m

 
 





m
m

CHOICE VS CONSTRAINTIncome
 Before we discuss problems of
defining poverty, we must illustrate
the difficulty in distinguishing
between someone who is poor BY
CHOICE and someone who is poor
BY CONSTRAINT.
 The diagram shows two people who
earn the same level of income ²
whatever definition is being used ²
and fall below what society regards
as the ¶poverty line·.
 However, one (on the red
indifference curve) is poor by choice Poverty
² by working more hours he could
go above the poverty line.
 The other one works far more (22
hours a day) yet will always be Hrs of
below the poverty line.
Leisure
 Thus, because preferences differ,
`     2 22 24



  
 
 
INCOME
 Because Income is central to all definitions and measurement
of Poverty and Inequality, one must first define it.
 The most logical and complete definition of income is:
  !"##
"#" " $
%&#
"#
" " $' # %
 However, there are distinct problems in measurement.
 u&` !& " 
 £ue to not being able to observe non-money income, we are restricted
to money income; HOWEVER, there is no systematic link between the
two component parts which means that money income is not
necessarily a good proxy for full income.
  " 
 £o we observe income per person or per household? The former would
leave a family as mostly destitute (if it relied on one bread winner),
the latter would not ² nor would it pick up on inter-family inequality.
 " 
&
 Income may not be a steady flow; although in the long run one may
earn a lot, he may earn nothing (a student) at points in time. Thus the
time period under consideration has to vary with purpose.
POVERTY
 Problems of £efinition:
 u&
#` #
! 
 Because we cannot calculate Full Income (and therefore we cannot calculate the
budget constraint in the diagram), three other measures are used:
 Money Income, Consumption, Expenditure
 All measures are problematic (we have already discussed Money Income), but they
also share a devastating flaw;  &!#
 (
 m.
 They are all ex-post measures, and as such cannot discern between a person who is
poor by choice (and thus has the opportunity to be rich) and one who is poor by
constraint (and therefore needs help).
 u " 
 We have already discussed the problem of the income unit, but there is also a problem
of comparing income between families of different size.
 Arguments when considering poverty between families; one may gain utility from an
extra child which compensates for the lower income per capita ² suggesting no change
of full income and therefore no need for intervention.
 u  # 

 Either ABSOLUTE or RELATIVE.
 A relative version will vary with general trends in living standards, whilst an absolute
version will vary much less.
 What concept to use depends on the utility functions of the rich ² if the rich are
supremely concerned with their own income, an absolute measure would be more
appropriate ² vice versa if they are more concerned about the incomes of the poor.
 
 
 ! )m*!·.
POVERTY

  "# !
" :
 UK Empirical £efinitions of the Poverty Line
 The UK uses a relative concept of poverty ² the real value of benefits
has risen in line with pre-tax earnings (until the mid ² 80·s, at the
very least).
 It has a broad definition of an income unit ² will lump together those
living in the same household, irrespective of marital status.
 A single person is considered below the poverty line if he is below 20%
of average earnings, whilst it is 40% for a family of four - this implies
that the Government feels that the utility gained from having a child
offsets some of the loss in income per capita.
 Extent of poverty
 Need to consider three fronts: (
u ((
u
(
u

+.
 How Many   The Poverty headcount. Count the number of people
under £X a week. However, needs to be done via surveys ² counting
those on benefits gives an underestimate due to some not taking up
benefits even if they are entitled to.
 How Much   The Poverty gap improves on the headcount by
considering the extent by which people fall under the line. Can be
weighted to take into account people with greater shortfalls.
 How Long   £istinguishing between transient and persistent poverty
is an important endeavour, but is not the focus of any current
measures.
POVERTY
 m"
m&   

 Care therefore needs to be taken in interpreting results of poverty
studies.
 
   &!" !

 
 ,-./0
 New Labour were determined to reduce Poverty ² in particular Child
Poverty (aiming to "  1/1/).
 However, whilst 
&  &!&
 !
(according to
an IFS briefing note), the decline has been " & 
 

 1//2, under both the Ô
 
 and
 

 measures.
 The fall in poverty has therefore been very slight ² only by around 3%
under the latter measure.
 Important to note that &&& 
`
 
 
 #
 # " !

 It is unlikely that the child poverty target for 2010 will be met, and it
will take time to tell whether a new Government will be able to follow
the now legally binding commitment.
 Although there are problems with cross-country comparisons
(completeness of data, common currency/measures), the UK fares
relatively badly   The Nordic countries tend to perform the best.
POVERTY
 Poverty relief is conducted in the UK via Cash Transfers.
 There are numerous different benefits available, each
targeting a different demographic, however, there are 6
main benefits:
 " !
   For those under 60 who have an income
below a specified minimum. Usually conditional on registering
for work. Can be thought of ¶topping up· current income to
achieve a minimum level.
 
