ee ec CHAPTER Overview of Development ely 2.1 INTRODUCTION ‘The enormous interest in the economic development of postwar East Asia has continued into the new millennium. The region's recent economic history has been marked by an “economic miracle” that spanned several decades followed by a severe financial and economic crisis. Problems af widespread poverty and economic inequality remain despite significant economic progress. Addressing these issues, as well as the impact of developments in the world economy, is a challenge the region's govern ments, international organizations, and the economics profession face as a whole. The region provides fertile ground for economists to study and address a wide variety of economic development issues. Fast Asia stands out because of the dynamic economic growth and development it has achieved throughout the postwar period. The development process began in Japan when it opened its econ. ‘omy to increased trade and investment. The rapid industrialization that followed quickly spread to the neighboring economies of South Korea, Singapore, Taiwan, and Hong Kong. Economic growth in these newly industrialized economies (NIEs), sometimes called the Asian “tigers,” averaged 8 percent a year in the three decades prior to the Asian financial crisis in 1997. This growth continued despite two oil crises in the 1970s, a sluggish world economy in the early 1980s, and rising protectionism and currency appreciation in the latter half of the eighties ‘The industrialization experiences of Japan and these Asian “tigers” formed the basis of the “East Asian development model? which has now become an accepted part of economic development litera ture. Recent studies have used this model to characterize the growth and development in the neighbor ing ASEAN economies and China. Inspired by the success of Japan and the NIEs, Indonesia, Maia Thailand, and the Philippines developed strategies that promoted the inflow of forcig) encouraged exports. These outward-oriented economic policies fuelled rapid growth during th China’ economic growth and development has likewise accelerated since the late 1970s when its govern ment shifted to an open-door policy that promoted foreign investment and export26 Economic Development However, the remarkable economic record of the Asian economies was marred by the Asian financial crisis. Triggered by the collapse of the ‘Thai baht in July 1997, equity markets and currencies throughout Southeast Asia came under great pressure and the ensuing currency devaluations led to foreign capital flight. Consequently, in a mater of two months or $0, Asias once vibrant economies were plunged into deep recession. This economic collapse forced an unprecedented reappraisal of poli- cies ranging from corporate government to exchange rate management. It also forced a rethink of the prescriptive policies imposed on the ailing economies by international development institutions such ° as the International Monetary Fund (IMF) and the World Bank. After the sharp economic contraction in 1998, the region rebounded rapidly. In South Korea, for example, year-on-year industrial production and gross domestic product (GDP) increased dramati- cally in 1999 while stock market values doubled in Thailand and Malaysia, The primary equity market indexes in Seoul and Singapore returned to their pre-crisis levels. However, as the US. economy slowed in 2001 and 2002, and war in Iraq and the spread of the SARS virus took place in 2003, prospects for the region were adversely affected and the future became uncertain, “The financial crisis also hampered progress in reducing poverty and addressing other social issues. ‘The human development gains in health, education, poverty, and equality, and the distribution of income achieved by East Asia in the two decades prior to the crises was eroded to some degree, result- ing in slower growth. ‘There is no doubt, however, that the economies of East Asia are in the process of recovering from the crisis and the region, as a whole, will play a major role in the global, high-tech world economy that ‘we are moving towards in this new millennium, In South Asia, where the impact of the financial crisis on the region was not as severe, economic progress has accelerated following a shift in policy in the late 1980s and early 1990s, Nevertheless, this region faces a number of challenges, including further progress in reducing poverty and the resolution of political disputes that have drawn resources away from economic development. “This book cannot tell you where Asia is going or exactly how it is going to get there. The dynamics of growth of the region and the world economy will determine this in the long run. What this book offers are tools of analysis and insights based on historical experiences so that the reader will be able to appreciate, understand, and evaluate economic development policy and issues in the region. ‘This knowledge will enable the reader to better understand and participate more fully in the ongoing dia- logue between policymakers, economists, business firms, and international agencies. 