Unit 1 Eco Highlighted

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16 PART one Principles and Concepts
savings, investment, product and factor prices, and foreign-exchange rates. As

the Indonesian intellectual Soedjatmoko, former rector of the United Nations
University in Tokyo, so aptly put it:
Looking back over these years, it is now clear that, in their preoccupation with growth
and its stages and with the provision of capital and skills, development theorists have
paid insufficient attention to institutional and structural problems and to the power
of historical, cultural, and religious forces in the development process.5
Just as some social scientists occasionally make the mistake of confusing their
theories with universal truths, they also sometimes mistakenly dismiss these
noneconomic variables as “nonquantifiable” and therefore of dubious impor-
tance. Yet these variables often play a critical role in the success or failure of
the development effort.
As you will see in Parts Two and Three, many of the failures of develop-
ment policies have occurred precisely because these noneconomic variables
(e.g., the role of traditional property rights in allocating resources and distribut-
ing income or the influence of religion on attitudes toward modernization and
Values Principles, standards, family planning) were excluded from the analysis. Although the main focus
or qualities that a society or of this text is on development economics and its usefulness in understanding
groups within it considers problems of economic and social progress in poor nations, we will try always
worthwhile or desirable.
to be mindful of the crucial roles that values, attitudes, and institutions, both
Attitudes The states of mind domestic and international, play in the overall development process.
or feelings of an individual,
group, or society regarding
issues such as material gain,
hard work, saving for the 1.3 What Do We Mean by Development?
future, and sharing wealth.
Institutions Norms, rules

Because the term development may mean different things to different people, it
of conduct, and generally is important that we have some working definition or core perspective on its
accepted ways of doing meaning. Without such a perspective and some agreed measurement criteria,
things. Economic institu- we would be unable to determine which country was actually developing and
tions are humanly devised
constraints that shape human
which was not. This will be our task for the remainder of the chapter and for
interactions, including both our first country case study, Brazil, at the end of the chapter.
informal and formal “rules of
the game” of economic life in
the widely used framework of Traditional Economic Measures
Douglass North.
In strictly economic terms, development has traditionally meant achieving sus-
Income per capita Total tained rates of growth of income per capita to enable a nation to expand its
gross national income of a output at a rate faster than the growth rate of its population. Levels and rates
country divided by its total
population. of growth of “real” per capita gross national income (GNI) (monetary growth
of GNI per capita minus the rate of inflation) are then used to measure the
Gross national income overall economic well-being of a population—how much of real goods and
(GNI) The total domestic services is available to the average citizen for consumption and investment.
and foreign output claimed
Economic development in the past has also been typically seen in terms of the
by residents of a country. It
comprises gross domestic planned alteration of the structure of production and employment so that agri-
product (GDP) plus factor culture’s share of both declines and that of the manufacturing and service indus-
incomes accruing to residents tries increases. Development strategies have therefore usually focused on rapid
from abroad, less the income
earned in the domestic
industrialization, often at the expense of agriculture and rural development.
economy accruing to persons With few exceptions, such as in development policy circles in the 1970s, devel
abroad. opment was until recently nearly always seen as an economic phenomenon in
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CHAPTER 1 Introducing Economic Development: A Global Perspective 17
which rapid gains in overall and per capita GNI growth would either “trickle
down” to the masses in the form of jobs and other economic opportunities or
create the necessary conditions for the wider distribution of the economic and
social benefits of growth. Problems of poverty, discrimination, unemployment,
and income distribution were of secondary importance to “getting the growth
job done.” Indeed, the emphasis is often on increased output, measured by
gross domestic product (GDP). Gross domestic product
(GDP) The total final output
of goods and services produced
The New Economic View of Development by the country’s economy,
within the country’s territory,
The experience of the first decades of post–World War II and postcolonial by residents and nonresidents,
development in the 1950s, 1960s, and early 1970s, when many developing regardless of its allocation
nations did reach their economic growth targets but the levels of living of between domestic and foreign
claims.
the masses of people remained for the most part unchanged, signaled that
something was very wrong with this narrow definition of development. An
increasing number of economists and policymakers clamored for more direct
attacks on widespread absolute poverty, increasingly inequitable income dis-
tributions, and rising unemployment. In short, during the 1970s, economic
development came to be redefined in terms of the reduction or elimination of
poverty, inequality, and unemployment within the context of a growing econ-
omy. “Redistribution from growth” became a common slogan. Dudley Seers
posed the basic question about the meaning of development succinctly when
he asserted:
The questions to ask about a country’s development are therefore: What has been
happening to poverty? What has been happening to unemployment? What has
been happening to inequality? If all three of these have declined from high levels,
then beyond doubt this has been a period of development for the country con-
cerned. If one or two of these central problems have been growing worse, espe-
cially if all three have, it would be strange to call the result “development” even if
per capita income doubled.6
This assertion was neither idle speculation nor the description of a hypo-
thetical situation. A number of developing countries experienced relatively
high rates of growth of per capita income during the 1960s and 1970s but
showed little or no improvement or even an actual decline in employment,
equality, and the real incomes of the bottom 40% of their populations. By the
earlier growth definition, these countries were developing; by the newer
poverty, equality, and employment criteria, they were not. The situation in the
1980s and 1990s worsened further as GNI growth rates turned negative for
many developing countries, and governments, facing mounting foreign-debt
problems, were forced to cut back on their already limited social and economic
programs.
But the phenomenon of development or the existence of a chronic state
of underdevelopment is not merely a question of economics or even one of
quantitative measurement of incomes, employment, and inequality. As Denis
Goulet forcefully portrayed it:
Underdevelopment is shocking: the squalor, disease, unnecessary deaths, and
hopelessness of it all!…The most empathetic observer can speak objectively about
underdevelopment only after undergoing, personally or vicariously, the “shock of
underdevelopment.” This unique culture shock comes to one as he is initiated to

the emotions which prevail in the “culture of poverty.” The reverse shock is felt
by those living in destitution when a new self-understanding reveals to them that
their life is neither human nor inevitable.…The prevalent emotion of underdevel-
opment is a sense of personal and societal impotence in the face of disease and
death, of confusion and ignorance as one gropes to understand change, of ser-
vility toward men whose decisions govern the course of events, of hopelessness
before hunger and natural catastrophe. Chronic poverty is a cruel kind of hell,
and one cannot understand how cruel that hell is merely by gazing upon poverty
as an object.7
Development must therefore be conceived of as a multidimensional pro-

cess involving major changes in social structures, popular attitudes, and
national institutions, as well as the acceleration of economic growth, the reduc-
tion of inequality, and the eradication of poverty. Development, in its essence,
must represent the whole gamut of change by which an entire social system,
tuned to the diverse basic needs and evolving aspirations of individuals and
social groups within that system, moves away from a condition of life widely
perceived as unsatisfactory toward a situation or condition of life regarded
as materially and spiritually better. No one has identified the human goals of
economic development as well as Amartya Sen, perhaps the leading thinker
on the meaning of development.
Amartya Sen’s “Capability” Approach

The view that income and wealth are not ends in themselves but instruments
for other purposes goes back at least as far as Aristotle. Amartya Sen, the 1998
Nobel laureate in economics, argues that the “capability to function” is what
really matters for status as a poor or nonpoor person. As Sen puts it, “the
expansion of commodity productions...are valued, ultimately, not for their
own sake, but as means to human welfare and freedom.”8
In effect, Sen argues that poverty cannot be properly measured by income or
even by utility as conventionally understood; what matters fundamentally is not
the things a person has—or the feelings these provide—but what a person is, or
can be, and does, or can do. What matters for well-being is not just the character-
istics of commodities consumed, as in the utility approach, but what use the con-
sumer can and does make of commodities. For example, a book is of little value
to an illiterate person (except perhaps as cooking fuel or as a status symbol). Or
as Sen noted, a person with a parasitic disease will be less able to extract nourish-
ment from a given quantity of food than someone without parasites.
To make any sense of the concept of human well-being in general, and
poverty in particular, we need to think beyond the availability of commodities
Functionings What people and consider their use: to address what Sen calls functionings, that is, what
do or can do with the com- a person does (or can do) with the commodities of given characteristics that
modities of given characteris-
tics that they come to possess
they come to possess or control. Freedom of choice, or control of one’s own
or control. life, is itself a central aspect of most understandings of well-being. A function-
ing is a valued “being or doing,” and in Sen’s view, functionings that people
have reason to value can range from being healthy, being well-nourished, and
well-clothed, to being mobile, having self-esteem, and “taking part in the life
of the community.”9
Sen identifies five sources of disparity between (measured) real incomes

and actual advantages:10 first, personal heterogeneities, such as those connected
with disability, illness, age, or gender; second, environmental diversities, such
as heating and clothing requirements in the cold or infectious diseases in the
tropics, or the impact of pollution; third, variations in social climate, such as
the prevalence of crime and violence, and “social capital”; fourth, distribution
within the family—economic statistics measure incomes received in a family
because it is the basic unit of shared consumption, but family resources may
be distributed unevenly, as when girls get less medical attention or education
than boys do; fifth, differences in relational perspectives, meaning that some
goods are essential because of local customs and conventions. For example, nec-
essaries for being able, in Adam Smith’s phrase, “to appear in public without
shame,” include higher quality clothing (such as leather shoes) in high-income
countries than in low-income countries.
In a richer society, the ability to partake in community life would be
extremely difficult without certain commodities, such as a telephone, a televi-
sion, or an automobile; it is difficult to function socially in Singapore or South
Korea without an e-mail address. And minimal housing standards to avoid
social disgrace also rise strongly with the average wealth of the society.
Thus, looking at real income levels or even the levels of consumption of spe-
cific commodities cannot suffice as a measure of well-being. One may have a
lot of commodities, but these are of little value if they are not what consumers
desire (as in the former Soviet Union). One may have income, but certain com-
modities essential for well-being, such as nutritious foods, may be unavailable.
Even when providing an equal number of calories, the available staple foods in
one country (cassava, bread, rice, cornmeal, potatoes, etc.) will differ in nutri-
tional content from staple foods in other countries. Moreover, even some sub-
varieties of, for example, rice, are much more nutritious than others. Finally,
even when comparing absolutely identical commodities, one has to frame their
consumption in a personal and social context. Sen provides an excellent exam-
ple of bread, the most basic of commodities. It has product “characteristics”
such as taste and nutrition such as protein; and it helps to meet conventions
of social exchange in the sense of breaking bread together. But many of these
benefits depend on the person and her circumstances, such as her activity level,
metabolism, weight, whether she is pregnant or lactating, nutrition knowledge,
whether she is infected with parasites, and her access to medical services. Sen
goes on to note that functioning depends also on (1) “social conventions in force
in the society in which the person lives, (2) the position of the person in the family
and in the society, (3) the presence or absence of festivities such as marriages,
seasonal festivals and other occasions such as funerals, (4) the physical distance
from the homes of friends and relatives...”11
In part because such factors, even on so basic a matter as nutrition, can
vary so widely among individuals, measuring individual well-being by levels
of consumption of goods and services obtained confuses the role of com-
modities by regarding them as ends in themselves rather than as means to
an end. In the case of nutrition, the end is health and what one can do with
good health, as well as personal enjoyment and social functioning. Indeed,
the capacity to maintain valued social relationships and to network leads
to what James Foster and Christopher Handy have termed external capabilities,
which are “abilities to function that are conferred by direct connection or

relationship with another person.” But measuring well-being using the concept
of utility, in any of its standard definitions, does not offer enough of an improve-
ment over measuring consumption to capture the meaning of development.12
As Sen stresses, a person’s own valuation of what kind of life would be
worthwhile is not necessarily the same as what gives pleasure to that person.
If we identify utility with happiness in a particular way, then very poor people
can have very high utility. Sometimes even malnourished people either have a
disposition that keeps them feeling rather blissful or have learned to appreci-
ate greatly any small comforts they can find in life, such as a breeze on a very
hot day, and to avoid disappointment by striving only for what seems attain-
able. (Indeed, it is only too human to tell yourself that you do not want the
things you cannot have.) If there is really nothing to be done about a person’s
deprivation, this attitude of subjective bliss would have undoubted advan-
tages in a spiritual sense, but it does not change the objective reality of depri-
vation. In particular, such an attitude would not prevent the contented but
homeless poor person from greatly valuing an opportunity to become freed
of parasites or provided with basic shelter. The functioning of a person is an
achievement. Sen provides the example of bicycling “[B]icycling has to be dis-
tinguished from possessing a bike. It has to be distinguished also from the
happiness generated by [bicycling]... A functioning is thus different both from
(1) having goods (and the corresponding characteristics), to which it is poste-
rior, and (2) having utility (in the form of happiness resulting from that func-
tioning), to which it is, in an important way, prior.”13
To clarify this point, in his acclaimed 2009 book, The Idea of Justice, Sen suggests
that subjective well-being is a kind of psychological state of being—a functioning—
that could be pursued alongside other functionings such as health and dignity. In the
next section, we return to the meaning of happiness as a development outcome,
in a sense that can be distinguished from conventional utility.
Capabilities The freedoms Sen then defines capabilities as “the freedom that a person has in terms
that people have, given their of the choice of functionings, given his personal features (conversion of char-
personal features and their
command over commodities.
acteristics into functionings) and his command over commodities.”14 Sen’s
perspective helps explain why development economists have placed so
much emphasis on health and education, and more recently on social inclu-
sion and empowerment, and have referred to countries with high levels of
income but poor health and education standards as cases of “growth without
development.”14a Real income is essential, but to convert the characteristics of
commodities into functionings, in most important cases, surely requires health
and education as well as income. The role of health and education ranges from
something so basic as the nutritional advantages and greater personal energy
that are possible when one lives free of parasites to the expanded ability to
appreciate the richness of human life that comes with a broad and deep edu-
cation. People living in poverty are often deprived—at times deliberately—
of capabilities to make substantive choices and to take valuable actions, and
often the behavior of the poor can be understood in that light.
For Sen, human “well-being” means being well, in the basic sense of being
healthy, well nourished, well clothed, literate, and long-lived, and more
broadly, being able to take part in the life of the community, being mobile, and
having freedom of choice in what one can become and can do.
Development and Happiness

Clearly, happiness is part of human well-being, and greater happiness may
in itself expand an individual’s capability to function. As Amartya Sen has
argued, a person may well regard happiness as an important functioning for
her well-being.15 In recent years, economists have explored the empirical rela-
tionship across countries and over time between subjectively reported satis-
faction and happiness and factors such as income. One of the findings is that
the average level of happiness or satisfaction increases with a country’s average
income. For example, roughly four times the percentage of people report that they
are not happy or satisfied in Tanzania, Bangladesh, India, and Azerbaijan as in
the United States and Sweden. But the relationship is seen only up to an average
income of roughly $10,000 to $20,000 per capita, as shown in Figure 1.2.16 Once
incomes grow to this point, most citizens have usually escaped extreme poverty.
At these levels, despite substantial variations across countries, if inequality is not
extreme, a majority of citizens are usually relatively well nourished, healthy, and
educated. The “happiness science” findings call into question the centrality of
economic growth as an objective for high-income countries. But they also reaf-
firm the importance of economic development in the developing world, whether
the objective is solely happiness or, more inclusively and persuasively, expanded
human capabilities.
Figure 1.2 Income and Happiness: Comparing Countries
100
Netherlands
• • •
Ireland
Average of percent “happy” and percent “satisfied”
Denmark Canada Switzerland

90 •
New Zealand ••• • • •
Sweden Finland
•• •
Norway USA
• • • •
Indonesia Singapore Austria
Colombia
Mexico
•
Britain •
Australia Belgium
•
El Salvador
•
Czech
• France
• • •
Chile Republic
80
Nigeria
• ••
Venezuela • Portugal
Italy
Germany
Vietnam
• • • • Brazil
Argentina
•• Spain Japan
•••
Uruguay Slovenia
Israel
Philippines
• •
Croatia Greece
China • • Dominican
Republic Hungary
South Korea
70 Egypt
• • •
Algeria
South Africa
Morocco
• • Poland
• • •• • • • •
Uganda Peru
Jordan Slovakia
Iran Estonia
India
••• • •
Lithuania
60 Azerbaijan
Turkey
Bangladesh
Tanzania Macedonia
Pakistan
• Latvia
50
Georgia •• • ••
Albania Belarus
Bulgaria
Moldova
• Romania
•• •
Zimbabwe
40 •
Ukraine
Russia
30
0 5,000 10,000 15,000 20,000 25,000 30,000 35,000
Income per head (U.S. $ per year)
Source: From Happiness: Lessons from a New Science by Richard Layard, copyright © 2005 by
Richard Layard. Used by permission of The Penguin Press, a division of Penguin Group
(USA) Inc. and United Agents Ltd. (www.unitedagents.co.uk) on behalf of the author.
Not surprisingly, studies show that financial security is only one factor affect-
ing happiness. Richard Layard identifies seven factors that surveys show affect
average national happiness: family relationships, financial situation, work, com-
munity and friends, health, personal freedom, and personal values. In particular,
aside from not being poor, the evidence says people are happier when they are not
unemployed, not divorced or separated, and have high trust of others in society,
as well as enjoy high government quality with democratic freedoms and have reli-
gious faith. The importance of these factors may shed light on why the percentage
of people reporting that they are not happy or satisfied varies so widely among
developing countries with similar incomes. For example, the fraction of people
who are not happy and satisfied on average is 4½ times as great in Zimbabwe as
in Indonesia, despite somewhat higher incomes in Zimbabwe, and over 3 times
as great in Turkey as in Colombia, despite somewhat higher incomes in Turkey at
the time of the study. Many opinion leaders in developing nations hope that their
societies can gain the benefits of development without losing traditional strengths
such as moral values and trust in others—sometimes called social capital.
The government of Bhutan’s attempt to make “gross national happiness”
rather than gross national income its measure of development progress has
attracted considerable attention.17 Informed by Sen’s work, its indicators extend
beyond traditional notions of happiness to include capabilities such as health,
education, and freedom. Happiness is not the only dimension of subjective well-
being of importance. As the 2010 Stiglitz-Sen-Fitoussi (“Sarkozy”) Commission
on the Measurement of Economic Performance and Social Progress put it:
Subjective well-being encompasses different aspects (cognitive evaluations of
one’s life, happiness, satisfaction, positive emotions such as joy and pride, and
negative emotions such as pain and worry): each of them should be measured sep-
arately to derive a more comprehensive appreciation of people’s lives.18
Although, following Sen, what people say makes them happy and satisfied
as just one among valued functionings is at best only a rough guide to what
people value in life, this work adds new perspectives to the multidimensional
meaning of development.
Sustenance The basic goods
and services, such as food, Three Core Values of Development
clothing, and shelter, that are
necessary to sustain an average Is it possible, then, to define or broadly conceptualize what we mean when we
human being at the bare mini- talk about development as the sustained elevation of an entire society and social
mum level of living.
system toward a “better” or “more humane” life? What constitutes the good life
Self-esteem The feeling of is a question as old as philosophy, one that must be periodically reevaluated and
worthiness that a society enjoys answered afresh in the changing environment of world society. The appropriate
when its social, political, and
answer for developing nations today is not necessarily the same as it would have
economic systems and institu-
tions promote human values been in previous decades. But at least three basic components or core values
such as respect, dignity, integ- serve as a conceptual basis and practical guideline for understanding the inner
rity, and self-determination. meaning of development. These core values—sustenance, self-esteem, and
Freedom A situation in
freedom—represent common goals sought by all individuals and societies.19
which a society has at its They relate to fundamental human needs that find their expression in almost all
disposal a variety of alterna- societies and cultures at all times. Let us therefore examine each in turn.
tives from which to satisfy its
wants and individuals enjoy
real choices according to their Sustenance: The Ability to Meet Basic Needs All people have certain basic
preferences. needs without which life would be impossible. These life-sustaining basic
human needs include food, shelter, health, and protection.20 When any of these is
absent or in critically short supply, a condition of “absolute underdevelopment”
exists. A basic function of all economic activity, therefore, is to provide as many
people as possible with the means of overcoming the helplessness and misery
arising from a lack of food, shelter, health, and protection. To this extent, we may
claim that economic development is a necessary condition for the improvement
in the quality of life that is development. Without sustained and continuous eco-
nomic progress at the individual as well as the societal level, the realization of
the human potential would not be possible. One clearly has to “have enough in
order to be more.”21 Rising per capita incomes, the elimination of absolute poverty,
greater employment opportunities, and lessening income inequalities therefore
constitute the necessary but not the sufficient conditions for development.22
Self-Esteem: To Be a Person A second universal component of the good life

is self-esteem—a sense of worth and self-respect, of not being used as a tool
by others for their own ends. All peoples and societies seek some basic form
of self-esteem, although they may call it authenticity, identity, dignity, respect,
honor, or recognition. The nature and form of this self-esteem may vary from
society to society and from culture to culture. However, with the proliferation
of the “modernizing values” of developed nations, many societies in develop-
ing countries that have had a profound sense of their own worth suffer from
serious cultural confusion when they come in contact with economically and
technologically advanced societies. This is because national prosperity has
become an almost universal measure of worth. Due to the significance attached
to material values in developed nations, worthiness and esteem are nowadays
increasingly conferred only on countries that possess economic wealth and
technological power—those that have “developed.”
As Denis Goulet put it, “Development is legitimized as a goal because it is
an important, perhaps even an indispensable, way of gaining esteem.”23
Freedom from Servitude: To Be Able to Choose A third and final universal

value that we suggest should constitute the meaning of development is the
concept of human freedom. Freedom here is to be understood in the sense
of emancipation from alienating material conditions of life and from social
servitude to nature, other people, misery, oppressive institutions, and dog-
matic beliefs, especially that poverty is predestination. Freedom involves an
expanded range of choices for societies and their members together with a
minimization of external constraints in the pursuit of some social goal we call
development. Amartya Sen writes of “development as freedom.” W. Arthur
Lewis stressed the relationship between economic growth and freedom from
servitude when he concluded that “the advantage of economic growth is
not that wealth increases happiness, but that it increases the range of human
choice.”24 Wealth can enable people to gain greater control over nature and
the physical environment (e.g., through the production of food, clothing, and
shelter) than they would have if they remained poor. It also gives them the
freedom to choose greater leisure, to have more goods and services, or to deny
the importance of these material wants and choose to live a life of spiritual
contemplation. The concept of human freedom also encompasses various
components of political freedom, including personal security, the rule of law,
freedom of expression, political participation, and equality of opportunity.25
Although attempts to rank countries with freedom indexes have proved highly
controversial,26 studies do reveal that some countries that have achieved high
economic growth rates or high incomes, such as China, Malaysia, Saudi Arabia,
and Singapore, have not achieved as much on human freedom criteria.
The Central Role of Women

In light of the information presented so far, it should come as no surprise that
development scholars generally view women as playing the central role in the
development drama. Globally, women tend to be poorer than men. They are also
more deprived in health and education and in freedoms in all its forms. More-
over, women have primary responsibility for child rearing, and the resources
that they are able to bring to this task will determine whether the cycle of trans-
mission of poverty from generation to generation will be broken. Children need
better health and education, and studies from around the developing world
confirm that mothers tend to spend a significantly higher fraction of income
under their control for the benefit of their children than fathers do. Women also
transmit values to the next generation. To make the biggest impact on develop-
ment, then, a society must empower and invest in its women. We will return to
this topic in more depth in Chapters 5 through 9 and 15.
The Three Objectives of Development

We may conclude that development is both a physical reality and a state of
mind in which society has, through some combination of social, economic, and
institutional processes, secured the means for obtaining a better life. Whatever
the specific components of this better life, development in all societies must
have at least the following three objectives:
1. To increase the availability and widen the distribution of basic life-sustaining

goods such as food, shelter, health, and protection
2. To raise levels of living, including, in addition to higher incomes, the provi-
sion of more jobs, better education, and greater attention to cultural and
human values, all of which will serve not only to enhance material well-
Millennium Development
being but also to generate greater individual and national self-esteem
Goals (MDGs) A set of 3. To expand the range of economic and social choices available to individuals and
eight goals adopted by the
nations by freeing them from servitude and dependence, not only in rela-
United Nations in 2000: to
eradicate extreme poverty tion to other people and nation-states, but also to the forces of ignorance
and hunger; achieve universal and human misery
primary education; promote
gender equality and empower
women; reduce child mortality;
improve maternal health; 1.4 The Future of the Millennium
combat HIV/AIDS, malaria,
and other diseases; ensure Development Goals
environmental sustainability;
and develop a global partner- In September 2000, the 189 member countries of the United Nations at that
ship for development. The
goals are assigned specific tar- time adopted eight Millennium Development Goals (MDGs), committing
gets to be achieved by 2015. themselves to making substantial progress toward the eradication of poverty
and achieving other human development goals by 2015. The MDGs are the
strongest statement yet of the international commitment to ending global poverty.
They acknowledge the multidimensional nature of development and poverty alle-
viation; an end to poverty requires more than just increasing incomes of the poor.
The MDGs have provided a unified focus in the development community unlike
anything that preceded them.27
The eight goals are ambitious: to eradicate extreme poverty and hunger;
achieve universal primary education; promote gender equality and empower
women; reduce child mortality; improve maternal health; combat HIV/AIDS,
malaria, and other diseases; ensure environmental sustainability; and develop
a global partnership for development. The goals are then assigned specific
targets deemed achievable by 2015 based on the pace of past international
development achievements. The goals and targets are found in Table 1.1.
Appropriately, the first MDG addresses the problem of extreme poverty
and hunger. The two targets for this goal are more modest: to reduce by half
Table 1.1 Millennium Development Goals and Targets for 2015

Goals Targets
1. Eradicate extreme poverty and hunger • Reduce by half the proportion of people living on less than $1 a day
• Reduce by half the proportion of people who suffer from hunger
2. Achieve universal primary education • Ensure that all boys and girls complete a full course of primary schooling
3. Promote gender equality and empower • Eliminate gender disparity in primary and secondary education, preferably by 2005,
women and at all levels by 2015
4. Reduce child mortality • Reduce by two-thirds the mortality rate among children under 5
5. Improve maternal health • Reduce by three-quarters the maternal mortality ratio
6. Combat HIV/AIDS, malaria, and other • Halt and begin to reverse the spread of HIV/AIDS
diseases • Halt and begin to reverse the incidence of malaria and other major diseases
7. Ensure environmental sustainability • Integrate the principles of sustainable development into country policies and
programs; reverse the loss of environmental resources
• Reduce by half the proportion of people without sustainable access to safe drinking
water
• Achieve significant improvement in the lives of at least 100 million slum dwellers
by 2020
8. Develop a global partnership for • Develop further an open, rule-based, predictable, nondiscriminatory trading and
development financial system; includes a commitment to good governance, development, and
poverty reduction—both nationally and internationally
• Address the special needs of the least developed countries; includes tariff and quota
free access for least developed countries' exports; enhanced program of debt relief for
heavily indebted poor countries (HIPCs) and cancellation of official bilateral debt;
and more generous official development assistance (ODA) for countries committed to
poverty reduction
• Address the special needs of landlocked countries and small-island developing states
• Deal comprehensively with the debt problems of developing countries through
national and international measures in order to make debt sustainable in the long term
• In cooperation with developing countries, develop and implement strategies for
decent and productive work for youth
• In cooperation with pharmaceutical companies, provide access to affordable essential
drugs in developing countries
• In cooperation with the private sector, make available the benefits of new technologies,
especially information and communications
Source: From “Millennium Development Goals” (accessed via www.undp.org). Reprinted with permission from the United Nations Development Programme.
the proportion of people living on less than $1 a day and to reduce by half the
proportion of people who suffer from hunger. “Halving poverty” has come to
serve as a touchstone for the MDGs as a whole. To achieve this target requires
that progress be made on the other goals as well.
As reported by the United Nations Development Programme (UNDP),
the halving of global poverty was achieved by 2012, but if current trends con-
tinue, not all of the other targets will be achieved; and great regional dispar-
ity is obscured when global averages are reported, as East Asia has done far
better than sub-Saharan Africa.28 Shockingly, in a world of plenty, the target
of cutting the proportion of people who are chronically hungry in half by
2015 is very unlikely to be achieved. Some conditions even worsened after a
food price spike in 2008 and thereafter as a result of the global economic cri-
sis. And the UNDP highlights that if global trends continue through 2015, the
reduction in under-5 mortality will reach roughly one-quarter, far below the
target reduction of two-thirds. This means that the target will be missed by
4.4 million avoidable deaths in 2015. Universal primary enrollment will not be
achieved unless faster progress can be made in sub-Saharan Africa. Projecting
current trends, there will still be 47 million children out of school in 2015. And
the UNDP reports that the gap between the current trends and the target of
halving poverty represents an additional 380 million people still living on less
than $1 a day in 2015.
The goal of ensuring environmental sustainability is essential for secur-
ing an escape from poverty. This is immediately seen by looking at two
of the targets: reduce by half the proportion of people without access to
safe drinking water and achieve significant improvement in the lives of at
least 100 million slum dwellers. But more generally, without protecting the
environment of the poor, there is little chance that their escape from poverty
can be permanent. Finally, the governments and citizens of the rich coun-
tries need to play their part in pursuit of the goal of “global partnership for
development.”
The MDGs were developed in consultation with the developing coun-
tries, to ensure that they addressed their most pressing problems. In addi-
tion, key international agencies, including the United Nations, the World
Bank, the International Monetary Fund (IMF), the Organization for Economic
Cooperation and Development (OECD), and the World Trade Organization
(WTO), all helped develop the Millennium Declaration and so have a col-
lective policy commitment to attacking poverty directly. The MDGs assign
specific responsibilities to rich countries, including increased aid, removal
of trade and investment barriers, and eliminating unsustainable debts of the
poorest nations.29
However, the MDGs have also come in for some criticism.30 For example,
some observers believe that the MDG targets were not ambitious enough,
going little beyond projecting past rates of improvement 15 years into the
future. Moreover, the goals were not prioritized; for example, reducing hunger
may leverage the achievement of many of the other health and education
targets. At the same time, although the interrelatedness of development objec-
tives was implicit in the MDGs’ formulation, goals are presented and treated
in reports as stand-alone objectives; in reality, the goals are not substitutes for
each other but complements, such as the close relationship between health
and education. Further, the setting of 2015 as an end date for the targets could
discourage rather than encourage further development assistance if it were
not met. Moreover, when the MDGs measure poverty as the fraction of the
population below the $1-a-day line, this is arbitrary and fails to account for
the intensity of poverty—that a given amount of extra income to a family with
a per capita income of, say, 70 cents a day makes a bigger impact on poverty
than to a family earning 90 cents per day (see Chapter 5). Other critics have
complained that $1 a day is too low a poverty line and about the lack of goals
on reducing rich-country agricultural subsidies, improving legal and human
rights of the poor, slowing global warming (which is projected to harm Africa
and South Asia the most), expanding gender equality, and leveraging the con-
tribution of the private sector. While the reasonableness of some of these criti- Sector A subset (part) of an
cisms may be questioned, it should be acknowledged that the MDGs do have economy, with four usages in
economic development:
some inherent limitations.
technology (modern and
With the imminent expiration of the MDGs, the UN coordinated global traditional sectors); activity
efforts to launch its successor, Sustainable Development Goals (SDGs), with the (industry or product sectors);
May 2013 agenda-setting report of the High-Level Panel of Eminent Persons trade (export sector); and
sphere (private and public
on Development Agenda.31 This highly diverse panel of political leaders from sectors)
every part of the world agreed upon a bold approach that is expected to sub-
stantially influence the eventual shape of the post-2015 agenda, the SDGs.
The panel repeatedly stressed that it is “a universal agenda” for all countries,
developed as well as developing and without exceptions, “to be driven by five
big, transformative shifts.” These universal shifts are:
1. Leave no one behind—to move “from reducing to ending extreme poverty,

in all its forms;” in particular, to “design goals that focus on reaching
excluded groups.”
2. Put sustainable development at the core, “to integrate the social, economic,
and environmental dimensions of sustainability.”
3. Transform economies for jobs and inclusive growth, while moving to sus-
tainable patterns of work and life.
4. Build peace and effective, open, and accountable institutions for all, which
“encourage the rule of law, property rights, freedom of speech and the
media, open political choice, access to justice, and accountable govern-
ment and public institutions.”
5. Forge a new global partnership so that each priority should involve gov-
ernments and also others, including people living in poverty, civil society
and indigenous and local communities, multilateral institutions, business,
academia, and philanthropy.
The High-Level Panel also agreed on well-recognized and illustrative uni-

versal goals and national targets for the SDGs, including an outright end by
2030 of poverty, hunger, child marriage, and preventable under-5 deaths, and
specific targets on stunting, social protection coverage, and maternal mortality.
The debate will be lively throughout 2014 and 2015.
1.5 Conclusions
Development economics is a distinct yet very important extension of both
traditional economics and political economy. While necessarily also concerned
with efficient resource allocation and the steady growth of aggregate output
over time, development economics focuses primarily on the economic, social,
and institutional mechanisms needed to bring about rapid and large-scale
improvements in standards of living for the masses of poor people in develop-
ing nations. Consequently, development economics must be concerned with
the formulation of appropriate public policies designed to effect major eco-
nomic, institutional, and social transformations of entire societies in a very
short time.
As a social science, economics is concerned with people and how best to
provide them with the material means to help them realize their full human
potential. But what constitutes the good life is a perennial question, and hence
economics necessarily involves values and value judgments. Our very concern
with promoting development represents an implicit value judgment about good
(development) and evil (underdevelopment). But development may mean dif-
ferent things to different people. Therefore, the nature and character of develop-
ment and the meaning we attach to it must be carefully spelled out. We did this
in section 1.3 and will continue to explore these definitions throughout the text.
The central economic problems of all societies include traditional ques-
tions such as what, where, how, how much, and for whom goods and services
should be produced. But they should also include the fundamental question at
the national level about who actually makes or influences economic decisions
and for whose principal benefit these decisions are made. Finally, at the inter-
national level, it is necessary to consider the question of which nations and
which powerful groups within nations exert the most influence with regard
to the control, transmission, and use of technology, information, and finance.
Moreover, for whom do they exercise this power?
Any realistic analysis of development problems necessitates the supple-
mentation of strictly economic variables such as incomes, prices, and savings
rates with equally relevant noneconomic institutional factors, including the
nature of land tenure arrangements; the influence of social and class strati-
fications; the structure of credit, education, and health systems; the organi-
zation and motivation of government bureaucracies; the machinery of public
administrations; the nature of popular attitudes toward work, leisure, and
self-improvement; and the values, roles, and attitudes of political and economic
elites. Economic development strategies that seek to raise agricultural output,
create employment, and eradicate poverty have often failed in the past because
economists and other policy advisers neglected to view the economy as an
interdependent social system in which economic and noneconomic forces are
continually interacting in ways that are at times self-reinforcing and at other
times contradictory. As you will discover, underdevelopment reflects many
individual market failures, but these failures often add up to more than the
sum of their parts, combining to keep a country in a poverty trap. Govern-
ment can play a key role in moving the economy to a better equilibrium, and
in many countries, notably in East Asia, government has done so; but all too
often government itself is part and parcel of the bad equilibrium.
Achieving the Millennium Development Goals will be an important mile-

stone on the long journey to sustainable and just development. Although prog-
ress has been substantial, many of the interim targets remain unachieved—nor
do the MDGs include all of the critical objectives of development. The emerging
Sustainable Development Goals, planned as the MDGs’ successor after 2015,
will be even more ambitious, including the full eradication of extreme poverty.
Despite the great diversity of developing nations—some large, others small;
some resource-rich, others resource-barren; some subsistence economies,
others modern manufactured-good exporters; some private-sector oriented,
others to a large degree run by the government—most share common problems
that define their underdevelopment. We will discuss these diverse structures and
common characteristics of developing countries in Chapter 2.
The oil price shocks of the 1970s, the foreign-debt crisis of the 1980s, and
the twenty-first-century concerns with economic globalization, economic
imbalances and financial crises, global warming, and international terrorism
have underlined the growing interdependence of all nations and peoples in
the international social system. What happens to life in Caracas, Karachi,
Cairo, and Kolkata will in one way or another have important implications for
life in New York, London, and Tokyo. It was once said that “when the United
States sneezes, the world catches pneumonia.” A more fitting expression for
the twenty-first century would perhaps be that “the world is like the human
body: If one part aches, the rest will feel it; if many parts hurt, the whole
will suffer.”
Developing nations constitute these “many parts” of the global organism.
The nature and character of their future development should therefore be a
major concern of all nations irrespective of political, ideological, or economic
orientation. There can no longer be two futures, one for the few rich and the
other for the very many poor. In the words of a poet, “There will be only one
future—or none at all.”
CHAPTER 2 Comparative Economic Development 45
stock and bond markets; although financial deepening is important, it is only

one aspect of economic development. Second, referring to nations as markets
may lead to an underemphasis on some non-market priorities in development.
Third, usage varies, and there is no established or generally accepted designa-
tion of which markets should be labeled as emerging and which as yet to emerge
(the latter now sometimes dubbed frontier markets in the financial press).
The simple division of the world into developed and developing countries
is sometimes useful for analytical purposes. Many development models apply
across a wide range of developing country income levels. However, the wide
income range of the latter serves as an early warning for us not to overgeneral-
ize. Indeed, the economic differences between low-income countries in sub-
Saharan Africa and South Asia and upper-middle-income countries in East
Asia and Latin America can be even more profound than those between high-
income OECD and upper-middle-income developing countries.
2.2 Basic Indicators of Development:

Real Income, Health, and Education
Gross national income
In this section, we examine basic indicators of three facets of development: (GNI) The total domestic
and foreign output claimed by
real income per capita adjusted for purchasing power; health as measured residents of a country, consist-
by life expectancy, undernourishment, and child mortality; and educational ing of gross domestic product
attainments as measured by literacy and schooling. (GDP) plus factor incomes
earned by foreign residents,
minus income earned in the
Purchasing Power Parity domestic economy by non-
residents.
In accordance with the World Bank’s income-based country classification Value added The portion
scheme, gross national income (GNI) per capita, the most common measure of a product’s final value that
of the overall level of economic activity, is often used as a summary index of is added at each stage of pro-
the relative economic well-being of people in different nations. It is calculated duction.
as the total domestic and foreign value added claimed by a country’s residents Depreciation (of the capital
without making deductions for depreciation (or wearing out) of the domestic stock) The wearing out of
capital stock. Gross domestic product (GDP) measures the total value for final equipment, buildings, infra-
structure, and other forms of
use of output produced by an economy, by both residents and nonresidents. capital, reflected in write-offs
Thus, GNI comprises GDP plus the difference between the income residents to the value of the capital
receive from abroad for factor services (labor and capital) less payments made stock.
to nonresidents who contribute to the domestic economy. Where there is a large Capital stock The total
nonresident population playing a major role in the domestic economy (such amount of physical goods
as foreign corporations), these differences can be significant (see Chapter 12). existing at a particular time
that have been produced for
In 2011, the total national income of all the nations of the world was valued at use in the production of other
more than U.S. $66 trillion, of which about $47 trillion originated in the eco- goods and services.
nomically developed high-income regions and about $19 trillion was generated
Gross domestic product
in the less developed nations, despite their representing about five-sixths of the
(GDP) The total final output
world’s population. In 2011, Norway had 240 times the per capita income of of goods and services produced
Ethiopia and 63 times that of India. by the country’s economy
Per capita GNI comparisons between developed and less developed coun- within the country’s territory
by residents and nonresidents,
tries like those shown in Figure 2.2 are, however, exaggerated by the use of regardless of its allocation
official foreign-exchange rates to convert national currency figures into U.S. between domestic and foreign
dollars. This conversion does not measure the relative domestic purchasing claims.
46 PART ONE Principles and Concepts
FIGURE 2.1 Nations of the World, Classified by GNI Per Capita
Income
GNI per capita, World Bank Atlas method, 2011
Lower-income-countries ($1,025 or less)
Lower-middle-income countries ($1,026–$4,035)
Upper-middle-income countries ($4,036–$12,475)
High-income countries ($12,476 or more)
Greenland (Den)
NO DATA
Faeroe
Islands
Iceland (Den)
Norway
The Netherlands
C a n a d a United
Kingdom Denm
Isle of Man (UK)
Ireland
Channel Islands (UK) Germ
Belgium
Luxembourg France
Switzerla
Ita
Liechtenstein
Andorra Kosov
Spain
U n i t e d S t a t e s Monaco
Portugal
Bermuda Gibraltar (UK)
(UK) Tun
British Virgin
Islands (UK) Morocco
The Bahamas
Middle East & North Africa
Turks and Caicos Algeria
St. Martin (Fr)
Mexico Islands (UK) Dominican
Republic US Virgin $7,097
Islands (US) Sint Maarten (Neth) Western
Cayman Islands (UK) Puerto St. Kitts and Nevis Sahara
Cuba Rico (US)
Antigua and Barbuda Mauritania
Belize Jamaica Haiti Cape Verde
Guadeloupe (Fr) Mali Nig
Guatemala Honduras Aruba Dominica Senegal
(Neth) Martinique (Fr) The Gambia
El Salvador St. Lucia
Nicaragua Barbados Guinea-Bissau Burkina Faso
Guinea Benin
Panama
Costa Rica Trinidad St. Vincent and the Grenadines Nigeria
and Tobago Grenada Sierra Leone Côte Ghana
Curaçao R.B. de Liberia d'Ivoire Cam
French Guiana
(Neth) Venezuela Guyana (Fr) Togo
Colombia Equatoria
Kiribati
Latin America & Caribbean Ecuador
Suriname São Tomé and Príncipe G
$8,645
Peru
B r a z i l
French Polynesia (Fr)
Bolivia
Brazil
Paraguay $10,720
Uruguay
Chile
Argentina
Source: Data from Atlas of Global Development, 4th ed., pp. 16-17: World Bank and Collins. 2013. ATLAS OF GLOBAL
DEVELOPMENT: A VISUAL GUIDE TO THE WORLD’S GREATEST CHALLENGES, FOURTH EDITION. Washington, DC
and Glasgow: World Bank and Collins. doi: 10.1596/978-0-8213-9757-2. License: Creative Commons Attribution CC BY 3.0
Russian Federation
Europe & Central Asia
$10,400
$23,562
Sweden
y Finland R u s s i a n F e d e r a t i o n
Estonia
Latvia
ark Lithuania Czech Republic
Belarus Slovak Republic
many Poland Slovenia
Ukraine Croatia
Kazakhstan
Austria Hungary Moldova Serbia
nd Romania Bosnia and Herzegovina Mongolia
aly FYR Macedonia
Montenegro Dem. People's
Bulgaria Uzbekistan Rep. of Korea
o Georgia
Albania Armenia Azerbaijan
Greece Turkmenistan Tajikistan Kyrgyz Republic
Turkey
San Cyprus
Syrian Rep. of Japan
Marino Islamic Republic Korea
isia Lebanon Arab Rep.
Malta Iraq
of Iran Afghanistan C h i n a
Israel Kuwait
Jordan
West Bank and Gaza Pakistan
Bahrain Nepal Bhutan
Libya Arab Rep.
of Egypt
Saudi Arabia
United Arab
China
Qatar Bangladesh
Emirates India
Myanmar
$4,930
Oman Lao
Eritrea P.D.R.
er
Chad
Rep. of
Yemen
India Thailand
Vietnam
N. Mariana Islands (US)
East Asia & Pacific
Sudan
Djibouti
$1,410 Cambodia
Philippines Guam (US) $7,857
Central South Ethiopia
African Sri Lanka Brunei Darussalam Marshall Islands
Sudan Palau
meroon Republic
Malaysia
al Guinea Somalia Federated States of Micronesia
Rep. of Uganda
Kenya Maldives Singapore
aboncongo Rwanda
Dem. Rep. Indonesia Nauru
of Congo Burundi
Solomon Islands Tuvalu
Seychelles Papua New
Tanzania Guinea
Comoros South Asia Timor-Leste
American Samoa (US)
Angola Mayotte
(Fr)
$1,299
Zambia Malawi
Fiji
Vanuatu Samoa
Madagascar
Zimbabwe Mozambique
Tonga
Namibia Botswana Mauritius New
Réunion (Fr) Caledonia
A u s t r a l i a (Fr)
Swaziland
South Africa
Lesotho Sub-Saharan Africa
$1,265
New Zealand
FIGURE 2.2 Income Per Capita in Selected Countries, 2011