&  income support for those over 60; however,
has less weighting on the effect of personal wealth avoid
penalizing pensioners with savings.
 (!3  #  Helps with paying rent (if receiving
income support, pays full rent) and local taxes.
 u
*
&  Aimed at relieving poverty AN£
incentivising people to work. Not available for those under
income support.
 &*
&  Heavily linked to WTC, but is not
conditional on being in work, scales with children and income.
 &3  #  Universal Benefit for ALL families.
POVERTY
 The State intervenes for both efficiency and equity arguments:
 m## ² the previous benefits and credits tackle the problem of those
whose National Insurance leaves them still short of the poverty line and
those who don·t have NI benefits for some reason.
 Thus,
`  
  "#!and the
 
!
 "
 ` !  
& for these risks, as much
poverty is associated with children or high housing costs ² issues of moral
hazard.
 m4! ² broad agreement amongst all schools that the state should
enforce a minimum standard of income to avoid destituteness.
 Poverty reducing schemes should be assessed on:
    #3  #
 
 
 
 Targeting in particular is tricky as there are numerous approaches:
  5    Highly accurate, but creates disincentives to work to
stay within the bracket and creates an implicit tax on first earnings. Also,
can be stigmatizing.
 &

    ¶Back to Beveridge·; uses non-income
characteristics of poverty. However, these characteristics need to be highly
correlated with poverty, be easily identifiable and exogenous to the
individual.
  #5 
   Provide incentives; price subsidies for inferior goods
(limited), Conditional benefits; ¶workfare·, receive benefit only if doing
training.
POVERTY
  " # 
  #
 " !
:
   : Generally seen to be about right; no one starves, but there are concerns about fuel
payments.
 
  Take-up is incomplete due to inconvenience and stigma ² hence, there are gaps;
However, there are no leakages ² only those who should be on it get it.
  Spending has sharply risen, despite National Insurance, and administrative costs
have also risen (in 2003/4 £WP spent £5.8 billion)
 (!3  #
 Largely the same issues as Income support as if you receive I.S, you automatically become
eligible for Housing Benefit.
 The economic problem of housing is more to do with insufficient income, and so should
therefore be moved from price support to income support, as has happened.
 u
*
&6 &*
&:
    Again, generally seen to be about right, however there are incentive effects, especially
for secondary earners.
 
 : Mix of all three targeting types, by tying WTC to work, there is an incentive to
find work in order to qualify.
 MC of WTC very small due to ¶piggybacking· off Income Support.
 &3  #
 No major problems with the level, !
  " ` 
 
 Because Child Benefit is universal, it may be accused of being poorly targeted; however, since
parents tend to be relatively young, they are also relatively more destitute.
 Hence, Child Benefit is fairly well targeted, although there are exceptions.
 &&`  &u 
&    ² if paid to
the mother, it empowers her, allowing for inter family targeting.
 Admin is relatively cheap.
POVERTY Income
 Poverty/Unemployment Trap:
 " !
,//7
 #
`&
`; for every pound earnt over
the threshold, income support withdraws
by a £1, acting like an implicit tax.
 It is shown in stylized form to the side.
 The red line shows the budget constraint
under Income Support.
 If we assume a certain amount of initial
earnings is disregarded, then there will
only be an incentive to work up until
point a, as between ¶a· and ¶b·, income is b a
constant, but you achieve less leisure (fall
onto a lower utility level).

###!
 ` 


&
  : in the
1990·s, if your income rose from £50 - Poverty
£200 per week, average weekly spending
allowance rose only by £10. Hrs of
 (` 
 ## " &  Leisure
 #* &!
#u &  5
#* &#
 
 24
 Because they are fixed, they will not be
immediately withdrawn; thus the
negative effect they have on earnings
may be discounted.
 Thus, they may cushion the impact of I.S
withdrawal.
POVERTY
 m"
m&  
   #3  #
 As already noted, poverty has fallen, but only slightly. The lack of a definitive poverty
¶line· makes analysis difficult, but the benchmark appears to be about 60% of median
household income.
 However, "# 

 ² in any four year period between 1991 ²
2000, only 1/10 of those in poverty remained such for three of those years.
 It does not appear that the level of benefits is too low; the problems lie in the targeting
and incentive effects.
 
 
  !
 - £9 out of every £10 of potential benefit is being taken up in
1994/5, so there are few gaps.
   
#
# `² benefits based on means testing tend to go to the lower
income quintiles, and taper off abruptly.
 Indicator targeting ² in particular the use of the CTC 5 
 &!
 

 
   m## 
 WTC schemes in the UK and US are associated with a
  
#
   ; although there is no clear evidence of impact on the hours worked.
 The  &
 

  `
if it pushes the family income up to
point ¶a· on the diagram.
 There is a trade off between creating incentives for participation at the expense of
creating incentives for moving from full time to part time work.
 There is, in some cases, a spike in the number of hours worked which are the
minimum requirement to participate for that scheme.
POVERTY + INEQUALITY
 Before discussing inequality, the distinction between
poverty must be made.
 Poverty is concerned with the amount of individuals
in a society who fall behind a certain defined income.
 Inequality is (crudely) concerned with the dispersion
between incomes in a society ² the distance and
relative magnitudes of the very poorest to the richest.
 The distinction is important to make in order to
realise that   ""  
*  #  
;
 Cutting the top rate of taxes may foster economic growth
which will pull people out of poverty, but at the expense of
more inequality.
 Taxing the rich highly may reduce economic growth, which
may reduce inequality at the expense of poverty.
INEQUALITY

