TA Development Economics Lecture 1 PDF

Comparative Development Indicators: Basic concepts, Exercises and Practical Examples. Tutorial in Development Economics Master in Area and Global Studies for International Cooperation Jeanne Pinay PhD Candidat...

Comparative Development Indicators: Basic concepts, Exercises and Practical Examples. Tutorial in Development Economics Master in Area and Global Studies for International Cooperation Jeanne Pinay PhD Candidate in Economics Collegio Carlo Alberto & University of Turin Fall 2024 Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 1 / 80 Tutorials in Development Economics - Outline Tutorial 1: Comparative Development Indicators GDP and GNI: concepts and calculations GDP PPP and Real GDP: concept and calculations GDP corrected for inflation and PPP: concept and calculations HDI and NHDI: concepts, differences and calculations Kuznet ratio: concept and calculations Lorentz curve: concept and hints on how to draw and interpret it Poverty trap: graphical representation of the debate on foreign aid Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 2 / 80 Tutorials in Development Economics - Outline Tutorial 2: Growth Theories and Migration Model Recap of the concepts: total, average and marginal productivity The Lewis Model: how to draw the graphs and understand the mechanism The Harrod-Domar Model: how to understand formulas and mechanisms The Solow Model: how to understand formulas and mechanisms (through simplified mathematical derivation) Recap of the concepts: probability and expected value Todaro Migration Model: how to graphically represent migration decisions Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 3 / 80 Tutorials in Development Economics - Outline Tutorial 3: Policy Impact Evaluation The concepts: observed difference in expected outcomes, selection bias, average treatment effect on the treated How to think about the ATET and the selection bias (through practical examples) Randomized controlled trials for evaluating development programs Case studies: impact evaluation of microfinance credit schemes and of deworming programs. Note: The tutorial sessions are scheduled a week before via Moodle poll – Vote! Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 4 / 80 GDP and GNI: Concepts The GDP and GNI are used to measure the status of development of a country Gross Domestic Product (GDP) measures the total value for final use of output produced by an economy, by both residents and nonresidents. Gross National Income (GNI) comprises GDP plus the difference between the income residents receive from abroad (e.g., remittances) and the payments made to nonresidents who contribute to the domestic economy (e.g., wages paid to non-residents). ⇒ GNI = GDP + Money flowing from other countries – Money flowing to other countries Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 5 / 80 GDP and GNI: Concepts Example: Migration and remittances Many people from the developing countries emigrate to developed countries, usually because wages are higher in developed countries, so they can send part of their income earned abroad to their family that remained in their country of origin. As a result, a large fraction of household income in developing countries comes from remittances sent by family members living and working abroad. ⇒ GN Ipercapita > GDPpercapita Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 6 / 80 GDP and GNI: Concepts Why do we need two measures? The GDP measures the value of the domestic production, while the GNI measures the actual flow of money within a country. Within the European Union, Taxes ad Official Development Aid contributions are calculated based on the GNI. What about per capita measures? GDPpercapita = GDP/P opulation GNIpercapita = GN I/P opulation Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 7 / 80 GDP calculation A practical example Consider an economy where expenditures are destined to only 4 goods: Coke, Fanta, Pizza and Chips. The prices and quantities of the goods consumed in the economy can be found in the following table. Compute the nominal GDP for the economy Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 8 / 80 GDP calculation Formula to compute the GDP: 4 X GDP = p i ∗ qi (1) i=1 Where i stands for good. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 9 / 80 GDP calculation Formula to compute the GDP: 4 X GDP = p i ∗ qi (1) i=1 Where i stands for good. In our example: GDP = (58 ∗ 6) + (65 ∗ 4) + (150 ∗ 10) + (20 ∗ 5) (2) GDP = 348 + 260 + 1500 + 100 = 2208 rupees (3) Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 9 / 80 Comparing different economies via GDP and GNI GDP and GNI for India. http://hdr.undp.org/en/countries/profiles/IND. