Development of Economies
Written by Togzhan Batyrbekova, Elin Thomas and Swati Bisht.
WHAT IS ECONOMIC DEVELOPMENT?
In economics, when the word “development” is used, it usually means economic development. As the name implies, this is the process of an economy growing, resulting in improvements in both social and economic conditions- in other words, a higher quality of life. There is a section of economics that studies this called development economics.
In general, countries’ economies can be sorted into 2 groups: MEDC or LEDC. LEDC stands for a less economically developed country, while MEDC stands for a more economically developed country. As a country progresses from an LEDC to an MEDC, it goes through economic development.
STAGES OF DEVELOPMENT
There are different models of the stages through which an economy goes through during this process.
One of them is the three-sector model, in which the level of economic development in a country can be determined by looking at its dominant sector of production. There are 3 sectors in total: the primary sector, which is the extraction of raw materials, for example, fishing, mining, or farming; the secondary sector, which is transforming raw materials into goods, e.g clothes; and the tertiary sector, which is services like transportation or teaching. As an economy develops, it goes from having the primary sector as the dominant to their secondary sector, and finally to their tertiary sector.
Another model is Rostow’s five stages of development. The first stage is a traditional society, where an economy is agricultural, with little to no trade, causing inefficiency and low productivity. The second stage is called pre-conditions for takeoff, which is when more of the agriculture is traded, which can set grounds for specialization and therefore higher productivity. More manufacturing occurs. The third stage is a take-off, which is when the manufacturing industry grows rapidly. But though agriculture is less important than before, it is still a major part of the economy. The fourth stage is the drive to maturity, when industries grow and develop, causing more innovation and improvements in technology. The fifth stage of development is the age of mass consumption, when the output of firms and industries grows, which means more people can afford goods and services. At this point, the economies move towards a more tertiary sector activity.
However, these models are not 100 percent accurate. A more precise way of measuring economic development, and therefore looking at which level it is, would be economic indicators:
ECONOMIC INDICATORS
Talking about the Development of economics, it is apparent to think about how an economy is defined as developed or developing. Here, economic indicators come to play. An economic indicator is a piece of statistical economic data, usually of macroeconomic scale, that is used by analysts to interpret, assess, measure, and evaluate the overall state of the economy.
The governments and private business organizations in various countries collect data via census or surveys, which is then analyzed further to generate an economic indicator.
This information helps individuals and businesses understand how well the economy is functioning under certain conditions.
They help in taking up important decisions like private investments. The government uses these indicators to devise well-suited economic policies. They are also the benchmarks that economists use when comparing one nation’s economy to another nation’s economy.
Some of the most common and widely accepted economic indicators are the Gross domestic product(GDP), Consumer price index(CPI), Purchasing manager’s Index, Unemployment rates, etc.
Types of indicators
The economic indicators can be classified in two ways -
On the basis of their timings
On the basis of their correlation with the general trend of the economy.
On the basis of timing-
Leading
Leading indicators are those which change before the economy changes as a whole. As the name suggests they help in leading us to an economic outcome and can be used for short-term predictions. For example, the stock market is a leading indicator- it goes down before the crash of an economy and goes up before the economy fully revives from the slump. It must also be noted that these indicators are sentiment-based and only tell us what might happen, they are not conclusive. As in this example, the stock market could be rising due to a market bubble as well ( Market bubble- A condition where the price of an asset rises much more than its own value). They are speculative in nature and forecast future events
Lagging
Lagging indicators are those which change after the economy changes as a whole. This lag could be a few quarters. These indicators confirm a long-term trend and can be used to analyze future trends. A lagging indicator is a financial sign that becomes obvious only after a large shift has taken place. For example, Unemployment rates- unemployment rates tend to decrease a few quarters after the economy has taken an upturn. This happens because even after the economy has revived, it takes time for the firms to have confidence in employing new workers again. Similarly, when the markets decline, it takes time to get rid of workers as more often than not they are bound by an agreement.