Congo, Dem. Rep.
Ethiopia
Haiti
Bangladesh
Kenya
Côte d’Ivoire
Pakistan
India
Country
Ghana
Egypt, Arab Rep.
Indonesia
Dominican Republic
China
Mexico
Brazil
United Kingdom
United States
Canada
0 10,000 20,000 30,000 40,000 50,000 60,000
Annual gross national income per capita (2012 U.S. $)
Source: Data from World Bank, World Development Indicators, 2013 (Washington, D.C.:
World Bank, 2013), tab. 1.1.
power of different currencies. In an attempt to rectify this problem, researchers

Purchasing power parity have tried to compare relative GNIs and GDPs by using purchasing power
(PPP) Calculation of GNI parity (PPP) instead of exchange rates as conversion factors. PPP is calculated
using a common set of inter- using a common set of international prices for all goods and services. In a sim-
national prices for all goods
and services, to provide more ple version, purchasing power parity is defined as the number of units of a for-
accurate comparisons of living eign country’s currency required to purchase the identical quantity of goods
standards. and services in the local developing country market as $1 would buy in the
United States. In practice, adjustments are made for differing relative prices
across countries so that living standards may be measured more accurately.6
Generally, prices of nontraded services are much lower in developing coun-
tries because wages are so much lower. Clearly, if domestic prices are lower,
PPP measures of GNI per capita will be higher than estimates using foreign-
exchange rates as the conversion factor. For example, China’s 2011 GNI per
capita was only 10% of that of the United States using the exchange-rate con-
version but rises to 17% when estimated by the PPP method of conversion.
Income gaps between developed and developing nations thus tend to be less
when PPP is used.
Table 2.2 provides a comparison of exchange rate and PPP GNI per capita
for 30 countries, 10 each from Africa, Asia, and Latin America, plus Canada,
the United Kingdom and the United States. In the first column of Table 2.2,
incomes are measured at market or official exchange rates and suggest that
income of a person in the United States is 242 times that of a person in the DRC.
But this is unbelievable, as many services cost much less in the DRC than in
the United States. The PPP rates give a better sense of the amount of goods and
services that could be bought evaluated at U.S. prices and suggest that real U.S.
incomes are closer to 135 times that of the DRC—still a level of inequality that
stretches the imagination. Overall, the average real (PPP) income per capita in
TABLE 2.2 A Comparison of Per Capita GNI in Selected Developing Countries, the
United Kingdom, and the United States, Using Official Exchange-Rate and
Purchasing Power Parity Conversions, 2011
GNI Per Capita (U.S. $)
Country Exchange Rate Purchasing Power Parity
Bangladesh 770 1,910
Bolivia 2,020 4,890
Botswana 7,070 15,550
Brazil 10,700 11,410
Cambodia 800 2,180
Canada 46,730 41,390
Chile 12,270 19,820
China 4,940 8,390
Colombia 6,090 9,600
Congo, Dem. Rep. 200 360
Costa Rica 7,660 11,910
Côte d’Ivoire 1,140 1,780
Dominican Republic 5,190 9,350
Egypt, Arab Rep. 2,760 6,440
Ghana 1,420 1,830
Guatemala 2,870 4,760
Haiti 700 1,190
India 1,450 3,680
Indonesia 2,930 4,480
Kenya 810 1,690
Korea, Rep. 20,870 29,860
Mexico 8,970 15,930
Niger 330 600
Nigeria 1,260 2,270
Pakistan 1,120 2,880
Peru 5,120 9,390
Philippines 2,200 4,120
Senegal 1,070 1,940
Thailand 4,620 8,710
Uganda 470 1,230
United Kingdom 37,840 35,950
United States 48,550 48,820
Vietnam 1,270 3,250

Low income 554 1,310
Middle income 3,923 6,802
High income 36,390 36,472
Source: Data from World Bank, World Development Indicators, 2013 (Washington, D.C.: World Bank, 2013), tab. 1.1.
high-income countries is more than 28 times that in low-income countries and

more than 5 times higher than in middle-income countries.
Indicators of Health and Education

Besides average incomes, it is necessary to evaluate a nation’s average health
and educational attainments, which reflect core capabilities. Table 2.3 shows
some basic indicators of income, health (the under-5 mortality rate for 1990
and 2011, plus the rate of malnutrition and life expectancy), and education
TABLE 2.3 Commonality and Diversity: Some Basic Indicators
Prevalence of Primary Completion

Malnutrition Rate Under-5 Mortality
Underweight Total Rate
% of Children Under % of Relevant Age Total
Age 5 Group per 1,000 Live Births Life Expectancy
2005-11 1991 2011 1990 2011
Bangladesh 41.3 46 .. 139 46 69
Bolivia 4.5 71 95 120 51 67
Botswana 11.2 89 97 53 26 53
Brazil 2.2 92 .. 58 16 73
Cambodia 29 38 90 117 43 63
Central African Republic 28 28 43 169 164 48
Chile 0.5 .. 95 19 9 79
China 3.4 109 .. 49 15 73
Colombia 3.4 73 112 34 18 74
Congo, Dem. Rep. 28.2 49 61 181 168 48
Costa Rica 1.1 80 99 17 10 79
Côte d’Ivoire 29.4 43 59 151 115 55
Cuba 1.3 94 99 13 6 79
Dominican Republic 3.4 63 92 58 25 73
Egypt, Arab Rep. 6.8 .. 98 86 21 73
Ethiopia 29.2 23 58 198 77 59
Ghana 14.3 65 94 121 78 64
Guatemala 13 .. 86 78 30 71
India 43.5 63 97 114 61 65
Indonesia 18.6 89 108 82 32 69
Mexico 3.4 88 104 49 16 77
Mozambique 18.3 27 56 226 103 50
Niger 39.9 18 46 314 125 55
Nigeria 26.7 .. 74 214 124 52
Pakistan 30.9 .. 67 122 72 65
Peru 4.5 .. 97 75 18 74
Philippines 20.7 89 92 57 25 69
Senegal 19.2 41 63 136 65 59
Uganda 16.4 .. 55 178 90 54
Vietnam 20.2 .. 104 50 22 75
Low income 22.6 46 67 164 95 59
Middle income 16 83 94 82 46 69
High income 1.7 97 101 12 6 79

East Asia & Pacific 5.5 84 .. .. 21 72
Latin America & 3.1 84 102 53 19 74
Caribbean
Middle East & North 6.3 77 91 70 32 72
Africa
South Asia 33.2 63 88 119 62 66
Sub-Saharan Africa 21.4 52 69 178 109 55
Note: Some of the specific countries listed in Table 2.3 differ from those listed in Table 2.2 due to differing availability of the most recent comparable data by
topic; for example, primary completion rate was not available for Haiti; and income was not available for Cuba.
Source: World Bank, World Development Indicators 2013, and World Bank WDI online, accessed 1 August 2013.
(the primary completion rate for 1991 and 2011). (Each country’s region and
income grouping can be found in Table 2.1). Life expectancy is the average
number of years newborn children would live if subjected to the mortality risks
prevailing for their cohort at the time of their birth. Undernourishment means
consuming too little food to maintain normal levels of activity; it is what is often
called the problem of hunger. High fertility can be both a cause and a conse-
quence of underdevelopment, so the birth rate is reported as another basic indi-
cator. Literacy is the fraction of adult males and females reported or estimated to
have basic abilities to read and write; functional literacy is generally lower than
the reported numbers.
Table 2.3 shows these data for the low-, lower-middle-, upper-middle-, and
high-income country groups. The table also shows averages from five devel-
oping regions (East Asia and the Pacific, Latin America and the Caribbean, the
Middle East and North Africa, South Asia, and sub-Saharan Africa) and from
30 illustrative countries balanced across developing regions similar to those in
Table 2.2 (with a few substitutions due to data availability).
Note that in addition to big differences across these income groupings, the
low-income countries are themselves a very diverse group with greatly differ-
ing development challenges.
For example, even Bangladesh has a real income that is now more than five
times greater than the DRC; and India’s income is more than 10 times greater.
Under-5 malnutrition (underweight) is higher in Bangladesh, at 41.3%, than
DRC (a still very high 28.2%). The under-5 mortality rate in Bangladesh is 46,
while that of the DRC is nearly quadruple that number at 168. Life expectancy
in Congo is just 48, compared with 69 in Bangladesh. But while India and Bangla-
desh clearly do better overall than countries like the DRC, most low- and lower-
middle-income countries still face enormous development challenges as seen by
comparing these statistics even to Botswana, Peru, or Thailand
2.3 Holistic Measures of Living Levels

and Capabilities
The New Human Development Index
The most widely used measure of the comparative status of socioeconomic
development is presented by the United Nations Development Programme
(UNDP) in its annual series of Human Development Reports. The centerpiece of
these reports, which were initiated in 1990, is the construction and refinement
of its informative Human Development Index (HDI). This section examines Human Development Index
the New HDI, initiated in 2010 (the well-known traditional HDI—the UNDP (HDI) An index measuring
centerpiece from 1990–2009—is examined in detail in Appendix 2.1). Box 2.2 national socioeconomic devel-
opment, based on combining
summarizes “What Is New in the New HDI.” measures of education, health,
The New HDI, like its predecessor, ranks each country on a scale of 0 (low- and adjusted real income per
est human development) to 1 (highest human development) based on three capita.
goals or end products of development: a long and healthy life as measured by
life expectancy at birth; knowledge as measured by a combination of average
schooling attained by adults and expected years of schooling for school-age
children; and a decent standard of living as measured by real per capita gross
Diminishing marginal utility domestic product adjusted for the differing purchasing power parity of each
The concept that the subjective country’s currency to reflect cost of living and for the assumption of dimin-
value of additional consump-
tion lessens as total consump- ishing marginal utility of income.
tion becomes higher. There are two steps in calculating the New HDI: first, creating the three
“dimension indices”; and second, aggregating the resulting indices to produce
the overall New Human Development Index (NHDI).
After defining the relevant minimum and maximum values (or lower and
upper “goalposts”), each dimension index is calculated as a ratio that basically
is given by the percent of the distance above the minimum to the maximum
levels that a country has attained.
Actual Value - Minimum Value
Dimension index = (2.1)
Maximum Value - Minimum Value
The health (or “long and healthy life”) dimension of the New HDI is calcu-
lated with a life expectancy at birth index, which takes a minimum value of
20 years and a maximum value of 83.57 years (the observed maximum value
for any country). For example, for the case of Ghana this is:
Life expectancy index = 164.6 - 202 > 1 83.6 - 202 = 0.701 (2.2)
The education (“knowledge”) component of the HDI is calculated with a

combination of the average years of schooling for adults aged 25 and older
and expected years of schooling for a school-age child now entering school.
As explained by the UNDP, these indicators are normalized using a minimum
value of 0, and maximum values are set to the actual observed maximum
value of mean years of schooling from the countries in the time series, 1980–
2012, which is 13.3 years estimated for the United States in 2010. For Ghana,
the average years of schooling among adults is 7 years, so the mean years of
schooling subindex is calculated as:
17.0 - 02 > 113.3 - 02 = 0.527 (2.3)
We can think of this as saying that Ghana is about 53% of the way to the global
standard of average education.
In considering expected future education, the highest value (cap, or “goalpost”)
is given as 18 years (which we may think of as approximately corresponding
to a master’s degree).
For Ghana, the expected number of years of schooling for a child entering
school now is estimated at 11.4 years. The expected years of schooling sub-
index is then calculated as:
111.4 - 02 > 1 18.0 - 02 = 0.634 (2.4)
The education index is then calculated as a version of the geometric mean

of the two subindexes.7
The standard of living (income) component is calculated using purchasing-
power-adjusted per-capita gross national income (GNI). For Ghana, the income
index then is (where ln stands for natural log):
Income index = 3ln11,6842 - ln110024 > 3ln187,4782 - ln110024 = 0.417 (2.5)

Using these three measures of development and applying the formula to

data for all 187 countries for which data is available, the HDI currently ranks
countries into four groups: low human development (0.0 to 0.535), medium
human development (0.536 to 0.711), high human development (0.712 to
0.799), and very high human development (0.80 to 1.0).
The component indexes of the NHDI are computed by taking the differ-
ence between the country’s actual achievement and the minimum goalpost
value, and then dividing the result by the difference between the overall maxi-
mum goalpost and minimum goalpost values. But in calculating the overall
index, in place of the arithmetic mean, a geometric mean of the three indexes
is used (a geometric mean is also used to build up the overall education index
from its two components).
Let’s look at why this change is important and how the calculations are done.
Computing the NHDI The use of a geometric mean in computing the New
HDI is very important. When using an arithmetic mean (adding up the com-
ponent indexes and dividing by 3) in the HDI, the effect is to assume perfect
substitutability across income, health, and education. For example, a higher
value of the education index could compensate, one for one, for a lower value
of the health index. In contrast, use of a geometric mean ensures that poor
performance in any dimension directly affects the overall index. Thus, allow-
ing for imperfect substitutability is a beneficial change; but there is active
debate about whether using the geometric mean is the most appropriate way
to accomplish this.8
Thus, as the UNDP notes, the new calculation “captures how well rounded
a country’s performance is across the three dimensions.” Moreover, the UNDP
argues “that it is hard to compare these different dimensions of well-being
and that we should not let changes in any of them go unnoticed.”
So in the New HDI, instead of adding up the health, education, and income
indexes and dividing by 3, the New HDI is calculated with the geometric mean:
NHDI = H1>3E1>3I1>3 (2.6)
where H stands for the health index, E stands for the education index, and
I stands for the income index. This is equivalent to taking the cube root of the
product of these three indexes. The calculations of the NHDI are illustrated for
Ghana in Box 2.1.
Table 2.4 shows the 2013 values of the New HDI for a set of 31 countries.
South Korea has achieved the status of a fully developed country, ranking
below Canada but above the United Kingdom. Countries such as the United
Arab Emirates, Turkey, Guatemala, Gabon, Côte d’Ivoire, Pakistan, Papua
New Guinea, and South Africa perform more poorly on the New HDI than
would be predicted from their income level, while the reverse is true of South
Korea, Chile, Bangladesh, Cuba, Madagascar, and Ghana. Countries such as
Russia, Mexico, India, and Niger perform on the New HDI just about as pre-
dicted by their income levels.
Income predicts rather weakly how countries will perform on education and
health, or on the NHDI in particular. For example, Cuba and Egypt have nearly
the same real income per person, but Cuba ranks 59th on the New HDI (44 points
BOX 2.1 Computing the New HDI: Ghana
Example: Ghana
Indicator Value
Life expectancy at birth (years) 64.6
Mean years of schooling 7.0
Expected years of schooling 11.4
GNI per capita (PPP $) 1,684
Indexes
Note: Values are rounded.
64.6 - 20
Life expectancy index = = 0.701
83.6 - 20
7.0 - 0
Mean years of schooling index = = 0.527
13.3 - 0
11.4 - 0
Expected years of schooling index = = 0.634
18.0 - 0
20.527 * 0.634 - 0
Education index = = 0.596
0.971 - 0
ln11,684) - ln1100)
Income index = = 0.417
ln187,478) - ln1100)
Human Development Index
3
= 2 0.701 * 0.558 * 0.417 = 0.596
UN income estimate will differ somewhat from World Bank estimate.
Source: UNDP, Human Development Report, 2013, Technical Notes (online):, http://hdr.undp.org/en/media/HDR%202013%20technical%20notes%20EN.pdf.
above where predicted by its income level) and Egypt ranks 112th (6 below where
predicted by income). Mexico and Gabon have a very similar income, but Mexico
is 4 places above what would be predicted by its income and Gabon is 40 points
below. Bangladesh and Pakistan have an identical New HDI ranking, but Paki-
stan has a much higher income, and Bangladesh is 9 places higher than expected
while Pakistan is 9 places below; see the case study at the end of this chapter for a
detailed examination of diverging development in these two countries.
The UNDP now also offers the Inequality-Adjusted Human Development
Index (IHDI)—which imposes a penalty on the HDI that increases as inequal-
ity across people becomes greater—and the Gender Inequality Index (GII), as
well as an important innovation, the Multidimensional Poverty Index (MPI),
which is examined in detail in Chapter 5.
Clearly, the Human Development Index, in its Traditional as well as New
forms, has made a major contribution to improving our understanding of
what constitutes development, which countries are succeeding (as reflected by
rises in their NHDI over time), and how different groups and regions within
countries are faring. By combining social and economic data, the NHDI allows
nations to take a broader measure of their development performance, both
relatively and absolutely.
Although there are some valid criticisms, the fact remains that the New
HDI and its Traditional version considered in Appendix 2.1, when used in
TABLE 2.4 2013 New Human Development Index and its Components for Selected Countries
Expected GNI Per

Life Mean Yrs Years Capita
NHDI Expectancy Schooling Schooling GNI Per New HDI Rank Minus
Country Rank at Birth (of Adults) (of children) Capita value HDI Rank
United States 3 78.7 13.3 16.8 43,480 0.937 6
Canada 11 81.1 12.3 15.1 35,369 0.911 5
South Korea 12 80.7 11.6 17.2 28,231 0.909 15
United Kingdom 26 80.3 9.4 16.4 32,538 0.875 5
Chile 40 79.3 9.7 14.7 14,987 0.819 13
United Arab Emirates 41 76.7 8.9 12 42,716 0.818 −31
Russian Federation 55 69.1 11.7 14.3 14,461 0.788 0
Cuba 59 79.3 10.2 16.2 5,539 0.78 44
Mexico 61 77.1 8.5 13.7 12,947 0.775 4
Costa Rica 62 79.4 8.4 13.7 10,863 0.773 12
Brazil 85 73.8 7.2 14.2 10,152 0.73 −8
Turkey 90 74.2 6.5 12.9 13,710 0.722 −32
Sri Lanka 92 75.1 9.3 12.7 5,170 0.715 18
China 101 73.7 7.5 11.7 7,945 0.699 −11
Gabon 106 63.1 7.5 13 12,521 0.683 −40
Egypt 112 73.5 6.4 12.1 5,401 0.662 −6
Botswana 119 53 8.9 11.8 13,102 0.634 −55
South Africa 121 53.4 6.7 10.6 9,594 0.629 −42
Guatemala 133 71.4 4.1 10.7 4,235 0.581 −14
Ghana 135 64.6 7 11.4 1,684 0.558 22
Equatorial Guinea 136 51.4 5.4 7.9 21,715 0.554 −97
India 136 65.8 4.4 10.7 3,285 0.554 −3
Kenya 145 57.7 7 11.1 1,541 0.519 15
Bangladesh 146 69.2 4.8 8.1 1,785 0.515 9
Pakistan 146 65.7 4.9 7.3 2,566 0.515 −9
Madagascar 151 66.9 5.2 10.4 828 0.483 28
Papua New Guinea 156 63.1 3.9 5.8 2,386 0.466 −15
Côte d’Ivoire 168 56 4.2 6.5 1,593 0.432 −9
Burkina Faso 183 55.9 1.3 6.9 1,202 0.343 −18
Chad 184 49.9 1.5 7.4 1,258 0.34 −20
Niger 186 55.1 1.4 4.9 701 0.304 −4
Source: 2013 Human Development Report 2013, Table 1, pages 144-147 (New York: United Nations Development Programme, 2013)
conjunction with other economic measures of development, greatly increase

our understanding of which countries are experiencing development and
which are not. And by modifying a country’s overall NHDI to reflect income
distribution, gender, regional, and ethnic differentials, as presented in recent
Human Development Reports, we are now able to identify not only whether a
country is developing but also whether various significant groups within that
country are participating in that development.9
2.4 Characteristics of the Developing World:

Diversity within Commonality
As noted earlier, there are important historical and economic commonalities
among developing countries that have led to their economic development
BOX 2.2 What Is New in the New Human Development Index
I n November 2010, the UNDP introduced its New

Human Development Index (NHDI), which has eight
notable changes, each with strengths but also a few
there have also been many development
upside surprises, such as rapid improvements
in educational attainment in some coun-
potential drawbacks. tries; there is a risk that low expectations will
prove discouraging. Note that life expectancy,
1. Gross national income (GNI) per capita
which remains the indicator for health, is also
replaces gross domestic product (GDP) per
a projection based on prevailing conditions.
capita. This should be an unambiguous
4. The two previous components of the edu-
improvement: GNI reflects what citizens can
cation index, literacy and enrollment, have
do with income they receive, whereas that is
been correspondingly dropped. In contrast
not true of value added in goods and services
to expected attainment, literacy is clearly an
produced in a country that go to someone
achievement, and even enrollment is at least
outside it, and income earned abroad still
a modest achievement. However, literacy has
benefits some of the nation’s citizens. As trade
always been badly and too infrequently mea-
and remittance flows have been expanding
sured and is inevitably defined more modestly
rapidly, and as aid has been better targeted
in a less developed country. And enrollment
to very low-income countries, this distinction
is no guarantee that a grade will be completed
has become increasingly important.
or for that matter that anything is learned or
2. The education index has been completely
that students (or teachers) even attend.
revamped. Two new components have been
5. The upper goalposts (maximum values) in
added: the average actual educational attain-
each dimension have been increased to the
ment of the whole population and the
observed maximum rather than given a pre-
expected attainment of today’s children. Each
defined cutoff. In some ways, this returns
of these changes to the index has implica-
the index to its original design, which was
tions. Use of actual attainment—average years
criticized for inadequately recognizing small
of schooling—as an indicator is unambigu-
gains by countries starting at very low levels.
ously an improvement. Estimates are regularly
6. The lower goalpost for income has been
updated, and the statistic is easily compared
reduced. This is based on updated estimates
quantitatively across countries. And even
for the historic low for recorded income for
though it is at best a very rough guide to what is
any country.10
actually learned—on average, a year of school-
7. Another minor difference is that rather than
ing in Mali provides students with much less
using the common logarithm (log) to reflect
than a year of schooling in Norway—this is
diminishing marginal benefit of income, the
the best measure we have at present because
NHDI now uses the natural log (ln), as used
more detailed data on quality that are credible
in the fifth equation in Box 2.1. This reflects
and comparable are simply not available.
a more usual construction of indexes.
3. Expected educational attainment, the other
8. Possibly the most consequential change is
new component, is somewhat more ambigu-
that the NHDI is computed with a geometric
ous: It is not an achievement but a UN fore-
mean rather than a simple arithmetic mean,
cast. History shows that much can go wrong
as examined previously.
to derail development plans. Nevertheless,
problems being studied within a common analytical framework in develop-

ment economics. These widely shared problems are examined here in detail
on an issue-by-issue basis. At the same time, however, it is important to
bear in mind that there is a great deal of diversity throughout the develop-
ing world, even within these areas of broad commonality. The wide range of
income, health, education, and HDI indicators already reviewed is sometimes
called a “ladder of development.”11 Different development problems call for
different specific policy responses and general development strategies. This
section examines the 10 major areas of “diversity within commonality” in the
developing world.
Lower Levels of Living and Productivity

As we noted at the outset of the chapter, there is a vast gulf in productivity
between advanced economies such as the United States and developing nations,
including India and the DRC, but also a wide range among these and other
developing countries. And as we have seen, all countries with averages below
what is defined as high income are considered developing in most taxonomies
(and some in the high-income range as defined by the World Bank are still
considered developing). The lower average levels but wide ranges of income
in developing areas are seen in Table 2.3. Even when adjusted for purchasing
power parity and despite extraordinary recent growth in China and India, the
low- and middle-income developing nations, with more than five-sixths (84%)
of the world’s people, received only about 46% of the world’s income in 2011,
as seen in Figure 2.3a. Though resulting from a number of deeper causes, the
wide disparity in income largely corresponds to the large gaps in output per
worker between developing and developed countries as seen in Figure 2.3b.12
At very low income levels, in fact, a vicious circle may set in, whereby low
income leads to low investment in education and health as well as plant and
equipment and infrastructure, which in turn leads to low productivity and
economic stagnation. This is known as a poverty trap or what Nobel laureate
Gunnar Myrdal called “circular and cumulative causation.”13 However, it is
important to stress that there are ways to escape from low income, as you will
see throughout this book. Further, the low-income countries are themselves a
very diverse group with greatly differing development challenges.14
Some star performers among now high-income economies such as South
Korea and Taiwan were once among the poorest in the world. Some middle-
income countries are also relatively stagnant, but others are growing rapidly—
China most spectacularly, as reviewed in the case study at the end of Chapter 4.
Indeed, income growth rates have varied greatly in different developing
regions and countries, with rapid growth in East Asia, slow or even no growth
in sub-Saharan Africa, and intermediate levels of growth in other regions.
Problems of igniting and then sustaining economic growth are examined in
depth in Chapters 3 and 4.
One common misperception is that low incomes result from a country’s
being too small to be self-sufficient or too large to overcome economic inertia.
However, there is no necessary correlation between country size in population
or area and economic development (in part because each has different advantages
and disadvantages that can offset each other).15
FIGURE 2.3 (a) Shares of Global Income, 2008. (b) Developing regions lag far behind the developed
world in productivity measured as output per worker.
(a) (b)
Output per worker, 1991, 2001, and 2011
East Asia and Pacific (Thousands of constant 2005 PPP-adjusted international dollars)
18%
Sub-Saharan Africa
5
Europe and 5
Central Asia 6
High-Income 7% Oceania
countries 5
54% Latin America
5
and Caribbean 6
8%
Southern Asia
Middle East and 4
North Africa 5
3% 9
South Asia South-Eastern Asia
Sub-Saharan 7% 6
Africa 7
2% 10
Caucasus and Central Asia
10
7
14
Eastern Asia
3
6
14
Northern Africa
17
18
21
Latin America and the Caribbean
20
21
23
Western Asia
30
35
40
Developed regions
48
57
64
Developing regions
6
8
13
0 10 20 30 40 50 60 70
1991 2001 2011*
* Figures for 2011 are preliminary estimates.
Source: Figure 2.3a, Data from World Bank, World Development Indicators 2013 (Washington, D. C.: World Bank, 2013), p.24.
Figure 2.3b, United Nations, Millenium Development Goals Report 2012, p.9.
TABLE 2.5 The 12 Most and Least Populated Countries and Their Per Capita Income, 2008
Population GNI Per Population GNI Per Capita

Most Populous (millions) Capita (U.S. $) Least Populousa (thousands) (U.S. $)
1. China 1,325 2,940 1. Palau 20 8,630
2. India 1,140 1,040 2. St. Kitts and Nevis 49 10,870
3. United States 304 47,930 3. Marshall Islands 60 3,270
4. Indonesia 227 1,880 4. Dominica 73 4,750
5. Brazil 192 7,300 5. Antigua and Barbuda 87 13,200
6. Pakistan 166 950 6. Seychelles 87 10,220
7. Bangladesh 160 520 7. Kiribati 97 2,040
8. Nigeria 151 1,170 8. Tonga 104 2,690
9. Russian Federation 142 9,660 9. Grenada 104 5,880
10. Japan 128 38,130 10. St. Vincent and the 109 5,050
Grenadines
11. Mexico 106 9,990 11. Micronesia 110 2,460
12. Philippines 90 1,890 12. São Tomé and Príncipe 160 1,030
a
Criteria for inclusion in the least-populous rankings: United Nations member as of mid-2010, with 2008 comparable population and GNI per capita data in
tab. 1.6 in the source.
Source: The World Bank, World Development Indicators, 2010 (Washington, D.C.: World Bank, 2010), tabs 1.1 and 1.6.
The 12 most populous countries include representatives of all four cate-

gories: low-, lower-middle-, upper-middle-, and high-income countries (see
Table 2.5). The 12 least populous on the list include primarily lower-middle- and
upper-middle-income countries, although the 12th least populous country,
São Tomé and Príncipe, has a per capita income of just $1,030. And four very
small but high-income European countries that are UN members (Andorra,
Monaco, Liechtenstein, and San Marino) would appear on the list if compa-
rable World Bank income data were available.
Lower Levels of Human Capital

Human capital—health, education, and skills—is vital to economic growth
and human development. We have already noted the great disparities in
human capital around the world while discussing the Human Development
Index. Compared with developed countries, much of the developing world
has lagged in its average levels of nutrition, health (as measured, for example,
by life expectancy or undernourishment), and education (measured by liter-
acy), as seen in Table 2.3. The under-5 mortality is 17 times higher in low-
income countries than in high-income countries, although great progress has
been made since 1990, as shown graphically in Figure 2.4.
Table 2.6 shows primary school enrollment rates (percentage of students
of primary age enrolled in school) and the primary school pupil-to-teacher
ratio for the four country income groups and for six major developing regions.
Enrollments have strongly improved in recent years, but student attendance
and completion, along with attainment of basic skills such as functional lit-
eracy, remain problems. Indeed, teacher truancy remains a serious problem in
South Asia and sub-Saharan Africa.16
Moreover, there are strong synergies (complementarities) between prog-
ress in health and education (examined in greater depth in Chapter 8). For
FIGURE 2.4 Under-5 Mortality Rates, 1990 and 2012
200
1990
160
Deaths per 1,000

2012
live births
120
80
40
0
Low Lower middle Upper middle High
income income income income
Source: Data drawn from World Bank, World Development Indicators, accessed 22 Sept. 2013
Reprinted with permission.
example, under-5 mortality rates improve as mothers’ education levels rise, as

seen in the country examples in Figure 2.5.
The well-performing developing countries are much closer to the devel-
oped world in health and education standards than they are to the lowest-
income countries.17 Although health conditions in East Asia are relatively
good, sub-Saharan Africa continues to be plagued by problems of malnourish-
ment, malaria, tuberculosis, AIDS, and parasitic infections. Despite progress,
South Asia continues to have high levels of illiteracy, low schooling attainment,
and undernourishment. Still, in fields such as primary school completion, low-
income countries are also making great progress; for example, enrollments in
India are up from 68% in the early 1990s to a reported 94% by 2008.
Higher Levels of Inequality and Absolute Poverty

Globally, the poorest 20% of people receive just 1.5% of world income. The
lowest 20% now roughly corresponds to the approximately 1.2 billion people
TABLE 2.6 Primary School Enrollment and Pupil-Teacher Ratios, 2010
Net Primary School Primary Pupil-

Region or Group Enrollment (%) Teacher Ratio
Income Group
Low 80 45
Lower Middle 87 23a
Upper Middle 94 22
High 95 15
Region
East Asia and Pacific 93a 19
Latin America and the Caribbean 94 25
Middle East and North Africa 91 24
South Asia 86 40a
Sub-Saharan Africa 73 49
Europe and Central Asia 92 16
a
Data for 2009.
Source: Data from World Bank, World Development Indicators, 2010 (Washington, D.C.: World Bank, 2010), tabs 2.11 and 2.12.
FIGURE 2.5 Correlation between Under-5 Mortality and Mother’s Education
Mother’s Education
No education
200 Some primary
Complete primary/some secondary
Deaths per 1,000
150 Complete secondary/some higher

live births
100
50
0
Tanzania Bolivia Bangladesh Philippines Egypt
(2004–05) (2003) (2004) (2003) (2005)
Source: International Bank for Reconstruction and Development/World Bank, World Development Indicators, 2007 (Washington,
D.C.: World Bank, 2007), p. 119. Reprinted with permission.
living in extreme poverty on less than $1.25 per day at purchasing power parity.18
Bringing the incomes of those living on less than $1.25 per day up to this
minimal poverty line would require less than 2% of the incomes of the world’s
wealthiest 10%.19 Thus, the scale of global inequality is also immense.
But the enormous gap in per capita incomes between rich and poor nations is
not the only manifestation of the huge global economic disparities. To appreciate
the breadth and depth of deprivation in developing countries, it is also necessary
to look at the gap between rich and poor within individual developing countries.
Very high levels of inequality—extremes in the relative incomes of higher- and
lower-income citizens—are found in many middle-income countries, partly
because Latin American countries historically tend to be both middle-income and
highly unequal. Several African countries, including Sierra Leone, Lesotho, and South
Africa, also have among the highest levels of inequality in the world.20 Inequality is
particularly high in many resource-rich developing countries, notably in the Mid-
dle East and sub-Saharan Africa. Indeed, in many of these cases, inequality is sub-
stantially higher than in most developed countries (where inequality has in many
cases been rising). But inequality varies greatly among developing countries, with
generally much lower inequality in Asia. Consequently, we cannot confine our
attention to averages; we must look within nations at how income is distributed to
ask who benefits from economic development and why.
Corresponding to their low average income levels, a large majority of the
extreme poor live in the low-income developing countries of sub-Saharan Africa
and South Asia. Extreme poverty is due in part to low human capital but also to
social and political exclusion and other deprivations. Great progress has already
been made in reducing the fraction of the developing world’s population living
on less than $1.25 per day and raising the incomes of those still below that level,
but much remains to be done, as we examine in detail in Chapter 5.
Absolute poverty The Development economists use the concept of absolute poverty to represent
situation of being unable or a specific minimum level of income needed to satisfy the basic physical needs
only barely able to meet the
subsistence essentials of food, of food, clothing, and shelter in order to ensure continued survival. A problem,
clothing, shelter, and basic however, arises when one recognizes that these minimum subsistence levels
health care. will vary from country to country and region to region, reflecting different
physiological as well as social and economic requirements. Economists have
therefore tended to make conservative estimates of world poverty in order to
avoid unintended exaggeration of the problem.
The incidence of extreme poverty varies widely around the developing
world. The World Bank estimates that the share of the population living on
less than $1.25 per day is 9.1% in East Asia and the Pacific, 8.6% in Latin America
and the Caribbean, 1.5% in the Middle East and North Africa, 31.7% in South
Asia, and 41.1% in sub-Saharan Africa.21 The share of the world population
living below this level had fallen encouragingly to an estimated 21% by 2010,
though there are concerns that the pace of poverty reduction may have slowed
recently.22 But as Figure 2.6 shows, the number living on less than $1.25 per
day fell from about 1.9 billion in 1981 to about 1.2 billion by 2008, despite a
59% increase in the developing world’s population.
Extreme poverty represents great human misery, and so redressing it is
a top priority of international development. Development economists have
also increasingly focused on ways in which poverty and inequality can lead
to slower growth. That is, not only do poverty and inequality result from
distorted growth, but they can also cause it. This relationship, along with
FIGURE 2.6 Number of People Living in Poverty by Region, 1981–2008

Number of poor by region, 1981-2008
Population living under $1.25 a day in 2005 PPP (millions)
2,000
Rest of the World
Sub-Saharan Africa
1,500
South Asia
1,000
500 East Asia and the Pacific
0
1981 1984 1987 1990 1993 1996 1999 2002 2005 2008
Source: World Bank, “World Bank sees progress against extreme poverty, but flags
vulnerability,” April 2012, http://web.worldbank.org/WBSITE/EXTERNAL/EXTDEC/
EXTRESEARCH/EXTPROGRAMS/EXTPOVRES/EXTPOVCALNET/0,,contentMDK:
22716987~pagePK:64168435~theSitePK:5280443~isCURL:Y,00.html.
measurements of inequality and poverty and strategies to address these problems,

is examined in depth in Chapter 5; because of their central importance in
development, poverty reduction strategies are examined throughout the text.
Higher Population Growth Rates

Global population has skyrocketed since the beginning of the industrial era,
from just under 1 billion in 1800 to 1.65 billion in 1900 and to over 6 billion by
2000. World population topped 7 billion by 2012. Rapid population growth
began in Europe and other now developed countries. But in recent decades,
most population growth has been centered in the developing world. Com-
pared with the developed countries, which often have birth rates near or even
below replacement (zero population growth) levels, the low-income develop-
ing countries have very high birth rates. More than five-sixths of all the people
in the world now live in developing countries; and some 97% of net popula-
tion growth (births minus deaths) in 2012 took place in developing regions.
But population dynamics varies widely among developing countries. Popula-
tions of some developing countries, particularly in Africa, continue to grow rap-
idly. From 1990 to 2008, population in the low-income countries grew at 2.2% per
year, compared to 1.3% in the middle-income countries (the high-income coun-
tries grew at 0.7% per year, reflecting both births and immigration).23
Middle-income developing countries show greater variance, with some
having achieved lower birth rates closer to those prevailing in rich countries.
The birth rate is about three times as high in the low-income countries as in
the high-income countries. In sub-Saharan Africa, the annual birth rate is 39
per 1,000—four times the rate in high-income countries. Intermediate but still
relatively high birth rates are found in South Asia (24), the Middle East and
North Africa (24), and Latin America and the Caribbean (19). East Asia and
the Pacific have a moderate birth rate of 14 per 1,000, partly the result of birth
control policies in China. The very wide range of crude birth rates around Crude birth rate The number
the world is illustrated in Table 2.7. As of 2010, the average rate of population of children born alive each
year per 1,000 population.
growth was about 1.4% in the developing countries.
A major implication of high birth rates is that the active labor force has
to support proportionally almost twice as many children as it does in richer
countries. By contrast, the proportion of people over the age of 65 is much
TABLE 2.7 Crude Birth Rates Around the World, 2012

45+ Chad, Dem. Rep. of Congo, Mali, Niger, Uganda, Zambia
40–44 Afghanistan, Angola, Benin, Burkina Faso, Liberia, Malawi, Mozambique, Nigeria, Somalia, South Sudan, Tanzania
35–39 Central African Republic, Côte d’Ivoire, Eritrea, Iraq, Jordan, Kenya, Madagascar, Senegal, Sierra Leone, Yemen
30–34 Ethiopia, Ghana, Papua New Guinea, Sudan, Timor-Leste, Vanatu, Zimbabwe
25–29 Algeria, Bolivia, Cambodia, Egypt, Guatemala, Haiti, Honduras, Kyrgyzstan, Pakistan, Philippines, Samoa, Tonga
20–24 Dominican Republic, El Salvador, India, Libya, Mexico, Peru, Saudi Arabia, South Africa, Venezuela
15–19 Argentina, Brazil, Colombia, Costa Rica, Indonesia, Jamaica, Sri Lanka, Turkey, Vietnam
10–14 Australia, Canada, China, France, Russia, United Kingdom, United States
<10 Austria, Croatia, Germany, Hungary, Italy, Japan, South Korea, Serbia, Portugal, Taiwan
Source: Population Reference Bureau, Population Data Sheet, 2012.
greater in the developed nations. Both older people and children are often
Dependency burden The referred to as an economic dependency burden in the sense that they must be
proportion of the total popu- supported financially by the country’s labor force (usually defined as citizens
lation aged 0 to 15 and 65+,
which is considered economi-
between the ages of 15 and 64). In low-income countries, there are 66 children
cally unproductive and there- under 15 for each 100 working-age (15–65) adults, while in middle-income
fore not counted in the labor countries, there are 41 and in high-income countries just 26. In contrast, low-
force. income countries have just 6 people over 65 per 100 working-age adults, com-
pared with 10 in middle-income countries and 23 in high-income countries.
Thus, the total dependency ratio is 72 per 100 in low-income countries and
49 per 100 in high-income countries.24 But in rich countries, older citizens are
supported by their lifetime savings and by public and private pensions. In
contrast, in developing countries, public support for children is very limited.
So dependency has a further magnified impact in developing countries.
We may conclude, therefore, that not only are developing countries char-
acterized by higher rates of population growth, but they must also contend
with greater dependency burdens than rich nations, though with a wide gulf
between low- and middle-income developing countries. The circumstances and
conditions under which population growth becomes a deterrent to economic
development is a critical issue and is examined in Chapter 6.
Greater Social Fractionalization

Low-income countries often have ethnic, linguistic, and other forms of social
Fractionalization Significant divisions, sometimes known as fractionalization. This is sometimes asso-
ethnic, linguistic, and other ciated with civil strife and even violent conflict, which can lead developing
social divisions within a
country.
societies to divert considerable energies to working for political accommoda-
tions if not national consolidation. It is one of a variety of governance chal-
lenges many developing nations face. There is some evidence that many of the
factors associated with poor economic growth performance in sub-Saharan
Africa, such as low schooling, political instability, underdeveloped financial
systems, and insufficient infrastructure, can be statistically explained by high
ethnic fragmentation.25
The greater the ethnic, linguistic, and religious diversity of a country, the
more likely it is that there will be internal strife and political instability. Some
of the most successful development experiences—South Korea, Taiwan, Sin-
gapore, and Hong Kong—have occurred in culturally homogeneous societies.
But today, more than 40% of the world’s nations have more than five sig-
nificant ethnic populations. In most cases, one or more of these groups face
serious problems of discrimination, social exclusion, or other systematic dis-
advantages. Over half of the world’s developing countries have experienced
some form of interethnic conflict. Ethnic and religious conflicts leading to
widespread death and destruction have taken place in countries as diverse
as Afghanistan, Rwanda, Mozambique, Guatemala, Mexico, Sri Lanka, Iraq,
India, Kyrgyzstan, Azerbaijan, Somalia, Ethiopia, Liberia, Sierra Leone,
Angola, Myanmar, Sudan, the former Yugoslavia, Indonesia, and the DRC.
Conflict can derail what had otherwise been relatively positive develop-
ment progress, as in Côte d’Ivoire since 2002 (see Chapter 14 and the case
study for Chapter 5). There is, however, a heartening trend since the late
1990s toward more successful resolution of conflicts and fewer new conflicts.
If development is about improving human lives and providing a widening

range of choice to all peoples, racial, ethnic, caste, or religious discrimination
is pernicious. For example, throughout Latin America, indigenous popula-
tions have significantly lagged behind other groups on almost every measure
of economic and social progress. Whether in Bolivia, Brazil, Peru, Mexico,
Guatemala, or Venezuela, indigenous groups have benefited little from overall
economic growth. Being indigenous makes it much more likely that an indi-
vidual will be less educated, in poorer health, and in a lower socioeconomic
stratum than other citizens.26 This is particularly true for indigenous women.
Moreover, descendants of African slaves brought forcefully to the western
hemisphere continue to suffer discrimination in countries such as Brazil.
Ethnic and religious diversity need not necessarily lead to inequality, tur-
moil, or instability, and unqualified statements about their impact cannot
be made. There have been numerous instances of successful economic and
social integration of minority or indigenous ethnic populations in countries as
diverse as Malaysia and Mauritius. And in the United States, diversity is often
cited as a source of creativity and innovation. The broader point is that the
ethnic and religious composition of a developing nation and whether or not
that diversity leads to conflict or cooperation can be important determinants
of the success or failure of development efforts.27
Larger Rural Populations but Rapid Rural-to-Urban Migration

One of the hallmarks of economic development is a shift from agriculture to
manufacturing and services. In developing countries, a much higher share of
the population lives in rural areas, and correspondingly fewer in urban areas,
as seen in Table 2.8. Although modernizing in many regions, rural areas are
poorer and tend to suffer from missing markets, limited information, and social
stratification. A massive population shift is also under way as hundreds of mil-
lions of people are moving from rural to urban areas, fueling rapid urbaniza-
tion, with its own attendant problems. The world as a whole has just crossed
the 50% threshold: For the first time in history, more people live in cities than
TABLE 2.8 The Urban Population in Developed Countries and Developing Regions
Region Population (millions, 2009) Urban Share (%)

World 6,810 50
More developed countries 1,232 75
Less developed countries 5,578 44
Sub-Saharan Africa 836 35
Northern Africa 205 50
Latin America and the 580 77
Caribbean
Western Asia 231 64
South-central Asia 1,726 31
Southeast Asia 597 43
East Asia 1,564 51
Eastern Europe 295 69
Source: Population Reference Bureau, 2009 World Data Sheet.
in rural areas. But sub-Saharan Africa and most of Asia remain predominantly
rural. Migration and agriculture issues are examined in Chapters 7 and 9.
Lower Levels of Industrialization and Manufactured Exports

