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Why are some countries richer than others? PART II: MONEY ISN’T EVERYTHING The first part of this article1 looked at several factors that could affect a country’s wealth, measured as Gross National Income per capita. It showed that neither total population nor population density make much difference, and that richer countries have liberal trading regimes and maintain inflation in low single figures, though these are not in themselves sufficient to guarantee prosperity. However, the three most important factors that correlate with national wealth and almost certainly contribute to it are urbanisation, democracy and a good business environment.

Measuring human development Economists, like the rest of us, know that there is more to life than money, and so have sought to find broader ways of measuring progress in the things that matter – in other words, to measure human development. The Human Development Index (HDI) The most widely-used measure of human development is the UNDP’s “Human Development Index”, developed by Nobel-prize winning economists Mahbub ul Haq and Professor Amartya Sen and applied regularly since 1990 2. This index measures three axes of human development: •

Health (life expectancy at birth)

Income (Gross National Income per capita at purchasing power parity)

Education (average of the “mean years of schooling” that each adult has actually achieved and the “expected years of schooling” that a child should normally receive) These three indices are combined as a geometric average, to give the country’s overall HDI score as a value between 0 and 1. In simple terms, it measures the extent to which people are healthy, wealthy and wise.

1

http://issuu.com/steve_goss/docs/why_are_some_countries_richer_I

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http://hdr.undp.org/en/humandev/

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The following graph shows that a country’s HDI score is quite closely related to its per capita Gross National Income (GNI), almost regardless of how well endowed it is with the key natural resource of oil:

Such a correlation should not really come as a surprise, since education increases income, income is income, and income buys health. However, at lower levels of income there are some large and important differences in the level of human development between countries with similar levels of GNI: for example Georgia, with a GNI of $ 5,350 per head and minimal oil production, achieves an HDI score of 0.745, more than two and a half times that of Angola at 0.285, whose GNI of $ 5,230 is heavily based on oil. Countries may drop below the curve when their income from natural resources is not reinvested in health and education, whether due to politics, war or other causes. Conversely, countries may rise above the curve when they devote a higher-than-average share of their national income to educating their youth and increasing health standards. Thus the Human Development Index is a useful tool for assessing how well countries are using their wealth to build a better future. The Inequality-adjusted Human Development Index (IHDI) One of the criticisms of the HDI is that it looks only at average achievements in health, income and education, and does not take account of how these goods are distributed throughout society. One answer to this is the “Inequality-adjusted Human Development Index”, introduced by UNDP in its 2010 global Human Development Report 3. 3

http://hdr.undp.org/en/statistics/ihdi/ The methodology is based around geometric averages of individual measures of health, income and education, so that the greater the variance in the dataset, the lower the inequality-adjusted index.

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As the following graph shows, IHDI also correlates well with GNI, though again with considerable variation amongst the poorer countries:

The Gender Inequality Index (GII) Another aspect of human development is equality between the sexes. In order to measure this, UNDP has developed a “Gender Inequality Index” following the same broad dimensions as the HDI but also taking into account the separate scores for men and women 4: •

Health (maternal mortality ratio and adolescent fertility ratio, for women)

Labour market (female and male labour force participation ratio)

Empowerment (female and male population with at least secondary education, and female and male shares of parliamentary seats) The various scores are combined to generate an index between 0 (perfect equality between the sexes on all indicators) and 1 (one gender or the other has the minimum possible score for every indicator).

4

http://hdr.undp.org/en/statistics/gii/

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The following chart shows that this index too is quite strongly correlated with GNI:

The correlation with income is not quite as strong as for either the HDI or the IHDI, at 66 % rather than 89 %. For this index there are significant variations between countries at all levels of income, with women tending to get a worse-than-predicted deal in several (but not all) of the oil-producing Arab countries, as well as in Afghanistan and the USA.