Coincident
These indicators change approximately at the same time as the economy and talk about current economic situations. Gross domestic product is an example of a coincident indicator.
On the basis of their correlation with the trend of the economy -
Procyclical Indicators
They move in the same direction as the general economy, they increase when the economy is doing well and decrease when it is doing badly. Gross domestic product (GDP) is a procyclic indicator.
Countercyclical indicators
They move in the opposite direction to the general economy. The unemployment rate and the wage share are countercyclical, they rise when the economy is deteriorating.
Acyclical Indicators
They are the ones with little or no correlation to the business cycle, they may rise or fall when the general economy is doing well and may rise or fall when it is not doing well.
Gross Domestic Product or GDP
Gross domestic product is the most basic indicator used to measure the overall health and size of a country's economy, so it is imperative to learn about it. As per definitions, GDP is the overall market value of the goods and services produced domestically by a country. Here, Market value refers to the value at which the goods and services are sold in the market and Produced domestically means the goods and services which are produced inside the geographical boundaries of a country irrespective of who has produced them.
GDP is an important figure because it gives an idea of whether the economy is growing or contracting.
Calculating GDP includes adding together private consumption or consumer spending, government spending, capital spending by businesses, and net exports—exports minus imports.
GDP= C + I + G + X
C - Private consumption or consumer spending (Consumption) - The value of all the goods and services consumed by the country’s households. This accounts for the largest part of GDP.
G - Government Spending - All consumption, investment, and payments made by the government for current use.
I - Capital Spending by Businesses - Spending on purchases of fixed assets and unsold stock by private businesses
X - Net Exports ( Export - Imports) - Represents the country's Balance of trade where a positive number bumps up the GDP as the country exports more than it imports and vice versa.
Types of GDP
Because it is subject to pressures from inflation, GDP can be broken up into two categories—real and nominal.
Real GDP
A country's real GDP is the economic output after inflation is factored in. The real GDP is calculated at a fixed base year price which is the same for real GDP calculated at any point in time. Hence the change accounted in GDP is only due to the change in output not due to change in price (Since most of the times, the general price level increases, the change in price is automatically considered as an increase in price)
Nominal GDP
Nominal GDP is the output that does not take inflation into account. It is not calculated at a common base year price, so it takes into account changes in price and hence doesn’t give a clear picture on whether GDP has increased due to an increase in production or just due to inflation. Nominal GDP is usually higher than real GDP because inflation is a positive number.
We observe that even though the real output has not increased, an increase in the price level causes the Nominal GDP to rise which gives us a false idea of the development of the economy, in cases like these Real GDP, proves to be meaningful.
GDP can be used to compare the performance of two or more economies, acting as a key input for making investment decisions in a country. It also helps the government draft policies to drive local economic growth.
When the GDP rises, it means the economy is growing. Conversely, if it drops, the economy shrinks and may be in trouble. But if the economy grows to the point where inflation builds up, a country may reach its full production capacity. Central banks will then step in, tightening their monetary policies to slow down growth. When interest rates rise, consumer and corporate confidence drop. During these periods, monetary policy is eased to stimulate growth.
Gross National Product or GNP
Gross national product is another metric used to measure a country's economic output. Where GDP looks at the value of goods and services produced within a country's borders, GNP is the market value of goods and services produced by all citizens of a country—both domestically and abroad. So it takes into account the factor of citizenship irrespective of where the citizens reside.
GNP = C + I + G + X + Z
Where C is consumption, I is an investment, G is government expenditure, X is net exports, and Z is net income earned by domestic residents from overseas (which is income earned by domestic residents abroad minus income earned by foreign residents from domestic countries).
Unemployment
The unemployment rate is the percent of the labor force that is jobless. It is a lagging indicator, meaning that it generally rises or falls in the wake of changing economic conditions, rather than anticipating them. When the economy is in poor shape and jobs are scarce, the unemployment rate can be expected to rise. When the economy is growing at a healthy rate and jobs are relatively plentiful, it can be expected to fall.
