SALALE UNIVERSITY

COLLEGE OF SOCIAL SCIENCE AND HUMANITIES

Department of Geography and Environmental studies

Course Name: Development Geography (GeES 3011)

Set by: Yomif Feye

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The concept of development

Development geography is a branch of geography which refers to the standard of

living and it's quality of life of it's inhabitants.

Development

Development is the use of resources and technology to bring about change. This change is
positive and generally involves the improvement in people’s quality of life and improving the
standard of living in a country.
According to Seers (1979), development is simply an action or progress made in three
dimensions;
 Decrease in poverty and malnutrition
 Decline in income inequality
 Decline in unemployment

According to G. Myrdal, development means simply an upward movement of the entire social
system which includes all sorts of consumption by various group of people, consumption
provided collectively, education, health at all levels, distribution of power in the society
economic, political and social stratification. Here we can find circular causation (when we make
changes on one system or factor, it will have its effect on others. E.g. Education-health).

A. Sen also defined development as enhancement of well being of people. The nature of the life
of the society is considered while we define development. As to him freedom is both the primary
end and the principal means of development. He specified two functioning or elements of well
being; doings (job, employment) and beings. So development is about the expansion of these
functioning and happiness. Expansion of functioning means avoiding misery, increasing
happiness etc. important freedoms include: freedom from famine and malnutrition, freedom from
poverty, freedom from illness and freedom from unemployment.

Briefly speaking, development refers to the institutional, economic, political, social and
economic change of communities of a given nation. It is the process of having a better position in
all aspects of life than yesterday. It is just moving from a certain situation up to higher level.
However, it is clear that all nations and even all communities may not have an evenly distributed
development. This could be partly resulted from;
 Unevenness in investment
 Inadequate infrastructure and uneven natural resource endowments
 Incomplete markets (some markets are sometimes missing for some goods)
 Colonization, etc.
Development from different contexts – local, regional and global

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Local – refers to development in the area in which you are living. Development in a local context
is often small-scale.
Regional – refers to development in an area that has similar characteristics which distinguish it
from other areas (e.g. Gauteng)
Global – refers to development worldwide. Here the best example is the Millennium
Development Goals. These goals included:
 Eradicating extreme poverty and hunger

 Achieving universal primary education

 Promoting gender equality and empowering women

 Reducing child mortality

 Improving maternal health

 Combating HIV/AIDS, malaria and other diseases

 Ensuring environmental sustainability

 Developing a global partnership for development

Economic development
Economic development refers to the widespread of income (production). In economic
development income should be sustainable and widely shared (distribution). In addition, there
should be structural change in which large numbers of people are employed. Structural change
also includes movement from diminishing return to constant or if possible to increasing return.
Structural change in institution also refers to movement from centralized to a more decentralized
and even decisions made on natural resources. Increasing return refers when output becomes
greater than double E.g. manufacturing and service. Constant return means when factors of
production is doubled, output is also doubled. Diminishing return also refers when output is less
than double. E.g. agriculture

The aim of economic development is closing the gap between living standard and availability of
income. E.g. we may have many but we may be illiterate and not well nourished.

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 Economic growth
It is the physical expansion or quantitative change in economy and deals only with income per
capita. In economic growth environmental issues are not considered because focus is on raising
income. Economic growth never tells us about the welfare of people.
Indicators of Development
Measuring development between different countries is very difficult. That is why geographers
make use of different indicators in order to compare the level of development around the world.
There are three different types of indicators that can be used in order to compare development

Indicators of development

Social Indicators Demographic Indicators

(Show level of human
(Statistics of a country’s
development) welfare and
quality of life) population)

Economic Indicators
 Gross National Income (GNI) – the amount of money the average person in a country can
expect to have. (Low income and middle income countries are developing while high income
countries are developed).
Economic Indicators
(Show how well off a country is
 Gross National Product (GNP) – Total value of all goods and services produced by a
economically)
country in one year including foreign earnings

 Gross Domestic Product (GDP) – Shows the total value of all goods and services produced
by a country in one year.

NB! All of the above indicators are often given as per capita or per person. To calculate this
amount you take the GNI, GNP or GDP and divide by the country’s total population. It is
therefore an average amount that is available to each person in that country.

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Human Development Index (HDI) – This indicator is a combination of GDP per capita, life
expectancy and literacy rate. Zero (0) indicates the worst quality of life, while one (1) shows an
almost perfect place.
Gini-coefficient – Indicates how wealth is shared in a country. A Gini score of 0 indicates
complete equality in income (every household receives the same amount of money). A Gini
score of 1 indicates complete inequality (income received is not the same; one household gets
more than the other).
Social Indicators
Social Indicators may include things like:
 The percentage of the population living in urban areas

 Education levels and level of literacy

 Availability of services such as water, electricity and healthcare

 Food and nutrition

Demographic Indicators
The following are examples of demographic indicators and are usually obtained through a census
in a particular country. A Census is an official counting a country’s population which is usually
done every ten years.
 Birth rate

 Death rate

 Infant mortality rate

 Life expectancy

 Maternal Mortality rate( the number of mothers who dies during childbirth)

 Population growth rate (the percentage by which a country’s population grows each year)

 Fertility rate (the expected number of children the average women in a country has)

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Dimensions of Development

G. Myrdal’s elements of dimensions of development

He used modernization ideas for development standard or for standard of perfection in general.
His first element is rationality in policy, in application of technology, in structuring social
relations and so on. Enough reason should be there and that reason should convince the society
in these areas. The second element is planning for development-searching for coherent system.
The third element is increase in production per capita and production per worker. The fourth
element is improvement in the standard of living. The income generated should bring positive
changes on the life of the society or should bring welfare. The fifth element is decline in social
and economic inequality. The sixth element is more efficient institutions and attitudes-like
diligence, orderliness, punctuality, honesty, rationality and so on. The seventh element is
consolidation of national state and national integration. The eighth element is national
independence. The ninth element is political democratization. The tenth element is increased
social discipline. All the aforementioned elements are interdependent so that failure one element
may affect the other elements.

Sen and Stiglitz elements of dimensions for development

 Material living standard (income consumption)
 Health, education, personal activities including work, to have fun and relax
 Political voice and government
 Social connections and relationships
 Environment
 Security of economic and physical nature

Classification of countries & their defining characteristics

Geographers classify countries according to their level of economic and human development.
There will always be poor people in rich countries and rich people in poor countries. The Brandt
Line is used to divide the world into two halves, the developed north (rich, industrialized) and
the developing south (poor).The Brandt Line may also be referred to as the North-South divide.
It is important to remember that the Brandt line is not the same as the equator. There are some
countries that are found in the Southern Hemisphere but are north of the Brandt Line e.g.
Australia.

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 Below is a table comparing the main differences between Developed and Developing countries:
DEVELOPED COUNTRIES DEVELOPING COUNTRIES
First world Third World
Rich world Poor World
They have They have not’s
More economically developed countries (MEDCs) Less economically developed countries (LEDCs)
Industrialized Non-industrialized/ Industrializing
The North The South
High income Low income
High human development index (HDI 0.8+) Low human development index (HDI 0,5 and less)
E.g. United States of America, France, Japan etc E.g. India, Ethiopia, Brazil etc

Underdevelopment

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Underdevelopment is low level of development characterized by low real per capita income,
wide-spread poverty, lower level of literacy, low life expectancy and underutilization of
resources etc. The state in underdeveloped economy fails to provide acceptable levels of living to
a large fraction of its population, thus resulting into misery and material deprivations. We need
to note here that underdevelopment is a relative concept but it sustains absolute poverty.
Criterion for Classifying Economies as Developed and Underdeveloped
Economies cannot be classified as developed and underdeveloped economies based on their
natural resources, population and sectoral dependency. However, there is a set of common
characteristics of underdeveloped economies such as low per capita income, low levels of living,
high rate of population growth, illiteracy, technical backwardness, capital deficiency,
dependence on backward agriculture, high level of unemployment, unfavorable institutions and
so on. It is on the basis of these characteristics that we draw a line of distinction between
developed and underdeveloped economies.
Underdevelopment is a Relative Concept
The concept of underdevelopment is a relative one because it is the comparison of quality of life
between the economies that differentiates them in underdeveloped and developed.
Underdevelopment Sustains Absolute Poverty
Although, concept of underdevelopment is a relative concept but it sustains absolute poverty.
Absolute poverty refers to the state of poverty wherein the people fail to fulfil even their basic
needs in terms of food, clothing and shelter. In fact, they are a class of people who are always
striving to survive. Thus, underdevelopment and absolute poverty go together or
underdevelopment sustains absolute poverty.
Characteristics of Underdeveloped Economies
It is difficult to find an underdeveloped economy representing all the representative
characteristics of underdevelopment. While most of them are poor in nature, they have diverse
physical and human resources, socio-political conditions and culture. Some of the common
characteristics displayed by most of the underdeveloped countries in the world are as follows:
Low Per Capita Income
Almost all underdeveloped countries of the world show low per capita income in comparison to
developed countries of the world.

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Slow Growth Rate of Per Capita Income
Low per capita income and slow growth rate of per capita income are characteristics of these
countries.
Economic Inequalities
High inequality of income and wealth is another common feature of underdeveloped countries.
In these countries, large percentage of national income is shared by a small segment of the
society while a large segment of the society gets barely enough to survive. Economic inequality
exists even in developed countries but it is not as much as found in underdeveloped countries.
Low Level of Living
Level of living in the underdeveloped countries is low because of low per capita income. Low
level of living of the people of underdeveloped countries is also reflected in Human
Development Index prepared by the United Nation Development Programme (UNDP). HDI of
developed countries is very high whereas for underdeveloped countries it is very low.
Low Rate of Capital Formation
Rate of capital formation is very low in underdeveloped economies due to low income levels and
high incidence of poverty.
Backward Techniques of Production
Underdeveloped economies use outdated technology for production. Lack of capital leads to less
spending on research and development.
High Growth Rate of Population and Dependency Burden
These countries are characterized by high growth rate of population and high dependency
burden.
Low Productivity of Labour
Underdeveloped economies are characterized by low labour productivity due to low level of skill
set.
Underutilization of Natural Resources
Natural resources are underutilized in underdeveloped economies. Their capability to exploit
them is very low.
Large Scale Unemployment
Large scale unemployment is another characteristic feature of underdeveloped countries.

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Dominance of Agriculture
Large section of people in underdeveloped economies depends on primary sector for
employment. But the primary sector is not well-developed in those countries.
High Incidence of Poverty
Low per capita income results in high incidence of poverty in underdeveloped economies.
Infrastructural Backwardness
Economic infrastructure and social infrastructure are almost at their bottom level in
underdeveloped countries.
Low Volume of Foreign Trade
Underdeveloped countries export primary products like, agricultural goods, minerals, petroleum
oil, etc., and import finished products, especially consumer goods. Terms of trade are grossly
unfavorable to underdeveloped countries.
Sustainable development
Sustainable development has become the buzzword in development discourse, having been
associated with different definitions, meanings and interpretations. Taken literally, SD would
simply mean “development that can be continued either indefinitely or for the given time period
The following points are focused on chronological overview of the meaning of sustainable development
in the period 1987 – 2015- Authors/publication and year Meaning and understanding of sustainable
development
WCED, 1987: Sustainable development is a development that meets the needs of the present
without compromising the ability of future generations to meet their own needs.
Pearce et al., 1989: Sustainable development implies a conceptual socio-economic system
which ensures the sustainability of goals in the form of real income achievement and
improvement of educational standards, health care and the overall quality of life.
Harwood, 1990: Sustainable development is unlimited developing system, where development
is focused on achieving greater benefits for humans and more efficient resource use in balance
with the environment required for all humans and all other species.
IUCN, UNDP &WWF, 1991: Sustainable development is a process of improving the quality of
human life within the framework of carrying capacity of the sustainable ecosystems.
Lele, 1991: Sustainable development is a process of targeted changes that can be repeated
forever.

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Meadows, 1998: Sustainable development is a social construction derived from the long-term
evolution of a highly complex system – human population and economic development integrated
into ecosystems and biochemical processes of the Earth.
PAP/RAC, 1999 Sustainable development is development given by the carrying capacity of an
ecosystem.
Vander-Merwe & Van-der-Merwe,1999: Sustainable development is a programme that
changes the economic development process to ensure the basic quality of life, protecting
valuable ecosystems and other communities at the same time.
Beck & Wilms, 2004: Sustainable development is a powerful global contradiction to the
contemporary western culture and lifestyle.
Vare & Scott, 2007: Sustainable development is a process of changes, where resources are
raised, the direction of investments is determined, the development of technology is focused and
the work of different institutions is harmonized, thus the potential for achieving human needs
and desires is increased as well.
Sterling, 2010: Sustainable development is a reconciliation of the economy and the environment
on a new path of development that will enable the long-term sustainable development of
humankind.
Marin et al., 2012: Sustainable development gives a possibility of time unlimited interaction
between society, ecosystems and other living systems without impoverishing the key resources.
Duran et al., 2015 Sustainable development is a development that protects the environment,
because a sustainable environment enables sustainable development.

