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IB Diploma Economics:
Measuring Economic Development
Gross national product (GDP)
GDP is a measure of economic output. It is the total value of all final goods and services that are produced within a country in a year. The ownership of the factors of production (land, labour, capital and entrepreneurship) are not considered in the calculation. A foreign owned factory, employing foreign labour, using foreign capital while returning profits overseas to its foreign owners would be included in a country’s GDP figures. Provided the goods and services are produced in the country, then their value is included in the GDP figure.
GDP per capita = GDP ÷ population.
All other things remaining equal (ceteris paribus), the smaller the size of the population the larger the GDP per capita, and the larger the population, the smaller the value of GDP per capita.
GDP per capita and GNI per capita
GDP per capita and GNI per capita figures for developed countries and LDCs
Essential statement: GNI = GDP + net property income from abroad. Therefore, GNI will be greater than GDP when a country earns relatively more from the factors of production it owns which are employed overseas than the income generated by foreign-owned factors of production employed in the domestic economy.
Essential statement: An LDC that manages to attract a high level of foreign direct investment will have relatively low GNI per capita figure in comparison to GDP per capita, as it will have a relatively high negative figure associated with its net property income, as income earned by overseas factors of production flows out of the LDC – i.e., as profits are repatriated to their overseas owners.
Thus, on a per capita basis, GNI is likely to be proportionally lower than GDP for LDCs, in comparison to developed economies; see figure 1 below.
Gross national income (GNI)
Income per capita
GNI takes into consideration the location of the factors of production from which a country’s income is generated. Income is earned based on the ownership of the factors of production. This, income earned from foreign owned businesses is subtracted from a country’s GDP figures, and income earned from businesses abroad who are owned by its citizens, is added to the GDP figure. The difference between the two is termed net property income from abroad.
It should be immediately apparent to the IB Economics student that developed economies will have more factors of production employed abroad simply because they have the skills and capital that afford them to be able to take advantage of overseas investment opportunities – on average, their GNI will be relatively higher than their GDP. Whereas LDCs are far less likely to have land, capital and entrepreneurship resources employed abroad, and as such, GNI will generally be relatively less than their GDP figure. The exception to this can come from a relatively high share of an LDC’s labour force being employed overseas. For example, a Bangladeshi labourer working in the construction industry in Dubai will send remittances home to his family.
GNI per capita = (GDP + net property income from abroad) ÷ population.
Foreign direct investment (FDI) is a controlling ownership in a business enterprise in one country by an entity based in another country. FDI is actively encouraged by many LDCs in order to boost GDP, increase domestic employment and increase skills and transfer knowledge. Profits will flow out of the LDC and be returned to the overseas owners, and if not reinvested locally, then this income will not be spent in the LDC and it makes no contribution to economic growth in the LDC.
GDP and GNI per capita figures at purchasing power parity
GDP per capita and GNI per capita figures at purchasing power parity exchange rates
Purchasing power parity (PPP) examines the buying power equivalence of one unit of currency between countries. PPP is the amount of a country’s currency that is needed to buy the same quantity of local goods and services that can be bought with US$1 in the United States. The purchasing power of a currency refers to the quantity of the currency needed to purchase a given unit of a good, or common basket of goods and services. Purchasing power is clearly determined by the relative cost of living and inflation rates in different countries. Purchasing power parity means equalising the purchasing power of two currencies by taking into account these cost of living and inflation differences. For example, if we took $US1 and converted it into the Afghan Afghani (the unit of currency) you would be able to purchase relatively more goods and services in Afghanistan than that dollar would buy you in the United States.
For example, if we convert GDP in Afghanistan to US dollars using market exchange rates, relative purchasing power is not taken into account, and the validity of the comparison is weakened. By adjusting rates to take into account local purchasing power differences, known as PPP adjusted exchange rates, international comparisons are more valid. When examining the GDP or GNI per capita figures for a country, the purchasing power of income approach provides a more accurate gauge of the country’s standard of living.
As can be seen in figure 2 right, while average incomes in countries such as Australia and Denmark are relatively high (GDP per capita), so too is the cost of living. Thus, incomes earned in these countries afford relatively less purchasing power and as such GDP per capita at PPP is comparatively less. The opposite is true for many developing countries and less developed countries. GDP per capita incomes can purchase relatively more goods and services because the cost of living is lower. Thus, the standard of living in countries such as China and Mexico are much higher than their GDP per figures indicate. Likewise, in all LDCs, the PPP of incomes is often two to three times higher than the GDP per capita figures suggest (e.g., Kenya and Afghanistan).
What is purchasing Power Parity?
Essential statement: The cost of living in LDCs is relatively low, thus their GDP per capita adjusted for PPP is comparatively higher than their GDP per capita.
