Quantitative Methods 2

Autumn 2013

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 “Diminishing returns” of gdp
“Concavity” of the utility function”.
Can be achieved by various means.
Actually, HDI shifted in this respect, previously
e.g. “Atkinson formula”.
I miss an explanation why ln.
Why not e.g. use the square roots.
Would transform 5 – 10 – 15
Into 2.24 – 3.16 – 3.87-

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Did the HDI create a different picture?
Yes, a bit.
Most countries get a different ranking when
ranked according to HDI instead of per capita
income.
But still, there is strong correlation between HDI
and GDP/head
(High on GDP tends also to be high on HDI).
Only plausible because …
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 However, …
Little correlation between GDP growth and non-
income dimensions of the HDI.
Takes time for life expectancy or education to
change too.
If GDP/head taken out of HDI, the correlation
between GDP and non-income components of
HDI becomes insignificant (more on significance
lecture 3 or 4).

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 Experiences last decades
See text Stanley Fischer in moodle.

HDI 1980-2000: almost monotonous improvement

every where.
Sole exception: Eastern/central Europe 1990-95.
Positive picture continued in 2000s.
The crisis after 2008 left little trace in the HDI.
Greece 2000 : 0.802
2009: 0.863
2011: 0.861
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 Is the HDI comprehensive enough?
Environment?
Criticism: HDI does not contain an indicator for
environment, substantial “hole”.
It is.
But very difficult, if not impossible to find
meaningful calculations of environmental
damages.
Same reasons why ideas about a “Green GDP”
did not come far.

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What about access to information?
HDI aims at informing about people’s choices.
Development defined as expansion of capabilities, among
them knowledge.
Is not free access to information central in this context?
The authors indicate this.
But when the Human Development Report 2010 (not the
HDI) contained tables about this, Cuba and the Arab
League filed official complaints.
Conclusion: UN agencies (such as the UNDP) work under
political constraints which impacts on their research.

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 “Substitutability”?
The old HDI was calculated as the arithmetic
mean of the three sub-indexes.
This meant that deterioration in one dimension
could be compensated for by improvement in
another.
In the theoretical extreme one dimension could
be zero and the HDI still quite high?
Does this make sense? Population is starving,
but education system is good?
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 Reform 2010 : Geometric Mean
The Human Development Report 2010
contained substantial alterations.
Among them changing the aggregation formula
from arithmetic to geometric mean.
This addresses the problem of “substitutability”
(but creates a new one, see below).

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 Geometric mean
The n elements of the set get multiplied, then
taken the nth root:
n√(x *x *…x )
1 2 n
In the case of the HDI:
3√(Hedu*Hhealth*Hliving standard)
This indeed reduces substitutability
substantially.

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 Io: old index; In: new index; If: Index under fixed coefficients.
Iso-capabilities: The points on the line get the same HDI. For a higher
HDI the whole curve must be moved towards “north east”.

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 Different types of substitution
Under the old index Io with arithmetic mean
there was linear substitution. On dimension
could substitute for another one at a fixed rate.
In the extreme one dimension could be zero.
In the case of fixed coefficients (also called
Leontief function) there is no substitution
possible. Improvement just in one dimension
does not bring you on higher level.

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 HDI as the solution “in between”.
Between the theoretical extremes of perfect
substitutability or no substitutability the HDI solution lies
in between.
Substitution still possible, but restricted.
But, as Martin Ravallion (World Bank), see text in moodle,
pointed at:
The Marginal Rate of Substitution changes, the “exchange
rate” between two dimension at a given point on the
curve.
In the middle, where it touches the other two, it is 1:1.
But high up it is very steep, and very flat at the right side.
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 Implicit “values” or weights.
If we look at the dimensions “life” and “income”.
In rich countries 1 additional year of life equals
about 9000 $ of income.
In Zimbabwe it is only 0.53 $.
Means it would be same most effective way to
promote human development by investing in
additional life years in the rich countries.

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 In Zimbabwe …
… practically the only way to raise the HDI is by
promoting growth in GDP.
Improvements in life expectancy or education
count extremely little. Although life expectancy
is among the lowest in the world.
“Concentration on GDP”? Against the basic
ideas behind the HDI.

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Klugmann/Rodriguez/Choi’s “defense”
“Was never the idea that HDI should be policy guide line and get
maximized.”
Would be wrong, e.g. HDI does not contain all important dimensions
(e.g. ecology), and maximizing HDI would give value of 0 to all the
omitted dimensions.
Is only very rough measure.
Fine.
But previous Human Development Reports lauded governments for
lifting their countries up the index. And countries get ranked according
to it.
Could be understood the way that maximizing the HDI was a political
goal.
Now this misunderstanding is out of the world.
HDI not perfect.

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 Dropping logging income?
Problem exacerbated because the HDI uses the
logarithms of income.
In a way superfluous.
Using geometric means implies that income (and
the other dimensions) become concave.
You cannot improve your HDI much by just raising
income and not raising education and health.
In a way, income gets logged twice.
But the authors refuse to consider not logging
income.

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 Innovation: Inequality adjusted HDI
(IHDI)
Basic idea: Big difference for most people if
resources or capabilities are distributed somehow
equally or very unequally.
The IHDI tries to capture this.
Use an measure for inequality:
A = 1 – (geometric mean/arithmetic mean).
Under condition of perfect equality geometric and
arithmetic mean are the same.
The A = 1 – (1/1) = 1 – 1 = 0.

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 Inequality measure A
In case the data are very unequal, some very
low, the geometric mean moves towards 0.
Becomes actually zero if one of the elements in
the set is 0.
Then
A= 1 – (geom mean / arithm mean) = 1- 0/1 = 1-
Consequently, A is between 0 and 1; the more
unequal, the closer to 1.
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 Inequality adjusted HDI
Can be used for a correction factor: (1 – A).
Thus:
HDIinequality-adjusted = HDI * (1 –A).
The effects are quite dramatic:

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 Gender Inequality Index
Similar exercise as to Gender Inequality.
The index is composed of data on differences in
achievements between men and women.
Indicators: Parliamentary representation, school
enrollment, labour force participation rates,
men and women. In addition: Maternal
Mortality and Adolescent Fertility Rates.
Effect on HDI likewise quite dramatical:

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 All in all
GDP and HDI are imperfect measures.
But rough estimates which can be useful for
many purposes.
An thinking about their construction and
discussing ways to improve them gives many
opportunities to think hard about what
development and progress actually is.

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