government and
peace, public policies change very often and create problems to ongoing investments. Further
economic plans cannot be implemented without efficient administration. So that the government
must offer:
 Order, justice, good policy and security,
 Rewards and incentives based on ability,
 Assurance that business contracts would be kept,
 Stability of the government itself to maintain a sense of order and future calculability of
expectations
1.7 Human Development (HD)
Human Development is a process of expanding the real freedom that people enjoy. This
approach is comprehensive and holistic, and calls for the removal of the major forces of un
freedom, including poverty as well as tyranny/amba geninet, poor economic opportunities as
well as a systematic social deprivation, and neglect of public facilities as well as intolerance or
over activity of repressive states. According to A.K Sen, Development is essentially concerned
with enhancing the lives people lead, as he stresses: “An adequate conception of development
must go much beyond the accumulation of wealth and the growth of gross national product and
other income-related variables.

In a similar line of thinking, the United Nations Development Programme (UNDP) has
developed the Human Development Index (HDI), which goes beyond narrow monetary income
definitions of development and consists of a combination of three indicators long and healthy
life, knowledge, and decent standard of living.
The Human Development Reports states that human development is a process of enlarging
people’s choices: “The most critical ones are to lead a long and healthy life, to be educated and
to enjoy a decent standard of living. Additional choices include political freedom, guaranteed
human right and self respect according to UNDP.

As can be seen, human development has two sides: one has to do with the formation of human
capabilities, such as improved health, knowledge and skills. The second is related to the use
people make of their acquired capabilities for leisure and for productive purposes of being active
in cultural, social and political affairs (UNDP, 1990). The capability approach helps in
understanding development outcomes because it is concerned with what people are capable of
doing or being. Thus, the ultimate focus of economic growth and development is human
development.

Every year, UNDP publishes HD report in which it tries to show HD status of 175 countries
using Human Development Index (HDI). The Human Development Index (HDI) is a
composite statistic used to rank countries by level of human development. The statistic is
composed from data on life expectancy, education (knowledge) and per-capita GDP (as an
indicator of standard of living) collected at the national level. HDI ranks all countries on a scale
of 0 (the lowest HD) to 1 (highest HD) based on the three goals or end products of development:
These are:
1. Longevity as measured by life expectancy at birth
2. Knowledge as measured by a weighted average of adult literacy (2/3) and mean
years of schooling (1/3).
3. Standard of living as measured by real per capita income adjusted for the
differing Purchasing power parity (PPP).
Using the above three measures of development and applying HDI formula, UNDP categorizes
countries into three groups:
 Low income countries (0.00 to 0.499)
 Medium income countries(0.50 to0.799)
 High income countries (0.80 to 1.0)

Method of Calculating Human Development Index (HDI)

To calculate HDI, First, we calculate three indices, namely income index (INI), life expectancy
index (LEI), and education index (EI) and then combine them in some way to arrive at HDI.

Step1. Calculate Income Index (INI):

Income Index is calculated by dividing the logarithm of current income minus the logarithm
of the lowest per capita income as observed over the past generations in any country by the
logarithm of maximum per capita income that a country could reasonably aspire to over the
coming generation minus the logarithm of the lowest per capita income as observed over the past
generations in any country
log(CI ) - log ( LPCI )
INI =
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 over the coming generation
NB: According to UNDP, LPCI = 100 PPP and MPCI = 40000 PPP
Activity: Suppose Ethiopia's 2004 PPP income per capita was $100. Calculate the income index.

Step 2. Calculate Life expectancy index (LEI)

LEI is calculated by dividing current life expectancy (CLE) in years minus the lowest life
expectancy as observed over the past generations in any country (LLE) by the range of life
expectancies expected over the previous and next generations (RLE).
CLE - LLE
LEI =
RLE
Where, LLE and RLE are taken to be 25 years and 65 years, respectively.
Activity: Suppose that in 2004 Ethiopia's population life expectancy was 47 years. Calculate the
life expectancy index.

