Economic development refers to an improvement in the economic well-being and quality of life of people in a country. It involves more than an increase in national income; it also includes improvements in health, education, living standards and access to essential services.
Economic growth is an increase in real GDP over time, whereas economic development is a broader improvement in people’s living standards and welfare.
→ Economic growth can provide the resources needed for development. → However, growth does not automatically lead to development if income is unequally distributed or environmental damage reduces people’s quality of life.
Classification of Economies by Level of Development
Economies are commonly classified according to their level of economic development. International organisations use several indicators, including national income per person, health, education and living standards.
Developed Economies
Developed economies generally have high average incomes and relatively high standards of living.
Characteristics:
- High real income per person.
- Better access to healthcare, education, clean water and sanitation.
- Higher life expectancy and lower infant mortality.
- More developed infrastructure, such as roads, electricity and communication networks.
- A relatively large tertiary and quaternary sector.
- Greater access to technology and financial services.
- Lower levels of absolute poverty, although inequality may still exist.
Example: Japan has high average incomes, advanced infrastructure and extensive access to healthcare and education.
Developing Economies
Developing economies generally have lower average incomes and face greater challenges in improving living standards and productive capacity.
Characteristics:
- Lower average real income per person.
- Greater differences in access to healthcare and education.
- Higher levels of poverty in some regions.
- A larger proportion of workers may be employed in agriculture or informal activities.
- Infrastructure and access to essential services may be less developed.
- Greater dependence on primary-product exports in some economies.
- Rapid population growth may place pressure on public services and resources.
Example: India has experienced substantial economic growth, but living standards and access to services vary considerably between regions and income groups.
Limitations of Classifying Economies
→ Countries within the same category may have very different living standards.
→ A country may have high average income but considerable income inequality.
→ Some developing economies may perform well in education or healthcare despite having relatively low national income.
→ Development is continuous, so a simple developed/developing division may not reflect the complexity of an economy.
Exam tip: Avoid assuming that every developing economy has the same characteristics. Use specific indicators and recognise differences within countries.
Classification of Economies by Level of National Income
The World Bank classifies economies into income groups using Gross National Income (GNI) per capita, expressed in US dollars using its specified conversion method.
The four categories are:
- Low-income economies
- Lower-middle-income economies
- Upper-middle-income economies
- High-income economies
The World Bank periodically updates the income thresholds to account for changes in prices and national income. Therefore, the exact thresholds depend on the classification year.
Gross National Income per Capita
GNI measures the total income earned by a country’s residents, including net primary income received from abroad.
GNI per capita=PopulationGNI
Example:
Suppose a country has a GNI of ₹12 trillion and a population of 60 million.
GNI per capita=60,000,000₹12,000,000,000,000
=₹200,000
The average GNI per person is ₹200,000 per year.
Why Use Income Classifications?
→ They provide a simple way to compare the average income levels of economies.
→ They help governments and international organisations identify economies that may need financial assistance.
→ They can help guide development programmes and international lending decisions.
Limitations of Income Classifications
→ GNI per capita is an average and does not show how income is distributed.
→ It does not directly measure health, education or environmental quality.
→ A high-income economy may still contain people living in poverty.
→ Average income may be affected by a small number of extremely wealthy individuals.
→ Two economies with similar GNI per capita may have different costs of living and purchasing power.
Key distinction: The World Bank’s income classification is based primarily on GNI per capita, whereas broader assessments of development consider several economic and non-economic indicators.
Indicators of Living Standards and Economic Development
Indicators are measures used to assess and compare the economic well-being and quality of life of people.
They can be divided into three broad categories:
→ Monetary indicators: measure income and economic output.
→ Non-monetary indicators: measure aspects of quality of life, such as health and education.
→ Composite indicators: combine several measures to provide a broader assessment.
Monetary Indicators
Monetary indicators use income or the value of economic output to assess living standards.
Gross Domestic Product (GDP)
GDP measures the total monetary value of final goods and services produced within a country’s geographical borders during a given period.
