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1.2 Economic growth and development

We have started our discussion of development by addressing very broad issues relating to the concept of development. However, much of the literature and thinking about 'development' focuses on economics. Indeed 'development' and 'economic development' have often been treated as synonymous concepts. The economic development of a country or society is usually associated with (amongst other things) rising incomes and related increases in consumption, savings, and investment.

Of course, there is far more to economic development than income growth; for if income distribution is highly skewed, growth may not be accompanied by much progress towards the goals that are usually associated with economic development.

What characteristics are typically associated with economic development? Write down a list of features that in your view might distinguish an economically developed country from one that is not.

You might have included the following in your list
  • low levels of poverty, of hunger and malnutrition, of serious infectious diseases, of homelessness, of crime, of corruption
  • high levels of income, of consumption, of saving and investment, of employment
  • universal access to social safety nets for the unemployed and people on low incomes, to primary and secondary education, to healthcare services, to good public services (policing, fire service, refuse collection etc)
  • widespread access to good housing infrastructure, road and transport infrastructure, public utilities (power, water and sanitation, telephones)
  • Check your answer

    Clearly not all developed countries exhibit all these characteristics in equal measure. And, some of you might even question the presence of certain items in the above list, pointing perhaps to countries (or regions within them) in which, for example, crime and employment levels appear to be quite high, or highlighting the fact that not everyone has access to good public services, housing and so on. Some of these points are clearly open to debate. For instance crime levels in the rural areas of many developing countries where most people live are often much lower than in some of the urban population centres of developed countries. Nonetheless, the above list is probably fairly indicative of the characteristics that distinguish countries that are economically developed from those that are not.

    Economic growth

    From the answer to the previous question you will have noticed that the listed characteristics once again say more about goals than the processes or mechanisms for achieving them. So what drives a country towards achieving these goals? The orthodox view, espoused by most governments, most major international organisations, and the economists that advise them, is that a big part of the answer lies in economic growth.

    However, economic growth can follow many different paths, and not all of them are sustainable. Indeed, there are many who argue that given the finite nature of the planet and its resources, any form of economic growth is ultimately unsustainable. We shall leave these debates for later. For now let us look at what exactly economic growth is and how it is measured.

    Economists usually measure economic growth in terms of gross domestic product (GDP) or related indicators, such as gross national product (GNP) or gross national income (GNI) which are derived from the GDP calculation. GDP is calculated from a country's national accounts which report annual data on incomes, expenditure and investment for each sector of the economy. Using these data it is possible to estimate the total income earned in the country in any given year (GDP) or the total income earned by a country's citizens (GNP or GNI).

    GNP is derived by adjusting GDP to include repatriated income that was earned abroad, and exclude expatriated income that was earned domestically by foreigners. In countries where inflows and outflows of this sort are significant, GNP may be a more appropriate indicator of a nation's income than GDP.

    There are three different ways of measuring GDP

    The income approach, as the name suggests measures people's incomes, the output approach measures the value of the goods and services used to generate these incomes, and the expenditure approach measures the expenditure on goods and services. In theory, each of these approaches should lead to the same result, so if the output of the economy increases, incomes and expenditures should increase by the same amount.

    Figures for economic growth are usually presented as the annual percentage increase in real GDP. Real GDP is calculated by adjusting nominal GDP to take account of inflation which would otherwise make growth rates appear much higher than they really are, especially during periods of high inflation.

    Short-term versus long-term growth

    A distinction needs to be made between short-term growth rates and longer term ones. It is quite normal for short-term growth rates to fluctuate in line with the business cycle. This can be seen in the two figures in 1.2.1 representing GDP growth in the US between 1930 and 2003.

    1.2.1 US GDP (1930 to 2003) in billions of $US (at year 2000 prices)

    US GDP growth rates (percentage change on previous year, 1930 to 2003)

    Source: unit author, based on statistics from US Department of Commerce, Bureau of Economic Analysis

    According to the measures of GDP and growth shown here, growth in recent decades has fluctuated between zero and 5% per annum. Clearly, based on long-term trends, growth rates exceeding 5% (as measured here) would seem to be unsustainable. When politicians are talking about sustainable growth they are often referring to macroeconomic concerns relating to the cycle of boom and bust.

    An economic boom involves high growth rates and is often accompanied by rising inflation. It is often followed by a period of lower growth rates and recession ('bust'). Sustainable growth in this context relates to stable growth rates that even out the fluctuations in the business cycle, thus avoiding high peaks and the large troughs associated with recessions. Note that this is different from the issues that environmentalists typically focus upon when they discuss the sustainability of economic growth. We shall say more on this later.

    Relationship between growth and development

    Now take a moment to think about what GDP and GDP growth tell us about a country's level of economic and social development.