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 10 / 80 Comparing different economies via GDP and GNI GDP and GNI for Mexico. http://hdr.undp.org/en/countries/profiles/MEX. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 11 / 80 Comparing different economies via GDP and GNI GDP and GNI for Mexico. http://hdr.undp.org/en/countries/profiles/MEX. What do you notice? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 11 / 80 Comparing different economies via GDP and GNI GDP and GNI for Mexico. http://hdr.undp.org/en/countries/profiles/MEX. What do you notice? All measures are reported in PPP Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 11 / 80 The concept of Purchasing Power Parity How to think about it in everyday life? Suppose you are going to India next year and you want to start saving money before leaving → You need to know what your travel expenses will be once you get there. The average price for a room in a decent guest house is 500 rupees. At the current exchange rate, 500 rupees are 6$. Suppose now that you decide to change destination and go to the United States (US) instead. Will your savings plan be affected by this decision? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 12 / 80 The concept of Purchasing Power Parity How to think about it in everyday life? Suppose you are going to India next year and you want to start saving money before leaving → You need to know what your travel expenses will be once you get there. The average price for a room in a decent guest house is 500 rupees. At the current exchange rate, 500 rupees are 6$. Suppose now that you decide to change destination and go to the United States (US) instead. Will your savings plan be affected by this decision? Yes! You will hardly be able to stay in a single room for 6$ a night in the US → 1$ is not worth the same in India and in the US (e.g., whole meal vs. coffee). ⇒ This is the reasoning behind PPP in practice. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 12 / 80 The concept of Purchasing Power Parity Definition of PPP: Number of units of a foreign country’s currency required to purchase the same quantity of goods and services in a local market as $1 would buy in the US. → We need PPP to compare the value of different economies. → You can think of PPP as a sort of exchange rate which takes into account the prices of non-tradable goods, i.e., a currency that is two-fold country-specific: (1) of the country analyzed (here, India) and (2) of the benchmark country (here, the US). Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 13 / 80 The concept of Purchasing Power Parity GDP at PPP (i.e., nominal) is higher than GDP at current exchange rates (for developing countries) because the prices of non-tradable goods1 are lower in developing countries. What about tradable goods? When the price of a tradable good is not in line with international prices, there is room for arbitrage2 → The prices of tradable goods tend to be aligned at current exchange rates. This can not happen for non-tradable goods. 1 E.g., the night in a guest house 2 Anyone could buy the tradable good where it is cheaper and sell it where it is more expensive, gaining a profit Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 14 / 80 The Math Behind PPP How to compute PPP? 3-step procedure: 1 Product Level: Register the price of the same goods in two different countries. 2 Group Level: The price relatives calculated for the products in the group (i.e., basket) are averaged to obtain unweighted PPPs for the group (i.e., category). 3 Aggregation level: The PPPs for the product groups are weighted and averaged to obtain weighted PPPs for the aggregation level up to GDP. The weights are the expenditures on the product groups as established in the national accounts. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 15 / 80 The Math Behind PPP: a simplified application Exercise: The procedure in practice3 Suppose that the US and Indian economies rely exclusively on the consumption of 4 goods: Coke, Fanta, Pizza, and Chips. The price and quantity of the goods produced in each economy are shown in the table below. Coke and Fanta belong to the ”Soft Drinks” category, while Pizza and Chips belong to the ”Junk Food” category. At the current exchange rate, 1 US$ is worth 84 rupees. Compute the Nominal GDP for US and India and the GDPP P P for India. 3 Note: this exercise is NOT related to the previous GDP calculation Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 16 / 80 Nominal GDP Recall: 4 X GDP = p i ∗ qi (4) i=1 For the US: GDPU S = (1.99 ∗ 6) + (1.89 ∗ 2) + (7 ∗ 8) + (1 ∗ 4) (5) GDPU S = 11.94 + 3.78 + 56 + 4 = 75.72 U S$ (6) For India: GDPInd = (58 ∗ 3) + (65 ∗ 1) + (150 ∗ 4) + (20 ∗ 2) (7) GDPInd = 174 + 65 + 600 + 40 = 879 rupees (8) 879 GDPInd = = 10.46 U S$ (9) 84 Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 17 / 80 The Math Behind PPP Let’s Now Compute the GDPP P P for India Step 1 - Product level Good 1: 1lt. of Coca Cola You know that: PCoke,India = 58Rupees PCoke,U S = 1.99U S$ What is the PPP for Coke between India and the US? