Poverty, Inequality, and Development

Chapter 6

Voices of the Poor

http://go.worldbank.org/H1N8746X10

Centesimus Annus

34. It would appear that, on the level of individual nations and of international relations, the free market is the most efficient instrument for utilizing resources and effectively responding to needs. But this is true only for those needs which are "solvent", insofar as they are endowed with purchasing power, and for those resources which are "marketable", insofar as they are capable of obtaining a satisfactory price. But there are many human needs which find no place on the market. It is a strict duty of justice and truth not to allow fundamental human needs to remain unsatisfied, and not to allow those burdened by such needs to perish. It is also necessary to help these needy people to acquire expertise, to enter the circle of exchange, and to develop their skills in order to make the best use of their capacities and resources. Even prior to the logic of a fair exchange of goods and the forms of justice appropriate to it, there exists something which is due to man because he is man, by reason of his lofty dignity. Inseparable from that required "something" is the possibility to survive and, at the same time, to make an active contribution to the common good of humanity.

Poverty across countriesCountry(in order of increasing GNP per capita)

% of Population below $1 a day

Bangladesh 29.1

Kenya 26.5

Sri Lanka 6.6

Indonesia 7.7

Philippines 14.6

Jamaica 3.2

Paraguay 19.5

Costa Rica 6.9

Malaysia <2

Brazil 9.0

Inequality across countriesCountry(in order of increasing GNP per capita)

The Poorest 40% get … % of income

Ratio of Highest 20% to lowest 20%

Bangladesh 22.9 4.0

Kenya 10.1 18.3

Sri Lanka 22.0 4.4

Indonesia 20.4 5.1

Philippines 15.5 8.4

Jamaica 16.0 8.2

Paraguay 8.2 27.1

Costa Rica 12.8 12.9

Malaysia 12.9 11.7

Brazil 8.2 25.7

United States 16.1 8.5

But careful ! In these surveys, both the very poor and the very rich and underrepresented.

But careful ! In these surveys, both the very poor and the very rich and underrepresented.

But careful ! In these surveys, both the very poor and the very rich and underrepresented.

Poverty, Inequality, and GNP per capita

There’s no simple relation between poverty/inequality and per capita income. Inequality (high or low) seems to be very

persistent; but it typically changes (up or down) when output per capita changes.

There might be a complicated relation, involving the interaction of many factors.

Poverty, Inequality, and GNP per capita

Inequality is probably determined by history social cleavages, politics and government policies

Careful statistical/econometric analysis is necessary to identify the effect of each factor.

The Growth Controversy: Seven Critical Questions

What is the extent of relative inequality, and how is this related to the extent of poverty?

Who are the poor? Who benefits from economic growth? Does rapid growth necessarily cause/require

greater income inequality? Do the poor benefit from growth? Are high levels of inequality always bad? What policies can reduce poverty?

The Growth Controversy: Seven Critical Questions

Inequality and poverty need to be defined carefully if we want to Compare countries to each other; Assess progress in fighting them; What kind of policies/incentives need to

be designed. What kinds of growth improve welfare? What are the main things to be done?

Measuring Inequality and Poverty

Measuring Inequality Size distributions Lorenz curves and Gini coefficients Functional distributions

Measuring Inequality and Poverty

Measuring Inequality size distributions

How much income does household X earn? Sort people according to income and put

them in major groups. Ignore differences in the source of income (or

capabilities, for example) A quartile is a fourth (25%) of the population;

a decile is a tenth; a quintile is a fifth.

The Kuznets ratio:

the ratio of the share of income of the highest 20% divided by the share of income of the lowest 40%.

Household

Measuring Inequality and Poverty

Measuring Inequality Lorenz curves

Arrange population according to the share of income they receive, from lowest to highest.

Calculate cumulative percentages (the lowest 5%, the lowest 45%, etc.)

Plot the cumulative percentage of households against the cumulative percentage of the income they earn.

http://mysite.avemaria.edu/gmartinez/Courses/ECON320/xls/Lorenz_Curve.xls

The Lorenz Curve

The Greater the Curvature of the Lorenz Line, the Greater the Relative Degree of Inequality

Four Possible Lorenz Curves

Which is the least unequal country?

