Differences in income

Economic Development – Differences in Income Between Countries

Learning Objective (Syllabus 5.4)

Explain why income levels differ between countries and identify the main factors that influence these differences, using the terminology and concepts required by the Cambridge IGCSE 0455 syllabus.

Key Concepts & Terminology (Syllabus 5.1)

• Gross National Income (GNI) per capita – total income earned by residents of a country divided by its population.
• Purchasing Power Parity (PPP) – adjustment of GNI to reflect differences in price levels, giving a more realistic picture of living standards.
• Human Development Index (HDI) – composite index of life expectancy, education and GNI per capita (PPP).
• Physical capital – machinery, infrastructure, technology that increase labour productivity.
• Human capital – skills, education and health of the workforce.
• Institutional quality – security of property rights, rule of law, level of corruption and efficiency of regulation.
• Geography & natural resources – climate, disease burden, access to sea routes and endowment of minerals/oil.
• Population dynamics – growth rate, age structure and migration.
• Sectoral structure – share of primary, secondary and tertiary activities in GDP.
• Savings & investment – proportion of GNI that is saved and used to build physical capital.
• Trade openness & foreign direct investment (FDI) – ability to import/export and attract external capital and technology.

Measuring Income and Development

Why Do Income Levels Differ? – Main Drivers (Syllabus 5.4)

1. Physical capital – More machinery, roads and electricity raise labour productivity.
   

   Production function: \(Y = A·f(K, L)\) where K = physical capital, L = labour, A = technology/human capital.

2. Human capital

   • Education – higher schooling → higher productivity.
   • Health – better nutrition and lower disease burden reduce absenteeism and improve efficiency.

3. Institutional quality

   • Secure property rights and an impartial legal system encourage domestic and foreign investment.
   • Low corruption reduces the cost of doing business.

4. Geography & natural resources

   • Climate, disease environment and distance from major markets affect agricultural yields and trade costs.
   • Abundant resources can boost income, but the “resource curse” shows that weak institutions may turn wealth into low growth.

5. Population dynamics

   • High population growth can dilute capital per worker, slowing income growth.
   • A favourable age structure (large working‑age cohort) can create a demographic dividend.
   • Migration can relieve labour pressure or bring in skilled workers.

6. Sectoral structure

   • Primary‑sector dominance (agriculture, mining) is usually associated with lower income.
   • Shift to secondary (manufacturing) and tertiary (services) sectors raises average productivity.

7. Savings & investment

   • Higher saving rates provide the funds needed for capital formation.
   • Investment in infrastructure, technology and R&D directly raises K in the production function.

8. Trade openness & FDI

   • Export‑oriented economies gain from larger markets, economies of scale and technology transfer.
   • FDI brings capital, managerial expertise and access to global value chains.

Illustrative Data – 2023 (PPP)

Case Studies

1. The “East Asian Miracle” (South Korea, Taiwan, Singapore)

• Average annual GNI per capita growth > 6 % (1960‑2000).
• Key drivers: massive investment in physical & human capital, export‑oriented industrial policies, strong low‑corruption institutions, and high savings rates.
• Result: rapid shift from agriculture to high‑value manufacturing and services.

2. The Resource Curse – Nigeria

• Abundant oil reserves but GNI per capita remains low.
• Causes: volatile oil prices, rent‑seeking behaviour, weak institutions, under‑investment in education and health, limited diversification.
• Illustrates that natural resources alone do not guarantee high income.

3. Demographic Dividend – Bangladesh

• Fertility fell from 6.3 (1990) to 2.1 (2022); working‑age population now > 60 % of total.
• Combined with expanding garment exports, improved primary education and health outcomes, per‑capita income rose from US\$1,100 (1990) to US\$6,800 (2023, PPP).

Discussion & Extension Questions

1. Explain how adjusting GNI for PPP can change a country’s ranking compared with current‑price GNI. Give an example from the table.
2. Using the “resource curse” theory, discuss why two resource‑rich countries (e.g., Norway vs. Nigeria) have very different income levels.
3. Two countries have similar amounts of physical capital per worker. Why might their incomes still differ? Consider human capital, institutions and sectoral structure.
4. How does a high savings rate translate into higher future income? Illustrate with the production function.
5. Assess the role of trade openness in the rapid growth of the East Asian economies. What risks can excessive openness bring?

Suggested Diagrams (for classroom use)

• Bar chart comparing GNI per capita (PPP) of a high‑income, middle‑income and low‑income country.
• Scatter plot of GNI per capita (PPP) vs. investment rate – shows a positive correlation.
• Stacked bar showing sectoral composition (agri‑industry‑services) for the five example countries.
• Production‑function diagram illustrating the impact of increases in K (physical capital) and A (technology/human capital) on output per worker.

Summary

Income differences between countries arise from a complex interplay of:

• Physical and human capital endowments,
• Institutional quality,
• Geography and natural‑resource availability,
• Population growth and age structure,
• Sectoral composition of the economy,
• Savings and investment rates, and
• Openness to trade and foreign investment.

Understanding these factors equips economists and policymakers to design strategies that promote sustainable, inclusive economic development.