The rate is calculated by taking the number of unemployed people, divided by the total labor force, and multiplying by 100 to get the percentage.
It must be noted that here, the labor force refers to the number of people who are employed plus the number of people who are unemployed.
Unemployed is a term that describes a person who could be working, and wants to work, but is not working; to be counted as unemployed you must be part of the eligible population, not working, and actively looking for work.
Types of Unemployment
The natural rate of unemployment is healthy for an economy and includes three components:
Frictional unemployment - occurs between the period of time when an individual quits a job and is looking for another which best suits their interests.
Structural unemployment - occurs when job skills no longer match any new jobs available. That's usually caused by, and also leads to long-term unemployment.
Cyclical unemployment - the type the media talks about most. It rises dramatically during the contraction phase of the business cycle. A recession has already started by the time it takes off because unemployment is a lagging indicator. Companies wait until they're sure to demand won't come back before laying off their workers
Economic costs of unemployment
We all know that unemployment is not desirable for the welfare of the country and its people but the economic costs of unemployment are more than just financial ones, here we take a look at the various implicit and explicit costs of unemployment on individuals, the government, and society in general.
Costs to individuals
Loss of earnings to the unemployed. Unemployment is one of the biggest causes of poverty. Prolonged periods of unemployment can push households into debt and increase rates of relative poverty.
Potential homelessness. Loss of income can leave people without sufficient income to meet housing costs. Rises in unemployment often exacerbate the rates of homelessness.
Harms future prospects. Those who are unemployed will find it more difficult to get work in the future (this is known as the hysteresis effect)
Lost human capital. If people are out of work, they miss out on ‘on-the-job training’ This is a vital component of human capital and labor skills; high rates of unemployment can reduce labor productivity. If someone is out of work for two years, they miss out on the latest working practices and trends. Being unemployed can also affect the confidence of the unemployed and they become less employable in the future.
Increase in social problems. Areas of high unemployment (especially youth unemployment) tend to have more crime and vandalism. It can lead to alienation and difficulties in integrating young unemployed people into society.
Costs to governments
Increased government borrowing. Higher unemployment will cause a fall in tax revenue because there are fewer people paying income tax and also spending less (hence lower Value Added Tax). Also, the government will have to spend more on unemployment and related benefits. The government doesn’t just pay unemployment benefits, but a family who has unemployment will be more likely to receive housing benefits and income support. Lesser revenue and higher spending will cause a debt which will in turn push the government to borrow.
Lower GDP for the economy. High unemployment indicates the economy is operating below full capacity and is inefficient; this will lead to lower output and incomes. The unemployed are also unable to purchase as many goods, so will contribute to lower spending and lower output. A rise in unemployment can cause a negative multiplier effect.
Political instability. The period of mass unemployment in the 1930s led to social unrest. In Germany, an unemployment rate of 6 million was an important factor in the rise of Hitler and the Nazi party.
Healthcare and Education
We know that healthcare and education are the major factors that determine the quality of human resources. The quality of human resources decides the efficiency, productivity, and development of the economy of a nation.
Healthcare
The role of health in economic development is analyzed via two channels: the direct labor productivity effect and the indirect incentive effect. The labor productivity hypothesis asserts that individuals who are healthier have higher returns to labor input. The incentive effect says that individuals who are healthier and have a greater life expectancy will have the incentive to invest in education as the time horizon over which returns can be earned is extended.
The health condition of an individual determines the efficiency of the work done by them. For example, the work productivity of a sick individual would be much less than that of a healthy individual. It creates a domino effect in which if the health at the individual level is not good then they are unable to perform their tasks and the burden of a task is pushed to another individual. Due to this they also might not be able to work with full efficiency and so it goes on to hamper the productivity of the whole nation.