Sustainable development goals

The overall goal of sustainable development (SD) is the long-term stability of the economy and
environment; this is only achievable through the integration and acknowledgement of economic,
environmental, and social concerns throughout the decision making process.There are about 17 goals of
SD.These are:
1. Goal1: End poverty in all its forms everywhere
2. Goal2: End hunger, achieve food security and improved nutrition and promote
sustainable agriculture
3. Goal3: Ensure healthy lives and promote well-being for all at all ages

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 4. Goal4: Ensure inclusive and equitable quality education and promote lifelong learning
opportunities for all
5. Goal5: Achieve gender equality and empower all women and girls
6. Goal6: Ensure availability and sustainable management of water and sanitation for all
7. Goal7: Ensure access to affordable, reliable, sustainable and modern energy for all
8. Goal8: Promote sustained, inclusive and sustainable economic growth, full and
productive employment and decent work for all
9. Goal9: Build resilient infrastructure, promote inclusive and sustainable industrialization
and foster innovation
10. Goal10: Reduce inequality within and among countries
11. Goal11: Make cities and human settlements inclusive, safe, resilient and sustainable
12. Goal12: Ensure sustainable consumption and production patterns
13. Goal13: Take urgent action to combat climate change and its impacts
14. Goal14: Conserve and sustainably use the oceans, sea and marine resources for
sustainable development
15. Goal15: Protect, restore and promote sustainable use of terrestrial ecosystems,
sustainably manage forests, combat desertification, and halt and reverse land degradation
and halt biodiversity loss
16. Goal16: Promote peaceful and inclusive societies for sustainable development, provide
access to justice for all and build effective, accountable and inclusive institutions at all
levels
17. Goal17: Strengthen the means of implementation and revitalize the Global Partnership
for Sustainable Development

Principles of sustainable development

The principles of sustainable development are as follows:

 Conservation of ecosystem.
 Development of sustainable society.
 Conservation of biodiversity.
 Control of population growth.
 Development of human resources.

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  Promotion of public participation.

Relationships among the environment, economy and society

 The concept of sustainability appears poised to continue to influence future discourse
regarding development science. This, in the view of Porter and van der Linde (1995),
implies that the best choices are likely to remain those that meet the needs of society and
are environmentally and economically viable, economically and socially equitable as well
as socially and environmentally bearable. This leads to three interconnected spheres or
domains of sustainability that describe the relationships among the environmental,
economic, and social aspects of SD as captured in Figure 2
 sustainable development requires the achievement of:
1) Ecological sustainability – maintaining the quality of the environment needed for economic activities
and quality of life (environmental protection, reduced emissions of pollutants, rational use of resources,
etc.),
2) Social sustainability – preservation of
society and cultural identity, respect of cultural diversity, race and religion, preservation of social values,
rules and norms, protection of human rights and equality, etc.),

3) Economic sustainability – maintaining the natural, social and human capital needed to achieve income
and living standard. The relationship between these pillars is set in the equilibrium sustainability
framework or concept called Triple bottom line concept set by John Elkington (1994). It represents the
inseparable interaction and correlation of the three basic pillars of sustainability, whose relationship must
be in balance. An illustrative scheme is given in Figure 1 showing the complex relationship between the
pillars of sustainable development. In order to achieve complete sustainable development, all pillars have
to be sustainable, i.e. they have to be in mutual balance. The balance between individual pillars of
sustainable development is not easy to achieve, because in the process of achieving its goals each pillar
must respect the interests of other pillars in order not to cause imbalance. This relationship is particularly
complex if involving the perspective of strong or rigorous sustainability without possibility of
substitution of natural capital with other forms of capital.
The Triple bottom line concept is well known and suitably adapted in different fields of human activities.

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Figure 1: Triple bottom line concept of sustainable development

Environmental Kuznets Curve

The implied inverted-U relationship between environmental degradation and economic growth
came to be known as the “environmental Kuznets curve,” by analogy with the income inequality
relationship postulated by Kuznets.

The Environmental Kuznets Curve (EKC) is often used to describe the relationship between
economic growth and environmental quality. It refers to the hypothesis of an inverted U-shaped
relationship between economic output per capita and some measures of environmental quality
the shape of the curve can be explained as follows: As GDP per capita rises, so does
environmental degradation. However, beyond a certain point, increases in GDP per capita lead to
reductions in environmental damage.

Specifically:
 At low incomes, pollution abatement is undesirable as individuals are better off using their
limited income to meet their basic consumption needs; at low levels of development, both
the quantity and the intensity of environmental degradation are limited to the impacts of
subsistence economic activity on the resource base and to limited quantities of

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 biodegradable wastes. As agriculture and resource extraction intensifies and
industrialization takes off, both resource depletion and waste generation accelerate.
 Once a certain level of income is achieved, individuals begin considering the trade-off
between environmental quality and consumption, and environmental damage increases at a
lower rate; and
 After a certain point, spending on abatement dominates as individuals prefer improvements
in environmental quality over further consumption, and environmental quality begins to
improve alongside economic growth. At higher levels of development, structural change
towards information-based industries and services, more efficient technologies, and
increased demand for environmental quality result in levelling-off and a steady decline of
environmental degradation as given in fig 1 below.

Figure 1: The environmental Kuznets curve: a development-environment relationship

Other possible explanations for the shape of the EKC include:

 Technological progress: firms initially concentrate on expanding production as quickly as
possible, but as technology evolves production processes become cleaner and more
resource efficient;

 Behavior Change: society is at first interested in higher levels of consumption, regardless

of the means by which it is achieved, but after a certain point greater consideration is given
to other factors affecting quality of life, including the environment;

 Lewis growth model: the development pattern of any economy is characterized by the
changing patterns of economic activity. Stage 1: society concentrates resources in the
primary sector (i.e. extraction, agriculture) to satisfy necessary consumption; Stage 2:
resources are switched to the secondary sector (i.e. manufacturing) as basic needs are
satisfied and further consumption is concentrated on consumption goods; and Stage 3:
society moves from the secondary to the tertiary sector (i.e. services) characterized by

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 much lower levels of pollution. However, this model is less applicable in an increasingly
globalised world where the move from stage 1 to 3 may happen as the result of a shift
rather than a reduction in the levels of pollution.

However, there are several reasons to question the relevance of the EKC hypothesis to policy-
making.
 First, the definitions of environmental quality normally used in EKC analyses are based on
a limited set of pollutants. As such, the conclusions reached by these analyses are not
applicable to all types of environmental damage. For example, there was no evidence of an
EKC relationship in the Ecological Footprint – an aggregate measure of the pressure human
beings place on the environment – unless energy use was removed from the measure
(Caviglia-Harris et al, 2009). The Environmental Kuznets relationship appears strongest for
pollutants with significant local impacts. For carbon and other greenhouse gases, on the
other hand, where the impacts are global and diffuse, emissions have continued to rise with
increases in income per capita – even in the richest countries.
 Second, the econometric evidence put forward in support of the EKC has been found to be
less reliable and robust than previously thought. For example, the choice of model used to
describe the relationship between income and pollution has a significant impact on the
results of the analysis.
 Third, the existence of hysteresis may reduce the relevance of EKC to environmental
policy. Specifically, the costs of repairing damage and improving environmental quality
once the economy is past its turning point may be drastically higher than the cost of
preventing the damage or undertaking mitigation earlier; for example, cleaning up a
polluted waterway, where the cost of avoiding the pollution in the first place is lower than
the subsequent cost of the cleanup.
 Fourth, it has been shown that countries with similar levels of wealth perform differently,
without any clear or systematic signs of convergence. Furthermore, it is been suggested that
the decreasing part of the EKC exists only for economies with less inequality and a
relatively uniform distribution of wealth.

Therefore, while there is some evidence of an EKC relationship existing for certain countries and
for certain local pollutants, it cannot be generalised to all types of environmental damage and
across all countries and income levels. Moreover, it has limited use as a predictor of
environmental performance as countries develop.

Alternative views on the economy-environment relationship

There are other alternate theories describing the relationship between economic growth and
environmental quality.

The limits theory considers the possibility of breaching environmental thresholds before the
economy reaches the EKC turning point. Commentators, such as Arrow et al., (1996), suggest

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that the risk of small changes causing catastrophic damage means that solely focusing on
economic growth to deliver environmental outcomes could be counter-productive. For example,
in the context of biodiversity, increased spending on maintaining species diversity will not be
able to recreate extinct species. The limits theory defines the economy-environment relationship
in terms of environmental damage hitting a threshold beyond which production is so badly
affected that the economy shrinks.

Another theory questions the existence of turning points, and considers the possibility that
environmental damage continues to increase as economies grow (see figure below). This is
similar to the new toxics view, where emissions of existing pollutants are decreasing with further
economic growth, but the new pollutants substituting for them increase.

Stern (2004) discusses a further possible relationship between economic growth and the
environment in the context of international competition. International competition initially leads
to increasing environmental damage, up to the point when developed countries start reducing
their environmental impact but also outsource polluting activities to poorer countries. The net
effect is, in the best case scenario, a non-improving situation (see figure below). This model is
known as ‘race to the bottom’.

Environmental damage Environmental damage Environmental damage

GDP/capita GDP/capita GDP/capita

I. Limits theory II. New Toxics & Davidson III. Race to the Bottom

Drivers of the economy-environment relationship

What these various theories demonstrate is that the relationship between economic growth and
the environment is complex and multi-dimensional. While there may be no conclusive evidence
on the shape of the economy-environment relationship, these theories provide a useful starting
point for thinking about the factors that drive this relationship. These can broadly be divided into
three effects:
 The scale effect – economic growth has a negative effect on the environment, where
increased production and consumption causes increased environmental damage;
 The composition effect – the composition of production changes along the growth path:
initially economic growth leads to industrialization (and as the goods balance shifts from
agriculture to manufactured products, environmental damage increases); but the balance

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 then shifts from producing manufactured goods to producing services, due to both demand-
and supply-side changes, reducing the level of domestic environmental damage;
 The technical effect – technological developments lead to a change in the environmental
impacts of production. Whilst this often means reductions in environmental intensity, for
example improvements in energy efficiency, it could also represent technological advances
that lead to greater environmental damage (such as through increased energy use). Changes
in the preferences of society may also drive changes in environmental damage, for example
through encouraging changes in the stringency of environmental regulation of industry.
The relative size of these effects determines the relationship between economic growth and
the environment.

Decoupling production from environmental damage

The development of cleaner technologies and more efficient use of natural resources is key to
reducing the environment impacts of production, and of economic activity more generally.
Decoupling refers to a breaking of the link between GDP and environmental damage, and can be
classified as:
 Relative, a decrease in environmental damage relative to GDP; or
 Absolute, a decrease in environmental damage even as GDP is rising.

Ekins (2000) compares GDP growth with the growth in emissions of CO2, SO2, and NOX in
seven developed countries between 1970 and 1993, and finds that while GDP rose by between
50% and 150% across the seven countries, emissions rose by less than GDP in the majority of
countries (relative decoupling) and fell in the others (absolute decoupling). Updated analysis
using OECD data up to 2005 indicates greater evidence of absolute decoupling in recent years;
for example, UK, Germany, and France report absolute decoupling for all indicators.

Decoupling in the international context

The globalised nature of the world economy means that decoupling needs to be discussed in the
international context, rather than in terms of individual countries. For example, shifting
manufacturing activities from advanced to developing countries without a significant change in
patterns of domestic consumption simply results in environmental damage being exported from
advanced to developing countries and, for global impacts, does not necessarily imply a reduction
in overall levels of environmental damage – in some cases it has even led to an increase in
environmental damage.

