The difficulties of measuring development

Overview

Economic development inherently harder to measure than economic growth, why comparing development across countries using exchange rates is problematic and purchasing power parity conversion improve comparisons of development between countries.

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Questions from this subtopic

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1. 1

   Why is economic development inherently harder to measure than economic growth?

   Model answer

   Growth has a single agreed definition and a single unit, the change in real output, whereas development covers several dimensions that are measured in different units and cannot simply be added together. Combining life expectancy in years, schooling in years and income in currency requires choices about how to scale each and how much weight to give it, and those choices are value judgements rather than facts. Development also includes qualities such as freedom, security and dignity for which no accepted numerical measure exists at all.

2. 2

   Explain the problem posed by the informal and subsistence economy for measuring development.

   Model answer

   In many low-income countries a large share of activity consists of subsistence farming, unpaid household production and unrecorded informal trading, none of which passes through a market where it could be counted. Official output figures therefore understate the true standard of living, and they understate it by a variable amount that shrinks as the economy formalises. This creates a second problem: as activity moves from the household or the informal sector into the formal economy, measured output rises even though no additional goods are actually being produced.

3. 3

   Why is the quality of statistical data itself a difficulty in measuring development in low-income countries?

   Model answer

   Reliable measurement requires a functioning statistical office, regular censuses, household surveys and business registers, all of which are expensive and require exactly the administrative capacity that poor countries lack. Population figures may be years out of date, which corrupts every per-head calculation. Governments also have incentives to present favourable numbers, whether to attract investment or to qualify for assistance. The result is that development comparisons between poor countries often rest on estimates with wide margins of error, and revisions can move a country's measured income by a large percentage overnight.

4. 4

   Explain why comparing development across countries using exchange rates is problematic.

   Model answer

   Converting national income into a common currency at market exchange rates leaves each country’s output valued at its own domestic prices and simply re-expresses the total in the reference currency, and exchange rates are driven by traded goods and by capital flows, not by the cost of the non-traded goods and services that make up much of what people consume. Housing, food from local markets, transport and personal services are typically much cheaper in poor countries, so market rate conversion understates what their incomes actually buy. Exchange rates are also volatile, so a country's measured income can move sharply from year to year with no change in its real output.

5. 5

   How does purchasing power parity conversion improve comparisons of development between countries?

   Model answer

   Purchasing power parity conversion values each country's output using a common set of prices reflecting what a comparable basket of goods and services actually costs there, rather than using the market exchange rate. Because non-traded goods and services are usually much cheaper in low-income countries, this raises their measured income relative to market rate conversion, often substantially, and gives a truer picture of the real consumption their income supports. It also removes the year-to-year noise caused by currency movements.

6. 6

   A country has gross national income per head of 30,000 pesos. The market exchange rate is 10 pesos to the dollar and the purchasing power parity rate is 6 pesos to the dollar. Calculate income per head on both bases and explain the difference.

   Model answer

   At the market rate income per head is 30,000 divided by 10, which is 3,000 dollars. At the purchasing power parity rate it is 30,000 divided by 6, which is 5,000 dollars, about 67 per cent higher. The difference arises because prices for non-traded goods and services in this country are lower than in the United States, so each peso buys more locally than the market exchange rate implies, and the market rate conversion therefore understates real living standards.

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