Any discussion of economic development – either implicitly or explicitly – contains the distinction between developed countries and developing (or under-developed) countries. While there are many theories on what promotes development and how best to achieve it, in all cases the goal is for a country to eventually become 鈥榙eveloped鈥�.

This begs the question – what is a developed country? There are at least three common definitions, which are presented below. These definitions overlap in many cases, but in others they are at odds. This piece argues that a broader definition is needed in light of recent failures of several 鈥榙eveloped鈥� countries to cope with shocks ranging from the COVID-19 pandemic to natural disasters.

The first definition is not really a definition but rather a classification. The considers any country with Gross National Income (GNI) per capita $12,536 or higher to be high-income, and therefore developed. The rest of the countries are considered developing – as they haven鈥檛 yet reached this threshold – and are further subdivided into low-income (under $1,035), lower middle-income ($1,036 to $4,045) and upper middle-income countries ($4,046 to $12,535).

In this view development is purely quantitative, and also continuous. A country climbs the development ladder simply by increasing its income over time and moving from one rung to a higher one. 

One problem with assessing the level of development using only income is that some countries have high income yet are rather poor in many other ways. Equatorial Guinea, for example, is classified as upper-middle income since its GNI per capita in 2019 was $6,460. However, people in that country can only expect to live to the age of 58.4, on average, and to complete 9.2 years of schooling. 

The (HDI) of the United Nations Development Programme (UNDP) therefore takes into account not only income but also health and education. It therefore ranks Equatorial Guinea 144 (medium human development), while Samoa is ranked higher at 111 (high human development). Even though Samoa鈥檚 income is lower (only $5,885), it has a longer life-expectancy at birth (73.2 years) and more expected years of schooling (12,5) than Equatorial Guinea.

Another, somewhat older view of what a developed country looks like has to do with the idea of industrialization. Starting with the industrial revolution, economic development has consisted in large part of shifting capital and labor from agriculture (which has constant or diminishing returns to scale) to manufacturing (which has increasing returns to scale), greatly raising productivity and incomes.

In this view, developed countries are industrialized countries. During the Cold War, this view divided the world into the capitalist West (the First World) and the communist East (the Second World), with the non-industrialized (developing) countries grouped as the Third World. While the Soviet Union and Eastern Europe started with barely any industry and much lower income, they caught up and even surpassed the west during the 1950s and 1960s.

Since the fall of the Berlin Wall in 1989 and the of formerly socialist countries to capitalism, some have considered this to be the 鈥楨nd of History鈥�, implying that the market system is the only path to true, lasting development. This gave rise to a new classification of development, through membership in the so-called 鈥榬ich-country鈥� club, the Organization for Economic Cooperation and Development (OECD). OECD members include the original recipients of Marshall Plan aid in 1948, but more recently also some former developing countries – Israel, Korea, Mexico, and Turkey – and several former communist countries – Czech Republic, Estonia, Latvia, Lithuania, Poland, Slovakia and Slovenia.

The average OECD country has an income of $40,115, but most have experienced some deindustrialization. Manufacturing in France, for example, has decreased from 22% of GDP in 1960 to 9.8% in 2019. By contrast, formerly agrarian South Korea has seen this ratio increase from 11% in 1960 to 25%. Korea鈥檚 income today is $33,720 compared to France鈥檚 $42,400, so which one is more developed depends on the definition or classification used.

Notwithstanding these subtle differences, both Korea and France are widely considered rich, developed countries today, as are the United States and the other members of the OECD. But recent events – such as the COVID-19 pandemic and the higher incidence of natural (although climate-change related and thus human-induced) disasters – have cast doubt on whether some of these countries truly deserve the label 鈥榙eveloped鈥�.

As shown in recent blogs (here and here), the United States in particular has performed especially badly in the current pandemic. Before the virus arrived, it already had far worse health system capacity than many poorer countries (in terms of hospitals and doctors per population, but also health insurance coverage). Once the pandemic arrived, many U.S. politicians reacted in chaotic and ineffective ways, resulting in some of the worst case and fatality ratios in the world.