One of the most widely used terminologies for the original Group of Seven
(G7) countries28 and other advanced economies such as smaller European
countries and Australia is the “industrial countries.” Industrialization is
associated with high productivity and incomes and has been a hallmark of
modernization and national economic power. It is no accident that most devel-
oping-country governments have made industrialization a high national pri-
ority, with a number of prominent success stories in Asia.
Table 2.9 shows the relationship between employment and share of GDP in
agriculture, industry, and services in selected developing and developed coun-
tries, in the 2004 to 2008 period. Generally, developing countries have a far
higher share of employment in agriculture than developed countries. More-
over, in developed countries, agriculture represents a very small share of both
employment and output—about 1% to 2% in Canada, the United States and
United Kingdom—although productivity is not below the average for these
economies as a whole. This is in sharp contrast to a majority of developing
nations, which have relatively low productivity in agriculture in comparison
TABLE 2.9 Share of the Population Employed in the Agricultural, Industrial, and Service Sectors in Selected
Countries, 2004–2008 (%)
Agriculture Industry Services
Share of Share of Share of
Males Females GDP (2008) Males Females GDP (2008) Males Females GDP (2008)
Africa
Egypt 28 43 13 26 6 38 46 51 49
Ethiopia 12 6 44 27 17 13 61 77 42
Madagascar 82 83 25 5 2 17 13 16 57
Mauritius 10 8 4 36 26 29 54 66 67
South Africa 11 7 3 35 14 34 54 80 63
Asia
Bangladesh 42 68 19 15 13 29 43 19 52
Indonesia 41 41 14 21 15 48 38 44 37
Malaysia 18 10 10 32 23 48 51 67 42
Pakistan 36 72 20 23 13 27 41 15 53
Philippines 44 24 15 18 11 32 39 65 53
South Korea 7 8 3 33 16 37 60 74 60
Thailand 43 40 12 22 19 44 35 41 44
Vietnam 56 60 22 21 14 40 23 26 38
Latin America
Colombia 27 6 9 22 16 36 51 78 55
Costa Rica 18 5 7 28 13 29 54 82 64
Mexico 19 4 4 31 18 37 50 77 59
Nicaragua 42 8 19 20 18 30 38 73 51
Developed Countries
United Kingdom 2 1 1 32 9 24 66 90 76
United States 2 1 1 30 9 22 68 90 77
Note: Ethiopia agricultural employment reflects limited coverage.
Source: World Bank, World Development Indicators, 2010 (Washington, D.C.: World Bank, 2010), tabs. 2.3 and 4.2.
to other sectors of their own economies—particularly industry. Madagascar is

a dramatic example: while about 82% of both men and women worked in agri-
culture, it represented only a quarter of total output. In Indonesia, 41% of both
men and women worked in agriculture, but it represented just 14% of output.
The proportion of women who work in the agricultural sector varies greatly
across the developing world. Generally, in Latin America a significantly higher
proportion of men work in agriculture than women; but in numerous countries
in Africa and Asia, a larger proportion of women work in agriculture.
Table 2.10 reveals the structural transformation of employment that has
been occurring in developing countries. Where available, the table shows
employment shares in both 1990–1992 and 2008–2011 periods. There have
been substantial declines over this two-decade period in the share in employ-
ment in agriculture in most developing countries for which comparable data
is available. For example, in Indonesia the proportion of men who work in
agriculture fell from 54% to 37%; and the proportion of women who work
in agriculture fell from 57% to 35%. Partial exceptions include Pakistan and
Honduras, for which the share of women’s agricultural employment rose by
approximately as much as that of men fell.
At the same time, the share of employment in industry in many devel-
oped countries is smaller now than in some developing countries, particularly
among women, as developed countries continue their secular trend to switch
to from industry to service sector employment. However, many developed-
country industrial jobs require high skills and pay high wages.
Relatively few countries managed a substantial gain of the fraction in
manufacturing in this period; Indonesia, Turkey, and Mexico showed modest
gains, particularly for men. (Other evidence indicates that a large fraction of
global manufacturing jobs were gained in one country—China—during this
period; but comparable data for China were unavailable for comparison.)
The share of industrial employment in Africa remains low for both men and
women in most countries.
Along with lower industrialization, developing nations tended to have a
higher dependence on primary exports. Most developing countries have diver-
sified away from agricultural and mineral exports to some degree. The middle-
income countries are rapidly catching up with the developed world in the share
of manufactured goods in their exports, even if these goods are typically less
advanced in their skill and technology content. However, the low-income coun-
tries, particularly those in Africa, remain highly dependent on a relatively small
number of agricultural and mineral exports. Africa will need to continue its
efforts to diversify its exports. We examine this topic in Chapter 12.
Adverse Geography
Many analysts argue that geography must play some role in problems of agri-
culture, public health, and comparative development more generally. Land-
locked economies, common in Africa, often have lower incomes than coastal
economies.29 As can be observed on the map on the inside cover, develop-
ing countries are primarily tropical or subtropical, and this has meant that
they suffer more from tropical pests and parasites, endemic diseases such as
malaria, water resource constraints, and extremes of heat. A great concern
68
PART ONE Principles and Concepts
TABLE 2.10 Share of the Population Employed in the Agricultural, Industrial, and Service Sectors in Selected Countries, 1990–92 and 2008–2011 (%)
Agriculture Industry Services

Males Females Males Females Males Females
% of Male % of Female % of Male % of Female % of Male % of Female
Employment Employment Employment Employment Employment Employment
1990–92 2008–11 1990–92 2008–11 1990–92 2008–11 1990–92 2008–11 1990–92 2008–11 1990–-92 2008–-11 Region
Cameroon .. 49 .. 58 .. 13 .. 12 .. 38 .. 30 Africa
Egypt, Arab Rep. 35 28 52 46 25 27 10 6 41 44 37 49 Africa
Liberia .. 50 .. 48 .. 14 .. 5 .. 37 .. 47 Africa
Mauritius 15 9 13 7 36 32 48 21 48 59 39 73 Africa
Namibia 45 23 52 8 21 24 8 9 34 53 40 83 Africa
Indonesia 54 37 57 35 15 24 13 15 31 40 31 50 Asia
Malaysia 23 16 20 9 31 31 32 21 46 53 48 71 Asia
Pakistan 45 37 69 75 20 22 15 12 35 41 16 13 Asia
Philippines 53 41 32 23 17 18 14 10 29 41 55 68 Asia
Thailand 60 41 62 37 18 23 13 18 22 37 25 45 Asia
Turkey 33 18 72 39 26 31 11 15 41 51 17 45 Asia
Chile 24 14 6 5 32 31 15 10 45 55 79 85 Latin America
Costa Rica 32 20 5 4 27 25 25 11 41 55 69 84 Latin America
Dominican 26 19 3 2 23 21 21 7 52 47 76 60 Latin America
Republic
Honduras 53 50 6 12 18 19 25 21 29 31 69 67 Latin America
Mexico 34 19 11 4 25 30 19 18 41 51 70 78 Latin America
Canada 6 3 2 1 31 32 11 10 64 65 87 89 Developed
Japan 6 4 7 4 40 33 27 15 54 62 65 80 Developed
United Kingdom 3 2 1 1 41 29 16 8 55 69 82 91 Developed
United States 4 2 1 1 34 25 14 7 62 72 85 92 Developed
Note: Country selection reflects that only a limited number of countries are covered or have data over time. Data represent most recent in timeframe if average for the period is not available.
Source: World Bank, World Development Indicators, 2013 (Washington, D.C.: World Bank, 2013), tab. 2.3.
going forward is that global warming is projected to have its greatest negative
impact on Africa and South Asia (see Chapter 10).30
The extreme case of favorable physical resource endowment is the oil- Resource endowment A
rich Persian Gulf states. At the other extreme are countries like Chad, Yemen, nation’s supply of usable
factors of production, including
Haiti, and Bangladesh, where endowments of raw materials and minerals and mineral deposits, raw materials,
even fertile land are relatively minimal. However, as the case of the DRC shows and labor.
vividly, high mineral wealth is no guarantee of development success. Conflict over
the profits from these industries has often led to a focus on the distribution of wealth
rather than its creation and to social strife, undemocratic governance, high inequal-
ity, and even armed conflict, in what is called the “curse of natural resources.”
Clearly, geography is not destiny; high-income Singapore lies almost directly
on the equator, and parts of southern India have exhibited enormous economic
dynamism in recent years. Prior to colonization, some tropical and subtropical
regions had higher incomes per capita than Europe. However, the presence of
common and often adverse geographic features in comparison to temperate
zone countries means it is beneficial to study tropical and subtropical develop-
ing countries together for some purposes. Redoubled efforts are now under way
to extend the benefits of the green revolution and tropical disease control to sub-
Saharan Africa. In section 2.7 of this chapter, we add further perspectives on the
possible indirect roles of geography in comparative development.
Underdeveloped Markets
Imperfect markets and incomplete information are far more prevalent in
developing countries, with the result that domestic markets, notably but not
only financial markets, have worked less efficiently, as examined in Chapters
4, 11, and 15. In many developing countries, legal and institutional founda-
tions for markets are extremely weak.
Some aspects of market underdevelopment are that they often lack (1) a
legal system that enforces contracts and validates property rights; (2) a sta-
ble and trustworthy currency; (3) an infrastructure of roads and utilities that Infrastructure Facilities that
results in low transport and communication costs so as to facilitate interre- enable economic activity and
markets, such as transporta-
gional trade; (4) a well-developed and efficiently regulated system of banking tion, communication and
and insurance, with broad access and with formal credit markets that select distribution networks, utili-
projects and allocate loanable funds on the basis of relative economic profit- ties, water, sewer, and energy
ability and enforce rules of repayment; (5) substantial market information for supply systems.
consumers and producers about prices, quantities, and qualities of products
and resources as well as the creditworthiness of potential borrowers; and
(6) social norms that facilitate successful long-term business relationships.
These six factors, along with the existence of economies of scale in major sec-
tors of the economy, thin markets for many products due to limited demand
and few sellers, widespread externalities (costs or benefits that accrue to com-
panies or individuals not doing the producing or consuming) in production
and consumption, and poorly regulated common property resources (e.g.,
fisheries, grazing lands, water holes) mean that markets are often highly
imperfect. Moreover, information is limited and costly to obtain, thereby
often causing goods, finances, and resources to be misallocated. And we have
come to understand that small externalities can interact in ways that add up
to very large distortions in an economy and present the real possibility of an
Imperfect market A market underdevelopment trap (see Chapter 4). The extent to which these imperfect
in which the theoretical markets and incomplete information systems justify a more active role for gov-
assumptions of perfect com-
petition are violated by the
ernment (which is also subject to similar problems of incomplete and imperfect
existence of, for example, a information) is an issue that we will be dealing with in later chapters. But their
small number of buyers and existence remains a common characteristic of many developing nations and an
sellers, barriers to entry, and important contributing factor to their state of underdevelopment.31
incomplete information.
Incomplete information The
absence of information that Lingering Colonial Impacts and Unequal
producers and consumers International Relations
need to make efficient deci-
sions resulting in underper- Colonial Legacy Most developing countries were once colonies of Europe or
forming markets.
otherwise dominated by European or other foreign powers, and institutions
created during the colonial period often had pernicious effects on development
that in many cases have persisted to the present day. Despite important varia-
tions that proved consequential, colonial era institutions often favored extrac-
tors of wealth rather than creators of wealth, harming development then and
now. Both domestically and internationally, developing countries have more
often lacked institutions and formal organizations of the type that have bene-
Property rights The fited the developed world: Domestically, on average, property rights have been
acknowledged right to use less secure, constraints on elites have been weak, and a smaller segment of soci-
and benefit from a tangible
(e.g., land) or intangible (e.g.,
ety has been able to gain access to and take advantage of economic opportuni-
intellectual) entity that may ties.32 Problems with governance and public administration (see Chapter 11), as
include owning, using, deriv- well as poorly performing markets, often stem from poor institutions.
ing income from, selling, and Decolonization was one of the most important historical and geopolitical
disposing.
events of the post–World War II era. More than 80 former European colonies
have joined the United Nations. But several decades after independence, the
effects of the colonial era linger for many developing nations, particularly the
least developed ones.
Colonial history matters not only or even primarily because of stolen
resources but also because the colonial powers determined whether the legal
and other institutions in their colonies would encourage investments by (and in)
the broad population or would instead facilitate exploitation of human and other
resources for the benefit of the colonizing elite and create or reinforce extreme
inequality. Development-facilitating or development-inhibiting institutions tend
to have a very long life span. For example, when the conquered colonial lands
were wealthier, there was more to steal. In these cases, colonial powers favored
extractive (or “kleptocratic”) institutions at the expense of ones that encouraged
productive effort. When settlers came in large numbers to live permanently,
incomes ultimately were relatively high, but the indigenous populations were
largely annihilated by disease or conflict, and descendants of those who sur-
vived were exploited and blocked from advancement. A growing body of evi-
dence demonstrates that practices such as forced labor had pernicious effects on
human development even centuries after they were discontinued (see Box 2.3).
In a related point of great importance, European colonization often created
or reinforced differing degrees of inequality, often correlated with ethnicity,
which have also proved remarkably stable over the centuries. In some respects,
postcolonial elites in many developing countries largely took over the exploit-
ative role formerly played by the colonial powers. High inequality sometimes
emerged as a result of slavery in regions where comparative advantage in crops
BOX 2.3 FINDINGS The Persistent Effects of Colonial Forced Labor on Poverty and Development
I n a 2010 study, Melissa Dell used historical district-

level data to examine the long-run impacts of the
mita forced labor system in Peru and Bolivia, which
some circumstances can make these studies virtually
as informative as a randomized trial.
One basic assumption of RDD is that individuals
“required over 200 indigenous communities to send just below and just above the cutoff are otherwise
one-seventh of their adult male population to work similar and have the same potential outcomes in the
in the Potosi silver and Huancavelica mercury mines absence of the treatment. This assumption means that
between 1573 and 1812.” Forced labor can severely individuals cannot “sort themselves” to be just under
harm subjected communities. But Dell finds even the cutoff (or over the cutoff, if that is the incentive).
today—two centuries later—districts covered by the For example, people cannot pretend to be poorer in
mita system have lower household consumption and order to get into a poverty program. Otherwise, the
higher probability of stunting in children. estimated effect can be compounded with the char-
Can development economists conclude with con- acteristics of those people who respond by sorting
fidence that a colonial system ending two centuries themselves (e.g., people with higher cognitive skills).
ago is the cause of worse performance in the districts Dell’s RDD strategy was to use longitude-latitude,
it affected? In principle, such correlations could be or simply distance to mines, as the assignment vari-
due to observed or unobserved factors other than the able to predict the mita coverage. The effect of the
mita. For example, households in mita districts may mita system on social or economic outcomes can be
have been less well off to begin with. To address this estimated by comparing districts with and without
question, Dell employed an important tool used by the mita system among those close to the mita cov-
development economists to establish causal effects, erage boundary. These districts were considered likely
known as regression discontinuity design (RDD). to be similar in all respects except for the mita; and
RDD has many uses, including evaluation of devel- indeed, Dell found that prior to the mita system, fac-
opment programs. In evaluating a program, if each tors such as tax rates, steepness of terrain, and ethnic
individual is associated with an “assignment vari- distribution were similar across the boundaries that
able,” z, and a “treatment” is assigned to individuals she studies. Using this strategy, Dell concluded that
with a value of z less than or equal to a cutoff level z0, the “mita effect” lowers household consumption
then the impact of the treatment on an outcome vari- by approximately 25% and that it increases child
able, y, can be identified by comparing observations stunting “by around 6 percentage points.” These are
of those who started just below the threshold z0 with really striking findings: Two centuries have passed
those who started just above it. For this group, any since the mita boundary line carried any legal mean-
difference in the outcome variable between people on ing whatsoever.
each side of the discontinuity would be caused by the Dell then asked, “Why would the mita affect eco-
treatment. The assignment z can represent many types nomic prosperity nearly 200 years after its aboli-
of threshold variables, including income, birth date, tion?” While “there exist many potential channels,”
test scores, or a geographic boundary. And it turns out Dell proposed, “the mita’s influence has persisted
that a very wide range of impacts can be considered as through its impacts on land tenure and public good
a treatment—whatever impacts only people who are provision.” Outside the mita district boundaries, the
on one side of a threshold, provided that all relevant Spanish hacienda system emerged—it was a feudal sys-
influences other than treatment vary smoothly across tem, not a market in which labor was free. While the
the threshold. Economists have learned that RDD measured impact of the mita likely would have been
estimates have statistically reliable properties that in even worse in comparison with “secure, enfranchised
smallholders,” Dell contrasted the two actual histori- Large landowners also had a profit incentive and the
cal experiences in this region. Some exploitive condi- political influence to get more roads built in their dis-
tions are worse than land inequality. Dell pointed out tricts. Dell argued that in this region of Peru, “large
that the land tenure system in non-mita districts was landowners—while they did not aim to promote eco-
more stable compared to mita districts, where there nomic prosperity for the masses—did shield individu-
was no system of enforceable peasant titling even after als from exploitation by a highly extractive state and
the mita ended. For example, Dell cites a judicial pro- did ensure public goods.”
cedure used in mita districts to seize land from peas-
Source: Melissa Dell. “The Persistent Effects of Peru’s Mining
ants by falsely claiming their land was abandoned. Mita.” Econometrica 78(2010): 1863–1903.
such as sugarcane could be profitably produced on slave plantations. It also

emerged where a large, settled indigenous population could be coerced into
labor. This history had long-term consequences, particularly in Latin Amer-
ica.33 Where inequality was extreme, the result was less movement toward
democratic institutions, less investment in public goods, and less widespread
investment in human capital (education, skills, and health). These are among
the ways in which extreme inequality is harmful to development and so is also
an important long-term determinant of comparative development. We return
to these themes later in this chapter.
The European colonial powers also had a dramatic and long-lasting impact
on the economies and political and institutional structures of their African and
Asian colonies by their introduction of three powerful and tradition-shattering
ideas: private property, personal taxation, and the requirement that taxes be
paid in money rather than in kind. These innovations were introduced in
ways that facilitated elite rule rather than broad-based opportunity. The worst
impact of colonization was probably felt in Africa, especially if one also con-
siders the earlier slave trade. Whereas in former colonies such as India local
people played a role in colonial governance, in Africa most governance was
administered by expatriates. Other well-documented impacts included lasting
damage to social trust.34
In Latin America, a longer history of political independence plus a more
shared colonial heritage (Spanish and Portuguese) has meant that in spite of
geographic and demographic diversity, the countries possess relatively simi-
lar economic, social, and cultural institutions and face similar problems, albeit
with particular hardships for indigenous peoples and descendants of slaves.
Latin American countries have long been middle-income but rarely have
advanced to high-income status—reflecting a situation now known as the
“middle-income trap.” In Asia, different colonial heritages and the diverse cul-
tural traditions of the people have combined to create different institutional
and social patterns in countries such as India (British), the Philippines (Span-
ish and American), Vietnam (French), Indonesia (Dutch), Korea (Japanese), and
China (not formally colonized but dominated by a variety of foreign powers).35
To a widely varying degree, newly independent nations continued to experi-
ence foreign domination by former colonial powers and the United States, and
in a number of countries by the Soviet Union, particularly during the Cold War
period. The diversity of colonial experiences is one of the important factors that
help explain the wide spectrum of development outcomes in today’s world.
External Dependence Relatedly, developing countries have also been less

well organized and influential in international relations, with sometimes
adverse consequences for development. For example, agreements within the
World Trade Organization (WTO) and its predecessors concerning matters such
as agricultural subsidies in rich countries that harm developing-country farm-
ers and one-sided regulation of intellectual property rights have often been rel-
atively unfavorable to the developing world. The “Doha Development Round”
of trade negotiations that began in 2001 was supposed to rectify some of these
imbalances, but talks have been essentially stalled since 2008 (see Chapter
12). During debt crises in the 1980s and 1990s, the interests of international
banks often prevailed over those of desperately indebted nations (discussed in
Chapter 13). More generally, developing nations have weaker bargaining posi-
tions than developed nations in international economic relations. Developing
nations often also voice great concern over various forms of cultural depen-
dence, from news and entertainment to business practices, lifestyles, and social
values. The potential importance of these concerns should not be underesti-
mated, either in their direct effects on development in its broader meanings or
indirect impacts on the speed or character of national development.
Developing nations are also dependent on the developed world for envi-
ronmental preservation, on which hopes for sustainable development depend.
Of greatest concern, global warming is projected to harm developing regions
more than developed ones; yet both accumulated and current greenhouse
gas emissions still largely originate in the high-income countries, despite the
role of developing-country deforestation and growing emissions from lower-
middle-income countries such as China and India. Thus the developing world
endures what may be called environmental dependence, in which it must rely on
the developed world to cease aggravating the problem and to develop solu-
tions, including mitigation at home and assistance in developing countries.
This topic is explored further in Chapter 10.
2.5 How Low-Income Countries

Today Differ from Developed
Countries in Their Earlier Stages
The position of developing countries today is in many important ways sig-
nificantly different from that of the currently developed countries when they
embarked on their era of modern economic growth. We can identify eight signifi-
cant differences in initial conditions that require a special analysis of the growth
prospects and requirements of modern economic development:
1. Physical and human resource endowments

2. Per capita incomes and levels of GDP in relation to the rest of the world
3. Climate
4. Population size, distribution, and growth
populations. To get a sense of how the acceleration of growth in China and

India, along with a few other countries, have changed the picture, the data are
broken up into four time periods. Figures 2.9a and 2.9b reflect that there was
relative per capita divergence from 1950 through 1976, but Figure 2.9d reflects
relative per capita convergence since 1989 (and less unambiguously but plau-
sibly from 1977 to 1989 as well—see Figure 2.9c). If current trends continue (a
“big if” given widespread predictions for a slowing of their growth rates), then
China, India, and Brazil will account for nearly 40% of global output by 2050,
compared with about 10% in 1950.54 Although it is true that conditions have
remained stagnant or even deteriorated in many of the least developed coun-
tries, because of their smaller population sizes with the population-weighted
approach, this divergence effect is more than compensated for by growth in
countries with large populations. Note that all such trends may be subject to
change. For example, the population growth rates of the 49 least developed
countries and other low-income countries are much higher than those of the
middle- and upper-income countries; so their population-weights are increasing
over time. African countries may see a furtherance of their recent trend to faster
growth magnifying the new trend to global convergence; or they and other
developing regions may see a growth slowdown, with commodity prices fall-
ing again and continuing governance problems; and the global economy could
return to a period of divergence. These trends will be watched closely.
World-as-One-Country Convergence An alternative approach to the study of

convergence is to think of the world as if it were one country. In the first such
study, Branko Milanovic stitched together household data sets from around the
world and concluded that global inequality rose significantly in the period 1988 to
1993.55 Studies of this kind are difficult to carry out. The most important difference
from population-weighted country convergence is that a world-as-one-country
convergence study can take into account changes in inequality within countries as
well as between them. In particular, the widening gulf between incomes in rural
and urban China had a major effect on the finding of global divergence using this
method. But most researchers and policymakers frame development as a process
that occurs on the national level, something rather different from global inequality;
and country convergence studies remain the standard.
Sectoral Convergence Despite evidence that economies are not converging

unconditionally, there can be cross-national convergence of economic sectors,
which in turn may signal the potential for future convergence. In particular,
Dani Rodrik found evidence that there has been convergence in manufactur-
ing, with implications that the failure to find overall convergence across coun-
tries is due to the small share and slow growth of manufacturing employment
in low-income countries.56
2.7 Long-Run Causes of Comparative Development

What explains the extreme variations in development achievement to date
among developing and developed countries? The next two chapters examine
theories of economic growth and development processes and policy challenges;
here we present a schematic framework for appreciating the major long-run

causes of comparative development57 that have been argued in some of the
most influential research literature of this century.58 (Bear in mind that research
on this important subject is still at a relatively early stage; scholars have legiti-
mate disagreements about emphasis and substance, and new findings are being
reported regularly.)
First, in the very long run, few economists doubt that physical geography,
including climate, has had an important impact on economic history. Geography
was once truly exogenous, even if human activity can now alter it, for better
or worse. But the economic role played by geography, such as tropical climate,
today is less clear. Some research suggests that when other factors, notably
inequality and institutions, are taken into account, physical geography adds little
to our understanding of current development levels. However, some evidence is
mixed. For example, there is some evidence of an independent impact of malaria
and indications that in some circumstances, landlocked status may be an impedi-
ment to economic growth; indeed, a direct link is argued by some economists,59
so this possible effect is reflected in Arrow 1 connecting geography to income and
human development on the left side of Figure 2.10. Recently, the debate on compar-
ative economic development has been widened further with some evidence that
an intermediate degree of genetic diversity (heterozygosity) of human popula-
tions is most conducive to long-run economic development.60
Economic Institutions Economic institutions, which play an important role in comparative
“Humanly devised” con- development, are defined by Nobel laureate Douglass North as the “rules of
straints that shape interac-
tions (or “rules of the game”)
the game” of economic life. As such, institutions provide the underpinning of
in an economy, including a market economy by establishing the rules of property rights and contract
formal rules embodied in enforcement; improving coordination;61 restricting coercive, fraudulent, and
constitutions, laws, contracts, anticompetitive behavior; providing access to opportunities for a broad popu-
and market regulations, plus
informal rules reflected in
lation; constraining the power of elites; and managing conflict more generally.
norms of behavior and con- Moreover, institutions include social insurance (which also serves to legiti-
duct, values, customs, and mize market competition) and the provision of predictable macroeconomic
generally accepted ways of stability.62 Countries with higher incomes can afford better institutions, so it
doing things.
is challenging to identify the impact of institutions on income. But recently,
development economists have made influential contributions toward achiev-
ing this research goal.
As noted earlier, most developing countries were once colonies. Geogra-
phy affected the types of colonies established (Arrow 2), with one of the now
best known geographic features being settler mortality rates, whose impact63
was examined in work by Daron Acemoglu, Simon Johnson, and James Robin-
son. In this argument, when potential settlers faced higher mortality rates (or
perhaps other high costs), they more often ruled at arm’s length and avoided
large, long-term settlement. Their interest could be summarized as “steal fast
and get out” or “get locals to steal for you.” Unfavorable institutions were
therefore established, favoring extraction over production incentives. But
where mortality was low, populations were not dense, and exploitation of
resources required substantial efforts by colonists, institutions broadly encour-
aging investments, notably constraints on executives and protection from
expropriation, were established (sometimes as a result of agitation from set-
tlers who had the bargaining power to demand better treatment). These effects
are reflected by Arrow 3. Acemoglu and colleagues present evidence that after
FIGURE 2.10 Schematic Representation of Leading Theories of Comparative Development
Physical geography
(including climate)
6
1 4 8
2 Precolonial Precolonial labor

institutions abundances, production
structure, and potential
comparative advantage
5 7
Local features affecting
types of colonies
established (e.g., potential Evolution and
settler costs such as mortality) timing of European
development
3
Type of colonial regime 9
11 10
Inequality 12
13 Postcolonial
Human capital institutional
quality
14 15 16 17 18 19
Public goods Well-functioning Effective civil

quality markets society
20 21 22
Income and human

development
accounting for institutional differences, geographic variables (e.g., closeness

to the equator) have little influence on incomes today.64 Their statistical esti-
mates imply large effects of institutions on per capita income.
The influence of geography on precolonial institutions is captured by Arrow 4.
Precolonial institutions also mattered to the extent that they had influence
on the type of colonial regime established. This possible effect is reflected by
Arrow 5.
Precolonial comparative advantage and evolving labor abundances in the
Americas and their relation to the institutions established have been examined
in the pioneering work of Stanley Engerman and Kenneth Sokoloff.65 When
climate was suitable for a production structure featuring plantation agriculture

(particularly sugarcane in the early history), slavery and other types of mass
exploitation of indigenous labor were introduced. In other areas, when indig-
enous peoples survived contact in sufficient numbers and mineral wealth was
available, vast land grants that included claims to labor were established (by
Spain). Although resulting from different comparative advantage (sugarcane
and minerals), economic and political inequality were high and remained high
in all of these economies (even among freemen), which had long-lasting nega-
tive effects on development. These links are reflected by Arrow 6 and Arrow 7.
Early inequities were perpetuated with limits on the nonelite population’s
access to land, education, finance, property protection, and voting rights,
as well as labor markets. This inhibited opportunities to take advantage of
industrialization when they emerged in the nineteenth century, a period when
broad participation in commercial activity had high social returns.
The contrast with North American potential production structure is strik-
ing. Its comparative (emerging) advantage in grain lacked at the time the scale
economies of tropical agriculture and of mineral extraction seen elsewhere in
the Americas. Scarce labor with abundant land inhibited the concentration of
power (despite efforts of colonizers to do so). The need to attract more settlers
and encourage them to engage the colonial economy led to the evolution of
more egalitarian institutions in the North American colonies. North Ameri-
cans enjoyed greater egalitarianism in access to all of the factors so restricted
elsewhere. This environment facilitated broad-based innovation, entrepre-
neurship, and investment and gave the United States and Canada a decisive
advantage despite their starting out as much poorer societies, which they used
to economically surpass societies whose populations were mostly illiterate,
disenfranchised, and lacking collateral.66 (We will examine further aspects of
Engerman and Sokoloff’s analysis shortly.)
When local populations were larger and denser and social organization
was more advanced, it was easier for colonists to take over existing social
structures to gain tribute. In such cases, resulting institutional arrangements
would tend to favor mechanisms of extraction of existing wealth over the
creation of new wealth, often leading to declines in the relative fortunes of
these regions. This is pointed up by Acemoglu, Johnson, and Robinson, whose
influential research on this historical “reversal of fortune"67 is also reflected by
Arrow 5. These authors stress that if geography were fundamental to devel-
opment prospects, the most prosperous areas prior to colonization should
continue to be relatively prosperous today. But the most prosperous formerly
colonized areas today tend to have been least prosperous in the past. Past
population density and past urbanization, which are positively correlated
with past income, are negatively correlated with current income, these authors
show.68 There is evidence that Europeans set up more extractive institutions
(ones designed to extract more surplus from colonized populations) in pros-
perous areas and that these institutions have often persisted to the contempo-
rary period.69
Geography undoubtedly influenced early economic history in Europe.70
This is reflected by Arrow 8, leading to evolution and timing of European devel-
opment. Early development in Europe gave it advantages over most other
regions—advantages that were used to colonize much of the world. But the
types of colonial regimes implemented varied considerably, depending on

conditions prevailing at the time of colonization both in the different parts
of the world colonized and within the colonizer’s home country. The timing
of European development influenced the type of colonial regime established,
reflected by Arrow 9. For example, it has been argued that for various rea-
sons, earlier colonization generally involved more plunder and less active
production than later colonization, although both occurred at the expense of
the indigenous populations.71
Precolonial comparative advantage may also have interacted with the timing
of European development in influencing institutions in that settlers in later-
colonized temperate zones arrived with more knowledge and more advanced
technology. In particular, Europeans brought better agricultural techniques to
the later-settled areas such as North America. As noted by David Fielding and
Sebastian Torres, by the eighteenth century, population growth in Europe and
technical change had produced a large supply of people with temperate-zone
agricultural skills in products such as wheat and dairy. They were able to gain
higher incomes using these skills in temperate colonies and former colonies
(the so-called neo-Europes).72 Thus, precolonial (potential) comparative advan-
tage again mattered. This link is reflected in the flow through Arrow 6 and
Arrow 7. The possible role played by specific skills also points up the impor-
tance of human capital investments for development, reflected by Arrow 14.
Thus, the types of colonial regimes established, while always designed for
the benefit of the colonizers, were influenced by local and European supply
and demand factors. The type of regime had enormous influence on postco-
lonial institutional quality, reflected by Arrow 10. For example, the depraved
rule of Belgium’s King Leopold II over the Congo (today’s Democratic Repub-
lic of Congo) was arguably an ultimate cause of the oppressive Mobutu reign
after independence. Of course, not all influences of colonialism were neces-
sarily bad. Along with enslavement, subjugation, exploitation, loss of cultural
heritage, and repression, colonists also brought modern scientific methods in
fields such as medicine and agriculture. Note that this can be no apologia for
colonialism, because these advances could have been gained without the soci-
eties’ becoming colonized, as in Japan. Still, there is some evidence that coun-
tries and territories that spent a longer time as colonies (at least in the case
of islands) have higher incomes than those that experienced shorter colonial
periods, with this effect greater for entities colonized later (perhaps because
earlier colonial activity had more pernicious effects than later ones). Even so,
there are strong caveats to this finding.73
Besides creating specific institutions, European colonization created or
reinforced differing degrees of inequality (often correlated with ethnicity), ulti-
mately leading to diminished prospects for growth and development, nota-
bly in Latin America and the Caribbean. This is reflected by Arrow 11. High
inequality often emerged as a result of slavery in regions where crops could
be “efficiently” produced on slave plantations. They also emerged where a
large, settled indigenous population could be coerced into labor. Such histo-
ries had long-term consequences, particularly in Latin America. As Engerman
and Sokoloff have argued, the degree of inequality itself can shape the evolu-
tion of institutions as well as specific policies. Where inequality was extreme,
there was less investment in human capital (Arrow 13) and other public goods
(Arrow 16) and, as reflected by the bidirectional Arrow 12, a tendency of less
movement toward democratic institutions (which could also have facilitated
movement to other constructive institutions).74
Thus, extreme inequality is likely to be a long-term factor in explaining
comparative development. This is raised in the striking historical contrast
between the states of North America and the states of Central and South America.
There was greater egalitarianism in North America, though the inhuman
treatment of Native Americans and of slaves in the southern colonies (later the
United States) reflects the fact that this is not because the English settlers were
inherently “nicer masters” than the Spanish. Still, much of the North American
experience contrasts strongly with the extreme inequality of Central and
South America and the Caribbean.75 Engerman and Sokoloff argued that high
inequality in Latin America led to low human capital investments, again in
contrast to North America;76 this mechanism is again reflected by Arrow 13.
Elites in Latin America then loosened their control only when their returns
to increased immigration, and thus to creating more attractive conditions for
immigrants, were high. Besides creating specific institutions, then, European
colonization created or reinforced different degrees of inequality, often cor-
related with ethnicity. This history had long-term consequences, particularly
in Latin America. In the direction from inequality to postcolonial institutional
quality, Arrow 12 reflects what has been termed the social conflict theory of
institutions. Box 2.4 presents findings that inequality does negatively affect
per capita income much in the way predicted by Engerman and Sokoloff.
Cultural factors may also matter in influencing the degree of emphasis on
education, postcolonial institutional quality, and the effectiveness of civil soci-
ety, though the precise roles of culture are not clearly established in relation
to the economic factors surveyed in this section and so are not included in the
diagram. In addition, institutional quality affects the amount and quality of
investments in education and health, via the mediating impact of inequality.
In countries with higher levels of education, institutions tend to be more dem-
ocratic, with more constraints on elites. The causality between education and
institutions could run in either direction, or both could be caused jointly by
still other factors. Some scholars argue that some countries with bad institu-
tions run by dictators have implemented good policies, including educational
investments, and subsequently, after reaping the benefits in terms of growth,
those countries have changed their institutions.77 They argue that human cap-
ital is at least as fundamental a source of long-run development as institu-
tions. In the diagram, this would suggest adding an arrow from human capital
back to postcolonial institutional quality; this is intuitively plausible, although
additional evidence for this link will be needed for it to become more fully
established.78 Clearly, however, in some cases extractive colonial institutions
left a legacy that resulted in poor health and education decades after indepen-
dence; an example from India is examined in Box 2.5.
For the relatively small number of developing countries never colonized,
such as Thailand, type of colonial regime can be reinterpreted in the diagram
as institutional quality at an early stage of development (or as cultural influ-
ences not shown)—but note that the evidence for causality patterns is not as
convincing in these cases. However, the diversity of development experiences
of never-colonized countries caution us not to place complete emphasis on the
choices of colonizers; preexisting social capital may matter at least as much.79
BOX 2.4 FINDINGS Instruments to Test Theories of Comparative Development: Inequality
I n a 2007 study, William Easterly used cross-country

data to examine the Engerman and Sokoloff
hypothesis. His research confirmed that “agricultural
effect on the outcome variable of interest. You saw ear-
lier that Acemoglu, Johnson, and Robinson used settler
mortality as an instrument for early institutions. East-
endowments predict inequality and inequality pre- erly uses “the abundance of land suitable for growing
dicts development.” Specifically, Easterly finds that wheat relative to that suitable for growing sugarcane”
inequality negatively affects per capita income; it also as an instrument for inequality. Using this strategy,
negatively affects institutional quality and schooling, Easterly concludes that high inequality of the Enger-
which are “mechanisms by which higher inequality man and Sokoloff variety is independently “a large
lowers per capita income.” That the negative relation- and statistically significant barrier to prosperity, good
ship between income and inequality is present in the quality institutions, and high schooling.” Schooling
data is clear—but how do development economists and institutional quality are precisely the mechanisms
take the step to prediction and assignment of causality proposed by Engerman and Sokoloff by which higher
when measurement error and many confounding fac- inequality leads to lower incomes. Like a leprechaun,
tors are present, such as the possible link that under- a good instrumental variable is hard to get hold of but
development itself is a cause of inequality? when caught can give the researcher’s equivalent of a
Sometimes development economists run field pot of gold. Though active debate on inequality and
experiments—but obviously, we cannot randomly development continues, the interplay between the
assign countries various levels of inequality to see what careful institutional analysis and economic history
happens! In the many cases when field experiments scholarship of Engerman and Sokoloff and the study of
are impossible, development economists frequently try causality with larger data sets as used by Easterly gives
to understand causality by searching for an instrumen- a window into how the field of development econom-
tal variable (or “instrument”); in fact, many researchers ics continues to make progress.
in development economics invest a lot of their time in
Sources: William Easterly, “Inequality does cause underde-
this search. This is a topic covered in classes in econo- velopment,” Journal of Development Economics 84 (2007):
metrics. But the basic idea is that to identify the effect 755–776; Joshua D. Angrist and Jorn-Steffen Pischke,
Mostly Harmless Econometrics: An Empiricist’s Companion
of a potential causal variable c (such as inequality) on (Princeton, N.J.: Princeton University Press, 2008). For an
a development outcome variable d (such as income or important critique of the use and interpretation of instru-
mental variables (and also of randomization) in devel-
educational attainment), the hunt is on for an elusive opment economics research see Angus Deaton, “Instru-
instrumental variable e that affects d only through ments, randomization, and learning about development,”
Journal of Economic Literature, 48, no. 2 (2010): 424–455.
e’s effect on c. So an instrument has no independent
Never-colonized countries also show a dramatic range in performance; Ethio-

pia and Afghanistan remain very poor, Thailand is in the lower-middle range,
Turkey is in the upper-middle range, and Japan is among the very wealthiest
countries; China, starting among the poorest countries 30 years ago, is now
rapidly ascending the income tables. The quality of institutions (and inequal-
ity) undoubtedly mattered in noncolonized societies; it is just harder to con-
clude that institutions led to income rather than only vice versa.
Clearly, human capital has a direct impact on income and on human devel-
opment more broadly, as reflected by Arrow 14. The depth and breadth of
education in the population will help determine the effectiveness of govern-
ment as a force for development, reflected by Arrow 15. This is due not only
BOX 2.5 FINDINGS Legacy of Colonial Land Tenure and Governance Systems
S ubstantial evidence on the importance of institu-

tions is provided in a study of the impact of land
revenue institutions established by the British Raj in
received the proprietary rights also had significantly
lower investments in health and education in the
postcolonial period.
India conducted by Abhijit Banerjee and Lakshmi In subsequent research, Lakshmi Iyer compared
Iyer. Because areas where land revenue collection was economic outcomes across areas in India that expe-
taken over by the British between 1820 and 1856 (but rienced direct versus indirect British colonial rule,
not before or after) were much more likely to have controlling for the apparent colonial preference to
a non-landlord system, the authors used being con- annex higher-quality lands using another instrumen-
quered in this period as an instrument for having a tal variable strategy. She found evidence that colonial
non-landlord system. They also used other statistical governance quality had persistent effects on postcolo-
tests that showed the results were robust. They found nial outcomes; areas under direct rule received signifi-
that historical differences in property rights institu- cantly less access to schools, health centers, and roads
tions led to sustained differences in economic out- in the postcolonial period, with higher levels of pov-
comes, in that the regions in which property rights erty and infant mortality.
to land were given to landlords have had significantly
Sources: Abhijit Banerjee and Lakshmi Iyer, “History, institu-
lower agricultural investments and productivity in tions, and economic performance: The legacy of colonial
the postindependence period than regions in which land tenure systems in India,” American Economic Review 95
(2005): 1190–1213; and Lakshmi Iyer, “Direct versus indi-
property rights were given to cultivators. The authors rect colonial rule in India: Long-term consequences,” Review
concluded that the divergence occurred because his- of Economics and Statistics 92 (2010): 693–713. Preparation
of this box also benefited from a manuscript, Lakshmi Iyer,
torical differences in institutions led to different pol- “The long-run consequences of colonial institutions,” draft,
icy choices. Tellingly, the regions in which landlords Harvard Business School, 2013.
to a better-qualified civil service but also to the understanding of citizens of

poor government performance and the knowledge of how to work for a bet-
ter outcome and capacity to organize.80 Of course, education could also inde-
pendently affect the organization and functioning of markets per se (arrow
omitted), but the literature to date has primarily viewed the productive impact
of human capital on market outcomes as a direct one, reflected by Arrow 14.
These impacts are explored further in Chapter 8.
The type and quality of global integration (particularly trade) have been
stressed as a boon to long-run growth and development in many World Bank
reports. Trade may be beneficial in that it provides various kinds of access to
technology.81 And some economists argue that greater openness to trade ben-
eficially affects the subsequent evolution of institutions. On the other hand,
critics argue that the wrong kind of integration or the failure to complement
integration with appropriate policies could be harmful to development. In
fact, evidence suggests that once institutions are accounted for, trade itself
explains very little, so for simplicity, integration is left out of the diagram.82
Postcolonial institutional quality has a strong impact on the effectiveness
of the private, public, and citizen (or civil society) sectors. Democratic gov-
ernance, rule of law, and constraints on elites will encourage more and better
quality public goods, reflected by Arrow 17. Better property rights protections
and contract enforcement for ordinary citizens and broad access to economic
opportunities will spur private investments, reflected by Arrow 18. And insti-
tutions will affect the ability of civil society to organize and act effectively as
a force independent of state and market, reflected by Arrow 19. Clearly, the
activities of the three sectors will each have an influence on productivity and
incomes, and on human development more generally, as reflected by Arrows
20, 21, and 22, respectively.83 These factors are explored further in Chapter 11.
It is not yet entirely clear which economic institutions are most important
in facilitating development or the degree to which strength in one institution
can compensate for weakness in another.84 Clearly, there are multiple paths to
economic development (see, e.g., the case study of China at the end of Chap-
ter 4). But a key finding of recent research is that forces that protect narrow
elites in ways that limit access of the broader population to opportunities
for advancement are major obstacles to successful economic development. If
institutions are highly resistant to attempts at reform, this helps clarify why
development is so challenging.
Nevertheless, in most countries with poor institutions, there is still much that
can be done to improve human welfare and to encourage the development of better
institutions. Indeed, economic institutions do change over time, even though
political institutions such as voting rules sometimes change without altering
the real distribution of power or without leading to genuine reform of economic
institutions. Although the evidence of the impact of democracy on growth in
the short to medium term is not strong (see Chapter 11), in the long run demo-
cratic governance and genuine development do go hand in hand, and the steady
spread of more genuinely democratic institutions in the developing world is a
very encouraging sign.85 As Dani Rodrik has noted, “Participatory and decen-
tralized political systems are the most effective ones we have for processing and
aggregating local knowledge. We can think of democracy as a meta-institution
for building other good institutions.”86 In addition, development strategies that
lead to greater human capital, improve access to new technologies, produce
better-quality public goods, improve market functioning, address deep-rooted
problems of poverty, improve access to finance, prevent environmental degrada-
tion, and foster a vibrant civil society all promote development.
2.8 Concluding Observations

