Economic growth and development

Economic growth and Development©

Unit 10

RASHAIN PERERA 077 059 37 52


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Prepared by:

RASHAIN PERERA


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SUMMARY• Section 1; Economic growth• Section 2; Economic

development• Section 3; Factors affecting

economic growth and development process


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ECONOMIC GROWTHSection 1


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What is economic growth?

• It is the persistent increase in the real GDP of a country

• In other words it is the increase of the potential output or GDP

• It can be shown as an outward shift of PPC• Here the production, output, income,

expenditure, demand, employment levels increase or appreciate leading the economy to grow

• Economic growth is a journey(dynamic process) but not a destination(static output)


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Presentation of economic growth on a PPC

• Economic growth can be shown as an outward shift of the PPC


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Merit goods Vs Luxury Goods


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Economic growth and aggregate supply

• Economic growth results in an expansion of aggregate supply and hence it can be depicted as a rightward shift of aggregate supply curve


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Opportunity cost of economic growth

• The opportunity cost of economic growth is the present consumption that is being sacrificed.

• Higher the investments done at present higher the economic growth will be and vice versa.

• To invest more at present an economy needs to sacrifice on consumption activities.

• Thus the opportunity cost of economic growth is the present consumption that is sacrificed


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What are the determinants/sources/causes of economic growth?

• Resource endowment• Productivity levels of the economy• Macro economic stability• Good governance• Political stability• Growth of opportunities for entrepreneurs• Increase in investments and stock of capital• Increase in the investment ratio• Creation of a favorable atmosphere inside the country to

promote foreign investments• Development of infrastructure facilities• Trained labour force


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Main wheels of economic growth

• Human resources• Natural resources• Capital• technology


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What factors limit economic growth?

• Lack of capital formation• Lack of savings• Rapid population growth compared to the growth in

output• Low labour productivity• Inadequacy of infrastructure facilities• Inefficiencies in public sector• Macro economic instability• Ethical issues and political instability• Cultural barriers• Unskilled labour• Imperfect labour markets


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Public sector strategies in promoting economic growth

• Increase government spending on technological development

• Increase government expenditure on infrastructure activities

• Increase government expenditure on human capital development

• Establish political stability• Keep interest rates at low level• Creating investor friendly economic environment• Establish macro economic stability• Promote private property rights• Establish a good tax system to promote savings and

investments• Increase government expenditure on research and

development


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Costs of economic growth

• Opportunity cost of investments or sacrificed present consumption– In order to avoid the opportunity cost, foreign aids and

grants should be obtained so that present consumption is not sacrificed.

• Negative externalities from the production process• Wastage of economic resources if the process of

economic growth is not properly planned– As a solution environmental preservation measures can

be taken• Socio cultural problems• Administrative costs


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Measuring economic growth

• Economic growth rate• Real GDP per capita


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Economic growth rate• This measures the percentage

growth of real GDP of a given year relative to the previous year

= real GDP current year - real GDP previous year

real GDP previous year


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• Per capita real GNP

= real GNPMid year population

• This measures the growth of living standards• Enable comparison of development among

nations


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year Per capita GDP (market price-USD)

2011 28362012 29222013 32802014 3625


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What is negative real growth?

• This is a situation where GDP or GNP at constant price has gone down in a particular year compared to the previous year

• Causes– Fall of output– Lack of infrastructure– Terrorism and civil war– Decline in investment ratio– Political instability– Recession


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Economic structure and structural changes with economic growth

• Structural composition• Employment composition• International trade structure- exports• Changed with economic growth• Agriculture sector involvement decreased• Service sector and industrial sectors expanded• Employment structure too changed• Employees are educated• They wanted white collar jobs• Thus employment in agricultural sector decreased


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Analyzing economic growth rates of Sri Lanka

• Highest growth rates are recorded in 1978 and 2011 – 8.3%

• Lowest growth rate is recorded in 2001 – (-1.5%)

• After the war 7.44%• Last decade economic growth rate is

6.74% (2005-2014)2007 2008 2009 2010 2011 2012 2013 2014

6.8 6 3.5 8 8.3 6.3 7.2 7.4


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Reasons for a higher economic growth rate in the recent years• Higher investor and consumer

confidence after the war• Macro-economic stability• Higher utilization of resources• Infrastructure development• Economic development in North and

Eastern provinces• Rapid expansion in industry and service

sectors.