Chapter3

Development Problems and Factors Affecting Development

3.1. Development Problems

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3.1.1 Poverty is a complicated and multi-dimensional phenomenon that goes beyond the
monetary aspects.
It is associated with poor economies, poor human resources, poor social services provision, and
poor policies to tackle the challenges facing human and socio-economic development. Poverty
also arises when people lack access to adequate civic amenities like education and health
services. Therefore, the status, the determinants, and the policy measures required to eradicate
poverty would, by definition, vary from one country to another.
Absolute poverty-is the situation of being unable or only barely able to meet the subsistence
essentials of food, clothing, and shelter. When Necessity Displaces Desire' A new basis for an
international poverty measurement is proposed based on linear programming for specifying the
least cost diet and explicit budgeting for non-food spending.
Relative poverty means poverty defined in comparison to other people’s standing in the
economy. Thus a person can be poor in the relative sense, even if she is not poor in the absolute
sense, that is, can meet his/ her basic needs. Relative poverty can be observed by looking at
relative standings within a society, or internationally. Sometimes relative poverty is seen as a
phenomenon most relevant in societies, in which there is no acute problem with absolute
poverty, thus being an ethically less severe problem.
3.1.2 Inequality
Inequality refers to disparities and discrepancies in areas such as income, wealth, education,
health, nutrition, space, politics and social identity.
Intersecting inequalities occur when people face inequality in multiple aspects of their lives.
Vertical inequalities occur between individuals.
Horizontal inequalities occur between groups.
Inequality of outcomes refers to differences in what people achieve in life (e.g. level of
income).
Inequality of opportunities refers to differences in people’s background or circumstances that
condition what they are able to achieve.
Global inequality refers to difference in income between all individuals in the world rather than
inequalities between countries.
Measures of Poverty and Inequality

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Some measures of poverty and inequality are more frequently used in the literature compared to
others. However, all measures have their own strengths and weaknesses which are largely
derived from the quality of different variables that are used in constructing these measures.
Measures of poverty
•Headcount Index
•Poverty Gap Index
•Squared Poverty Gap Index
•Sen Index
•The Sen-Shorrocks-Thon Index
•The Watts Index
•Human Poverty Index
•Multidimensional Poverty Index (2010)
•Global Hunger Index (GHI)
•Growth Incidence Curve
•At-Risk-of-Poverty or Social Exclusion Indicator (AROPE)
Measures of inequalityeasures
•Gini Index
•Gender Development Index
•Inequality of Economic Opportunity (IEO) Index
•Polarization
•At-Risk-of-Poverty or Social Exclusion Indicator (AROPE)
Unemployment
Unemployment refers to group of people who are in a specified age (labour force), who are
without a job but are actively searching for a job. To better understand what unemployment is, it
is important to begin with classifying the whole population of a country into two major groups:
those in the labour force and those outside the labour force.
Labor force includes group of people within a specified age (for instance, people whose ages are
greater than 14 are considered as job seekers though formal employment requires a minimum of
18 years of age bracket) who are actually employed and those who are without a job but are
actively searching for a job, according to the Ethiopian labour law. Therefore, the labour force

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does not include: Children <14 and retired people age >60, and also people in mental and
correctional institutions, and very sick and disabled people etc.
Types of unemployment
1. Frictional unemployment: refers to a brief period of unemployment experienced due to.
 Seasonality of work E.g. Construction workers
 Voluntary switching of jobs in search of better jobs
 Entrance to the labor force E.g. A student immediately after graduation
 Re-entering to the labor force
2. Structural unemployment: results from mismatch between the skills or locations of job
seekers and the requirements or locations of the vacancies. E.g. An agricultural graduate looking
for a job at Piassa. The causes could be change in demand pattern or technological change.
3. Cyclical unemployment: results due to absence of vacancies. This usually happens due to
deficiency in demand for commodities/ the low performance of the economy to create jobs.
E.g. During recession
Note: Frictional and structural unemployment are more or less unavoidable; hence, they are
known as natural level of unemployment.
 What Is Inflation? Inflation is defined as a general increase in the price of goods and
services across the economy, or, in other words, a general decrease in the value of
money. Conversely, deflation is a general decrease in the price of goods and services
across the economy, or a general increase in the value of money.
Types of Inflation
 From the quantitative point of view
 Creeping inflation- the rate of inflation doesn’t exceed the rate of production growth;
Creeping inflation is < 10%
 Galloping inflation-the rate of inflation exceeds the rate of production growth, Galloping
inflation is from 10% to 100%. Money loose purchase power, people hold as little money as
possible.
 Hyperinflation- is inflation that is "out of control", a condition in which prices increase
rapidly as a currency loses its value. Hyperinflation is over 100% per year. Prices as well as
wages are extremely erratic. Money has no value and barter trade emerges (barter means the
exchange of good for good). Example: Germany after I.WW, Hungary after II.WW

21
. Open inflation- if economic imbalance is accompanied with rising price level.
 Suppressed inflation- if state authorities damp or even stop the rise of price level by
administrative means. Such situation is followed by existence of scarce commodities, shadow
economy etc. In such cases the provision of basic necessities such as agricultural products is set
by the government by introducing price controls on commodities
 Hidden inflation- government imposes strict controls to curb price inflation; producers are
forced to sell the products at the prices required. Producers cannot sell the commodity at higher
prices to get the profit, therefore, lower on the quality of products. This means that employers are
selling lower quality products at higher prices -> inflation is hidden.
Causes of Inflation
Causes of Inflation
 Demand-pull inflation
Arises when aggregate demand in an economy outpaces aggregate supply
 It involves inflation rising as real gross domestic product rises and unemployment falls. This is
commonly described as "too much money chasing too few goods".
 Possible causes of demand-pull inflation:
 Excessive investment expenditures
 Excessive growth of consumption expenditures
 Low-cost loans
 Tax cutting
 Augmentation of government expenditures
Cost-push inflation (or supply-shock inflation)-is a type of inflation caused by large increases
in the cost of important goods or services where no suitable alternative is available.
 Possible causes of cost-push inflation:
 Imperfect competition
 Increased taxes
 Rising wages
 Political incidents (like oil crises)
Built-in inflation (or Anticipated inflation)
 induced by adaptive expectations, often linked to the "price/wage spiral“

22
 it involves workers trying to keep their wages up with prices and then employers passing
higher costs on to consumers as higher prices as part of a "vicious circle.“
 Built-in inflation reflects events in the past, and so might be seen as hangover inflation.
Effects of Inflation
Redistribution effect of inflation
 Inflation affects recipients of fixed income firstly (nominal incomes remain same but the real
value of income drop)
 Inflation affects the purchasing power of wages that don’t follow the rise of prices
 Inflation causes diminishing value of loans and savings
Social impact of inflation
 Socially poor persons suffer from inflation more then rich

Impact on economy balance

 Fall of real product bellow potential product
 Changes in the structure of consumption (consumers are buying cheaper goods)
 In case of fixed currency exchange rate higher exports are incited
Inflation deforms prices
 Inflation causes higher costs and makes economy less efficient
 Creeping and anticipated inflation has positive effect on economy and stimulates economic
growth
 High inflation and not anticipated inflation are serious problems in economy
Stopping the inflation
 There are a number of methods which have been suggested to stop inflation.
 Managing the wages and prices – determined by state income policy (authority can set
wages ceiling)
 Stimulating market competition – e.g. antimonopoly regulations
 Fiscal and monetary policy – e.g. central banks can affect inflation to a significant extent
through setting interest rates
Factors of Development
A) Economic Factors

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Economists regard factors of production as the main economic forces that determine growth. The
growth rate of the economy rises or falls as a consequence of changes in them. Some of the
economic factors are discussed below:
Natural Resources- The principal factor affecting the development of an economy is the natural
resources or land. “Land” as used in economics includes natural resources such as the fertility of
land, its situation and composition, forest wealth, minerals, climate, water resources, sea
resources etc. For economic growth, the existence of natural resources in abundance is essential.
A country which is deficient in natural resources will not be in a position to develop rapidly. As
pointed out by Lewis, “Other things being equal, men can make better use of rich resources than
they can of poor
Capital Accumulation. The second important economic factor in growth is capital
accumulation. Capital means the stock of physical reproducible factors of production. When the
capital stock increases with the passage of time, this is called capital accumulation (or capital
formation). The process of capital formation is cumulative and self-feeding and includes three
inter-related stages:
(a) The existence of real savings and rise in them;
(b) The existence of credit and financial institutions to mobilize savings and to divert them in
desired channels; and
(c) To use these savings for investment in capital goods.
Organization- It is an important part of the growth process. It relates to the optimum use of
factors of production in economic activities. Organization is complement to capital and labour
and helps in increasing their productivities. In modern economic growth, the entrepreneur has
been performing the task of an organizer and undertaking risks and uncertainties.
The entrepreneur is not a man of ordinary ability. He is an economic leader who possesses the
ability to recognize opportunities for successful introduction of new commodities, new
techniques, and new sources of supply, and to assemble the necessary plant and equipment,
management and labour force and organize them into a running concern. He is the kingpin of any
business enterprise for without him the wheels of industry cannot move.
Technological Progress Technological changes are regarded as the most important factor in the
process of economic growth. They are related to changes in the methods of production which are

24
the result of some new techniques of research or innovation. Changes in technology lead to
increase in the productivity of labour, capital and other factors of production.
Kuznets traces five distinct patterns in the growth of technology in modern economic growth.
They are: a scientific discovery or an addition to technical knowledge; an invention; an
innovation; an improvement; and the spread of invention usually accompanied by improvements.
Division of Labour and Scale of Production They lead to economies of large-scale production
which further help in industrial development. They increase the rate of economic development.
Adam Smith gave much importance to the division of labour in economic development. Division
of labour leads to improvement in the productive capacities of labour. Every laborer becomes
more efficient than before. He saves time. He is capable of inventing new machines and
processes in production. Ultimately, production increases manifold. But division of labour
depends upon the size of the market. The size of the market, in turn, depends upon economic
progress, that is, the extent to which the size of demand, the general level of production, the
means of transport, etc., are developed. When the scale of production is large there is greater
specialization and division of labour. As a result, production increases and the rate of economic
progress is accelerated. Larger pecuniary external economies are available and benefits of
indivisibilities accrue.
Structural Changes-Structural changes imply the transition from a traditional agricultural
society to a modern industrial economy involving a radical transformation of existing
institutions, social attitudes, and motivations.
Such structural changes lead to increasing employment opportunities, higher labour productivity
and the stock of capital, exploitation of new resources and improvement in technology.
Non-economic factors
There are, therefore, numerous non-economic factors that may impact on the process of
economic growth and economic development. These factors are: culture; religion; class and
family; tradition; the role of individual; sociopolitical dependencies; the role of government; and
existence of duality in the society.

As far as culture is concerned, the culture of a society can be a major impetus for economic
development. Societies which have considerable potential for economic development, such as
discipline and positive attitudes towards work, capital accumulation, production, and the quantity
and quality of consumption are in a better position to become economically developed than those
25
which are deprived of these attitudes. Although rapid progress in communication technology has
affected traditional societies, traditional and peasant societies still predominate in Third World
countries.

Political dependency is also another non economic factor of development. Political dependency
which is one of the main characteristics of Third World countries is a fifth non-economic factor
in development. After World War II, despite the end of the colonization period, dependency of
weak countries on powerful countries continued but in a different way. The political
environment of a country, which is often closely linked to its history, also has a significant
impact on its level of development. In general, governments have the power to take actions
which direct a country's social and economic development. In many developing countries with
unstable political histories, however, government corruption and greed have caused problems
which have hindered such progress.

In most historical cases, colonization has occurred as a result of the colonizing power's desire to
exploit new lands and peoples for their own economic and political gain. Natural resources,
agricultural commodities, minerals, plants and spices are some common examples of products
that colonizing powers throughout history have taken from their colonies. In addition to this, the
indigenous populations of colonies have often been forced to work under slave-like conditions
for colonizing powers. In almost all instances, land has been taken away from indigenous
peoples and divided amongst colonial settlers.

Apart from the exploitation of underdeveloped countries by developed ones, there are at least
two aspects in the association between these countries that prevent Third World countries from
achieving appropriate economic development.
 Developed countries, and the international organisations (IMF, World Bank, etc.) that they
dominate, tend to control developing countries politically and economically in ways that
serve their own economic interests. This is not necessarily concordant with the long-term
benefits of underdeveloped countries. As a result, Third World countries have often to
follow projects and plans that are not normally appropriate to their social and economic
potential. After some time, not only do they not progress, but their dependency has been

26
 aggravated - because of wastage of economic resources. The experience of the last forty
years of economic development in Third World countries is the best evidence of this.

 Political dependency has caused instability in underdeveloped countries, which, in turn,

causes capital flight from them to developed ones. Thus, even if there are enough
entrepreneurs in developing countries, given that the political situation is not reliable for
long-term investment, they still prefer to transfer their capital to developed countries.