Which is the most unequal?

Can we rank them all?

Measuring Inequality and Poverty

Measuring Inequality Gini coefficients (an aggregate measure

of inequality) It’s a quantitative measure of how far a

society is from being perfectly equal. Calculate the area between the perfect-

equality curve and the actual curve. Divide that area by the total area under the

perfect-equality curve.

Estimating the Gini Coefficient

http://mysite.avemaria.edu/gmartinez/Courses/ECON320/pdf/CalculationGini.pdf

The Gini Coefficient

The Gini coefficient is interesting because It’s anonymous: it doesn’t treat some people as

better than others, it just reports their income. It’s scale-independent: measuring income in

dollars or in rupees doesn’t change it. It’s population-independent: changing the amount

of people but keeping income distribution constant doesn’t change it.

It follows the transfer principle: transferring income from a richer to a poorer person (without changing their order) improves it. The coefficient of variation (stdev/mean) also follows

these principles.

Measuring Inequality and Poverty

Measuring Inequality Functional Distributions What is the income that goes to each

kind of factor of production? That is, what is the labor share in income? What is the profit-rent-interest share in income?

Functional Income Distribution in a Market Economy: An Illustration

According to this theory, incomes are determined by demand for the input (and therefore by it’s marginal productivity) and by its supply.

Non-market influences (or market imperfections) are ignored.

Measuring Poverty

Measuring Poverty

Poverty is Lack of income; Lack of drinking water Lack of access to health care Lack of protection against adverse

shocks

Measuring Poverty

Measuring Absolute Poverty The Absolute Poverty Headcount H simply

adds the number of people whose income is below an agreed upon poverty line.

The Headcount index H/N divides this number by the population.

The international poverty line is $1 a day, but adjustment to local conditions can lead to a different number.

Measuring the Poverty Gap

The “poverty gap” is different but H or H/N would be the same.

Measuring Poverty

Measuring Absolute Poverty Total poverty gap

where Yp is the absolute poverty line

Yi is income of person i

TPG Y Yp ii

H

( )1

Measuring Poverty

Measuring Absolute Poverty Average poverty gap

where H is number of persons under

poverty line

TPG is total poverty gap

APGTPG

H

Measuring Poverty

Measuring Absolute Poverty The Normalized Poverty Gap is the Total

Poverty Gap divided by the product of the poverty line and the population

p

H

i ip

NY

YYNPG

1)(

Measuring Poverty

Measuring Absolute Poverty Foster-Greer-Thorbecke measure

Is a very general form of poverty measure that satisfies anonymity (no person is worth more than another), population independence (a larger population

doesn’t change it, ceteris paribus), monotonicity (making a person richer won’t

decrease the index) and distributional sensitivity (taking income away from a

poor person makes the poverty index worse).

Measuring Poverty

Measuring Absolute Poverty Foster-Greer-Thorbecke measure

If =2, you get a measure that is extremely sensitive to the depth and severity of poverty.

H

i p

ip

Y

YY

NP

1

1

2222 )()1()/( pCVNPGNPGNHP

Coefficient of variation of incomes of the poor

Measuring Poverty

Measuring Absolute Poverty The Human Poverty Index (UNDP)

Deprivation of life (percentage whose life expectancy is below 40%)

Deprivation of education (percentage of illiterate people)

Deprivation of economic provisioning (percentage without access to health care and safe water plus percentage of underweight under-5 children)

Measuring Poverty

Measuring Absolute Poverty Is “$1 a day” too low? Is “$2 a day” too low?

Lots of people live between “$1 a day” and “$2 a day”, and although there are fewer people below “$1 a day”, the proportion of people living under “$2 a day” hasn’t fallen much.

Measuring Poverty

Measuring Absolute Poverty How about “$15 a day” as the standard to

say that someone is poor? If “$15 a day” makes your poor in the US,

why should you be non-poor if you make “$10 a day” in Zambia?

How about using income rather than consumption, and national accounts rather than surveys? The number of poor people seem to be much

fewer.