2.2 Hows Devecopment Economics Distinct FROM OTHER Aspects of Economics? In today’s classrooms, economic development concentrates on economies that have low per-capita incomes, These economies are set apart, for argument’ sake, from the industrial economies of Europe, North America, Japan, and Australia/New Zealand. Economic development considers the experience of these industrial countries as relevant for analyzing the process of economic growth. In Asia, there are many poor countries, as well as some that have recently joined the group of industrialized countries, such as Singapore, Hong Kong, Korea, and Taiwan. We will study all of these Asian economies, par- ticularly those that have been highly successful in achieving high growth and high levels of per-capita income. Many useful lessons can be learned from them by comparing their development experience with economies that have grown less rapidly. The book does not deal with the economies of Central ‘Asia, but focuses on East and Southeast Asia (including the Mekong economies), and South Asia. Development economists also make use of analytical tools and methods developed in a variety of other branches of economics, such as growth theory, macroeconomics, microeconomics, labor,Chapter 2 Overview of Development Economics 27. industrial organization, international trade, and fiscal and monetary policies, to name just a few. They apply these tools of analysis to the problems and challenges of developing countries 2.3 Measurinc Growtx ano DeveLopmMENT For many years, economic development was considered to be synonymous with economic growth ~ either total economic growth or economic growth in per-capita terms. The two concepts of economic growth and economic development are, however, not necessarily the same. The concept of economic development is a broader and much more encompassing view than economic growth, and relates to levels of social and humanitarian achievement and income distribution, as well as a narrower measure of per-capita income, Using a measure of the amount of goods and services produced in an economy in a year, we can get some idea about the standard of living in that economy. When the value of these goods increases over time, there is economic growth, Gross domestic product (the total value of production in an economy) or gross national product (GNP—which is GDP plus net factor income from abroad) is used as a mea- sure of the nation’s income or production. The size of the total population can be used to deflate it to per-capita terms. An improvement in the living standards of the population is a natural consequence of economic growth over a period of time. Thus, by looking at GDP or GNP growth rates, we get some idea about living standards and how they change over time. Comparisons of these figures also allow us to relate the performances of countries or regions in terms of their growth. Figure 2.1 shows GDP in constant 2000 US. dollars for selected Asian countries over the period 1960-2007. As you can see, some countries have grown very rapidly during this period while oth- ers have progressed very slowly. These comparisons may be somewhat misleading, particularly for countries where their currencies were devalued against the U.S. dollar during the period (more on this later). Nevertheless. they give some indication of the relative performance of different economies By 2007, among the sclected Asian countries, China, India, and Korea appear to have had the highest evel of GDP (over US$400 billion) whereas Pakistan, Bangladesh, and Sri Lanka lagged behind, with their GDP less than US$100 billion. The GDP for Indonesia, Hong Kong, Singapore, and Malaysia lies between US$100 and US$200 billion. However, care should be exercised when interpreting the economic growth and standard of living in these countries based only on aggregate GDP levels since population levels are not taken into account here. Table 2.1 shows a clearer picture of economic growth over time as it takes into account poptlation changes by using data for GDP per capita for 1960 and 2007. Since GDP per capita measures the level of GDP for each country, itis an indication of the standard of living at the individual country level. As can be seen, GDP per capita in the NIEs, such as Singapore, Hong Kong, and Korea, grew rapidly while other countries such as India and Nepal grew at a slower rate. Current figures show that Singapore's GDP per capita is almost twice that of Korea, more than six times that of Malaysia, and more than six- teen times that of China (see last column of Table 2.1). ‘As noted above, when we speak of economic development, we usually mean economic growth accompanied by an improvement in the people’ quality of life. To a large degree, economic develop- ment results from economic growth. However, the experiences of many economies have shown that economic growth can occur without any improvement