Many countries lack basic infrastructure, such as roads, water and power utilities, hospitals,
schools and welfare services for the disadvantaged. In most developing countries, this is because
there is not enough public money (money raised by the government through taxes and national
industries) to invest in the infrastructure which ensures that people's basic needs are met. A lack
of government spending on promoting contraception (prevention of pregnancy) in some
developing countries has also seen birth rates rise considerably. High birth rates in developing
countries exacerbate problems related to poverty, as often these countries do not have the social
or economic stability to support such a large population.

Social and cultural dependency can be also another non economic factor to development.
Nowadays, the rapid spread of communication and transportation technologies has resulted in
many social and cultural values in developed countries being transferred to underdeveloped
countries.

One significant environmental factor that can contribute to a country's level of development is
the availability of natural resources. Countries naturally rich in coal and oil, for example, do not
need to spend money on importing these resources, which are used to produce energy. When
exported, natural resources also generate wealth for countries, which means that money can then
be spent on other, new industries. Countries with well-developed industries are able to provide
jobs, infrastructure and services for their populations, which increase the overall quality of life of
their citizens. Other natural factors that create and exacerbate global inequalities are natural
disasters, such as floods, hurricanes and volcanic eruptions.

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4. Theories of Development

Theories of development and under development

What is theory?
Theory is a formal statement of rules, ideas, and principles, techniques that applies to a certain
subject or phenomena. It is also a critique, revision and summing up of past knowledge in a form
of general preposition or fusion of diverse views to explain the variation of specified phenomena.

Development theory is a conglomeration or a collective vision of theories about how desirable

change in society is best achieved. Such theories draw on a variety of social science disciplines
and approaches. Theories of development are the principal theoretical explanations to interpret
development efforts carried out especially in the developing countries. These theoretical
perspectives allow us not only to clarify concepts, to set them in economic and social
perspectives, but also to identify recommendations in terms of social policies.

Rostow’s stage of Economic Development

According to Rostow’s, Societies will inevitably move through four stages of development:
traditions, preconditions, take off, drive to maturity, capitalist heaven. He argues that within a
society sequential economic steps of modernization can be identified. These steps are linear and
towards an evolutional higher development. He identifies five growth stages (Figure 1):

Figure 1. Rostow's five-stage model of development

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(Source: Potter, Binns, Eliott & Smiith 1999: 51)

1. The Traditional Society

The economic system is stationary and dominated by agriculture with traditional cultivating
forms. Productivity by man-hour work is lower, compared to the following growth stages. The
society characterizes a hierarchical structure and so there is low vertical as well as social mobility.

2. The Preconditions for Take-Off

During this stage the rates of investment are getting higher and they initiate a dynamic
development. This kind of economical development is a result of the industrial revolution. As a
consequence of this transformation, which includes development of the agriculture too,
workforces of the primary sector become redundant. A prerequisite for “The Preconditions for
Take-Off” is industrial revolution, which lasted for a century.

3. Take Off
According to Rostow’s model, a country needed to follow some rules of development to reach
the take-off: (1) The investment rate of a country needs to be increased to at least 10% of
its GDP, (2) One or two manufacturing sectors with a high rate of growth need to be
established, (3) An institutional, political and social framework has to exist or be created in
order to promote the expansion of those sectors.

This stage is characterized by dynamic economic growth. The main characteristic of this
economic growth is self sustained growth which requires no exogenous inputs. Like the textile
industry in England, a few leading industries can support development. Generally “Take Off”
lasts for two to three decades, e.g. in England it took place by the middle of the 17 C or in
Germany by the end of the 17 C.

4. The Drive to Maturity

This stage is characterized by continual investments by 40 to 60 per cent. It is dominated by
economic and technical progress. Here, there is a continuous employment growth, growth in
national income, rise of consumer demands, and strong domestic markets. New forms of
industries like neo-technical industries emerge, e.g. electrical industry, chemical industry or
mechanical engineering. Neo-technical industries supplement the paleo- technical industries. As a
29
consequence of this transformation social and economic prosperity, especially the latter, increase.
Generally “The Drive to Maturity” starts about 60 years after “Take Off”. In Europe this
happened by 1900.

5. The Age of high Mass Consumption

This is the final step in Rostow’s five-stage model of development. Here, most parts of society
lives in prosperity and persons living in this society are offered both abundance and a multiplicity
of choices. According to him the West or ‘the North’ belongs today in this category.

The Rostow’s model has serious flaws, of which the most serious are:

 The model assumes that development can be achieved through a basic sequence of stages
which are the same for all countries, a doubtful assumption;
 The model measures development solely by means of the increase of GDP per capita;
 The model focuses on characteristics of development, but does not identify the causal
factors which lead development to occur. As such, it neglects the social structures that have
to be present to foster development.

Core-periphery model

What is the Core Periphery Model?

 It was developed in 1963 by John Friedman
 The core periphery model shows spatially how economic, political, and cultural authority
is dispersed in core or dominant regions and the surrounding peripheral and semi-
peripheral regions.

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The Core
 Countries in the Core: Europe, United States, Canada, Australia, New Zealand, Israel,
Japan, and South Korea.
 Countries in the Core have:
 Higher Wages
 Healthcare
 More technologies
 Sufficient food, water, shelter, supplies, etc.
 Scientific Innovations
 Core countries possess many advantages like humans or resources but can also exploit
colonies that they have for resources.
The Periphery
 Countries in the periphery are in Africa, South America, Asia
 Countries in the periphery have:
 Lower Wages
 Less technological advancements
 Reduced access to healthcare
 Sometimes insufficient food, water, shelter, etc.

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  There is massive population to keep up with the rural lifestyles that many in these
countries have since they are lower in the Demographic Transition Model.
 Countries in the Periphery are usually characterized as poor and many times families live
in slums instead or rural areas.
 There are low standards of living.
 Despite low living standards, there has been some improvement to several areas (mainly
in China) that increase the lifestyle there.
 Also, many people in the Periphery are moving from the rural lands into urban areas
creating megacities.
Colonization and the Core Periphery Model
 Many countries in the Core had or have colonies that they get resources from.
 Britain had many African countries as colonies and used a lot of resources which has
created come conflict.
 Many countries like these got resources from the colony, processed it, and then sold it
back to the periphery countries.
 The damage done by the Core countries have left the Periphery countries so far behind
that it may be impossible to now compete in the global market.
Core-Periphery Conflicts
 The Demilitarized zone between North and South Korea.
 The border of the United States and Mexico to prevent illegal immigrants.
 Air and naval patrols between various countries
 Super imposed boundaries in many countries have created massive conflict as well.
 Not just global but local conflicts between wages and more.

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Modernization theory
Modernization theory is used to analyze in which modernization processes in societies take
place. This theory basically depends on two theories: Evolutionary and Functionalist.

Evolutionary theory suggests that other nations should follow the paths or ways in which
western nations would have been followed to develop. The modernization theory is mainly based
on evolutionary view.

Functionalist theory has its roots from biology and relates fields and suggests that an organism
is made up of a number of organs and the well functioning of an organ determines the well
functioning of a system which ultimately determines the wellbeing or life of the organism. Here,
organs are treated as different institutions.

The basic premise of modernization theory is that the theory saw economic development as a
universal process upon which all states would embark. As economic development advanced,
political systems would move toward democratization. E.g. Rostow: The Stages of Economic
Growth 1961: The major assumptions of the modernization theory of development basically are:
 Modernization is a phased process; for example Rostow has 5 phases according to his theory
of economic development for a particular society,

33
 Modernization is a homogenizing process, in this sense, we can say that modernization
produces tendencies toward convergence among societies, for example, Levy (1967, p. 207)
maintains that : “as time goes on, they and we will increasingly resemble one another
because the patterns of modernization are such that the more highly modernized societies
become, the more they resemble one another”.

 Modernization is an Europeanization or Americanization process; in the modernization

literature, there is an attitude of complacency toward Western Europe and the United States.
These nations are viewed as having unmatched economic prosperity and democratic stability
(Tipps: 1976, 14).

 In addition, modernization is an irreversible process, once started modernization cannot be

stopped. In other words, once third world countries come into contact with the West, they
will not be able to resist the impetus toward modernization.

 Modernization is a progressive process which in the long run is not only inevitable but
desirable. According to Coleman, modernized political systems have a higher capacity to
deal with the function of national identity, legitimacy, penetration, participation, and
distribution than traditional political systems.

 Finally, modernization is a lengthy process. It is an evolutionary change, not a revolutionary

one. It will take generations or even centuries to complete, and its profound impact will be
felt only through time. All these assumptions are derived from European and American
evolutionary theory.

There is also another set of classical assumptions based more strictly on the functionalism-
structuralism theory which emphasizes the interdependence of social institutions, the importance
of structural variables at the cultural level, and the built in process of change through
homeostasis equilibrium. These are ideas derived especially from Parsons’ sociological
theories. These assumptions are as follows:

 Modernization is a systematic process. The attribute of modernity forms a consistent

whole, thus appearing in a cluster rather than in isolation;

34
  Modernization is a transformative process; in order for a society to move into modernity
its traditional structures and values must be totally replaced by a set of modern
values; and
 Modernization is an imminent process due to its systematic and transformative nature,
which builds change into the social system.

The strengths of modernization theory can be defined in several aspects. First, we can identify
the basis of the research focus. A second feature of the modernization perspective is the
analytical framework. Authors assume that Third World countries are traditional and that
Western countries are modern. In order to develop, those poor nations need to adopt Western
values. In third place, the methodology is based on general studies; for example the expositions
regarding the value factors in the Third World, and the differentiation between unstable
democracies, dictatorships and stable dictatorships.

Criticisms of the theory include the following: First, development is not necessarily
unidirectional. This is an example of the ethnocentricity of Rostow’s perspective. Second, the
modernization perspective only shows one possible model of development. The favored
example is the development pattern in the United States. Nevertheless, in contrast with this
circumstance, we can see that there have been development advances in other nations, such as
Taiwan and South Korea; and we must admit that their current development levels have been
achieved by strong authoritarian regimes.

Dependency Theory

Dependency can be defined as an explanation of the economic development of a state in terms

of the external influences--political, economic, and cultural--on national development
policies (Osvaldo 1969, p. 23). Theotonio Dos Santos emphasizes the historical dimension of the
dependency relationships in his definition: [Dependency is]...an historical condition which
shapes a certain structure of the world economy such that it favors some countries to the
detriment of others and limits the development possibilities of the subordinate economics...a
situation in which the economy of a certain group of countries is conditioned by the development
and expansion of another economy, to which their own is subjected.

35
The basic premise of this theory is colonialism and imperialism prevent or distort development—
progression through Marx’s stages—because of unequal terms by which the colony or dependent
state is incorporated into the capitalist economy. Advocators of this theory believed that for
capital formation developing nations on developed/former colonizers so that the root cause for
their underdevelopment is this dependence. The major hypotheses with regard to development in
Third World countries according to the dependency school are the following:
 First, in contrast to the development of the core nations which is self-contained, the
development of nations in the Third World necessitates subordination to the core. Examples
of this situation can be seen in Latin America, especially in those countries with a high
degree of industrialization, such as Sao Paulo, Brazil

 Second, the peripheral nations experience their greatest economic development when their
ties to the core are weakest. An example of this circumstance is the industrialization process
that took root in Latin America during the 1930s, when the core nations were focusing on
solving the problems that resulted from the Great Depression, and the Western powers were
involved in the Second World War.

 A third hypothesis indicates that when the core recovers from its crisis and reestablishes
trade and investments ties, it fully incorporates the peripheral nations once again into the
system, and the growth of industrialization in these regions is stifled.

 Lastly, the fourth aspect refers to the fact that regions that are highly underdeveloped and still
operate on a traditional, feudal system are those that in the past had the closest ties to core.

The foundations of the theory of dependency emerged in the 1950s of which one of the most
representative authors was Raul Prebisch. The principal points of the Prebisch model are that in
order to create conditions of development within a country, it is necessary:
 To control the monetary exchange rate, placing more governmental emphasis on fiscal
rather than monetary policy;

 To promote a more effective governmental role in terms of national development;

 To create a platform of investments, giving a preferential role to national capitals;

36
  To allow the entrance of external capital following priorities already established in
national plans for development;

 To promote a more effective internal demand in terms of domestic markets as a base to

reinforce the industrialization process in Latin America;

 To generate a larger internal demand by increasing the wages and salaries of workers,
which will in turn positively affect aggregate demand in internal markets;

 To develop a more effective coverage of social services from the government, especially
to impoverished sectors in order to create conditions for those sectors to become more
competitive; and

 To develop national strategies according to the model of import substitution, protecting

national production by establishing quotas and tariffs on external markets.

