Chapter 5 Human Development. Human Development Index (UNDP) Mahbub ul Haq: Founder HD Report Geometric mean of 3 indices (Sen): – Life expectancy – Education.

Chapter 5Human Development

Human Development Index (UNDP)

• Mahbub ul Haq: Founder HD Report• Geometric mean of 3 indices (Sen):– Life expectancy– Education– GDP (log transformation)

min( )0 1

max( ) min( )j j

jj j

x xI

x x

Lowest: Black-Red

Highest: Dark Green

Why the Ln of Income?

• P/cap Incomes ranged from $260 (Liberia) to $93,383 (Qatar)– That’s really big

• Would an increase in income in rich countries affect human development as much as the same increase in poor countries? (No)

• The natural log compresses the income range– Ln(260) = 5.56 (Liberia) and Ln(93,383) = 11.44

(Qatar).

An Index of Indexes

• Education Index:

)(*)()( iii MYSAIEYSCIEI

• HDI:3 )(*)(*)( iiii EILEIGNIIHDI

• EYSC: Expected Years of School Completion• MYSA: Mean Years of School Attainment• E: Education• GNI: (Ln) of Gross Domestic Income• LE: Life Expectancy

Human Development Highs and Lows

HDI and Income

HDI and (Ln) Income

Why the Variation?

• Non-economic factors?– E.g., Swaziland and Ukraine have similar levels of per-capita GDP

($4,300, PPP)

– But HIV/AIDS lowered life expectancy to 38 years in Swaziland (vs. 69 yrs in Ukraine)

• Education and other policies?– Algeria and Panama ~$6,000

– But 92% of Panamanians are literate vs. 68% of Algerians

• Inequality? According to the World Bank:– Panama: Gini = 51.9

– Algeria: Gini = 35.3

The Best and the Worst at

Turning Income into

Human Development

Worst Performers:

Equatorial Guinea 143 54 89

Kuwait 181 129 52

Botswana 124 74 50

Oman 150 100 50

South Africa 109 66 43

Angola 79 40 39

Gabon 121 83 38

Qatar 187 153 34

Bhutan 82 49 33

United Arab Emirates 185 158 27

Trinidad and Tobago 151 125 26Average, Worst 137 94 44

Best Performers:

Cuba 84 131 -47

Georgia 76 111 -35

Grenada 93 121 -28

Palau 110 138 -28

New Zealand 153 180 -27

Madagascar 11 37 -26Average, Best 88 120 -32

Source: Analysis of data from the UNDP Human Development Report

CountryGNI Rank (Lowest to Highest)

HDI Rank (Lowest to Highest)

GNI Rank - HDI Rank

Delving into the HDI’s Components

• Income (Chapter 2) and income growth (Chapter 6)

• Education• Health Supplemental Reading for Chapter 5

Big Challenges: Positive Externalities and Public Goods

Educating a Country• Externalities of schooling

– Left to own devices, people underinvest in schooling under the best of circumstances

– The reason for public education

• Poor countries aren’t the best of circumstances– High costs of sending kids to school

• Cash• Opportunity costs

• If you make education available to everyone (like massive online open courses—MOOC), how do you make a profit?– All costs are fixed, like a bridge; IRS

Making a Country Healthy

• When you are healthy, you and the people you work with are more productive. – When you are not, you can make others sick

• When investing in health, do people consider the benefits and costs for the rest of society?– Free-rider problem: Should I get vaccinated if you do?–

• IRS: Public health projects have high fixed costs then low or negligible marginal costs– Potable water systems, sanitation, vaccinations, disease

prevention– Marginal-cost pricing doesn’t work (like bridges)

Costs• Cash costs (fixed costs and maintenance costs)

• Opportunity costs– What’s the next best thing you could be doing with the money?

• Build clinics or school rooms?• Run a public information campaign to reduce HIV?• Give cash transfers to poor households?• Build a new airport that can bring tourists in?• Put in new roads or cell towers?