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The impact of democracy on human development To recap quickly, the following graph shows the correlation between the Economist Intelligence Unit’s “Democracy Index” and Gross National Income per capita – once a country reaches a score of at least 6.0 (the minimum to qualify as a “Flawed democracy”), income is strongly correlated with democracy; below this democracy seems to have little effect and most variation in income can be explained by oil:

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Democracy and the Human Development Index (HDI) When looking at the correlation between democracy and HDI, it is more useful to split countries into two groups: “Oil producers” generating at least one barrel of oil per person per year, and “Non-oil producers”:

Most oil-producing countries have higher scores for human development than non-oil producers at the same level of democracy, probably because of the direct role of income in the HDI calculation. There is also a tendency for oil-producing countries to have higher levels of human development as they become more democratic (correlation of 32 %), something that was not apparent on the previous graph looking at income. However, it is for the non-oil producing countries (small green dots) that the correlation between democracy and human development is most striking. The correlation here is 62 %, even higher than that between democracy and income, and in this case there is no minimum level where democracy starts to count: if it can be assumed that democracy is a direct driver of human development, then even the most undemocratic countries should start to see improvements in HDI as soon as they begin to increase their level of democracy. The essence of democracy is that government responds to the needs and wishes of its people, and the things that people most expect of their government are security, a reasonable standard of living, health care and education; thus it is little surprise that the Human Development Index is so closely correlated to democracy.

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Democracy and the Inequality-adjusted Human Development Index (IHDI) One of the measures of the Democracy Index is whether every adult has the right to vote; if they do, then in order to be re-elected a government must take account of the concerns of all citizens, not just those of a wealthy elite. It might therefore be expected that the Inequality-adjusted HDI should correlate even more closely with democracy:

The graph confirms that this is indeed the case: the correlation for non-oil producers has risen from 62 % to 64 %, whilst that for oil-producing countries has risen much more markedly, from 32 % to 50 %. In fact, the advantage that oil producers show over others in respect of GNI and HDI almost disappears once inequality is taken into account – it seems that the benefits brought by oil are very unevenly distributed amongst the population, and so if these countries want to achieve equitable human development, they have little alternative but to follow the example of other countries that have succeeded in this respect, and embrace democracy.

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Democracy and the Gender Inequality Index If democracy reduces inequality in income, health and education, then it might also be expected to reduce inequality between the sexes. The following graph shows the relationship between democracy and the Gender Inequality Index, treating all countries together since income no longer forms any part of the index:

Once again there is a correlation, with increases in democracy accounting for 42 % of the decrease in inequality. Here the situation with many of the Arab oil-producing countries is rather paradoxical: women tend to get a bad deal compared to those in other countries with similar levels of income (of which these Arab countries have a lot), but a better deal compared to countries with similar levels of democracy (of which these countries have rather little). Conclusion: Democracy works! These data strongly refute the notion that democracy is a western concept not applicable to the rest of the world. Countries with more democracy have higher levels of income, higher human development, greater equality in the distribution of income, health and education, and greater equality between the sexes. It seems that a country needs to achieve a minimum level of democracy before it starts to see benefits in terms of national income, but increases in democracy bring improvements in human development and equality no matter where the country begins – it is a recipe for human progress equally applicable to the richest countries and the poorest, to those with the best democracies and to those with almost none. But are there alternatives to democracy? Can countries use their wealth from oil or other natural resources to achieve human development without suffering the inconveniences of 8


democracy? If they are concerned about income alone, then the answer seems to be yes, a country can become wealthy without being democratic, if it has sufficient natural resources. But as the focus moves beyond income to wider aspects of human development, the compensatory effects of oil wealth begin to pale, and once equality is brought into the equation, it seems that democracy is an essential prerequisite for human development.

The business environment and human development For more than a decade, the World Bank has carried out annual monitoring of the business environment affecting small and medium-sized businesses, now covering some 185 countries. It seems logical that the business climate should have a direct effect on national incomes, but can it also affect wider aspects of human development and equality? This section looks at correlations between the Bank’s “Ease of Doing Business” rankings and the set of key development indicators, and discusses the possible causal relations between them. The first part of this paper showed the following relation between the “Doing Business” ranking and GNI – an exponential curve with an overall correlation of 57 %, fitting well amongst countries with a poor business environment but having considerably less power to explain the differences in wealth between the top 50 or so countries in the ranking:

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Doing Business and the Human Development Index (HDI) The following graph shows the correlation between these two indices:

Here the correlation with HDI is rather stronger than that for GNI, at 63 % rather than 57 %, and the variation is now greatest amongst countries with the poorest business environment. The thorny issue of causality will be discussed after looking at some other correlations with this ranking:

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Doing Business and the Inequality-adjusted Human Development Index (IHDI) Here the amount of variation is almost constant throughout the ranking:

The correlation in this case reaches 67 %, making this the strongest of all correlations examined in this paper.

