Classifications of economies by development level

Economies vary in their stage of progress, which can be assessed through factors like income levels, market maturity, living standards, and productivity.

Traditional categories of economies

• Developed economies - These feature high income per person, well-established financial systems, advanced technology, and a dominant service sector.
• Developing economies - These typically have lower income per person, dependence on a limited range of goods, a significant focus on agriculture and raw materials, and reduced productivity.

Some experts avoid the terms 'developed' and 'developing' because all economies are evolving. Instead, they focus on current progress or income metrics to group countries.

Alternative ways to compare economies

Economies can be compared using measures such as gross domestic product (GDP) per capita, gross national income (GNI) per capita, or net national income (NNI) per capita.

Income-based classification using GNI per capita

The World Bank uses GNI per capita to group economies into categories, helping to analyse global patterns and allocate resources.

World Bank categories by GNI per head

The World Bank divides economies into four groups based on GNI per capita. Thresholds are adjusted each year to reflect global inflation, maintaining their real value.

Movements between categories

Countries can shift groups over time due to economic changes. For instance, a country might advance from lower middle-income to upper middle-income, while a nation could drop from high-income to upper middle-income.

Benefits and limitations of income-based classifications

Classifying economies by income offers a simple way to compare nations, but it has both advantages and drawbacks that affect its usefulness.

Benefits of income-based classifications

• Ease of use - The method is simple to apply, relying on readily available income data.
• Identifying support needs - It highlights economies that may require financial aid or development assistance.
• Guiding financial decisions - The World Bank uses these categories to set interest rates on loans, with higher rates applied to countries in the high-income group for two years in a row.

Limitations of income-based classifications

• Ignores economic trends - It does not show whether an economy is expanding or shrinking.
• Misses broader factors - Income alone overlooks other aspects of development.

Poverty cycles in low-income economies

Low-income economies often face ongoing challenges that trap them in poverty, creating self-reinforcing loops that hinder progress.

Key poverty cycles

• Cycle involving savings and productivity:

  • Low incomes lead to limited savings.
  • This results in reduced investment.
  • Low investment causes low productivity.
  • Consequently, incomes remain low, continuing the cycle.

• Cycle involving growth and human capital:

  • Low incomes restrict economic growth.
  • This leads to inadequate education and healthcare.
  • Poor education and health reduce human capital.
  • As a result, incomes stay low, perpetuating the cycle.