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 18 / 80 The Math Behind PPP Let’s Now Compute the GDPP P P for India Step 1 - Product level Good 1: 1lt. of Coca Cola You know that: PCoke,India = 58Rupees PCoke,U S = 1.99U S$ What is the PPP for Coke between India and the US? PPPCoke,India,U S = 58/1.99 = 29.15P P P U S$. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 18 / 80 The Math Behind PPP Let’s Now Compute the GDPP P P for India Step 1 - Product level Good 1: 1lt. of Coca Cola You know that: PCoke,India = 58Rupees PCoke,U S = 1.99U S$ What is the PPP for Coke between India and the US? PPPCoke,India,U S = 58/1.99 = 29.15P P P U S$. → For every dollar spent on a liter of Coke in the US, you need to spend 29.15 PPP $ to obtain the same volume of Coke in India. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 18 / 80 The Math Behind PPP Step 1 - Product level Good 2: 1lt. of Fanta You know that: PF anta,India = 65Rupees PF anta,U S = 1.89U S$ What is the PPP for Fanta between India and the US? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 19 / 80 The Math Behind PPP Step 1 - Product level Good 2: 1lt. of Fanta You know that: PF anta,India = 65Rupees PF anta,U S = 1.89U S$ What is the PPP for Fanta between India and the US? PPPF anta,India,U S = 65/1.89 = 34.39P P P U S$. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 19 / 80 The Math Behind PPP Step 1 - Product level Good 2: 1lt. of Fanta You know that: PF anta,India = 65Rupees PF anta,U S = 1.89U S$ What is the PPP for Fanta between India and the US? PPPF anta,India,U S = 65/1.89 = 34.39P P P U S$. → For every dollar spent on a liter of Fanta in the US, you need to spend 34.39 PPP $ to obtain the same volume of Fanta in India. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 19 / 80 The Math Behind PPP Step 1 - Product level Good 3: 1 Pizza (300g) You know that: PP izza,India = 150Rupees PP izza,U S = $7 What is the PPP for Pizza between India and the US? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 20 / 80 The Math Behind PPP Step 1 - Product level Good 3: 1 Pizza (300g) You know that: PP izza,India = 150Rupees PP izza,U S = $7 What is the PPP for Pizza between India and the US? PPPP izza,India,U S = 150/7 = 21.43P P P $. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 20 / 80 The Math Behind PPP Step 1 - Product level Good 3: 1 Pizza (300g) You know that: PP izza,India = 150Rupees PP izza,U S = $7 What is the PPP for Pizza between India and the US? PPPP izza,India,U S = 150/7 = 21.43P P P $. → For every dollar spent on Pizza in the USA, you need to spend 21.43 PPP $ to obtain the same volume of Pizza in India. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 20 / 80 The Math Behind PPP Step 1 - Product level Good 4: 1 Bag (50g) of Chips You know that: PChips,India = 20Rupees PChips,U S = $1 What is the PPP for Chips between India and the US? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 21 / 80 The Math Behind PPP Step 1 - Product level Good 4: 1 Bag (50g) of Chips You know that: PChips,India = 20Rupees PChips,U S = $1 What is the PPP for Chips between India and the US? PPPChips,India,U S = 20/1 = 20P P P $ Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 21 / 80 The Math Behind PPP Step 1 - Product level Good 4: 1 Bag (50g) of Chips You know that: PChips,India = 20Rupees PChips,U S = $1 What is the PPP for Chips between India and the US? PPPChips,India,U S = 20/1 = 20P P P $ → For every dollar spent on Chips in the USA, you need to spend 20 PPP $ to obtain the same volume of Chips in India. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 21 / 80 The Math Behind PPP Step 2 - Group level Group 1: Soft Drinks You know that: PPPCoke,India,U S = 29.15P P P $ PPPF anta,India,U S = 34.39P P P $ What is the unweighted average of the price relatives in the category ”Soft Drinks”? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 22 / 80 The Math Behind PPP Step 2 - Group level Group 1: Soft Drinks You know that: PPPCoke,India,U S = 29.15P P P $ PPPF anta,India,U S = 34.39P P P $ What is the unweighted average of the price relatives in the category ”Soft Drinks”? P P PCoke,India,U S + P P PF anta,India,U S P P PSD,India,U S = (10) 2 29.15 + 34.39 P P PSD,India,U S = (11) 2 P P PSD,India,U S = 31.77P P P $ (12) Note: the denominator is 2 because we have 2 goods. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 22 / 80 The Math Behind PPP Step 2 - Group level Group 2: Junk Food You know that: PPPP izza,India,U S = 21.43P P P $ PPPChips,India,U S = 20P P P $ What is the unweighted average of the price relatives in the category ”Junk Food”? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 23 / 80 The Math Behind PPP Step 2 - Group level Group 2: Junk Food You know that: PPPP izza,India,U S = 21.43P P P $ PPPChips,India,U S = 20P P P $ What is the unweighted average of the price relatives in the category ”Junk Food”? P P PP izza,India,U S + P P PChips,India,U S P P PJF,India,U S = (13) 2 21.43 + 20 P P PJF,India,U S = (14) 2 P P PJF,India,U S = 20.72$P P P (15) Note: the denominator is 2 because we have 2 goods. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 23 / 80 The Math Behind PPP Step 3 - Aggregation GDP PPP in the economy with four goods You know that: PPPSD,India,U S = 31.77P P P PPPJF,India,U S = 20.72P P P In both economies, 40% of GDP is allocated to Soft Drinks and 60% to Junk Food. This means that the weight for the category ”Soft Drinks” is 0.4, while the weight for the category ”Junk Food” is 0.60. What is the GDP PPP for India? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 24 / 80 The Math Behind PPP Step 3 - Aggregation GDP PPP in the economy with four goods You know that: PPPSD,India,U S = 31.77P P P PPPJF,India,U S = 20.72P P P In both economies, 40% of GDP is allocated to Soft Drinks and 60% to Junk Food. This means that the weight for the category ”Soft Drinks” is 0.4, while the weight for the category ”Junk Food” is 0.60. What is the GDP PPP for India? GDPP P P = 0.4 ∗ P P PSD,India,U S + 0.6 ∗ P P PJF,India,U S (16) GDPP P P = 0.4 ∗ 31.77 + 0.6 ∗ 20.72 (17) GDPP P P = 12.71 + 12.43 = 25.14P P P $ (18) Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 24 / 80 The Math Behind PPP: a Roadmap 1 Step 1 - Product Level: compute the prices PPP for every good in the economy. You have to compute as many prices as the number of goods in the economy 2 Step 2 - Group Level: compute the unweighted average of the prices in each category. You have to compute as many unweighted averages as the number of categories of goods in the economy. 3 Step 3 - Aggregation Level: compute the weighted average of the PPP in the two categories. The weights are the share of total income spent on each group of goods4. 4 In the simplified exercise we assumed equal weights in the two economies and we did not use the weights of the OECD definition Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 25 / 80 Main take-home messages from PPP: Compare economies based on the GDP evaluated at PPP because exchange rates do not account for non-tradable goods. In a simplified world (i.e., if everything were tradable) we would not need PPP: P riceIndexU S ExchangeRateU S,India = P riceIndexIndia ← Not true in reality. PPP is used to compare the economies of different countries in a meaningful way. In developing countries GDPP P P > GDP , because the currency of DCG is generally weaker than the currency of DDC. This is not always true for developed countries. The benchmark currency when evaluating GDP at PPP is always US$ → PPP are two-fold country specific: of the country analysed and of the US. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 26 / 80 GDP and Inflation We just learned that the GDPP P P is a tool to compare different economies in a meaningful way. But how do we analyse the evolution of the same economy over time? We must take into account inflation → Going to the restaurant today is much more costly than going to the restaurant 30 years ago. → Nominal vs. REAL income: Earning 1,000$ when a pizza costs 5$ is different from earning 1,000$ when a pizza costs 7$. → When we evaluate the GDP of the same economy over time, we need to make sure we are performing an ”apples-to-apples” comparison! Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 27 / 80 Real GDP Definition of Real Income: How much money an individual or entity makes after accounting for inflation – also called real wage when referring to an individual’s income. GDPnominal GDPreal = (19) P riceIndex The real GDP takes into account prices. The Price Index is an average of the prices of all the goods in a given economy. We have: P riceIndex ∗ GDPreal = GDPnominal (20) GDPnominal P riceIndex = (21) GDPreal Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 28 / 80 Real GDP The Price Index is also known as GDP deflator because it is used to ”clean” the GDP from the growth due to inflation, i.e., clean the GDP from the growth of the economy which is not due to an increase in production. Recall: 4 X GDP = p i ∗ qi (22) i=1 ⇒ If prices increase, the GDP increases Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 29 / 80 Real GDP: a practical example Consider the following economy, in which only 4 goods are produced and consumed. Compute the nominal GDP in each of the two years, the percentage growth of the nominal GDP between the two years and the real GDP in year 2 (with year 1 as base year). Also, compute the GDP deflator and the real GDP growth. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 30 / 80 Nominal GDP: computation Recall that the standard formula for the nominal GDP computation is: n X GDP = p i ∗ qi (23) i=1 Hence, we have to perform the following computations: GDPnominal,year1 = 2∗5+8∗4+5∗2+1∗5 = 10+32+10+5 = 57 (24) GDPnominal,year2 = 3∗6+9∗5+4∗2+2∗6 = 18+45+8+12 = 83 (25) Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 31 / 80 Nominal GDP growth Now we turn to the GDP growth computation, and we do it by using the following formula: GDPnominal,year2 − GDPnominal,year1 GDPnominal,growth = (26) GDPnominal,year1 Which in our example is: 83 − 57 GDPnominal,growth = = 0.46 (27) 57 In this exercise, between year 1 and 2 the nominal GDP has increased by 46%. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 32 / 80 Real GDP: calculation When computing the real GDP, we are answering the following question: What would have been the GDP in year 2 if the prices had remained unchanged? → We apply the following formula: n X GDPreal = pi,1 ∗ qi,2 (28) i=1 In our example: GDPreal = 2 ∗ 6 + 8 ∗ 5 + 5 ∗ 2 + 1 ∗ 6 = 12 + 40 + 10 + 6 = 70 (29) Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 33 / 80 GDP deflator The formula for the GDP deflator is: GDPnominal GDPdef lator = (30) GDPreal So, in our example: 83 GDPdef lator = = 1.19 (31) 70 ⇒ The inflation rate between year 1 and year 2 is 19% Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 34 / 80 Real GDP growth To compute the real GDP growth, we must consider how much the real GDP of year 2 has grown compared to the nominal GDP of year 1: GDPreal,year2 − GDPnominal,year1 GDPreal,growth = (32) GDPnominal,year1 70 − 57 GDPreal,growth = = 0.23 (33) 57 ⇒ The real economy has grown by only 23%! ⇒ The nominal growth rate overestimates the growth of the economy. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 35 / 80 Correcting GDP for inflation and PPP The following table reports the evolution of two different economies over time. How can we compare country i and country j? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 36 / 80 Step 1: Correcting GDP for inflation The Real GDP can be computed according to the Price Index definition, i.e. applying the following formula: GDPN ominal GDPReal = (34) P riceIndex Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 37 / 80 Step 2: Correcting for PPP The Real GDP PPP can now be computed according to the PPP definition, i.e. applying the following formula: GDPReal GDPReal,P P P = (35) PPP → After correcting for both inflation and PPP, the economies look quite alike! Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 38 / 80 Comparative Development Indicators: Going Beyond The Economy To overcome the shortcomings of comparing different countries based only on their economy, economists came up with more comprehensive measures. The most used in the reports of international organizations is the Human Development Index (HDI). There are two versions of that index, which differs in the way they are calculated, but the dimensions considered are the same, namely: 1 Longevity 2 Education 3 Income Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 39 / 80 Human Development Index The HDI is computed taking into account a different index for each of the three dimensions it considers: 1 Longevity → Life Expectancy Index 2 1 2 Education → 3 Adult Literacy rate Index + 3 Gross Enrollment Rate Index 3 Income → Income Index (1), (2) and (3) are calculated using the min-max normalization: ActualV alue − M inV alue Index = ∈ [0, 1] (36) M axV alue − M inV alue Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 40 / 80 Human Development Index The HDI calculates a minimum and maximum value for each dimension referred to as ”goalposts” and then displays where each nation sits regarding these goals. The value of the index is calculated for each dimension on a scale from 0 to 1, with 0 denoting the least value and 1 denoting the highest value allocated to the associated indicator. A country’s HDI value increases with its level of human development. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 41 / 80 Human Development Index: Intermediate Indices The HDI is calculated taking the arithmetic mean of the three dimensions it considers. 1 1 1 HDI = Longevity + Education + Income (37) 3 3 3 → Longevity and Education have the same weight as Income → A country could have a high GDP but short life expectancy and still perform well in terms of HDI. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 42 / 80 The Math Behind the Human Development Index Exercise: Starting from the following table, compute the HDI. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 43 / 80 HDI: Intermediate Indices Calculation 1 45 − 0 LE = = 0.52 (38) 85 − 0 2 2 25 − 0 1 60 − 0 EDU C = ∗ + ∗ = 0.16 + 0.2 = 0.36 (39) 3 100 − 0 3 100 − 0 3 log(3000) − log(100) 3.47 − 2 1.47 IN C = = = = 0.16 (40) log(40000) − log(100) 4.60 − 2 2.60 Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 44 / 80 Human Development Index We can now compute the HDI: 1 1 1 HDI = ∗ LE + ∗ EDU C + ∗ IN C (41) 3 3 3 1 1 1 HDI = ∗ 0.52 + ∗ 0.36 + ∗ 0.16 (42) 3 3 3 HDI = 0.172 + 0.119 + 0.053 (43) HDI = 0.34 (44) Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 45 / 80 New Human Development Index What is new and what is not? Intermediate Indices: 1 Longevity → Life expectancy Index (same as the HDI) 2 Education → 12 * Average Years of Schooling Index+ 1 2 * Expected Years of Schooling Index 3 Income → Income index is built on the GN IP P P and uses the natural log instead of the log in base 10 New Human Development Index: 1 N HDI = (Longevity ∗ Education ∗ Income) 3 (45) It is calculated using the geometric mean instead of the arithmetic mean → mathematical way to penalize countries if they perform badly in one of the three dimensions considered. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 46 / 80 The Math Behind the New Human Development Index Exercise: Starting from the following table, compute the NHDI. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 47 / 80 NHDI: Intermediate Indexes Calculation 1 76.4 − 0 LE = = 0.90 (46) 85 − 0 2 1 7.8 − 0 1 13.8 − 0 1 EDU C = ∗ + ∗ = ∗(0.52+0.77) = 0.64 (47) 2 15 − 0 2 18 − 0 2 3 ln(15270) − ln(100) 6.64 − 4.60 2.04 IN C = = = = 0.33 (48) ln(45000) − ln(0) 10.71 − 4.60 6.11 Recall: Intermediate Indices are still computed by min-max normalization. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 48 / 80 New Human Development Index We can finally compute the NHDI: 1 N HDI = (LE ∗ EDU C ∗ IN C) 3 (49) 1 N HDI = (0.90 ∗ 0.64 ∗ 0.33) 3 (50) 1 N HDI = 0.19 = 0.57 3 (51) Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 49 / 80 Human Development Index When comparing countries based on the HDI or on the NHDI, remember that the higher the HDI, the higher the level of development. If HDI > NHDI → There is inequality among the three dimensions (i.e. longevity, education and income). If HDI = NHDI → There is equality among the three dimensions Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 50 / 80 Inequality in Developing Countries Where were these pictures shot? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 51 / 80 Inequality in Developing Countries Where were these pictures shot? In Delhi, India Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 51 / 80 Inequality in Developing Countries Inequality is usually widespread in developing countries, and we must think about it when performing a comparative development analysis. Here we focus on how to measure inequality in income distribution. Two indices are particularly important to measure inequality: The Kuznet Ratio The Lorentz Curve Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 52 / 80 Kuznet Ratio Definition of Kuznet Ratio: Ratio among income of the richest 20% (highest income quintile) and income of the poorest 40% (lowest 2 income quintiles). Definition of Quantile: In statistics quantiles are cut points dividing the observations in a sample so that each interval contains the same number of observations → Quintile: you divide the sample into 5 groups, each group containing the same number of observations. Intuition: If you have 100 observations (or individuals) and you divide them in 5 quantiles (i.e., in quintiles), each quintile contains 20 observations. → The richest quantile is composed by 20 individuals (i.e., by 20% of all individuals, because 100/5=20). In the Kuznet Ratio definition: Richest 20% → Higest income quintile Poorest 40% → Lowest two income quintiles Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 53 / 80 Kuznet Ratio Exercise: Consider a society where individuals have the following income: Compute the Kuznet Ratio. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 54 / 80 Kuznet Ratio Steps to compute the Kuznet Ratio: 1 Order individual incomes from the lowest to the highest 2 Divide individuals in 5 groups of the same size (i.e., n/5) 3 Take the ratio between the highest income quintile and the 2 lowest income quintiles → 43.5/8 = 5.4375 → The highest the Kuznet Ratio, the more unequal the society Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 55 / 80 The Lorentz Curve Definition of Lorentz Curve: Graphical representation of the distribution of income among the population. The axes of the Lorentz curve can also be called: X → Cumulative share of the population Y → Cumulative share of income Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 56 / 80 How to think about the Lorentz Curve: The Equality Line Along the equality line, 1% of the population receives 1% of the total income, 10% of the population receives 10% of income, 23% of the population receives 23% of income... Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 57 / 80 How to think about the Lorentz Curve The Area where we have to draw the Lorentz Curve: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 58 / 80 How to think about the Lorentz Curve Exercise: Starting from the following table, draw the Lorentz curve. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 59 / 80 How to think about the Lorentz Curve How to read the points that compose the Lorentz Curve: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 60 / 80 How to think about the Lorentz Curve Point A: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 61 / 80 How to think about the Lorentz Curve Point B: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 62 / 80 How to think about the Lorentz Curve Point C: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 63 / 80 How to think about the Lorentz Curve Point D: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 64 / 80 How to think about the Lorentz Curve Point E: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 65 / 80 How to think about the Lorentz Curve Point F: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 66 / 80 How to think about the Lorentz Curve Point G: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 67 / 80 How to think about the Lorentz Curve Point H: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 68 / 80 How to think about the Lorentz Curve Point I: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 69 / 80 How to think about the Lorentz Curve Connect the points to obtain the Lorentz Curve: Note: Point L is the top right corner. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 70 / 80 How to compare different Lorentz Curves Definition of Lorenz Dominance: The Lorentz Dominance of one income distribution over another occurs when, for any given cumulative proportion of population, the Lorenz Curve of a given income distribution is above the Lorenz Curve(s) of the other distribution(s). Given the Lorenz Curve and its properties, the dominating Lorenz Curve implies a less unequal income distribution. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 71 / 80 How to compare different Lorentz Curves Which country Lorentz Dominates the others? Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 72 / 80 How to compare different Lorentz Curves What if Lorentz Curves intersect? Nothing can be said about which country has a more equal income distribution. However, we can say that the poorest would prefer to live in country B, while the richest in country C → Before the intersection of the curves, B dominates C. After the intersection, C dominates B. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 73 / 80 Poverty Traps and Foreign Aid The debate on foreign aid William Easterly in ”The White Man’s Burden” (2006): Foreign aid is detrimental to developing countries, because it prevents people from searching for their own solutions, while enhancing corrupting, undermining local institutions, and creating self-perpetuating lobby of aid agencies. https://www.youtube.com/watch?v=inClCwsVwjY Jeffrey Sachs in ”The End of Poverty” (2005): Poor countries are poor because of specific characteristics (climate, landlocked, diseases) that make it hard for them to be productive without an initial large investment to help them deal with these endemic issues https://www.youtube.com/watch?v=uUHf_kOUM74. Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 74 / 80 Understanding Poverty Traps Sachs’ argument is based on the concept of Povery Trap: Present income influences future income → The poor are more likely to remain poor. The debate on foreign aid can be simplified in a debate about the existence of poverty traps: No Poverty Trap → Income Today < Income Tomorrow Poverty Trap → Income Today > Income Tomorrow Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 75 / 80 Understanding Poverty Traps Drawing the debate on foreign aid: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 76 / 80 Understanding Poverty Traps Drawing the debate on foreign aid: Jeanne Pinay (CCA & UniTo) First Turorial Fall 2024 77 / 80 Understanding Poverty Traps No Poverty Trap: The curve lies in the area where Income TodayIncome Tomorrow and partly in the area where Income Today