– They’re all important; how do we choose?

– How can we estimate opportunity costs?• Compare benefits from other uses of money and time

Benefits: Usually a Lot Harder

• How do you quantify the economic benefits of a public health or education project?– Lives saved; what’s the ECONOMIC value of a life?– Healthy people are more productive– Human capital theory…

• Of a new road, cell tower, or airport?– How much new income will these create?

Discounting• Costs happen right away, but we have to wait to see the benefits• Income in the future is worth less than now

– …so we have to discount

• Need a discount rate, r—the opportunity cost of money– What’s the opportunity cost of money?

• Value of next-highest alternative use of money• The interest rate, the benefit of investing in something else, etc.• What if there is no bank?

• Lesotho: interest rate = .044 (or 4.4%) in 2012– Development banks often use 12% to evaluate their projects– What does a higher discount rate do to a Cost-benefit analysis?

• Need to calculate present value of any future benefits and costs.

Present Value

• The present value (PV) of $100 a year from now is $100/(1+r)– If r=.05, we get $100/1.05 = $95.24– If TWO years from now, $100/(1+r)2

• In general, the PV of income Y received at time t is:

, / (1 )tY t tPV Y r

Net Present Value of an Investment

• If NPV>0 the investment (project) passes the cost-benefit test

• The trick is always figuring out the benefits and costs– …and attach a dollar value to them.

0 (1 )

t tT

tt

Benefits CostsNPV

r

A Private Cost-benefit Analysis of Going to School

• You’re a kid in a poor village in Lesotho• Just finished 6th grade• Should you go on and complete secondary

school (grades 7-9)?• What are the costs and benefits of going to

school?

Benefits: Human Capital Theory(Gary Becker, Jacob Mincer)

• Wage=marginal value product of labor:

• The Mincer Equation: Wages thus depend on schooling (S) and work experience (EXP):

20 1 2 3i i i i iLnW S EXP EXP

The (private) returns to schooling

Benefits and Opportunity Costs in a Lesotho Village

• Mincer wage equation: each additional year of schooling raises the wage by 9.8% for males and 18.6% for females– So 3 years => 29% and 56%, respectively

• Opportunity cost: Average annual wage, <16 years old: 487 maloti (around US$64) per year for boys and 279 maloti (US$52) for girls– There are cash costs, too, but for simplicity we ignore

them

Cost-Benefit Analysis

Oppor-tunity

Cost (B')

Benefit (C')

Benefit Minus

Cost (D')

Cumu-lative Net

Benefit (E')

279 0 -279 -279267 0 -267 -546256 0 -256 -802

0 191 191 -6110 183 183 -4280 176 176 -2520 168 168 -840 161 161 770 154 154 2320 148 148 3790 142 142 5210 136 136 6570 130 130 7870 124 124 9110 119 119 10300 114 114 11440 109 109 12540 105 105 1359

.0 41 41 2816

Females

Oppor-tunity

Cost (B)

Benefit (C)

Benefit Minus

Cost (D)

Cumu-lative Net

Benefit (E)

1 487 0 -487 -4872 467 0 -467 -9543 447 0 -447 -14014 0 125 125 -12765 0 120 120 -11576 0 114 114 -10427 0 110 110 -9328 0 105 105 -8279 0 101 101 -727

10 0 96 96 -63011 0 92 92 -53812 0 88 88 -45013 0 85 85 -36514 0 81 81 -28415 0 78 78 -20616 0 74 74 -13217 0 71 71 -6118 0 68 68 8

. .40 0 26 26 958

Males

Year (A)

NPV (Sum)=958

NPV (Sum)=2816

NPV=958 (Boys) and 2816 (Girls).Is It Worth the Wait?

• A big “if”: What if educated kids migrate?– They won’t be in our analysis– Are we under-estimating the economic benefits of education for rural kids?