Real GDP adjusts nominal GDP for changes in the general price level.
→ If real GDP increases, the quantity of goods and services produced has increased.
→ Higher real GDP may create more employment, raise incomes and increase tax revenue.
→ However, the benefits depend on how additional income and output are distributed.
Gross National Income (GNI)
GNI measures the total income earned by a country’s residents, including net primary income from abroad.
GNI=GDP+Net primary income from abroad
Net primary income from abroad includes income received by residents from employment and investments abroad, minus corresponding income paid to non-residents.
Example:
A country has GDP of ₹500 billion. Its residents receive ₹40 billion in primary income from abroad, while non-residents receive ₹15 billion from the country.
GNI=500+40−15
GNI=₹525 billion
GNI is higher than GDP because residents receive more primary income from abroad than non-residents receive from the country.
Net National Income (NNI)
NNI measures national income after deducting the consumption of fixed capital, commonly called depreciation.
NNI=GNI−Depreciation
Example:
If GNI is ₹525 billion and depreciation is ₹25 billion:
NNI=525−25
NNI=₹500 billion
NNI gives an indication of the income remaining after allowing for the wearing out of capital assets, such as machinery, buildings and equipment.
GDP, GNI and NNI: Comparison
| Indicator | What it measures | Key feature |
|---|---|---|
| GDP | Output produced within national borders | Based on location of production |
| GNI | Income earned by residents, including net primary income from abroad | Accounts for cross-border primary income |
| NNI | GNI after depreciation | Accounts for the consumption of fixed capital |
Real Per Capita National Income
Per capita income measures average income per person. Real per capita national income adjusts for inflation and population.
A simplified calculation is:
Real income per capita=PopulationReal national income
Example:
A country has real national income of ₹8 trillion and a population of 40 million.
Real income per capita=40,000,000₹8,000,000,000,000
=₹200,000
If real national income grows by 3% while population grows by 2%, real income per person rises by approximately 1%.
→ Real national income increases → average resources available per person may increase.
→ However, average income does not reveal whether most people benefit from the increase.
Purchasing Power Parity (PPP)
Purchasing power parity adjusts income comparisons for differences in the prices of goods and services between countries.
The same amount of money can purchase different quantities of goods and services in different economies.
Example:
Suppose an identical basket of goods costs:
- ₹1,000 in India.
- The equivalent of ₹2,000 in Country B.
A person with ₹10,000 could purchase ten baskets in India but only five equivalent baskets in Country B.
Therefore, comparing incomes using market exchange rates alone may give a misleading impression of differences in living standards.
Why PPP is useful:
→ It adjusts for differences in the cost of living.
→ It gives a more meaningful comparison of the quantity of goods and services people can afford.
→ It can reveal that people in a lower-income country have greater purchasing power than a simple currency conversion suggests.
Limitation: PPP is based on a representative basket of goods and services. Actual spending patterns differ between households, and some services are difficult to compare accurately.
Issues with Comparing Monetary Indicators
Monetary indicators are useful, but they do not provide a complete picture of living standards.
Income distribution
→ Average income may rise because high-income earners receive most of the additional income.
→ Many low-income households may experience little improvement.
Differences in the cost of living
→ The same nominal income may buy different quantities of goods and services in different countries.
→ PPP adjustments improve comparisons but cannot remove every difference in spending patterns.
Changes in the general price level
→ Nominal income may increase because prices rise.
→ Real income adjusts for inflation and provides a better indication of changes in purchasing power.
Population changes
→ Total GDP may rise while population grows even faster.
→ Real GDP per capita may fall, meaning average real output per person has declined.
Non-market activities
→ Unpaid work, such as caring for family members, may not be fully included in GDP.
→ A country with substantial unpaid household production may have a lower measured GDP than its actual level of useful activity suggests.
Income earned but not retained domestically
→ GDP includes production within national borders, even when profits are sent abroad.
→ GNI adjusts for net primary income from abroad and may therefore provide a different picture of residents’ income.
Quality of goods and services
→ Higher expenditure does not always mean higher welfare.
