The Human Development Index

The UN's HDI combines three dimensions into a single index between 0 and 1:

• Health — life expectancy at birth.
• Education — mean years of schooling (for adults aged 25+) and expected years of schooling (for a child entering school today).
• Living standards — GNI per capita, at purchasing power parity (PPP), so that a dollar buys a comparable basket in every country.

How it is combined. Each indicator is first turned into an index between 0 and 1 using fixed goalposts:

The three dimension indices are then combined as a geometric mean — the cube root of their product:

Why a geometric mean and not a simple average? Because it means the three dimensions are not substitutable: a country cannot compensate for terrible health outcomes by getting very rich. A zero in any dimension drags the whole index towards zero. That is a deliberate statement about what development means.

A dimension index

Calculate the HDI

What the HDI misses

Other indicators of development

• Health: infant and maternal mortality rates; doctors per 1,000 people; access to clean water and sanitation; calorie intake.
• Education: adult literacy rate; pupil–teacher ratios; enrolment rates by gender.
• Inequality & poverty: the Gini coefficient; the % below $2.15/day; the Multidimensional Poverty Index.
• Economic structure: the % of the workforce in agriculture (high = less developed); energy consumption per head; mobile phone and internet penetration.
• Institutions: Transparency International's Corruption Perceptions Index; measures of the rule of law and political freedom.
• Environment: CO₂ per head; deforestation rates — recognising that development which destroys the natural capital base is not sustainable.

Why bother with several? Because any single indicator can mislead. GNI per capita alone ignores distribution, the informal economy, non-market production and negative externalities. Use a basket of indicators and triangulate — and say so in the exam.

Primary product dependency & volatile prices

Many developing countries rely on a handful of primary commodities (coffee, copper, cocoa, oil) for the bulk of their export earnings. That creates three linked problems.

• Volatile prices. Both supply (weather, disease, harvests) and demand (the global business cycle) are price inelastic. When both curves are steep, any shift produces a huge swing in price. Export revenue, government tax revenue and the exchange rate therefore lurch about unpredictably — making planning and investment almost impossible.
• Declining terms of trade — the Prebisch–Singer hypothesis: over the long run, the prices of primary products tend to fall relative to manufactures, because the income elasticity of demand for food and raw materials is low (as the world gets richer it does not eat proportionally more coffee) while that for manufactures and services is high. Commodity exporters must therefore export ever more just to import the same.
• Low value added — the profitable processing, branding and retailing happens in the developed world. The grower of the coffee bean captures a tiny fraction of the price of a latte.

The "resource curse": a natural-resource windfall can harm development. It causes Dutch disease — the currency appreciates, making all other exports uncompetitive and hollowing out manufacturing — and it fuels corruption and rent-seeking, since capturing the state becomes the fastest route to wealth. Botswana (diamonds, good institutions) and Nigeria (oil, weak institutions) is the classic comparison: institutions decide whether resources are a blessing or a curse.

Why are commodity prices so volatile?

The savings gap & the Harrod–Domar model

Investment must be financed by saving. But in a very poor country, incomes are so low that almost everything is consumed — there is nothing left to save. That is the savings gap, and it produces the poverty cycle:

The Harrod–Domar model puts a number on the escape route:

Evaluation of Harrod–Domar: it is a very simple model. It assumes saving automatically becomes productive investment — but that needs a functioning banking system to channel it, which many poor countries lack (hence the case for microfinance). It ignores human capital, institutions and technology. And raising the savings ratio means cutting consumption today — brutal in a country where consumption is already at subsistence.

Harrod–Domar growth rate

The other barriers to development

• The foreign currency gap — a country needs hard currency to import capital goods, but export earnings are low and debt repayments drain what it has. Capital flight makes it worse.
• Capital flight — domestic savings and elite wealth are sent abroad for safety or higher returns, so the money that could have financed investment leaves the country. Caused by instability, corruption and fear of expropriation.
• Debt — heavy external debt means large annual interest payments in foreign currency, crowding out spending on health, education and infrastructure. Debt servicing can consume a large share of export earnings.
• Demographics — a very high birth rate produces a large dependency ratio: many children per worker, so income per head is dragged down and saving is impossible.
• Poor access to credit and banking — the poor have no collateral and no bank account, so entrepreneurial ideas go unfunded.
• Infrastructure — without roads, ports, reliable power and telecoms, transaction costs are crippling and no firm will invest.
• Education and skills — low human capital means low productivity and low MRP.
• Absence of property rights — Hernando de Soto's argument: the poor hold vast assets (land, homes) with no legal title, so they cannot use them as collateral to borrow. It is "dead capital", worthless as a source of finance.

Non-economic factors: war and conflict, corruption, weak rule of law, disease (HIV/AIDS, malaria), geography (landlocked, arid), climate change, and colonial legacy.

Constraint or strategy?

Tap an item, then tap the correct box.