Figure 2: GDP per capita and GDP per capita at purchasing power parity
Health and Education indicators - selected countries comparisons
Figure 3: Selected countries used by IB Economics for making health and education comparisons
Life expectancy generally increases in line with a country's GDP per capita at PPP
Infant mortality generally decreases in line with a country's GDP per capita at PPP
Health indicators for economically developed countries and LDCs
In the table above, GDP per capita at PPP is given for a selection of countries to show the relationship between income and two indicators of health: life expectancy and infant mortality. As a general; rule of thumb, we can see that the higher a countries income, the longer its citizens can expect to live, on average; and the lower the number of infants dying under the age of one. The Central African Republic is the poorest country in our selection and its citizens can expect to live, on average, until only 51 years of age. Whereas, in affluent Switzerland, its citizens can expect to live, on average, to the ripe old age of 81 years of age. There are odd exceptions such as Russia, where incomes are 12 time higher than Rwanda, yet Russians could only expect to live for a further four years, on average.
Afghanistan is a very dangerous country to give birth in, where more than ten per cent of babies will die in their first year of life. This both reflects the country’s very high birth rate (6.7 children, on average, per woman) and the fact that almost all births occur in the home. Relatively wealthy Norway has reduced its infant mortality to below 2.5 per cent. Brunei has a higher per capita income than Norway, but an infant mortality rate over four times higher.
Health indicators generally improve as incomes rise. The governments of developed countries have many more resources than the governments of LDCs. Developed countries will have better health infrastructure – clean drinking water, sewerage systems, the supply of food, hospitals and general practitioners, access to medicines, and so on and such forth. Many LDCs are badly affected by war and conflict resulting in many deaths and the disruption of important food and medical supplies and services.
Adult literacy rates generally increase in line with a country's GDP per capita at PPP
The number of primary school students per teacher generally decreases in line with a country's GDP per capita at PPP
Education indicators for economically developed countries and LDCs
In a similar relationship to health, higher GDP per capita is positively rated to improving education indicators. As can be seen above, wealthy countries tend to have literacy rates that hover around 100 per cent, meaning all adults have learned to read and write to functional levels in their education systems. There are some exceptions, the United Arab Emirates has a GDP per capita that is over seven times higher than that of China, yet its adult literacy rates are slightly lower. This is thought to reflect cultural differences. In China, education has been considered to be very important for a very long time. In the UAE, the education of girls has not always been a top priority and there are still subcultures within it today where this thinking continues.
The relationship between income and education is mostly a question of resources. Governments of LDCs have much fewer resources to build schools and pay and train teachers. For example, there is just one primary school teacher for every 80 children, on average, in the Central African Republic – the poorest LDC. Contrast this to our wealthiest country – Luxembourg – where there is a primary teacher for every eight students, on average.
Essential statement: The most important determinant of the education and health of a country’s population is its GDP per capita at PPP.
Human Development Index
The Human Development Index (HDI) is a tool developed by the United Nations to measure and rank countries' levels of social and economic development based on four criteria: Life expectancy at birth, mean years of schooling, expected years of schooling and gross national income per capita.
Across each of these variables, each countries performance is scored between 0 and 1, with the four scores then combined to give the HDI value. Countries are categorised into one of four groups as follows:
What is the HDI?
In 2015, the index ranked Norway, Australia, Switzerland, Denmark and the Netherlands at the top of its list for "very high human development." The countries that fell at the bottom of its "low human development" list were Mozambique, Burundi, Niger, Congo and Zimbabwe. There is a clear positive relationship between GDP per capita at PPP and performance on the other factors. It is relatively easy to educate a population well when good schools and teachers can be resourced, for example. The index also shows that countries with lots of income do not always spend that money in ways that create high life expectancies or education levels.
However, as GDP per capita at PPP is one of the four components of the HDI, all things being equal, high ranking countries are much more likely to have a high HDI ranking than countries with low GDP per capita. In instances where a country has a high GDP per capita but a relatively low HDI ranking (e.g., Russia), or conversely, a relatively low GDP per capita ranking to its high ranking HDI (e.g., New Zealand), then it is indicative of how a country is using its income to improve the lives of its citizens. Often the root cause can be seen in the distribution of income within a country. In a country where the income distribution is relatively more unequal (e.g., Russia), the benefits of additional resources may only go to a few, and education and health services are ineffective for low income earners in that country and drag down the HDI score. Conversely, in countries where income is more evenly distributed such as Denmark, education and health services for all are better resourced. Progressive taxation and generous transfer payments mean that incomes at the bottom are boosted, and outcomes are better for the poorest.
PROGRESS CHECK - TEST YOUR UNDERSTANDING BY COMPLETING THE ACTIVITIES BELOW
You have below, a range of practice activities, flash cards, exam practice questions and an online interactive self test to ensure you have complete mastery of the IB Economics requirements for the Development Economics – Understanding Economic Development: 4.2 Measuring Economic Development topic.
IB Economics interactive QUIZZES AND TWO CLASSROOM GAMES
Test how well you know the IB Economics Understanding Economic Development: 4.2 Measuring Economic Development topic with the interactive self-assessment quizzes below. Aim for a score of at least 80 per cent.