Chapter 7 Notes: Indicators of Economic Development and Human Development Index

Indicators of Economic Development

• Main indicators of economic development are classified into two categories:

  • Income-based measures (primarily per capita income)
  • Indicators measuring quality of life (e.g., Physical Quality of Life Index (PQLI), Basic Needs Index, and Human Development Index (HDI))

• Two key income-related indicators frequently cited:

  • Per Capita Income Index
  • Human Development Index (HDI) as a broader measure including non-income aspects

• Real per capita income vs. total national income

  • Real per capita income is a better indicator than total national income for assessing economic development because:
  • Historically, development indicators emphasized real per capita income growth over long periods
  • A mere rise in GDP or GNP does not necessarily reflect economic growth
  • Economic growth should reflect an increase in the average standard of living (income per head)
  • Real per capita income measures the per capita availability of goods and services and is corrected for population change and price level changes (inflation):
  • If nominal per capita income rises by 10% while the price level rises by 10%, real income power does not increase
  • Real income growth requires that the increase in income exceeds the increase in prices
  • Real per capita income is calculated using constant prices to remove price fluctuations

• Real per capita income: key definitions and implications

  • Real per capita income: a measure of per person availability of goods and services
  • If per capita income increases in money terms but prices rise equally, real purchasing power does not rise
  • Important to compare incomes in real terms (constant prices) to assess true development progress

• Q2: Real per capita income is a more appropriate indicator of economic development than total national income. Justifications

  • Traditional emphasis on real per capita income growth over long periods
  • GDP/GNP growth alone does not guarantee improvements in living standards
  • Since growth should reflect higher average living standards, income per head is more relevant
  • Real per capita income isolates changes in living standards from population growth and inflation
  • Per capita income measures per person availability of goods and services

• Per Capita Income Index: limitations and criticisms

  • Limitations (at a glance):
  • 1) It does not consider the composition of output
  • 2) Distribution of income is ignored
  • 3) It does not address poverty
  • 4) Ignores costs like depletion of natural resources and environmental degradation
  • 5) Services of housewives (and other non-market activities) are excluded
  • 6) Exchange rate issues in international comparisons: (i) Different concepts of national income, (ii) Differences in price levels
  • 7) It ignores social, human, and institutional aspects
  • Some nuanced shortcomings:
  • 1) The composition of output matters for interpreting growth (e.g., armaments versus civilian goods)
  • 2) Distribution of income accompanying growth may widen inequalities
  • 3) Increases in per capita income may not reduce poverty if the poor do not benefit
  • 4) Output growth may be achieved at the expense of environmental costs or labor conditions
  • 5) Many goods/services do not pass through markets and are not included in national income (e.g., housewives’ work, home production)
  • 6) International comparisons are problematic due to exchange rates and price level differences

• Q3: Real per capita income: definition and interpretation

  • Real per capita income measures the per-person availability of goods and services in real terms
  • If real per capita income grows, people can purchase more goods/services on average
  • If nominal income grows but prices rise by the same or more, real per capita income may not rise
  • The calculation uses money terms adjusted to remove the effect of price level changes (i.e., constant prices)

• Q4: Limitations of Per Capita Income Index (summary)

  • Key limitations include:
  • Non-consideration of output composition
  • Ignoring income distribution
  • Not addressing poverty directly
  • Excluding non-market services and environmental/resource costs
  • Exchange rate and price level complications in international comparisons
  • Neglect of social, human, and institutional dimensions

• Q5: Problems in international comparison when using per capita income as an indicator

  • (a) Expressing national income in a common currency (e.g., USD) via exchange rates can be misleading because:
  • Exchange rates vary and may not reflect relative price levels
  • (b) Different countries use different concepts of national income (e.g., some socialist economies include only material goods; services may be treated differently elsewhere)
  • (c) Differences in price levels lead to distorted comparisons of purchasing power across countries (global PPP comparisons address this)

• Q6: Quality of Life Index

  • Quality of Life Index is constructed by combining indicators related to basic needs and living standards
  • Factors include availability of basic income/wealth, food, clothing, shelter, literacy, healthcare, clean environment, political rights, etc.
  • The index of quality of life is a broader construct used to gauge overall well-being beyond income

• Q7: What is Human Development? (HDI overview)

  • The Human Development Report (1997) defines human development as widening people’s choices and raising their well-being
  • Human development goes beyond income and includes economic, social, cultural, and political dimensions
  • The concept places people at the center and emphasizes a broad set of capabilities

