Indicators/Parameters of Economic Development

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Economic development is a multidimensional process. It is a dynamic process of change. Economic development is a positive change whereby opportunities, the living standard of people, etc. increases along with the economic prosperity of the nation.

The measurement of the extent and pace of economic development and expressing it in any specific index is a very difficult task. Regarding indicators or measures or parameters of economic development, there are different opinions of different economists.

Indicators of economic development refer to the measurement or indication of the change that takes place when a country goes on developing process. As economic development is a dynamic and continuous process, its indicators also vary with passes of time. So the set of indicators defined during any particular period may not be always appropriate. However, the main indicators of economic development are classified into two categories;

  • Income-based measures of development or indicators of economic development consist of mainly per capita income.
  • Those indicators of economic development measure economic development in terms of the quality of life, such as the Physical Quality of Life Index (PQLI), Basic Needs Index, and Human Development Index (HDI).

The major indicators of economic development can be briefly explained below;

Per Capita Income Index

It is the traditional and most widely used index of development, which means an increase in real per capita income over a long time is a widely used measure of economic development. It is the measure of the level of economic activity and the economic size of a country. Development is related to the improvement of the standard of living or welfare of the population so it is said that it is represented by output per head of population.

From the development viewpoint simply an increase in the economy’s real national income is not a real representation of development rather it is represented by a change in per capita income. Growth of real per capita GNP takes into account the ability of a nation to expand its output at a faster rate than the growth rate of the population. In this view, the rate of growth of real per capita GNP is typically used to measure the overall economic well-being of the population.

Recently the World Bank has categorized the nations into various groups based on GNI per capita in current USD as below:

GroupJuly 1, 2020 (new)July 1, 2019 (old)
Low income< 1,036< 1,026
Lower-middle income1,036 – 4,0451,026 – 3,995
Upper-middle income4,046 – 12,5353,996 – 12,375
High income> 12,535> 12,375

The World Bank assigns the world’s economies to four income groups—low, lower-middle, upper-middle, and high-income countries. The classifications are updated each year on July 1 and are based on GNI per capita in current USD (using the Atlas method exchange rates) of the previous year (i.e. 2019 in this case).

Limitations of Per Capita Income Index

Though per capita income has been traditionally used as an important index of development or indicators of economic development, it suffers from various limitations. Because of these limitations, per capita, real income cannot be considered as the perfect index of economic development. At best, per capita, real income is only a partial index of economic development and economic welfare. Some of the limitations of the Per Capita Income Index are;

  • It does not consider the composition of output
  • Per Capita Income is that it does not take into account the distribution of income that accompanies an increase in income.
  • It does not address the problem of poverty. Despite the increase in per capita income, the average standard of living of the masses, may not improve because the number of people below the poverty line may have increased.
  • An increase in income is not a sufficient condition for an increase in welfare and development because an increase in income can involve costs such as more work, depletion of natural resources, increased environmental pollution, etc. Per capita income index does not take into account any allowances for these cost elements.
  • The per capita income index excludes many goods and services not passing through the market.
  • Per capita income is not a perfect indicator to measure economic development as it does not consider various issues related to the social, human, and institutional dimensions of the country.
  • There may be several problems while using the per capita income index in the international comparison.

Quality of Life Index

Due to the different shortcomings of the Per Capita GNI Index, economists and policymakers at present are not satisfied with the use of this index as an indicator of welfare or development. As a result, many of the intellectuals and policy-makers have advocated discarding the income-based indicator of economic development.   

Quality of life is based on different factors such as availability of necessities of life (food, clothing, shelter, etc.), equity in the distribution of income and wealth, literacy, healthcare, clean environment, political and civil rights, etc. By taking some of these indicators of quality of life, several attempts have been made in the recent past to construct an index which may be called the quality of life index. 

Several studies focused on the basic needs of the majority of the population to denote the quality of life. By assigning weights to veracious indicators of the basic needs and combining them, these studies have developed a composite index of development. Here are two major composite indexes as PQLI and HDI.

Physical Quality of Life Index (PQLI)

The quality of life index was made by Morris D. Morris at the end of the 1970s. This has come to be known as the Physical Quality of Life Index (PQLI). It is one of the major human-centric indicators of economic development.

This index takes into account three times as indicators of the quality of life. These three indicators are;

Life Expectancy: Life expectancy refers to the number of years newborn children would live. It is a universally accepted fact that people want to enjoy a longer life. Therefore, PQLI emphasizes that a country should have a higher life expectancy. Life expectancy can be increased through better medical facilities, better sanitation, and better nutrition. In the ultimate analysis higher life expectancy is the result of economic development.

Infant Mortality: Infant mortality refers to deaths among children between birth and 1 year of age. The number of children who die before attaining the age of 1 year. POLI focuses that people want to lead a life with less illness and less death of infants.

Literacy: Literacy refers to the ability to read and write. The need for a higher level of literacy is something that is universally accepted. People want to have more opportunities in life by increasing the level of literacy through education. Rate of literacy (the percentage of population aged 7 years and above, which can read and write) is often used as one of the indicators of the state of development of a country.