Market-oriented strategies

Let the price mechanism allocate resources; get the state out of the way.

• Trade liberalisation — remove tariffs and quotas, exploit comparative advantage. But infant industries may be wiped out before they reach minimum efficient scale.
• Promotion of FDI — inward investment brings capital, technology, skills and jobs, filling the savings and foreign-currency gaps. But TNCs may repatriate profits, use transfer pricing to avoid tax, exploit weak labour and environmental law, and create enclaves with few local linkages.
• Removal of government subsidies — ends the distortion of prices and saves public money. But cutting food or fuel subsidies hits the poorest hardest and has repeatedly triggered riots.
• Floating exchange rates — automatic correction of a deficit; no need to hold vast reserves. But volatile, which deters trade and investment.
• Microfinance — very small loans to poor entrepreneurs with no collateral (the Grameen Bank model). Directly attacks the credit constraint, and lending to women has strong development effects. But interest rates can be high, evidence of impact on poverty is mixed, and over-indebtedness is a real risk.
• Privatisation — the profit motive raises efficiency and cuts X-inefficiency. But a private monopoly in a country with weak regulation simply exploits consumers.

Interventionist strategies

The state acts directly, because markets alone will not correct the failures.

• Development of human capital — education and healthcare. Raises productivity, has enormous positive externalities, and is the strongest long-run driver of development. But it is expensive, slow, and risks a brain drain if the newly-skilled emigrate.
• Protectionism — the infant industry argument (see 4.1). But protection is rarely temporary, and invites retaliation.
• Managed exchange rates — deliberately keeping the currency undervalued to make exports competitive (the classic Chinese strategy). But it makes imports of capital goods dearer and can be denounced as currency manipulation.
• Infrastructure development — roads, ports, power, broadband. A public good the market will under-provide, and a precondition for all other investment. But huge cost, long lead times, and a serious risk of corruption in procurement.
• Joint ventures with global companies — a domestic firm partners a TNC, which forces technology transfer and skills into the local economy rather than leaving them in an enclave.
• Buffer stock schemes — the agency buys the commodity when the price is low and sells from the store when it is high, stabilising prices and farm incomes. But they are notoriously expensive to run, need a correct estimate of the long-run average price (set it too high and stocks pile up until the scheme goes bust), and perishable goods cannot be stored.

Why do buffer stocks fail?

Industrialisation, tourism, Fairtrade, aid & debt relief

• Industrialisation — the Lewis model. A developing economy has a surplus of labour in subsistence agriculture, where the marginal product of an extra worker is close to zero. Moving those workers into a modern industrial sector therefore costs agriculture almost no output but adds a great deal in manufacturing. Profits are reinvested, the modern sector expands, and the economy transforms. Criticisms: it assumes surplus labour actually exists, that profits are reinvested at home (not sent abroad — capital flight), and it ignores the growth of urban slums and unemployment when migration outruns job creation.
• Tourism — earns foreign currency, creates jobs, has a high income elasticity of demand. But it is highly vulnerable to shocks (pandemics, terrorism), profits leak abroad to foreign hotel chains, jobs are often low-skilled and seasonal, and there is environmental damage.
• Fairtrade — guarantees a minimum price plus a social premium. Raises and stabilises grower incomes. But it is effectively a minimum price, so it may encourage over-supply of the very crop the world already has too much of, and only a small share of the premium reaches the farmer.
• Aid — bilateral or multilateral; grants or concessional loans; tied or untied.
• Debt relief — cancelling debt (the HIPC initiative) frees up government revenue for health and education. But moral hazard: it may encourage reckless future borrowing, and reward the corrupt governments that ran up the debt.

Does aid work?

The role of international institutions

• The IMF — the world's financial firefighter. It provides short-term lending to countries in a balance of payments or currency crisis, and surveillance of the world economy. Its loans come with conditionality: structural adjustment — cut the fiscal deficit, liberalise trade, privatise, deregulate. Criticism: those conditions are often contractionary, deepening recession and hitting the poorest through cuts to subsidies and public services, and they impose a one-size-fits-all free-market template regardless of local conditions.
• The World Bank — long-term lending for development projects: dams, roads, schools, power grids. Focused on poverty reduction and infrastructure. Criticism: some projects have been white elephants; environmental and displacement costs; conditionality again.
• NGOs — Oxfam, Médecins Sans Frontières and thousands of smaller bodies. They work at the grassroots, can reach where governments cannot, and target specific problems (clean water, vaccination, microfinance). Limitation: small scale, dependent on donations, sometimes poorly coordinated with national plans.

The judgement most examiners reward: no single strategy is sufficient. Growth without institutions — property rights, rule of law, low corruption, effective tax collection — does not become development. Increasingly, economists argue that institutions are the deepest determinant of long-run prosperity, which is why two countries with identical resources can diverge so completely.

Match the concept to its meaning

Tap a definition on the left, then its concept on the right.

The resource curse

The big ideas to know

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