II. Comparing Levels Of Development

Countries are unequally endowed with natural resources. For example, some countries benefit from fertile agricultural soils, while others have to put a lot of effort into artificial soil amelioration. Some countries have discovered rich oil and gas deposits within their territories, while others have to import most “fossil” fuels. In the past a lack or wealth of natural resources made a big difference in countries' development. But today a wealth of natural resources is not the most important determinant of development success. Consider such high-income countries as Japan or the Republic of Korea. Their high economic development allows them to use their limited natural wealth much more productively (efficiently) than would be possible in many less developed countries. The productivity with which countries use their productive resources - physical capital, human capital, and natural capital - is widely recognized as the main indicator of their level of economic development.

Theoretically, then, economists comparing the development of different countries should calculate how productively they are using their capital. But such calculations are extremely challenging, primarily because of the difficulty of putting values on elements of natural and human capital. In practice economists use gross national product (GNP) per capita or gross domestic product (GDP) per capita for the same purpose. These statistical indicators are easier to calculate, provide a rough measure of the relative productivity with which different countries use their resources, and measure the relative material welfare in different countries, whether this welfare results from good fortune with respect to land and natural resources or from superior productivity in their use.

Gross Domestic Product and Gross National Product

GDP is calculated as the value of the total final output of all goods and services produced in a single year within a country’s boundaries. GNP is GDP plus incomes received by residents from abroad minus incomes claimed by nonresidents.

There are two ways of calculating GDP and GNP:

• By adding together all the incomes in the economy - wages, interest, profits, and rents.
• By adding together all the expenditures in the economy- consumption, investment, government purchases of goods and services, and net exports (exports minus imports).

In theory, the results of both calculations should be the same. Because one person’s expenditure is always another person’s income, the sum of expenditures must equal the sum of incomes. When the calculations include expenditures made or incomes received by a country's citizens in their transactions with foreign countries, the result is GNP. When the calculations are made exclusive of expenditures or incomes that originated beyond a country’s boundaries, the result is GDP.

GNP may be much less than GDP if much of the income from a country’s production flows to foreign persons or firms. For example, in 1994 Chile’s GNP was 5 percent smaller than its GDP. If a country’s citizens or firms hold large amounts of the stocks and bonds of other countries’ firms or governments, and receive income from them, GNP may be greater than GDP. In Saudi Arabia, for instance, GNP exceeded GDP by 7 percent in 1994. For most countries, however, these statistical indicators differ insignificantly.

GDP and GNP can serve as indicators of the scale of a country's economy. But to judge a country's level of economic development, these indicators have to be divided by the country's population. GDP per capita and GNP per capita show the approximate amount of goods and services that each person in a country would be able to buy in a year if incomes were divided equally (Figure 2.1). That is why these measures are also often called "per capita incomes."

In the Data Tables at the end of this book GNP per capita is shown not only in U.S. dollars but also in PPP dollars - that is, adjusted with the help of a purchasing power parity (PPP) conversion factor. The PPP conversion factor shows the number of units of a country's currency required to buy the same amount of goods and services in the domestic market as one dollar would buy in the United States. By applying this conversion factor, one can, for example, convert a country's nominal GNP per capita (expressed in U.S. dollars in accordance with the market exchange rate of the national currency) into its real GNP per capita (an indicator adjusted for the difference in prices for the same goods and services between this country and the United States, and independent of the fluctuations of the national currency exchange rate). GNP in PPP terms thus provides a better comparison of average income or consumption between economies.

In developing countries real GNP per capita is usually higher than nominal GNP per capita, while in developed countries it is often lower (Table 2.1). Thus the gap between real per capita incomes in developed and developing countries is smaller than the gap between nominal per capita incomes.

Although they reflect the average incomes in a country, GNP per capita and GDP per capita have numerous limitations when it comes to measuring people's actual well-being. They do not show how equitably a country's income is distributed. They do not account for pollution, environmental degradation, and resource depletion. They do not register unpaid work done within the family and community, or work done in the shadow (gray) economy. And they attach equal importance to "goods" (such as medicines) and "bads" (cigarettes, chemical weapons) while ignoring the value of leisure and human freedom. Thus, to judge the relative quality of life in different countries, one should also take into account other indicators showing, for instance, the distribution of income and incidence of poverty (see Chapters 5 and 6), people's health and longevity (Chapter 8), access to education (Chapter 7), the quality of the environment (Chapter 10), and more. Experts also use composite statistical indicators of development (Chapter 15).

Grouping Countries by Their Level of Development

A more popular, though apparently more disputable, approach involves dividing all countries into "developing" and "developed"—despite the general understanding that even the most developed countries are still undergoing development. Dividing countries into "less developed" and "more developed" does not help much, because it is unclear where to draw the line between the two groups. In the absence of a single criterion of a country's development, such divisions can only be based on convention among researchers. For example, it is conventional in the World Bank to refer to low-income and middle-income countries as "developing," and to refer to high-income countries as "industrial" or "developed."

The relatively accurate classification of countries into “developing” and “developed” based on their per capita income does not, however, work well in all cases. There is, for instance, a group of "high-income developing countries" that includes Israel, Kuwait, Singapore, and the United Arab Emirates. These countries are considered developing because of their economic structure or because of the official opinion of their governments, although their incomes formally place them among developed countries.

Another challenge is presented by many of the countries with “transition” or “formerly planned” economies—that is, countries undergoing a transition from centrally planned to market economies. On the one hand, none of these countries has achieved the established threshold of high per capita income. But on the other, many of them are highly industrialized. This is one reason their classification by the World Bank is currently “under review.” Note that in the World Bank’s World Development Report 1982 these same countries were classified as “industrial nonmarket,” and in current United Nations publications most of them are still grouped among “industrial” countries.

In 1999 fewer than 1 of every 6 people in the world lived in high-income (developed) countries, and almost 2 of every 6 lived in transition economies—including 21 percent of the world population in China alone (Figure 2.2).