• Q8: Main propositions of the concept of human development

  • 1) Human development places people and the quality of life at the center of development, emphasizing participation and equity
  • 2) Human development is the end goal; economic growth is a means to that end
  • 3) The purpose of development is to widen people’s choices
  • 4) Human development covers all aspects of development (economic, social, cultural, political) and involves the entire society, not just the economy
  • 5) Human development is universal and applicable to both less-developed and highly developed countries

• Q9: Basis of construction of the Human Development Index (HDI)

  • The HDI provides a single index to capture three key dimensions of human development:
  • A long and healthy life
  • Knowledge acquisition (education)
  • A decent standard of living
  • The HDI uses three variables/systems to measure these dimensions:
  • Life expectancy at birth (to measure a long and healthy life)
  • Education attainment (to measure knowledge): a combination of mean years of schooling and expected years of schooling; also includes indicators like adult literacy rate and gross enrolment ratio
  • Gross National Income (GNI) per capita adjusted for Purchasing Power Parity (PPP) in US dollars (to measure standard of living)
  • HDI construction procedure:
  • Construct individual indices for each dimension (LEI, EAI, AGNII)
  • Use fixed minimum and maximum values for each dimension
  • Compute each index as: ext{Index}(X) = rac{X - X{ ext{min}}}{X{ ext{max}} - X_{ ext{min}}} for X ∈ {LEI, EAI, AGNII}
  • Combine the three indices by simple arithmetic average: ext{HDI} = rac{LEI + EAI + AGNII}{3}
  • Example: If life expectancy at birth is 65 years, with min 20 and max 80, then
  • LEI = rac{65 - 20}{80 - 20} = rac{45}{60} = 0.75
  • If the other two indices (EAI and AGNII) are also 0.75, then HDI = rac{0.75 + 0.75 + 0.75}{3} = 0.75

• Q10: Three variables chosen for designing the HDI (V imp)

  • 1) Life expectancy at birth: long life is measured by life expectancy at birth; higher life expectancy indicates higher development
  • 2) Education: a combination of two indicators to measure educational attainment:
  • (a) Mean years of schooling: average number of years of schooling received by people aged 25 and above
  • (b) Expected years of schooling: number of years of schooling that a child of school entrance age can expect to receive
  • The constituents of educational attainments include:
  • (a) Adult literacy rate: percentage of people aged 15 and above who can read and write
  • (b) Gross enrolment ratio: percentage of the population enrolled at primary, secondary, and tertiary levels; higher gross enrolment ratio implies higher development
  • 3) Standard of living: AGNII (or Standard of Living Index, SLI) measured as GNI per capita adjusted for PPP in US dollars

• Q11: Explain the concept of Purchasing Power Parity (PPP)

  • PPP is the rate adjusted for differences in the cost of purchasing the same basket of goods across currencies
  • For international comparison, GNI per capita is often expressed in PPP-adjusted US dollars (PPP US$)
  • PPP exchange rate accounts for differences in cost of living, making international comparisons more meaningful
  • In practice:
  • GNI per capita is converted to a common currency for comparison, but market exchange rates can mislead due to price level differences
  • PPP-based conversions mitigate this by reflecting relative buying power rather than nominal exchange rates

• Q12 Merits of HDI

  • 1) HDI combines economic (GDP per capita) and social indicators (life expectancy, education), making it multidimensional
  • 2) HDI provides a more comprehensive measure of development than per capita income alone
  • 3) HDI enhances understanding of development performance and helps identify countries truly experiencing development (via HDI trends)
  • 4) HDI focuses policy attention on ultimate development objectives, guiding policymakers toward areas needing improvement

• O13: Shortcomings of HDI (read for context)

  • 1) HDI simplifies and captures only a few dimensions of human development
  • 2) It cannot be treated as a fully comprehensive index since it uses only three variables
  • 3) It does not reflect on inequalities, poverty, human security, environment, etc.
  • UNDP groups for HDI performance (grouped into four tiers):
  • Very high human development index (HDI ≥ 0.800): Examples include Norway, Australia, Japan, New Zealand
  • High HDI (0.700 < HDI ≤ 0.800): Examples include China, Sri Lanka
  • Medium HDI (0.550 ≤ HDI ≤ 0.699): Examples include India, Philippines, Bhutan, Ghana, Nepal
  • Low HDI (HDI < 0.550): Examples include Nigeria, Uganda, Afghanistan

• Practical takeaways

  • HDI provides a more nuanced view than income alone but remains a simplified, multidimensional measure
  • PPP-adjusted metrics help make international comparisons more meaningful by aligning currencies to relative purchasing power
  • The HDI framework emphasizes capabilities and choices beyond mere income, aligning with broader development goals