In terms of preparedness for natural disasters, the Katrina Hurricane which struck the U.S. in 2005 caused 1,200 deaths, over $100 billion in damage, and turned numerous people homeless. The recent Tropical Storm Isaiah – which hit the northeastern U.S. – was much weaker but caused 2.2 million households to lose electrical power, in some cases for over a week. Unlike Katrina, where the ineffective response was blamed on discrimination against mostly minority residents in New Orleans, more than half a million people each in New York, New Jersey and Connecticut – some of the wealthiest states in the union – were left in the dark for prolonged periods. Many people have expressed outrage at having to experience what – in their view – felt like developing country conditions.

Clearly the U.S. does not lack the resources – income or industrial equipment – to better prepare or more effectively respond to shocks such as pandemics or hurricanes. But it has, as have other rich countries such as the U.K., knowingly reduced its own capacity to take care of the public well-being in recent decades.

The ideology of neoliberalism – best represented by Ronald Raegan and Margaret Thatcher – focuses most attention on individual well-being, slashing investment in public infrastructure, public services, and public planning (including for disasters and pandemic). Thatcher went even further, claiming 鈥榯here is no such thing as society鈥�. These ideas have translated into attacks not only on welfare support, but on state programs designed to protect the public from both viruses and hurricanes, among other threats. Already in 2018, infectious diseases experts expressed concern about the U.S. Congress slashing budgets for prevention and public health . 

Looking at UNDP鈥檚 recent COVID-19 , the US and UK perform worse than most OECD countries on several fronts. They have far less hospital beds per 10,000 people and higher poverty and inequality.

This discussion thus leads to a new possible definition of development. Rather than just having the means – income, industrial technology etc. – to take care of the public good, developed countries are those that also have the will to do so, rather than merely serve the interests of individuals (usually the wealthiest). 

Developed countries are often also assumed to be democratic. Therefore, the recent 鈥榙e-development鈥� in the US and UK (and other countries) has not gone unnoticed by voters, who chose to blame outsiders (migrants or the EU) and turned to natoinalist policies and leaders. 

Unfortunately, such politics can only further damage both economies and societies, rendering even more harm to the public good. We therefore urgently need a new vision of what the goal of development is – a truly developed country has both the means and the will to take care of all its citizens, in good times as well as in crises.

By Dr. Jacob Assa, The New School for Social Research. He Tweets at .

The current pandemic is a human tragedy on an enormous scale, not only in terms of death and illness but also in loss of employment, disruption to education and increased anxiety. Perhaps of most concern to politicians, the various restrictions put in place to reduce the spread of COVID-19 have had large negative effects on national and regional economies.听

As a result, many leaders have opted to 鈥榬e-open鈥� their economies prematurely, partly since economic performance affects electoral cycles. In some cases there have been disastrous consequences to such loosening of social distancing restrictions, with spikes in infections in various countries or states. This has led to a discussion of a false dichotomy – between protecting human life and reviving the economy.听

This dichotomy is false for several reasons. At the most basic level, if large parts of the population get infected and either die or are unable to work, this would not bode well for the economy either. But more fundamentally, what we think of as 鈥榯he economy鈥� is really broader than just profits and asset values.听

One clear indication of this ontological mismatch is the fact that, while GDP is shrinking and unemployment is rising in many countries, stock markets are on a euphoric roll. Unlike their plunges in the face of previous shocks –听 such as the dot.com and subprime mortgage crises – stock markets rallied at an . Paul Krugman quipped that, rather than following economic fundamentals, the stock market is moved by a combination of .

But there is a deeper and older explanation for this spurious puzzle. Our current understanding of 鈥榯he economy鈥� is rooted in a relatively modern definition by Lionel Robbins in 1932: 鈥渢he allocation of scarce means that have alternative ends鈥�. This is a fundamental notion for neoclassical economics, which focuses on the market as intermediating the supply of (scarce) resources among demand from alternative buyers based on prices. This worldview sees consumers as seeking to maximize their 鈥榰tility鈥� (an unobserved quantity which roughly represents satisfaction), while firms who produce the goods are maximizing their profits.听

But how can firms maximize profits if consumer spending is tanking due to business and travel restrictions? Indeed, many small as well as large corporations have gone bankrupt during the pandemic. But the process of financialization in recent decades has broken the link between productive investment (making tangible things for profit) and generating revenues. More and more firms are making their profits from financial products and services, and increasing shares of countries鈥� economies and are coming from pure speculation in real-estate or financial markets.听

This disconnect between the 鈥榬eal鈥� and the financial parts of the economy came to the fore during the 2007-8 global financial crisis, as hyper-speculation in the financial sector caused enormous damage on the real side of many economies. So what is ultimately the relationship between finance and the economy?听