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Factors required in promoting economic growth

• Investments• Savings• Lower ICOR-productivity of capital• Technology• Education and training• Entrepreneurship• Research and development• Macro economic stability• Good governance


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Investments • The main source of investment is

savings• If investment exceeds savings from

domestic sources, foreign savings are used to bridge the gap

• In other words investments can only be increased than savings from domestic sources through savings from foreign sources


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Sources of investmentDomestic sources Foreign sources

Household savingsCorporate savingsGovernment savings

Foreign loans and aidsForeign grantsForeign investments

Foreign direct investmentsPortfolio investments


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Saving-investment gap• In a given period the difference

between savings from domestic sources and investment is known as saving-investment gap

Saving-investment gap=domestic savings-investments


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Strategies to bridge saving-investment gap

• Control inflation– Positive real interest rates lead to promote savings in

the mid term and long term– Increase in real income leads to promote savings and

labour productivity• Liberalizing financial market– Liberalizing foreign exchange controls– Introducing innovative and effective financial

instruments– Stabilizing financial system and provide more

opportunities for financial institutions• Improve infrastructure facilities• Fiscal discipline


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Incremental Capital Output Ratio-ICOR

• Is incremental percentage of capital required to increase gross domestic product by 1%. Higher the ICOR lower the productivity of capital

ICOR = change in K / Change in Y


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Social capital• Social capital refers to the institutions,

relationships and norms established by a group of people for the common well being to shape the quality and quantity of a society’s social interactions.

• Social capital leads to better interaction and co-ordination of the society through which it helps to improve productivity. Thus it leads to economic growth


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• Importance of social capital– Helps to improve social interactions and

coordination– Helps to improve public productivity– Improve social trust and harmony– Helps in sustainable growth– Reduces social unrest and ethical problems– Improve quality of life– Create a friendly social environment helps to

disseminate knowledge


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ECONOMIC DEVELOPMENTSection 2


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What is economic development?

• This is the process of upgrading the quality of all human lives

• Provision of facilities for the people to enjoy a better standard of living

• Through improvements in economic, social and cultural aspects

• Economic development is with the improvement of economic growth where growth benefits flow down to all people of the economy to ensure acceptable living standards for everyone


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Defining economic development

• Economic development is analyzed using different approaches because there is no universal agreement as how to define standard of living improvement of quality of life.

• Following are the approaches used– Economic growth approach– Economic development approach– Basic needs approach– Human development approach– Sustainable development approach


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Economic growth approach

• Oldest concept on development• Argues that economic growth equals to

economic development• According to this approach ability of an

economy to improve its real GDP and capability of sustaining it for a long period is considered as economic development

• Measurements used in this approach– Real GDP growth rate– Per capita real GDP


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Economic development approach

• Is the process of improving both quantity and quality of life

• Thus this approach argues that the economic growth is not a sufficient measure to evaluate economic development but along with economic growth other factors such as structural changes needs to be considered

• Measures used– Economic growth

• Real GDP growth• Per capita real GDP

– Structural and other economic changes• Sectorial contribution to GDP• Factor productivity• Technological improvement• Relative income distribution


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Basic needs approach• An approach based on development of people• Economic development = ability to acquire a goods and

service basket that meets acceptable minimum living standard by everyone in the society

• In this approach labour productivity was identified as the main force to achieve economic development

• Measurements include– Economic growth

• Real GDP growth• Per capita real GDP

– Quality of life• Physical quality of Life index PQLI• Absolute poverty• Unemployment rate• Relative income distribution