Thus, PQLI emphasizes the fact that quality of life, in general, will improve and people will enjoy the fruits of economic development if life expectancy goes up, infant mortality falls and the literacy rate increases.

Construction of PQLI

A composite PQLI is constructed by taking into account a simple average of the three indicators, with equal weightings to each on the assumption that all these indicators of quality of life are equally important.  These three indicators are;

  • Life Expectancy Indicator (LEI)
  • Infant Mortality Indicator (IMI)
  • Basic Literacy Indicator (BLI)

Thus,

PQLI= (LEI+IMI+BLI)/3

These three indicators of quality of life are measured in terms of different variables. Life expectancy is measured in terms of years, the infant mortality rate is measured in terms of per thousand, and the basic literacy rate is measured in percentage terms. Therefore they cannot be simply added to get PQLI. To calculate PQLI these are converted into normalized values and dividing by the difference between the maximum and minimum observed values of these indicators.

Thus,

For example LEI= (Actual Life Expectancy at Age 1- Minimum Life Expectancy)/ (Maximum Life Expectancy-Minimum Life Expectancy)

For example, if 78 years is the maximum life expectancy in case of developed countries and 38 year is minimum life expectancy in case of very poor countries and the actual life expectancy in any particular country is 68 years then LEI may be calculated as;

LEI= 68-38/78-38 = 30-40= 0.75.

But for IMI the numerator is modified as the difference between maximum infant mortality and actual infant mortality.

In such a way each of these three indicators is calculated on a scale between 0 to 1 and each country would be at some point in the scale. Talking the unweighted average of the three indicators would give us PQLI which would also range between 0 to 1.

Merits of PQLI

  • Simple to construct and comprehend
  • Concentrates on results rather than determinants of development
  • Takes into account universally accepted determinants of quality of life

Demerits of PQLI

  • It uses two indicators of health and ultimately appears to be interrelated
  • PQLI gives equal weight to all the indicators
  • It is aggregate in nature
  • PQLI focuses on only two indicators of quality of life.

Human Development Index (HDI)

The latest and the most ambitious index of economic development or indicators of economic development is the Human Development Index devised by the United Nations Development Program (UNDP) an agency of the United Nations. The UNDP prepared the Human Development Index (HDI) for the first time in 1990 in its first Human Development Report. The Human Development concept was initially developed by Pakistani economist Mahbud Ul Haq and Indian economist Amartya Sen. Since then the UNDP has been publishing Human Development Report every year. 

The Human Development Reports have called for a new approach to economic development-one that puts people at the center. The basic proposition of the new approach is that the development of a nation should be measured not only by national income as had long been the practice but also by various other aspects of human development such as life expectancy, literacy, political freedom, human rights, gender equality, etc. These reports have been considering various aspects of human development. Besides, they have been ranking various countries according to the level of the Human Development Index.  The centerpiece of these reports is the construction of the Human Development Index. This measure has been enlarged and refined over the year.

What is Human Development?

The Human Development Report (1997) has defined human development as the process of widening people’s choices as well as raising the level of well-being achieved. Traditionally, economic development has focused exclusively on the expansion of only one choice-income. But the concept of human development has gone far beyond income and well-being to cover all human choices-economic, social, cultural, and political.

It views economic development to improve human conditions from all angles. This concept puts humans at the center stage. It is universally accepted that the well-being of humans, as well as the country’s progress, cannot be evaluated by income only. We must also consider whether people have the opportunity to get educated and healthy. Thus the evaluation of development is viewed in terms of reduction in poverty, and inequality, gender equality, political freedom, and political power.

The main propositions of the concept of human development are;

  • It views people and the quality of their life as the center of development. People are not just the instruments for producing commodities but they occupy the central stage. Putting people at the center of development means making progress equitable and broad-based, enabling people to be active participants in the change.   
  • Human development is the end of all activities while economic growth is only a means to this end.   
  • The purpose of economic development is to widen all choices.
  • Human development is concerned with widening not merely income choice but covering all aspects of human development.
  • Human development is universal. It applies equally to less develop as well as developed countries.

Construction of the Human Development Index

  • Human Development Index (HDI) is a strategic element in the new approach to economic development.
  • Under this criterion, the economic development is evaluated based on per capita income (standards of living), literacy rate, and life expectancy at birth.
  • The most important and interesting fact about HDI is that it not only looks into the GDP or PCI of the country but it also includes long and healthy life, access to education, and a decent standard of living. 
  • Its value ranges from 0 to 1. A value closer to 0 reflects low economic development and its value closer to 1 reflects high economic growth and development.
Components of Human Development Index (HDI)

The human development index is a combination of three different components, which are as below.

  • A Long and healthy life: it is measured by life expectancy at birth. That is the number of years a newborn infant is expected to live. The current life expectancy of Nepalese is 70.5 years.
  • Knowledge: the ability to acquire knowledge is measured by the combination of two variables. The average of these two variables measures the value of knowledge. For this equal weight is given to both average expected years of schooling and mean year of schooling.
    • Mean years of schooling: Average number of years of school education received by adults aged 25 and above.
    • Expected years of schooling: Number of years of schooling that a child of school entrance age can expect to receive.
  • A decent standard of living is measured by a country’s gross national income (GNI) adjusted for Purchasing Power Parity in terms of USD.  Real per capita income is taken as a measure of the standard of living of the people of the country.