History matters. We have learned that conditions prevailing in a developing
nation when European colonialism began had a large impact on the subse-
quent history of inequality and institutional development in the nation in
ways that either facilitated or thwarted participation in modern economic
growth after the Industrial Revolution arrived in the late eighteenth century.
And poor institutions have generally proved very resistant to efforts at reform.
But the new perspectives do not imply that development is impossible!
Instead, they serve to clarify the nature of the great challenges facing many
developing nations. The phenomenon of underdevelopment is best viewed in
both a national and an international context. Problems of poverty, inequality,
low productivity, population growth, unemployment, primary-product export
8/15/2020 New country classifications by income level: 2019-2020
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24
(mailto:?
body=https%3A%2F%2Fblogs.worldbank.org%2Fopendata%2Fnew-
Updated country income classi cations for the World Bank’s 2020 scal year are
country-
available here. (https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-
classi cations-
world-bank-country-and-lending-groups)
income-
The World Bank classi es the world's economies into four income groups — high,
level-
upper-middle, lower-middle, and low. We base this assignment on Gross National
2019-
Income (GNI) per capita (current US$) calculated using the Atlas method
2020%3Fcid%3DSHR_BlogSiteEmail_EN_EXT&subject=New%20country%20classi cat
(https://datahelpdesk.worldbank.org/knowledgebase/articles/77933-what-is-the-
2020)
world-bank-atlas-method). The classi cation is updated each year on July 1st.
The classi cation of countries is determined by two factors:
1. A country’s GNI per capita, which can change with economic growth,
in ation, exchange rates, and population. Revisions to national accounts
methods and data can also in uence GNI per capita.
2. Classi cation threshold: The thresholds are adjusted for in ation
annually using the SDR de ator.
New data on GNI per capita data for 2018 is now available here
(http://data.worldbank.org/indicator/NY.GNP.PCAP.CD). More detailed
information on how the World Bank classi es countries is available here
(https://datahelpdesk.worldbank.org/knowledgebase/articles/378834-how-does-
the-world-bank-classify-countries).
Until last year (Fiscal Year 2019), the income classi cations had an analytical
purpose and did not in uence the World Bank’s lending terms. However, since
the last scal year, the high-income threshold is also a determining factor for
lending rates
https://blogs.worldbank.org/opendata/new-country-classifications-income-level-2019-2020 1/9
(http://siteresources.worldbank.org/DEVCOMMINT/Documentation/23776700/DC20
0002_PSustainableFinancing421.pdf). Surcharges are applied for lending rates of
countries which have been categorized as high income for two consecutive years.
Upd t d Thr sholds

New thresholds are determined at the start of the World Bank’s scal year in July
and remain xed for 12 months regardless of subsequent revisions to estimates.
The thresholds for income classi cation have increased from last year due to SDR
in ation. As of July 1, 2019, the new thresholds for classi cation by income are:
Threshold July 2019/$ (new) July 2018/$ (old)
Low income
Lower-middle
1,026 - 3,995 996 - 3,895
income
Upper-middle
3,996 - 12,375 3,896 - 12,055
income
High income > 12,375 > 12,055
Ch n s in Cl ssific tion
The following countries are assigned to new income groups:
GNI/Capita/$ GNI/Capita/$
New group Old group (2018) as of (2017) as of
July 1, 2019 July 1, 2018
Lower-middle
Comoros Low income 1,320 760
income
Upper-middle Lower-middle
Georgia 4,130 3,790
income income
Kosovo 4,230 3,890
income income
Lower-middle
Senegal Low income 1,410 950
income
Sri Lanka 4,060 3,840
income income
Lower-middle
Zimbabwe Low income 1,790 910
income
Upper-middle
Argentina High income 12,370 13,040
income
The country and lending groups page (http://data.worldbank.org/about/country-

and-lending-groups) provides a complete list of economies classi ed by income,
region, and lending status and links to previous years’ classi cations. The
classi cation tables include all World Bank members, plus all other economies
with populations of more than 30,000. The term country, used interchangeably
with economy, does not imply political independence but refers to any territory
for which authorities report separate social or economic statistics.
Data for GNI (http://databank.worldbank.org/data/download/GNI.xls), GNI per

capita (http://databank.worldbank.org/data/download/GNIPC.xls), GDP
(http://databank.worldbank.org/data/download/GDP.xls), GDP PPP
(http://databank.worldbank.org/data/download/GDP_PPP.xls), and Population
(http://databank.worldbank.org/data/download/POP.xls)for 2018 are now
available on World Bank's Open Data Catalog (http://datacatalog.worldbank.org/).
Note that these are preliminary estimates and may be revised. For more
information, please contact us at data@worldbank.org
(mailto:data@worldbank.org).
THE WORLD REGION (/SEARCH?F[0]=REGIONS:280&F[1]=LANGUAGE:EN)
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DEC Data Team
MORE BLOGS BY WORLD (/TEAM/WORLD-BANK-DATA-TEAM)
Economic Growth in
Developing and
Transitional
36
Economies CHAPTER OUTLINE
Life in the Developing
Nations: Population
and Poverty p. 714
Our primary focus in this text has
been on countries with modern Economic
industrialized economies that rely
Development: Sources
and Strategies p. 715
heavily on markets to allocate
The Sources of Economic
resources, but what about the eco- Development
nomic problems facing countries
Strategies for Economic
such as Somalia and Haiti? Can we Development
apply the same economic princi- Two Examples of
ples that we have been studying to Development: China
these less developed nations? and India
Yes. All economic analysis deals
with the problem of making choices Development
under conditions of scarcity, and Interventions p. 723
the problem of satisfying people’s Random and Natural

Experiments: Some New
wants and needs is as real for Somalia and Haiti as it is for the United States, Germany, and Techniques in Economic
Japan. The universality of scarcity is what makes economic analysis relevant to all nations, Development
regardless of their level of material well-being or ruling political ideology. Education Ideas
The basic tools of supply and demand, theories about consumers and firms, and theories Health Improvements
about the structure of markets all contribute to an understanding of the economic problems con-
Population Issues
fronting the world’s developing nations. However, these nations often face economic problems
quite different from those that richer, more developed countries face. In developing nations, an The Transition to a
economist may have to worry about chronic food shortages, explosive population growth, and Market Economy p. 727
hyperinflations that reach triple, and even quadruple, digits. The United States and other indus- Six Basic Requirements for
trialized economies rarely encounter such difficulties. Successful Transition
The instruments of economic management also vary from nation to nation. The United
States has well-developed financial market institutions and a strong central bank (the Federal
Reserve) through which the government can control the macroeconomy to some extent. Even
limited intervention is impossible in some of the developing countries. In the United States, tax
laws can be changed to stimulate saving, to encourage particular kinds of investments, or to redis-
tribute income. In most developing countries, there are neither meaningful personal income
taxes nor effective tax policies.
713
714 PART VII The World Economy
Even though economic problems and the policy instruments available to tackle them
vary across nations, economic thinking about these problems can be transferred easily from
one setting to another. In this chapter, we discuss several of the economic problems specific
to developing nations in an attempt to capture some of the insights that economic analysis
can offer.
Life in the Developing Nations: Population

and Poverty
In 2010, the population of the world reached over 6.8 billion people. Most of the world’s more
than 200 nations belong to the developing world, in which about three-fourths of the world’s
population lives.
In the early 1960s, the nations of the world could be assigned rather easily to categories:
The developed countries included most of Europe, North America, Japan, Australia, and New
Zealand; the developing countries included the rest of the world. The developing nations were
often referred to as the Third World to distinguish them from the Western industrialized
nations (the First World) and the former Socialist bloc of Eastern European nations (the
Second World).
In 2010, the world did not divide easily into three neat parts. Rapid economic progress
brought some developing nations closer to developed economies. Countries such as Argentina
and Chile, still considered to be “developing,” are often referred to as middle-income or newly
industrialized countries. Other countries, such as those in much of sub-Saharan Africa and
some in South Asia, have stagnated and fallen so far behind the economic advances of the rest
of the world that the term Fourth World has been used to describe them. China and India, while
usually labeled developing countries, are fast becoming economic superpowers. It is not clear
yet where some of the republics of the former Soviet Union and other formerly Communist
countries of Eastern Europe will end up. Production fell sharply in many of them in the early
transition stage to a market economy. Post-2000, however, the Russian economy began grow-
ing more rapidly.
Although the countries of the developing world exhibit considerable diversity in both
their standards of living and their particular experiences of growth, marked differences
continue to separate them from the developed nations. The developed countries have a
higher average level of material well-being (the amount of food, clothing, shelter, and other
commodities consumed by the average person). Comparisons of gross national income
(GNI) are often used as a crude index of the level of material well-being across nations. GNI
is a new measure of a nation’s income, computed using a more accurate way of converting
purchasing power into dollars. See Table 36.1, where GNI per-capita in the industrial
TABLE 36.1 Indicators of Economic Development

Gross
National Infant
Income per Literacy Rate Mortality, 2006 Internet
Capita, (percent over (deaths before Users per
Population, 2006 15 years age 5 per 1,000 people,
Country Group 2006 (dollars) of age) 1,000 births) 2005
Low-income 2.4 billion 650 60.8 114 44
Lower middle-income 2.3 billion 1,778 88.9 39.8 86
Upper middle-income 810 million 5,913 93.1 29.9 194
High-income 1.0 billion 36, 487 98.7 6.9 523
Source: International Bank for Reconstruction and Development / The World Bank: World Development Report 2002.
CHAPTER 36 Economic Growth in Developing and Transitional Economies 715
market economies significantly exceeds GNI of both the low- and middle-income develop-
ing economies.
Other characteristics of economic development include improvements in basic health
and education. The degree of political and economic freedom enjoyed by individual citizens
might also be part of what it means to be a developed nation. Some of these criteria are easy
to quantify. Table 36.1 presents data for different types of economies according to some of
the more easily measured indexes of development. As you can see, the industrial market
economies enjoy higher standards of living according to whatever indicator of development
is chosen.
Behind these statistics lies the reality of the very difficult life facing the people of the
developing world. For most people, meager incomes provide only the basic necessities. Many
people share a small room, usually with an earthen floor and no sanitary facilities. The great
majority of the population lives in rural areas where agricultural work is hard and extremely
time-consuming. Productivity (output produced per worker) is low because household plots
are small and only the crudest of farm implements are available. Low productivity means
farm output per person is barely sufficient to feed a farmer’s own family. School-age children
may receive some formal education, but illiteracy remains chronic for young and old. Infant
mortality runs 20 times higher than in the United States. Although parasitic infections are
common and debilitating, there is only one physician per 5,000 people. In addition, many
developing nations are engaged in civil and external warfare.
Life in the developing nations is a continual struggle against the circumstances of poverty,
and prospects for dramatic improvements in living standards for most people are dim. As with all
generalizations, there are exceptions. Some nations are better off than others, and in any given
nation an elite group always lives in considerable luxury. India is on the World Bank’s list of low-
income countries, yet Mumbai, a state capital, is one of the top 10 centers of commerce in the
world, home to Bollywood, the world’s largest film industry.
Poverty—not affluence—dominates the developing world. Recent studies suggest that
40 percent of the population of the developing nations has an annual income insufficient to
provide for adequate nutrition. While the developed nations account for only about one-
quarter of the world’s population, they are estimated to consume three-quarters of the
world’s output. This leaves the developing countries with about three-fourths of the world’s
people but only one-fourth of the world’s income. The simple result is that most of our
planet’s population is poor.
In the United States in 2005, the poorest one-fifth (bottom 20 percent) of the families
received 3.4 percent of total income; the richest one-fifth received 50 percent. Inequality in the
world distribution of income is much greater. When we look at the world population, the poorest
one-fifth of the families earns about .5 percent and the richest one-fifth earns 79 percent of total
world income.
Economic Development: Sources and

Strategies
Economists have been trying to understand economic growth and development since Adam
Smith and David Ricardo in the eighteenth and nineteenth centuries, but the study of develop-
ment economics as it applies to the developing nations has a much shorter history. The geopolit-
ical struggles that followed World War II brought increased attention to the developing nations
and their economic problems. During this period, the new field of development economics
asked simply: Why are some nations poor and others rich? If economists could understand the
barriers to economic growth that prevent nations from developing and the prerequisites that
would help them to develop, economists could prescribe strategies for achieving economic
advancement.
The Sources of Economic Development

Although a general theory of economic development applicable to all nations has not emerged,
some basic factors that limit a poor nation’s economic growth have been suggested. These include
insufficient capital formation, a shortage of human resources and entrepreneurial ability, and a
lack of social overhead capital.
Capital Formation One explanation for low levels of output in developing nations
is insufficient quantities of necessary inputs. Developing nations have diverse resource
endowments—Congo, for instance, is abundant in natural resources, while Bangladesh is
resource-poor. Almost all developing nations have a scarcity of capital relative to other
resources, especially labor. The small stock of physical capital (factories, machinery, farm
equipment, and other productive capital) constrains labor’s productivity and holds back
national output.
Nevertheless, citing capital shortages as the cause of low productivity does not explain much.
We need to know why capital is in such short supply in developing countries. There are many
vicious-circle-of-poverty explanations. One, the vicious-circle-of-poverty hypothesis, suggests that a poor nation must
hypothesis Suggests that consume most of its income just to maintain its already low standard of living. Consuming most
poverty is self-perpetuating of national income implies limited saving, and this implies low levels of investment. Without
because poor nations are investment, the capital stock does not grow, the income remains low, and the vicious circle is
unable to save and invest
enough to accumulate the
complete. Poverty becomes self-perpetuating.
capital stock that would help The difficulty with the vicious-circle argument is that if it were true, no nation would
them grow. ever develop. Japanese GDP per capita in 1900 was well below that of many of today’s
developing nations, yet today it is among the affluent, developed nations. Among the many
nations with low levels of capital per capita, some—like China—have managed to grow and
develop in the last 20 years, while others remain behind. In even the poorest countries, there
remains some capital surplus that could be harnessed if conditions were right. Many current
observers believe that scarcity of capital in some developing countries may have more to
do with a lack of incentives for citizens to save and invest productively than with
any absolute scarcity of income available for capital accumulation. Many of the rich in
developing countries invest their savings in Europe or in the United States instead of in their
own country, which may have a riskier political climate. Savings transferred to the United
capital flight The tendency States do not lead to physical capital growth in the developing countries. The term capital
for both human capital and flight refers to the fact that both human capital and financial capital (domestic savings)
financial capital to leave leave developing countries in search of higher expected rates of return elsewhere or
developing countries in search returns with less risk. Government policies in the developing nations—including price ceil-
of higher expected rates of
return elsewhere with less risk.
ings, import controls, and even outright appropriation of private property—tend to discour-
age investment. There has been increased attention to the role that financial institutions,
including accounting systems and property right rules, play in encouraging domestic
capital formation.
Whatever the causes of capital shortages, it is clear that the absence of productive capital pre-
vents income from rising in any economy. The availability of capital is a necessary, but not a
sufficient, condition for economic growth. The landscape of the developing countries is littered
with idle factories and abandoned machinery. Other ingredients are required to achieve eco-
nomic progress.
Human Resources and Entrepreneurial Ability Capital is not the only factor of
production required to produce output. Labor is equally important. First of all, to be produc-
tive, the workforce must be healthy. Disease today is the leading threat to development in much
of the world. In 2009, more than 1 million people died of malaria, almost all of them in Africa.
The Gates Foundation has targeted malaria eradication as one of its key goals in the next decade.
HIV/AIDS was still responsible for more than 2 million deaths in 2009, again mostly in Africa,
and has left Africa with more than 14 million AIDS orphans. Iron deficiency and parasites sap
the strength of many workers in the developing world.
Health is not the only issue. Look back at Table 36.1 You will notice that low-income
countries lag behind high-income countries not only in health but also in literacy rates.
To be productive, the workforce must be educated and trained. Basic literacy as well as
specialized training in farm management, for example, can yield high returns to both
the individual worker and the economy. Education has grown to become the largest category
of government expenditure in many developing nations, in part because of the belief
that human resources are the ultimate determinant of economic advance. Nevertheless,
in many developing countries, many children, especially girls, receive only a few years of for-
mal education.
Just as financial capital seeks the highest and safest return, so does human capital.
Thousands of students from developing countries, many of whom were supported by their
governments, graduate every year from U.S. colleges and universities. After graduation, these
people face a difficult choice: to remain in the United States and earn a high salary or to
return home and accept a job at a much lower salary. Many remain in the United States. This
brain drain siphons off many of the most talented minds from developing countries. brain drain The tendency for
It is interesting to look at what happens to the flow of educated workers as countries talented people from
develop. Increasingly, students who have come from China and India to study are returning developing countries to
become educated in a
to their home countries eager to use their skills in their newly growing economies. The
developed country and remain
return flow of this human capital stimulates growth and is a signal that growth is occurring. there after graduation.
Indeed, development economists have found evidence that in India, schooling choices made
by parents for their children respond quite strongly to changes in employment opportuni-
ties.1 The connection between growth and human capital is in fact a two-way street.
Even when educated workers leave for the developed world, they may contribute to the
growth of their home country. Recently, economists have begun studying remittances, com-
pensation sent back from recent immigrants to their families in less developed countries.
While measurement is difficult, estimates of these remittances are approximately $100 billion
per year. Remittances fund housing and education for families left behind, but they also can
provide investment capital for small businesses. In 2007, it appeared that remittances from
illegal immigrants in the United States to Mexico, which had been growing by 20 percent per
year, were beginning to fall with tightening of enforcement of immigration rules. Remittances
fell further in 2008–2009 with the recession.
In recent years, we have become increasingly aware of the role of entrepreneurship
in economic development. Many of the iconic firms in the nineteenth century that
contributed so strongly to the early industrial growth of the United States—Standard
Oil, U.S. Steel, Carnegie Steel—were begun by entrepreneurs starting with little capital. In
China, one of the top search engines is Baidu, a firm started in 2000 by two Chinese nation-
als, Eric Xu and Robin Li, and now traded on NASDAQ. Providing opportunities and incen-
tives for creative risk takers seems to be an increasing part of what needs to be done to
promote development.
Social Overhead Capital Anyone who has spent time in a developing nation knows
how difficult it can be to carry on everyday life. Problems with water supplies, poor roads,
frequent electrical power outages—in the few areas where electricity is available—and often
ineffective mosquito and pest control make life and commerce difficult.
1 The classic work in this area was done by Kaivan Munshi and Mark Rosenzweig, “Traditional Institutions Meet the
Modern World: Caste, Gender, and Schooling Choice in a Globalizing Economy,” American Economic Review,
September 2006, 1225–1252. More recent work includes Emily Oster and Bryce Millett, “Do Call Centers Promote School
Enrollment? Evidence from India,” Chicago Booth Working Paper, June 2010.
E C O N O M I C S I N P R AC T I C E
Corruption
Many people have argued that one barrier to economic develop- stock price reflects investors’ views of what earnings the firm can
ment in a number of countries is the level of corruption and inef- expect to have. In the case of firms connected to Suharto, the
ficiency in the government. Measuring levels of corruption and decline in their stock prices tells us that a large part of the reason
inefficiency can be difficult. Some researchers have tried surveys investors think that those firms are doing well is because of the
and experiments. Ray Fisman1 had a more unusual way to measure family connection rather than the firm’s inherent efficiency. One
the way in which political connections interfere with the workings reason corruption is bad for an economy is that it often leads to
of the market in Indonesia. the wrong firms, the less efficient firms, producing the goods and
From 1967 to 1998, Indonesia was ruled by President Suharto. services in the society.
While Suharto ruled, his children and longtime allies were affili- The following chart shows the World Bank’s rating of corrup-
ated with a number of Indonesian companies. Fisman had the tion levels in a number of countries around the world. The coun-
clever idea of looking at what happened to the stock market tries are ranked from those with the strongest controls on
prices of those firms connected to the Suharto clan relative to corruption—Germany and France—to those with the lowest
unaffiliated firms when Suharto unexpectedly fell ill. Fisman controls—Pakistan and Nigeria. Indonesia, as you can see, is near
found a large and significant reduction in the value of those affil- the bottom of the list.
iated firms on rumors of illness. What does this tell us? A firm’s
Control of corruption (2006)
Germany
France
Japan
United States
Turkey
India
Thailand
Brazil
Mexico
Egypt
China
Ethiopia
Iran
Vietnam
Philippines
Russia
Indonesia
Pakistan
Nigeria
0 25 50 75 100
Country's percentile rank (0-100)
Note: The governance indicators presented here aggregate the views on the quality of governance provided by a large number of enterprise, citizen, and expert
survey respondents in industrial and developing countries. These data are gathered from a number of survey institutes, think tanks, nongovernmental orga-
nizations, and international organizations. The aggregate indicators do not reflect the official views of the World Bank, its executive directors, or the countries
they represent.
1 Raymond Fisman, “Estimating the Value of Political Connections,” The American Economic Review, September 2001, 1095–1102.
In any economy, developing or otherwise, the government plays an investment role. In a

developing economy, the government must create a basic infrastructure—roads, power gen-
eration, and irrigation systems. Such projects, referred to as social overhead capital, often social overhead capital Basic
cannot successfully be undertaken by the private sector. Many of these projects operate with infrastructure projects such as
economies of scale, which means they can be efficient only if they are very large, perhaps too roads, power generation, and
large for any private company or group of companies to carry out. In other cases, the bene- irrigation systems.
fits from a development project, while extraordinarily valuable, cannot be easily bought and
sold. The availability of clean air and potable water are two examples. Here government must
play its role before the private sector can proceed. For example, some observers have recently
argued that India’s growth prospects are being limited by its poor rail transport system.
Goods from Singapore to India move easily over water in less than a day, but they can take
weeks to move from port cities to supply factories in the interior. China, by contrast, spent
the bulk of its stimulus money in the 2008–2009 period trying to build new transportation
networks in part because the government understood how key this social overhead capital
was to economic growth.
To build infrastructure requires public funding. Many less developed countries struggle with
raising tax revenues to support these projects. In 2010, Greece struggled to repay its debt partly
because of widespread tax evasion by its wealthiest citizens. In many less developed countries,
corruption limits the public funds available for productive government investments, as the
Economics in Practice on p. 718 suggests.
Strategies for Economic Development

Just as no single theory appears to explain lack of economic advancement, no one develop-
ment strategy will likely succeed in all nations. How active a role should government play in
directing economic development? What sectors should be emphasized? Should one focus on
new business as a growth engine? These questions are being debated by economists and gov-
ernments across the globe.
Governments or Markets? Soviet-style development was accomplished with

detailed central planning, state ownership, and control of prices and output. Today in devel-
oping economies, the market plays a much stronger role. In most parts of the world,
including nondemocratic countries like China, state ownership has declined and prices are
mostly set in markets. International agencies like the International Monetary Fund (IMF), International Monetary Fund
whose primary goals are to stabilize international exchange rates and to lend money to (IMF) An international
countries with problems financing international transactions, and the World Bank, agency whose primary goals
which lends money to countries for development projects, have pushed hard for market- are to stabilize international
exchange rates and to lend
oriented reforms. money to countries that have
Market-oriented reforms, however, have not eliminated the role of government. As indi- problems financing their
cated earlier, governments play a vital role in creating institutions that allow markets to work international transactions.
effectively—physical institutions like roads and schools, and business and legal institutions
such as accounting systems and property rights. Many governments also use their taxing and World Bank An international
expenditure policies to favor specific sectors over others as they try to grow. Industrial agency that lends money to
policy, in which governments actively pick industries to support as a base for economic individual countries for
projects that promote
development, is still carried on at some level in most developing nations. The greater central
economic development.
control of the economy in China was very evident during the recent recession in the
speed with which China could direct its government expenditures as it sought to stimulate industrial policy A policy in
its economy. which governments actively
pick industries to support as a
base for economic
Agriculture or Industry? Consider the data in Table 36.2. The richest countries development.
listed—the United States, Japan, and Korea—generate much of their GDP in services, with
little value contributed by agricultural production. The poorest countries, on the other
hand, have substantial agricultural sectors, although as you can see, the service sector is also
large in a number of these economies. A casual look at the data might well lead one to con-
clude that moving out of agriculture was the path to development. And, indeed, industrial-
ization was the path that Eastern Europe and other economies pursued in the post-World
War II period.
TABLE 36.2 The Structure of Production in Selected Developed and Developing

Economies, 2008
Percentage of Gross Domestic Product
Per-Capita Gross National
Country Income (GNI) Agriculture Industry Services
Tanzania $ 440 45 17 38
Bangladesh 520 19 29 52
China 2,940 11 49 40
Thailand 3,670 12 44 44
Colombia 4,620 9 36 55
Brazil 7,300 7 28 65
Korea (Rep.) 21,530 3 37 60
Japan 38,130 1 29 70
United States 47,930 1 22 77
In many countries, however, industrialization has been unsuccessful. Some have argued
that a move out of agriculture may be a result of development, rather than a cause. Others
have suggested that industrialization worked for the Western economies but may not work as
well for economies with other distributions of human and physical capital. Indeed, in the
last several decades the agricultural sector has received more attention as a source of eco-
nomic development. Many agricultural projects with large productivity enhancement poten-
tial have relatively low capital requirements and thus may better match the capital-poor
developing world. Agricultural development also improves the lot of the rural population,
where more of the poor typically live. Finally, improving agriculture may slow the move of
the poor to cities, where infrastructure is inadequate for the growing population.
Experience over the last three decades suggests that some balance between industrialization
and agricultural reform leads to the best outcome—that is, it is important and effective to pay
attention to both industry and agriculture. The Chinese have referred to this dual approach to
development as “walking on two legs.”
Exports or Import Substitution? As developing nations expand their industrial

activities, they must decide what type of trade strategy to pursue. Development economists
discuss two alternatives: import substitution or export promotion.
import substitution An Import substitution is a strategy used to develop local industries that can manufacture
industrial trade strategy that goods to replace imports. If fertilizer is imported, import substitution calls for a domestic
favors developing local fertilizer industry to produce replacements for fertilizer imports. This strategy
industries that can
gained prominence throughout South America in the 1950s. At that time, most developing
manufacture goods to replace
imports. nations exported agricultural and mineral products, goods that faced uncertain and often
unstable international markets. Under these conditions, the call for import substitution
policies was understandable. Special government actions, including tariff and quota
protection and subsidized imports of machinery, were set up to encourage new domestic
industries. Multinational corporations were also invited into many countries to begin
domestic operations.
Most economists believe that import substitution strategies have failed almost every-
where they have been tried. With domestic industries sheltered from international competi-
tion by high tariffs (often as high as 200 percent), major economic inefficiencies were
created. For example, Peru has a population of approximately 29 million, only a tiny fraction
of whom can afford to buy an automobile. Yet at one time, the country had five or six differ-
ent automobile manufacturers, each of which produced only a few thousand cars per year.
Because there are substantial economies of scale in automobile production, the cost per car
was much higher than it needed to be, and valuable resources that could have been devoted
to another, more productive, activity were squandered producing cars.
Furthermore, policies designed to promote import substitution often encouraged capital-
intensive production methods, which limited the creation of jobs and hurt export activities. A
country such as Peru could not export automobiles because it could produce them only at a
cost far greater than their price on the world market. Worse still, import substitution policies
encouraged the use of expensive domestic products, such as tractors and fertilizer, instead of
lower-cost imports. These policies taxed the sectors that might have successfully competed in
world markets.
As an alternative to import substitution, some nations have pursued strategies of export
promotion. Export promotion is the policy of encouraging exports. As an industrial market export promotion A trade
economy, Japan was a striking example to the developing world of the economic success that policy designed to encourage
exports can provide. Japan had an average annual per-capita real GDP growth rate of roughly exports.
6 percent per year from 1960–1990. This achievement was, in part, based on industrial produc-
tion oriented toward foreign consumers.
Several countries in the developing world have attempted to emulate Japan’s success.
Starting around 1970, Hong Kong, Singapore, Korea, and Taiwan (the “four little dragons”
between the two “big dragons,” China and Japan) began to pursue export promotion of manu-
factured goods. Today their growth rates have surpassed Japan’s. Other nations, including Brazil,
Colombia, and Turkey, have also had some success at pursuing an outward-looking trade policy.
China’s growth has been mostly export-driven as well.
Government support of export promotion has often taken the form of maintaining an
exchange rate favorable enough to permit exports to compete with products manufactured in
developed economies. For example, many people believe China has kept the value of the yuan arti-
ficially low. Because a “cheap” yuan means inexpensive Chinese goods in the United States, sales of
these goods increased dramatically.
A big issue for countries growing or trying to grow by selling exports on world markets is free
trade. African nations in particular have pushed for reductions in tariffs imposed on their
agricultural goods by Europe and the United States, arguing that these tariffs substantially reduce
Africa’s ability to compete in the world marketplace.
Microfinance In the mid 1970s, Muhammad Yunus, a young Bangladeshi economist

created the Grameen Bank in Bangladesh. Yunus, who trained at Vanderbilt University and
was a former professor at Middle Tennessee State University, used this bank as a vehicle to
introduce microfinance to the developing world. In 2006, Yunus received a Nobel Peace
Prize for his work. Microfinance is the practice of lending very small amounts of money,
with no collateral, and accepting very small savings deposits. 2 It is aimed at introducing
entrepreneurs in the poorest parts of the developing world to the capital market. By 2002,
more than 2,500 institutions were making these small loans, serving over 60 million people.
Two-thirds of borrowers were living below the poverty line in their own countries, the poor-
est of the poor.
2 An excellent discussion of microfinance is contained in Beatriz Armendariz de Aghion and Jonathan Morduch, The Economics
of Microfinance, (MIT Press, 2005.)

E C O N O M I C S I N P R AC T I C E
Cell Phones Increase Profits for Fishermen in India
Kerala is a poor state in a region of India. The fishing industry is a
major part of the local economy, employing more than one mil-
lion people and serving as the main source of protein for the pop-
ulation. Every day fishing boats go out; and when they return, the
captain of the ship needs to decide where to take the fish to sell.
There is much uncertainty in this decision: How much fish will
they catch; what other boats will come to a particular location;
how many buyers will there be at a location? Moreover, fuel costs
are high and timing is difficult, so that once a boat comes ashore,
it does not pay for the fishermen to search for a better market-
place. In a recent study of this area, Robert Jensen1 found on a
Tuesday morning in November 1997, 11 fishermen in Badagara simple laws of supply and demand, the prices of fish across the var-
were dumping their load of fish because they faced no buyers at ious villages along the fishing market route were closer to each
the dock. However, unbeknownst to them, 15 kilometers away, other than they were before. Jensen found that with less waste fish-
27 buyers were leaving their marketplace empty-handed, with ermen’s profits rose on average by 8 percent, while the average price
unsatisfied demand for fish. of fish fell by 4 percent.
Beginning in 1997 and continuing for the next several years, In fact, cell phones are improving the way markets in less
mobile phone service was introduced to this region of India. By developed countries work by providing price and quantity infor-
2001, the majority of the fishing fleet had mobile phones, which mation so that both producers and consumers can make better
they use to call various vendors ashore to confirm where the buyers economic decisions.
are. What was the result? Once the phones were introduced, waste, 1Robert Jensen, “The Digital Provide: Information Technology, Market
which had averaged 5 to 8 percent of the total catch, was virtually Performance, and Welfare in the South Indian Fisheries Sector,” The
eliminated. Moreover, just as we would have predicted from the Quarterly Journal of Economics, August 2007.
Yunus, while teaching economics in Bangladesh, began lending his own money to poor
households with entrepreneurial ambitions. He found that with even very small amounts of
money, villagers could start simple businesses: bamboo weaving or hair dressing. Traditional
banks found these borrowers unprofitable: The amounts were too small, and it was too expen-
sive to figure out which of the potential borrowers was a good risk. With a borrower having no
collateral, information about his or her character was key but was hard for a big bank to dis-
cover. Local villagers, however, typically knew a great deal about one another’s characters. This
insight formed the basis for Yunus’s microfinance enterprise. Within a village, people who are
interested in borrowing money to start businesses are asked to join lending groups of five peo-
ple. Loans are then made to two of the potential borrowers, later to a second two, and finally to
the last. As long as everyone is repaying their loans, the next group receives theirs. But if the first
borrowers fail to pay, all members of the group are denied subsequent loans. What does this do?
It makes community pressure a substitute for collateral. Moreover, once the peer lending mech-
anism is understood, villagers have incentives to join only with other reliable borrowers. The
mechanism of peer lending is a way to avoid the problems of imperfect information described
in an earlier chapter.
The Grameen model grew rapidly. By 2002, Grameen was lending to two million mem-
bers. Thirty countries and thirty U.S. states have microfinance lending copied from the
Grameen model. Relative to traditional bank loans, microfinance loans are much smaller,
repayment begins very quickly, and the vast majority of the loans are made to women (who, in
many cases, have been underserved by mainstream banks). A growing set of evidence shows
that providing opportunities for poor women has stronger spillovers in terms of improving
the welfare of children than does comparable opportunities for men. While the field of micro-
finance has changed considerably since Yunus’s introduction and some people question how
big a role it will ultimately play in spurring major development and economic growth, it has
changed many people’s views about the possibilities of entrepreneurship for the poor of
the world.
Two Examples of Development: China and India

China and India provide two interesting examples of rapidly developing economies. While low
per-capita incomes still mean that both countries are typically labeled developing as opposed to
developed countries, many expect that to change in the near future. In the 25-year period from
1978 to 2003, China grew, on average, 8 percent per year, a rate faster than any other country in
the world. While India’s surge has been more recent, in the last 5 years, it too has seen annual
growth rates in the 8 to 9 percent range. Many commentators expect India and China to domi-
nate the world economy in the twenty-first century.
How did these two rather different countries engineer their development? Consider
institutions: India is a democratic country, has a history of the rule of law, and has an
English-speaking heritage—all factors typically thought to provide a development advan-
tage. China is still an authoritarian country politically, and property rights are still not well
established—both characteristics that were once thought to hinder growth. Both China and
India have embraced free market economics, with China taking the lead as India has worked
to remove some of its historical regulatory apparatus.
What about social capital? Both India and China remain densely populated. While China
is the most populous country in the world, India, with a smaller land mass, is the world’s
most densely populated country. Nevertheless, as is true in most developing nations, birth
rates in both countries have fallen. Literacy rates and life expectancy in China are quite high,
in part a legacy from an earlier period. India, on the other hand, has a literacy rate that is less
than that of China’s and a lower life expectancy. In terms of human capital, China appears to
have the edge, at least for now.
What about the growth strategies used by the two countries? China has adopted a prag-
matic, gradual approach to development, sharply in contrast to that adopted some years ago
in Poland. China’s approach has been called moshi guohe, or “Crossing the river by feeling for
stepping stones.” In terms of sector, most of China’s growth has been fueled by manufactur-
ing. The focus on manufacturing is one reason that China’s energy consumption and envi-
ronmental issues have increased so rapidly in the last decade. In India, services have led
growth, particularly in the software industry. In sum, it is clear that there is no single recipe
for development.
Development Interventions
To this point we have used the terms growth and development interchangeably, assuming
that as an economy grows in its level of income, it will develop to provide benefits to most of
its population. Since the 1970s at least, however, economists and policy makers have ques-
tioned the relationship between growth and development. A 1974 World Bank study con-
cluded that “More than a decade of rapid growth in underdeveloped countries has been of
little or no benefit to perhaps a third of their population.” In the last 20 years, development
economists have increasingly turned to much narrower, more microeconomically oriented
programs to see if they can figure out which interventions do help the condition of the bot-
tom of the income distribution in developing countries and how to replicate those successful
programs.
Random and Natural Experiments: Some New Techniques

in Economic Development
Suppose we were trying to decide whether it was worthwhile in terms of student achieve-
ment to hire another teacher to reduce the student-faculty ratio. One traditional way we
might try to answer that question is to find two classrooms with different enrollments in
otherwise similar school systems and look at the educational performance of the students.
We see comparisons of this sort everyday in newspaper discussions of policies, and many
research projects take a variant of this approach. But the approach is subject to serious
criticism. It is possible that differences in the two classrooms beyond the enrollment
numbers also matter to performance—differences we have failed to correct in the compar-
isons we make. Crowded classrooms may be in poorer areas (indeed, this may account for
the crowding); they may have less effective teachers; they may lack other resources.
In the social sciences, it is very difficult to ensure that we have comparisons that differ only
in the one element in which we are interested. The fact that our interventions involve people
makes even harder. In the case of the classrooms with small enrollment, it may well be that
the most attentive parents have pushed to have their children in these classrooms, believing
them to be better. Perhaps the best teachers apply to lead these classrooms, and their
higher quality makes it more likely that they get their first choice of classrooms. If either of
these things happens, the two classrooms will differ in systematic ways that bias the results in
favor of finding better performance in the smaller classrooms. More attentive parents may
provide home support that results in better test outcomes for their children even if
the classrooms are crowded. Better teachers improve performance no matter how crowded
the classrooms are. Problems of this sort, sometimes called selection bias, plague social sci-
ence research.
In recent years, a group of development economists began using a technique borrowed
random experiment from the natural sciences, the random experiment, to try to get around the selection
(Sometimes referred to as a problem in evaluating interventions. Instead of looking at results from classrooms that have
randomized experiment.) A made different choices about class size or textbooks, for example, the experimenters
technique in which outcomes randomly assign otherwise identical-looking classes to follow an intervention or not.
of specific interventions are
determined by using the
Students and teachers are not allowed to shift around. By comparing the outcomes of large
intervention in a randomly numbers of randomly selected subjects with control groups, social scientists hope to identify
selected subset of a sample effects of interventions in much the same way natural scientists evaluate the efficacy of vari-
and then comparing outcomes ous drugs.
from the exposed and control The leading development group engaged in random experiments in the education and
group. health areas is the Poverty Research Lab at MIT, run by Esther Duflo and Abhijit Banerjee. By
working with a range of NGOs and government agencies in Africa, Latin America, and Asia, these
economists have looked at a wide range of possible investments to help improve outcomes for the
poorest of the poor.
Of course, not all policies can be evaluated this way. Experimenters do not always
have the luxury of random assignment. An alternative technique is to rely on what have been
natural experiment Selection called natural experiments to mimic the controlled experiment. Suppose I am interested in
of a control versus experimental the effect of an increase in wealth on the likelihood that a poor family will enroll its
group in testing the outcome of daughters in school. Comparing school behavior of rich and poor families is obviously
an intervention is made as a problematic because they are likely to differ in too many ways to control adequately. Nor
result of an exogenous event
outside the experiment itself
does it seem feasible to substantially increase the wealth of a large number of randomly
and unrelated to it. selected parents. But in an agrarian community we may observe random, annual weather
occurrences that naturally lead to occasional years of plenty, and by observing behavior in
those years versus other years, we may learn a good deal. The weather in this case has created
a natural experiment.
Empirical development economics thus has added experimental methods to its tool kit
as a way to answer some of the very difficult and important questions about what does and
does not work to improve the lot of the poor in developing nations. We turn now to look at
some of the recent work in the fields of education and health, focusing on this experimental
work, to provide some sense of the exciting work going on in this field.
Education Ideas
As we suggested earlier, human capital is an important ingredient in the economic growth of
a nation. As economies grow, returns to education also typically grow. As we move from
traditional agrarian economies to more diversified and complex economies, the advantages
to an individual from education rises. So if we want a nation’s poor to benefit from growth,
improving their educational outcomes is key. This leads us to one of the central preoccupations
of development economists in the last decade or so: Of the many investments one
could make in education, which have the highest payoffs? Is it better to invest in more books
or more teachers? How much does the quality of teachers matter? Are investments most
important in the first years of education or later? In a world with limited resources in which
educational outcomes are very important, getting the right answers to these questions
is vital.
For most middle-class American students, it may come as a surprise that in the developing
world, teacher absenteeism is a serious problem. A recent study led by researchers from the
World Bank found, for example, that on an average day, 27 percent of Ugandan and
25 percent of Indian teachers are not at work. Across six poor countries, teacher absences aver-
aged 19 percent. The Poverty Research Lab has conducted a number of experiments in a
range of developing countries to see how one might reduce these absences. The most successful
intervention was introduced in Rajasthan, India, by an NGO called Seva Mandir. Each day when
he or she arrived, the teachers in half of Seva Mandir’s 160-single teacher schools were asked to
have their picture taken with the children. Cameras were date-stamped. This evidence of atten-
dance fed into the compensation of the teacher. Teacher absentee rates were cut in half relative
to the seemingly identical classrooms in which no cameras were introduced.
Student absenteeism is also a problem throughout the developing world, reducing
educational outcomes even when schools are well staffed with qualified teachers. Several
countries, including Mexico, have introduced cash payments to parents for sending their
children to school regularly. Since the Mexican government introduced these payments over
time, in ways not likely to be related to educational outcomes, researchers could compare stu-
dent absenteeism across seemingly identical areas with and without the cash incentives as a
form of natural experiment. There is some evidence that cash payments do increase school
attendance. Natural experiments have also been used to look at the effect of industrialization
that improves educational returns as a way to induce better school attendance; the results have
been positive.
Work using experiments, both natural and random, is still at an early stage in development
economics. While many reform ideas have proven helpful in improving educational outcomes
in different developing countries, it has proven hard up to now to find simple answers that
work across the globe. Nevertheless, these new techniques appear to offer considerable promise
as a way of tackling issues of improving education for the poor of the developing world.
Health Improvements
Poor health is a second major contributor to individual poverty. In the developing world, esti-
mates are that one-quarter of the population is infected with intestinal worms that sap the
energy of children and adults alike. Malaria remains a major challenge in Africa, as does
HIV/AIDS.
In the case of many interventions to improve health, human behavior plays an important
role, and here is where development economics has focused. For many diseases, we
have workable vaccines. But we need to figure out how to encourage people to walk to health
clinics or schools to get those vaccines. We want to know if charging for a vaccine will substan-
tially reduce uptake. For many waterborne diseases, treatment of drinking water
with bleach is effective, but the taste is bad and bleach is not free. How do we induce usage?
Treated bed nets can reduce malaria, but only if they are properly used. In each of these cases,
there are benefits to the individual from seeking treatment or preventive care, but also costs. In
the last several years, a number of development economists have explored the way in which
individuals in developing economies have responded to policies that try to change these costs
and benefits.
Intestinal worms, quite common in areas of Africa with inadequate sanitation, are treatable
with periodic drugs at a relatively low cost. Michael Kremer and Ted Miguel, working with
the World Bank, used random experiments in Kenya to examine the effect of health education
and user fees on families’ take-up of treatment of their children. Kremer and Miguel found a
number of interesting results, results very much in keeping with economic principles. First, a pro-
gram of charging user fees—even relatively low ones—dramatically reduced treatment rates. The
World Bank’s attempts to make programs more financially self-sustaining, if used in this area, were
likely to have large, averse public health effects. Elasticities were well above one. Kremer and
Miguel also found that as the proportion of vaccinated people in a village grew, and thus the risk of
contagion fell, fewer people wanted treatment, indicating some sensitivity to costs and benefit cal-
culations by the villagers. Disappointingly, health education did not seem to make much difference.
As with the area of education, much remains for development economists to understand
in the area of health and human behavior. Development economics continues to be one of the
most exciting areas in economics.
Population Issues
The populations of the developing nations are estimated to be growing at about 1.7 percent
per year. If the Third World’s population growth remained at this level, within 41 years its
population would double from its 1990 level of 4.1 billion to over 8 billion by the year 2031.
For poor nations, rapid population growth can strain infrastructure and may impede devel-
opment. For this reason, population control has at times been part of the development strat-
egy of a number of nations.
Figure 36.1 provides the long historical record of population growth in the world. More
than 200 years ago, the Reverend Thomas Malthus, England’s first professor of political
economy, expressed his fears about this record of population growth. Malthus believed that
populations inexorably grew geometrically at a constant growth rate, while the diminishing
productivity of land caused food supplies to grow more slowly. Looking at the two phenom-
ena together led Malthus to predict the increasing impoverishment of the world’s people
unless population could be slowed.
Malthus’s fears for Europe and America proved unfounded. Technological changes revo-
lutionized agriculture so that food supplies grew despite the scarcity of land. At the same
Modern
7
New Age
Old Stone Age New Bronze Middle
6 Stone Age commences Stone Age Age Iron Age Ages
Billions of people
Bubonic
1
plague
0
2–5 million 8000 7000 6000 5000 4000 3000 2000 1000 1 1000 2020
years B.C. B.C. B.C. B.C. B.C. B.C. B.C. B.C. B.C. A.D. A.D. A.D.
FIGURE 36.1 The Growth of World Population, Projected to A.D. 2020

For thousands of years, population grew slowly. From A.D. 1 until the mid 1600s, population grew at
about .04 percent per year. Since the Industrial Revolution, population growth has occurred at an
unprecedented rate.
time, population growth fell dramatically in Europe and America. Nor did Malthus
fully see the causal connection between technical change, economic growth, and population.
As early as the mid 1960s, economist T. W. Schultz argued that technical progress increased
the returns to education by making it harder for children to simply move into the
jobs of their parents. Faced with this recognition, more parents in the developing world
reduced their family sizes to better consolidate resources for education. Economists have
referred to this reduction in family size and increase in child education levels as trading
quantity of children for quality. In some countries, market forces pushing populations
toward reduced family size have been helped along by government policies aimed at reduc-
ing populations.
Of course, there are parts of the developing world in which population growth contin-
ues at high levels. Uganda, with a GDP of $300 per capita, had a population growth rate in
2008 of 3.6 percent, one of the highest in the world. As an agrarian economy with high infant
mortality rates, Uganda, as well as a number of other countries, still values large families. In
agrarian societies, children are sources of farm labor and they may make significant contri-
butions to household income. In societies without public old-age-support or social security
programs, children may also provide a source of income for parents who are too old to sup-
port themselves. With the high value of children enhanced by high rates of infant mortality,
it is no wonder that families try to have many children to ensure that a sufficient number will
survive into adulthood.
Economic theories of population growth suggest that fertility decisions made by poor
families should not be viewed as uninformed and uncontrolled. An individual family may
find that having many children is a rational strategy for economic survival given the condi-
tions in which it finds itself. Only when the relationship between the costs and benefits of
having children changes, in places like Uganda, will fertility rates decline. This does not mean,
however, that having many children is a net benefit to society as a whole.When a family
decides to have a large number of children, it imposes costs on the rest of society; the children
must be educated, their health provided for, and so on. In other words, what makes sense for
an individual household may create negative effects for the nation as a whole.
The Transition to a Market Economy

In the last several decades, a number of countries have made the transition from a planned
economy to a market economy. Russia and the formerly Communist countries of Eastern
Europe led the way in this transition beginning in the late-1980s. For a number of these coun-
tries, the early transition period was difficult, and there has been considerable debate about the
optimal speed of transitions and ways to manage the social upheaval that often comes with
economic reform.
For example, between 1992 and 2002, while per-capita income grew by 51 percent in Poland,
it shrank by 63 percent in the Ukraine. Countries of the former USSR seem to have had a partic-
ularly difficult transition to market economies. Economists have attributed differences in ease of
transition to reform strategies (slow versus fast), resource endowments of the country, and differ-
ences in institutions.
In more recent years, China and Vietnam have joined the collection of transition
economies, coming to rely less on central planning for economic decisions and more on the
market. India too is sometimes thought to be a transition economy, as it has in the last
decade dismantled much of its government ownership and elaborate rules governing
market transactions.
Six Basic Requirements for Successful Transition

Economists generally agree on six basic requirements for a successful transition to a market-
based system: (1) macroeconomic stabilization, (2) deregulation of prices and liberalization of
trade, (3) privatization of state-owned enterprises and development of new private industry,
(4) establishment of market-supporting institutions such as property and contract laws and
accounting systems, (5) a social safety net to deal with unemployment and poverty, and (6) exter-
nal assistance. We now discuss each component.
Macroeconomic Stabilization Many countries in transition have had a problem with

inflation, but nowhere has it been worse than in Russia. As economic conditions worsened, the
government found itself with serious budget problems. As revenue flows slowed and expenditure
commitments increased, large budget deficits resulted. At the same time, each of the new
republics established its own central bank. Each central bank began issuing “ruble credits” to keep
important enterprises afloat and to pay the government’s bills. The issuance of these credits,
which were generally accepted as a means of payment throughout the country, led to a dramatic
expansion of the money supply.
Almost from the beginning, the expanded money supply meant too much money was
chasing too few goods. This was made worse by government-controlled prices set substan-
tially below market-clearing levels. The combination of monetary expansion and price con-
trol was deadly. Government-run shops that sold goods at controlled prices were empty.
People waited in line for days and often became violent when their efforts to buy goods at
low official prices were thwarted. At the same time, suppliers found that they could charge
much higher prices for their products on the black market—which grew bigger by the day,
further exacerbating the shortage of goods at government shops. Over time, the ruble
became worth less and less as black market prices continued to rise more rapidly. Russia
found itself with near hyperinflation in 1992. To achieve a properly functioning market sys-
tem, prices must be stabilized. To do so, the government must find a way to move toward a
balanced budget and to bring the supply of money under control. China and India, in
contrast to Russia and Eastern European states, initially suffered only modest inflation
as they decontrolled their prices, though more recently inflation appears to be increasing
in China.
Deregulation of Prices and Liberalization of Trade To move successfully

from central planning to a market system, individual prices must be deregulated. A system of
freely moving prices forms the backbone of a market system. When people want more of a
good than is currently being produced, its price will rise. This higher price increases produc-
ers’ profits and provides an incentive for existing firms to expand production and for new
firms to enter the industry. Conversely, if an industry is producing a good for which there
is no market or a good that people no longer want in the same quantity, the result will be
excess supply and the price of that good will fall. This outcome reduces profits or creates
losses, providing an incentive for some existing firms to cut back on production and
for others to go out of business. In short, an unregulated price mechanism ensures an
efficient allocation of resources across industries. Until prices are deregulated, this mecha-
nism cannot function. In practice, transition economies have moved at varying speeds in
decontrolling prices. Vietnam, for example, decontrolled prices very quickly in moving to a
market economy, as did Poland. China, on the other hand, took a slower path in freeing
prices from state control.
Trade barriers must also be removed. Reform-minded countries must be able to import
capital, technology, and ideas. In addition, it makes no sense to continue to subsidize indus-
tries that cannot be competitive on world markets. If it is cheaper to buy steel from an effi-
cient West German steel mill than to produce it in a subsidized antiquated Russian mill, the
Russian mill should be modernized or shut down. Ultimately, as the theory of comparative
advantage suggests, liberalized trade will push each country to produce the products it pro-
duces best.
Deregulating prices and eliminating subsidies can bring serious political problems.
Many products in Russia and the rest of the socialist world were priced below market-
clearing levels for equity reasons. Housing, food, and clothing were considered by many to
be entitlements. Making them more expensive, at least relative to their prices in previous
times, is not likely to be popular. In 2008, rising rice prices in Southeast Asia caused con-
siderable unrest in Vietnam, Thailand, and Cambodia. In addition, forcing inefficient
firms to operate without subsidies will lead many of them to go out of business, and jobs will
be lost. So while price deregulation and trade liberalization are necessary, they are very diffi-
cult politically.
Privatization One problem with a system of central ownership is a lack of accountability.