→ For example, spending on pollution clean-up may increase GDP while the original pollution has reduced quality of life.
Working hours and leisure
→ A country may have higher income per person because people work longer hours.
→ Another country may have lower measured income but more leisure time and a better work-life balance.
Conclusion: Real per capita national income adjusted for PPP is more useful than nominal total GDP for comparing average material living standards, but it should be used alongside non-monetary and composite indicators.
Non-Monetary Indicators
Non-monetary indicators measure aspects of well-being that cannot be fully captured by income.
Health Indicators
Life expectancy
→ Measures the average number of years a person is expected to live under prevailing mortality conditions.
→ Higher life expectancy may indicate better nutrition, healthcare, sanitation and living conditions.
Infant mortality rate
→ Measures the number of deaths of children under one year of age per 1,000 live births during a given period.
→ A lower infant mortality rate may indicate improved maternal care, nutrition, sanitation and access to medical services.
Access to healthcare
→ Greater access to doctors, hospitals, vaccinations and medicines can improve health outcomes.
→ Better health can increase productivity and enable people to participate more fully in economic activity.
Education Indicators
Literacy rate
→ Measures the proportion of people who can read and write, according to the definition used.
→ Higher literacy may improve employment opportunities and access to information.
School enrolment and attendance
→ Higher enrolment and regular attendance can increase skills and future earning potential.
→ However, enrolment alone does not prove that students are receiving a high-quality education.
Years of schooling
→ More years of education can improve human capital, productivity and occupational mobility.
Other Non-Monetary Indicators
- Access to clean water and sanitation → reduces disease and improves quality of life.
- Nutrition → adequate nutrition supports health, learning and productivity.
- Housing quality → safe housing improves living conditions.
- Access to electricity and transport → enables households to access services and businesses to operate efficiently.
- Personal safety → lower levels of crime and violence can improve well-being.
- Environmental quality → cleaner air, water and public spaces improve health and living standards.
Limitations of Non-Monetary Indicators
→ A single indicator cannot measure every aspect of development.
→ National averages may conceal large differences between regions, genders and income groups.
→ High school enrolment does not necessarily mean that education is effective.
→ Longer life expectancy does not automatically imply high income or equal access to resources.
→ Data may be incomplete, outdated or collected using different methods.
Composite Indicators
A composite indicator combines several indicators into one measure. It provides a broader picture of development than a single monetary or non-monetary indicator.
Human Development Index (HDI)
The Human Development Index is published by the United Nations Development Programme (UNDP). It measures development using three dimensions:
- Health → measured by life expectancy at birth.
- Education → measured using mean years of schooling for adults and expected years of schooling for children.
- Standard of living → measured by GNI per capita, adjusted for purchasing power parity.
The three dimension indices are combined using a geometric mean to produce an HDI value between 0 and 1.
→ A value closer to 1 indicates a higher level of human development.
→ A higher HDI generally suggests better health, educational achievement and average material living standards.
Example:
Country A may have a high GNI per capita but relatively low life expectancy and educational achievement. Country B may have a lower GNI per capita but better health and education outcomes.
→ HDI allows these different dimensions to be considered together rather than judging development only by income.
Advantages of HDI
→ Combines income, health and education.
→ Makes comparisons between countries more comprehensive.
→ Highlights that development involves more than economic growth.
→ Helps identify areas where a country needs improvement.
Limitations of HDI
→ It does not directly measure income inequality within a country.
→ It does not fully capture poverty, political freedom, personal safety or environmental sustainability.
→ National averages may hide differences between groups.
→ Countries with similar HDI values may have different development challenges.
Measure of Economic Welfare (MEW)
The Measure of Economic Welfare attempts to adjust conventional national income measures to provide a better indication of economic welfare.
It generally includes the value of beneficial activities not fully captured by GDP and makes adjustments for activities or costs that reduce welfare.
Possible adjustments include:
→ Adding the estimated value of unpaid household work and leisure.
→ Including benefits from some non-market activities.
