Chapter 5
Human Development
Human Development Index (UNDP)
• Mahbub ul Haq: Founder HD Report
• Geometric mean of 3 indices (Sen):
– Life expectancy
– Education
– GDP (log transformation)
Lowest: Black-Red
0 Ij 
x j  min( x j )
max( x j )  min( x j )
Highest: Dark Green
1
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:
I ( Ei )  I ( EYSCi ) * I (MYSAi )
• HDI:
HDI i  3 I (GNIi ) * I ( LEi ) * I ( Ei )
•
•
•
•
•
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
Country
The Best and
the Worst at
Turning
Income into
Human
Development
Worst Performers:
Equatorial Guinea
Kuwait
Botswana
Oman
South Africa
Angola
Gabon
Qatar
Bhutan
United Arab Emirates
Trinidad and Tobago
Average, Worst
Best Performers:
Cuba
Georgia
Grenada
Palau
New Zealand
Madagascar
Average, Best
GNI Rank HDI Rank
GNI Rank (Lowest to (Lowest to
HDI Rank
Highest)
Highest)
143
181
124
150
109
79
121
187
82
185
151
137
54
129
74
100
66
40
83
153
49
158
125
94
89
52
50
50
43
39
38
34
33
27
26
44
84
76
93
110
153
11
88
131
111
121
138
180
37
120
-47
-35
-28
-28
-27
-26
-32
Source: Analysis of data from the UNDP Human Development Report
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:
PVY ,t  Yt / (1  r )
t
Net Present Value of an Investment
 Benefits t  Costs t 
NPV   

t
(1

r
)
t 0 

T
• 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.
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):
The (private) returns to
schooling
LnWi   0  1Si   2 EXPi  3 EXPi 2   i
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
Males
Females
CumuCumuOpporBenefit lative OpporBenefit lative
Year (A)
Benefit
Benefit
tunity
Minus
Net
tunity
Minus
Net
(C)
(C')
Cost (B)
Cost (D) Benefit Cost (B')
Cost (D') Benefit
(E)
(E')
1
487
0
-487
-487
279
0
-279
-279
2
467
0
-467
-954
267
0
-267
-546
3
447
0
-447
-1401
256
0
-256
-802
4
0
125
125
-1276
0
191
191
-611
5
0
120
120
-1157
0
183
183
-428
6
0
114
114
-1042
0
176
176
-252
7
0
110
110
-932
0
168
168
-84
8
0
105
105
-827
0
161
161
77
9
0
101
101
-727
0
154
154
232
10
0
96
96
-630
0
148
148
379
11
0
92
92
-538
0
142
142
521
12
0
88
88
-450
0
136
136
657
13
0
85
85
-365
0
130
130
787
14
0
81
81
-284
0
124
124
911
15
0
78
78
-206
0
119
119
1030
16
0
74
74
-132
0
114
114
1144
17
0
71
71
-61
0
109
109
1254
18
0
68
68
8
0
105
105
1359
.
.
.
40
0
26
26
958
0
41
41
2816
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?