Under a system of private ownership, owners reap the rewards of their successes and suffer the
consequences of their failures. Private ownership provides a strong incentive for efficient oper-
ation, innovation, and hard work that is lacking when ownership is centralized and profits are
distributed to the people.
The classic story to illustrate this point is called the tragedy of commons, which is the tragedy of commons
idea that collective ownership may not provide the proper private incentives for efficiency The idea that collective
because individuals do not bear the full costs of their own decisions but do enjoy the full ben- ownership may not provide the
efits. Suppose an agricultural community has 10,000 acres of grazing land. If the land was proper private incentives for
efficiency because individuals
held in common so that all farmers had unlimited rights to graze their animals, each farmer do not bear the full costs of
would have an incentive to overgraze. He or she would reap the full benefits from grazing their own decisions but do
additional calves while the costs of grazing the calves would be borne collectively. The system enjoy the full benefits.
provides no incentive to manage the land efficiently. Similarly, if the efficiency and benefits of
your hard work and managerial skills accrue to others or to the state, what incentive do you
have to work hard or to be efficient?
One solution to the tragedy of commons attempted in eighteenth-century Britain was to
divide up the land into private holdings. Today, many economists argue, the solution to the
incentive problem encountered in state-owned enterprises is to privatize them and let the
owners compete.
In addition to increasing accountability, privatization means creating a climate in which new
enterprises can flourish. If there is market demand for a product not currently being produced,
individual entrepreneurs should be free to set up a business and make a profit. During the last
months of the Soviet Union’s existence, private enterprises such as taxi services, car repair ser-
vices, restaurants, and even hotels began to spring up all over the country.
Like deregulation of prices, privatization is difficult politically. Privatization means that
many protected enterprises will go out of business because they cannot compete at world prices,
resulting in a loss of jobs, at least temporarily.
Market-Supporting Institutions Between 1991 and 1997, U.S. firms raced to Eastern
Europe in search of markets and investment opportunities and immediately became aware of a
major obstacle. The institutions that make the market function relatively smoothly in the United
States did not exist in Eastern Europe. For example, the capital market, which channels private
saving into productive capital investment in developed capitalist economies, is made up of hun-
dreds of different institutions. The banking system, venture capital funds, the stock market, the
bond market, commodity exchanges, brokerage houses, investment banks, and so on, have devel-
oped in the United States over hundreds of years, and they could not be replicated overnight in
the formerly Communist world.
Similar problems exist in the Chinese economy. While the Chinese equity market has grown
rapidly in the last decade, that growth has been accompanied by problems with weak governance
and lack of transparency. These issues discourage investments by western firms.
Many market-supporting institutions are so basic that Americans take them for granted.
The institution of private property, for example, is a set of rights that must be protected by laws
that the government must be willing to enforce. Suppose the French hotel chain Novotel decides
to build a new hotel in Moscow or Beijing. Novotel must first acquire land. Then it will con-
struct a building based on the expectation of renting rooms to customers. These investments are
made with the expectation that the owner has a right to use them and a right to the profits that
they produce. For such investments to be undertaken, these rights must be guaranteed by a set
of property laws. This is equally true for large business firms and for local entrepreneurs who
want to start their own enterprises. China’s ambiguous property rights laws may also be prob-
lematic. While farmers can own their own homes, for example, all rural land is collectively
owned by villages. Farmers have the right to manage farmland, but not own it. As a result, trans-
fer of land is difficult.
Similarly, the law must provide for the enforcement of contracts. In the United States, a huge
body of law determines what happens if you break a formal promise made in good faith.
Businesses exist on promises to produce and promises to pay. Without recourse to the law when a
contract is breached, contracts will not be entered into, goods will not be manufactured, and ser-
vices will not be provided.
Protection of intellectual property rights is also an important feature of developed market
economies. When an artist puts out a record, the artist and his or her studio are entitled to reap
revenues from it. When Apple developed the iPod, it too earned the right to collect revenue for its
patent ownership. Many less developed countries lack laws and enforcement mechanisms to
protect intellectual property of foreign investments and their own current and future investors.
The lack of protection discourages trade and home-grown invention. For example, in late 2007,
China, in recognition of some of these issues, began drafting a new set of laws for intellectual
property protection.
Another seemingly simple matter that turns out to be quite complex is the establishment
of a set of accounting principles. In the United States, the rules of the accounting game are
embodied in a set of generally accepted accounting principles (GAAP) that carry the force of
law. Companies are required to keep track of their receipts, expenditures, and liabilities so
that their performance can be observed and evaluated by shareholders, taxing authorities,
and others who have an interest in the company. If you have taken a course in accounting,
you know how detailed these rules have become. Imagine trying to do business in a country
operating under hundreds of different sets of rules. That is what happened in Russia during
its transition.
Another institution is insurance. Whenever a venture undertakes a high-risk activity, it buys
insurance to protect itself. Several years ago Amnesty International (a nonprofit organization that
works to protect civil liberties around the world) sponsored a worldwide concert tour with a
number of well-known rock bands and performers. The most difficult part of organizing the tour
was obtaining insurance for the artists and their equipment when they played in the then-
Communist countries of Eastern Europe.
Social Safety Net In a centrally planned socialist economy, the labor market does not func-
tion freely. Everyone who wants a job is guaranteed one somewhere. The number of jobs is deter-
mined by a central plan to match the number of workers. There is essentially no unemployment.
This, it has been argued, is one of the great advantages of a planned system. In addition, a central
planning system provides basic housing, food, and clothing at very affordable levels for all. With
no unemployment and necessities available at very low prices, there is no need for unemploy-
ment insurance, welfare, or other social programs.
Transition to a free labor market and liberalization of prices means that some workers
will end up unemployed and that everyone will pay higher prices for necessities. Indeed,
during the early phases of the transition process, unemployment will be high. Inefficient
state-owned enterprises will go out of business; some sectors will contract while others
expand. As more and more people experience unemployment, popular support for reform is
likely to drop unless some sort of social safety net is erected to ease the transition. This social
safety net might include unemployment insurance, aid for the poor, and food and housing
assistance. The experiences of the developed world have shown that such programs
are expensive.
External Assistance Very few believe that the transition to a market system can be achieved
without outside support and some outside financing. Knowledge of and experience with capitalist
institutions that exist in the United States, Western Europe, and Japan are of vital interest to the
Eastern European nations. The basic skills of accounting, management, and enterprise develop-
ment can be taught to developing nations; many say it is in everyone’s best interest to do so.
There is little agreement about the extent of financial support that should be given, how-
ever. In the case of Russia, the United States pushed for a worldwide effort to provide billions
of dollars in aid, to stabilize its macroeconomy, and to buy desperately needed goods from
abroad. For China, no such aid was thought to be necessary.
Shock Therapy or Gradualism? Although economists generally agreed on what

the former socialist economies needed to do, they debated the sequence and timing of spe-
cific reforms.
The popular press described the debate as one between those who believe in “shock therapy”
(sometimes called the Big Bang approach) and those who prefer a more gradual approach. Advocates
of shock therapy believe that the economies in transition should proceed immediately on all fronts. shock therapy The approach
They should stop printing money, deregulate prices and liberalize trade, privatize, develop market to transition from socialism to
institutions, build a social safety net, and acquire external aid—all as quickly as possible. The pain will market capitalism that
be severe, the argument goes, but in the end, it will be forgotten as the transition raises living standards. advocates rapid deregulation
of prices, liberalization of
Advocates of a gradualist approach believe the best course is to build up market institutions first, grad- trade, and privatization.
ually decontrol prices, and privatize only the most efficient government enterprises first.
Those who favor moving quickly point to the apparent success of Poland, which moved
rapidly through the first phases of reform. Russia’s experience during the first years of its
transition demonstrated that, at least in that country, change must, to some extent, be grad-
ual. In theory, stabilization and price liberalization can be achieved instantaneously. To enjoy
the benefits of liberalization, a good deal of privatization must have taken place—and that
takes time. One analyst has said that privatization means “selling assets with no value to peo-
ple with no money.” Some estimates suggest that half of Russian state-owned enterprises
were incapable of making a profit at world prices. Simply cutting them loose would create
chaos. In a sense, Russia had no choice but to move slowly.
SUMMARY
1. The economic problems facing the developing countries ECONOMIC DEVELOPMENT: SOURCES AND
are often quite different from those confronting industri- STRATEGIES p. 715
alized nations. The policy options available to govern- 3. Almost all developing nations have a scarcity of physical
ments may also differ. Nonetheless, the tools of economic capital relative to other resources, especially labor. The
analysis are as useful in understanding the economies of vicious-circle-of-poverty hypothesis says that poor coun-
less developed countries as in understanding the tries cannot escape from poverty because they cannot
U.S. economy. afford to postpone consumption—that is, to save—to
make investments. In its crude form, the hypothesis is
wrong inasmuch as some prosperous countries were at
LIFE IN THE DEVELOPING NATIONS: POPULATION one time poorer than many developing countries are
AND POVERTY p. 714 today. However, it is often difficult to mobilize saving effi-
2. The central reality of life in the developing countries ciently in many developing nations.
is poverty. Although there is considerable diversity 4. Human capital—the stock of education and skills
across the developing nations, most of the people in embodied in the workforce—plays a vital role in
most developing countries are extremely poor by economic development.
U.S. standards.
5. Developing countries are often burdened by inadequate social In these experiments, modeled after the natural sciences,
overhead capital, ranging from poor public health and sanita- individuals or even villages are randomly assigned to
tion facilities to inadequate roads, telephones, and court sys- receive various interventions and the outcomes they expe-
tems. Such social overhead capital is often expensive to provide, rience are compared with those of control groups. In the
and many governments are not in a position to undertake many areas of education and health, random experiments have
useful projects because they are too costly. been most prevalent.
6. Inefficient and corrupt bureaucracies also play a role in 14. Development economists also rely on natural experiments
retarding economic development in places. to learn about the efficacy of various interventions. In a
7. Among the many questions governments in developing natural experiment, we compare areas with differing con-
nations must answer as they seek a road to growth and devel- ditions that emerge as a consequence of an unrelated out-
opment is how much to rely on free working markets versus side force.
central planning. In recent decades, the pendulum has shifted 15. Many of the newer economic studies focus on understand-
toward market based strategies, with governments playing ing how to motivate individuals to take actions that sup-
more of a role in creating institutions supportive of markets. port policy interventions: to use health equipment
8. Because developed economies are characterized by a large properly, to attend schools, to receive vaccinations.
share of output and employment in the industrial sector, many 16. Rapid population growth is characteristic of many devel-
developing countries seem to believe that development and oping countries. Large families can be economically ratio-
industrialization are synonymous. In many cases, developing nal because parents need support in their old age or
countries have pursued industry at the expense of agriculture, because children offer an important source of labor.
with mixed results. Recent evidence suggests that some balance However, having many children does not mean a net bene-
between industry and agriculture leads to the best outcome. fit to society as a whole. Rapid population growth can put a
9. Import-substitution policies, a trade strategy that favors strain on already overburdened public services such as edu-
developing local industries that can manufacture goods to cation and health.
replace imports, were once very common in developing
nations. In general, such policies have not succeeded as well
as those promoting open, export-oriented economies. THE TRANSITION TO A MARKET ECONOMY p. 727
10. The failure of many central planning efforts has brought 17. Economists generally agree on six requirements for a suc-
increasing calls for less government intervention and more cessful transition from socialism to a market-based system:
market orientation in developing economies. (1) macroeconomic stabilization, (2) deregulation of prices
and liberalization of trade, (3) privatization, (4) establish-
11. Microfinance—lending small amounts to poor borrowers ment of market-supporting institutions, (5) a social safety
using peer lending groups—has become an important net, and (6) external assistance.
new tool in encouraging entrepreneurship in develop-
ing countries. 18. Much debate exists about the sequence and timing of spe-
cific reforms. The idea of shock therapy is to proceed
12. China and India have followed quite different paths in recent immediately on all six fronts, including rapid deregulation
development. of prices and privatization. The gradualist approach is to
build up market institutions first, gradually decontrol
prices, and privatize only the most efficient government
DEVELOPMENT INTERVENTIONS p. 723 enterprises first.
13. Development economists have begun to use randomized exper-
iments as a way to test the usefulness of various interventions.
REVIEW TERMS AND CONCEPTS
brain drain, p. 717 International Monetary Fund (IMF), p. 719 social overhead capital, p. 719
capital flight, p. 716 natural experiment, p. 724 tragedy of commons, p. 729
export promotion, p. 721 random experiment, p. 724 vicious-circle-of-poverty hypothesis, p. 716
import substitution, p. 720 shock therapy, p. 731 World Bank, p. 719
industrial policy, p. 719
PROBLEMS
All problems are available on www.myeconlab.com
1. One of the biggest problem facing developing countries across 8. How does peer lending used in microfinance help to solve the
the globe in 2009 was disease. More than 1 million people died problem of adverse selection?
of malaria and over 2 million deaths were due to HIV/AIDS, 9. [Related to the Economics in Practice on p. 722] Find another
with most of these deaths occurring in Africa. Describe the example of the use of cell phones as a way to improve market
effects of these diseases on the economies of these countries. functioning in a developing economy.
Make sure you discuss the sources of economic growth and the
10. [Related to the Economics in Practice on p. 718] Corruption
use of scarce resources.
in a government is often accompanied by inefficiency in the
2. For a developing country to grow, it needs capital. The major economy. Why should this be true?
source of capital in most countries is domestic saving, but the
11. The distribution of income in a capitalist economy is likely to be
goal of stimulating domestic saving usually is in conflict with
more unequal than it is in a socialist economy. Why is this so? Is
government policies aimed at reducing inequality in the dis-
there a tension between the goal of limiting inequality and the
tribution of income. Comment on this trade-off between
goal of motivating risk taking and hard work? Explain your
equity and growth. How would you go about resolving the
answer in detail.
issue if you were the president of a small, poor country?
12. The following quote is from the Encyclopedia of the Developing
3. The GDP of any country can be divided into two kinds of
World: “[Some scholars] suggest that poor people are not poor
goods: capital goods and consumption goods. The proportion
because they have large families, but rather they have large fami-
of national output devoted to capital goods determines, to some
lies because they are poor.” Explain the logic behind this quote.
extent, the nation’s growth rate.
a. Explain how capital accumulation leads to economic growth. Source: Thomas M. Leonard, editor, Encyclopedia of the
b. Briefly describe how a market economy determines how Developing World, Vol. 3, p. 1297, 2006.
much investment will be undertaken each period. 13. Explain how each of the following can limit the economic
c. Consumption versus investment is a more painful conflict to growth of developing nations.
resolve for developing countries. Comment on that statement. a. Insufficient capital formation
d. If you were the benevolent dictator of a developing country, b. A shortage of human resources
what plans would you implement to increase per capita GDP? c. A lack of social overhead capital
4. The World Bank and the International Monetary Fund were 14. Of the roughly 7 billion people in the world, more than 75 per-
scheduled to formally cancel the debts of 18 very poor coun- cent live in developing countries, and one issue of economic
tries in 2006, and the African Development Bank was com- concern in many of these countries is that of population
mitted to taking the same action during its 2006 annual growth. In the summary report of the Population Reference
meeting. Go online and find out whether these debts were Bureau’s 2008 World Population Data Sheet, PRB president Bill
indeed canceled. How much debt was forgiven during that Butz made the following comment: “Nearly all of world popula-
year in each of the countries involved? What are the expected tion growth is now concentrated in the world’s poorer coun-
benefits to those countries? tries. Even the small amount of overall growth in the wealthier
5. Poor countries are trapped in a vicious circle of poverty. For nations will largely result from immigration.” Explain how rapid
output to grow, they must accumulate capital. To accumulate population growth can limit a nation’s productivity. Are there
capital, they must save (consume less than they produce). any ways in which population growth can have a positive eco-
Because they are poor, they have little or no extra output avail- nomic effect? Explain.
able for savings—it must all go to feed and clothe the present Source: “2008 World Population Data Sheet,” Population
generation. Thus they are doomed to stay poor forever. Reference Bureau, August 19, 2008.
Comment on each step in that argument. 15. You have been hired as an economic consultant for the nation
6. Famines are acts of God resulting from bad weather or other of Ishtar. Ishtar is a developing nation that has recently
natural disasters. There is nothing we can do about them except emerged from a 10-year civil war; as a result, it has experienced
to send food relief after they occur. Explain why that position is appreciable political instability. Ishtar has a serious lack of cap-
inaccurate. Concentrate on agricultural pricing policies and dis- ital formation, and capital flight has been a problem since
tributional issues. before the civil war began. As an economic consultant, what
7. In China, rural property is owned collectively by the village policy recommendations would you make for the economic
while being managed under long-term contracts by individual development of Ishtar?
farmers. Why might this be a problem in terms of optimal land
managment, use, and allocation?
Introducing the SDG India Index
About the report
set out a universal and an unprecedented agenda which embraces economic, environmental and
social aspects of the wellbeing of societies. The progress of the world to meet the SDGs, largely
depends on India’s progress. India played a prominent role in the formulation of SDGs and much
of the country’s National Development Agenda is mirrored in the SDGs. However, with 17 Goals,
considering how to implement and measure success against the Goals. This report shows how
processes shall be improved, and the potential for disaggregating data shall be explored over
the coming years.
I. SDGs: A global perspective

The SDGs are a bold universal set of 17 Goals and 169 targets to help organise and streamline
development actions for greater achievement of human wellbeing, while leaving no one behind
– by 2030. They are a part of Transforming our world: the 2030 Agenda for Sustainable Develop
The spectrum of the 17 SDGs and 169 targets range from poverty eradication, human health and
sanitation to urban settlements and to safeguarding the global ecosystems on which humanity
depends for its survival.
II. Evolution of SDGs
at establishing measurable goals and targets on key challenges facing the world within a single
regions of the world saw rapid and continuous economic growth, and millions of people were lifted
out of poverty during this period. However, new set of challenges arose. In many countries, the
coincided with an equally rapid increase in energy consumption, depletion of natural resources
and other material inputs to the point where the increase in economic welfare – after accounting
the growth in incomes. As a result, in 2015, SDGs came into being to address these challenges
The SDGs have been formulated based on a series of global conferences that deliberated on the
crucial agenda of environmental sustainability. The Rio Declaration on Environment and Devel
Heads of States at the Third International Conference on Financing for Development, held in Addis
enabling environment at all levels for sustainable development in the spirit of global partnership
and solidarity.
The Paris Declaration on Climate Change with its objective of strengthening the global response
to
poverty, and the Sendai Framework for Disaster Risk Reduction 2015–2030 to adopt a concise, focused,
1
SDG INDIA INDEX
Table 1: Sustainable Development Goals
Goal 1: No Poverty Goal: 2 Zero Hunger

End poverty in all its forms everywhere End hunger, achieve food security and improved
nutrition and promote sustainable agriculture
Goal 3: Good Health and Well-being Goal 4: Quality Education

Ensure healthy lives and promote Ensure inclusive and equitable quality
education and promote lifelong
learning opportunities for all
Goal 5: Gender Equality Goal 6: Clean Water and Sanitation

Achieve gender equality and Ensure availability and sustainable
empower all women and girls management of water and sanitation for all
Goal: 7 Affordable and Clean Energy Goal 8: Decent Work and

Economic Growth
sustainable and modern energy for all Promote sustained, inclusive and sustainable
economic growth, full and productive
employment and decent work for all
Goal 9: Industry, Innovation and Infrastructure Goal 10: Reduced Inequality

Build resilient infrastructure, promote inclusive and Reduce inequality within and among countries
sustainable industrialization and foster innovation
Goal 11: Sustainable Cities Goal 12: Sustainable Consumption

and Communities and Production
Ensure sustainable consumption
inclusive, safe, resilient and sustainable and production patterns
Goal 13: Climate Action Goal 14: Life Below Water

Take urgent action to combat Conserve and sustainably use the
climate change and its impacts oceans, seas and marine resources
for sustainable development
Goal 15: Life on Land Goal 16: Peace, Justice and

Protect, restore and promote sustainable Strong Institutions
use of terrestrial ecosystems, sustainably Promote peaceful and inclusive societies for
sustainable development, provide access to
and halt and reverse land degradation
and halt biodiversity loss and inclusive institutions at all levels
Goal 17: Partnerships for the Goals

Strengthen the means of implementation and revitalize
the global partnership for sustainable development
2
National Development Agenda outlines the measures the Gov
ernment is taking on issues like poverty, sustainable growth,
for achieving the objects of SDGs. health, nutrition, gender equality and quality education, among
several others.
SDGs are the universal frame of reference which are holistic
The key actions undertaken so far by key entities responsible
negotiations that involved both the developing and developed for spearheading the work on SDGs include:
countries.
NITI Aayog: NITI Aayog is mandated with the task of coordinat
ing work on SDGs by adopting a synergistic approach, involving
organizations, academia and business sector to achieve India’s

tal sustainability, urbanisation, governance and partnerships SDG targets. A comprehensive mapping of SDG targets with
schemes and programmes has been developed. This suggests
an approach to sustainable development that brings together
making them more inclusive and wider in scope, but also more economic, social and environmental pillars, with a focus on
their interlinkages. A series of consultations have been con
Two important global cornerstones of SDGs – missing in the

goals, capacity building, evaluation framework, sharing of new
knowledge and best practices, and progress mapping. So far,
22 such national and regional consultations have happened.
Ministry of Statistics and Programme Implementation

(MoSPI
84 of the 2030 Agenda, regular reviews by the HLPF are to be
has also been leading discussions at the global level on the
oping countries, and shall provide a platform for partnerships, indicator framework for the SDGs.
including through the participation of major groups and other
States/UTs: Several States/UTs have mapped State and cen
relevant stakeholders”. Focussing on seven Goals, India pre
III. India and the SDGs

The Government of India is strongly committed to Agenda 2030, IV. Introducing the SDG India Index 2018
including the Sustainable Development Goals.
Given the importance accorded by the Government of India to
achieving SDGs, NITI Aayog decided to estimate the progress
ble Development Summit in New York on 25 September 2015 through a single measurable index that would serve as an advo
cacy tool and trigger action at the State level.
SDGs. He drew attention to the fact that we live in “an age of
NITI Aayog has constructed the SDG India Index spanning
unprecedented prosperity, but also unspeakable deprivation
around the world” and pointed out that “much of India’s devel
The Index tracks the progress of all the States and UTs on a
opment agenda is mirrored in the Sustainable Development
set of 62 Priority Indicators, measuring their progress on the
Goals”. Further, he has reiterated the importance of the SDGs
outcomes of the interventions and schemes of the Government
of India. The SDG India Index is intended to provide a holistic
India has taken exemplary initiatives to propel the SDG agenda
view on the social, economic and environmental status of the
forward. The Speaker of the Lok Sabha, the Lower House of
country and its States and UTs.
The SDG India Index is an aggregate measure which can be

legislators from South Asia and other BRICS nations to col understood and used by everyone—policymakers, businesses,
lectively work towards the realisation of these goals. India has civil society and the general public. It has been designed to
provided strong endorsement to the SDGs, giving a considerable provide an aggregate assessment of the performance of all
Indian States and UTs, and to help leaders and change makers
evaluate their performance on social, economic and environ
It is widely agreed that India will play a leading role in deter
mental parameters. It aims to measure India and its States’
mining the relative success or failure of the SDGs, as it is the
progress towards the SDGs for 2030.
second most populous country in the world. India is already
3
SDG INDIA INDEX
Key features of the SDG India Index 2018 Pradhan Mantri Gram Sadak Yojana
Haryana because they have already been performing

better on these targets. Thus, their progress on these
UTs, NITI Aayog has constructed a list of 62 priority indicators.
schematic indicators will seem less in comparison to
To determine suitable metrics for inclusion in the Index, techni
other States but it does not signify that these States
following criteria:
all Goals, equal weights have been assigned to all the
i. Relevance to the SDG targets considered SDGs.
ii.
Missing data: Data for a few States /UTs is not available
iii. Availability of data at national level for States and UTs from
for some indicators. In computing the Index, these miss
ing /null values have not been given any weightage. This
iv.
methodology may have a bearing on the Index score.
v.
vi. Advantages of the SDG India Index 2018
cent of the States/UTs is available
The SDG India Index 2018 report provides critical insights on
Sixty two priority indicators were selected for computation of the status of SDGs in the country even though it may not be a
the SDG India Index after extensive discussions with 38 Central comprehensive representation of overall baseline since it is con
strained by limited data availability. As data availability improves
report, this report does not consider time series comparison of and new estimation techniques become available, subsequent
data. As a result, the SDG India Index tells us where a State/UT reports of SDG India Index will become more comprehensive
currently stands on each of the indicators considered, and will with additional indicators, and also help to measure incremental
present incremental change in subsequent versions. progress. Despite these gaps and limitations, the SDG Index
can be useful to States/UTs in assessing their starting point on
the SDGs in the following ways:
Limitation of the SDG India Index 2018
Support States/UTs to benchmark their progress:
This report should not be considered as a holistic performance SDG India Index can help States/UTs to benchmark their
report of States/UTs. This is because, the index takes into progress against the national targets and performance
account some process and scheme level indicators pertaining
only to Government of India’s interventions on the SDG targets. performance and devise better strategies to achieve
the SDGs by 2030.
where States/UTs stand on the SDGs are highlighted below.
Support States/UTs to identify priority areas: The
Exclusion of goals: SDG India Index does not currently SDGs undoubtedly present a very bold agenda. It is
cover Goals 12, 13 and 14 largely on account of una clear from this analysis, that several States face major
vailability of comparable data across States and UTs. challenges in achieving the SDGs. SDG India Index
Further, SDG 17 is also not included given that indicators will act as a tool to highlight the key areas on which the
respective States/UTs need to invest and improve by
enabling States/UTs to measure incremental progress.
Selection bias: Selection of indicators is based on the
criteria that emphasises availability, coverage across Highlight data gaps related across SDGs: The prepa
ration of the index has highlighted data gaps related to
the SDGs. As highlighted earlier, SDG India Index does
Indicators emerging from the State schemes not
not currently cover certain goals such as Goals 12, 13
included : The Indicators focus largely on data sources
and 14 largely on account of unavailability of comparable
data across States and UTs. Even for basic indicators
schemes and their data sources have not been tapped

for this exercise.
of this index highlights the need for India to develop its
Limitation of equal weightage: Assigning equal statistical systems at the national and State levels. It
weightage for all indicators across all Goals may lead to highlights the need to increase the capacity and capa
biased results. Additionally, some indicators may be less bility of data collection.
relevant to some States. For example, indicators like the
4
V. SDG India Index 2018 Methodology Stages of building the SDG India Index
Stages of building the SDG India Index
The SDG India Index is a product of a chain of three stages.
Stage 1: SDGs and Targets
Each of the 17 Sustainable Development Goals are mapped with Globally

a set of 169 targets to be achieved by 2030. These were used agreed Goals
as the foundation for building the SDG India Index. and Targets
Stage 2: National Priority Indicators list
The next stage was to identify the national level Priority Indi NITI Selected
cators and map them to the 169 targets of the SDGs for 2030. Priority
Indicators
NITI Aayog selected a list of 62 Priority Indictors that was guided
NITI computed
nationally available datasets that align with the 17 SDGs and
SDG India
Index
Indicator Framework for measuring India’s progress against
SDGs and associated targets.
The National Indicator Framework is the largest monitoring

framework in the country, comprising of 306 indicators. It con
priorities and needs.
NITI Aayog 62 Priority

Aayog constructed a draft list of 62 Priority Indicators. These Indicators
Priority Indicators were selected by following a set of criteria.
Criteria Adopted in selecting National Indicators

Consultation
i. Relevance to the UN SDG targets
ii. Guided by the National Indicator Framework
iii. Availability of data at national level for States and UTs from
iv.
v. MoSPI 38 Central Ministries 29 States/7 UTs
vi.
percent of the States/UTs is available
Data challenges
The need to measure progress against SDGs rekindled an interest in the quality and availability of data for
measuring country’s performance, scheme design and management. Although some progress has been made
in strengthening the statistical system, this progress is uneven and India continues to lack in uniform statistical
systems. All 29 States and 7 Union Territories use varied data monitoring systems.
Domestic requirements for good governance and accountability as a tool for evaluating government perfor
mance have increased demand for reliable data. A national framework will enable the development of reliable,
high quality data on a range of subjects.
and consider those indicators for designing the SDG India Index.
5
SDG INDIA INDEX
Once the draft list of the Priority Indicators was selected, the For indicators where increasing value means worse
was computed
Departments, followed by a round of consultation with them, as follows:
before being circulated to all States/UTs for their suggestions
and comments. Finally 62 Priority Indicators were selected for
computation of the SDG India Index.
Stage 3: Computing the SDG India Index Scores Where, x= raw data value,
SDG India Index score was computed for India and each of its
States and UTs based on the 62 Priority Indicators. The Index cator in the dataset
measures India’s progress towards the 13 of the 17 Sustainable
Development Goals, leaving out SDG 12, 13, 14 and 17 from the x’ = normalized value after rescaling
purview of this Index. Progress on SDG 12, 13 and 14 could not
In instances where States and UTs performed better than the
be measured because relevant state level data could not be
target, their Index Score has been capped at 100.
consolidated or found. SDG 17 was left out because the Goal
is focussed on international partnerships, being less relevant v. SDG Index Score: For each of the Goals under SDGs
for domestic level policy actions.
was computed for each State/UT. This was calculated
The SDG India Index was used to rank the States/UTs according
as the arithmetic mean of the normalised values of all
to their progress on the 62 Priority Indicators.
the Priority Indicators within the Goal. In calculating the
The steps involved in computing the Index are as follows. average, equal weights were assigned to each indicator
i. Raw data: Raw data for each of the 62 Priority Indicators

whole number.
was compiled for each State, UT and at the national level.
ii. Missing data: The purpose of the SDG Index is to guide

States/UTs on their SDG priorities. Data for some States/
UTs is missing for some indicators. This missing data has
Where, Iij= Goal score for State i under SDG j
been marked as “Null”. In computing the Index, these
Nij
“null” values have not been given any weightage. In the
Iijk= Normalised value for State i of indicator k under
SDG j
The Goal Score I ij for State i under SDG j was then

iii. Target setting: For each indicator, a national target
value for 2030 has been set. This target value has been
SDG Index Score. Based on the SDG India Index, States
a.
Government of India, or Achiever – when SDG India Index score is equal
b. to 100
UN SDGs for 2030, or Front Runner – when SDG India Index score is less
c. The average of the values of the top 3 performing than 100 but greater than or equal to 65
States/UTs Performer – when SDG India Index score is less than
65 but greater than or equal to 50
iv. Normalising: To make data comparable across indi
Aspirant – when SDG India Index score is less than
50
Indicators were rescaled from its raw form into a score
ranging from 0 to 100— with 0 denoting lowest performer vi. Composite SDG India Index Score: Every State’s
and 100 indicating that the target has been achieved.
computed to quantify the overall progress of the States
For indicators where increasing value means better
and UTs towards the SDGs. This was calculated as the
was
arithmetic mean of the Goal scores across 13 out of the
computed as follows:
17 Goals. This was done by assigning equal weight to
every Goal score and the arithmetic mean was rounded
Where, x= raw data value,
in the dataset
6
x’ = normalized value after rescaling
Where, Ii = Composite SDG index score of State i
Ni nearest whole number to give the composite SDG India Index
null data
Iij = Goal score for State i under SDG j
Runner, Performer and Aspirant.
Figure 1: Methodology for Index Construction
RAW DATA
Raw data for the Priority Indicators was compiled and
TARGET SETTING
A National Target value for 2030 was set
for each indicator
NORMALISATION
Rescaled the raw values to a score between 0 to 100,
the score denoting the distance achieved towards target
GOAL SCORE
Computed aggregate score under each SDG by
calculating arithmetic mean of normalised score values
COMPOSITE SDG SCORE

Measured the composite SDG India Index
score by averaging all Goal Scores
7
SDG INDIA INDEX
V. Composite SDG India Index, 2018

About the SDG India Index The SDG Index Score for Sustainable Development Goals
2030 ranges between 42 and 69 for States and between 57
A composite score was computed for each State and UT of
and and 68 for UTs.
India based on their aggregate performance across 13 of the
17 SDGs. The value of the score indicates the average perfor Among the States, Kerala and Himachal Pradesh are the front
mance of the State/UT towards achieving the 13 SDGs and runners with an SDG India Index score of 69. Among the UTs,
their respective targets. The score ranges between 0 and 100. Chandigarh is a front runner with a score of 68.
achieved the national target set for 2030. On the other hand,
the worst performer. Please refer to Annexure ii for a note on

target setting.
Figure 2 - Performance of States and UTs on SDG India Index
8
Figure 3 - India SDG Index Score of States and UTs
Kerala’s top rank is attributed to its superior performance in Among the UTs, Chandigarh takes the lead because of its
providing good health, reducing hunger, achieving gender exemplary performance in providing clean water and sanita
equality and providing quality education. Himachal Pradesh tion to its people. It has further made good progress towards
ranks high on providing clean water and sanitation, in reducing
inequalities and preserving mountain ecosystem. and economic growth, and providing quality education.
9
SDG INDIA INDEX
for each State and UT. The table can be read both horizontally and vertically. Horizontal view helps to
gauge a State/UT’s performance across the 13 Goals. The vertical view enables a reader to compare
the distance to target achieved by a State/UT relative to other States/UTs.
TABLE 2: PERFORMANCE OF STATE/UT ON EACH SDG
The subsequent chapters present detailed view of the performance of States and UTs under each Goal.
10
When reading SDG India Index scores within each Goal,
Goal 1: No Poverty Goal 2: Zero Hunger

Tamil Nadu and Puducherry Goa and Delhi
Goal 3: Good Health and Well-being Goal 4: Quality Education

Kerala and Puducherry Kerala and Chandigarh
Goal 5: Gender Equality Goal 6: Clean Water and Sanitation

Kerala, Sikkim and Andaman Gujarat, Chandigarh, Dadra & Nagar
& Nicobar Islands Haveli and Lakshadweep
Goal 7: Affordabl and Clean Energy Goal 8: Decent Work and

Tamil Nadu and Chandigarh Economic Growth
Goa and Daman & Diu
Goal 9: Industry, Innovation Goal 10: Reduced Inequality

and Infrastructure
Nagar Haveli, Daman & Diu and Lakshadweep
Goal 11: Sustainable Cities Goal 15: Life on Land

and Communities Assam, Chhattisgarh, Goa,
Goa and Andaman & Nicobar Island
& Nagar Haveli and Lakshadweep
Goal 16: Peace, Justice and Strong Institutions

Himachal Pradesh and Puducherry
11
TIF - The Unequal Effects of the Covid-19 Crisis
on the Labour Market
RADHICKA KAPOOR August 7, 2020
Casual workers in sectors such as construction are likely to have been hit harder by the Covid-19 shock than
the skilled and educated in sectors like finance. Working from home is not an option for them. | Darshak
Pandya (Pexels)
The unequal labour market in India would have seen a widening of disparities
after Covid-19 struck. Those at the bottom, with few skills, limited education
& without security, would have been affected the most; they are the ones in
immediate need of support.
The widespread loss of jobs and incomes following the dual shocks of the pandemic and the lockdown have
generated much concern. What is particularly worrying is that the impact of these shocks is not likely to have
been uniform across the workforce.
Using data from the latest Periodic Labour Force Survey (PLFS 2018-19), which captures the conditions of the
labour market prior to the Covid-19 crisis, I argue here that the effects of the shocks would be particularly harsh
on specific groups of workers. These would be the less-educated workers who are typically engaged in low
paying, precarious and unstable work arrangements in sectors that have been hardest hit by the shocks.
Page 1 www.TheIndiaForum.in August 7, 2020

Therefore, we can expect the crisis to accentuate the pre-existing inequalities in India’s dualistic labour market,
which has been characterized by stark disparities between, at one end, a small percentage of the workforce that
is engaged in jobs that offer stability of income and social security benefits, and, at the other end, a
disproportionately large proportion engaged in informal employment.
In 2018–19, the most recent year for which for the labour force data is available, 52% of the workforce were
classified as self-employed. Over 95% of the self-employed were either own account workers (i.e., those who
operate enterprises without hired labour) or unpaid family workers. Less than 5% of the self-employed were
classified as employers (i.e., those who operated enterprises with hired labour). Approximately 24% of the
workforce were employed as casual workers with no stability of income or security of tenure. And like the self-
employed, they too were outside the ambit of employer-employee relationships that offered employment-
linked benefits.
Regular wage salaried (RWS) workers constituted the remaining 24% of the workforce. These workers received a
salary on a regular basis and not on the basis of daily or periodic renewal of a work contract. This made them
better off than casual workers, but not all of them had access to social security benefits or secure job contracts.
[A] mere 4.2% of the total workforce [in 2018-19] had jobs that
offered them the maximum possible protection that would … fit the
criteria of what is often described as a ‘good job’ or ‘decent work’.
In 2018–19, the proportion of RWS workers who had access to at least one social security benefit (among
provident fund/pension, gratuity, health care, or maternity benefits) and therefore a minimal degree of social
protection was 40.6%. These workers — referred to as regular formal workers — accounted for 9.6% of the total
workforce. Of course, it should be noted that the definition of regular formal employment based on having
access to just one social security benefit is a fairly relaxed one. If we adopt more stringent then only 17.7% of
RWS workers had access to all available forms of social security cover. This, in turn, means that a mere 4.2% of
the total workforce had jobs that offered them the maximum possible protection that would therefore fit the
criteria of what is often described as a ‘good job’ or ‘decent work’.
Regular formal jobs provide some degree of security, they also, on average, offer higher earnings than regular
informal jobs (i.e., the RWS jobs that offer no social security benefits), casual work, or self-employment. This is
apparent from Table 1 that reports average earnings by employment status. Casual workers, who on average
earn Rs 209 a day, are clearly at the bottom of the pyramid. The financial vulnerability of casual workers is
exacerbated by the fact that they are unlikely to get work every day and are therefore not likely to earn the bare
minimum needed for the month. A sudden loss of income for those who have such low levels of earnings is likely
to be devastating and will push them deeper into poverty. This may well be true of the self-employed as well,
where 58% reported monthly earnings below Rs 9,750 (the amount recommended in January 2019 as a national
minimum wage by a Government of India-constituted expert committee).1 In fact, 42% of RWS workers too
earned less than this amount.

