Classification of Economies (Cambridge (CIE) A Level Economics): Revision Note

Classification of economies in terms of their level of development

• Economic development is defined as a broad, multidimensional process involving improvements in living standards, health, education and political freedom

  • It goes beyond economic growth to include quality of life and human capability

  • Development is distinct from economic growth - a country can have rising GDP per capita while development indicators (inequality, health, education access) stagnate or worsen

• Economies are classified by their level of development into three broad groups

• The United Nations designates LDCs based on three criteria

  • Low GNI per capita

  • Human asset weakness (health and education)

  • Economic vulnerability (exposure to shocks)

Limitations of development classification

• There is no single agreed definition of development

  • Different organisations use different criteria, making cross-country comparisons inconsistent

• Classification is partly subjective

  • Qualitative indicators such as institutional strength and political freedom are difficult to measure precisely

• Countries within the same classification group can vary enormously

  • India and Nigeria are both lower-middle income but have very different development profiles

• Classification can change over time

  • Institutional inertia means some countries retain a classification that no longer reflects their current situation

Classification of economies in terms of their level of national income

• The World Bank classifies economies annually by GNI per capita using the Atlas method, which smooths exchange rate fluctuations using a three-year average exchange rate adjusted for inflation differentials

Classification by income

• There are four income groups

• GNI per capita is preferred over GDP per capita for international income comparisons because it includes net income from abroad

  • This is important for countries with large remittance flows or significant foreign-owned production

• PPP adjustments are used alongside Atlas method figures to correct for differences in price levels between countries

  • A dollar buys more in Ethiopia than in Germany, so unadjusted figures understate real living standards in low-income economies

• Countries can move between income groups as they develop

  • China moved from low income to upper-middle income between the 1980s and 2010s

  • South Korea progressed from lower-middle to high income over the same period

Limitations of income classification

• A single GNI per capita figure does not capture income distribution

  • Two countries with identical GNI per capita can have vastly different levels of inequality

• GNI figures do not account for non-marketed activity such as subsistence agriculture, which is significant in low-income economies and understates true living standards

• The Atlas method corrects for exchange rate volatility but does not correct for differences in purchasing power

  • PPP-adjusted figures give a more accurate picture of real living standards

• Classification thresholds are arbitrary

  • A country just above or just below a threshold may have very similar characteristics to one on the other side

Income classification vs development classification

• Income classification (World Bank) is based purely on GNI per capita - a single quantitative measure

• Development classification is broader - it incorporates health, education, political freedom, sustainability and inequality

• A country may be classified as upper-middle income but remain poorly developed if income gains are concentrated among a small elite - making the two classifications complementary rather than interchangeable