But how can firms maximize profits if consumer spending is tanking due to business and travel restrictions? Indeed, many small as well as large corporations have gone bankrupt during the pandemic. But the process of financialization in recent decades has broken the link between productive investment (making tangible things for profit) and generating revenues. More and more firms are making their profits from financial products and services, and increasing shares of countries鈥� economies and are coming from pure speculation in real-estate or financial markets.听

This disconnect between the 鈥榬eal鈥� and the financial parts of the economy came to the fore during the 2007-8 global financial crisis, as hyper-speculation in the financial sector caused enormous damage on the real side of many economies. So what is ultimately the relationship between finance and the economy?

Aristotle, in his book on Politics, distinguished between two kinds of activities. Chrematistike (蠂蟻畏渭伪蟿喂蟽蟿喂魏萎) – sheer money-making – was considered morally inferior to Oikonomia (慰峒拔何课轿课嘉�) –听 the concern for morally adequate individual and public household management. In fact Aristotle cautioned against separating financial activities from public (political) oversight, as this Chrematistic logic leads to . By contrast, the desirable Oikonomic processes promote overall well-being in social, ecological, financial and even inter-generational dimensions.听

While the recent stock-market rally is a pure example of Chrematistics, another trend is actually an example of how the holistic concept of Oikonomia is making a (partial) come-back due to the virus-related restriction on economic activity. Pandemic-related reductions in demand for fuel, air-transport, industrial production and car transport have all contributed to a greater-than-expected drop in CO2 emissions in the past few months. Historically, emissions move in tandem with GDP, but . This is due to the fact that reductions in emissions in the current crisis are concentrated in sectors which emit more CO2, proportionally, than others, leading to more reductions in emissions than those resulting from other shocks. This divergence of emission and growth opens up the possibility of policies to delink our economies from fossil fuels.

But CO2 emissions are not the only things that have dropped. People commute less, resulting in less traffic and car accidents. Families spend more time together, strengthening social bonds. Consumers spend more locally, invigorating small businesses and communities. And while many people have lost their jobs, some countries support citizen incomes to maintain both livelihoods and overall demand (thus indirectly helping businesses).听

Taken together, these positive side-effects of an otherwise tragic situation suggest that this crisis is teaching us a lesson. Instead of an unlimited pursuit of profit, our economy could (and according to Aristotle, should) be focused on meeting basic needs, cultivating social relationships, and even doing better by our planet. In fact, recent suggests that zoonotic diseases like COVID-19 are directly related to the encroachment of the global economy on ecosystems (which leads to loss of habitat and transmittal of viruses from animal to human in previously untouched areas).听

So in a way, the fact that (chrematistic) stock-markets rally in the face of human and economic (oikonomic) decline is not surprising. We have let our greed go wild at the expense of human, social, economic and ecological well-being. It is time to return to the original meaning of Oikonomia, enhancing the well-being of people and the planet alike.听

Dr.听Jacob Assa, The New School for Social Research. He Tweets at听.

听

By Jacob Assa and Cecilia Calderon

Unlike other epidemics or pandemics 鈥� such as tuberculosis, SARS, MERS or HIV/AIDS 鈥� COVID-19 has hit hardest at the world鈥檚 wealthiest countries. As of early June 2020, the 37 industrialized countries of the OECD accounted for 59% of all cases and 78% of deaths, even though they constitute less than 18% of the total population affected.

Looking at the pandemic鈥檚 effects in another way 鈥� using cases and deaths per million population 鈥� paints an even starker picture. OECD countries have a prevalence ratio of 2,890 cases per million and a mortality rate of 225 per million, compared with 869 cases and 51 deaths per million in the rest of the world. Furthermore, the case fatality ratio (CFR) 鈥� the ratio of deaths to cases 鈥� is also higher in the OECD (7.8%) than in the rest of the world (5.9%).

What can explain this phenomenon, the world鈥檚 richest countries impacted more than middle-income and poor countries?听 One explanation is that COVID-19 spreads faster in countries that are more integrated to the globalized economy, as the OECD members certainly are. A recent found that globalized countries have indeed experienced more cases per population, but less mortality.