Step 3. Calculate Education index (EI):

To calculate EI, we need first to calculate two indices: adult literacy index and gross enrollment
index.
A. Adult literacy index (ALI):
 Calculate ALI using the following formula
Current adult literacy
ALI =
100
Activity: suppose the 2004 adult literacy rate in Ethiopia is 60%. Calculate adult literacy index.
B. Gross enrolment index (GEI):
GEI is calculated using the following formula

Percentage of primary, secondary and tertiary ¿

GEI=¿ 100
age population enrolled in school ¿
Activity: suppose, in 2004, 45 percent of Ethiopia's primary, secondary, and tertiary age
populations are enrolled in school. Calculate gross enrollment index.
Education Index (EI) is therefore calculated by taking the weighted average of the above two
indices.
2 1
EI = ( ALI)+ (GEI )
3 3
Finally our Human Development Index (HDI) is therefore,
 1 1 1
HDI= (IE )+ (LEI )+ (EI )
3 3 3
Measurement and Comparability of Per Capita Income (PCI)

PCI is often used as a summary index of the relative economic wellbeing of people in different
nations. PCI is given by a formula,
GDP
PCI=
POPn
Where PCI – Per Capita Income
GDP – Gross Domestic Product
PoPn- Population
Gross Domestic Product (GDP) is defined as the total final output of goods and services
produced by the country's economy, within the country's territory, by residents and non-
residents, regardless of its allocation between domestic and foreign claims.

It is inappropriate to use PCI of developing countries for comparing them with other countries
because:
i. the majority of the population in LDCs are subsistence farmers who produce for own
consumption and such outputs are not reported correctly in calculation of GDP
ii. people in LDCs under report their income for fear of tax
iii. the gradual extension of monetary economy and the shift of economic activities from
the HH to the market place in LDCs affects GDP
iv. distortion of prices is very high in LDCs than in MDCs
v. the cost of pollution and other environmental degradation are not deducted from the
GDP to get net GDP in LDCs. These are deducted in MDCs (e.g., Sweden,
Netherlands)

Even if the above problems don't exist, there is still another problem which renders the use of
PCI as economic wellbeing index inappropriate. The problem arises when the national income
measured in local currencies are converted into US dollar at official exchange rate determined by
free exchange market or by the action of governments. In this case, GDP of LDCs will tend to
underestimate the economic wellbeing of the people of LDCs. For example, if GDP of Ethiopia
is 870 birr, this can be converted to into US dollar by using official exchange rate as follows:
GDP in USD = 870/8.7 = $100
Dear student do you think that Br8.7 (=$1) in Ethiopia equivalent to $1 in USA in terms of
purchasing power? That is, can it buy the same level of living standard in both countries, or is the
official exchange rate a good measure of purchasing power parity between countries?
The official exchange rate, even if it is determined by a free market, is not a good measure of
purchasing power parity (equality) between countries at different stages of development. The
reason is exchange rates are determined by the supply and demand for currencies based on traded
goods only. But domestic price is a composite of prices of
i. traded commodities whose prices are equalized internationally, and
ii. Non-traded commodities whose prices are largely determined by the cost of
labor which tends to be lower for poor countries.
Therefore, in LDCs where the ratio of prices of non-traded goods to traded goods is lower, GDP
converted to foreign currency using official exchange rate will understate the living conditions of
the people.
For that reason, to make meaningful international comparison of economic wellbeing, we need to
convert PCIs of each country into their purchasing power equivalents (PPE) where by PPE we
mean the real buying power of a given monetary income. But, how do we convert PCI in local
currency into its PPE? In its simplest version, PPE of PCI is calculated by multiplying PCI in
local currency by PPPs instead of official exchange rates. As an example, suppose:
 A basket of goods costs $20 in USA and Br 36 in Ethiopia.
 Ethiopia’s PCI in 2004 is Br 870.
 Official exchange rate: $1 = Br 8.70
Given the above information, the PPE of Ethiopia’s per capita income will be
PPE= PCI* PPP
= Br 870 X (20/36)
= 483.3.
Where PCI*PPP is PPE of per capita income.
The above result says that, in terms of purchasing power, Br 870 in Ethiopia is equivalent to
$483.3 in USA. But in terms of official exchange rate Br 870 is equivalent to only $100.
 Note that the gap between the rich and poor nations is not as wide under PCI*PPP as compared
to the gap that exists when we uses PCI calculated using official exchange rate.