Source: PLFS unit data (2018-19)
On the basis of earnings and access to social security, the four basic forms of employment described above fall
into a hierarchical order: regular formal employment, regular informal employment, self-employment, and casual
employment (Ghose 2019). That just a small proportion of workers is engaged in what is described as the best
form of employment (and that too based on a very relaxed definition of formal employment) is reflective of the
overall conditions of the quality of employment.
In previous employment-unemployment surveys too, the share of regular formal workers was barely above 10%.
Regular formal jobs are a privilege for a limited few and are also typically held by those at the top of the
education ladder. In 2018–19, more than 50% of those in regular formal jobs were graduates or post-graduates
(Table 2). In contrast, most self-employed and casual workers had low levels of education. For instance, 25.7% of
the self-employed were not literate and 80% had secondary education or below. Amongst casual workers, the
share of those who were not literate was 37% and those who had secondary education or below was over 90%.
That it is the relatively less educated who are predominantly engaged in precarious work arrangements and
therefore have a high probability of being rendered unemployed suggests that they stand to bear a
disproportionate brunt of the Covid-19 shock.

Source: Kapoor (2020) based on PLFS 2018–19 unit data
Furthermore, the less educated are typically employed in sectors where the first order effects of the pandemic
have been severe and the options for remote work are either limited or do not exist. Outside of the agricultural
sector, which accounts for 42.2% of total employment, the three sectors which cumulatively account for
approximately 36% of total employment are manufacturing, construction and trade, and hotels and restaurants.
These sectors have been significantly affected by the pandemic and the lockdown and other containment
policies, due to both supply-side disruptions and a fall or collapse of demand. Adoption of physical distancing
measures has not only adversely impacted production but has also affected consumption patterns of the goods
and services being provided by these industries. These sectors are a critical source of employment for the less
educated (Table 2).
For instance, over 90% of workers in construction have secondary education or below. In the manufacturing
sector and the trade, hotels and restaurants sector the corresponding statistics stood at 76% and 70%,
respectively. What is more, as the statistics in Table 4 suggest, these sectors are also dominated by informal and
precarious work arrangements. This makes workers engaged in these sectors highly vulnerable to layoffs. In the
construction sector over 80% of the workers are in casual employment and therefore can be fired easily. In the
manufacturing sector, too, almost 85% are in informal work arrangements. In the trade, hotels and restaurant
segment, less than 5% are in regular formal jobs.
In contrast, high-end services sectors (such as finance, business, real estate and public administration, health,
and education) are more amenable to remote work and have a higher share of regular formal employment. As
Table 4 shows, the share of casual workers in these sectors is less than 5%. These sectors offer more secure
terms of employment and they also pay higher wages. This gives workers a greater financial wherewithal to cope
with any loss of earnings or periods of unemployment. However, the contribution of these sectors to total
employment is low (approximately 14%). Furthermore, these sectors largely generate employment
opportunities for those at the top end of the education ladder (Table 3).

That the impact of the Covid-19 crisis on workers varies and depends on the nature of the employment
arrangement and the sector of employment, suggests that we are likely to see increasing inequality in India’s
labour markets. There are the more educated workers who are engaged in work arrangements that offer a
steady source of income and some degree of social security and who are able to shift their work online. Then
there are those who have low levels of education and are engaged in precarious and low paying work of the kind
that does not offer them the luxury of working from home. It would not be unreasonable to expect the latter to
account for a disproportionate share of the pandemic-related job losses.
Estimates from CMIE peg job losses at 122 million in April 2020, with most of these losses accounted for by small
traders, hawkers and daily wage-earning labourers (90 million) who fall in the category of casual workers and
self-employed. Given the low and volatile earnings of this cohort, they are at a risk of falling into poverty. Their
financial inability to cope with the ongoing economic distress is evident from several recent surveys.
Even at the best of times, the poor and uneducated do not have the
financial wherewithal to remain unemployed in developing countries
such as India where there is no unemployment insurance.
For instance, a survey conducted by economists from Azim Premji University after the announcement of the
lockdown in March found that the share of households without enough money to buy even a week's worth of
essentials stood at 64% in urban areas and 35% in rural areas (Lahoti et al. 2020). In a separate study, Bertrand,
Krishnan and Schofield (2020) analysed data collected by CMIE and found that only 66% of households reported
having the resources to go on for more than another week before facing distress. The ILO (2020) estimates that
in India about 400 million workers in the informal economy are at risk of falling deeper into poverty.
Estimates from the World Bank suggest that the Covid-19 shock will push 12 million people in India into extreme
poverty i.e. those living on less than $1.90 per day (Mahler et al. 2020). Significantly, these estimates are based
on the poverty data available from the Consumer Expenditure Survey (CES) of 2011–12). More recent data from
the CES (2017-18), leaked to and published by the Business Standard (Jha 2019), indicates that there was a
decline in real consumption expenditure of around 4% per annum between 2011–12 and 2017–18, and that
poverty in India may have started rising even before the Covid-19 crisis. This suggests that the estimate of those

at risk of falling into extreme poverty based on the CES of 2011-12 may well be on the lower side.
Even at the best of times, the poor and uneducated do not have the financial wherewithal to remain
unemployed in developing countries such as India where there is no unemployment insurance. This is reflected in
their low unemployment rates. In 2018–19, the unemployment rate of the illiterate was 1.08%, whilst the rate
for those with secondary education and above was 11.03%.
In the current crisis, where there is considerable uncertainty about the duration and intensity of the pandemic
and an absence of direct income support, the poor and illiterate certainly do not have the luxury of waiting for a
good job. In rural areas, MGNREGA has emerged as a critical safety net. It involves hard physical labour and is
likely to have provided employment for the unskilled and low skilled. In June 2020, 32.2 million households were
employed under the programme, a 50% increase from the number of households employed in June 2019.
However, in urban areas where there is no fallback employment option such as MGNREGA and the costs of living
are higher than in rural areas, many of those rendered unemployed will be compelled to do any low paying and
low productivity work that comes their way in order to eke out a subsistence living. They are likely to create self-
employment or seek casual employment, even if the remuneration offered is lowered or the terms of
employment are more precarious than before the shock of the pandemic.
Against this backdrop, it is perhaps not surprising that we are already witnessing a decline in the unemployment
rate from the estimate of 23% reported for April and May. For June, the CMIE estimates the unemployment rate
at 10.99%. In rural and urban areas, the rate stood at 10.52% and 12.02%, respectively. The lower unemployment
rate in rural areas is not just a consequence of employment generated under MGNREGA, but also of the uptick in
agricultural activities during the kharif sowing season. The overall decline in the unemployment rate may give
the illusion that the effects of the pandemic and lockdown on the labour market are not long lasting and
persistent. However, it is important to note that the decline in open unemployment rate masks the problem of
underemployment. This problem is not just of reduced working hours but also of a deterioration in the quality
of employment in terms of earnings, job security and access to social security, in particular in urban areas.
Addressing the deteriorating conditions of employment and the

widening disparities in the job market requires a strengthening and
rebuilding of the labour market from the bottom up.
Recent evidence suggests that by adversely affecting the prospects for market work, pandemics have driven
more activity into precarious work. Furceri et al. (2020) find that there is a statistically significant increase in the
share of self-employment for about three years following an epidemic. Whether laid off regular formal workers,
particularly the more educated ones, too opted for self-employment or other informal work arrangements is
unclear at this point. They may have even chosen to withdraw from the labour force for the short term, given the
bleak prospects of finding new regular formal work in the midst of the pandemic and the contraction of the
economy. Whilst a detailed analysis of the issue will be possible only once data on the labour force participation
and employment rates are available, the recent decline in the unemployment rate is potentially a consequence
of two factors. One, the fact that the poor and uneducated do not have the luxury of remaining unemployed.
Two, the educated and better off, who typically have a high unemployment rate, may have withdrawn from the
labour force. Of course, the former is likely to be the more dominant factor in a developing country.
Therefore, despite the recent decline in unemployment rates estimated by the CMIE, the employment situation
remains dismal. Prior to the Covid-19 crisis, much of the workforce was already engaged in unstable work
arrangements that offered no social security benefits and provided low earnings, which left them with little or
no financial buffer to protect themselves from any shock. The pandemic and lockdown have worsened the
situation by pushing even more people into a dire position.

Addressing the deteriorating conditions of employment and the widening disparities in the job market requires a
strengthening and rebuilding of the labour market from the bottom up. In the immediate term, this calls for an
expansion of social assistance and public workfare programmes to provide relief and protection to the most
vulnerable and disadvantaged. However, this alone is not enough. In the long run, there is a need to expand
earnings, job opportunities and give security to those at the lower end of the education and skills ladder. This
will require a serious rethinking of our growth and development strategy.
I am extremely grateful to Prof Ajit Ghose, Dr Nomaan Majid and Srinivasan Iyer for their valuable comments and
suggestions. I would like to express my sincere thanks to Abhishek Kumar for his help with the Periodic Labour Force
Survey data.
The India Forum welcomes your comments on this article for the Forum/Letters section.
Write to editor@theindiaforum.in.
References:
Bertrand, Marianne, Kaushik Krishnan, and Heather Schofield. 2020. 'How are Indian households coping under
the COVID-19 lockdown? 8 Key findings’. Rustandy Center for Social Sector Innovation Blog, 11 May 2020.
Furceri, David, Prakash Loungani, Jonathan D. Ostry, Pietro Pizzuto. 2020. ‘Pandemics and inequality: Assessing
the impact of COVID‑19’. In COVID-19 in Developing Economies, edited by Simeon Djankov and Ugo Panizza.
London, VoxEU/ CEPR Press.
Ghose, Ajit. 2019. Employment in India, Oxford India Short Introductions. New Delhi: Oxford University Press.
ILO (International Labour Organisation). 2020. ‘ILO Monitor: COVID-19 and the world of work’. Second edition.
Briefing note, 7 April 2020.
Jha, Somesh. 2019. ‘Consumer Spend Sees First Fall in 4 Decades on Weak Rural Demand: NSO Data’. Business
Standard, 14 November 2019.
Kapoor, Radhicka. 2020. ‘COVID-19 and the State of India’s Labour Market’. ICRIER Policy Series 18. June 2020.
Lahoti, Rahul, Amit Basole, Rosa Abraham, Surbhi Kesar, and Paaritosh Nath. 2020. ‘Hunger Grows as India’s
Lockdown Kills Jobs-Results of a Survey from 12 States’. The India Forum, 5 June 2020.
Mahler, Daniel Gerszon, Christoph Lakner, R. Andres Castaneda Aguilar and Haoyu Wu. 2020. ‘The impact of
COVID-19 (Coronavirus) on global poverty: Why Sub-Saharan Africa might be the region hardest hit’. World Bank
Data Blog, 20 April 2020.
Tags: Employment
Jobs
Unemployment
Workforce
PLFS 2018-19
Inequalities
COVID-19
Regular Wage Salaried
Casual Labour
Self-employed
Wage rate
Salaries

Underemployment
Footnotes:
1.
The expert committee set the national minimum wage (NMW) for India at Rs 375 per day (or Rs 9,750 per
month) as of July 2018, irrespective of sectors, skills, occupations, or rural-urban locations. It also introduced
an additional house rent allowance (city compensatory allowance), averaging up to Rs 55 per day (Rs 1,430
per month) for urban workers over and above the NMW. It also established the NMW for five different
regions with diverse socio-economic and labour market situations, ranging from a low of Rs 342 per day (Rs
8,892 per month) in Region I to a high of Rs 447 per day (Rs 11,622 per month) in Region IV.

Relying on Serendipity is Not Enough: Fixing the Health System in India for Future Pandemics 29
RELYING ON SERENDIPITY IS NOT 4

ENOUGH: FIXING THE HEALTH CHAPTER
SYSTEM IN INDIA FOR FUTURE PANDEMICS

Indrani Gupta
A lot has been written about the state of India’s health sector even before COVID-19 hit
the global world and India. However, the discussions and debates - often restricted among
health sector experts and researchers – have now brought out in the open some key
issues plaguing India’s health sector that have impacted the way we have responded to the
pandemic.
There have been many major decisions and announcements by the government since
the pandemic began, and various departments and teams of the government have been
engaged round-the-clock in combating the pandemic, including the country’s medical
personnel, sanitation workers and many others, whose services have been essential and
central to our fight against containment of COVID-19. While sincerely acknowledging
their contributions, it is important to self-assess and analyse the challenges the country
faced – and is still facing – as far as the health sector is concerned, and what, if anything,
can be learnt from this catastrophe, in case another such unfortunate pandemic or disaster
comes our way.
With rapid increases in COVID-19 testing over the last several weeks to almost 6 million
Health emergencies
by the middle of June, the ratio of positive cases to total tests has also increased steadily. such as COVID-19
With the testing criteria widened, this is to be expected. However, there is yet to be a will impact on health
outcomes by adversely
decline in this ratio1. As for deaths from COVID-19, the government data indicates it is affecting health-seeking
less than 3 percent. Others have argued that the methodology could be incorrect, and behaviour of the general
population.
the death rate could be higher at about 5 percent, though still somewhat lower than
the global 7.6 percent2. The earlier view that India has a low burden of infections is no
longer valid, but there are significant variations and uneven occurrences of cases across
the country, adding to the puzzle. The pandemic is still unfolding, and India’s cases are now
fourth highest in the world. With the lockdown being gradually removed, cases have seen a
surge, with Maharashtra, Tamil Nadu, Delhi and Gujarat remaining the most affected states
in terms of total confirmed cases. Reports indicate increasing cases in rural areas as well
due to the influx of return migrants. Despite the government’s position on community
transmission, experts seem to suggest that the virus is spreading into populations where
1 https://indianexpress.com/article/opinion/coronavirus-testing-india-numbers-6434215/
2 https://www.outlookindia.com/website/story/india-news-indias-covid-19-death-rate-could-be-higher-than-the-us-govt-
advisory-firm/353801
30 Fighting COVID-19: Assessments and Reflections
the source of infection cannot be tracked down3. Overall, the situation remains grim,
and cities like Delhi and Mumbai are grappling with severe shortages of hospital beds,
equipment and personnel.
There are a few facts that need to be recalled about the health sector response in India.
Low testing was intitially mainly out of compulsion because of shortages of testing kits and
low capacities of government laboratories – both in numbers and ability to analyse the
samples. After a hit and trial with Chinese test kits, India decided to depend on domestic
test kits and is now procuring a majority of test kits from domestic manufacturers. It
can now test more than 1.5 lakh sample a day and plans to increase testing further. The
government has also enlisted private laboratories for testing. Currently, 674 government
and 2504 private laboratories have been enlisted for COVID-19 testing, resulting in a very
rapid improvement in the testing situation.
Despite recent increases in tesnnng rates, India is far behind other countries in its tests
per 1,000 population. The testing rates of selected countries that have been hard hit by
the pandemic are presented below in Figure 4.1 and bear this out. If testing does reach the
levels achieved in these countries, it is frightening to even contemplate what might emerge
on the other side.
Figure 4.1: Tests per 1000 over 7-15 June, 2020

Source: Our World in Data
An equally important but less articulated reason for low testing- despite significant
India’s health system
is not prepared to
improvement in testing capacity - has been our inadequate health infrastructure, which is
handle pandemics and nable to handle the high volume of COVID-19 cases. The pandemic has once again brought
epidemics.
out the long overdue but critical task that India faces: strengthening the health system.
Infectious diseases and outbreaks need a resilient public health system, particularly a
strong surveillance mechanism, adequate health personnel, sufficient medical supplies and
preventive equipment and continuous training. A resilient health system has been defined
3 https://www.hindustantimes.com/india-news/community-transmission-of-covid-19-on-in-many-parts-of-india-icmr-
survey-not-reflective-of-current-reality-experts/story-LZZbgWBIMvLgs3JZQvsYNL.html
4 https://www.icmr.gov.in/pdf/covid/labs/COVID_Testing_Labs_16062020.pdf
as “the capacity of health actors, institutions, and populations to prepare for and effectively
respond to crises; maintain core functions when a crisis hits; and, informed by lessons
learnt during the crisis, reorganize if conditions require it”5.
In India, the state of Kerala comes closest to this definition of resilience; instead of waiting
for the Centre’s directions, Kerala moved swiftly to contain the pandemic by screening
all arrivals, tracing contacts and adopting a robust testing strategy. It also shut down
educational institutions and entertainment centres and banned large gatherings including
religious ones6. The COVID-19 alert was issued as early as on January 18, much before the
Central government announced the lockdown; by that time, many had been put in isolation
and quarantine and 30,000 healthcare workers had already been deployed7. The ICMR
termed this the “Kerala model” for testing and containment strategies8.
But does the rest of the country have resilient health systems with all the 6 WHO-defined
building blocks in robust condition: service delivery, health workforce, information, medical
products, vaccines & technologies, financing and leadership/governance? The evidence,
unfortunately, indicates it does not.
In the case of infectious disease, even a day’s delay can result in unnecessary infections and
COVID-19 gives
deaths, and continuous supply of medical devices and other supplies is critical. During the
India an opportunity
crisis, shortages of essential medical supplies and personal protective equipment (PPE) to prioritize health by
massively increasing
have been reported, especially from the hardest hit cities, as also an increasing number of
investment in the health
health workers getting infected due to lack of PPE. When the pandemic started, India had sector on a sustained
basis.
almost zero capacity for producing PPE. In two months, domestic capacity did increase to
4.5 lakh PPE suits daily. As for ventilators for critical patients, according to a government
source, a total of 19,398 ventilators are available right now in the government sector, and
the government has ordered 60,884 ventilators because the current situation requires
75,000 ventilators9. A recent report states that combining public and private sectors,
47,000 ventilators are available and the PM-CARES fund has enabled availability of 50,000
ventilators now10. Domestic production of ventilators has been stepped up and some
are being brought in to the country from USA as well11. A recent study by a team of
researchers from CDDEP and Princeton University has brought out sharply the shortages
in beds, ICU beds and ventilators in the context of COVID12.
For other medical supplies, India has had to depend on countries like the UAE, which has
sent 7 metric tonnes of the supplies13. The medical device industry depends on imports
5 https://www.thelancet.com/journals/lancet/article/PIIS0140-67361560755-3/fulltext
6 https://www.thehindu.com/opinion/editorial/the-mark-of-zero-on-containment-of-covid-19-cases-in-kerala/
article31512638.ece
7 https://www.project-syndicate.org/commentary/kerala-model-for-beating-covid-19-by-shashi-tharoor-2020-05
8 https://economictimes.indiatimes.com/news/politics-and-nation/icmr-lauds-keralas-containment-strategy-for-covid-19/
articleshow/75510869.cms?from=mdr
9 https://timesofindia.indiatimes.com/business/india-business/covid-19-govt-orders-60884-ventilators-of-which-59884-to-
be-made-by-domestic-firms/articleshow/75494999.cms
10 https://theprint.in/india/48000-ventilators-in-70-years-50000-with-pm-cares-govt-on-how-fund-is-being-utilised/442252/
11 https://www.thehindu.com/news/national/covid-19-bel-to-make-30000-ventilators-within-two-months-defence-
ministry/article31377555.ece
12 https://cddep.org/wp-content/uploads/2020/04/State-wise-estimates-of-current-beds-and-ventilators_24Apr2020.pdf
13 https://health.economictimes.indiatimes.com/news/industry/uae-sends-7-metric-tonnes-of-medical-supplies-to-boost-
indias-covid-19-fight/75514166
to the extent of almost 80% for its requirements14 and there remains a paucity of Indian
players in the manufacture of high-end medical devices, indicating a major constraint for
meeting unanticipated demand. There are indications that the responsible department -
Department of Pharmaceuticals under the Ministry of Chemical and Fertilizers – had
recognized (and possibly planned for) greater focus on increasing production capacity of
medical supplies within the country. Now that there is evidence of domestic production
being increased for some products, it is puzzling why this could not have been happened
earlier by removing any technical or other barriers that may have impeded expansion of
Indian production capabilities. Also, with newer guidelines on specifications of PPE and
other devices laid down by the government, there seems to be a tradeoff between quality
and time, posing a further challenge15.
As for health personnel and services,Table 4.1 below presents some statistics on physicians,
nurses & midwives, and hospital per 1,000 population. The countries selected are some of
the worse-hit countries from COVID-19 as well as a few middle-income countries. India’s
indicators of health personnel and hospital beds are much below those of other countries,
including MIC countries like Iran, Turkey and South Africa. India is struggling to meet even
the WHO norms of physicians which is 1 per 1,000 population.
The last column reflects the prioritization of health, gleaned from how much the government
spends out of its GDP on health. Here India is at the bottom of the list, and we return to
this point later in this paper.
Table 4.1: Key health systems indicators for countries most impacted by COVID-19
Physicians Nurses & midwives Hospital beds Govt health spending

Country
/1000 /1000 /1000 as % of GDP
China 1.8 2.3 4.2 2.9
Spain 3.9 5.5 3.0 6.3
Italy 4.0 5.9 3.4 6.5
France 3.2 11.5 6.5 8.7
Germany 4.2 13.2 8.3 8.7
UK 2.8 8.3 2.8 7.7
South Korea 2.4 7.0 11.5 4.4
Turkey 1.8 2.7 2.7 3.3
Iran 1.6 2.6 1.5 4.4
South Africa 0.9 1.3 2.8 4.4
India 0.8 2.1 0.7 1.0
Source:World Bank Data Bank

Note: the data pertains to the latest available estimates and differs across countries
While there are indications that COVID-19 patients are mostly being treated at public
sector hospitals inititally, with tests and cases going up, public sector facilities have been
unable to deal with the additional burden. This is very clear from the case of Mumbai
14 https://pharmaceuticals.gov.in/sites/default/files/Annual%20Report%202019-20.pdf
15 https://fit.thequint.com/coronavirus/india-may-be-making-2-lakh-ppes-but-quality-issues-remain
and Delhi, where shortage of beds and staff have become a critical bottleneck in the
cities’ response to COVID-1916. Private sector hospitals have been roped in and there
are reports also indicate that Delhi is planning to keep hotels and dharmshalas ready for
COVID-19 patients who cannot be accommodated in elsewhere17.
The inability of public sector health care to cater to patients is evidenced by the fact that
these facilities are much less used by patients in the country. As Table 4.2 – based on the
most recent National Sample Survey18 (NSS) data indicates - patients visit mostly private
facilities and providers. This is more pronounced for non-hospitalisation episodes with
a reference period of last 15 days, with only 1/3rd of the patients visiting a government
provider, whereas slightly more than half of all patients seek private hospitalization. In
many of the EAG states like Bihar and Uttar Pradesh, the share of government hospitals in
hospital visits is much lower (38 and 28 percentage respectively).
Table 4.2: Treatment sought at type of facilities by ownership, NSS 75th round
Public facilities/ Private facilities/ Charitable/

Type of care
consultations consultations Trust/NGO
Ailments, last 15 days 30 66 4
Hospitalisation 42 55 3
Cleary affordability cannot be the basis of preferring private providers. Figure 4.2 indicates
straightaway why out-of-pocket expenditures are so high in India; private hospitals are
several times more expensive than government hospitals, and despite this, patients visit
private providers.
NSS 75th round
Figure 4.2: Avergae medical expenditure per hospitalisation case
16 https://science.thewire.in/health/mumbai-coronavirus-hospital-beds-staff-shortage/
17 https://www.hindustantimes.com/delhi-news/delhi-to-get-2-000-oxygen-concentrators-may-change-norms-to-buy-
more-ppes/story-wTfLjdSCBF0FNFQOvEKZPI.html
18 MoSPI. NSS 75th Round: Key Indicators of Social Consumption in India: Health.
Despite the elaborate public health infrastructure visualised by policymakers of independent

India and implemented subsequently - meant to launch a model of government-financed
and government-provided healthcare in the country - evidence indicates that access to
public health facilities in India has been a source of constant concern14 due to inadequate
numbers of such facilities, lack of quality, dearth of doctors and poor infrastructure15,16.
Enough evidence exists to indicate that private providers are present where there are
no public facilities. Unfortunately, due to lack of data, it is difficult to discuss the quality
question, but unregulated private sector does not give confidence about the quality either.
A recent analysis19 based on National Rural Health Statistics of the Ministry of Health and
Family Welfare corroborates the infrastructure and personnel gaps.
In terms of infrastructutre, the highest shortage in the country is observed of Community

Health Centres (30%) followed by Primary Health Centres (22%) and Sub-centres (19%)
respectively. Seventy nine percent of Sub-centre shortages and 69% of shortages in PHC
and CHC, were in EAG states in 2017, especially Bihar, Jharkhand and Madhya Pradesh.
As for health personnel, the Indian Public Health Standards (IPHS) lay down norms of
each category of personnel. As per IPHS norms for manpower, there should be 1 doctor
per PHC and 4 specialists per CHC. EAG (non-EAG) states have 0.82 (1.27) doctors per
PHC and only 0.67 (0.81) specialists at CHCs, indicating that the EAG states are not being
able to meet the norms for most of the categories. Figure 4.3 presents these shortages in
EAG and non-EAG states for some other types of personnel and indicates that there are
significant shortages in pharmacists, lab technicians and radiographers in CHCs, and these
gaps are worse for the EAG states.
Figure 4.3: In-position manpower as a percentage of required manpower
The National Health Profile 2019 indicates that there are only 25,778 hospitals in the
government sector in the entire country. If one adds hospitals run by the railways, ESIC
and others, the total number of government hospitals still remains less than 30,000 for a
population of 1.3 billion.
19 Gupta and Ramandeep (2019). Rolling out Universal Health Coverage: How ready is India’s health system? Mimeo.
We observed that India does not meet WHO standards for hospital beds per 1,000
population from Table 1. There are only about 7,20,000 government beds in the system and
adding additional availability in railways and others, maybe a total of 7,50,000 government
beds. At a 3% rate of hospitalization based on NSS latest round, there would be more than
40 million people accessing hospitals in a year, or on average 3.3 million in a month would
require hospitalization. As the NSS data shows, about half of these individuals – or about
1.6 million or 16 lakhs - would have been hospitalized in a government hospital, indicating a
substantial demand for beds in government hospitals. If the increased tests throw up increased
number of symptomatic cases requiring hospitalizations, there will have to be some way of
accommodating these individuals across these many beds. Hospitalisations for COVID-19
do not seem to be of short durations, and can often take at least 2 weeks, making turnover
lower than usual. There are already numerous reports on shortage of beds for COVID
patients, but the important point is that there is likely to be shortage for other patients too,
especially since the government has decided to keep aside beds for COVID patients.
This shortage leads to a very unfortunate trade-off between COVID-19 and other non-
COVID patients. Admittedly, some of these people will overlap with the population most
vulnerable to complications from COVID-19. The NSS 2017-18 health data indicates that
those aged 60 and above had the highest treatment seeking behaviour – for OPD as well as
hospitalisations – indicating that the elderly are going to be impacted the most.The shortage
of hospital and hospital beds would mean that many with non-COVID illnesses would forego
hospitalisation and many would also switch to private providers, incurring out-of-pocket
expenditures. There are already reports of patients suffering from cancer, diabetes, heart
diseases etc not being able to get treatment due to the lockdown. It is not clear how many
are being forced to avail treatment at private facilities with substantial financial burden, since
these facilities are closer home and may be accessible even during lockdown.
Apart from hospital and hospital beds, services of medical personnel are being stretched.
The public health
Additional medical staff, including doctors, nurses, technicians, sanitation workers etc are
cadre in the country
being deployed for the COVID-19 situation.The infection rate among health care workers needs strengthening.
is also increasing. Shortage of staff to begin with, coupled with diversion of staff to COVID
care and infection among medical staff is likely to impact on care for non-COVID patients.
A quick note about overall impact on out-of-pocket spending (OOPS): there are already
reports of high OOPS for COVID patients accessing private hospitals, with hospitals
charging exorbitant amounts for PPE and other consumables – which can be as much as half
of the total bill - and insurance companies refusing to cover such costs20. With a majority
of Indians without health coverage, out-of-pocket expenditure during COVID-19 is almost
certainly going to rise. It is too early to assess the benefits of PM’s Jan Arogya Yojana for
poor COVID-19 patients, but reports seem to indicate that the access has been low so far21.
Coming to the last but most important point on health financing. The low level of health
financing has been an old story and a constant one – nothing seems to change it over the
years. With COVID-19, there have been substantial allocations on the health system to
20 https://www.indiatoday.in/india/stor y/coronavirus-treatment-cost-private-hospitals-ppe-n95-masks-
india-1683567-2020-05-30
21 https://www.thehindu.com/news/national/only-2132-availed-or-being-treated-for-covid-19-under-ab-pmjay/
article31635083.ece
enable the health sector to respond with some minimum efficiency. The question is, could
this not have happened gradually over the years? Adequate health finances is the first step
towards prioritization of the health sector and demonstrates political will.
The total health expenditure as a percentage of GDP in the country was 3.8% of GDP in
2016-17, according to the latest National Health Accounts22. Of this, only 32% is government
health expenditure, the remaining being mostly expenditure incurred by households as
out-of-pocket expenditure (58.7%). Overall, government health financing out of GDP has
remained around 1 percent over the years (Figure 4.4).The share of the central government
in government health expenditure is about 1/3rd, indicating that the bulk of the financing of
COVID-19 prevention and treatment will necessarily be dealt with at the state level.
Figure 4.4: Public Health Expenditure as a % of GDP (Centre & States combined)
Source: Economic Surveys
Given the figures of total government health finances, it stands to reason that state health
finances could not be much better, since the major share of total health finances come from
the states. Table 4.3 presents the share of government health expenditure in GSDP of EAG
and non-EAG states and also some selected states for 2015-16, obtained from RBI data.
The governments of non-EAG states are spending much less than 1% of their GSDP on
health; this number is slightly better for EAG states at 1.2%, though per capita expenditure
is very low for this group. North eastern states are doing much better, and spending almost
2.5% of their state incomes on health and spending substantially more per capita. If we
look at some of the states hard hit by COVID like Maharashtra, Delhi and Tamil Nadu -
less than 1% of GSDP is being spent on the health sector. Kerala spends the most in this
group, though still less than 1% of GSDP. Delhi’s per capita expenditure is higher than that
of other states, followed by Kerala. Higher spending is necessary but not sufficient for
better outcomes - as indicated by Kerala’s success with the pandemic, which is also due to
a better managed health system.
Of the meagre funds that the Indian government spends on health, the share of public health
in total expenditure for states, excluding UTs, was less than 11% in 2015-16, with significant
22 http://nhsrcindia.org/sites/default/files/FINAL%20National%20Health%20Accounts%202016-17%20Nov%202019-
for%20Web.pdf
variation across states. This includes prevention & control of diseases, all the national
disease programmes, vaccination, public health laboratories etc. This is the category that
is most important in the context of an outbreak. Also, India is still missing a strong public
health cadre23,24 a critical component for tackling disease outbreaks seriously.
Table 4.3: Government health expenditure, selected states (2017-18 Actuals)
Per capita public Health expenditure

States
health expenditure as % of GDP
EAG 927 1.2
Non-EAG 1292 0.7
North eastern states 3121 2.5
Selected states
Bihar 585 1.3
Uttar Pradesh 758 1.2
Kerala 1802 0.9
Maharashtra 996 0.5
Gujarat 1326 0.6
Delhi 2131 0.7
Tamil Nadu 1493 0.7
There have been many instances of outbreaks like the SARS, H1N1 and Ebola in the world.
Each time lessons in health sector preparedness have emerged, but unfortunately, India has
not taken steps to put a resilient system in place. Evidence of action would have been an
increase in total health finances, not redistributing existing finances over a greater number
of schemes and programmes.
Of course, with the crisis raging, the government has put in significant amounts of resources
into the health system; however, responding to a crisis with ad hoc solutions to systemic
issues plaguing the health sector over decades can only postpone the much-needed health
sector reforms that India needs. Our extremely committed cadre of health workers who
are working round the clock in the country at great risks to themselves, deserve a more
conducive system that does not constantly trigger worries about shortage of medical
supplies, protective equipment, beds and larger teams. Countries like South Korea and
Germany have demonstrated that it is possible to respond more effectively with a robust
health system in place. Kerala also is an example that the rest of the country should analyse
to see what lessons can be learnt and replicated in other states.
The COVID crisis is a wake-up call for the country to initite a series of urgent measures to
address the serious gaps in the health sector, beginning with a substantial and permanent
leap in the health financing level, plugging the personnel and infrastructure gaps, improving
efficiency through other required administrative restructuring and other similar reforms.
The Centre’s leadership and collaboration with the states would be critical in the federal
structure of the country. In the meantime, one can only hope that India turns the corner
soon and sees the flattening of the COVID curve that is much awaited.
23 https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5112964/
24 https://apps.who.int/iris/handle/10665/329499
WP-2020-013
Covid-19: Impact on the Indian Economy
S. Mahendra Dev and Rajeswari Sengupta
Indira Gandhi Institute of Development Research, Mumbai

April 2020
Covid-19: Impact on the Indian Economy
S. Mahendra Dev and Rajeswari Sengupta
Email(corresponding author): rajeswari@igidr.ac.in
Abstract
The outbreak of the Covid-19 pandemic is an unprecedented shock to the Indian economy. The economy
was already in a parlous state before Covid-19 struck. With the prolonged country-wide lockdown,
global economic downturn and associated disruption of demand and supply chains, the economy is
likely to face a protracted period of slowdown. The magnitude of the economic impact will depend upon
the duration and severity of the health crisis, the duration of the lockdown and the manner in which the
situation unfolds once the lockdown is lifted. In this paper we describe the state of the Indian economy
in the pre-Covid-19 period, assess the potential impact of the shock on various segments of the
economy, analyse the policies that have been announced so far by the central government and the
Reserve Bank of India to ameliorate the economic shock and put forward a set of policy
recommendations for specific sectors.
Keywords: Covid-19, pandemic, economic downturn, aggregate demand, supply chain, informal
sector, financial institutions, fiscal policy.
JEL Code: E2, E5, E6, G2

Impact of Covid-19 on the Indian Economy: An Interim Assessment
by
S. Mahendra Dev1
Rajeswari Sengupta2
Indira Gandhi Institute of Development Research (IGIDR)
1. Introduction
We are in the middle of a global Covid-19 pandemic, which is inflicting two kinds of shocks on countries: a
health shock and an economic shock. Given the nature of the disease which is highly contagious, the ways to
contain the spread include policy actions such as imposition of social distancing, self-isolation at home,
closure of institutions, and public facilities, restrictions on mobility and even lock-down of an entire country.
These actions can potentially lead to dire consequences for economies around the world. In other words,
effective containment of the disease requires the economy of a country to stop its normal functioning. This
has triggered fears of a deep and prolonged global recession. On April 9, the chief of International Monetary
Fund, Kristalina Georgieva said that the year 2020 could see the worst global economic fallout since the
Great Depression in the 1930s, with over 170 countries likely to experience negative per capita GDP growth
due to the raging coronavirus pandemic.34
The world has witnessed several epidemics such as the Spanish Flu of 1918, outbreak of HIV/AIDS, SARS
(Severe Acute Respiratory Syndrome), MERS (Middle East Respiratory Syndrome) and Ebola. In the past,
India has had to deal with diseases such as the small pox, plague and polio. All of these individually have
been pretty severe episodes. However the Covid-19 which originated in China in December 2019 and over
the next few months rapidly spread to almost all countries of the world can potentially turn out to be the
biggest health crisis in our history. Many experts have already called this a Black Swan event for the global
economy.
1
Director, Indira Gandhi Institute of Development Research (IGIDR), Mumbai.
2
Assistant Professor of Economics, IGIDR, Mumbai. Corresponding author, email: rajeswari@igidr.ac.in.
The authors thank the co-editors of the IFPRI blog series Jo Swinnen and John Mcdermott as well as Josh Felman and Harsh
Vardhan for useful comments and discussions. Some portions of the chapter have been published as separate articles in popular
media and blogs as mentioned in the references section.
3
The name of the virus is SARS-COV-2 (Severe acute respiratory syndrome coronavirus 2) which causes the coronavirus disease
2019 referred to as Covid-19. Accordingly in this chapter we use Covid-19 to refer to the disease.
4
See: https://time.com/5818819/imf-coronavirus-economic-collapse/
1
India recorded the first case of the disease on January 30, 2020. Since then the cases have increased steadily
and significantly. At the time of writing of this chapter (July 2nd week, 2020), and as shown in figure 1,
India has recorded the third highest Covid-19 caseload in the world after the United States and Russia with
more than a million confirmed cases and more than 25,000 deaths .5 The doubling rate has steadily gone up
to around 18-22 days (figure 2) and the daily new confirmed cases are around 28,000-30,000.
However, as shown in figure 1 the growth in active cases is lower than the growth in total cases implying a
relatively high recovery rate which has continued to improve. Also figure 3 shows that, unlike other affected
countries the number of daily new cases is yet to reach the peak in India. Globally there have been more than
13million confirmed cases and close to 6 lakh deaths (World Health Organization).
In order to curb the spread of the virus, the government of India announced a nationwide lock-down starting
March 25, 2020 which continued for about two months. All non-essential services and businesses, including
retail establishments, educational institutions, places of religious worship, across the country stayed closed
during this period and all means of travel were stopped, aside from some inter-state transport permitted
towards end April and early May to let migrant workers, stranded pilgrims, tourists and students return to
their native places At the time this was the most far-reaching measure undertaken by any government in
response to the pandemic and till date remains the world’s biggest lock-down in context of this disease
Subsequently from end May early June onward the lock-down was gradually relaxed in a phased manner
but continued in high-risk zones or ‘containment’ areas. This was required given the uneven spread of the
pandemic across the country with some states like Delhi, Gujarat, Maharashtra, Tamil Nadu, West Bengal
etc reporting higher than average confirmed cases and also given the tremendous hardship that the
nationwide lock-down had begun imposing on the overall economy. With the continued surge in cases, after
an initial phase of relaxations in June, the nationwide lock-down was extended till July 31 albeit in a less
strict manner compared to the lock-down of March 24.
Measured relaxations have been permitted in areas outside the ‘containment or high-risk zones’ including
opening of non-essential establishments, and businesses. Domestic flights have been allowed subject to the
guidelines issued by the government to ensure safe travel of the passengers amidst the pandemic. However
restrictions on educational institutions, places of public gathering such as shopping malls, gymnasiums,
swimming pools, cinema theatres, entertainment parks, places of religious worship, operation of metro train
services etc continue. While vehicular movement within states is allowed there remains in place a night-
curfew period in almost all states. The re-imposition of the lock-down has delayed any chance of economic
recovery that was anticipated once the first phase of ‘unlocking’ had begun in June.
The lock-down was primarily intended to buy time to prepare the health system and to put together a plan of
5
Data on Indian cases are from https://www.covid19india.org/ and the Ministry of Health and Family Welfare. D
2
how to deal with the outbreak once the case-load started accelerating. India's public health system is
relatively weaker than other countries. The government spends only 1.5% of the total GDP on public health
as a result of which the system remains grossly under-prepared to deal with a health crisis such as this.6
Figure 1: Confirmed Covid-19 cases in India
To the extent possible, the lock-down period was used to ramp up testing, contact-tracing, isolating
confirmed patients in designated quarantine centres and setting up treatment facilities including makeshift
hospitals. However the health care system continues to be overwhelmed by the rising number of patients
every day especially in the worst affected states.
Figure 2: Doubling rate of confirmed Covid-19 cases in India
Source: Ministry of Health and Family Welfare; Citibank Research. Doubling rate represents the number of days it would take for the
cases to double if the daily percentage increase in confirmed cases remains unchanged.
The unprecedented lock-down has had a significant adverse effect on the economy. Millions of jobs and
livelihoods are now at stake. As activity around the country came to a halt, with no job or income, more than
50 million migrant workers either returned to their native villages or shifted to camps inside the cities
because state borders were sealed. While there are reports of some of them returning back to the cities now
in search of jobs and livelihoods majority have not yet come back thereby imposing a massive strain on
6
Economic Survey, 2019-20; https://www.indiabudget.gov.in/economicsurvey/
3
labour supply in the urban areas. Transportation of raw materials and finished goods across states was also
severely constrained. Countries have closed national borders bringing international trade and commerce to an
abrupt halt. All these are severely disrupting supply mechanisms and distribution chains in almost all sectors.
At the same time, there has been a complete collapse of consumption demand as millions of people stay
home and postpone their non-essential expenditures.
Figure 3: New daily confirmed cases across the world
Sourc
e: Ministry of Health and Family Welfare, Citibank Research.
The overall magnitude of the impact of the pandemic will depend upon the duration and severity of the
health crisis, the extent to which intermittent lock-downs are required in different regions of the country and
the manner in which the situation unfolds as and when the nationwide lock-down is finally lifted and normal
economic activity is permitted. The loss to the economy has already been substantial.
This crisis comes at a time when India's GDP growth was slowing down, and unemployment was on the rise
owing to poor economic performance over the last several years. The precarious situation that the economy
was in before getting hit by this shock will potentially worsen the effect of the shock. This is especially
because the financial sector which is the brain of the economy has not been functioning properly and the
macroeconomic policy space to respond to such a crisis is severely limited.
Earlier, Indian economy was primarily experiencing a demand slowdown whereas now both demand and
supply have been disrupted. There are four channels through which the impact is getting transmitted to
output growth. These are: external supply and demand constraints due to global recession and disruption of
global supply chains, domestic supply disruptions, and decline in domestic demand. The economic shock is
impacting both formal and informal sectors.
It may take a long time for the economy to recover from this shock even if the lock-down is fully lifted by
August or September, 2020. To a large extent the recovery will depend on the policy responses of the
4
government and the Reserve Bank of India (RBI) during the crisis period. The policymakers have already
announced an initial round of actions. Much more needs to be done to minimize the impact of the shock on
the economy.
In this chapter we analyze the Indian economy in the pre Covid-19 period and assess the potential impact of
the shock on various segments of the economy. We discuss the policies that have been announced so far to
ameliorate the economic shock and finally end with some policy recommendations.
2. Indian economy in pre-Covid-19 period

The shock is playing out in almost a similar manner in all countries of the world in terms of demand and
supply disruptions and the consequent economic slowdown. In case of India however the problem might be
more acute and longer lasting owing to the state the economy was in, in the pre-Covid-19 period. By the time
the first Covid-19 case was reported in India, the economy had deteriorated significantly after years of feeble
performance.
GDP (gross domestic product) growth rate has been on a downward trajectory since 2015-16.
According to the official statistics, GDP growth slowed down to 4.2% in 2019-20, the lowest level since
2002-03. Industry, which accounts for 30% of GDP, shrank by 0.58% in Q4, 2019-20. Unemployment
reached a 45-year high. A major driver of growth in any economy is investment by the private corporate
sector. In the pre-Covid19 period, nominal values of private sector investment have been declining. The total
outstanding investment projects between 2015-16 and 2019-20 declined by 2.4%, whereas new projects
announced fell by 4%, as per data from the CMIE (Centre for Monitoring Indian Economy). Consumption
expenditure had also been falling, for the first time in several decades.
High frequency indicators (figure 4) of urban consumption demand show that sales of passenger vehicles as
well as consumer durables growth contracted in February 2020. Overall, urban consumption appears to have
lost steam in Q4. Among the indicators of rural consumption, motorcycle sales and the consumer non-
durable segment remained in contraction in February 2020, reflecting weak rural demand. The lock-down
would have dampened any chance of revival of consumption demand and private investment.
5
Figure 4: High frequency indicators: Consumption demand
Source: RBI (2020)
A few specific factors make India's position particularly vulnerable as it tries to deal with the ongoing
economic crisis.
2.1 Informal sector

India has a vast informal sector, the largest in the world, employing close to 90% of its working population
and contributing more than 45% to its overall GDP. This sector was hit by two consecutive shocks in a short
span of time, from 2016 to 2019. The first shock was Demonetisation in November 2016 when 86% of the
money in the economy became unusable overnight owing to a government decree, followed by the
haphazard introduction of the Goods and Services tax in 2017.7
While demonetisation was a big enough monetary shock, it did not fundamentally disrupt demand and
supply mechanisms for too long. There was a temporary lack of means of payment. 8 We now know in
hindsight that people found work-arounds in the forms of electronic payments, informal credit, converting
black money into white, using old notes etc. In the case of the current crisis, the demand is not there, the
supply is not there, and hence the underlying revenues are not there. This is therefore much more
problematic. With the Covid-19 outbreak, the already struggling informal sector has been disproportionately
affected (Ray and Subramanian, 2020).
2.2 The banking and corporate sectors