  "#& #
 Major problem is Inequality of WHAT?
 & m4!#!"   But we can·t measure this.
 Equality of use/outcome/expenditure? All these, as discussed in the equity essay, are
incomplete.
 )3 0" !
  & #
  m4!#

!
 Means that all people have the opportunity to earn the same income regardless of non-
relevant characteristics (social class, race, religion etc.).
 However, where to set the bar? What characteristics are down to ¶choice· and
what are ¶discriminatory·?
 In addition, Equality of Opportunity must apply to both money income and in-
kind transfers; for the latter, there must therefore be equality of access (which
raises further issues).

  "# !
" 
 Between Individuals:
 Because we are using a definition based on opportunity, money income is a poor proxy
because of variables such as AGE (lifecycle hypothesis), CHOICE and TIME   the
difference between transient and intra-generational inequality.
 Between Families:
 Much the same argument as for poverty; do families gain utility from children or not?
£epending on the weighting the scale gives, inequality between families can vary
drastically.
 However, main issue is AGGREGATE MEASURES.
INEQUALITY
 
  !

 
4! 8
 !$ 
"%
 One can use the 
 #" ) 0although it is sensitive to the absolute level
of income.
 Alternatively, use the  ## # 
) 0(which uses ¶V·), but it is neutral
to the level at which income transfers take place.
 These problems are ameliorated by using )(0   
 # 
"#
" .
 However, ALL suffer from 



 &!
#4!
 & #
"
 " and ONLY considering the distance from the mean.
  
9 !
 6+  ## 
 Shown on the next slide; it shows what percent of the population own what percent of
the income.
 The Gini Coefficient is the ratio of A / B.
 It has the advantage of being non-arbitrary in it·s procedure and "

" `m m

(m
m'! " 
 Problems with the Lorenz Curves/Gini arise when they CROSS, as shown. Then there
is no unambiguous answer on whether inequality has risen or fallen.
 The main criticism of These measures is that  ! &3

&  u #
!. ¶V· and ¶C· consider all
redistribution to be beneficial, regardless of the level it takes place at, ¶H· uses
implied weights in it·s formula and the Gini Coefficient uses weights by a
person·s rank order in a distribution ² the very poorest has a higher weight
than the very richest.
 To Continue, we need to make these Social Welfare Functions Explicit.
INEQUALITY
r
 

 r
 



 


 
 

r
 
 r
 

INEQUALITY
 u #
! !
" 
 Consider the second diagram (from the red curve to the blue one);
although at the lower end of the income scale income power has
increased, that story is reversed higher up.
 There is therefore no unambiguous answer as to whether society
prefers the blue distribution or red one; it depends on the weighting
society gives people at each income group.
 If the curves did not intersect and the blue was wholly inside the red,
it would be unambiguous that the blue puts society onto a higher
utility level.
   4! !

 (  ! #
  4!
:ï
 If dž = 0, society is indifferent to inequality, if it is infinity it is a Rawlsian
society that is concerned with the position of the least well off.
 Can be calculated by thinking of a ¶leaky bucket· ² how much can £100 be
reduced by due to admin costs etc. Before it·s redistribution from rich to
poor is no longer seen as desirable?
   !
  " !
# 4!
&& *#` #
#
"
&
 !
 The main criticism of the Atkinson measure is that it relies on the additive
nature of utility functions ² the welfare of society is the sum of all
individual·s utility.
INEQUALITY
 m"
m&  
 2007/8 income inequality was slightly higher than when Labour came to power
in 1997.
 However, the rise in income inequality was far less than what occurred under the
Conservative·s administration.
 In addition, the inequality was driven by different income growth at the EXTREMES
of the spectrum; across most of the population income growth was even ² IFS.
 Labour·s tax and benefit measures have reduced inequality relative to what would
have occurred if the conservative era infrastructure had simply been duly maintained.
 The UK performs badly in cross country comparisons, often appearing with a
relatively high level of inequality, using data from the Luxembourg Income
Study.
 Interestingly, post 1997, u  4!
   `
m 8

 , suggesting a fundamental and global driving force for this rise.
 A report by the LSE is broadly congruous with the conclusion of the IFS report;
 Finds that Inequality has risen under Labour, however  &
  
  ## &
 !$3
03! %, with no
increases (but some decreases) in the bottom half.
 Largely &!   *;  # "`  u
 Although the specific extent by which Labour has redistributed changes depending on
what index you use, broad agreement that there has been significant redistribution
from rich   poor.
 The next step is to focus on RE£UCING inequality rather than stabilising it.
 However, one has to be careful in interpreting the results, given the previously
listed criticisms of the various measures.