We find this explanation incomplete. First, the extent of a country鈥檚 globalization may be masking other factors. And second, some of the most globalized countries have lower COVID-19 prevalence and mortality than countries more integrated into the global economy. For example, Germany has a higher KOF globalization index than the United states, but the latter has more than double the prevalence and mortality rates. Likewise, the UK is more globalized than Spain, but Spain has fared worse in cases per one million people.

Clearly something else is at play. One possible reason for the virus鈥檚 differential impact on countries is the relative structure of their health systems. In fact, a 2015 of tuberculosis (TB) rates in 99 countries found that cuts in public spending on healthcare and the privatization of the health sector were related to higher prevalence of TB. This was set against decades of privatization of health-care systems in developing countries, often encouraged by the World Bank and IMF.

However, the TB sample only included developing countries, while COVID-19 has struck across the entire world. We set out to find whether a similar difference in the financing structure of health care 鈥� private vs. public 鈥� had something to do with COVID-19 prevalence and mortality rates in countries at all different stages of development. We used data for 147 countries accounting for 93% of the world鈥檚 population, and spanning the five continents and all income levels.听

We ran several regression models for both COVID-19 prevalence 鈥� cases per million people 鈥� and mortality 鈥� deaths per million, and in each case the extent of private expenditure on health care had a large and positive relationship with the impact of the pandemic (see our full paper ).听

The first chart shows that, even when controlling for the level of income, the extent of urbanization, globalization and democracy, a 10% increase in private health expenditure results in a 4.85% increase in COVID-19 cases.听

The second chart shows that, controlling for the same variables, a 10% increase in private health expenditure results in a 6.91% increase in COVID-19 deaths. This is an average, and some countries perform worse (e.g. the United States in the top right corner) while some fare a little better (e.g. New Zealand). But the relationship is clear and statistically significant.听

For COVID-19 mortality we also looked at the proportion of people over 65 in the population. Since this is a high-risk group, we were not surprised to find that, on average, 10% increase in the percentage of older people results in a 1.18% increase in COVID-19 deaths.

While policymakers cannot change the demographic structure of the population very quickly, they do have control of policies such as cost-cutting and privatization, which also affect hospital capacity. We found that a 10% increase in the percentage of hospital beds per 1,000 people results in a 1.67% decrease in COVID-19 deaths. Some of the highest mortality rates are in the US, Italy and Spain (which have around 3 hospital beds per 1,000 people), whereas less privatized systems have a much higher ratio of hospital beds per people, e.g. Germany (8.2), South Korea (10.9), and Japan (13.4).

These findings suggest that short-term gains from privatization of health-care systems (such as cost-cutting and in some cases shorter waiting times at clinics) have to be weighed against long-term risks of lower capacity (in both equipment and staffing), less equitable coverage, lower adherence to medical standards and often over-prescription of antibiotics. In the case of COVID-19, the equity element may have played a large role, as uninsured people feeling ill are more likely to avoid costly testing or treatment, as well as less likely to be able to work from home, thus facilitating the spread of the virus.

While the most urgent task is coping with the pandemic at hand, it is not likely to be the last or even worst. Recent has linked the emergence of zoonotic diseases such as COVID-19 to increased pressure from human economies on nature, leading to declines in wildlife populations and thus a higher risk of animal-to-human transmission of such diseases. With this in mind, policy-makers need to urgently re-evaluate neoliberal policies such as privatization and commercialization of healthcare systems, if these are to become sustainable in the long-run.

Dr.听Jacob Assa, The New School for Social Research. He Tweets at听.

Cecilia Calderon, statistics specialist, United Nations Development Program.

The spread of the coronavirus epidemic around the world in the past few weeks has exposed not only differences in the lack of preparedness of various public health systems, but also differences in reactions to the crisis. Some governments imposed an early lockdown in their attempt to 鈥榝latten the curve鈥� while others have taken a more gradual approach, proceeding from travel restrictions through limits on non-essential businesses to shelter-in-place regimes.听

As the epicenter of the pandemic shifts from Asia to Europe and the U.S, however, some reactions stand out among the rest in their utter disregard for human life. Federal and state officials in the U.S. have first downplayed the threat two months before it arrived in the country, as well as refused offers for help from the World Health Organization. Now, as the curve in the U.S. is about to get steeper (see the surgeon general鈥檚 , top levels of government are considering scaling back the moderate measures that have been taken so far, with a view to return to normal activity within a few weeks. While blaming China for not controlling the virus early enough, some officials are contemplating consciously allowing their own citizens to experience a much worse spread of infection and death than China has seen.听