During crisis times, one sector of the economy that is required to play a crucial role in terms of alleviating
the pressures on the real economy is the financial sector. The need of the hour is to keep credit flowing to all
7
See: https://www.ideasforindia.in/topics/macroeconomics/reviving-the-informal-sector-from-the-throes-of-demonetisation.html
8
See: https://www.ideasforindia.in/topics/macroeconomics/a-macro-view-of-india-s-currency-ban.html and
ideasforindia.in/topics/money-finance/a-monetary-economics-view-of-the-demonetisation.html
6
categories of economic agents- firms, households etc., to help them tide over this crisis.
In a bank dominated economy, particularly at a time when the stock market is touching new lows every day,
the financial intermediaries that most firms will turn to are the banks. Actions taken by banks would be
crucial in addressing this economic challenge. Banks also play a vital role as institutional participants in the
debt market.
However, the banking sector in India is badly broken. Banks, especially the public sector banks, have been
struggling to deal with mounting losses from non-performing assets on their balance sheets. The problems in
the banking sector have been adversely affecting credit growth and by the time the pandemic hit India,
these problems had begun to hurt the debt markets as well which also play an important role in the context of
financial intermediation. This could rapidly become a serious choke point as the Indian economy struggles to
come to terms with this unprecedented shock.
Over the last few years, India has been dealing with the Twin Balance Sheet (TBS) stresses in the banking
and corporate sectors. This was a consequence of high levels of non-performing assets (NPAs) in an
inadequately capitalised banking system, combined with over-leveraged and financially weak firms in the
private corporate sector (Sengupta and Vardhan, 2017, 2019).
The government and the banking regulator (RBI) took a series of steps to address the crisis. These included
putting the weakest ten banks under a Prompt Corrective Action framework which prevented them from
expanding their books, initiating investigations by the Central Vigilance Commission (CVC), Central Bureau
of Investigation (CBI) etc. against senior officials of the banks, and directing banks to trigger the Insolvency
and Bankruptcy Code (IBC, 2016) against defaulting firms and accept large haircuts even when capital to
provide for the losses was not sufficient.
In some cases senior officials of banks were arrested for allegedly fraudulent credit transactions.9 In February
2016, the Supreme Court issued a ruling which held that employees of all banking companies, foreign as
well as domestic, are “public servants” under India's Prevention of Corruption Act, 1988 (“POCA”). This
implies that all bank employees now face the risk of investigation and prosecution under the POCA for
issues related to corruption. Nearly any decision about NPAs could come under the scanner. This single step
is likely to deter bank officers from taking commercial decisions. This is particularly worrisome, given the
expansive description of corruption under POCA and minimal restrictions on investigations, as highlighted
by commentators at the time.10 These measures arguably led to a rise in the risk aversion in the banking
system (Sengupta and Vardhan, 2020b).
As the NPA crisis began plateauing out, the financial system faced another blow when a large non-banking
9
See https://economictimes.indiatimes.com/news/politics-and-nation/cbi-arrests-former-idbi-chairman-yogesh-aggarwal-and-8-
others-in-vijay-mallya-loan-default-case-sources/articleshow/56740233.cms?from=mdr
10
See https://www.livemint.com/Opinion/aHPk4JfpTEpmefmKIlizQK/The-benefit-of-the-doubt.html
7
finance company (NBFC), IL&FS (Infrastructure Leasing and Financial Service) defaulted on its debts in
September, 2018. This sent shockwaves through the banking system as well as the debt markets- the two
biggest funding sources for the NBFC sector. The reaction of the bond markets was reflected in a sharp
increase in credit spreads of all financial sector bond issuers. The total volume of bond issuances dropped
significantly, not just for financial sector firms but for all borrowers. Banks continued lending, primarily
encouraged by the RBI and the government, but this lending was limited to a handful of highly rated NBFCs.
The IL&FS episode further worsened the risk appetite of the banks and triggered risk aversion in the debt
markets as well.
One direct consequence of the heightened risk aversion in the banking system has been the lack of growth in
commercial credit supply. Banks, especially the public sector banks (PSBs) which account for close to 90%
of the NPAs, severely cut back lending to the private corporate sector. By FY2017, net bank credit was
growing at a decade's low of 2.69% per year. By FY2018, PSBs were lending mostly to NBFCs, and private
sector banks were mainly lending to retail customers. Credit to industry had declined dramatically whereas
credit off-take in personal loans segment accounted for the largest share (figure 6).
Post the IL&FS crisis credit spreads on corporate debt securities remained elevated and overall bank lending,
after an initial spurt in the last quarter of FY2019 (mostly lending to NBFCs), tapered off. Commercial credit
witnessed a sharp decline of almost 90% in the first half of FY2020. In the months of February and March,
2020, the near-demise of Yes bank, a large private sector bank, triggered the risk of deposit squeeze for
private sector banks which would further curtail credit growth.11 As a result, credit off-take during 2019-20
(up to March 13, 2020) was muted with non-food credit growth at 6.1% being less than half the growth of
14.4% in the corresponding period of the previous year (figure 5). This was also the lowest growth rate of
non-food bank credit in nearly six decades.
Figure 5: YoY Credit and deposit growth of the banking sector
Source: ICRA report. This shows total non-food credit growth.
11
See: https://www.livemint.com/industry/banking/rbi-imposes-moratorium-on-yes-bank-caps-withdrawals-at-rs-50-000-sources-
11583421982753.html and https://theprint.in/economy/dont-withdraw-funds-from-private-banks-itll-hurt-financial-stability-rbi-tells-
states/380055/
8
Figure 6: Sectoral deployment of credit
Source: RBI (2020)
While part of the fall in commercial credit growth may have been due to lack of demand given the balance
sheet crisis in the private corporate sector, anecdotal evidence suggests that reluctance in banks to extend
credit has also been a big factor.12 As admitted by the RBI Governor himself in recent times (italics and
highlight added): “In view of subdued profitability and deleveraging by certain corporates, risk-averse
banks have shifted their focus away from large infrastructure and industrial loans towards retail loans.”13
The consequences of heightened risk aversion in the banking system have begun hurting the debt markets. In
a situation where bank credit growth has been at a multi-decade low, debt market especially the short term
debt market plays a vital role in financing firms. As shown in figures 7a and 7b, banks’ holding of non-SLR
bonds has declined sharply which means they are averse to credit risk. Banks are instead holding more G-
Secs than the SLR requirements and the excess SLR of all banks – PSBs, private, and foreign has gone up
sharply which means the credit risk aversion is across the board.
12
See: https://indianexpress.com/article/business/economy/credit-growth-to-industry-farm-sector-falls-despite-rbi-rate-cuts-6294701/
13
See: https://indianexpress.com/article/business/economy/credit-growth-to-industry-farm-sector-falls-despite-rbi-rate-cuts-6294701/
9
Figure 7a: Non-SLR investment and adjusted non-food credit
Source: RBI (2020)
Figure 7b: Excess SLR of banks
Source: RBI (2020)
Just as the debt market was beginning to regain its appetite for corporate debt securities in the aftermath of
the NBFC crisis of 2018-19, it was hit by the Yes Bank episode. As part of the restructuring of Yes Bank, its
additional tier 1 (AT1) bonds were written down completely.14 These AT1 bonds are an important
component of capital for banks. Roughly Rs 89,000 crore worth of bonds were outstanding in the banking
system as a whole, at the time of this write down. These were widely held by mutual funds, pension funds
and even retail investors.
Credit spreads on all these AT1 bonds shot up and several planned issuances were cancelled. It is unlikely
14
AT1, short for Additional Tier-1 bonds, are a type of unsecured, perpetual bonds that banks issue to shore up their core
capital base to meet the Basel-III norms. See: https://economictimes.indiatimes.com/markets/stocks/news/rbi-releases-yes-bank-
rescue-plan-sbi-can-pick-49-stake-at-minimum-rs-10-per-share/articleshow/74513250.cms and
https://www.ideasforindia.in/topics/money-finance/the-anatomy-of-a-crisis.html
10
that any bank will be able to issue these bonds in the near future making it difficult for banks, especially
private sector banks to raise capital. This is going to become a serious constraint as banks struggle to deal
with the impact of the Covid-19 shock on their already fragile balance sheets.
The private corporate sector had already been facing significant balance sheet stress over the last few years.
Their financial performance in 2019-20 was exceptionally poor. The first three quarters of the year saw
inflation-adjusted sales decline in year-on-year comparisons. All the quarters also saw a similar decline in
inflation-adjusted gross value added by companies. Private sector investment has been declining. Gross fixed
capital formation (GFCF) growth turned negative in Q2 and Q3, 2019-20. Two key indicators of investment
demand, production and imports of capital goods remained in contraction in January and February 2020
(RBI, 2020). Capacity utilisation in the manufacturing sector declined below the long-term average in Q3,
2019-20.
2.3 Limited policy space
Given the state of the economy and especially the state of the financial institutions, the policy levers
available to the government to deal with the economic crisis are limited. When the effects of 2008 Global
Financial Crisis (GFC) were felt in India, the domestic economy was in a better shape having experienced a
credit boom and a high growth rate for the preceding years and the government was also in a position to
implement both monetary and fiscal stimulus measures. More importantly, the financial institutions were not
so badly damaged.
In contrast, the fiscal deficit of the government was already high in the pre-Covid-19 period and had
breached the target as specified in the FRBM Act (Fiscal Responsibility and Budget Management Act). The
fiscal deficit of the central government in 2019-20 was 4.6% of GDP against the target of 3.5% of GDP. This
has been the highest fiscal deficit since 2012-13. The Finance Minister in her Budget Speech of February 1,
2020 had pegged the target for FY2021 to 3.5% (table 1) which will be breached by a wide margin. The FM
had already used the escape clause provided under the FRBM Act to allow the relaxation of target for 2019-
20. The clause allows the government to relax the fiscal deficit target for up to 50 basis points or 0.5%.
This shows that the government now has very little fiscal room. As the crisis unfolds, falling tax collections,
declining revenues of public sector enterprises and rise in health sector expenses will further hamper the
ability of the government to support the economy. Even without any additional expenditure, the deficit
would go up substantially because of the decline in tax revenues and disinvestment receipts. Net tax revenues
in April 2020 fell by a staggering 70% compared to April 2019. If state-level deficits are added, then the
overall fiscal deficit in 2020-21 could very well exceed 10% of GDP, even without taking into account the
off-balance sheet items. Financing such high levels of deficit poses a serious challenge.
11
Table 1: Key Fiscal Indicators – Central Government Finances
Source: RBI (2020)
Monetary policy has its limitations too which had become apparent in the run-up to this crisis. In response to
the growth slowdown, the Reserve Bank of India (RBI) embarked on a path of monetary expansion. Between
October 2018 and December 2019, it freed up around Rs. 4 trillion of liquidity through open market
operations15, and reduced the repo rate16 by 135 basis points to 5.15% – the lowest since March 2010. Yet,
credit growth did not pick up, primarily due to the heightened risk aversion in the banking sector, as
discussed earlier, and low credit demand from the stressed private corporate sector.
Monetary policy transmission in India has been weak owing to structural deficiencies such as illiquid bond
market, large sections of the population left out of the formal financial system etc. In addition, an impaired
banking system and lacklustre investment demand from the private corporate sector, will further hamper the
transmission of a policy rate cut to aggregate demand and hence growth.
In other words, the combination of demand and supply shocks are hitting the Indian economy at a time when
the tools to deal with the crisis are mostly ineffective, namely fiscal, monetary and financial. Over and above
this, the external sector of the economy has been weakening as well. The nominal value of exports of goods
and services – another important driver of growth – witnessed a decline by 8.49% in Q4, 2019-20.
3. Impact of the crisis

3.1 Overall macro impact
The countrywide lockdown has brought nearly all economic activities to an abrupt halt. The disruption of
15
RBI conducts monetary policy through open market operations (OMO) – purchase (or sale) securities to infuse (or
absorb) liquidity. OMO though essentially a monetary tool, has to factor in the large market borrowing at times to
maintain orderly financial conditions.
16
The rate at which RBI lends money to commercial banks.
12
demand and supply forces are likely to continue even after the lockdown is lifted. It will take time for the
economy to return to a normal state and even then social distancing measures will continue for as long as the
health shock plays out. Hence demand is unlikely to get restored in the next several months, especially
demand for non-essential goods and services. Three major components of aggregate demand- consumption,
investment, and exports are likely to stay subdued for a prolonged period of time.
In addition to the unprecedented collapse in demand, widespread supply chain disruptions will continue for
a while due to the unavailability of raw materials, exodus of millions of migrant workers from urban areas,
slowing global trade, and shipment and travel related restrictions imposed by nearly all affected countries.
The supply chains are unlikely to normalise for some time to come. Already several industries are struggling
owing to complete disruption of supply chains from China. The longer the crisis lasts, the more difficult it
will be for firms to stay afloat. This will negatively affect production in almost all domestic industries. This
in turn will have further spill over effects on investment, employment, income and consumption, pulling
down the aggregate growth rate of the economy.
At this stage, the possible duration of the underlying health crisis remains uncertain. In addition there are
multiple unknown factors such as the true extent of impairment suffered by the different sectors of the
economy, the magnitude of deterioration of the balance sheets of economic agents such as firms and
households, the ability of both the formal and informal sectors to bounce back to normalcy once the
lockdown is fully relaxed and most importantly, the potential destruction of the productive capacity of the
economy. Therefore, it is difficult to fully comprehend the extent of the damage that the Indian economy is
currently incurring. Some of the statistics available now already highlight the severity and duration of the
slowdown the economy may experience going forward. After some amount of recovery in economic activity
in June, 2020 it appears that the slowdown has resumed once again in most of the sectors. The improvement
seen in most high-frequency indicators in June after the dramatic collapse in the April-May period has begun
to wane since mid June. This is presumably due to the renewed lockdowns all over the country and damage
to consumer sentiment and overall economic productivity.
Figure 8: All India electricity demand (YoY)
Elect
13
ricity demand declined to 30% below last year’s levels (figure 8) and gradually recovered thereafter. Since
June end there has been no further moderation in the pace of deceleration in electricity demand. Vehicle
registration related transactions declined dramatically in end March and April, began improving since May
but have begun falling again in the first couple of weeks of July (figure 9).
Figure 9: Vehicle registration related activities
Sourc
e: Citibank Research
Overall cargo throughput at majority of theIndian ports was down by around 20% year on year in March and
April, particularly in cargo segments such as petroleum products, thermal coal and containers.17 This
contraction was recorded despite the fact that the port sector is counted among ‘essential services’ and was
primarily due to the shock to global trade and reduced domestic industrial activity owing to the lockdown.
Railway freight which is an important indicator of economic activity was down by more than 35% year on
year in April and began recovering slowly since May, a trend which has continued in July.18
India's aviation, tourism and hospitality industries have already sustained maximum damage because of the
Covid-19 outbreak, and after the lockdown, it is questionable to what extent they will be able to ride out this
storm. The shutdown is bound to push India's fast-growing aviation industry into peril. The Centre for Asia
Pacific Aviation (CAPA) has assessed that the Indian aviation industry will post staggering losses worth
nearly $4bn this year.
There will also be large scale cascading effects for the hospitality and tourism industries. Hotels and
restaurant chains across the country are closed right now They are unlikely to witness a pick-up in demand
even when the lockdown is relaxed. Their businesses will suffer for several months, sparking worries of
large-scale layoffs.
17
https://www.business-standard.com/article/companies/covid-impact-indian-ports-to-see-5-8-slump-in-cargo-volumes-in-fy21-
120062901154_1.html.
18
Source: Rail Drishti.
14
The World Travel and Tourism Council has projected that travel could fall by 25% in 2020 putting to risk
12-14% of the jobs in the sector. This translates into 50 million jobs at risk, globally. According to estimates
from CMIE’s Consumer Pyramids Household Survey, travel and tourism accounts for five per cent of total
employment in India (nearly 20 million jobs). Hotels and restaurants account for another 4 million jobs.
Employment in the travel and tourism industry has already been declining since late 2017.19 These sectors
are going to be disproportionately affected during the on-going crisis.
Google has released a mobility report, which shows changes in the footfalls and length of stays at different
types of places across the country during the lockdown period against a baseline. The baseline they use is the
median value for the corresponding day of the week, during the 5-week period Jan 3- Feb 6 2020. The left
hand panel of figure 10, shows the percentage change in number of visits and duration of stay at different
places against the baseline whereas the left hand panel shows an average of five categories of places from the
left hand panel, excluding residential. After a steep decline in April which only marginally recovered in June,
the major improvement in July has only been recorded in the grocery and pharmacy sectors both of which
are essential sectors.
Figure 10: Google Mobility Report
Source: Citibank Research
With all non-essential businesses closed, most industries have been witnessing a drastic decline in sales.
Revenue losses will force businesses to either close down or opt for wholesale retrenchment of workers.
Operations of a large number of companies in specific sectors will not see business getting back to normal
even after the lockdown ends, as the labour has moved out. Even capital intensive sectors such as real estate,
consumer durables, and jewellery may not see a demand revival for several months or quarters.
Data from the Consumer Pyramid household level survey of the CMIE shows that the overall weekly
unemployment rate went up drastically from an average of 9% in March to around 23% in May and to as
high as 35% by early-June. It was higher in the urban areas compared to the rural areas. In June the
19
“A third shock”, Mahesh Vyas, CMIE Economic Outlook, 16 March, 2020.
15
unemployment rate fell sharply to 11% reflecting the first round of relaxation of lockdown restrictions. There
was also a significant recovery in the labour participation rate. Since then the unemployment rate has been
stagnant at 11%. This is still higher than the pre-lockdown rate but significantly less than what was recorded
during the peak of the lockdown from end March to end May. The labour participation rate recovered faster
than the unemployment rate but in July this too has been slowing down indicating some sort of a plateauing
out.
The firms in the private corporate sector which have been deleveraging for the last few years in response to
the TBS crisis and those with relatively deep financial pockets, will perhaps be able to tide over this episode,
also depending on which sector they are operating in. A large number of firms will however struggle to
survive. They have to pay rents, salaries, debts etc., even as their revenues will steadily keep falling as
people change lifestyles and cut back on expenditures.
Many of these firms will end up defaulting on their loans due to persistent fall in revenues. The firms that
were near insolvency will end up in the bankruptcy process (which too is likely to get jeopardised further
owing to the lockdown measures), and those that were undergoing insolvency resolution process under IBC
will most likely get pushed to liquidation. Several large business houses have already invoked the provisions
of force majeure to stall the payment of license fees, rents etc., and to restrain the invocation of
penalties.20 This further highlights the severity of the problem at hand.
Over and above the domestic problems, the Indian economy will also continue to get affected by the global
recession that may last for a while.21 This is bound to have spill over effects through financial and trade
linkages of India with the rest of the world. Already foreign investors have been pulling money out of the
Indian financial markets and are fleeing to safe assets as stock markets have crashed.
3.2 Agriculture and Rural Activities

The agriculture sector is critical as large number of workers and the entire country's population are
dependent on this sector. The performance of agriculture is also key to the state of rural demand. In the pre-
Covid-19 period, agricultural GDP experienced an average growth rate of 3.3% per year in the six-year
period 2014-15 to 2019-20 with intermittent fluctuations22. The provisional estimates of the National
20
Force majeure or an ‘act of God’ is a contractual clause that refers to an unnatural event such as an earthquake, fire, war, or
other such situation which prevents parties from continuing or performing their contractual provisions. This clause exonerate s
parties from contractual penalties or liabilities during the occurrence of force majeure. Such contractual duties could mean and
include the occupation of premises, the delivery of goods, the payment for services and other such acts for which the contrac t
has been entered. The force majeure event must make the contract impossible to perform and not just impose a financial burden
on the performance of the contract. (See: https://thewire.in/law/force-majeure-india-economy-covid-19-lockdown)
21
See Carlsson-Szlezak et al (2020) on Covid-19 and global economy.
22
Himanshu (2019) reports that farm incomes grew at around 5.5% per annum during 2004-05 to 2011-12 but declined to around
1.3% per annum during 2011-12 to 2015-16 and the trend of deceleration continued till 2017-18.
16
Statistical Office (NSO) show that GDP growth in agriculture has increased from 2.4% in FY19 to 4% in
FY20. It was also relatively better at 3.5% in Q3 of FY20. However, the terms of trade have moved against
agriculture during 2016-17 to 2018-19 due to bumper crop and horticultural production which caused a
decline in food prices. Terms of trade for agriculture seems to have improved in 2019-20 as the nominal
agricultural GDP growth was 11.4% as compared to real growth of 4%.
Growth in rural wages was subdued in the pre-Covid-19 period, particularly for agricultural labour in both
nominal and real terms, partly due to the slowdown in the construction sector (figure 11).
Figure 11: Growth in rural wages
Source: RBI (2020)
The adverse impact of Covid-19 on agriculture has been much less as compared to manufacturing and
services. However the initial lockdown did affect agricultural activities and the necessary supply chains
through several channels: input distribution, harvesting, procurement, transport hurdles, marketing and
processing. Closure of restaurants, transport bottlenecks etc reduced the demand for fresh produce, poultry
and fisheries products, affecting producers and suppliers.
A study by Narayanan (2020) indicates that when the initial lockdown was imposed in March, farmers were
stuck with harvest as APMC (agricultural product market committee) mandis closed in several states thereby
disrupting food supply disruption from the production to the consumption centres. The study indicates that
the government should focus on post-harvest activities, wholesale and retail marketing and initiate
procurement operations. Some state governments have already taken initiatives.
Since supply chains have not been working properly, vast amounts of food started getting wasted leading to
17
massive losses for Indian farmers. Media reports show that the closure of hotels, restaurants, sweet shops and
tea shops during the lockdown affected the milk producers adversely. Due to lack of demand, the dairy
farmers dumped the milk in the drains. Unable to export their produce many farmers are also dumped their
seasonal products such as grapes etc.23
Poultry farmers have been badly hit due to misinformation particularly on social media at one stage, that
chickens are the carriers of Covid-19. Millions of small poultry farmers across the country particularly in the
states of Maharashtra, Karnataka, Orissa and Andhra Pradesh were struggling after sales have crashed 80%
over these false claims. Some of these developments have since then got reversed.
There is evidence that despite being considered an essential service, agriculture and food supply chains were
impacted in the initial days of the lockdown. However over the last two months, activity seems to have been
recovering to some extent as agriculture markets adapted to the lockdown. Accordingly the prices of cereal
and vegetables which had initially gone up have been reversing.
Agriculture growth is expected to be between 2.5% to 3% in FY21 as India is likely to have a bumper crop
production. Rabi crop period witnessed high production of wheat, mustard, gram, sesame etc. Similarly,
Kharif production is going to be good due to normal monsoon this year. Agriculture, therefore, is a saving
grace for the Indian economy as manufacturing and services would record negative growth in FY21.
However, it is not clear whether farmers will get remunerative prices as the country is still facing supply
chain problems due to continued partial lockdown. A survey by Azim Premiji University shows that 37% of
farmers were unable to harvest, 37% have sold at reduced prices and 15% were unable to sell the harvest.
It may be noted that in rural areas, non-farm incomes and employment have been rising. In fact, a NABARD
survey shows that only 23% of rural income is from agriculture (cultivation and livestock) if we consider all
rural households. Around 44% of income is from wage labour, 24% from government/private service and 8%
from other enterprises. It shows that income from non-farm sector is the major source in rural areas. In the
pre-Covid-19 period, rural incomes were partly affected because of lower real wage growth24. Media reports
reveal that the rural wages are declining due to the arrival of migrant workers from the cities. However, the
lockdown has affected urban areas more than rural areas. In June and July, 2020, the rural recovery outpaced
that of urban areas. The demand for tractors also rose in rural areas.
On the health risk in rural areas, it is true that presently the problem is much more serious in urban areas
23
See https://theprint.in/economy/everything-is-rotting-say-maharashtra-and-karnataka-farmers-as-shut-
markets-spell-doom/393546/
24
According to Himanshu (2019) the growth rate of real rural wages was more than 6% per annum between
2008 and 2012. But, real wages of agricultural labourers grew at 0.87% per annum between May 2014 and December
2018, whereas for non-agricultural labourers they grew by only 0.23% per annum.
18
because of high density. But, it can spread to 70% of the India’s population who live in rural areas. Many
migrant workers have gone back to rural areas. There is a risk of Covid-19 spreading to the farmers,
agricultural labourers, workers and others working throughout the food supply chains. The agriculture and
rural population have to be protected as social distance will be practiced relatively less in rural areas.
3.3 Informal sector

India has a very high share of informal employment in total employment. The share, which includes
agricultural workers, has declined marginally from 94% in 2004-05 to 91% in 2017-18 (table 2). Out of a
total of 465 million workers, 422 million were informal workers in 2017-18. Even in non-farm sector
(manufacturing and services), the share of informal workers was around 84% in the same year.
Table 2: Informal Employment: Number and Shares

Total Employment (in Informal Employment % Share of Informal
millions) (in millions) workers in total
employment
2004-05 459.4 430.9 93.8
2011-12 474.2 436.6 92.5
2017-18 465.1 421.9 90.7
Source: Mehrotra and Parida (2019)
There are significant inequalities between informal and formal sector workers. The informal/unorganised
workers do not have access to any social security benefits and also face uncertainty of work. Out of the total
workers, the shares of self-employed, casual and regular workers respectively were 51.3%, 23.3%, and
23.4%. Most of the self-employed and casual employees are informal workers.
The informal workers were already facing problems with low wages and incomes in the pre-Covid-19
period. The pandemic has affected all levels of the society but it is the informal workers including migrants
are the worst affected. With almost no economic activity particularly in urban areas, the lockdown has led to
large scale losses of jobs and incomes for these workers. There was a loss of 122 million jobs in April, 2020.
Out of that, the small traders and daily wage labourers lost 91 million jobs (CMIE). The employment rate
was 39.1% on 22nd March, 2020 which declined to 26.4% on 3rd May, 2020 before improving to 37.8% on
21st June, 2020. Although there has been improvement in employment rate, it has not still reached the pre-
covid 19 levels. A survey by Azim Premiji University shows that 57% of rural workers and 80% urban
workers lost work during lockdown. Around 77% of the households consumed less food than before. Thus,
livelihoods of millions of workers were affected and it would take longer time for them to recover from this
economic shock.
There are about 40 to 50 million seasonal migrant workers in India. They help in the construction of urban
19
buildings, roads, factory production and participate in several service activities. Soon after the lockdown was
announced , one could see the images of hundreds of thousands of migrant workers from several states
walking on foot for several hundred miles to go back to their respective villages in search of safety. This
exodus was triggered by the March 24 lockdown which was announced rather abruptly without giving the
people of the country any time to prepare for it.
Most of these migrants continue to be out of work as businesses and establishments have shut down or
because it is not easy for them to return back to the urban areas having gone through one round of extreme
hardship. In the absence of money, jobs, and any food, savings, or shelter in large cities, they had been
desperate to reach their villages but had allegedly received little support. Few migrants even died on the way
due to exertion and lack of food. These workers feel villages are better for them as they can stay with their
families. However it is questionable whether they will be able to support themselves and their families by
staying in the villages where the income earning opportunities might be significantly worse than in the cities,
the very reason why they had migrated out of their native places in the first place.
Some of the migrants have returned to urban areas after relaxation of the lockdown but many of them are still
in rural areas. These workers are looking for jobs in rural areas. Even the skilled and semi-skilled are
working in the works of MGNREGA. It will take some time for the economy to pick up in the post-Covid-19
period and this will further aggravate the future uncertainty for informal workers in general and migrant
workers in particular.
In the formal sector to the extent that firms do not close down, employees will still have their jobs and
receive their salaries. The informal sector works differently. It depends crucially on people’s daily demand.
With a large chunk of the potential customers of the informal sector staying at home right now and
withdrawing from non-essential expenditures, the survival of informal sector units will become questionable
with every passing day, especially as the health crisis and the associated lockdown drags on. Many firms in
the informal sector will be forced to shut down.
3.4 MSMEs
The micro, small and medium enterprises as a whole form a major chunk of manufacturing in India and play
an important role in providing large scale employment. Recent annual reports on MSMEs indicate that the
sector contributes around 30% of India’s GDP, and based on conservative estimates, employs around 50% of
industrial workers and contributes half of the overall exports. Over 98% of MSMEs can be classified as
micro firms, and 94% remain unregistered with the government. Many of the micro enterprises are small,
household-run businesses.25
25
See: https://www.hindustantimes.com/analysis/msmes-is-critical-in-times-of-covid-19/story-
6Juiu9zs4jKUdkHLobT6WJ.html
20
However, many aspects of government policy are at best scale neutral and do not explicitly favour these
enterprises. This sector does not have access to adequate, timely and affordable institutional credit. More
than 81% MSMEs are self-financed with only around 7% borrowing from formal institutions and
government sources (Economic Census, 2013).
The MSMEs are present in manufacturing, trade and service sectors. Table 3 provides growth rates of
industry-wise deployment of bank credit by major sectors. It shows that growth of credit was either low or
negative for the MSMEs. Demonetisation and GST also contributed to the low performance of MSMEs. The
recent problems with the NBFC sector have further hampered credit allocation to this sector.
Table 3: Growth in Industry-wise Deployment of Bank Credit by Major Sectors (YOY, %)

Item March-15 March-16 March-17 March-18 March-19 Nov-19#
Non-food Credit 8.6 9.1 8.4 8.4 12.3 7.2
Industry 5.6 2.7 -1.9 0.7 6.9 2.4
Micro&Small 9.1 -2.3 -0.5 0.9 0.7 -0.1
Medium 0.4 -7.8 -8.7 -1.1 2.6 -2.4
Large 5.3 4.2 -1.7 0.8 8.2 3.0
Textiles -0.1 1.9 -4.6 6.9 -3.0 -6.1
Infrastructure 10.5 4.4 -6.1 -1.7 18.5 7.0
Source: Economic Survey 2019-20; # as on November 22, 2019
Although all businesses have been affected by the pandemic, the MSME sector would be particularly worse
hit by reduced cash flows caused by the nationwide lockdown. Their supply chain has been disrupted, and
they have been adversely affected by the exodus of migrant workers, restrictions in the availability of raw
materials, by the disruption to exports and imports and also by the widespread travel bans, closure of malls,
hotels, theatres and educational institutions etc. This, in turn, have massively hampered the MSME
businesses. A recent survey in MSMEs by the All India Manufacturers Organisation (AIMO, June 2020)
shows that 35% of MSMEs and 43% of the self-employed said that they see no chance of recovery in their
businesses and have begun shutting down their operations. As a consequence, hundreds of thousands of
people who work for these small businesses may end up with job and salary losses.
The experience of small and medium businesses during the lockdown in China might be useful for India. In
order to examine the impact of the pandemic on SMEs, the Enterprise Survey for Innovation and
Entrepreneurship in China led by Peking University did a rapid follow-up survey of 2349 previously sampled
SMEs which are largely representatives at the provincial level (Zhand, 2020). According to this survey,
SMEs are struggling to survive. Around 14% of the surveyed firms will be unable to last beyond a month on
a cash flow basis, and 50% beyond three months.
21
It shows a gloomy picture of SMEs under an extended epidemic scenario in China. The constraints vary
along the supply chain. For example, upstream firms are mainly affected by labour shortage while
downstream firms face more serious challenges related to supply constraints and consumer demand.
However, the impact seems to be different across sectors. Export firms suffered more than non-export firms
as they employ more migrant workers and their supplies are highly concentrated. Overall the survey shows
that Covid-19 has dealt a heavy blow on the SMEs of China. The same story is likely to get repeated for
India as well.
3.5 Financial markets and institutions

As the ramifications of the health shock and the repercussions of the country-wide lockdown become clear
with each passing day, the risk aversion of the banking system will get significantly aggravated. As more and
more firms struggle to stay afloat and are unable to repay their dues amidst the massive demand and supply
disruptions, corporate delinquencies will go up and the level of NPAs in the already fragile banking system
will increase precipitously. Moody’s Investors Service has already changed the outlook for the Indian
banking system to negative from stable, as it expects deterioration in banks’ asset quality due to disruption in
economic activity.
In the 2011-2019 period, bulk of the NPAs originated in the private corporate sector. These were secured
loans where some recoveries are possible especially given the IBC. With Covid-19 disrupting jobs and
income sources of millions of people, defaults from the retail sector are also likely to soar. Indian households
were already highly leveraged going into the current crisis. Once unemployment goes up and source of
income disappears especially for those connected to the informal sector, they will find it difficult to repay
existing loans, let alone make new expenditures. All these are unsecured loans which make the situation
worse. India does not have a personal insolvency law yet. In other words, there is no recourse for either the
defaulting individuals or the banking system when personal loan defaults start rising, both from urban and
rural regions of the country.
It is also possible that this time around the private sector banks will be worse affected than the PSBs. In the
earlier NPA crisis, bulk of the NPAs originated in the infrastructure and other heavy industries who had
borrowed from PSBs during the credit boom period of 2003-2008. However as the TBS stress began to
unfold during the 2011-2019 period, firms in these industries either began deleveraging or they are already
undergoing bankruptcy resolution in the courts
Defaults will not only rise in the banking system but also in the NBFCs who lend to the MSME (Micro,
Small and Medium Enterprises) sector as the latter's earnings will fall sharply. Particularly worrisome might
be the depth of financial stress faced by the large micro-finance sector (NBFC-MFIs) that provides support
to innumerable small and micro enterprises throughout the country. Micro finance institutions (MFIs) serve
many low income poor people with their saving and credit services. The economics of micro finance requires
high repayment rates. Any slip in repayment rate makes these institutions insolvent.
22
Repayment rates may fall drastically now as borrowers struggle to make ends meet in the face of the
precipitous income shock. Most of MFI customers operate in the micro or even smaller enterprises and
borrow for the short term say one year. As a result of the prolonged lockdown, their revenues will
completely collapse. Moreover, most of the MFI loans are in cash and in the middle of a lockdown, even if
borrowers are able to repay, collection of the payments is a serious problem.
The inability of the SMEs to repay will severely hurt the financial viability of the MFIs. To the extent that
these NBFCs have been borrowing from banks, the probability of them defaulting will commensurately go
up. As the NPAs on existing loans keep accumulating, officers in an already risk-averse banking system are
likely to become even more reluctant to extend fresh credit, especially if the banks are not adequately
capitalised. In other words there are multiple channels through which an already fragile financial system may
get choked as the crisis worsens, thereby aggravating the slowdown.
3.5.1 Financial markets

Since the outbreak of Covid-19, there has once again been turbulence in the debt markets. Credit spreads of
corporate debt papers have risen sharply to levels higher than what was witnessed in the aftermath of the
IL&FS crisis of September 2018. Debt mutual funds, even those that invest at the short end of maturity –
liquid funds, ultra-short duration funds etc. have taken serious hits to their net asset values (NAVs) making
investors nervous. These funds are considered investments second only to bank deposits in terms of safety
and hence decline in their NAVs is a matter of concern.
Confluence of several factors has led to the current turmoil in the debt market. Foreign institutional investors
(FIIs) have been steady investors in Indian debt over the last few years due to arbitrage between international
interest rates and Indian rates along with a generally stable currency. As the Covid-19 pandemic began
spreading across countries and especially affected the US, growing risk aversion and flight to safety led these
investors to sell large volumes of Indian debt paper, in addition to stocks (figure 12). Overall, FPI outflows
were of the order of USD 7.1 billion in 2019-20 (up to March 31, 2020). In addition to this, March is
generally tight liquidity period in India. Advance tax payments, financial year ending, etc. result in greater
demand for cash during this period.
Figure 12: FPI investment in Equity and Debt
23
Source: RBI (2020).
These factors along with the general risk aversion triggered by the Covid-19 outbreak and the associated
business disruption are likely to push firms to redeem their investments in debt funds and stock pile cash.
This has already created extra ordinary redemption pressures on mutual funds. Ideally, mutual funds would
respond to these redemption pressures by selling the debt securities that they have been holding to interested
buyers in the secondary market.
However we are now facing a peculiar situation wherein the mutual funds are not able to do so because of
high risk aversion on part of the biggest liquidity suppliers in the markets – the banks. Indian banks have
been largely absent from participating in the secondary debt market. As shown in figure 7a earlier, banks’
investments in commercial papers, bonds, debentures and shares of public and private corporations, as
reflected in non-SLR investment, were lower during H2:2019-20 (up to March 13, 2020) than a year ago
(RBI, 2020).
With the largest liquidity pool away from the secondary markets mutual funds are left with no option other
than distress selling securities at whatever price they get in order to meet the redemptions. This has severely
impacted their NAVs which may further exacerbate investor concerns leading to more redemptions and
triggering a vicious cycle.
The equity market has been hitting new lows every day since the outbreak of Covid-19. In March 2020,
panic selling due to the pandemic shaved off 23% market capitalisation of companies listed on the National
Stock Exchange (NSE) within a span of just a single month.26 The BSE S&P Sensex behaved similarly,
losing 23% of its value during March 2020. Although the sell-off was witnessed across-the-board, it was
more severe for industries that are hit the hardest by the Covid-19 pandemic and the consequent lockdown,
26
Source: CMIE Economic Outlook, “April 2020 Review of Indian Economy: Financial Market Performance”, 5 April, 2020.
24
such as tourism and hotels, real estate, asset financing services, banks, metals industry, automobile and
ancillaries, textiles, electricity, mining and food product companies.
4. What kind of policy support is needed?

The immediate objective of the policy responses to the economic impact of Covid-19 is to ameliorate the
effect of the shock on economic agents in both the formal and the informal sectors and to help them tide over
the crisis. Against the background of a weak economy, the twin shocks of Covid-19 and lockdown are
operating at two levels:
 Creating supply-side disruptions
 Triggering reduction in aggregate demand
The need of the hour are policy actions to deal with both supply- and demand-side problems. The supply side
has been reeling under three pre-existing shocks: (i) demonetisation of 2016, (ii) goods and services tax
(GST) since 2017, and (iii) slowdown in credit growth. The pandemic is creating additional disruptions due
to the following factors:
 Mass exodus of migrant workers from urban areas: Many firms will not be able to find the required
number of workers, and hence production will be constrained even if they do not face a demand
shortage. This will be acute in sectors such as construction, logistics (last-mile delivery of goods),
unskilled manufacturing, etc., where large number of migrant workers are employed.
 Non-availability of financing: Finance is the backbone of business. As mentioned in section 2.2. the
banking sector, especially public sector banks (PSBs), have been operating under high levels of risk
aversion. The future prospects of borrowers have become more uncertain in the ongoing crisis. This
will further affect credit availability. Bond markets have also become risk averse. Credit spreads on
corporate bonds are the highest since 2009.
 Restrictions on international trade: The pandemic has disrupted global supply chains. To the extent
that international transport of goods is adversely affected, importing firms will face supply
constraints.
 Logistics issues: The lockdown has imposed restrictions on intra- and inter-state movements. This
has made transportation of raw materials and finished goods difficult even within the national
boundaries.
In other words, all factors of production are facing disruptions – capital, labour, and raw materials. In
25
addition, marketing has been disrupted, retail stores are closed and e-commerce is also not operating
smoothly. The gradual relaxation of lockdown will release some pent-up demand, but the supply-side
disruptions are unlikely to get resolved soon. This in turn will exacerbate the demand shortage. For example,
firms have fixed expenses such as rent, wages, inventory maintenance, etc., but a large number of them are
earning no revenues. If they do not receive financing to tide over this crisis, they will be forced to downsize
their businesses or even shut shop. This will add to unemployment and aggravate the demand problem.
Hence, authorities need to figure out ways to offer funding to the firms who need it, to help them stay
solvent.
The demand-side problem is due to the following factors:

 Right now, a large number of consumers all over the country are only spending on essential
commodities such as food, groceries, and medicines. Demand for nearly all non-essential goods and
services has remained suppressed for nearly two months, even if consumers have the purchasing
power. We call this Round 1 of the demand problem. The gradual relaxation of the lockdown that is
currently underway will release some pent-up consumption demand. However, in view of the
prevailing jobs and income related uncertainty, large parts of demand are likely to stay subdued for a
long time, especially discretionary expenditures.
 The Round 1 demand problem is getting aggravated due to the loss of jobs of millions of migrant
workers and daily wage earners, who have been forced to return to their native villages because of
the lockdown. The formal sector too has been witnessing retrenchment of contract employees,
reduction in variable pay, etc. These factors have led to a significant decline in disposable incomes.
This problem will worsen over time, unless the authorities step in with adequate relief measures.
 If the lockdown continues in some form or the other, and supply shocks continue unabated, there
will be a Round 2 of the demand problem. A large number of white-collar workers will lose jobs or
face reduced salaries because many financially stressed businesses will no longer be able to keep
them on the payroll. The Round 2 effect, which will play out in the medium term, might be more
severe because it will have a broader impact on purchasing power. As this happens, and the demand
contraction becomes more acute, many more firms will struggle to stay solvent or even to survive. In
other words, the economy may get trapped in some sort of a vicious cycle of low demand–high
unemployment–low demand.
 In addition to the reduction in consumption demand, private sector investment which has already
been declining over the last few years, is unlikely to get restored in the next few quarters. Due to
demand contraction, capacity utilisation of manufacturing firms has fallen drastically, eliminating
any possibility of investments in new capacity addition. Most firms will struggle to obtain financing
26
for working capital in order to simply stay afloat.
The discussion above demonstrates the kind of fiscal support that might be necessary right now.
 On the supply side: To extend financing to firms to enable them to stay solvent and to help resolve
other supply disruptions.
 On the demand side: To give relief to those who are in need, to help prop up demand.
The central government and RBI have announced an initial round of fiscal and monetary policies
respectively as well as some broader economic reforms. In addition, several state governments have also
announced fiscal stimulus measures.
5. Analysis of policies announced

5.1 Policy package for informal sector workers
On March 26, 2020 the Finance Minister announced a Rs. 1.7 lakh crore package largely aimed at providing
a safety net for those who have been worse affected by the Covid-19 lockdown i.e. the unorganised sector
workers, especially daily wage workers, and urban and rural poor.27 The “Pradhan Mantri Garib Kalyan
Yojana” contains the following components:
 Free additional 5 kg wheat or rice per person for 3 months;
 1 kg free pulses per household for 3 months;
 Free LPG for Ujjwala beneficiaries for 3 months;
 Rs.2000 to 87 million farmers under PM Kisan Yojana in 10 days;
 Increase in MGNREGA wages to Rs.202 from Rs.182;
 Rs.500 per month to 200 million female Jan Dhan account holders for next 3 months;
 Ex-gratia of Rs.1000 to poor senior citizens, widows and disabled;
 Rs.20 lakh collateral-free loans to women self-help groups;
 Govt. to contribute EPF to companies with less than 100 workers;
 Non-refundable advances of 75% or 3 months wages from PF account;
 States to use Rs.31 crore from construction workers welfare fund;
 States to use district mineral fund for medical activities.
The new spending proposed in this package would amount to around 0.85% of estimated GDP.
27
These measures are in addition to a previous commitment by the Prime Minister that an additional Rs 150 billion (about
0.1% of GDP) will be devoted to health infrastructure, including for testing facilities for COVID-19, personal protective equipment,
isolation beds, ICU beds and ventilators.
27
5.2 Atmanirbhar Package:
In May 2nd week the Finance Minister announced a comprehensive economic relief package called the
“Atmanirbhar (self-sufficient) package”, which had three components: (i) monetary actions, (ii) fiscal
actions, and (iii) economic reforms.
Fiscal actions: Policies focusing on low-income households include repackaging old schemes, increasing the
allocation of existing schemes, and some new initiatives:
 Front-loading payments under the existing Pradhan Mantri Kisan Samman Nidhi (PM-KISAN)
Yojana to the tune of Rs. 160 billion
 Direct benefit transfers (DBT) to old age people, and widows, under Ujjwala Yojana, and under Jan
Dhan Yojana amounting to Rs. 470 billion
 Extending MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) to migrant
workers, and to some workers in organised employment, adding up to about Rs. 922 billion
 A fund for construction workers of about Rs. 310 billion
 Direct food distribution using stocks available with the Food Corporation of India (FCI) to the tune
of Rs. 35 billion
Salient fiscal initiatives focusing on MSMEs (micro, small, and medium enterprises) include:
 Rs. 3 trillion collateral-free bank loans to MSMEs with 100% credit guarantee28. The guarantee will
be provided by the National Credit Guarantee Trust Co. Ltd (NCGTC).
 Government investment of Rs 100billion in funds that in turn will invest Rs 500 billion in the equity
capital of MSMEs
 Rs. 200 billion subordinate debt issued by banks and other financial institutions (such as SIDBI) for
stressed MSMEs, out of which the government will refinance Rs. 40 billion
 Rs. 450 billion partial credit guarantee scheme for NBFCs (non-banking financial companies), where
first 20% of the loss will be borne by the government
New spending on all these initiatives amounts to around Rs. 2.04 trillion.
Economic reforms: A few policy reforms (such as, amendments to the Essential Commodities Act,
liberalisation of investment norms for some sectors, etc.) and schemes (setting up of a social infrastructure
fund, agriculture infrastructure fund, micro food processing enterprises scheme, etc.) were also announced.
Total government expenditure on these new schemes will be about Rs. 0.55 trillion.
5.2.1. Package for Agriculture