These three indicators reflecting three basic choices are used to prepare three basic indices;

  1. Health Index
  2. Education Index
  3. Income Index

While computing HDI we may face the problem of common measure of the three dimensions of human development. Life expectancy is measured in years, adult literacy and gross enrolment ratio in percentage, and real income are measured in the PPP-adjusted dollar. To construct a human development index fixed minimum and maximum values have been established for each of three indicators. Each of the three components of HDI is computed according to the general formula;

Index= (Actual value- Minimum value)/ (Maximum value-Minimum value)

HDI is the geometric mean of normalized indices of each of the three dimensions of human development viz. long and healthy life, access to knowledge, and a decent standard of living. The performance of a country in each of these indicators is expressed as a value between 0 to 1. Each country would be at some point on the scale between 0 and 1 for each of the three indicators.

After calculating the dimensional index, the HDI is the geometric mean of the three-dimensional indices;

HDI= (Health Index*Education Index *Income Index) 1/3

Calculation Process of HDI Score for Nepal in 2019
Country & ValueLife expectancy at birthMean years of schoolExpected years of schoolGNI per capitaLog values
Nepal70.5years4.9 years12.2 years$27483.4390
Highest85 years15 years18 years$750004.8750
Lowest20 years0 years0 years$1002.000
Calculated 0.7760.326670.5020.500

Now

  • Health Index (HI) = (70.5-20)/ (85-20) = 0.776
  • Mean year of schooling index= (4.9-0)/ (15-0) = 0.32667
  • Expected years of schooling index= (12.2-0)/ (18-0) = 0.502
  • Education Index (ED) = (0.32667+0.50225)/2= 0.502225
  • Income Index (II) = {log(2748)-log(100)}/ {log(75,000)-log(100)}

= (3.4390-2)/ (4.8750-2) = 1.439/2.875= 0.500

Human Development Index (HDI) of Nepal= (HI*EI*II) 1/3

= (0.776*0.502*0.500) 1/3

= (0.1947) 0.3333

HDI= 0.579

Human Development Index is widely used these days, particularly by international agencies such as UNDP, to show the average achievement of an economy in the economic and social sectors.

The Major Merits of HDI
  • HDI has combined economic (GDP per capita) and social 9life expectancy and education) indicators. It is multidimensional.
  • HDI is a more comprehensive measure of development than either the per capita income of PQLI. It is a broader indicator of the development performance of a country.
  • HDI increases understanding of what constitutes development and which countries are experiencing development as indicated by the rise in the value of HDI over time.
  • It focuses on the ultimate objective of development.

Human Development Index and Nepal

UNDP has been determining HDI for a large number of countries using three indices-life expectancy index, education index, and adjusted GDP per capita index. It ranks countries on a scale of 0(lowest human development index) to 1(highest human development index. The UNDP has been ranking the countries into four groups;

  • Low human development- less than 0.550 HDI
  • Medium human development countries- 0.550 to 0.699 HDI
  • High human development countries- 0.700 to 0.799 HDI
  • Very high human development countries- 0.800 or above HDI

The Human Development Report 2019 like its earlier reports has calculated HDI values for different countries on a uniform basis.  The following table shows the values of HDI for Nepal since 1990.

Year199020002005201020152019
HDI Value0.3800.4460.4740.5270.5680.579
HDI Values of Nepal
  • HDI is improving continuously since 1990. It increased from 0.380 in 1990 to 0.446 in 2000 and 0.579 in 2019 an increase of 52.6 percent driven by the increased life expectancy of people and years of schooling. Between 1990 and 2019 Nepal’s life expectancy increased by 16.1 years to 70.5 years and mean years of schooling increased by 2.8 years to 4.9 years and expected years of schooling increased by 4.7 years to 12.2 years. Nepal’s gross national income per capita increased by about 130.5 percent between 1990 and 2019.
  • As per the category of UNDP Nepal lies in the group of medium human development countries since 2015
  • As compared to most of the developed countries the HDI of Nepal is very low. However, Nepal has been performing must better than several comparable countries during the last 5-6 years.
  • Among South Asian Countries the rank of Nepal is 7th above Pakistan and Afghanistan.

Top Ten Countries in terms of HDI values in 2019;

RankCountriesHDI Value
1Norway0.954
2Switzerland0.946
3Ireland0.942
4Germany0.939
4Hong Kong, China (SAR)0.939
6Australia0.938
6Iceland0.938
8Sweden0.937
9Singapore0.935
10Netherlands0.933
Top Ten Countries in terms of HDI values in 2019

Limitations of the Human Development Index (HDI)

Human Development Index (HDI) evaluates human development based on life expectancy, education, and income. Although it is regarded as superior to other indicators of human development, it has some limitations, which are;

  • It does not include gender discrimination
  • HDI does not include income inequality
  • It does not include aspects of human rights and political freedom
  • HDI does not include environmental degradation due to the development and consumption activities of human beings.

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