One clear example of this misguided and dangerous ideology can be seen in the pressure put on the U.S. government by corporate lobbyists not to activate the – which enables the executive branch to order corporations to manufacture the direly-needed medical supplies for testing and treating the virus. Large swaths of the political elite, instead, are relying on the private sector鈥檚 voluntary offers to produce such goods. Worse, these same politicians are aching to get the economy back to normal, so as to boost the stock market and their own ratings at the same time. The听 lieutenant-governor of Texas even went as far as suggesting that older citizens – the group most prone to dying from the virus – would gladly themselves in the interest of getting the economy moving again.

How can this idolizing of the economy over the polity – and citizens鈥� very survival – be possible in a democracy? Those in听 power are clearly acting in their own self-interest rather than in that of the public. Most people are probably scratching their heads for an explanation of how this could be happening in a country previously considered the beacon of freedom. A straightforward explanation is that the U.S. has not been a real democracy for a while, if by that term one means enacting policies in the interest of the voting majority. While it had never topped the EIU Democracy Index, the U.S. has from 鈥榝ull democracy鈥� to 鈥榝lawed democracy鈥� in 2018.听

But this decline has been in the works since 1980. From that time, economic 鈥榝reedoms鈥� have increased in the U.S., as corporations, consumers, investors and wealthy individuals have benefitted more than ever from improvements in technology, healthcare, education and other aspects of living in a rich society. The majority of the population, however, has been doing worse, as evident by stagnating or declining real wages, increasing inequalities in various dimensions, and even a .听

In short, the U.S. is only a nominal democracy, in that anyone of voting age can select candidates for local, state and national office and also run for such office. However, the two-party system, coupled with the unparalleled impact of money in political campaigns (made worse by the Citizens United decision of the supreme court) have deflated the power of electoral democracy, since both major parties in the U.S. accept enormous donations from corporations, and are also lobbied much more by firms than by non-profit organisations or individuals (as the latter two groups do not have nearly the same financial resources as private firms). The expansion of economic freedom then – at least of this sort – has come at the expense of political freedom and representation of the public interest, which is now merely a pretense.听

While the US had both political and economic freedoms – at least immediately after WWII – it has since sacrificed its citizens鈥� political freedoms for more corporate freedom. The US case shows that what has long been known as Laissez-Faire – leaving the economy to its own devices – works to diminish political freedoms and make democracy a sham.听

To return to the virus, the U.S. may end up in a much worse place than other, poorer countries. Its extreme neoliberal policies of the past four decades have weakened its public health system, while also brainwashing millions of voters to see the government as the enemy. Thus, one of听 the richest countries on earth faces shortages of everything from masks, testing equipment, ventilators and even medical staff. Laissez-Faire, in the extreme, means Laissez-Mourir (let die): more people are left to die as public services have been savaged by years of austerity.听

As the chart below shows (using World Bank data), the U.S. was leading the world in 1960 with 9.2 beds per 1000 people (compared to 8.7 in the OECD, the group of industrialized countries). By the second decade of the 21st century, this ratio dropped to 3 (a decrease of two-thirds) in the U.S. while the OECD was averaging about 4. Meanwhile, poor and emerging countries have increased their hospital capacity from 1.4 in 1970 to 2.4 in 2011.

As data on the spread of the virus is still being collected, it is instructive to compare hospital capacity across countries. The chart below shows that more unequal countries have, ceteris paribus, less beds per 1,000 people. But the link is neither perfect nor deterministic. While the U.S and China had similar average levels of inequality of the period 2011-2018 (41.2 and 40.1, respectively), China has 4 beds per 1,000 while the U.S. has 2.9. Serbia and Russia are only slightly more equal (with Gini coefficients of around 39 for both), but have 5.7 and 8.4 beds per 1,000 people, respectively. Japan and Korea, which were earlier the epicenter of the pandemic, coped very effectively with the crisis, partly since they have 13.4 and 10.9 beds per 1,000 people, respectively. In other words, these two countries have 3-4 times more hospital capacity than the U.S., despite their per capita income being about third lower (even using PPPs).

