Poverty, Inequality, and Development

Poverty, Inequality, and Development

• Outline:

–Measurement of Poverty and Inequality

– Economic characteristics of poverty groups

–Why is inequality a problem?

– Relationship between growth and inequality

–Relationship between growth and poverty

Poverty, Inequality, and Development

• Introduction and Importance

–Absolute poverty and indicators

– Economic characteristics of the poor

–Policy options for addressing poverty

Measuring Inequality and Poverty

• Measuring Inequality:

–Personal or size distribution of income deals with the individual persons or households and the total income they receive

– Functional or factor share distribution of income uses the share of total national income that each of the factors of production receives

Measuring Inequality

• Personal or size distribution of income

–Quintiles and Deciles

– Lorenz Curve

–Gini Coefficients

–Coefficient of Variation (CV)

Measuring Inequality

• Quintiles and Deciles

–Divide the population into successive quintiles or deciles according to ascending income levels and then determine the proportion of N.I received by each income group

–Common measure of income inequality is the ratio of incomes received by the top 20% and bottom 40% of the population

Calculating Income Quintiles

Individual Income

A 5000

B 10000

C 18000

D 15000

E 500

F 200

G 3000

H 1000

I 800

J 20000

Steps involved in calculating quintiles

• Step1: Sort the values from the lowest to the highest

• Step2: Calculate the total values for all cases

• Step3: Sum up all the incomes

• Step4: Calculate total amount in each quintile

• Calculate each quintile as percentage of total amount in step3

Calculating Income Quintiles

Income Step1 Step2 Step3 Step4 Step5 Quintile

5000 200 200 73500 700 1% 1st

10000 500 500 18000 800 800 1800 2% 2nd

15000 1000 1000 500 3000 3000 8000 11% 3rd

200 5000 5000 3000 10000 10000 25000 34% 4th

1000 15000 15000 800 18000 18000 38000 52% 5th

20000 20000 20000

Exercise: Calculate the Quintile

Individual Income

A 1000

B 100

C 200

D 200

E 400

F 900

G 1200

H 700

I 500

J 200

Answer

Income Share of Quintile in income Quintiles

300 6% 1st

400 7% 2nd

900 17% 3rd

1600 30% 4th

2200 41% 5th

Measuring Inequality

• Lorenz curves

– Show the actual quantitative relationship between the percentage of income recipients and the percentage of total income they received during a time period (year)

–Depict the variance of the size distribution of income from perfect equality

Measuring Inequality

• Gini coefficient

– Is measured graphically by dividing the area between the perfect equality line and the Lorenz curve by the total area lying to the right of the equality line in a Lorenz curve diagram

–Ranges in value from 0 (perfect equality) to 1 (perfect inequality)

– Satisfies the properties of anonymity, scale independence, population independence, and transfer principles

Figure 6.3 Estimating the Gini Coefficient

Measuring Inequality

• Coefficient of Variation (CV)

– Is sample SD divided by the sample mean also satisfies the properties of anonymity, scale independence, population independence, and transfer principles

• Functional distribution

• Second common measure of income distribution

• Attempts to explain the share of total national income that each factor of production receives

Measuring Inequality

• Supply and demand curves are assumed to determine the unit prices of each productive factor.

• Unit prices multiplied by the quantities employed by each factor yields total payment to each factor

• All inequality measures are measuring relative income distribution

Measuring Absolute Poverty

• A situation where a population or sections of the population are able to maintain minimum levels of living (IPL)

• Absolute poverty is measured using

–Headcount (H)

–Headcount Index (H/N)

–Poverty Gap (total income shortfall)

Measuring Absolute Poverty

• Headcount

• Number of people whose incomes fall below the absolute poverty line

• The poverty line is set at a level that remains constant in real terms

• To do this, define an adequate basket of food, based on nutritional requirements, and cost it

• Add other expenditures such as shelter, clothing and medical care to determine the poverty line

Measuring Absolute Poverty

Measuring Absolute Poverty

– Average poverty gap

where H is number of persons

TPG is total poverty gap

APGTPG

H

Measuring Absolute Poverty

• The Human Poverty Index (HPI) is used by the UNDP and measures poverty as three key deprivations- survival, knowledge, and economic provisions

• Survival: fraction of people unlikely to live beyond 40 years of age

• Knowledge: % of illiterate adults

• Economic: % of people without safe drinking water plus % of children who are underweight

Characteristics of Poverty Groups

• Rural poverty

• Women and poverty

• Ethnic minorities and poverty

Why is inequality bad?

• Extreme inequality leads to economic inefficiency and curtails growth

• Extreme inequality undermines social stability and solidarity

• Extreme inequality is viewed as unfair

Figure 6.10 The “Inverted-U” Kuznets Curve

Kuznets’ Inverted- U Hypothesis

• In the early stages of growth, distribution of income will tend to worsen, where as in later stages it will improve

• Reasons for the inverted- U curve not given

• Evidence indicates that the inverted U- hypothesis does not hold Taiwan, S. Korea, Costa Rica, etc)

Relation between economic growth and inequality

• Does growth affect the level of inequality? – No consensus

• Does initial inequality affect growth? – Negative relation between growth and initial

inequality in income (refer to Why is inequality bad?)

– Positive relation between growth and initial inequality (only Forbes found this relation)

– Initial inequality in assets and human capital negatively affects growth (as it hurts the poor the most)

• The main flow of causation appears to be initial inequality hampering growth and not the other way round.

Relation between economic growth and poverty

• Traditionally, it was considered that there is trade-off between growth and poverty.

• Why are similar rates of growth associated with different rates of poverty reduction?

– Redistribution of growth benefits reduces poverty

– Initial inequality in income enhances poverty

– Sectoral composition of growth (agriculture versus modern, rural versus urban)

• Efforts to reduce poverty lead to higher growth and higher growth leads to reduction in poverty.

Policy Options- • Altering the functional distribution of income

through policies designed to change relative factor prices

– Removal of factor price distortions

• Modifying the size distribution through progressive redistribution of asset ownership

– Redistribution policies such as land reform

• Reducing the size distribution at the upper levels through progressive income and wealth taxes

– Direct progressive income taxes

– Indirect taxes

• Direct transfer payments and the public provision of goods and services

– Workfare programs superior to welfare and handouts.