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PQLI• This is an index that measures the quality

of life or well being of a country• PQLI uses the equally weighted average of

thee statistics– Basic literacy rate– Infant mortality rate– Life expectancy

• PQLI value varies from 100 where 100 is the best physical quality of life and 1 is the worst


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Human development approach

• Was introduced by UNO in 1990• Argues that economic development is through improving

human capabilities, expanding the choices and opportunities people have to live lives that they value

• In simple converting living standard of people from bad to good

• Human development is measured using 3 main dimensions– Long and healthy life/longivity

• Life expectancy at birth– Knowledge/education

• Mean years of schooling• Expected years of schooling

– Decent standard of living• GNI per capita PPP in USD


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Sustainable development approach

• Human life is on a finite planet• Development is achieving economic

growth to meet human needs without undermining the sustainability of natural systems and the environment so that future generations may also have their needs met.


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Essential requirements for economic development

• Except economic growth• Reduction in income disparity• Reduction in poverty and unemployment• Fulfillment of basic needs• Changes in economic structure• God governance• Balanced regional development• Sustainable development• Self sufficiency


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What is sustainable development?

• Sustainable development is the development which meets the needs of the present generation without compromising the needs of the future generation.

• There are four types of capital necessary for sustainable development– Physical capital– Human capital– Natural capital– Social capital

• The sectors that needs improvement with sustainable development– Economic development– Social development– Protection of environment


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Factors and indices used to measure economic development.


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Economic factorsEconomic growth Real GDP/GNP growth rate, annual growth rate of per

capita real GDP/GNP, purchasing power parity GDP

Employment and unemployment

Employment ratio, labour force participation rate, unemployment rate

Income distribution

Lorenz curve and gini co-efficient to measure relative income distribution, absolute income distribution

Economic stability Inflation rate, surplus or deficits of BOP, changes in exchange rates

Social factorshealth Life expectancy at birth, infantile mortality rate, maternal

mortality rate, underweight child birth below 5 years

nutrition Average daily calorie consumption, malnutritioneducation Literacy rate, drop out rate, educational level of labour

force, educational level of women, teacher pupil ratio

Living standards Physical quality life index, human development index, human poverty index, millennium development goals, sustainable development


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Economic growth VS economic development.

Economic growth Economic developmentA persistent or sustained increase in country’s real GDP or GNP over a long period of timeIs a quantitative measureIs an essential requirement for development

Economic development shows an increase in the quality of all human lives

Is a qualitative measure


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FACTORS AFFECTING ECONOMIC GROWTH AND DEVELOPMENT.

Section 3


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What factors affect economic growth and development process?

• Income• Equity• Poverty• Population• Employment• Unemployment


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INCOMESection 3 A


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Measuring income• World bank classification of

economies• Per capita GNP• Purchasing power parity income

distribution (PPP)


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World bank classification of economies.

• Here based on GDP per capita every economy is classified as low income, middle income or high income.

• 2012 GNI per capita calculated using the World Bank Atlas method.

Low incomeLower middleUpper middleHigh income

$1035 or less$1036-$4085$4086-$12615$12616 or more


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Purchasing power parity income distribution.

• purchasing power parity can be defined as the presentation of the ability that a country has to buy goods and services in local currency in terms of the exchange rate

• The purchasing power parity income and per capita income measured in 2012.

Country Per capita GNP PPP per capita GNPBangladeshNepalPakistanIndiaSri LankaChinaSwitzerlandUSANorway

7526901257148929236091789255174999558

185114512741381361869083532815174965640


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Reasons for the difference between per capita income and PPP per capita income.

• Differentials in price levels between countries

• Self sufficient closed economies are not considered for this measure

• Changes in economic and social policies


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EQUITYSection 3 B


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What is equity?• Non existence of high inequality in

the distribution of income among households is equity. This does not mean that income is equally distributed households.

• Basis of studying equity– Relative income distribution– Absolute income distribution


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Relative income distribution.

• Illustration of the distribution of income as a percentage among households or income shares by deciles of income receivers is relative income distribution.