in the quality of the lives of its people. A case in point is the resource-rich country of Papua New Guinea, Its mineral-based modern economic sector has grown quite rapidly in the past few decades, pushing up total income and income per capita, In spite of this it is common to find households in the rural areas continuing to live ata subsistence level. ‘The fruits of this economic growth have not been distributed throughout the society and the govern- ment still provides few opportunities for education and health. Human development indicators, such28 Economic Development Figure 2.1 GDP in Constant 2000 U.S. Dollars for Selected Asian Economies, 1960-2007 GDP in Current USS (Billions) | 2,500 HE China 2250 a india — Korea, Rep. of HE Indonesia 2,000 —— Hong Kong alan —e— Singapore ecg oe Malaysia 1,500 1.250 1,000 750 300 250 ° 1960 1970 1980 1990 2000 2007 SOURCE: Data from World Bank (2008), as life expectancy, infant mortality, and the average level of educational attainment have lagged behind those of the other countries in the Asian region. Asa result, there is a growing awareness that the concepts of GDP (and GNP) need to be broad- ened in order to include other factors that measure economic development. As they stand, GDP and GNP are not sufficiently balanced to adequately capture the essence of economic development. Several additional indicators of growth and development have therefore been proposed in this book 2.4 New Approacues To Measurinc Economic DeveLopMENT 2.4.1 The Human Development Index (HDI) ‘The United Nations Development Program (UNDP) developed the HDI in the late 1980s and has been publishing it since 1990. This index has three components: per-capita income and two additional—-— — Chapter 2 Overview of Development Economics 29. Table 2.1. GDP Per Capita by Country in Constant 2000 US. Dollars* | Japan 7.018 40,656 Singapore 2.251 28,964 | Hong Kong 3,080 34.037 ‘South Korea ino 145540 | Malaysia 784 ans Thailand 37% 2713, Philippines 612 1216 Indonesia 196 1.034 China 105 1791 | Pakistan 188 660 India 181 686 | Nepal 135 243 “*eowever, gues for GOP per capita wil ot accurately reflect the standard of Ming when there exists a bios n income dstibuton since ‘assumes that GDP is equly distibuted among the population, This willbe discussed in greoter detain Chapter “SOURCE: Data from World Bank (2009), ‘measures—life expectancy at birth, and level of educational attainment that combines adult literacy and educational enrolment rates. These are added to per-capita income, which is adjusted to reflect the diminishing marginal use of money, to obtain HDI. The HDI is developed as a ratio of a particu- lar country to the most developed country. It varies between zero and one. Both of these additional indicators are somewhat related to per-capita income. However, the HDI can be useful in recognizing that some countries may have rather low income levels, but still have achieved a lot in terms af cattery ing human needs (see Table 2.2, ranked in terms of descending HDI values). Examples are Sri Lanka, China, and several countries in Central Asia For other countries, such as Papua New Giinea and Pakistary the HDI is much lower than we would expect by looking at per-capita income alone Several countries, such as Kuwait and Guatemala, rate much higher in per-capita income terms than they do with respect to human development, Within A: a, the rankings are more closely correlated. 2.4.2 Healthy Life Expectancy A measure used by the World Hfealth Organization (WHO) summarizes the expected number of years 10 be lived in “full health.” The yeas of ill-health are weighted according to severity and subtracted from the overall life expectancy rate to give the equivalent years of healthy life According to the latest data available from the WHO' Statistical Information System Online Database, Japanese men have the longest healthy lie expectancy of 72 years among 191 countries, compared with 2? years for the lowest ranking country, Sierra Leone (see Table 2.3, arranged in descending order of healthy life expectancy values for 2003),30 Economie Developm { anette’ ne acne Cet 2007; Wied Nets ere Pye ( Table 2.2. GOP V1 €opita versa 1, 2000 and 2005 | Pn a | CHS Teese Sera (PPPs) Peers ny fener | Hong Kong 0.888 34,833 0937 | Stogapore 08ss 29 isa | roves sez 22029 asi | Kuwait. 