The principal critics of the dependency theory have focused on the fact that this school does not
provide exhaustive empirical evidence to support its conclusions. Furthermore, this theoretical
position uses highly abstract levels of analysis. Another point of critique is that the dependency
movement considers ties with transnational corporations as being only detrimental to countries,
when actually these links can be used as a means of transference of technology. In this sense, it
is important to remember that the United States was also a colony, and this country had the
capacity to break the vicious cycle of underdevelopment.

Three issues made this policy difficult to follow. The first is that the internal markets of the
poorer countries were not large enough to support the economies of scale used by the richer
countries to keep their prices low. The second issue concerned the political will of the poorer
countries as to whether a transformation from being primary products producers was possible or
desirable. The final issue revolved around the extent to which the poorer countries actually had
control of their primary products, particularly in the area of selling those products abroad. These
obstacles to the import substitution policy led others to think a little more creatively and
historically at the relationship between rich and poor countries.

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Neo liberalism Theory

According to this theory, stagnation in structural change is due to poorly designed domestic
policy and political factors. Early contributors to this theory are Adam Smith and David Ricardo.
Classical economists argued - as do the neoclassical ones - in favor of the free market, and
against government intervention in those markets. The 'invisible hand' of Adam Smith makes
sure that free trade will ultimately benefit all of society.

One of the implications of the neoclassical development theory for developing countries were
the Structural Adjustment Programmes (SAPs) which the World Bank and the International
Monetary Fund wanted them to adapt. Important aspects of those SAPs include:
 Fiscal austerity (reduction in government spending)
 Privatization (which should both raise money for governments and improve efficiency and
financial performance of the firms involved)
 Trade liberalization, currency devaluation and the abolition of marketing boards (to
maximize the static comparative advantage the developing country has on the global market)
 Retrenchment of the government and deregulation (in order to stimulate the free market)

The New (Endogenous) Growth Theory

Endogenous growth theory explains long-run growth as emanating from economic activities that
create new technological knowledge. Endogenous growth is long-run economic growth at a rate
determined by forces that are internal to the economic system, particularly those forces
governing the opportunities and incentives to create technological knowledge. In the long run the
rate of economic growth, as measured by the growth rate of output per person, depends on the
growth rate of total factor productivity (TFP), which is determined in turn by the rate of
technological progress. The neoclassical growth theory of Solow (1956) and Swan (1956)
assumes the rate of technological progress to be determined by a scientific process that is
separate from, and independent of, economic forces. Neoclassical theory thus implies that
economists can take the long-run growth rate as given exogenously from outside the economic
system. Endogenous growth theory challenges this neoclassical view by proposing channels
through which the rate of technological progress, and hence the long-run rate of economic
growth, can be influenced by economic factors. It starts from the observation that technological

38
progress takes place through innovations, in the form of new products, processes and markets,
many of which are the result of economic activities. For example, because firms learn from
experience how to produce more efficiently, a higher pace of economic activity can raise the
pace of process innovation by giving firms more production experience. Also, because many
innovations result from R&D expenditures undertaken by profit-seeking firms, economic
policies with respect to trade, competition, education, taxes and intellectual property can
influence the rate of innovation by affecting the private costs and benefits of doing
R&D(Research and Development).

Criticisms of Endogenous Growth Theory

An important shortcoming of the new growth theory is that it remains dependent on a number of
traditional neoclassical assumptions that are often inappropriate for developing economies. For
example, it assumes that there is but a single sector of production or that all sectors are
symmetrical. This does not permit the crucial growth-generating reallocation of labor and capital
among the sectors that are transformed during the process of structural change. Moreover,
economic growth in developing countries is frequently impeded by inefficiencies arising from
poor infrastructure, inadequate institutional structures, and imperfect capital and goods markets.
Because endogenous growth theory overlooks these very influential factors, its applicability for
the study of economic development is limited, especially when country-to-country comparisons
are involved.
For example, existing theory fails to explain low rates of factory capacity utilization in low-
income countries where capital is scarce. In fact, poor incentive structures may be as responsible
for sluggish GNI growth as low rates of saving and human capital accumulation. Allocation
inefficiencies are common in economies undergoing the transition from traditional to
commercialized markets. However, their impact on short- and medium-term growth has been
neglected due to the new theory’s emphasis on the determinants of long-term growth rates.
Finally, empirical studies of the predictive value of endogenous growth theories have to date
offered only limited support.
Balanced Versus Unbalanced Growth

39
A major development debate from the 1940s through the 1960s concerned balanced growth
versus unbalanced growth. Some of the debate was semantic, as the meaning of balance can
vary from the absurd requirement that all sectors grow at the same rate to the more sensible plea
that some attention be given to all major sectors – industry, agriculture, and services. However,
absurdities aside, the discussion raised some important issues. What are the relative merits of
strategies of gradualism versus a big push? Is capital or entrepreneurship the major limitation to
growth?
BALANCED GROWTH
The synchronized application of capital to a wide range of different industries is called balanced
growth by its advocates. Ragnar Nurkse (1953) considers this strategy the only way of escaping
from the vicious circle of poverty. He does not consider the expansion of exports promising,
because the price elasticity of demand (minus percentage change in quantity demanded divided
by percentage change in price) for the LDCs’ predominantly primary exports is less than one,
thus reducing export earnings with increased volume, other things being equal.

Those advocating this synchronized application of capital to all major sectors support the big
push thesis, arguing that a strategy of gradualism is doomed to failure. A substantial effort is
essential to overcome the inertia inherent in a stagnant economy. The situation is analogous to a
car being stuck in the snow: It will not move with a gradually increasing push; it needs a big
push.

For Paul N. Rosenstein-Rodan (1943), the factors that contribute to economic growth, such as
demand and investment in infrastructure, do not increase smoothly but are subject to sizable
jumps or indivisibilities. These indivisibilities result from flaws created in the investment market
by external economies, that is, cost advantages rendered free by one producer to another. These
benefits spill over to society as a whole, or to some member of it, rather than to the investor
concerned.
As an example, the increased production, decreased average costs, and labor training and
experience that result from additional investment in the steel industry will benefit other
industries as well. Greater output stimulates the demand for iron, coal, and transport. Lower costs
may make vehicles and aluminum cheaper. In addition other industries may benefit later by
hiring laborers who acquired industrial skills in the steel mills. Thus, the social profitability of

40
this investment exceeds its private profitability. Moreover, unless government intervenes, total
private investment will be too low.
Indivisibility in infrastructure
For Rosenstein-Rodan, a major indivisibility is in infrastructure, such as power, transport, and
communications. This basic social capital reduces costs to other industries. To illustrate, the
railroad from Kanpur to the
Calcutta docks increases the competitiveness of India’s wool textiles domestically and abroad.
However, the investment for the 950-kilometer, Kanpur–Calcutta rail line is virtually indivisible,
in that a line a fraction as long is of little value. Building the Aswan Dam or the Monterrey–
Mexico City telegraph line is subject to similar discontinuities.
Indivisibility in demand
This indivisibility arises from the interdependence of investment decisions; that is, a prospective
investor is uncertain whether the output from his or her investment project will find a market.
Rosenstein-Rodan uses the example of an economy closed to international trade to illustrate this
indivisibility. He assumes that there are numerous subsistence agricultural laborers whose work
adds nothing to total output (that is, the marginal productivity of their labor equals zero). If 100
of these farm workers were hired in a shoe factory, their wages would increase income.
If the newly employed workers spend all of their additional income on shoes they produce the
shoe factory will find a market and would succeed. In fact, however, they will not spend all of
their additional income on shoes. There is no “easy” solution of creating an additional market in
this way. The risk of not finding a market reduces the incentive to invest, and the shoe factory
investment project will probably be abandoned. (Rosenstein-Rodan 1951:62)

However, instead, let us put 10,000 workers in 100 factories (and farms) that among them will
produce the bulk of consumer goods on which the newly employed workers will spend their
wages. What was not true of the shoe factory is true for the complementary system of 100
enterprises. The new producers are each others’ customers and create additional markets through
increased incomes. Complementary demand reduces the risk of not finding a market. Reducing
interdependent risks increases the incentive to invest.

THE MURPHY–SHLEIFER–VISHNY MODEL

41
Kevin Murphy, Andrei Shleifer, and Robert Vishny (1989:537–564) analyze an economy in
which world trade is costly – perhaps today, Bolivia, where a majority of the population live on a
high plateau between two north–south Andes mountain chains; landlocked east-central African
states Rwanda, Burundi, Uganda, or Malawi; or isolated islands Papua New Guinea; or, in the
19th century, the United States, Australia, or Japan. Domestic agriculture or exports may not be
sufficient for industrialization, so these economies need large domestic markets, `a la
Rosenstein-Rodan. For increasing returns from sliding down the initial part of a U-shaped long-
run average cost curve (representing successive plants with more specialized labor and
equipment), sales must be high enough to cover fixed setup costs.

To illustrate, “in the first half of the nineteenth century, the United States greatly surpassed
England in the range of consumer products it manufactured using mass production techniques”
(ibid., p. 538). In contrast to high-quality English artisan products for a quality-conscious upper
class, American producers offered standardized mass-produced utilitarian items, largely bought
by relatively well-off farmers and other middle classes. Colombia’s tobacco export boom failed
to lead to widespread economic development, as incomes went to a few plantation owners who
spent on luxury imports. Later, from 1880 to 1915, however, the boom in coffee exports, grown
on small family enterprises, benefited large numbers demanding domestic manufactures (ibid., p.
539). For industrialization, incomes from the leading sector must be broadly distributed,
providing demand for manufactures.

CRITIQUE OF BALANCED GROWTH

Advocates of balanced growth emphasize a varied package of industrial investment at the
expense of investment in agriculture, especially exports. Recent experience indicates that LDCs
cannot neglect agricultural investment if they are to feed their population, supply industrial
inputs, and earn foreign currency.
Furthermore, infrastructure is not so indivisible as Rosenstein-Rodan implies. Roads, rivers,
canals, or air traffic can substitute for railroads. Roads may be dirt, graveled, blacktopped, or
paved and of various widths. Power plants can differ greatly in size, and telegram and telephone
systems can be small, large, or intermediate.
Large infrastructure facilities, although perhaps economical at high levels of economic
development, are not essential for LDC growth (Hagen 1980:89–90).

42
[

Some critics argue that the resources required for carrying out a policy of balanced growth are so
vast that a country that could invest the required capital would not, in fact, be underdeveloped. In
fact, farm workers with zero marginal labor productivity are not available (Chapter 9). In any
case, where will a LDC obtain the capital, skilled labor, and materials needed for such wide
industrial expansion? We cannot forget that although new industries may be complementary on
the demand side, they are competitors for limited resources on the supply side.
Advocates of balanced growth assume LDCs start from scratch. In reality every developing
country starts from a position that reflects previous investment decisions.
Thus, at any time, there are highly desirable investments programs not balanced in themselves
but well integrated with existing capital imbalances.
HIRSCHMAN’S STRATEGY OF UNBALANCE
Albert O. Hirschman (1958) develops the idea of unbalanced investment to complement existing
imbalances. He contends that deliberately unbalancing the economy, in line with a predesigned
strategy, is the best path for economic growth. He argues that the big push thesis may make
interesting reading for economists, but it is gloomy news for the LDCs: They do not have the
skills needed to launch such a massive effort.
The major shortage in LDCs is not the supply of savings, but the decision to invest by
entrepreneurs, the risk takers and decision makers. The ability to invest is dependent on the
amount and nature of existing investments. Hirschman believes poor countries need a
development strategy that spurs investment decisions.
He suggests that since resources and abilities are limited, a big push is sensible only in
strategically selected industries within the economy. Growth then spreads from one sector to
another (similar to Rostow’s concept of leading and following sectors).

However, investment should not be left solely to individual entrepreneurs in the market, as the
profitability of different investment projects may depend on the order in which they are
undertaken. For example, assume investment in a truck factory yields a return of 10 percent per
year; in a steel factory, 8 percent, with the interest rate 9 percent. If left to the market, a private
investor will invest in the truck factory. Later on, as a result of this initial investment, returns on
a steel investment increase to 10 percent, so then the investor invests in steel.