Hospital beds are not the only factor in a country鈥檚 ability to respond to a pandemic, but they do play a role, especially when more people start getting infected. As of Friday, 27 March, the infection rate in the US was than many other countries which were affected earlier:

There is another sense in which Laissez-Faire is literally deadly. Leaving the fate of the environment and the planet in the hands of the market has produced a threshold-level catastrophe, and even now, with only a few years left – if any – to take action on climate change, the U.S. is in denial about its very existence. And it鈥檚 not just future generations who will suffer. Recent research has the spread of deadly viruses to humans鈥� ever increasing encroachment onto previously untouched natural environments. When species in those areas go extinct, disease vectors such as COVID-19 find new homes in the bodies of humans.听

This double-danger of Laissez-Faire – hurting people, destroying the environment and thus hurting even more people in the name of economic growth – is not new to many developing countries, where decades of Washington Consensus policies have ravaged social safety nets, commodified the environment, and emptied democracy of its content as elected government were powerless against (or alternatively, colluding with) multinational corporations. Ironically, global corporations appeared first as instruments of colonization (e.g. the British and Dutch East India companies), but during the industrial revolution came home to roost, 鈥榗olonizing鈥� working classes in the rich countries鈥�.

Maybe now, as the dangers of infectious disease, social breakdown, and even economic meltdown occur in rich countries, people there may finally take notice. Austerity – the latest form of Laissez-Faire in the North – has hollowed countries鈥� ability to not only support the vulnerable in normal times, but even to save their lives during a pandemic. And while it is true that the viral infections do not discriminate by income, the poorest are most vulnerable and least equipped to cope with them, also in rich countries.听

The virus may be blind to political beliefs, but not vice versa. It may be a coincidence that so-called 鈥榬ed-states鈥� in the U.S. have reacted more slowly and with less concern than 鈥榖lue states鈥� to the virus, and some are already contemplating going back to normal, or that republican senators seem to be more affected by it than their democratic colleagues.

However, the poor and middle-classes of both parties will likely suffer far more than their politicians. The same happens during wars, where the bulk of ordinary soldiers are drawn not from the top but from the bottom and middle of the social hierarchy. But World-War II showed not only the horrors of war, but also the enormous potential of collective action, including the boost it gave to the U.S. economy, the disappearance of unemployment, the demonstration of women鈥檚 equal ability to work, as well as the virtue of balancing political and economic freedoms, which is the only stable path to real democracy.听

The recent virus is a tragedy given the lives already lost and those who will die next, the economic hardship and rising unemployment, and the complete disruption of a way of life once taken for granted. But it is also an opportunity to remember that pushing private, economic freedoms to their limit is not without a cost. They come at the extent of political freedoms, public goods such as health and safety, and ironically – even at the cost of long-run economic well-being itself. Just as the stock-market crash of 1929 helped elect FDR and rebalance economic and political freedoms – even before the outbreak of WWII – we can only hope that the economic slowdown currently affecting the U.S. and other countries will shake voters of all political stripes out of their fairy-tale belief in the market as a guarantor of any freedoms – economic or political – in the long run.听

A pandemic, like fascism, cannot be priced in by markets. It is not an externality to be internalized by a tax. It cannot be traded between those with different 鈥榚ndowments鈥� of the disease. It takes a society to fight a war, and as several countries have already shown during this crisis, Maggie Thatcher was wrong: there is such as a thing as society. While we need to be cautious not to to curtail political freedoms, we cannot sacrifice ourselves to the short-term 鈥榚conomic freedoms鈥� of a minority. If we do, we are all dead, even before the long-run.

By Dr. Jacob Assa, The New School for Social Research. He Tweets at .

Photo: Emergency hospital during influenza epidemic, Camp Funston, Kansas in 1918.

Developed countries often lecture developing and emerging countries on the appropriate policies and institutions necessary for economic success. This is done either bilaterally or through multilateral organizations such as the World Bank, IMF, OECD or European Union. Cambridge economist Ha-Joon Chang exposed the hypocrisy of this approach in his provocative 2002 book . Chang suggests that when today鈥檚 rich countries were themselves developing, they used practices opposite to what they preach today, including industrial policies, high tariffs and infant industry protection. Therefore their current advice to poorer countries amounts to 鈥榢icking away the ladder鈥� of development.

