Economic development

Economic development is a broad improvement in living standards and welfare, so it is measured using several types of indicator: monetary, non-monetary and composite.

Monetary indicators measure development through income or output. The main one is real GNI (or GDP/NNI) per head, adjusted for inflation (real), population (per head) and — for cross-country comparison — purchasing power parity (PPP), which converts incomes by what money actually buys. Monetary indicators are objective and widely available, and higher income generally allows more spending on goods, health and education. However, they are averages that hide the distribution of income, ignore the informal sector and non-material welfare (health, leisure, environment), and so are an incomplete measure of development.

Non-monetary indicators measure living standards directly, without using money. Examples include life expectancy and infant mortality (health), literacy rates and years of schooling (education), and access to clean water, sanitation and electricity (living conditions). They capture aspects of wellbeing that income misses, but each measures only one dimension, so no single non-monetary indicator captures development as a whole.

Composite indicators combine several measures into one index to give a fuller picture. The best known is the Human Development Index (HDI), which combines income (GNI per head at PPP), education (years of schooling) and health (life expectancy) into an index from 0 to 1. Others include the Measure of Economic Welfare (MEW), which adjusts GDP by adding leisure/unpaid work and subtracting 'bads' like pollution, and the Multidimensional Poverty Index (MPI), which measures poverty across health, education and living standards. Composite indicators are broader than income alone, though they still involve value judgements about what to include and how to weight it.

In short, monetary indicators measure development by income, non-monetary indicators measure specific living standards directly, and composite indicators combine several dimensions into a single index — and the fullest picture of development uses all three together.

Comparing living standards between countries requires a measure that captures more than just output. The Human Development Index (HDI) is a leading candidate, but whether it is the best measure is open to debate.

The case for the HDI. The HDI is a composite index combining income (GNI per head at PPP), education (years of schooling) and health (life expectancy) into a single number from 0 to 1. This is a clear improvement on GDP per head, because it recognises that development is multidimensional — two countries with the same income can have very different health and education, and the HDI captures that. It is widely published, comparable across countries, and uses PPP-adjusted income so cost-of-living differences are allowed for. It therefore gives a fuller, more balanced comparison of living standards than income alone.

The limitations of the HDI. First, it still omits important dimensions: it ignores inequality (two countries with the same average HDI can have very different distributions), the environment, political freedoms, security and gender equality. Second, it relies on just three proxies, each imperfect (years of schooling does not measure quality of education; life expectancy does not capture morbidity). Third, the weighting of the three components is a value judgement. Fourth, like all such measures it depends on data quality, which varies between countries, and the large informal sector in developing economies is hard to measure.

Alternative and complementary measures. Because of these gaps, other measures may be better for particular purposes: the Multidimensional Poverty Index (MPI) captures the depth and breadth of poverty across several deprivations; the Gini coefficient captures inequality; the MEW adjusts GDP for welfare 'goods' and 'bads'; and non-monetary indicators (clean water, sanitation) capture specific conditions. An inequality-adjusted HDI exists precisely because the standard HDI ignores distribution.

Judgement. The HDI is better than GDP per head as a measure of living standards because it is multidimensional, and it is a very useful headline measure — so the view has real merit. But it is not the single best measure, because it omits inequality, the environment and freedoms, and rests on value judgements about weighting. The most defensible conclusion is that there is no single best measure: the HDI should be used alongside the MPI, the Gini coefficient and selected non-monetary indicators, so that income, health, education, poverty and distribution are all considered. For comparing living standards specifically, a basket of indicators led by the HDI is better than relying on the HDI — or GDP — alone.

To judge living standards, nominal GDP must be converted to real GDP per head, because both inflation and population have risen.

First, adjust for inflation: nominal GDP rose 8% but prices rose 6%, so real GDP rose by roughly 8% − 6% = 2%. Most of the headline rise was simply higher prices, not more output.

Second, adjust for population: real output rose about 2% but population grew 3%, so real GDP per head actually fell by roughly 2% − 3% = −1%. On average, output (and income) per person has fallen, so material living standards have probably worsened, not improved, despite the 8% nominal headline.

However, this is only the material picture. Living standards (development) also depend on non-material factors — health, education, the distribution of income and the environment — which GDP per head does not capture. So while the income evidence suggests living standards have likely fallen slightly, a full judgement would also need non-monetary and composite indicators (e.g. HDI, MPI).

Economic growth is a rise in real output (real GDP per head); economic development is the wider improvement in living standards — health, education, freedoms and reduced poverty. Growth and development are linked, but growth does not always lead to development.

The case that growth leads to development. Higher real output raises incomes, allowing households to spend more on food, housing, healthcare and education, and giving governments more tax revenue to fund public services, infrastructure and poverty reduction. Sustained growth has historically lifted millions out of poverty and is reflected in higher HDI scores, so growth is usually necessary for development and often drives it.

The case that growth does not always lead to development. Growth raises development only if its benefits are widely shared and not offset by costs. If the gains accrue to a small elite (high inequality — consistent with the rising portion of the Kuznets curve), average development improves little for most people. Growth driven by pollution or resource depletion can damage health and the environment, reducing welfare even as GDP rises. Growth in non-welfare output (e.g. military spending) adds to GDP without improving living standards. And growth measured by GDP may ignore the informal sector and non-material wellbeing. So growth can occur with little or even negative development.

Judgement. Economic growth is usually necessary for development and often leads to it — it provides the income and tax revenue that fund better living standards. But it does not always do so: whether growth translates into development depends on the distribution of the gains, the environmental and social costs, and whether governments use the extra resources to improve health, education and poverty. The most defensible conclusion is that growth is necessary but not sufficient for development; it leads to development only when it is inclusive and sustainable.