Poverty, Inequality, and Social Welfare

What’s so bad about inequality? Extreme income inequality leads to

inefficiency. Lack of access to credit leads to

underfinancing of good productive opportunities.

Since the middle-class has the highest average and marginal saving rates, income inequality leads to lower saving and investment.

Poverty, Inequality, and Social Welfare

What’s so bad about inequality? Extreme income inequality leads to

inefficient allocation of assets. Overemphasis on higher education to the

detriment of basic education. Inefficiently large farms next to inefficiently

small farms.

Poverty, Inequality, and Social Welfare

What’s so bad about inequality? Extreme income inequality leads to

political and social instability The poor try revolution while the rich try

corruption and rent-seeking to retain power. Most people think it’s unfair.

Rawls’s “veil of ignorance.” A sense of unfairness lowers welfare.

Poverty, Inequality, and Social Welfare

What’s so bad about inequality? St. Augustine on the Preferential Option for

the Poor God does not demand much of you. He asks

back what he gave you, and from him you take what is enough for you. The superfluities of the rich are the necessities of the poor. When you possess superfluities, you possess what belongs to others. (Exposition on Psalm 147, 12).

Poverty, Inequality, and Social Welfare

What’s so bad about inequality? CIC: 2444 "The Church's love for the poor . . .

is a part of her constant tradition." This love is inspired by the Gospel of the Beatitudes, of the poverty of Jesus, and of his concern for the poor. Love for the poor is even one of the motives for the duty of working so as to "be able to give to those in need.” It extends not only to material poverty but also to the many forms of cultural and religious poverty.

Poverty, Inequality, and Social Welfare

Dualistic development and shifting Lorenz curves: some stylized typologies modern sector enlargement modern sector enrichment traditional sector enrichment

Improved Income Distribution under the Traditional-Sector Enrichment Growth Typology

Sri Lanka, Kerala (India).

Low growth by great struggle against poverty.

Worsened Income Distribution under the Modern-Sector Enrichment Growth Typology

Latin America, Africa

Growth only in modern sector: unchanged proportion of traditional sector workers.

Crossing Lorenz Curves in the Modern-Sector Enlargement Growth Typology

OECD, East Asia

The poor get richer as they become modern-sector workers, increasing the share of the middle class.

Those who are left in the traditional sector get a smaller share of income.

With careful math, one can show that the Gini coefficient will first worsen and then improve.

Poverty, Inequality, and Social Welfare

So is inequality bad? Kuznets’s inverted-U hypothesis

Historically, he found that inequality falls and then rises as countries develop.

The reasons may be complicated… …and the validity of the hypothesis is an

empirical question.

The “Inverted-U” Kuznets Curve

Kuznets Curve with Latin American Countries Identified

Circles represent Latin America: without them there’s no inverted-U pattern.

The evolution of inequality over time is most often due to sociopolitical factors.

Poverty, Inequality, and Social Welfare

Growth and inequality High overall growth may or may not be

accompanied by improved income for the poorest 40%. Low growth may or many not lead to low growth of the

incomes of the poor.

The poor almost always share in (some of) the benefits of growth.

But whether growth leads to less inequality depends on who does the growing.

Absolute Poverty: Extent and Magnitude

Poverty: some progress (1987-1998) The share of people living under $1 a day

fell in most regions of the world; remained the same in some; and only rose in the ex-communist countries.

This is in spite of population growing from 5 billion to 6 billion, with pop. growth concentrated in poor countries.

Where Poverty Has Fallen, and Where It Has Not

Poverty in the Developing World Is Shifting toward South Asia and Sub-Saharan Africa

Absolute Poverty: Extent and Magnitude

Growth and poverty “Growth is bad for the poor. They are

marginalized from modernization, so inequality rises and even absolute poverty may rise as jobs disappear.”

“Poverty/Inequality-reduction programs are bad for growth. Redistribution curtails incentive for saving and work.”

“The poor save a surprisingly large proportion of their income. And extra income for the poor is invested into better nutrition, education, health.”

