Lecture Development economics - Lecture 29: Poverty, inequality, and development

This chapter presents the following content: Inequality across countries; poverty, Inequality, and GNP per capita; the growth controversy: seven critical questions; the growth controversy: seven critical questions; measuring inequality and poverty; the greater the curvature of the lorenz line, the greater the relative degree of inequality;...

Poverty, Inequality, and

Development

Lecture 29

Poverty across countries

Inequality across countries

Country

(in order of increasing

GNP per capita)

The Poorest 40% get …

% of income Ratio of Highest 20% to lowest 20%

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

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

Household

Measuring Inequality and

• 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

Households Income

Cummulative Percentage of Households

Percentage of income earned

Cumulative Cummulative

Percentage of income earned

Cumulative Cumulative

Percentage of income earned

Percentage of income earned

Households Income Percentage of

Households

Cumulative Cumulative

Percentage of income earned

Percentage of income earned

Households Income

Cummulative Percentage of Households

Percentage of income earned

Percentage of income earned

The Lorenz Curve

The Greater the Curvature of the

Lorenz Line, the Greater the Relative Degree of Inequality

Four Possible Lorenz Curves

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 equality curve

perfect-Estimating the Gini Coefficient

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

Non­market 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

TPG i H1( Yp Yi )

Measuring Poverty

• Measuring Absolute Poverty

– Average poverty gap

poverty line

TPG is total poverty gap

APG TPG

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

– 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).

1

1

2 2

2

P

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

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

Worsened Income Distribution under the Modern-Sector

Enrichment Growth Typology

Crossing Lorenz Curves in the Modern-Sector

Enlargement Growth Typology

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.

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.

Comparison of Gross National Product Growth Rates and Income Growth Rates of the Bottom 40% of the Population in Selected Less

Developed Countries

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 intensive?

labor-– Ruthless

• Does inequality worsen?

– Voiceless

• Does democracy expand?

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

• 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, indigenous

populations, 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

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

• 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