    Do high levels of GDP necessarily correspond with high levels of development? Not necessarily. It is not aggregate GDP that is important, but GDP per capita. Countries like China and India have much higher levels of GDP than, say, Singapore, New Zealand or Belgium, but few would suggest that the latter are economically less developed than the former.

    If GDP growth is to translate into higher GDP per capita, it has to outpace population growth. Assuming that it does, is it reasonable to say that development is taking place?

    The standard answer is yes.

    Check your answer

    Certainly, statistics reveal that the most developed countries are those with the highest GDP per capita. Clearly, though, GDP per capita doesn't tell the whole story. GDP per capita is calculated by dividing GDP by the population. It says nothing about how incomes are distributed or spent. Growth in GDP per capita could result from growth in the incomes of richer groups in society, with incomes of poorer groups remaining largely unchanged. It coincides with spending patterns that are skewed towards the rich and which exclude the needs of the poor. It doesn't necessarily follow that growth in per capita GDP will lead to a reduction in poverty or to broader social and economic development. Indeed, there are those who argue, rightly or wrongly, that in many countries economic growth is associated with increasing levels of poverty, rather than the reverse.

    The relationship between economic growth and poverty is a hotly debated topic, about which people are very divided. Some people highlight the negative effect of growth on low income groups, stressing the need for new approaches to economic development that will allow the poor to benefit more from economic growth than they do at present. Others are more sanguine, believing that the benefits of current models for growth will eventually 'trickle down' to poorer groups in society, if they are not already doing so.

    Inequality

    Most development professionals now believe that growth, at least in poorer countries, is essential (but not always sufficient) for poverty reduction in the longer term. However, inequality is a potentially important factor in determining how quickly and effectively growth reduces poverty, with growth in countries that start out with high levels of inequality being less effective in reducing poverty than it would be were inequality less pronounced (see Ravallion 2005). A renewed interest in the role of inequality and efforts to reduce it appears to have entered the development discourse since the global economic crisis of the late 2000s.

    Much of the debate in this area revolves around the values and ideals of those engaged in it, as well as the different theories on the subject. It also hinges upon interpretations of the empirical evidence. Poverty and income distribution are hard to measure, especially in developing countries where the capacity to gather and analyse data is often very weak. Consequently, the strength of the statistical relationship between growth, poverty and inequality remains the subject of heated debate. There is also controversy about the mechanisms by which economic growth may reduce poverty, the timing of these and the policy implications. This has been heightened by the 'bottom billion' debate (see 1.2.2).

    1.2.2 The bottom billion

    The bottom billion debate which revolves around the question of whether the poorest people (the bottom billion) are to be found in the poorest countries ( see Collier 2007) or in fast growing middle income countries (see Sumner 2010). The policy implications and the politics of tackling poverty depend greatly on which perspective is taken in this debate. Should, for example, international efforts to reduce poverty be focused on the poorest countries (much of sub-Saharan Africa plus various failed states) or on reducing poverty in more densely populated parts of the world (especially South Asia, but elsewhere too) where most of the world's poor now live, but where average incomes in the countries they live in are much higher than in low income countries? Some would argue that the poor in middle income countries should be the responsibility of the national government concerned and international efforts should be concentrated instead on countries where governments have far fewer resources at their disposal. Others argue that this is to neglect the plight of the majority of the world's poor people.

    Source: unit author

    GDP and purchasing power parity

    An additional problem with GDP as a measure of development occurs when one compares per capita GDP across countries. This problem arises because one US dollar in the United States or Europe, for example, does not buy the same amount of goods and services as it would do in, say, Africa or Asia. For many goods and services one dollar will purchase significantly more in a developing country than it will in a developed one. To overcome this difficulty, economists often use purchasing power parity (PPP) dollars when making cross-country comparisons of GDP. These are dollars that are adjusted to account for the differences in purchasing power between different countries.

    Human development index

    The weaknesses inherent in the use of GDP as a measure of development have led to the creation of other measures. The most well known of these is the human development index (HDI) published on a regular basis by The United Nations Development Programme (UNDP) in its Human Development Report. The HDI is a composite index that rates countries according to their overall performance in relation to three criteria

    As noted earlier, these are related to fundamental freedoms to live and to participate in society.

    UNDP publishes a number of different human development indicators, many of which are composites of other weighted indexes. The main indexes are

    A diagrammatic overview of how these are calculated is shown in 1.2.3.

    1.2.3 Calculating human development indicators

    Source: UNDP (2011) p. 167.

    Exploring human development indicators

    Go to the UNDP website and see what you can learn about the HDI and other human development indicators.

    Try and find out where your country sits in the HDI rankings. How does it compare with the performance of other countries that you are familiar with? Do the results surprise you and how do you think they might be explained?

    Also, see if you can find the latest Human Development Report. You might want to download this for future reference.

    You will also find information on the Millennium Development Goals at the UNDP site, if you would like to learn more about these.