Note that Purchasing Power Parity (PPP) mean

that an economic theory that estimates the amount of adjustment needed on the
exchange rate between countries in order for the exchange to be equivalent to
each currency’s purchasing power.
The relative version of PPP is calculated as:

Where:
"S" represents exchange rate of currency 1 to currency 2
"P1" represents the cost of good "x" in currency 1
"P2" represents the cost of good "x" in currency

1.8 Development Gap

The term "Development Gap" is used in both an international and domestic context to describe
the gap in level of development of two geographical areas. Alternatively, the term also refers to
the notable disparity/inequality in development between the more industrialized countries and
its more underdeveloped counterpart. When comparing the development gap of two areas, one
can focus on different aspects of development such as humanitarian, ecologic, and economic.

There is wide development gap between rich and poor countries in terms of level of per capita
GDP, level of employment, level of education, quality of infrastructure, public service, and etc.
The development gap is the divide between rich and poor. This exists at several levels. In the
world the ‘the richest ’, represent 20% of people, who consume around 80% of all resources.
While the poorest 20% of people who earn only 1.3% of global income.

Unit summary

 Development certainly implies change or transformation but, when referring to a

country, its society or its economy, the concept of development can be interpreted very
 broadly. It would include, in addition to certain economic changes and processes, other
transformations which would usually be regarded as political and/or social.
 Economic Growth refers basically to the rise in the value of the goods and services
produced by an economy. It is conventionally measured as the percentage increase in real
Gross Domestic Product (GDP) or Gross National Income (GNI). Economic growth is a
mere quantitative expansion of the economy without structural changes. Economic
Development on the other hand is a multi-dimensional process involving changes in
individual behaviours, social structures, popular attitudes and national institutions. It is a
process that includes the organization of economic, political and social systems. Simply
stated, development refers to the process of improving the quality of life of all human
lives.
 The core values of Development are life sustenance, self esteem, and freedom from
servitude. Similarly, there are three major objectives of development These are: to
increase the availability and widen the distribution of basic life sustaining goods, to raise
the level of living including more jobs, better education, greater attention to cultural and
humanistic values and all of which serve to generate individual and national self esteem,
and to expand the range of economic and social choice available to individuals and
nations by freeing them from servitude.

 There are many obstacles to economic development of developing nations. The major
are: vicious circle of poverty, political instability, corruption, lack of investment, socio -
cultural obstacles, international forces, and inadequate infrastructure facilities.

 Development is a multidimensional in nature. Different countries have experienced

different approaches to economic development. However, there are some common
requirements for development that poor nations must fulfil. These are: removing market
imperfections changing the structure, capital formation, following suitable investment
criterion, socio-cultural requirements and administrative Requirements.
 Human development is a process of enlarging people’s choices: “The most critical ones
are to lead a long and healthy life, to be educated and to enjoy a decent standard of living.
It has two sides: one has to do with the formation of human capabilities, such as
 improved health, knowledge and skills. The second is related to the use people make of
their acquired capabilities for leisure and for productive purposes of being active in
cultural, social and political affairs. Every year, UNDP publishes HD report in which it
tries to show HD status of 175 countries using Human Development Index (HDI).
 The Human Development Index (HDI) is a composite statistic used to rank countries
by level of human development. The statistic is composed from data on life expectancy,
education (knowledge) and per-capita GDP (as an indicator of standard of living)
collected at the national level.

 Development Gap refers to the notable disparity in development between the more
industrialized countries and its more underdeveloped counterpart. When comparing
the development gap of two areas, one can focus on different aspects of development
such as humanitarian, ecologic, and economic. The level of human development of
various countries is measured with the Humanitarian Development Index (HDI.

Main points:
Economic Development

Economic growth

Human Development

Development Gap

Human Development Index

Life sustenance

Self esteem

Core values of Development

Objectives of Development

Review Questions

1. How do you explain Development?

2. Explain the factors that contribute for the emerging of Development Economics
as a separate field of Economics?
3. Distinguish between Economic growth and development?
4. What are the major challenges of Development?
5. What are the core values and objectives of Development?
6. Explain the pre conditions for economic development?
7. Discuss development gap