0813 26,321 0.891 tay ane vss on | thailand 0.762 8677 0.781 i | enone rsa 537 wn | | sitanka ova 4595 or | | china a7 6751 | Vietnam ass 30 o733 Guatemala 342i asst se0 oss India 2380 os77 asa osi9 Pakistan 1928 0499 2370 osst | | sangladesh 1602 oars 2053 | | uganda 1.208 oad 1454 0505 i | swonds ons 03 1206 oa | i aM wm os oes | | 243 Green GNP ‘One of the more recent approaches developed (oaudress the inherent shortcomings uf GDP and GNP as growth and developmient measures is based on what is known as the "gieeu” system of national accounting. Green GNP is the informal name given 10 national income teisutes thit are adjusted to take into account the depletion of natural resources (both renewable and non-renewable) aud envi- ronmental degradation. “the types of adjustments made to standard GNP would include the cost of exploiting a natural resource and valuing the social cost of pollution emissions. Damages to the global cnvironment, such as global warnting and depletion of the ozone layer, should also be deducted; but these damages are hard to estimate. Others suggest that “defensive” expenditures, those for environ, ‘mental protection and compensation for environmental damage, inclucling medical expenses, should also be deducted. The argument here is that these costs would not ha ‘ment had not been damaged been incurred if the environ31 Japan Singapore, Kuwait Korea China Malaysia Vietnam SeiLanka Thailand Indonesia Philippines Bangladesh Pakistan India eos Uganda Tanzania Rwanda Sierra Leone. ‘SOURCE: Worl Heath Orgaization, Statistical Information System fnlne database. 2.5 Makinc Comparisons BETWEEN COUNTRIES ‘There are two different methods currently in use for comparing income between countries using the GDP measure—the exchange rate method and the purchasing power parity (PPP) method. (Notice in Table 2.2that a PPP measure was used to compare GDP per capita). 2.5.1 Exchange Rate Method The exchange rate method uses the exchange rate between the local currency and the US. dollar to convert the currency into its US. dollar equivalent. A country’s GDP and GDP per capita would then be valued accordingly, in US. dollars. 2.5.2 PPP Method ‘The purchasing power parity method develops a cost-index for comparable baskets of consumption goods in the local currency and then compares this with prices in the United States for the same set of32 Economie Development Income Level (3) (ess cost of ull degradation) Year | | | | | 1975 1978 } = | sounc: over pet, ia Moga, ich Wel Chis Bea and Fb Rosin, wring Ase Maa ese 8 |) Nowonotincome Accounts (Washington, DC. Word Hesourcesinsttue, 189) j y) commodities, A country’s PPP is defined as the number of units of the country’s currency required! 10 buy the same amount of goods and services that a dollar would buy in the United States. Because the PPP methodt-wseserbusket of many goods and calculates the relative price of these goods, many econo tists view this av a better peasure of the relative standards of living than the conventional exchange rate method described abovs “hese two different methods can give widely varying estimates uf GDP. In general, the PPP method gives higher estimates of living standards for developing countries compared with the exchange rate sethod: ‘The reason is that calculations of GDP based on exchange rate values depend only on the relative prices of traded goods, whereas the PPP method considers a basket of goods that include both (laded and nontraded goods. Nontraded goods’ are generally much cheaper in developing countries and this helps to lft the estimate of GDP for these economies. A further advantage of the PPP method. is that itis unaffected by exchange rate changes. As a result of these advantages, the PPP method has become the preferred measure of GDP for country comparisons. One difficulty with the PPP method, however, is that it is costly to maintain since price movements need to be updated on a regular basis Figure 2.3 shows an alternate indicator of national income other than GDP and GNP, namely, gross national income (GNI), under both the PPP and exchange rates in 2007. ly pul, nontraded goods are those which do not leave their country of production, perhaps because of their nature or ple, dame rapa and cunstructivn) or because of government-policy restrictions, or simply the lack of an intertatioul ake.Chapter 2 Overview of Development Economics 33 gure 2.3. GNI Per Capita, Exchange Rate, and PPP, 2007 40.000 30.600 21,000 1.900 e CE ASF LS see £F SE EEE PERE S rte s re GN per Capita 60.000 PPP 50,000 BW Exchange Rate (Atlas) SOURCE: Data from World Bank (2000) 2.6 Summary Economic development is a special field of economics which concentrates on the study of countri which are in the process of moving upward from low levels of income, and social progress, There are many features of an economy that are relevant for measuring its level of national well-being, includ- ing the annual production of goods and services (GDP/GNP/GNI) and social indicators, such as life expectancy, educational attainment, and environmental quality. ‘To compare and contrast the level of economic development in different economies, it is useful to consider all these factors. In particular, it is important to recognize that there are two popular ways to compare levels of income: the exchange rate and purchasing power parity methods. The exchange rate method has the advantage of simplicity and ease of calculation. The PPP method, while more costly to calculate and maintain over time. is a better measure of relative living standards since it is unaffected by exchange rate fluctuations and includes all goods produced rather than traded goods only.