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Doing Business and the Gender Inequality Index (GII) Finally, the correlation between business environment and gender equality is shown below:

For both these measures, low scores are best. The countries that have the best business environment also have the most gender equality, and at 59 % the correlation is markedly higher than that between democracy and GII. Why is the business environment so closely correlated with human development? Why is it that the “Ease of Doing Business” ranking correlates so closely with every indicator of human development, more closely even than democracy? Firstly it must be remembered that there is a moderate correlation between the “Ease of Doing Business” ranking and the Democracy Index (38 %), so many countries occupy similar positions in both sets of graphs. However, all of the correlations in this section are much higher than 38 %, so clearly something more fundamental lies behind them. Possible explanations for the strong correlation between the business environment and human development include the following: •

A good business environment helps a country to become richer, contributing both directly and indirectly to the HDI and IHDI indices. It is also probable that wealthier countries will be prepared to spend more on educating women and providing them with health care.

Whilst the “Doing Business” project focuses on bureaucracy in relation to businesses, bureaucracy also plays its part in the education system and, even more, in health delivery. It is likely that a country which tries to help its businesses rather than 12


hinder them also treats its patients better and has a more client-centred approach to education. •

Countries that have bad bureaucracies tend to have not just a lot of rules and slow processes, but unclear rules that leave a lot of scope for interpretation, and ways of speeding up the process if you know the right person or how to oil the wheels. In practice, bureaucracy and corruption are usually two sides of the same coin, and so the wealthy and well-connected can circumvent bureaucratic obstacles that hinder other people. Thus a good business environment not only raises incomes for all, it also reduces inequality. In conclusion, it seems that a good business environment is both a direct contributor to human development and equality, and an indicator that a government has an attitude to its people that frees them up to express their full potential.

Rurality and human development The first part of this paper included the following chart showing how GNI varies with the share of population living in rural areas:

Urbanisation is strongly correlated with income (55 %), and it was suggested that this is because economic growth is most commonly centred around towns and cities, both raising the country’s average income and attracting more people to urban areas. How then does rurality relate to other aspects of human development?

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Rurality and the Human Development Index (HDI) The following chart shows that HDI shows a 50 % correlation with the share of total population living in rural areas, slightly below the 55 % correlation between rurality and income:

Here the variation is greatest amongst the most rural countries – effectively the less developed countries where HDI varies considerably from country to country. Once again, causality will be discussed at the end of this section.

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Rurality and the Inequality-adjusted Human Development Index (IHDI) The Inequality-adjusted Human Development Index shows the same 50 % correlation with rurality:

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Rurality and the Gender Inequality Index (GII) The final graph shows that the Gender Inequality Index also correlates with rurality, with greater inequality in more rural countries:

With a correlation of 35 %, this link is the weakest of all those presented in this part of the paper, but it is still very highly significant. How does rurality affect human development? We have seen that urbanisation is associated with higher per capita income, which contributes directly to the HDI and IHDI indices and may have indirect effects on gender equality, but the links between rurality and development may go deeper than that: •

It costs more to deliver health services and education in rural areas, and rural populations often have to make do with more basic services, with limited choice in education and with few medical specialists. Therefore rural countries can be expected to have lower HDI scores relative to their level of income, and it is perhaps a surprise that the correlation between HDI and rurality is not even stronger than the 50 % found here.

•

The weaker position of women in more rural countries could have two different aspects: o These less-developed countries may have greater gender inequality throughout their societies, in urban as well as rural areas; o Within the same country, attitudes and opportunities for women may be lower in rural than in urban areas. 16


The relative role of these two different factors has to be considered for each country, and may bring some surprises, for example, research in Bosnia and Herzegovina, one of the most rural countries in Europe, found that most measured aspects of attitudes and behaviour were almost identical in rural and urban areas5.