43
Assume, however, that establishing a steel factory would increase the returns in the truck factory
in the next period from 10 to 16 percent. Society would be better off investing in the steel factory
first, and the truck enterprise second, rather than making independent decisions based on the
market. Planners need to consider the interdependence of one investment project with another so
that they maximize overall social profitability. They need to make the investment that spurs the
greatest amount of new investment decisions. Investments should occur in industries that have
the greatest linkages, including backward linkages to enterprises that sell inputs to the industry,
and forward linkages to units that buy output from the industry. The steel industry, with
backward linkages to coal and iron production, and forward linkages to the construction and
truck industries, has good investment potential, according to Hirschman.
Even a government that limits its major role to providing infrastructure can time its investment
projects to spur private investments. Government investment in transport and power will increase
productivity and thus encourage investment in other activities.

Initially, planners trying to maximize linkages will not want to hamper imports too much,
because doing so will deprive the country of forward linkages to domestic industries using
imports. In fact, officials may encourage imports until they reach a threshold in order to create
these forward linkages. Once these linkages have been developed, protective tariffs will provide
a strong inducement for
CRITIQUE OF UNBALANCED GROWTH
Hirschman fails to stress the importance of agricultural investments. According to him,
agriculture does not stimulate linkage formation so directly as other industries.
However, empirical studies indicate agriculture has substantial linkages to other sectors;
moreover, agricultural growth makes vital contributions to the nonagricultural sector through
increased food supplies, added foreign exchange, labor supply, capital transfer, and larger
markets (Johnston and Mellor 1961:571–581).

What constitutes the proper investment balance among sectors requires careful analysis. In some
instances, imbalances may be essential for compensating for existing imbalances. By contrast,
Hirschman’s unbalanced growth should have some kind of balance as an ultimate aim.

44
Generally, the concepts of balance and imbalance are of limited value. To be helpful, their
meanings need to be defined carefully in specific decision-making contexts.
[

Coordination Failure: The O-Ring Theory of Economic Development

Balanced and unbalanced growth advocates focus on preventing or overcoming coordination
failure. Michael Kremer (1993) uses the 1986 space shuttle Challenger as a metaphor for
coordinating production in “The O-Ring Theory of Economic Development.”
The Challenger had thousands of components, but it exploded because the temperature at which
it was launched was so low that one component, the O-rings, malfunctioned. In a similar fashion,
Kremer proposes a production function in which “production consists of many tasks, [either
simultaneous or sequential], all of which must be successfully completed for the product to have
full value” (ibid., p. 551).
To illustrate, a violinist who plays off key or misses the beat can ruin a whole symphony
orchestra. This function describes production processes subject to mistakes in any of several
tasks. You cannot substitute quantity for quality; indeed, “quality is job one.” This production
function does not allow the substitution of quantity (two mediocre violinists, copyeditors, chefs,
or goalkeepers) for quality (one good one). Highly skilled workers who make few mistakes will
be matched together, with wages and output rising steeply with skill.2 Rich countries specialize
in complicated products, such as aircraft, whereas poor countries produce simpler goods, such as
textiles and coffee. Kremer thinks the O-ring theory can explain why rich countries specialize in
more complicated products, have larger firms, and have astonishingly higher worker productivity
and average incomes than poor countries.
Taiwan and South Korea, otherwise ready for takeoff in the mid-1960s, relied on government action to
override coordination failure. Both countries have a reasonably skilled labor force but a low
endowment of physical capital, especially for taking advantage of scale economies. Additionally,
some labor skills are not available locally and some technologies are not readily transferable
internationally (Rodrik 2000:195– 201).
Korea’s government provided the initiative, subsidized capital, and guaranteed markets to
chaebols, such as Hyundai and Lucky Goldstar, allowing them to internalize spillovers from one
affiliate to another (ibid., p. 197). For example, “Hyundai used its cement plant . . . to train its
managers with background in construction, before assigning them to other manufacturing
affiliates” (Amsden 1989).

45
Taiwan’s government took the initial steps in establishing enterprises such as plastics, textiles,
fibers, steel, and electronics. In some instances, such as plastics, the state firm was handed over
to private entrepreneurs on completion (Rodrik 2000:198– 199).

For Mankiw, Romer, and Weil (1992:407–437), human capital, and for Romer, endogenous
(originating internally) technology, when added to physical capital and labor in neoclassical
growth theory, are important factors contributing to economic growth. Microeconomic studies by
Gregory Clark (1987:141–173) indicate that an early-20th-century New England (U.S.) cotton
textile mill operative, with the same equipment, “performed as much work as 1.5 British, 2.3
German, and nearly 6 Greek, Japanese, Indian, or Chinese workers.”
Implications of the O-Ring Theory
The analysis has several important implications:
• Firms tend to employ workers with similar skills for their various tasks.
• Workers performing the same task earn higher wages in a high-skill firm than in a low-skill
firm.
• Because wages increase in q at an increasing rate, wages will be more than proportionally
higher in developed countries than would be predicted from standard measures of skill.
• If workers can improve their skill level and make such investments, and if it is in their interests
to do so, they will consider the level of human capital investments made by other workers as a
component of their own decision about how much skill to acquire. Put differently, when those
around you have higher average skills, you have a greater incentive to acquire more skills. This
type of complementarily should by now be a familiar condition in which multiple equilibriums
can emerge; it parallels issues raised in our analysis of the big push model.
• One can get caught in economy wide low-production-quality traps. This will occur when there
are (quite plausibly) O-ring effects across firms as well as within firms. Because there is an
externality at work, there could thus be a case for an industrial policy to encourage quality
upgrading, as some East
Asian countries have undertaken in the past. This could be relevant for a country trying to escape
the middle-income trap.
• O-ring effects magnify the impact of local production bottlenecks because such bottlenecks
have a multiplicative effect on other production.

46
• Bottlenecks also reduce the incentive for workers to invest in skills by lowering the expected
return to these skills.

Orthodox Marxists and Neo-Marxian theories

Orthodox Marxists tend to base their analysis on what is actually occurring in the third world,
and see neo-Marxist analyses to be overly vague, even wrong. For Orthodox Marxists,
development is always uneven; therefore that the third world is underdeveloped by the first is not
a new problem. However, they see it as a problem to treat the world as a whole. They prefer a
state-centered, class struggle – after all, the third world has many countries at different stages of
development. Orthodox Marxists also argue that neo-Marxists focus on external exploitation
which deflects from internal dynamics. Orthodox Marxists featured here are Laclau, Brenner
(1977), Warren (1973, 1991), and Sender & Smith.
According to neo-Marxists, with in a nation there is exploitation of a certain group by the other
but more emphasis is given to the exploitation that exists between nations. They give more focus
to international exploitation. They support class struggle to overcome domestic exploitation and
delinking former colonies with their colonizers to overcome international exploitation.
Therefore, neo-Marxists give elites the opportunity to use ‘underdevelopment’ and ‘dependency’
to their own advantage to serve the masses… so they say, but actually they serve their own
interests. They all are criticized for their failure to consider the role of connection.

However, Marxists theorists viewed the persistent poverty as a consequence of capitalist

exploitation. And a new body of thought, called the world systems approach, argued that the
poverty was a direct consequence of the evolution of the international political economy into a
fairly rigid division of labor which favored the rich and penalized the poor. In addition to its
structuralist roots, dependency theory has much overlap with Neo-Marxism and World Systems
Theory, which is also reflected in the work of Immanuel Wallerstein, a famous dependency
theorist. Wallerstein rejects the notion of a Third World, claiming that there is only one world
which is connected by economic relations (World Systems Theory). He argues that this system
inherently leads to a division of the world in core, semi-periphery and periphery. One of the
results of expansion of the world-system is the commodification of things, like natural
resources, labor and human relationships.

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Structuralism theory

Structuralism is a development theory which focuses on structural aspects which impede the
economic growth of developing countries. This theory advocates that the type of relationship that
exists between economically developed and developing country doesn’t support low income
countries to prosper but keep them under primary activity. Therefore, as far as these two
countries are connected structural change in economy (primary to industry) is impossible.
The unit of analysis is the transformation of a country’s economy from, mainly, subsistence
agriculture to a modern, urbanized manufacturing and service economy. Policy prescriptions for
structural change resulting from structuralist thinking include major government intervention in
the economy to fuel the industrial sector, known as import substitution
industrialization (ISI). This structural transformation of the developing country is pursued in
order to create an economy which in the end enjoys self-sustaining growth. This can only be
reached by ending the reliance of the underdeveloped country on exports of primary
goods (agricultural and mining products), and pursuing inward-oriented development by
shielding the domestic economy from that of the developed economies. Trade with advanced
economies is minimized through the erection of all kinds of trade barriers and an overvaluation
of the domestic exchange rate; in this way the production of domestic substitutes of formerly
imported industrial products is encouraged. The logic of the strategy rests on the infant industry
argument, which states that young industries initially do not have the economies of scale and
experience to be able to compete with foreign competitors and thus need to be protected until
they are able to compete in the free market. The Prebisch–Singer hypothesis states that over time
the terms of trade for commodities deteriorate compared to those for manufactured goods,
because the income elasticity of demand of manufactured goods is greater than that of primary
products. If true, this would also support the ISI strategy.

Structuralists argue that the only way Third World countries can develop is through action by the
state. Third world countries have to push industrialization and have to reduce their dependency
on trade with the First World, and trade among themselves.

Dependency theory is essentially a follow up to structuralist thinking, and shares many of its core
ideas. Whereas structuralists did not consider that development would be possible at all unless a
strategy of delinking and rigorous ISI was pursued, dependency thinking could allow

48
development with external links with the developed parts of the globe. However, this kind of
development is considered to be "dependent development", i.e., it does not have an internal
domestic dynamic in the developing country and thus remains highly vulnerable to the economic
vagaries of the world market.

Postmodernism
Postmodernism which is also referred to as late capitalism is thought to be a post industrial
society; an informational society and an electronic society. A postmodern society as a social
formation has no respect for the laws of capitalism such as the primacy of industrial production.
Postmodernism: According to Kuhn (1996) post modernism is a rapid change of the basis of
scientific knowledge to a provisional consensus among scientists. That it is a “paradigm shift” in
the structure of scientific revolutions. It is an abstract expressionism in painting, music, science,
architecture, poetry, films, politics etc. Daniel (1999) clearly described a postmodern society as a
Postindustrial and consumer society, a media society, an information society, an electronic
society, a high tech society and the like. The post modern society in all ramifications and with
the new social formation has no respect for the laws of capitalism, namely the primacy of
industrial production and the omnipresence of class struggle. A postmodern society ushers in a
more pure stage of capitalism (Globalization).

5. Development Policy and Strategies

Planning is a technique, a means to an end being the realization of certain pre-determined and
well-defined aims and objectives laid down by a central planning authority. The end may be to
achieve economic, social, political or military objectives. Therefore, the issue is not between a
plan and no plan, it is between different kinds of plans.
Some of the definitions of economic planning are:
Professor Robbins defines economic planning as “collective control or supersession of private
activities of production and exchange.”
To Hayek, planning means, “the direction of productive activity by a central authority.”

49
According to Dalton, “Economic planning in the widest sense is the deliberate direction by
persons in charge of large resources of economic activity towards chosen ends.”
Lewis Lordwin defines economic planning ,”as a scheme of economic organization in which
individual and separate plants, enterprises, and industries are treated as coordinate units of one
single system for the purpose of utilizing available resources to achieve the maximum
satisfaction of the people’s needs within a given time.”
In the words of Zweig, “Economic planning consists in the extension of the functions of public
authorities to organization and utilization of economic resources...Planning implies and leads to
centralization of the national economy.”
One of the most popular definitions is by Dickinson who defines planning as “the making of
major economic decisions what and how much is to be produced, how, when and where it is to
be produced, to whom it is to be allocated, by the conscious decision of a determinate authority,
on the basis of comprehensive survey of the economic system as a whole.”
Even though there is no unanimity of opinion on the subject, yet economic planning as
understood by the majority of economists implies deliberate control and direction of the
economy by a central authority for the purpose of achieving definite targets and objectives within
a specified period of time.
Types of development planning
Economic plan A written document containing government policy decisions on how resources
shall be allocated among various uses so as to attain a targeted rate of economic growth or other
goals over a certain period of time.
Comprehensive plan An economic plan that sets targets to cover all the major sectors of the
national economy.
Partial plan A plan that covers only a part of the national economy (e.g., agriculture, industry,
tourism).
Development planning process

Planning process can be described as an exercise in which a government first chooses social
objectives, then sets various targets, and finally organizes a framework for implementing,
coordinating, and monitoring a development plan. It is the procedure for drawing up and carrying
out a formal economic plan.
Stages of Planning

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Most development plans have traditionally been based initially on some more or less formalized
macroeconomic model. Such economy wide planning models can be divided into two basic
categories: (1) aggregate growth models, involving macroeconomic estimates of planned or
required changes in principal economic variables, and (2) multi-sector input-output, social
accounting, and computable general equilibrium (CGE) models, which ascertain (among other
things) the production, resource, employment, and foreign-exchange implications of a given set
of final demand targets within an internally consistent framework of inter industry product flows.
Finally, probably the most important component of plan formulation is the detailed selection of
specific investment projects within each sector through the technique of project appraisal and
social cost-benefit analysis. These three “stages” of planning aggregate, sectoral, and project
provided the main intellectual tools of the planning authority.
All of these tools have been, and still are, extensively used by the World Bank and other
development agencies, as well as developing country governments.
Development strategies
Agriculture’s Role in Transforming the Economy
Agriculture contributes to economic growth through domestic and export surpluses that can be
tapped for industrial development through taxation, foreign exchange abundance, outflows of
capital and labor, and falling farm prices. As agricultural product and factor markets become
better integrated by links with the rest of the economy, farm income expansion augments the
market for industrial products.