A lesser-known but equally disturbing process has occurred in the realm of economic statistics, in particular national income accounts. The EU and OECD often criticize the national accounts of developing countries, and a recent example is a claim made in a by Robert Barro: “There are suspicions that China鈥檚 reported growth rates in recent decades have been boosted by manipulation of the national-accounts data.” While no statistical system is beyond doubt, the biggest manipulations of data in history, in fact, have benefited (and were supported by) rich countries.

The Rhetoric of Economic Statistics
Efforts to measure the 鈥榚conomy鈥� have taken place since the 17th century, beginning with William Petty鈥檚 (1665) and (1676). Right from the beginning, this seemingly technical exercise has involved geopolitical competition to establish the economic (and by extension, military) superiority of countries. William Petty and Gregory King in England, as well as Pierre de Boisguilbert and Marshall Vauban in France, all used their estimates of national income to demonstrate their countries鈥� fiscal strength (or weakness) and urge for certain policies (for a political history of this practice see ).

A recent parallel of this statistical race was the revision of US GDP (for 2013 Q2) by the Bureau of Economic Analysis (BEA). The new definition used by the BEA includes R&D and original entertainment works in fixed investment, whereas these were previously classified as intermediate inputs and thus excluded. This revision added $560 billion to total US GDP (more than the whole economy of Sweden), increasing it to $16.2 trillion, and conveniently 鈥渞einforcing America鈥檚 status as the world鈥檚 largest economy and opening up a bit more breathing space over fast-closing China鈥� (). Canada had done the same in 2012 and Australia as early as 2009, 鈥渓eapfrogging Canada in the OECD鈥檚 country rankings of GDP per person鈥� ().

These statistical maneuvers pale, however, in comparison to the 1968 revision to the international standard called the System of National Accounts (SNA). Up to this point, the interest income of banks (traditionally derived from financial intermediation) had been completely left out of the national accounts, as it was considered merely an unproductive transfer. The 1968 SNA 鈥�made finance productive鈥� () by a bizarre sleight of hand, which presented net interest earned by banks as an input to a 鈥榥otional鈥� (read: imaginary) industry. This strange treatment was given the name Financial Intermediation Services Indirectly Measured (FISIM), to distinguish it from financial fees, which were directly measurable.

The Financialization of GDP
While this revision gave finance a foothold in GDP (and made the output of other sectors paying this interest seem lower), it did not affect the overall level of GDP. And at that point in time, the other stream of financial income – explicit fees charged by banks and other financial institutions – was relatively small. In time, however, the share of finance, insurance and real estate (the FIRE sectors which create and trade assets rather than produce and sell goods and services) rose dramatically in a process called , and financial fees increased accordingly. In 1997, the last year in which the US reported FISIM separately (afterwards it was 鈥榙istributed鈥� to uses, meaning deducted from other sectors鈥� net outputs), net interest income was just 3.1% of GDP, while the fee-based profits (鈥榲alue-added鈥�) of the FIRE sector accounted for 27.1% of GDP. By 2011 (the last year for which sectoral data are available), fee-based FIRE 鈥榦utput鈥� (in reality imputed based on net income) accounted for a staggering 33% of total US value added (or 36% of GDP).

What does all this have to do with developing countries? Both financialization and therefore the financial sector鈥檚 statistical footprint in GDP are much larger in developed countries than in developing ones. In China, for example, although the FIRE sector doubled its share of GDP from 6% in 1978 to 12% of GDP in 2011, it still only accounts for less than an eighth of all economic activity. In the US, by contrast, the FIRE sector has gone up from over a quarter (26.5%) of GDP in 1990 to over a third in 2011 (see figure 1).

Figure 1: FIRE sectors as share of GDP, China and US

Recent research has suggested that the imputation of productive output for the FIRE sector in the national accounts has distorted GDP in several ways. First, the FIRE imputation drives a wedge between output (as measured by GDP and employment trends), as visible in the phenomenon of 鈥榡obless growth鈥� observed after the three most recent recessions in the US (see figure 2).

Figure 2: US GDP (constant prices) and total employment, 1977=100

Second, real per capita GDP has likewise diverged from a more realistic measure of standard of living, real median income. This divergence of overall economic growth from an experience of stagnation for the median voter has been at the heart of increased inequality, and has also been cited as one of the reasons for the rise of populism in the recent US election (e.g. the Sanders and Trump movements) and perhaps also Brexit in the UK.