• Lorenz curve and Gini-co-efficient can be used to measure the relative income distribution.


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Lorenz curve• This was introduced by Max Auto Lorenz to

measure relative distribution of income.• It shows the degree of inequality that

exists in the distributions of two variables and is often used to illustrate the extent that income or wealth is distributed unequally in a particular society.


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Gini-coeffecient• A gini co-efficient is a numerical

measure that measures how unequally one variable is related to another.

= area between 45 degree line of Lorenz curve

area below the line of perfect equity


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Absolute income distribution

• This shows the percentage of households that belong to different income groups. In other words this shows absolute poverty, the percentage of households less than a certain level of income.


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POVERTYSection 3 C


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What is poverty?• Poverty refers to the state of inability

to fulfill the basic needs. • In other words inability to obtain a

minimum living standard acceptable in the society is poverty.

• There are 3 types of poverty


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Absolute/income/consumption poverty

• This is the most important to identify poverty.

• Absolute poverty is the inability to fulfill basic human needs or minimum living standard.

• When human beings are not able to consume sufficient necessities to maintain life or when human beings are homeless and malnourished they suffer from income poverty.


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Relative poverty• Inequality in the distribution of

income in a country is relative poverty.

• Here the income earned by one group is compared with that of another group.

• Relative poverty always exists in a society. Lorenz curve and Gini-co efficient are used to measure this.


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Human poverty• The denial of choices and opportunities for

living a life one has reason to value could be simply known as human poverty

• HDI(Human Development Index) is used to measure human poverty. This was introduced by the united nations.

• Long and healthy life• Knowledge• Decent standard of living

• When these requirements are not satisfied it is meant to be human poverty.


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Vicious cycle of poverty


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Measuring poverty• Poverty line• Human poverty index– HPI -I– HPI -II


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Poverty line• Poverty line is the monthly expenditure needed to

obtain minimum quantity of goods that is required for the subsistence of an individual. This minimum quantity of goods should supply daily 2500 calories and 53g of protein (20-39 years). Poverty line is a criterion used to measure the absolute poverty.

• When the sector of population below the poverty line is shown as a percentage of total population it is called a Head Count Index (HCI). Poverty line takes two forms. They are;– Lower poverty line– Upper poverty line


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Human Poverty IndexHPI is a composite index formed in 1977. This is an

indication of the standards of living in a country. There are two indices namely HPI 1 and HPI 2.

HPI 1-This is a composite index measuring deprivation in 3 basic dimensions captured in the HDI. They are;– Probability at birth of not surviving till the age of 40 years– Adults without literacy rate– Underweighted average population without sustainable

access to an impoverished water source and children underweight for their age.

HPI 2- The components or dimensions of HPI 2 are as follows;– Probability at birth of not surviving till the age of 60 years– Adults lacking functional literacy skills– Rate of long term unemployment. (lasting 12 months and

more)– Population below income poverty line.


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POPULATIONSection 3 D


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What is population?• Population is a dynamic phenomenon.• Population growth– Population growth is the change in population

over time. In other words it is the change in the number of individuals of a country’s population.

– Population growth rate is used to determine the percentage in which population changed over time.

– Population growth rate is the percentage by which the total population has increased during a year in consideration compared to a previous year.


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= (crude birth rate % - crude death rate % ± net immigration %) /1000

x 100

= (natural growth rate % ± net immigration %) /1000 x 100


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Population density• Population density is the number of

people per square kilometer of land. While the land area remains constant, the population density increases with the growth of the population.

• According to 2001 census, Sri Lanka population density stands at 300 persons per square kilometer.


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The main reasons for change in population

• Fertility• Mortality• Net migrations


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Fertility/births • Birth rate (crude birth rate)-Birth

rate is the number of live births per 1000 people in a given year. The birth rate is usually the dominant factor in determining the rate of population growth

= (total number of live births / mid

year population ) x 1000


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• Life expectancy– Life expectancy at birth is the average

number of years to be lived by a group of people born in the same year, if mortality at each age remains constant in future.