Import substitution
A deliberate effort to replace consumer imports by promoting the emergence and expansion of
domestic industries.

7. Measures of Growth and Development

Gross Domestic Product (GDP)
Gross Domestic Product (GDP) is the market value of all the final goods and services produced
within the domestic territory of a country during a year.
It is the total value of currently produced final goods and services that are produced within a
country‘s boundary during a given period of time, usually one year. From this definition, we can
infer that:
 It measures the current production only.

51
(o It takes in to account final goods and services (only the end products of various production
processes) or we do not include the intermediate products in our GDP calculations.
 It measures the values of final goods and services produced within the boundary/territory of a
country irrespective of who owns that output.

 In measuring GDP, we take the market values of goods and services (GDP= ¿ ∑ ❑PiQi)

where:
Pi = series of prices of outputs produced in different sectors of an economy in certain period
Qi = the quantity of various final goods and services produced in an economy
In order to understand the meaning of GDP, note the following points:
Gross Measure: It is an aggregate measure. It measures gross value of the products.
Market value: GDP measures the value of goods and services at their Market Price. Hence it is
also termed as Gross Domestic Product at market prices (GDPMP).
New Production: GDP includes the value of output produced in the “new” current accounting
year only. It does not account for the value of existing or old goods.
GDP includes only the value of final goods and services, i.e., finished products only: It does
not take into account the value of intermediate goods, such as raw materials, power, fuel, etc. We
differentiate between intermediate and final goods as follows:
Intermediate goods – Goods which are used for further production by passing through some
production process as secondary inputs are called intermediate goods. Goods which are used for
resale in the same year are also included in intermediary goods. For example, cotton for the
thread manufacturing mill, thread for the cloth mill and cloth for the ready made goods lying
with wholesalers and retailers for resale in the same year are also intermediate goods.
Final goods –Goods which are used either for final consumption by the consumers or for
investment by the producers are called final goods. For example bread, butter, biscuits, milk,
clothes, shoes, watches, radios, etc. used by the consumers, and also machines and tractors used
by the producers are final goods or finished goods.
 In Gross Domestic Product, we include only the goods and services produced within the
domestic territory of a country. It includes the incomes locally earned by the non-nationals and
excludes the incomes received by the resident nationals from abroad.

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Gross National Product (GNP)

Gross National Product (GNP) is the money value of all final goods and services produced in the
domestic territory of a country during a year plus net-factor income from abroad minus factor
income of non residents in domestic territories.
It is the total value of final goods and services currently produced by domestically owned factors
of production in a given period of time, usually one year, irrespective of their geographical
locations.

It is the Gross Domestic Product at market price plus NFI (net factor income from abroad minus
factor income of non-residents in domestic tertiary).
Thus,
GNPMP = GDPMP + NFI
Where, GNPMP = Gross National Product at market prices
GDPMP = Gross Domestic Product at market prices
NFI = Net Factor Income
NFI could be negative, positive or zero depending on the amount of factor income received by
the two parties.
 If NFI >0, then GNP > GDP
 If NFI<0, then GNP < GDP
 If NFI =0, then GNP =GDP

Approaches to measure GDP/GNP

There are three approaches to measure GDP/GNP. These are:

A) Product/value added approach,
B) Expenditure approach and
C) Income approach

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Final Product Approach: According to this approach, in the estimation of GDP, we include the
market value of all final goods and services produced in a country. For example, if we
manufacture thread from cotton, cloth from thread and shirts from cloth, here shirts are the final
good. Hence, we should include the value of shirts only in the calculation of national income.
Thus, GDP is calculated by multiplying all the final goods and services produced in a country
with their respective market prices.
GDPMP = P (Q) + P (S)
Where, P = Market price
Q = Quantity of goods
S = Quantity of services

Problem of Double Counting in the Final Product Approach: The final product approach
cannot be used in actual practice because production is a continuous process and in this process it
is difficult to know the final product. It gives rise to the problem of double counting. What is the
problem of double counting? Counting the value of a commodity more than once in the
measurement of national income is called double counting. So far as an individual enterprise is
concerned, it considers its output as final product.
For example, for a farmer, cotton is a final product, for a spinning mill, thread is a final product,
for a cloth-mill, cloth is a final product, and for a garment manufacturer, shirts are a final
product. All these enterprises take the sale value of their products as the value of their final
output.
When we take into account the sum total of the value of output of all these individual enterprises
in the estimation of national income, it suffers the problem of double counting. This leads to
overestimation of the value of goods and services produced.
To overcome the difficulty of double counting, the value added approach is used.
Value Added Approach: The value added approach measures the value added (contribution) by
each producing enterprise in the production process in the domestic territory of a country in an
accounting year. Value added is defined as the difference between total value of the output of a
firm and the value of inputs bought from other firms. Clearly, the value added approach
measures the contribution of each producing unit in the domestic economy without any
possibility of double counting.
The following steps are involved in estimating national income by the value added approach:

54
  Identifying all the producing units in the domestic economy and classifying them into
three economic sectors: primary, secondary and territory sectors. (The primary sector
exploits natural resources, the secondary sector transforms one type of commodity into
another, and the tertiary sector renders services.),
  Estimating the value added by each producing unit. (By deducting intermediate
consumption, from value of output, we get the value added.),
  Estimating the value added of each economic sector by summing up the value added of all
producing units falling in each industrial sector,
 Computing GDPMP by adding up the value added of all economic sectors.
  Estimating net factor income from abroad, which is added to GDPMP to obtain GNPMP.
Example: GDP by final product approach. The final productions of a hypothetical nation is given
by the following table.
The table shows how GDP is calculated using final product and current prices.

Sectors Value of Output (in million birr)

Agriculture and allied activities 9309
- Agriculture 7000
- Forestry 1000
- Fishing 1309
Industry 147413
- Mining & quarrying 9842
- Large & medium scale manufacturing 91852
- Electricity & water 13717
- Construction 32002
Service 357 872
- Banking insurance and real estate 121704
- Public administration & defense 36605
- Health 20000
- Education 32509
- Domestic & other services 147054
4. Net factor income from abroad 87348
GDP = 9,309+147,413+357,872 = 514,594

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GNP = GDP + NFI = 514,594 +87,348 = 601,942

B) Expenditure Approach: here GDP is measured by adding all expenditures on final goods
and services produced in the country by all sectors of the economy. Thus, GDP can be estimated
by summing up personal consumption of households (C), gross private domestic investment (I),
government purchases of goods and services (G) and net exports (NE).
Personal consumption expenditure includes expenditures by households on durable consumer
goods (automobiles, refrigerators, video recorders, etc), non-durable consumer goods (clothes,
shoes, pens, etc) and services.
Gross private domestic investment is defined as the sum of all spending of firms on plants,
equipment, and inventories, and the spending of households on new houses. Investment is broken
down into three categories: residential investment (the spending of households on the
construction of new houses), business fixed investment (the spending of firms on buildings and
equipment for business use), and inventory investment (the change in inventories of firms).
Note that gross private domestic investment differs from net private domestic investment in that
the former includes both replacement and added investment whereas the latter refers only to
added investment. Replacement means the production of all investment goods, which replace
machinery, equipment and buildings used up in the production process. In short, net private
domestic investment = gross private domestic investment minus depreciation.
Government purchases of goods and services include all government spending on finished
products and direct purchases of resources less government transfer payments because transfer
payments do not reflect current production although they are part of government expenditure.
Net exports refer to total value of exports less total value of imports. Note that net export is
different from the terms of trade in that the latter refers to the ratio of the value of exports to the
value of imports.
Example: GDP at current market price measured using expenditure approach for a hypothetical
economy.
Types of expenditure Amount (in million Birr)
1. Personal consumption expenditure 1300
Durable consumer goods 100
Non-durable consumer goods 200
Services 1000

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2. Gross private domestic investment 310
Business fixed investment 150
Construction Expenditure 100
Increases in inventories 10
3. Government expenditure on goods and services 300
Federal government 100
State government 300
4. Net export -100
Exports 200
Imports 300
GDP at current market price 1810

C) Income approach
The income method measures national income from the side of payments made to the primary
factors of production in the form of rent, wages, interest, and profit for their productive services
in an accounting year. Since the income of factors of production is cost to their employers, so
factor income and factor cost are the same. Thus if the factor incomes of all the producing units
generated within the domestic economy are added up, the resulting total will be the domestic
income at factor cost. If we add the value of depreciation and indirect taxes to this, we get
GDPMP. Adding further net factor income from abroad gives us GNPM
NOTE:

1 Depreciation means loss of the value of fixed capital assets during production. In other words,
depreciation is the value of existing capital stock that has been consumed (used up) in the
process of producing output.
Fall in the value of fixed assets due to normal wear and tear and to expected obsolescence is
called consumption of fixed capital or depreciation.
2 Taxes which are levied by the government on production and sale of commodities are called
indirect taxes — for example, excise duty, sales tax, custom duty, etc. The buyer of a taxed
commodity pays the tax indirectly because the tax is included in the price which the buyer pays.
The effect of indirect tax is that it increases the price of a commodity.
Types of Income Amount (in millions Birr

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 Types of income Amount( in Million)
Compensation of employes 84,000
Rental income 9,200
Interest income 12,100
Profits (properietor’s income) 30,000
Depreciation 10,000
Indirect business taxes 4,000
GDP: 149,300

Income from abroad 5000

Payments to abroad 4500

Real vs. Nominal GDP Practice

Real vs Nominal

Values Prices in an economy do not stay the same. Over time the price level changes (i.e., there
is inflation or deflation). A change in the price level changes the value of economic measures
denominated in dollars. Values that increase or decrease with price level are called nominal
values. Real values are adjusted for price changes. That is, they are calculated as though prices
did not change from the base year. For example, gross domestic product (GDP) is used to
measure fluctuations in output. However, since GDP is the dollar value of goods and services
produced in the economy, it increases when prices increase. This means that nominal GDP
increases with inflation and decreases with deflation. But when GDP is used as a measure of
short-run economic growth, we are interested in measuring performance—real GDP takes out the
effects of price changes and allows us to isolate changes in output. Price indices are used to
adjust for price changes. They are used to convert nominal values into real values.

Converting Nominal GDP to Real GDP

To use GDP to measure output growth, it must be converted from nominal to real. Let’s say
nominal GDP in Year 1 is $1,000 and in Year 2 it is $1,100. Does this mean the economy has
grown 10 percent between Year 1 and Year 2? Not necessarily. If prices have risen, part of the

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increase in nominal GDP for Year 2 will represent the increase in prices. GDP that has been
adjusted for price changes is called real GDP. If GDP isn’t adjusted for price changes, we call it
nominal GDP.

To compute real GDP in a given year, use the GDP Deflator. The GDP deflator for a given year
is 100 times the ration of nominal GDP to real GDP in that year. The GDP deflator is a type of
price index, or form of measurement, that tracks changes in the value of goods produced in a
nation from one year to another. Here is the formula to find the real GDP in a given year using
the GDP deflator:

Real GDP = nominal GDP x 100

GDP deflator

If the GDP deflator is not provided, the following is the formula:

GDP deflator = nominal GDP x 100

real GDP

To compute real output growth in GDP from one year to another, subtract real GDP for Year 2
from real GDP from Year 1. Dived the answer (the change in real GDP from the previous year)
by real GDP in GDP declines from Year 1 to Year 2, the answer will be a negative percentage.)
Here’s the formula:
Output growth = (real GDP in Year 2 – real GDP in Year 1) x 100
real GDP in Year 1
For example, if real GDP in Year 1 = $1,000 and in Year 2 = $1,028, then the output growth rate
from Year 1 to Year 2 is 2.8%; (1,028-1,000)/1,000 = .028, which we multiply by 100 in order to
express the result as a percentage. To understand the impact of output changes, we usually look
at real GDP per capita. To do so, we divide the real GDP of any period by a country’s average
population during the same period. This procedure enables us to determine how much of the
output growth of a country simply went to supply the increase in population and how much of
the growth represented improvements in the standard of living of the entire population. In our
example, let’s say the population in Year 1 was 100 and in Year 2 it was 110. What is the real
GDP per capita in Years 1 and 2?

