Defining economic development

Economic development can be defined as the improvement of the well-being of a country’s citizens over time. Economic development is, however, difficult to define because it focuses on the improvement in the welfare or well-being of a country’s population. Welfare or well-being are subjective terms, which makes defining economic development as 'an improvement in well-being' an open-ended statement that is difficult to quantify. Economists often view economic development in a multi-dimensional way that takes into account a number of different factors. 

Characteristics of economic development

Many economists look at improvements in welfare by considering the following characteristics:

• Rising household incomes, which gives the population greater access to goods and services that improve their material quality of life
• Falling levels of poverty so everyone in society can enjoy a basic level of welfare
• Increased provision of public services like education and health to give people the ability to improve their well-being.

Many other characteristics could be considered, but these provide economists with a basic framework to understand and measure economic development. The characteristics considered above are based on the UN Development Programmes, Human Development Index (HDI), which we will cover later in this chapter.

Measuring economic development

Real GNI per capita

The principle that the higher the real GNI per capita a country has the more advanced its economic development is based on the idea that countries with a higher real GNI per capita will have:

• Higher average incomes and their households have greater access to goods and services
• Lower levels of poverty as the poorest in society have more income.
• Better healthcare and education provision as the government has more tax revenue to spend on public services.

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This means countries with a higher real GNI per capita will have a better level of welfare for their population than countries with a lower real GNI per capita. The table sets out GNI per capita for five More Economically Developed Countries (MEDCs) in 2021.

Purchase power parity (PPP)

An important element of using GNI per capita to measure economic development is to convert GNI numbers into a common currency so they can be used for international comparison. For example, to compare the GNI of European countries with the US, Euros need to be converted into US dollars. We could use market exchange rates to do this, but market exchange rates are constantly changing from day to day because of demand and supply changes in the currency markets. A current market exchange rate would give a misleading GNI conversion. Countries use a method called purchase power parity(PPP) to convert their GNIs into US dollars.

The PPP is a long-term exchange rate calculated by considering the ratio of prices in one country compared to another.  A basket of goods is chosen in each country that represents the typical basket of goods consumers buy.

Price of the basket of goods in the US / price of the basket of goods in the EU = PPP exchange rate

Problems of using GNI per capita to measure economic development

Income distribution

The GNI per capita is an average and that does not account for the disparity between the richest and poorest people in society.  The GNI per capita of a country may be high, but this can give a misleading view of welfare if there is a high concentration of income amongst a small percentage of the richest people in society. 

The nature of goods produced

Some goods produced and consumed in a country add more to welfare than others.  For example, $20 million spent on a school may well create more welfare than the same amount spent on a very expensive yacht because the social benefit to society of the consumption of education is greater than a yacht.   Countries, where a high proportion of output is spent on luxury goods compared to necessity or merit goods, may have lower levels of overall welfare amongst the population.

Diagram 3.3 shows the production possibility curves for two economies, country A and country B. Country A could be said to have higher welfare amongst its citizens relative to country B because it allocates more resources to necessity goods.

Changes in quality over time

It can be argued that economic growth understates economic development because the quality of products produced by an economy improves over time.  The cars, computers and mobile phones consumers buy now are superior to the cars, computers, and mobile phones they bought 10 years ago.  This will not be reflected in the GNI figures because they only reflect the money value of the products bought by consumers.

Non-monetary factors

Some factors in a country add to welfare but cannot be measured in money terms, and so will not show in the GDP/GNI figures.  Here is a sample list of factors that can affect the welfare of the population and are not included in real GNI per capita data:

• Crime rates - a high crime rate will reduce welfare in a country.
• Political Freedom - greater political freedom in a nation is often seen to increase welfare.
• Leisure time - societies, where people have more leisure time, can offer their population a greater quality of life.
• Climate - favourable weather conditions can offer a better standard of living.
• Family and cultural values - societies where people feel closer to friends and relatives are often viewed as happier.
• Mental health - low levels of stress, anxiety and depression are indicators of good levels of welfare.
• Gender and racial equality - more equal societies are often viewed as ones with higher welfare.

Alternative methods of measuring economic development

The real GNI per capita figure offers economists an objective figure with which to assess the economic development of a country, but it has limitations in terms of its use to measure the welfare or well-being of a country’s population. To consider welfare data in a wider sense, economists have developed a range of broader-based methods of measuring economic development. Whilst these alternative measures look at welfare in society in a more sophisticated way than GNI, they do have weaknesses. As they are averages they do not reflect everyone’s well-being and they try to measure things that are very difficult to measure, like collective happiness.

Human development index (HDI)

The Human Development Index is used by the United Nations Development Programme to measure a country's economic development in terms of life expectancy, education, and material standard of living.

The following criteria are used in the construction of the HDI:

• Life Expectancy in years (health indicator)
• Mean years of schooling and expected years of schooling (education indicator)
• Real GDP per capita (income indicator)

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The three criteria are combined to give a numerical value from 0-1, where the HDI value is closer to 1 the more developed a country is.

OECD Better Life Index

The Organisation for Economic Co-operation and Development has developed a broader measure of well-being which looks at some of the key factors that affect the welfare of a nation’s population.  The Better Life Index uses 11 criteria that are objectively measured in a country to form an index number.  The criteria include:

• Housing
• Income
• Employment
• Community life
• Education
• Environmental factors
• Governance
• Health
• Level of happiness
• Safety and security
• Work-life balance

World Happiness Report

Along with the Human Development Index, the United Nations has also developed the World Happiness Report is based on a survey of how people rate their own lives. The survey ranks national happiness using a survey that asks a sample of respondents to think of their happiness as a ‘ladder’, with the highest life rating being a 10 and the lowest life rating being a zero. The individuals who are part of the survey have to consider factors such as citizen engagement, communications, technology, education, health, emotion and diversity, etc when they are making their judgement about happiness. The responses of a sample of individuals within a country are then aggregated to form the index.

Happy Planet Index

The Happy Planet Index measures the sustainable well-being of a nation’s population. It considers the welfare of a nation in terms of achieving sustainable lives for its citizens. It was introduced by the New Economics Foundation (NEF) and uses a weighted index that favours countries with smaller ecological footprints. There are four elements used to construct the Happy Planet Index: well-being (based on the World Happiness Report), life expectancy, inequality of outcomes (based on well-being and life expectancy) and ecological footprint (average impact a citizen has on the environment).

Costa Rica is a country that has always performed well in Happy Planet Index. Its relatively good scores on life expectancy, well-being, ecological footprint and inequality give it a Happy Planet Index score of 44.7 well above its richer neighbour, the United States.