Education
Education plays a significant role in economic development as it helps individuals to gain knowledge, skills, and attitude which would enable them to understand changes in society and scientific advancements. Education increases the accessibility of people to modern and scientific ideas. It creates awareness of the available opportunities and mobility of labor. It increases the efficiency and ability of people to use new technology. Therefore, an available educated labor force facilitates the adaptation of advanced technology in a country.
Change in Demographics
Various evidence-based practices have shown that the demographic transitions are associated with economic development. Demographic transition refers to a population cycle that begins with a fall in the death rate, continues with a phase of rapid population growth, and concludes with a decline in the birth rate.
The four stages of demographic transition that a country goes through during economic development are-
Stage 1 - High birth rates and high death rates
A country is subjected to both high birth and death rates at the first stage as an agrarian economy.
The birth rates are very high due to universal and early marriages, widespread prevalence of illiteracy, traditional social beliefs and customs, absence of knowledge about family planning techniques, attitudes towards children for supplementing family income, etc. The death rates are also high due to insufficient diets and the absence of adequate medical and sanitation facilities. At this stage, the rate of growth of the population is still high because high birth rates are not compensated by high death rates.
Stage 2 - High birth rates but lower death rates
With the gradual attainment of economic development, the living conditions of people start to improve due to better and regular diet, better medical and sanitation facilities leading to a fall in the death rate.
Regular food supply, improved law and order situations, medical innovations and advancement, development of antibiotics, vaccines, and introduction of immunization programs have led to a substantial reduction in the incidence of disease and death. But at this stage, the birth rate continues to remain very high in-spite of a substantial fall in death rates leading to accelerated growth of the population.
Stage 3 - Lower birth rates and low death rates
With the gradual attainment of economic development, the economy of the country starts to experience a change in its structure from a purely agrarian to an industrialized one.
During this stage, people become conscious about the size of the family and also on limiting the size of the family. There is an exodus of the population from rural to urban areas in search of food and jobs.
With the growing industrialization of the economy, the adoption of small family norms become very popular among the people of higher sections of society and then they start to percolate among the lower sections of society. One of the features of economic development is typically increasing urbanization, and children are usually more of a burden and less of an asset in an urban setting than in a rural one. Thus at this stage, the country will experience a fall in the birth rate, low death rate, and consequently a fall in the rate of growth of the population.
Stage 4 - Low birth rates and low death rates
The fourth stage of demographic transition is characterized by a low birth rate and a low death rate of population, leading to a stationary population. It is, therefore, known as the stage of the stationary population where both the birth rate and death rate remain at a low level leading to very little growth in population.
Due to the attainment of economic development, the standard of living of the people reaches a high level during this fourth stage. During this stage, a significant change in the social outlook of the people has taken place under the impact of urbanization, industrialization, and a high rate of literacy. Thus at this stage, the population becomes stationary at a low rate. Demographics do not determine the fate of economic growth, but they are certainly a key determinant for an economy's growth potential. An aging population coupled with a declining birth rate in the developed world points to a decline in future economic growth.
CASE STUDIES OF COUNTRIES WITH VARIOUS DEVELOPMENT LEVELS
Why is Bolivia underdeveloped?
Bolivia is the poorest nation in South America with almost 40% of its population living in extreme poverty. Bolivia's progress is hindered by the lack of human development making it unable to exploit its many natural resources.
Political Instability:
During the 1980s, Bolivia suffered a recession which included hyperinflation - in which the value of the currency is decreasing so rapidly it becomes of little use in the economy and savers suffer hugely, as well as this unemployment was extremely high, meaning average real incomes were down and there was lots of poverty. The little economic growth happening in Bolivia meant these conditions weren’t changing - and they didn’t until 2005 where GDP per capita was restored.
This wasn’t helped by the resignation of President Hugo Banzer in 2001, whose next four successors were extremely controversial figures. This was mainly caused by a disagreement between the Bolivian population and the government over the plans to export the newly found natural gas.