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Mortality/deaths • Mortality rate (crude death rate)-The

mortality rate measures the average annual number of deaths during a year per 1000 populations at midyear and also known as crude death rate. It is a rough indicator of the mortality situation in a country. It accurately indicates the current mortality impact on population growth.

= average number of deaths during the year / mid year population x 1000


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• Infant mortality rate-Infant mortality rate is the number of deaths of infants under one year old in a given year, per 1000 live births in the same year. This rate is often used as an indicator of the level of health in a country

= number of infants deaths during the period / total number of live births during the year x 1000


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Births VS deaths• Natural increase / decrease

(births- deaths)-Natural increase / decrease is the surplus / deficit of births over deaths in a population in a given time period.

= crude birth rate% - crude death rate % / 1000 x 100


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Net migrations• Net migrations/immigrations- This is

the difference between the number of persons entering and leaving a country during the year per 1000 persons.

• An excess of persons entering the country is referred to as net immigrations

• While an excess of persons leaving the country could be known as net emigrations.


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Note!!! • With the change in population over time

following factors should also be considered:– Population density– Sex composition– Dependency ratio– Age structure– Teacher : pupil ratio– Ageing population– Literacy rate – And others


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EMPLOYMENTSection 3 E


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• Before studying employment it is worth to study on “LABOR FORCE”


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What is labor force?• Population in working age that already work and have

offered themselves for employment could be simply known as labour force. Labour force consists two types of labour. They are;– People who are already employed– People who are unemployed and expecting a job

opportunity• There are four types of people who are already

employed. They are;– Employees who are obtaining wages– Self employed persons– Family workers who are obtaining wages– Employers


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Labor force participation rate/activity rate

• labour force particiapation rate is the labour force as a percentage of population of working age. In Sri Lanka the labour force is defined as persons aged 10 years and above, who are able to work in a given reference period.

= (employed aged 10 and above + unemployed aged 10 and above) /population aged 10 and above x 100


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What is employment?• Employment is working for a public

or private employer receiving remuneration in wages, salary, commission, tips, piece rates, or pay in kind.


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Employment rate• The proportion of working age adults

employed, as a percentage of total labour force.

= working age adults employed

labour force x 100


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Full employment Vs under employment


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• Full employment-Full employment is when all or nearby all people who are able to work and willing to work can work at a certain or minimum wage. In other words full employment is when; all available labour resources are being used in an economically efficient way. However, full employment doesn’t mean there’s zero unemployment.

• Under-employment-Underemployment means that the workers who have a high level of training are employed at jobs which they are overqualified for, wasting their skills on that rather than doing something they specialize in.– Visible under employment-Visible under

employment reflects an insufficiency in the volume of employment

– Invisible under employment-It is the under employment characterized by low income, under utilization of skills, low productivity and other factors.


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UNEMPLOYMENTSection 3 F


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What is unemployment?• Unemployment is the labour force

that is currently unemployed. In other words it is the proportion of working age adults unemployed.


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Unemployment rate• Unemployment rate is the

percentage of the labour force shown that is currently unemployed.

= unemployed people

labour force x 100


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Types of unemployment


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• Structural unemployment-This is the unemployment resulting from people having skills and training that do not have jobs available in that field, or live in an area where those skills are not required.

• Frictional unemployment-A type of unemployment that occurs because people do not always want to take their first job offer and businesses do not always hire the first person that applies.

Ex; A works at the University of Colombo library. After graduation, it takes him 6 months to find a new job. He is no longer unemployed, but had 6 months of frictional unemployment.

• Seasonal unemployment-A type of unemployment that occurs when a worker can only work during a specific season, and when those seasons are over, they no longer employed due to lack of need.

• Cyclical / demand- deficient unemployment-This occurs when there is not enough aggregate demand in the economy.


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Costs of unemployment• Government has to increase the

expenditure for social benefits• Waste of resources• Decrease in quality of resources• Production goes down• GDP decreases• Under-utilization of resources• Deflation• De-skilling


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END