→ Deducting costs associated with pollution, congestion and other forms of environmental damage.
→ Allowing for other social costs that reduce people’s welfare.
Example:
Suppose two countries have the same GDP. Country A has severe pollution and long commuting times, while Country B has cleaner air and more leisure time.
→ A measure of economic welfare may show Country B performing better after adjustments for these costs and benefits.
Advantages of MEW
→ Recognises that GDP does not measure every activity affecting welfare.
→ Considers some environmental and social costs of production.
→ Can provide a broader assessment of quality of life.
Limitations of MEW
→ The value of unpaid work, leisure and environmental damage can be difficult to calculate.
→ Different methods of valuation may produce different results.
→ Comparisons are difficult if countries use different methods or lack reliable data.
→ It is less widely used and less standardised than GDP.
Multidimensional Poverty Index (MPI)
The Multidimensional Poverty Index measures overlapping disadvantages faced by people in areas such as health, education and living standards.
The global MPI developed by UNDP and the Oxford Poverty and Human Development Initiative uses indicators including:
Health
- Nutrition.
- Child mortality.
Education
- Years of schooling.
- School attendance.
Living standards
- Access to cooking fuel.
- Sanitation.
- Drinking water.
- Electricity.
- Housing.
- Assets.
A household is identified as multidimensionally poor when its weighted deprivations reach the specified poverty threshold under the MPI methodology.
→ MPI recognises that poverty is not only a lack of income.
→ A household may have some income but still lack safe drinking water, adequate sanitation or access to education.
Example:
A family may earn enough to be above a monetary poverty line but have no electricity, poor sanitation and children who are not attending school. MPI can help reveal these overlapping disadvantages.
Advantages of MPI
→ Identifies several forms of deprivation at the same time.
→ Helps governments target policies towards the specific needs of poor households.
→ Reveals problems that income-based measures may overlook.
→ Can be used to monitor changes in poverty over time.
Limitations of MPI
→ The selected indicators and their weights influence the result.
→ Data collection can be expensive and time-consuming.
→ National MPI figures may conceal regional differences.
→ It does not capture every dimension of poverty, such as personal insecurity or the full effects of low income.
Comparing Composite Indicators
| Indicator | Main focus | Key advantage | Main limitation |
|---|---|---|---|
| HDI | Health, education and income | Broad comparison of human development | Does not fully show inequality or environmental quality |
| MEW | Economic welfare after selected adjustments | Includes some non-market benefits and social costs | Difficult to value and standardise |
| MPI | Overlapping health, education and living-standard deprivations | Identifies specific forms of poverty | Depends on selected indicators, weights and data |
Exam tip: Choose the indicator that matches the question. Use HDI for broad human development, MEW for adjustments to economic welfare, and MPI for multiple forms of poverty.
The Kuznets Curve
The Kuznets curve is a hypothesis about the relationship between economic development and income inequality.
It suggests that as an economy develops, income inequality may initially rise and then fall, producing an inverted-U relationship.
Early Stage of Development
→ The economy begins to industrialise.
→ Workers move from relatively low-productivity agriculture into higher-productivity industries and services.
→ Some workers and business owners benefit more quickly than others.
→ Differences in wages, profits and access to education may increase.
→ Income inequality may rise.
Later Stage of Development
→ More people gain access to education, training and better-paid employment.
→ A larger proportion of workers may enter higher-productivity sectors.
→ Governments may expand public services and social protection.
→ Progressive taxation and redistribution may reduce differences in disposable income.
→ Income inequality may fall.
Limitations of the Kuznets Curve
→ The relationship is a hypothesis, not a guaranteed pattern.
→ Inequality does not necessarily rise and then fall in every country.
→ Government policies, trade, technology, institutions and labour-market conditions can affect inequality.
→ Economic growth may increase inequality if most gains go to high-income groups.
→ Some countries may achieve relatively low inequality at an early stage through effective public services and redistribution.
Conclusion: Economic development may be associated with changing income inequality, but the outcome depends on how growth occurs and how its benefits are distributed.