Absolute Poverty: Extent and Magnitude

Growth and poverty Growth comes from taking advantage of profitable

opportunities. If the poor can’t invest because they don’t have access to credit, fewer profitable opportunities will be taken. Then poverty/inequality-reduction is good for growth.

Unlike the elites of the Industrial Revolution, today’s Third-World elites are not high savers and do not devote large resources to improving the productivity of their business concerns.

Absolute Poverty: Extent and Magnitude

Growth and poverty Poverty and destitution lead to

unproductive workers. Higher incomes for the poor create a

strong domestic market. Poverty/Inequality reduction generates

support for development policies and programs.

Is Growth Good for the Poor?

Is Growth Good for the Poor?

No, if it’s Jobless

Is growth labor-intensive?

Ruthless Does inequality

worsen?

Voiceless Does democracy

expand?

Rootless Are people able to retain

their cultural identity?

Futureless Does growth squander

resources for future generations?

Human Development Report, UNDP

Is Growth Good for the Poor?

Yes, if it is accompanied by Expanded opportunity

Are the losers compensated by the winners? Is competition open and fair? Are services (education, health, transportation,

communication) good and reliable?

Macroeconomic stability Are the costs of stabilization worth the benefits?

Specialization in the country’s comparative advantage

Growth and the Poor

Higher average income levels are associated with higher income for the poor.

Growth and the Poor cont’d

Higher average income growth is associated with higher income growth for the poor.

Economic Characteristics of Poverty Groups

Rural Poverty There are fewer income, health,

education, and insurance possibilities in rural areas than in urban areas.

Economic Characteristics of Poverty Groups

Women and poverty Poor households are usually female-headed.

But females have less access to education, credit, jobs, etc., and often live in more deprived areas.

Within families, females often get fewer resources.

Often, nutrition-improvement programs work better if targeted at women.

Ethnic minorities, indigenouspopulations, and poverty

Policy Options

The Range of Policy Options: Some Basic Considerations

Areas of intervention Change the functional distribution

Give more income to labor and less to capital.

Change asset and skill inequality: the sources of income inequality. Land reform; microcredit; basic education

Make taxes more progressive. Poverty reduction programs: direct transfers or

subsidies for food, education, health, etc.

The Range of Policy Options: Some Basic Considerations

Policy options Changing relative factor prices

Traditional-sector workers have very low incomes and minimum-wage laws are seldom enforced.

Artificially high modern-sector wages (due to unions or laws) reduce the growth of the modern sector, condemning more people to poverty and exclusion.

The Range of Policy Options: Some Basic Considerations

Policy options Changing relative factor prices

Market-determined wages (which would be lower) in the modern sector would increase employment and incomes for the poor.

Market-determined cost of capital (which would be higher) would encourage firms to hire workers rather than buy capital.

The Range of Policy Options: Some Basic Considerations

Policy options Transfer payments and public provision

of goods and services Make sure it’s targeted to the poor. Prevent the poor from becoming dependent

on it … but encourage appropriate risk taking. Discourage switching from work to program. Avoid resentment by nearly-poor-but-not-

enough who are working.

The Range of Policy Options: Some Basic Considerations

Policy options “workfare” is better than welfare if it

Does not undermine incentives for acquiring human capital needed for private sector jobs

Increases net benefits – including externalities Is difficult to identify the needy without work

requirement There are relatively few poor people There less social stigma / political resentment

from workfare

Poverty Declines as National Income Rises

The Range of Policy Options: Some Basic Considerations

The need for a ‘package’ of policies Eliminate price distortions: more

efficiency, more employment and less poverty

Structural change in asset ownership Progressive taxes and transfers; safety

net

Global Inequality

Global Inequality

Measures Unweighed

Lesotho and China get the same weight Population-weighed

More populous nations get more weight, but people are assumed to have identical incomes.

Global Household surveys.

Global Inequality

Measures Unweighed

Global inequality has been getting worse: dominated by lots of countries in Sub-Saharan Africa and Latin America.

Population-weighed Global inequality has been getting better:

dominated by China, India, and East Asia. Global Household surveys

Inequality seems worse because of US, China, and India.