The government announced the following measures for agriculture in May, 2020 as part of ‘Atmanirbhar’
package.
28
Additionally, on July 2, 2020 World Bank announced a US $750 million budget support to 15 crore MSMEs to increase liquidity
access for viable small businesses impacted by Covid-19.
28
 Rs. 1 lakh crore Agri Infrastructure Fund for farm-gate infrastructure for farmers.
 Rs. 20,000 crores for Fishermen through Pradhan Mantri Matsya Samparda Yojana
 Rs. 10,000 crores scheme for formalisation of Micro Food Enterprises
 Rs. 15,000 crores Animal Husbandry Infrastructure Development Fund
 National Animal Disease Control Programme for Foot and Mouth Disease (FMD) and Brucellosis
launched with total outlay of Rs.13,343 crores
 Rs.4000 crores for promotion of Herbal Cultivation
 Rs. 500 crores for Beekeeping initiatives
 Rs. 500 crores for improving supply chains for all fruits and vegetables
Agricultural Reforms
 Amendments to Essential Commodities Act to Enable better price realisation for farmers
 Agricultural Marketing Reforms to provide marketing choices to farmers
 Agriculture Produce Price and Quality Assurance: Facilitative legal framework will be created to
enable farmers for engaging with processors, aggregators, large retailers, exporters etc. in a fair
and transparent manner. This reforms basically relates to contract farming.
The policy package including agricultural reforms are in the right direction. There has been demand for these
reforms in the last few decades. Government has already brought the ordinances for implementation of the
reforms. However, the infrastructure development funds and reforms are helpful in the medium term and
may not be useful in the short run.
5.3 An analysis of the fiscal announcements

 A major component of the ‘fiscal package’ is the MSME loans backed by 100% government
guarantee (Sengupta and Vardhan, 2020a). Given the risk aversion in the banking system, the
government needs to step in to bear some of the credit risk, so that banks can do what they are good
at, which is, allocating capital. To this end, a credit guarantee scheme is a step in the right direction.
Another advantage is that credit guarantees do not have immediate impact on the government
budget. However, there are two issues with the announced scheme. First, credibility of a credit
guarantee scheme and the lenders’ trust in it depends a lot on the details of the scheme. There may
not be any take up until the government clarifies the mechanics of the scheme (such as conditions
imposed on availability of the guarantee, time line to make claims and en-cash the guarantee, etc).
Second, even if these issues are resolved to banks’ satisfaction, credit allocation may be distorted
because with a 100% credit guarantee, banks have no skin in the game. This takes away the incentive
of the bank to scrutinise loan applications, and can lead to moral hazard. Instead, the credit guarantee
could have been a partial one.
 The fiscal announcements (more than 70% of the intended benefits) rely disproportionately on the
29
financial sector – especially the government-owned banks and NBFCs – to deliver the credit-related
components of the package. There are two problems with this:
◦ Given the risk aversion in the PSBs, unless the detailed mechanics of the scheme (such as the
conditions imposed on the availability of the guarantee, the timeline to make claims and encash
the guarantee, etc.) are spelled out by the government, the banks are unlikely to embrace it
despite the 100% guarantee. Credibility of such a scheme and the lenders’ trust in it depends on
the details of the scheme.
◦ The PSBs are undergoing a process of mergers. Hence, the ability and efficiency of these banks
to deliver the schemes appear doubtful.
 Implementation of many of the initiatives will require proper targeting of beneficiaries and an
efficient delivery mechanism. This in turn would require close coordination between the central,
state, and local governments. In absence of this, effective implementation of these announcements
would be doubtful.
 On the supply side, the package addresses the financing problems, but in an inadequate way, and
there is nothing to address the other issues related to supply chain disruptions. Announcements
regarding existing schemes (such as MGNREGA, DBT, PM-Kisan etc) are meant to address the
demand side problems but given the severity of collapse in aggregate demand, the monetary
amounts appear insufficient. Overall the package is unlikely to provide any significant relief to a
crisis-ridden economy.
 The economic reforms that were announced are necessary and long awaited, but their benefits will
accrue in the long term. They will not do anything to resolve the problems that the economy is facing
right now.
 While the aggregate ‘benefit’ of the package was announced to be Rs. 20 trillion or 10% of GDP the
package entails an incremental government spending of only Rs. 2.6 trillion, which is less than 2%
of GDP.
Careful assessment of the package announced by the Indian government therefore shows that
given the widespread demand destruction, the package will fall short and may need to be
enhanced. The fiscal initiatives only address the financing constraints on the supply side, that too
inadequately.
Table 4: Covid-19 Stimulus Commitment Size (as % of GDP)
30
Country % of GDP Country % of GDP Country % of GDP
India 1.3** France 11.38* Australia* 8.02
US 10.71* UK 15.27* Russia 0.30
Italy 1.30 South Korea 5.13 Malaysia 16.17
China 1.32* Brazil 2.10 Japan*** 10.00
Spain 15.29* Canada 2.16
Germany 20.95* Israel 5.94
Note: Govt. support includes loans and credit guarantees for companies, direct transfers (in some cases via employers) to workers,
tax freeze and debt repayment moratorium. Not all countries have done all of these.
*includes loan packages/bailout funds, and liquidity support, apart from fiscal response.
** India estimate is added by the authors. This is the incremental government spending after the announcement of ‘Atmanirbhar
package’.
***Not announced yet, based on government intention.
Source: Economic Times, April 4, 2020
Reacting to the ‘Pradhan Mantri Garib Kalyan Yojana’ announced in the end of March, 2020, Nobel Prize
winning economists Abhijit Banerji and Esther Duflo have commented that the government should have
been more bold with the social transfer schemes. According to them “what the government is offering now is
small potatoes – at most a couple of thousands for a population that is used to spending that much every few
days. If the point is to stop them from going out to find work and thereby spreading the disease, the amounts
probably need to be much larger” (Duflo and Banerji, 2020). These comments may be true even after the
announcement of the comprehensive ‘Atmanirbhar’ package.
Several commentators have highlighted that countries in Europe and the US are spending significantly more
to take care of the impact due to the pandemic (table 4). The US has announced a package of $2 trillion and
it is 10.7% of their GDP. Similarly, the financial package as per cent of GDP is much higher in countries like
France, Spain, Germany, Australia and Malaysia (table 4).
5.4 RBI's policy actions

The “Atmanirbhar package” also included monetary policy actions introduced by the RBI earlier. For
instance, on 27 March, 2020 RBI announced a number of major initiatives to combat the crisis.29 In
particular, Four bold measures were taken, following an “out of cycle” i.e., unscheduled Monetary Policy
Committee (MPC) meeting:
 The repo/reverse repo rates were cut by sizeable amounts, to 4.40/4.00% from 5.15/4.90%. The 91-
day Treasury bill rate, which measures the de facto stance of monetary policy, dropped to 4.31%
from 5.09% on 26 March. Subsequently in April the repo rate was further cut to 4%.
29
See: https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=3847;
https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49581;
https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49582.
31
 Ordinarily, banks can borrow on a short-term basis from the RBI using the repo window. To
supplement this facility, a new `targeted long-term repo operations' (T-LTRO) mechanism, with a
limit of Rs.1 trillion, was announced. Banks may find this attractive because they do not have to
mark to market the investments made with these borrowed funds for the next three years. However,
there is a condition: the money that is borrowed here must be deployed in investment-grade
corporate bonds, commercial paper, and non-convertible debentures, over and above the outstanding
level of their investments in these bonds as on March 27, 2020. Subsequently RBI announced
another round of such targeted repo operations...
 The cash reserve ratio (CRR) was reduced by 1 percentage point, bringing it down to 3% of deposits
(“net demand and time liabilities”). This is the first time the CRR has been changed in the last 8
years.
 Banking regulation requires banks to recognise and provide for a loan when there is a delay in
payment. According to the Prudential Framework for Resolution of Stressed Assets, banks are
required to classify loan accounts in special mention categories in the event of a default. 30 The
account is to be classified as SMA-0, SMA-1 and SMA-2, depending on whether the payment is
overdue for 1-30 days, 31-60 days or 61-90 days, respectively. RBI has now modified this
regulation, so that banks can offer a moratorium of 90 days (subsequently extended to 180 days) for
term loans and working capital facilities for payments falling due between 1 March, 2020 and 31
May, 2020. If a firm applies for and receives a moratorium, the loan account in consideration will
continue to be recognised as a standard asset and the SMA classifications will no longer apply.
Interest on the term loans will continue to accrue during this period.
In addition to these policy actions, earlier in February, the CRR was exempted for all retail loans to ease
funding costs for banks. The implementation of the net stable funding ratio (NSFR) and the last stage of the
phased-in implementation of the capital conservation buffers have been delayed by six months. On 1 April,
the RBI created a facility to help with state governments' short-term liquidity needs. Earlier, the RBI
introduced regulatory measures to promote credit flows to the retail sector and MSMEs and provided
regulatory forbearance on asset classification of loans to MSMEs and real estate developers. CRR
maintenance for all additional retail loans has been exempted, and the priority sector classification for bank
loans to NBFCs has been extended for on-lending for FY 2020/21 (IMF, 2020).
On the external front, on 16 March, RBI announced a second FX swap (USD2 billion dollars, 6 months,
auction-based) in addition to the previous one with equal volume and tenor. The limit for FPI investment in
corporate bonds has been increased from 9% to 15% of outstanding stock for FY 2020/21. Restriction on
30
See: https://www.rbi.org.in/scripts/FS_Notification.aspx?Id=11580&fn=2&Mode=0
32
non-resident investment in specified securities issued by the Central Government has been removed. 31
5.4.1. Analysing monetary policy announcements

Monetary policy is most effective when economic agents understand and can anticipate the behaviour of the
MPC. This process of learning and understanding is still underway, since India is in the early years of
building up the credibility of the inflation targeting (IT) framework and the MPC process. So, one would
have expected that the MPC statement would take pains to spell out its macroeconomic forecast, explaining
why it believed the rate cut was consistent with its commitment to the 4% inflation target. But it did no such
thing.
The MPC statement did not explain the rate decision in the context of a revised inflation forecast, or any
other element of a macroeconomic forecast. Indeed, it did not offer any justification at all for the magnitude
of rate cut chosen. Since the rate cut announcement was not couched in the standard IT framework, the
public does not have the assurance that the rate cuts will be reversed when inflation begins to rise again.
Furthermore, the rate cut actions taken by the RBI are unlikely to have any impact either on the supply or the
demand side. As discussed in detail earlier in the paper, on the supply side, risk-averse banks are reluctant to
lend despite the rate cuts and liquidity injection. In the absence of proper transmission, the monetary policy
changes will fail to revive demand. When the financial intermediaries do not function normally, the
usefulness of monetary policy gets limited. The rate cuts will however relieve the debt-servicing of the
stressed firms in the corporate sector.
5.4.2. Analysing banking regulation announcements

Under the March 27 package, the RBI has given regulatory approval to banks and other lending institutions
to decide which of their customers needs a 90-day (or 180-day as per the extension later on) deferral. This
decision, to allow banks but not require them, to grant moratoria is a good one, as it allows banks to
distinguish amongst the three types of firms. Even so, the plan is not without drawbacks:
 No mechanism was created to classify the loans that have been rescheduled, so transparency has
been lost. Investors – already nervous because of accounting surprises at Yes Bank and other
financial institutions – will consequently provide capital only at a cost marked up to reflect this
information risk premium. And this increase in banks’ costs will be passed on to the borrowing
corporate sector.
 There seems to be a considerable amount of confusion about how EMIs on retail loans will be
treated. For example, many borrowers may have missed one payment on their loans in say February
31
See: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11849&Mode=0 and
https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11850&Mode=0
33
2020. If they receive a moratorium on their EMI payments for March, April and May it is not clear
whether their February EMI will become 90dpd in May. If that happens, then their accounts will
become NPAs and the borrowers will get reported to the Credit Bureau thereby affecting their credit
histories.
 It seems that the moratorium is not applicable to loans taken from banks by the NBFCs. This is
problematic. NBFCs have already been in significant financial trouble since 2018 and now they may
have to offer the 3month moratorium to their customers. But if they themselves are not able to
benefit from this deferral, then their financial stress will get even more aggravated. This is especially
true of the MFIs. While RBI has announced the T-LTRO mechanism, most NBFCs do not issue
bonds and hence are unlikely to benefit from this.
 Finally, and most importantly, there is no clarity on what happens once the moratorium period is
over. How will banks clean up the mess that will be created later, as many of the firms which
benefitted from the moratorium end up defaulting? There will be a new wave of NPAs, which we
know from experience will be difficult to resolve. This gets all the more complicated because the
Insolvency and Bankruptcy Code (IBC, 2016) has now been suspended for one year. This implies
that once the moratorium period gets over there is no recourse to any systematic legal framework for
the banks to resolve the stressed assets that may accumulate on their balance sheets if firms start
defaulting on their debts at the end of the moratorium period.
 There is also a risk that now that a “temporary” moratorium has been introduced, there will be
pressure for it to be extended again and again which has already happened once and is likely to
happen again for some specific sectors. If the RBI is unable to resist, we will quickly find ourselves
back in the ‘extend and pretend’ era of post-2008, where banks, investors, the RBI, are all navigating
in a fog, since no one will know, and hence, be able to deal with the true size of the bad loan
problem.
 Banks are already saddled with old NPAs from the pre 2020 period much of which have not yet been
resolved and with the IBC suspended are unlikely to see any resolution for the rest of 2020. This is
already acting as a drag on their balance sheets. Over and above this the ongoing crisis will lead to
large scale corporate bankruptcies. Any return to the post-2008 era style restructuring schemes by
the RBI, which permitted the banks to hide the problem for years, will further worsen the problem.
In this context the moratorium announced by the RBI is only a temporary palliative which is
postponing the resolution of the problem to the future.
5.4.3 Liquidity injection

Figure 13 shows the weighted average call money market rate juxtaposed against the “corridor” defined by
RBI’s repo, reverse repo and marginal standing facility rates. The call rate remains close to the reverse repo
34
rate which indicates that banks are flush with liquidity. There has not been a sharp rise in demand for funds
in the overnight money market. It appears that the banks are hoarding liquidity. Despite having so much
liquidity cushion, bank lending has not picked up. As shown earlier in figures 6, 7a and 7b, even in the pre-
Covid-19 period, banks were mostly lending to the retail sector (unsecured loans by private banks) or
holding G-Secs more than the SLR requirements.
Figure 13: The call money rate vs. RBI's LAF 'corridor': March, 2020
Source: RBI database
RBI has announced that its recent policy actions will free up Rs 3.74 trillion in banks' funds. The
announcement of T-LTRO wherein banks can borrow money from the RBI, with the condition that they will
invest in secondary market instruments has been a welcome step. This may help revive much needed
participation by the banks in the debt market provided the banks are able to overcome their risk aversion. It
is likely that even with this scheme, many banks will stay away from the debt markets out of apprehension of
bond-issuers defaulting given the uncertain economic environment.
It is also questionable whether adding more liquidity to a system that is already flush with it is going to boost
credit growth in and of itself, given the heightened risk aversion in the banking sector. The marginal benefit
of the RBI adding more liquidity to a system that is already in a surplus mode is therefore not clear.
By reducing the reverse repo rate (i.e. the rate at which banks lend money to the RBI on the LAF window)
effectively the RBI has increased the opportunity cost for banks that are not lending commercially. While
this is an attempt to enhance bank lending, once again risk aversion on part of the banks is likely to limit the
gains. Banks will most likely be content with lower returns on liquidity even at 4% (reverse repo rate) than
35
take on additional risk and lend which is what has been happening till now32
6. Policy challenges
While some policy actions have already been announced by the government and the RBI, they are mostly
interim measures and are not going to be adequate to support the economy. Given the current
macroeconomic and financial environment in India, there are significant challenges in fiscal, monetary and
financial policies which have to be taken into consideration by the policymakers. Even more important, there
are some policy traps that must be avoided in order to prevent a long-term economic disaster. The objective
must be to ensure a V-shaped economic recovery once the health crisis abates.
In case of fiscal policy, even assuming a conservative scenario where the government does not incur any
additional expenses due to Covid-19, the deficit will be greater than projected value in the FY2021 budget.
During the two month long lockdown, almost all economic activities had been suspended and most of these
are unlikely to resume in near future given the nature of the health shock. As a result government revenues
will fall drastically.
Given the depressed equity market condition and global economic uncertainty, the disinvestment targets are
unlikely to be met. Over and above this, much of the policy actions required to minimise the economic
fallout of the shock will involve government spending. It is almost certain that the government will not be
able to adhere to its fiscal target for 2020-21 and will most likely breach it by a big margin.
In India fiscal deficit is supported by financial repression wherein government borrows from a captive
market of banks and other institutional buyers. In the pre-Covid-19 period, total government borrowing
(central and state) had already exceeded total household savings. Further borrowing will sharpen the yields
in the bond market and crowd out private capital at a time when a large number of firms and households will
need to borrow to stay afloat. Moreover, gross domestic saving rate decreased to 30.1% of GDP in 2018-19
from 32.4%in 2017-18 (RBI, 2020). The saving rate of the household sector, which is a net supplier of funds
to the economy, declined from 23.6% of GDP in 2011-12 to 18.2% in 2018-19. To the extent that
government relied heavily on households for financing its deficit, this decline in savings does not bode well.
The large scale income losses of many businesses and households that are inevitable during this crisis imply
that the savings rate is likely to fall even further. These factors leave little room for the government to
increase its domestic borrowing.
RBI has announced a scheme to encourage foreign investment (FII) in government securities.33 As discussed
32
https://www.thehindubusinessline.com/money-and-banking/banks-continue-to-park-money-under-reverse-repo-
despite-the-meagre-returns/article32080666.ece
33
See: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11849&Mode=0
36
in section 3, with the global spread of the pandemic, FIIs have already been taking money out of the Indian
capital markets. Given the widespread risk aversion, it is unlikely that this route will bring in a lot of
financing for the government. If anything, the widening fiscal deficit may lead to a sovereign rating
downgrade or a lowering of the macro outlook which in turn will increase the risk premium demanded by the
FIIs. Therefore, the biggest policy challenge now will be financing the rise in government deficit. The only
favourable factor in this regard is the sharp decline in global oil prices. Brent crude price has declined
drastically to USD 31.87 per barrel.
There are now calls from certain quarters for the RBI to print money to finance the rise in fiscal deficit, a
practice that was prevalent in pre-liberalisation India but since then has been discontinued. Monetisation of
fiscal deficit will create inflationary pressures, lead to greater uncertainty about future inflation, increase
long term interest rates and adversely impact growth, thereby defeating the very objective of supporting the
economy. This move will hurt the credibility of India's inflation-targeting framework and attenuate the
effectiveness of future monetary policy actions.
If at all monetisation of fiscal deficit needs to be resorted to given the extraordinary circumstances, extreme
caution and thought must be devoted to work out the details, an end date must be specified by which time the
process will be stopped and there must be complete transparency about every step of the process including
the total amount of money printed, and the specific uses of the funding as decided by the government. Most
importantly there must be a well-planned, well-defined exit strategy which is crucial. The exit from such a
plan is likely to happen at a time when the economy is starting to recover and inflation is picking up as a
result of expansion of RBI's balance sheet. The monetary tightening that needs to be done at that stage may
in fact end up hurting the recovery. Therefore, this is a very risky tool to deploy especially for a country like
India where state capacity is significantly weaker than developed countries and institutional credibility is
fragile.
Finally, in the financial sector, as mentioned earlier, banks and NBFCs will witness a precipitous rise in
NPAs, both from the private corporate and the retail sectors. Large number of firms especially the MSME
businesses and also self-employed individuals are likely to default on their bank and NBFC loans. Rising
NPAs will erode the capital of lenders at a time when they are expected to lend aggressively to revive
economic growth.
Given the decline in stock prices, it will be difficult for private banks to raise capital and the strained fiscal
situation will make it difficult for the government to recapitalise the public sector banks. Capital deficiency
in the face of rising NPAs, will lead to demands for ‘forbearance’ from the RBI. The net result of such
regulatory concessions would be that the banking sector will remain undercapitalised for some time and will
hide its losses.
37
When the Covid-19 shock hit India, the economy was still recovering from the TBS problems, the seeds of
which were sown in the years of regulatory forbearance of the post-2008 period. Postponement of NPA
recognition helps to 'extend and pretend'. Soon the problem becomes too big to tackle and the damage to the
economy becomes long-lasting. If allowed now, this will lead to system wide crisis as it did in 2016-17 post
the asset quality review by RBI.
Defaults by firms would trigger a wave of bankruptcies. The Insolvency and Bankruptcy Code (IBC, 2016)
has introduced for the first time, a rigorous and disciplined process for dealing with bankruptcies. The
decision to suspend this framework for 1 year has already undermined the most important reform of the last
decade and rendered the code ineffective for the time being.
6.1 Principles of policy response

The on-going crisis consists of three interlinked problems: a health shock, an economic shock following
from the lockdown, and a global economic downturn. Each one of these shocks on its own is significant; put
together, they have created considerable pressure upon policy makers to act quickly and decisively. But
coming up with an effective policy response is not an easy task. For one thing, the crisis poses some
exceptional difficulties. It is clear that the human and economic toll will be serious, but it is unclear how long
the crisis will last or how deep the damage will be. And without a clear understanding of the size and
duration of the problem, it is difficult to know how to calibrate the policy response.
Policy making is difficult in the best of times. It is even harder in exceptional times, when there is pressure
for quick actions, grounded in reduced analysis. In fact, it is in exceptional times that the toolkit of good
governance becomes even more important:
 The lowest cost actions are those which are grounded in root cause analysis.
 Each action needs to be carefully weighed in terms of the costs and benefits imposed upon society
 As much as possible, policy responses should be fitted into existing rules and frameworks.
 All state actions should be preceded by public debate and consultation.
This toolkit is a valuable discipline, an institutionalised application of mind.
Why is root cause analysis important? Consider the problem of weak bank lending to corporations in recent
years. From 2018 onwards, RBI has been trying to address this problem by injecting ever-greater amounts of
liquidity into the banking system, in the hopes that banks would deploy these resources and lend more. But
liquidity issues were not at the root of the problem. The Twin Balance Sheet stresses in firms and banks were
the real issue. As discussed in section 2 earlier, bank lending has also been discouraged by the government’s
measures to investigate and prosecute bank officials for their lending decisions. As a result of these factors,
banks have remained reluctant to lend to the corporate sector, curtailing credit to industry to a year-on-year
rate of just 0.67% in February 2020.
38
As an example of poor cost-benefit analysis, consider the regulatory decisions after the Global Financial
Crisis. At the time, it was felt that exceptional times called for exceptional deviation from prudent financial
regulation. A series of restructuring schemes followed, allowing banks to postpone NPA recognition and
hide bad news. With the benefit of hindsight, we know that this restructuring worked poorly, and helped
prepare the ground for the twin balance sheet crisis of 2011-2020.34
As for respecting frameworks, there is a temptation during crises to abandon rules and resort to discretion.
This approach is neither effective nor sustainable. Recent experience warns us that “temporary measures” are
often difficult to reverse (consider the 2010 fiscal stimulus), while inadvertent consequences (such as NPAs)
are difficult to resolve. More fundamentally, temporary measures disrupt the stable configuration of
expectations of economic agents, which will hamper the recovery. It takes many decades of consistent
behaviour in a rules-based framework to shape the rhythm of the working of state institutions, to build up
policy credibility. This credibility can be rapidly dissipated.
Over the last two decades several important policy frameworks have been put in place such as Inflation
Targeting, Basel norms, IBC, etc. These frameworks provide institutional support to policy decisions and
must be adhered to in the interest of the long term health of the economy. Policy responses to the ongoing
crisis potentially risk undermining these institutions and must be decided with utmost care and caution.
7. Policy recommendations
Within the constraints discussed above, there are a few actions that the policymakers can consider as they
gear up to deal with the economic crisis. A joint effort from both the state and central governments is critical.
Agriculture:
 Safety of farm population: Farmers, agricultural labourers, workers in supply chains have to be
protected from the health shock. Now the pandemic is spreading to the rural areas. Some of the
measures like testing of rural population, social distancing in harvest operations, procurement,
marketing, packaging etc. will help in less spreading of the pandemic.
 Supply chains: During the lockdown and beyond, one has to concentrate on smooth operation of
post-harvest activities, marketing of production, retail, wholesale, storage and transport. Negotiable
warehouse receipts for godowns and storage have to be intensified. Revival of supply chains is
needed for ensuring higher prices for farmers and generating employment for agricultural labourers
and other rural workers.
34
See: https://www.ideasforindia.in/topics/money-finance/bank-financing-of-stressed-firms.html
39
 Procurement measures: It is important to have continued markets for farmers. Farmers with
perishable products need help as they face more problems. Government should have smooth
procurement operations for Kharif crops. Milk and poultry industry: Small farmers in poultry and
milk activities need more help as they are facing problems due to the pandemic. For industry,
moratorium or restructuring of loans may be needed.
 Food security for farm families and agricultural workers: Although farmers are involved in
production of crops, they also face food related problems. Farmers and agri. Workers have to be
included in the in-kind assistance package or any social protection programmes announced by the
governments. At present, PM-Kisan includes only land owners. Tenant farmers who are the actual
cultivators should be included in the scheme.
 Avoid export bans: At the macro level, trade in food and agriculture has to be maintained in order to
have availability of food. Access to food has to be tackled in a different way than having export
bans. For example, some of the farmers are suffering because of export restrictions. After the
lockdown period, exports of farm products have to be continued.
 Agriculture reforms: The reforms relating to the Essential Commodities Act, agricultural marketing
and contract farming would help the farmers in raising their incomes in the medium term. But, the
government has to provide more clarity on these reforms. One big point of discord that relates to the
amendments to the Essential Commodities Act is the provision to invoke its controlling powers on
exempted food items. That is, 100 per cent increase in retail price of horticultural produce or 50 per
cent increase in retail price of non-perishable items as compared to the previous 12 months or last
five years average, whichever is lower. This provision would restrict big-ticket investments in the
sector. There is a lot of confusion over some of the definitions which, unless fixed, could lead to
major implementation challenges. In addition, the provision to refer all disputes in such forms of
trade to the sub-divisional magistrate or the conciliation board appointed by him gives a lot of
powers to the officer. Another point which is missing is taxes on inter-state trade. Now, if a trader
buys goods from other states, what happens to taxes other than mandi tax and cess that is levied.
Though GST will have taken care of a lot of these issues, but some clarity could have been better.
Informal sector: It is very important now to protect the workers in the informal sector, who have been badly
affected, and yet have little savings to tide them over the shock. Over and above the fiscal package that the
central government has already announced, some more relief measures for the informal sector workers may
be considered till the economic activities and employment improve.
 Food and nutritional security: India has nearly 56 million tonnes of excess stock of grains and
cereals compared to the usual norms. In March, the government declared 5kg free rations in addition
to the present entitlement of buying 5kg at subsidized prices. In June, the Prime Minister announced
extension of the Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY), a programme to provide
free ration for over 80 crore people, mostly poor, by five more months till November end. This will
help the informal sector workers in both rural and urban areas. However, government has to make
40
sure that no one is excluded as we still have exclusion errors in the Public Distribution System (PDS
system). State governments have also announced free basic and enhanced rations. The nutrition
levels of informal workers and the unemployed poor were low even before the crisis. It will decline
further due to lack of jobs and incomes during lockdown and beyond. Therefore, there is a need to
have pulses, oils, jaggery etc in ration shops to ensure a diversified diet for them. Anganwadis and
schools can provide rations at home. Eggs can be added to improve nutrition for children and
women. Government has to make sure that the prices of essential food items are under control.
Otherwise high prices would have adverse impact on the food and nutrition security of the poor.
 Cash transfers: Given the widespread loss of jobs and incomes and no certainty about when the
situation may normalise, the informal sector workers would need cash income support. The
government has provided Rs.500 per month to women through their Jan Dhan Yojana accounts.
There is some consensus that this may not be sufficient. The suggestions on this vary from Rs.3000
per month to Rs. 6,000 per month35. Experts argue that a higher amount of cash transfer as compared
to the government announcement is needed as a one-time measure. Khera (2020) indicates that it is
better to use the NEFT system rather than using the Aadhar Payment Bridge system as the latter has
some rejections and failed payments. It may be noted that some of the informal workers and other
vulnerable groups do not have Jan Dhan accounts. These groups also need cash assistance. The
optimal design of the cash transfer programme needs to be figured out in terms of targeted recipients,
amounts, and duration.
 To a certain extent, the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA)
scheme works as an automatic stabiliser because if people need jobs they can just apply. Also the
number of days under the program maybe increased. There is significant increase in MGNREGA
enrollments in rural areas as migrants have gone back to rural areas. Rangarajan and Dev (2020)
suggested (a) expanding the number of days under MGNREGA from 100 to 150 days and (b)
introduction of employment guarantee scheme with 150 days in urban areas to address the problem
of joblessnes in the urban informal sector. A related issue is payments to MGNREGA workers. All
the arrears for these workers have to be released.36
 Migrant workers: The migrant workers are the worst affected by the lockdown and will continue to
be so in the next few months. . They have faced extreme hardships. There have been several
suggestions to help the migrant workers. After the lockdown, an orderly return of the migrant
workers to their respective work places must be arranged. Steps must be taken such that the benefits
of social safety nets like PDS, Ujjwala scheme etc. become available to them even in the urban and
semi-urban areas (Kapur and Subramanian, 2020). The government wants to introduce one nation
one ration card which will help the migrants. But, one has to make sure that all the migrants have
35
See the proposals of the Indian Society of Labour Economics submitted to Prime Minister and Chief Ministers.
https://www.ihdindia.org/pdf/Final-Press-Release.pdf
36
It maybe worth noting in this context that in recent years, the MGNREGA scheme does not seem to have offered much
support to rural income due to delayed wage payments, lower wages and insufficient budgetary allocations. The Periodic Labour
Force Survey (PLFS) report released by the NSO in May 2019 shows that wages under MGNREGA work are lower than the market
wage rate for non-public work by 74% for rural men and 21% for rural women (RBI, 2020).
41
access to this card.
 MSME and MFI: Since most MSMEs primarily operate on cash, they require immediate liquidity to
cope with adverse events. As mentioned above, the government announced collateral free automatic
loans to the tune of Rs. 3 lakh crores over the next five months guaranteed by the government.
According to the government, the stimulus is Rs. 5.9 lakh crores for MSMEs (3% of GDP). But, the
estimates show that the fiscal implication is only Rs. 16,500 crores (0.08% of GDP). A small number
of firms can actually benefit from the government announcements. Supply chain disruptions have
also created demand problem for MSMEs from the larger firms. A survey by All India
Manufacturers Organisation (AIMO) says that at least 78% of the MSMEs are not satisfied with the
financial package execution. They are expecting the government to provide an alternative financial
mechanism than just loans and provide a wage stimulus for their workers. Firms also suggested relief
through interest free loans, deferring tax refund, and reducing GST slabs. The immediate problem is
survival and recovery in the next few months. There are also many opportunities for MSMEs in the
space vacated by China. Indian can’t become Atmanirbhar without dynamic MSMEs.
 State level programmes: Several state governments have initiated innovative programmes to help the
informal workers and the unemployed poor. Kerala government for example has announced a
Rs.20,000 crore package. The components of this package are: (a) Two months of welfare pensions
to be given as an advance; (b) All needs families get free food grains from the PDS; (c) A subsidized
meal programme at Rs.20 to be delivered at home; (d) Loans worth Rs.2000 crore will be given
through Kudumbashree programme; (e) Rs.500 crore of health package; (f) employment guarantee
programme of Rs. 3000 crore in the first two months. The food assistance programmes are
noteworthy as they focus on diversified diet to improve nutrition. It is worth studying the Kerala
package and its viability more closely and the potential replicability in other states.
Banking sector: In absence of a liquid and well-functioning bond market, given the extra-ordinary nature of
the crisis and given the dependence of the Indian economy on banks, the banking system needs to step up to
provide the necessary credit to firms as well as households. Otherwise far too many enterprises will get
destroyed and unemployment will go up dramatically.
Resolving firms: We know that the health crisis is a temporary shock. Standard economic theory tells us that
the optimal response to a temporary shock is for (viable) firms and households to obtain financing, to tide
them over the difficult period. Over the next few months, three categories of firms will emerge: a) firms that
are able to pay their dues throughout the crisis period; b) firms that are fundamentally viable and can survive
provided they are given adequate credit support; and c) firms whose business models are broken and who
will become bankrupt as a result of this shock. It will be important for the banks to distinguish among these
firms. Banks should ideally do nothing with firms in category (a), give the 6-month loan moratorium and
also credit support only to firms in category and maintain a systematic database with information on these
42
firms (b), and take the firms in category (c) to the insolvency and bankruptcy courts.
The suspension on IBC needs to be lifted so that in particular firms in category (c) can get resolved fast and
resources currently locked up in these firms can get deployed for more productive purposes. In absence of
IBC, resolution of failed firms is likely to get delayed thereby causing significant deterioration in the value
of the underlying assets and worsening the eventual losses for the creditors.
Several firms which are in category (b) may default once the 6-month moratorium period is over. It is
unlikely that their financial situation will improve significantly in this 6 month period. They should be
declared NPA in the usual 90dpd cycle starting October 2020 and banks should write off the assets in their
books as per the prudential norms of RBI. If at all some of them require a one-time restructuring of their
loans, RBI should leave the decision to banks to figure out which firms need this and let them work out the
details of the restructuring schemes. This solution should be applied only to firms who are genuinely not able
to repay because of the cash-flow shock and not to firms in the (c) category who are fundamentally bankrupt.
Reviving credit growth: As explained earlier, RBI's strategy of adding more liquidity to the system has
already been tried, without success; it is unclear why it would work now, especially now that uncertainty
about firms' prospects has only increased. When a bank decides to approve a loan, it performs two functions
simultaneously: it is assuming risk, and it is allocating capital. In the current circumstances, it is still possible
for banks to allocate capital: they can still figure out which firms are more likely to be hit badly by the crisis
and which firms are going to be less affected. That is, banks can figure out relative risk.
The problem for the banks is that right now they can't really assess the absolute level of risk, because they
don't have no idea how long the crisis is going to last, or how deep the crisis is going to be. And this shock
has come at a time when banks have already become risk-averse given the last few years of balance sheet
problems. Hence, it is difficult for them to lend, especially to new customers.
In these circumstances, giving the banks more liquidity, exhorting them, coming up with any number of
subsidy schemes, will not work. Moreover, as mentioned earlier, there is heightened risk aversion in the
banking system right now and steps must be taken to first address this in order to make other policy actions
effective. The following are some of the steps that maybe taken:
 The government, not the RBI, could relieve the banks of the burden that it cannot manage: the
burden of risk. The government can capitalize a fund which will then give loan guarantees. The
scheme would have some selection criteria, say MSMEs that have been current on their bank loans.
It would also specify maximum rupee amounts per firm, pegged say to the annual revenues of the
company. Once the eligibility criteria are specified by the government, the actual selection of the
firms would be done by the banks. They would identify the best firms, originate the loans, and then
43
apply to the fund for guarantee coverage. Of course, the banks should be charged a fee for this, to
discourage them from using the fund unnecessarily.
In this way, we could use the law of comparative advantage to obtain better economic outcomes: the
government would do what it does best in crises, namely bearing risk; while the banks would
continue to do what they do best, namely allocating capital.
The ‘Atmanirbhar package’ announced by the government contains such credit guarantee schemes for
MSMEs however as discussed about a 100% credit guarantee can lead to distortions of incentives and
adverse selection problems. Also despite the scheme the credit offtake has not been very significant. In fact
credit to deposit ratio has been declining continuously since the lockdown was announced and didn’t
improve even after this scheme was announced. Also this facility was extended only for existing borrowers
above a certain threshold of revenue.
 As regards banking regulation and dealing with defaulting firms, to supplement the policy actions
already taken of 27 March, RBI could announce that firms and individuals seeking a loan
moratorium would be marked in a separate category. That way, there would be transparency
regarding the true financial situation of the banks and an account of how many moratoriums have
been offered. There would also be a bit of a stigma for borrowers, helping to preserve debtor
discipline. If a firm had no choice, it would still have postponed repayment. But if it could afford to
pay, it would have done so, in order to escape the stigma.
 Recapitalise the banks adequately or issue a promise of capital, so that the banks are able to provide
for the rising NPAs, instead of postponing the recognition and kicking the can down the road.
 Provide interest subvention in lending to specific segments, and create a dedicated fund to provide
this subvention. This will improve banks’ ability to appropriately price the risk they are taking.
 Notify the personal insolvency sections of the IBC so that banks are better equipped to deal with the
rise in NPAs owing to impending defaults in the retail sector. The defaults in the retail sector are
likely to be huge and banks would need a legal mechanism to deal with these.
 Forward planning could help deal with the consequences of the inevitable surge in defaults. Even
before the corona crisis, bankruptcy cases were taking far longer than envisaged; large cases were
taking several years to resolve. If this situation is not addressed, there is a risk that large sections of
the economy will be tied up in bankruptcy courts, making it impossible for the economy to return to
normal, even after the virus abates. To make sure this does not happen, the IBC needs to be reformed
and capacity at the courts needs to be increased in order to ensure faster and effective resolution.37
37
See: https://blog.theleapjournal.org/2018/12/the-indian-bankruptcy-reform-state-of.html
44
Such reforms would also have an immediate benefit: banks would be more confident in lending if
they knew the IBC would not be overwhelmed by cases after the crisis is over. Most importantly the
provisions of IBC should not be diluted citing extraordinary circumstances
 Release the banks, both domestic and foreign, from the ambit of the Prevention of Corruption Act, in
order to encourage them to freely take business decisions, including extending loans to new
customers.
Monetary policy: The design of inflation targeting (IT) is well suited for such crisis times. IT anchors
inflation expectations, thereby giving monetary policy more room to manoeuvre during downturns.
Accordingly, efforts must be put into retaining and even enhancing the credibility of this mechanism. What
is required is accurate inflation forecast targeting.
Monetary policy actions should be couched in terms of this framework, as a way of assuring the public that
the RBI is keeping its eye on this critical objective, and that the mistakes of the past will not be repeated. The
MPC has to be careful about the delayed transmission of rate changes in India. For example, monetary easing
could take a year to have a significant effect, by which time the problem might be over, and inflation might
have re-emerged, at which point painful measures would be required to bring it back down. This is not just a
theoretical possibility: it is precisely what happened in 2009-13.
Fiscal policy: Most of the policy actions to support the economy during such extra-ordinary times will entail
a rise in fiscal deficit. As discussed in detail in section 6, the government currently has very little fiscal space
to accommodate a substantial stimulus. There is a lot of pressure from multiple quarters to let go of the fiscal
consolidation rules, enlarge the fiscal deficit and let the debt/GDP ratio go up. This may be unavoidable
given the circumstances but should be done subject to adequate checks and balances so that the long term
consequences of a fiscal expansion do not jeopardise the economic recovery.
Perhaps a one-time relaxation of the FRBM Act can be considered in view of the extraordinary situation.
State governments also have to incur a lot of expenses to take care of the health and economic crisis.
Therefore, the FRBM Act has to be substantially relaxed for state governments too much more than what has
already been done so far. The government can also make use of the windfall gains emanating from the
global oil price collapse. The appropriate design of the stimulus measures therefore needs to be carefully
thought about.
7. Conclusion
45
Covid-19 has posed an unprecedented challenge for India. Given the large size of the population, the
precarious situation of the economy, especially of the financial sector in the pre-Covid-19 period, and the
economy’s dependence on informal labour, lockdowns and other social distancing measures are turning out
to be hugely disruptive. The central and state governments have recognized the challenge and have
responded but this response should be just the beginning.
The eventual damage to the economy is likely to be significantly worse than the current estimates.
On the demand side, the government needs to balance the income support required with the need
to ensure the fiscal situation does not spin out of control. The balance struck so far seems to be a
reasonable one but the government needs to find a greater scope for supporting the incomes of
the poor. Involvement of the state and local governments may also be crucial in the effective
implementation of further fiscal initiatives.
Policy makers need to be prepared to scale up the response as the events unfold so as to minimise the impact
of the shock on both the formal and informal sectors and pave the way for a sustained recovery. At the same
time they must ensure that the responses remain enshrined in a rules-based framework and limit the exercise
of discretion in order to avoid long-term damage to the economy.
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16 PART one Principles and Concepts

savings, investment, product and factor prices, and foreign-exchange rates. As

Institutions Norms, rules

CHAPTER 1 Introducing Economic Development: A Global Perspective 17

18 PART one Principles and Concepts

underdevelopment.” This unique culture shock comes to one as he is initiated to

Development must therefore be conceived of as a multidimensional pro-

Amartya Sen’s “Capability” Approach

CHAPTER 1 Introducing Economic Development: A Global Perspective 19

Sen identifies five sources of disparity between (measured) real incomes

20 PART one Principles and Concepts

which are “abilities to function that are conferred by direct connection or

CHAPTER 1 Introducing Economic Development: A Global Perspective 21

Development and Happiness

Figure 1.2 Income and Happiness: Comparing Countries

Denmark Canada Switzerland

Income per head (U.S. $ per year)

22 PART one Principles and Concepts

CHAPTER 1 Introducing Economic Development: A Global Perspective 23

Self-Esteem: To Be a Person A second universal component of the good life

Freedom from Servitude: To Be Able to Choose A third and final universal

24 PART one Principles and Concepts

The Central Role of Women

The Three Objectives of Development

1. To increase the availability and widen the distribution of basic life-sustaining

CHAPTER 1 Introducing Economic Development: A Global Perspective 25

Table 1.1 Millennium Development Goals and Targets for 2015

26 PART one Principles and Concepts

CHAPTER 1 Introducing Economic Development: A Global Perspective 27

1. Leave no one behind—to move “from reducing to ending extreme poverty,

The High-Level Panel also agreed on well-recognized and illustrative uni-

28 PART one Principles and Concepts

CHAPTER 1 Introducing Economic Development: A Global Perspective 29

Achieving the Millennium Development Goals will be an important mile-

CHAPTER 2 Comparative Economic Development 45

stock and bond markets; although financial deepening is important, it is only

2.2 Basic Indicators of Development:

46 PART ONE Principles and Concepts

FIGURE 2.1 Nations of the World, Classified by GNI Per Capita

CHAPTER 2 Comparative Economic Development 47

48 PART ONE Principles and Concepts

FIGURE 2.2 Income Per Capita in Selected Countries, 2011

power of different currencies. In an attempt to rectify this problem, researchers

CHAPTER 2 Comparative Economic Development 49

high-income countries is more than 28 times that in low-income countries and

Indicators of Health and Education

50 PART ONE Principles and Concepts

TABLE 2.3 Commonality and Diversity: Some Basic Indicators

Prevalence of Primary Completion

CHAPTER 2 Comparative Economic Development 51

2.3 Holistic Measures of Living Levels

52 PART ONE Principles and Concepts

The education (“knowledge”) component of the HDI is calculated with a

17.0 - 02 > 113.3 - 02 = 0.527 (2.3)

111.4 - 02 > 1 18.0 - 02 = 0.634 (2.4)

The education index is then calculated as a version of the geometric mean

Income index = 3ln11,6842 - ln110024 > 3ln187,4782 - ln110024 = 0.417 (2.5)

CHAPTER 2 Comparative Economic Development 53

Using these three measures of development and applying the formula to

NHDI = H1>3E1>3I1>3 (2.6)

54 PART ONE Principles and Concepts

BOX 2.1 Computing the New HDI: Ghana

CHAPTER 2 Comparative Economic Development 55