Comparing Economic Growth Rates and Living Standards
Economic growth rates measure changes in real output, while living standards reflect the well-being and material conditions of people. They are related, but they are not the same.
Comparing Economic Growth Over Time
Economic growth over time is measured by the percentage change in real GDP.
Economic growth rate=Real GDP1Real GDP2−Real GDP1×100
Example:
Real GDP rises from ₹500 billion to ₹525 billion.
Growth rate=500525−500×100
=5%
Real GDP has increased by 5%.
However, the growth rate alone does not show whether average living standards have improved.
Population growth
→ If real GDP grows by 5% and population grows by 2%, real GDP per capita rises by approximately 3%.
→ If population grows faster than real GDP, real GDP per capita can fall even when total real GDP increases.
Inflation
→ Nominal GDP may rise because prices increase.
→ Real GDP removes the effect of inflation and is therefore more useful for measuring changes in output.
Income distribution
→ Growth may increase national income while the majority of households receive little additional income.
→ Inequality may rise even when average income increases.
Changes in public services
→ Higher tax revenue may allow governments to improve healthcare, education, transport and sanitation.
→ Living standards may improve even if household income does not rise by the same proportion.
Environmental effects
→ Growth may increase pollution, congestion and resource depletion.
→ These costs may reduce quality of life despite higher measured output.
Working conditions and leisure
→ Growth based on longer working hours may increase output but reduce leisure time.
→ Productivity-led growth may allow people to enjoy higher incomes without working proportionately longer hours.
Conclusion: To compare living standards over time, consider real income per capita, income distribution, health, education, public services and environmental quality, rather than relying only on total real GDP.
Comparing Economic Growth Between Countries
Countries may experience different growth rates because of differences in investment, productivity, technology, labour force growth, infrastructure, education, natural resources, political stability and government policies.
Example:
Country A has real GDP growth of 6%, while Country B has growth of 3%.
This does not automatically mean that living standards are improving faster in Country A.
→ Country A may have much faster population growth.
→ Country B may have higher initial income per person.
→ Country B may have lower inequality and better public services.
→ Country A’s growth may be concentrated in a small number of industries or among high-income households.
Factors to Consider When Comparing Countries
| Factor | Why it matters |
|---|---|
| Real GDP growth rate | Shows the rate at which total real output is increasing |
| Real GDP per capita | Adjusts output for population size |
| Real GNI per capita | Considers national income, including net primary income from abroad |
| PPP | Adjusts income comparisons for differences in purchasing power |
| Income distribution | Shows whether the gains from growth are widely shared |
| HDI | Considers health, education and income |
| MPI | Reveals overlapping forms of poverty |
| Environmental quality | Shows whether growth creates environmental costs |
| Employment | Indicates whether growth creates jobs and improves access to work |
| Public services | Helps assess access to healthcare, education, sanitation and infrastructure |
Why Countries with Similar Growth Rates May Have Different Living Standards
→ Country A may have rapid growth but high income inequality, while Country B may distribute additional income more widely.
→ Country A may depend on resource extraction, creating high output but relatively few jobs.
→ Country B may experience slower growth but have better healthcare, education and social protection.
→ Differences in prices mean that the same income converted at market exchange rates may buy different quantities of goods and services.
→ Historical differences in wealth, infrastructure and human capital may also affect current living standards.
Why Higher Growth May Not Always Mean Better Development
Economic growth is more likely to improve living standards when it creates productive employment, raises real incomes, improves public services and protects the environment.
However:
→ Growth may benefit only a small proportion of the population.
→ Inflation may reduce the purchasing power of households if nominal incomes do not keep pace with prices.
→ Pollution and resource depletion may damage health and reduce future productive capacity.
→ Growth may be driven by industries that generate high output but relatively few jobs.
→ Benefits may take time to reach poorer households.
Overall conclusion: Economic growth provides an important source of resources for development, but its impact on living standards depends on population growth, income distribution, purchasing power, public services, health, education and environmental sustainability.