Summary and conclusions The correlations found in this paper are summarised below: Correlation with: GNI

HDI

IHDI

GII

Gross National Income per capita

Human Development Index

Inequality-adjusted Human Development Index

Gender Inequality Index

Democracy Index

0.1 % (DI < 6) 59 % (DI ≥ 6)

32 % (oil producers) 62 % (others)

50 % (oil producers) 64 % (others)

42 %

Ease of Doing Business ranking

57 % exponential

63 %

67 %

59 %

Share of population in rural areas

55 % exponential

50 %

50 %

35 %

Factor

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Democracy plays a major role in improving all of the indices, it increases income, raises human development, and reduces inequalities between rich and poor and between men and women. A minimum level of democracy is required before the effects on income begin to be felt, but every increase in democracy improves human development and equality. Oil can to some extent substitute for democracy when only income is considered, but when wider aspects of human development – and particularly equality – are taken into account, the effect of oil begins to fade and democracy emerges as an essential component of a successful society.

The business climate has a strong correlation with all of the indices, for rich countries and poor, oil-rich and oil-less alike. A good business environment matters even more to human development and equality than it does to the simple measure of money.

Urbanisation is linked with higher incomes, human development and equality. The correlation is slightly weaker than either democracy or ease of doing business, but it is still extremely significant.

The importance of a liberal trade regime is not examined in detail here, but there is a 29 % negative correlation between applied average tariff and the Human Development Index – exactly the same as the correlation between tariffs and Gross National Income.

UNDP Human Development Report 2013: “Rural development in Bosnia and Herzegovina: Myth and reality”

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The individuals and organisations striving to make the world a better place often seem to fall into two camps. In one camp are the economists and organisations such as the World Bank, focussing on “hard” economic indicators such as GDP and GNI, and stressing factors such as the business environment and tariff liberalisation. In the other camp are the sociologists and organisations such as UNDP, focussing on “soft” indicators such as HDI, IHDI and GII. What this analysis has shown is that all these factors are intimately linked, that where the fundamental values of a country are concerned, what is good for business is good for human development, what makes countries richer makes them more equal. One common concern shared quite rightly by both camps is the need for democracy and good government, as the starting point for everything else. The correlation between income and development is clear. Whilst a high average income may not guarantee a decent income, health care and education for all – particularly when that income is based on oil – it is hard to have development without income, and in practice the two go together. The link between income and gender equality may not be immediately obvious, but as countries become richer, the status of their women improves. The most striking of all the findings in this paper is the very strong correlation between the “Ease of Doing Business” ranking and every indicator that matters – Gross National Income, Human Development Index, Inequality-adjusted Human Development Index and Gender Inequality Index. It may seem strange that a rather mundane focus on cutting red tape and simplifying forms should bring such far-reaching benefits, but the link is there and it is fundamental: a country’s greatest resource is not its oil or its gas, its coal or its minerals, its fields or its forests. Its greatest resource is its people – their labour, their energy, their creativity, their striving together and individually to build a better future for themselves their families and their country. What bad bureaucracy does is squander the country’s greatest resource. It wastes people’s time, saps their energy, diminishes their enthusiasm. It creates delays, causes people to miss their moment, slows down progress. More than this, bad bureaucracy reflects an attitude that people are not important, that their time doesn’t matter, that the state and the institution are what count, not the individual and their ideas. It is an approach that denigrates human dignity, whilst the corruption that so often accompanies bureaucracy favours the rich and well-connected, and fosters inequality. Mahbub ul Haq, founder of the UNDP Human Development Report and co-creator of the Human Development Index, said that “The objective of development is to create an enabling environment for people to enjoy long, healthy and creative lives.” Those countries that rank well in their Ease of Doing Business have understood the need to create such an enabling environment, to give people freedom and equality to develop themselves and their society. Dr Steve Goss 4 July 2013

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Why are some countries richer than others? Part II: Money isn't everything