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Year 1

Real GDP per capita = Year 1 real GDP = $1,000 = $10

Population in Year 1 100
Year 2

Real GDP per capita = $1,028 = $9.30

110
GDP per capita

GDP per capita is gross domestic product divided by midyear population. GDP at purchaser's
prices is the sum of gross value added by all resident producers in the economy plus any product
taxes and minus any subsidies not included in the value of the products.

GNP per capita

Gross national product (GNP) per capita is the dollar value of a country's final output of
goods and services in a year, divided by its population. It reflects the average income of a
country's citizens.
Gini Coefficient
The Gini coefficient is a measure of inequality of a distribution. It is defined as a ratio with
values between 0 and 1: the numerator is the area between the Lorenz curve of the distribution
and the uniform distribution line; the denominator is the area under the uniform distribution line.
It was developed by the Italian statistician Corrado Gini and published in his 1912 paper
"Variabilità e mutabilità" ("Variability and Mutability"). The Gini index is the Gini coefficient
expressed as a percentage, and is equal to the Gini coefficient multiplied by 100. (The Gini
coefficient is equal to half of the relative mean difference.)
The Gini coefficient is often used to measure income inequality. Here, 0 corresponds to perfect
income equality (i.e. everyone has the same income) and 1 corresponds to perfect income
inequality (i.e. one person has all the income, while everyone else has zero income).

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The Gini coefficient can also be used to measure wealth inequality. This use requires that no one
has a negative net wealth. It is also commonly used for the measurement of discriminatory power
of rating systems in the credit risk management
The Gini coefficient is defined as a ratio of the areas on the Lorenz curve diagram. If the area
between the line of perfect equality and Lorenz curve is A, and the area under the Lorenz curve
is B, then the Gini coefficient is A/(A+B). Since A+B
= 0.5, the Gini coefficient, G = 2A = 1-2B.

Lorenz curve

It is one of the simplest representations of inequality. On the horizontal axis is the cumulative
number of income recipients ranked from the poorest to the richest individual or household. The
vertical axis displays the cumulative percentage of total income. The Lorenz curve reveals the
percentage of income owned by x per cent of the population. It is usually shown in relation to a
45-degree line that represents perfect equality where each x percentile of the population receives
the same x percentile of income. Thus the farther the Lorenz curve is in relation to the 45-degree
line, the more unequal the distribution of income.

Human development index (HDI)

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The HDI was created to emphasize that people and their capabilities should be the ultimate
criteria for assessing the development of a country, not economic growth alone. was suggested
by A. Sen and his colleagues in the 1990s and being modified around 2010. It includes
longevity, literacy and material living standard (income). The HDI can also be used to question
national policy choices, asking how two countries with the same level of GNI per capita can end
up with different human development outcomes. These contrasts can stimulate debate about
government policy priorities.
The Human Development Index (HDI) is a summary measure of average achievement in key
dimensions of human development: a long and healthy life, being knowledgeable and have a
decent standard of living. The HDI is the geometric mean of normalized indices for each of the
three dimensions.

The 2010 Human Development Report introduced an Inequality-adjusted Human Development

Index (IHDI).

Life expectance refers to a year a newly born baby expected to live in that country. Mean years
of schooling is years that a 25-year-old person or older has spent in schools. An expected year of
schooling refers to years that a 5-year-old child will spend in education in his whole life.

Dimensions of index Observed value

Maximum Minimum
Health 83.6 (Japan, 2012) 20
Mean years of schooling 13.2 (USA, 2010) 0
Expected years of schooling 18 (capped at) 0
Combined education index 0.971 (New zealand, 2010) 0
Percapita income 87,478 (Qatar, 2012) 100
Table.1. Goal posts for the human development index in 2013 report

The steps for calculating HDI are as follows; CEI-combined education index
Education
 Mean years of schooling = Actual value - minimum value
Maximum value - minimum value
 Expected years of schooling = Actual value - minimum value

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 Maximum value - minimum value
 Finally they are combined by using a geometric mean.

 Education index=
√ EYS . MYS−MIN
CEI−MIN
Health
 Life expectance = Actual value - minimum value
Maximum value - minimum value
Income
 Income index= ln (Actual) – ln(minimum)
ln (maximum) – ln (minimum)

HDI= √3 IH . IE . II

Dimension index always falls between 0 and 1. A value approaching to 1 indicates a higher
human development where as a value close to 0 indicates the contrary.
Example: E country
Life expectancy at birth (years) 71.7
Expected years of schooling (years) 13.1
Mean years of schooling (years) 7.2
Gross national income per capita (2020 PPP $) 10355

Inequality-adjusted Human Development Index (IHDI)

The IHDI is the actual level of human development (accounting for inequality)" and "the HDI
can be viewed as an index of 'potential' human development (or the maximum IHDI that could
be achieved if there were no inequality".

The IHDI takes into account not only the average achievements of a country on health, education
and income, but also how those achievements are distributed among its population by
“discounting” each dimension’s average value according to its level of inequality. The IHDI is
distribution-sensitive average level of HD. Two countries with different distributions of
achievements can have the same average HDI value. Under perfect equality the IHDI is equal to
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the HDI, but falls below the HDI when inequality rises. The difference between the IHDI and
HDI is the human development cost of inequality, also termed – the loss to human development
due to inequality. The IHDI allows a direct link to inequalities in dimensions, it can inform
policies towards inequality reduction, and leads to better understanding of inequalities across
population and their contribution to the overall human development cost.

This year we have introduced the Coefficient of human inequality, a new measure of inequality
in HDI, calculated as an average inequality across three dimensions. For more details on
computation, see Technical notes.

The IHDI is calculated for 145 countries.

The average global loss in HDI due to inequality is about 22.9 %—ranging from 5.5% (Finland)
to 44.0% (Angola). People in sub-Saharan Africa suffer the largest losses due to inequality in all
three dimensions, followed by South Asia and the Arab States and Latin America and the
Caribbean. Sub-Saharan Africa suffers the highest inequality in health (36.6%), while South Asia
has the highest inequality in education (41.6%). The region of Arab States also has the highest
inequality in education (38%), Latin America and the Caribbean suffers the largest inequality in
income (36.3%).

Gender Inequality Index (GII)

Gender inequality remains a major barrier to human development. Girls and women have made
major strides since 1990, but they have not yet gained gender equity. The disadvantages facing
women and girls are a major source of inequality. All too often, women and girls are
discriminated against in health, education, political representation, labour market, etc — with
negative repercussions for development of their capabilities and their freedom of choice. The GII
measures gender inequalities in three important aspects of human development—reproductive
health measured by maternal mortality ratio and adolescent birth rates; empowerment, measured
by proportion of parliamentary seats occupied by females and proportion of adult females and
males aged 25 years and older with at least some secondary education; and economic status
expressed as labour market participation and measured by labour force participation rate of
female and male populations aged 15 years and older. The GII sheds new light on the position of
women in over 150 countries, it yields insights in gender gaps in major areas of human
development. The component indicators highlight areas in need of critical policy intervention

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and it stimulates proactive thinking and public policy to overcome systematic disadvantages of
women.

The GII is built on the same framework as the HDI and the IHDI — to better expose differences
in the distribution of achievements between women and men. It measures the human
development costs of gender inequality, thus the higher the GII value the more disparities
between females and males. The GII values vary tremendously across countries, they range from
2.1 percent to 73.3 percent.

Countries with high gender inequality also experience more unequal distribution of human
development.

Income Poverty
Income poverty measures the level of income or consumption expenditures which is designated
as the minimum needed by an individual or household to avoid poverty in a country. At the
national level, the governments set national poverty lines to measure the incidence of poverty
among the population. However, based on the specific socio-economic conditions, poverty lines
differ from one country to another and hence, are not usually comparable across the countries.
Multidimensional Poverty Index (MPI)
Like development, poverty is multidimensional — but this is traditionally ignored by headline
money metric measures of poverty. The Multidimensional Poverty Index (MPI), published for
the first time in the 2010 Report, complements monetary measures of poverty by considering
overlapping deprivations suffered by people at the same time. The index identifies deprivations
across the same three dimensions as the HDI and shows the number of people who are multi-
dimensionally poor (suffering deprivations in 33% of weighted indicators) and the number of
deprivations with which poor households typically contend with. It can be deconstructed by
region, ethnicity and other groupings as well as by dimension, making it an apt tool for
policymakers. For more technical details see Technical notes.

The MPI can help the effective allocation of resources by making possible the targeting of those
with the greatest intensity of poverty; it can help addressing MDGs strategically and monitoring
of impacts of policy intervention.

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The MPI can be adapted to the national level using indicators and weights that make sense for
the region or the country, it can be adopted for national poverty eradication programs, and it can
be used to study changes over time.

Almost 1.5 billion people in the 91 countries covered by the MPI—more than a third of their
population — live in multidimensional poverty — that is, with at least 33 percent of the
indicators reflecting acute deprivation in health, education and standard of living. This exceeds
the estimated 1.2 billion people in those countries who live on $1.25 a day or less. And close to
800 million people are vulnerable to fall into poverty if setbacks occur – financial, natural or
otherwise.

The 2018 global MPI has the same functional form as in previous years, but some indicators
have changed. It continues to use 10 indicators in three dimensions—health, education and
standard of living—following the same dimensions and weights as the Human Development
Index.
Each person is assigned a deprivation score according to his or her household’s deprivations in
each of the 10 indicators. The maximum deprivation score is 100 percent, with each dimension
equally weighted; thus the maximum deprivation score in each dimension is 33.3 percent or
more accurately 1/3. The health and education dimensions have two indicators each, so each
indicator is weighted as 1/6. The standard of living dimension has six indicators, so each
indicator is weighted as 1/18.

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Dimensions Indicators Deprived if… Weight
Health Nutrition Any adult under age 70 or any child for whom nutritional 1/6
information is available is undernourished. Adults over age 20 are
considered undernourished if their body mass index is below 18.5
m/kg2, individuals ages 15–19 are considered undernourished
based on
World Health Organization age-specific body mass index cutoffs
and children are considered undernourished if the z-score of their
height-forage (stunting) or weight-for-age (underweight) is more
than two standard deviations below the median of the reference
population.

Any child in the household has died in the five years preceding the
Child mortality
survey. When a survey lacks information about the date of child
deaths, deaths that occurred at any time are taken into account. 1/6

Education Years of schooling
School attendance
Standard of Electricity
living
No household member age 10 or older has completed six years of 1/6
schooling.
Any school-age child is not attending school up to the age at which
he or she would complete class 8. 1/6
The household has no electricity. Improved sanitation (according to 1/18
Sustainable Development Goal guidelines), or it is improved but
shared with other households.

Sanitation A household is considered to have access to improved sanitation if 1/18

it has some type of flush toilet or latrine or ventilated improved pit
or composting toilet that is not shared. When a survey uses a
different definition of adequate sanitation, the survey report is
followed.

The household does not have access to an improved source of

Drinking water drinking water (according to Sustainable Development Goal
guidelines), or safe drinking water is at least a 30-minute walk from
1/18
home, roundtrip. A household is considered
to have access to an improved source of drinking water if the
source is piped water, a public tap, a borehole or pump, a protected

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 well, a protected spring or rainwater. When a survey uses a
different definition of safe drinking water, the survey report is
followed.

The household cooks with dung, wood, charcoal or coal.

Cooking fuel 1/18
At least one of the household’s three dwelling elements floor, walls
Housing or roof—is made of inadequate materials—that is, the floor is made
of natural materials and/or the walls and/or the roof are made of
1/18
natural or rudimentary materials. The floor is made of natural
materials such as mud, clay, earth,
sand or dung; the dwelling has no roof or walls; the roof or walls
are constructed using natural materials such as cane, palm, trunks,
sod, mud, dirt, grass, reeds, thatch, bamboo or
sticks or rudimentary materials such as carton, plastic or polythene
sheeting, bamboo or stone with mud, loosely packed stones,
uncovered adobe, raw or reused wood, plywood, cardboard,
unburnt brick, or canvas or tent.

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