Poor Education:
Public education is particularly poor in rural areas where teachers are unlikely to be properly trained - but is not much better in urban areas. Private education is available but too expensive for most. This leads to what some may describe as a poverty cycle - where someone’s circumstances determine that they are unable to release themselves from poverty - without a proper education it is extremely hard to escape poverty. Not only does it make the poor stay poor but also allows the wealthy privately educated children to grow and prosper, increasing wealth inequality in Bolivia dramatically.
Lack of Access to Clean Water and Sanitation
In rural areas, communities with access to clean water are few and far between. This results in the drinking of contaminated water, one consequence of which is a third of the deaths in children under five being a result of diarrhea - an illness closely linked to contaminated water. Improvements have been made in the past 30 years but these are focused around the urban areas, so rural parts of the country are still in dire need of a clean water supply.
Rural Areas’ Low Productivity Rates
Rural areas are generally farming orientated. In Bolivia, these farms are faced with frequent water shortages, a lack of basic infrastructures such as roads and water management systems, and no mass production techniques at hand. This makes it incredibly hard for them to produce a yield that is of good quality or quantity, not only does this mean they face food shortages but also only a tiny profit as they have limited amounts to sell and limited reach because of the poor transport opportunities.
Why is Brazil a developing country?
Corruption and Government
Brazil has been subject to a plethora of corruption and scandals - with government officials often getting involved with some of the largest businesses in Brazil. The government also puts in incredibly high tariffs on imports, not only does this make general imports more expensive - increasing the price level to one higher than the UK, Canada, or Denmark by the Big Mac index of $5.10. The Big Mac index compares how much a McDonald’s Big Mac would cost in different countries in dollars to compare price levels. These tariffs are the highest in Latin America, discouraging companies from setting up in Brazil as a result of how expensive it would be to import all the necessary goods for manufacture. Brazilians call this ‘custo Brazil’ - the premium you pay for living in the country of samba and carnivals. With prices just as high as Houston, the US, or Germany.
Infrastructure
Brazil’s roads are worse than India’s, with any decent amount of rain making them into unpassable muddy tracks. It is said for every American farmer spending $9 on transport, a Brazillian farmer pays $25 - this leads to reduced profits and less incentive to produce food and perhaps switch to another business. However, Brazil has a front of good infrastructure as seen by the Olympic stadium, etc. What we don’t see is just outside all the impressive stadiums there are unfinished roads and barely existent public transport.
Inflation and Debt
Brazil has one of the highest inflation rates in the world, making it an unstable currency to live with. In many stores they have stickers saying in how many installments one may pay for the product, for example 10x, 12x, or 20x, adding huge amounts of interest. This is so common it means the Brazillian middle class is constantly paying off debt, with 60% of Brazilians being in debt by payment deadlines. With the introduction of credit cards this issue only worsened. By 2012 on average every Brazilian had 2 credit cards; they are the largest consumers of credit in Latin America. The extortionate interest rates of 414% are caused by the increased unemployment and falling wages which means most Brazilians find it incredibly difficult to ever pay off their debt. These low wages mean little to none gets saved and therefore when people become unemployed they have nothing - resulting in the homeless population of Rio De Janeiro increasing by 150% in only three years.
Why is Norway a developed country?
Sparse Population
Norway has a huge landmass, coastline, and waters, but a relatively small population - similarly to other Nordic countries it means the population puts little to no strain on resources and the money earned through their land and ocean can be distributed quite thickly throughout Norway.
Natural Resources
There are rich fishing opportunities surrounding Norway and the fishing industry still plays a critical part in the local economy, as well as strong agricultural development so they are rich in food supplies to support their limited population.
Oil
In 1962 Phillips Petroleum first investigated the North Sea for oil. The Norwegian government claimed sovereignty of large offshore areas but allowed private companies to conduct seismic surveys. In 1969 Ekofisk field was discovered which was a major discovery and would soon become a huge contributor to economic growth in Norway. The industry has created more than NOK 12,000 billion for Norway, with the oil and gas sectors accounting for around 23% of Norway’s value creation.