Figure 3: US per capita GDP (constant prices) and median income, 1984=100

Putting out the FIRE
These and other anomalies have been investigated by recent research, which has also proposed some corrected measures of output. Basu and Foley (2013), in their paper , exclude the FIRE sector from their measure of output (called Non-financial Value Added or NFVA) and find a much improved correlation between NFVA and GDP. In my own research, I go a step further, first excluding and then deducting financial fees from GDP. This is symmetrical to the treatment of financial interest income (FISIM) in the SNA, and also echoes Nordhaus and Tobin鈥檚 of some government services as 鈥榠nstrumental鈥�, i.e. intermediate consumption. I call this adjusted measure Final GDP (FGDP), since it treats finance as an intermediate input to the rest of the (productive) economy, and deducts it as such (for a full discussion of this methodology and its implications for economic theory and policy, see my new on the Financialization of GDP).

Figure 4 shows GDP against FGDP and NFGDP (the GDP equivalent of Basu and Foley鈥檚 NFVA). Both alternative measures match employment better than GDP, with FGDP being the closest. FGDP also fits median income far better than per capita GDP, and even performs better than GDP in forecasting employment trends (see this ).

Figure 4: Three measures of US output (constant prices) and employment, 1977=100

What would FGDP imply for a developing economy like China? Given the small and relatively stagnant size of its financial sector (compared to the US, UK etc.), one would expect the distortion to GDP (and its concomitant correction in FGDP) to be smaller than that for the US. Figure 5 illustrates that this is indeed the case. While per capita FGDP and NFGDP are lower than GDP per capita (as they both exclude finance and FGDP further deducts it from GDP), the differences are not dramatic (China鈥檚 real per capita income in $PPP increased by over 500% by all measures). Furthermore, comparing the three measures across the two countries gives us a new insight into the extent of convergence between them.

Figure 5: Per Capita measures of output, PPP (constant 2011 international $)

As mentioned, China鈥檚 three measures are pretty close to each other given the relatively small share of FIRE in its economy. In the US, on the other hand, official GDP per capita (in 2011 $PPP) increased from $37,062 in 1990 to $49,782 in 2011, an increase of 34%. Just excluding FIRE, NFGDP per capita starts from a lower $27,224 in 1990 and rises less dramatically to $31,841 in 2011, a 17% increase. FGDP, by contrast, actually declines by 20%, from $17,387 in 1990 to $13,901. This implies, for the US, that while financial activity (and net revenues) exploded in the past two decades, the real US economy (net of financial fees) has stagnated and even contracted. More importantly for the present discussion, China has caught up far more than previously thought if we consider FIRE as a cost or economic input rather than impute to it an artificial 鈥榦utput鈥�. Per capita GDP would have us believe that in 2011 China鈥檚 income per head was only 21% of that in the US. NFGDP presents it as 28%, but FGDP, by 鈥榩utting out the FIRE鈥�, so to speak, shows Chinese per capita income to be a more realistic 56% of American GDP.

Measuring Development in Historical Context
Going back to Barro鈥檚 claim that Chinese GDP statistics are manipulated, this last chart seems to suggest that rich countries have gone even farther. Advanced countries (which influenced the revisions to the SNA in 1993 and 2008 through the EU, OCED, World Bank and IMF) have portrayed themselves as more productive and richer based on imputations of output to the FIRE sectors, which merely create and trade assets rather than goods and services. This amounts to kicking away the statistical ladder, by moving the goalpost for developing countries by defining growth differently now from when the US and others were industrializing (i.e. employment-intensive production in agriculture, manufacturing, utilities and non-financial services).

The national accounts treat the two income streams of the FIRE sectors inconsistently, since they deduct net interest income from GDP as an input to other industries but add financial fees income to GDP as 鈥榲alue added鈥�. There is no conceptual reason for this (it is simply easier to capture fees than it is interest differentials). If we correct this inconsistency by deducting both interest and fee incomes of the FIRE sector from GDP (as 鈥榠nstrumental expenditures鈥� in Nordhaus and Tobin鈥檚 term), we not only solve a conceptual problem and improve the performance of our measure of output vis-a-vis employment and median income trends, but we also judge developing countries鈥� progress by the same yardstick afforded to more advanced ones when they were at the same level of development.

Dr. Jacob Assa is Economic Affairs Officer at the United Nations. The views expressed herein are those of the author and do not necessarily reflect the view of the United Nations.

Data: and
Photo: 听William Murphy