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 countries

Country (in order of increasing GNP per capita) Bangladesh Kenya Sri Lanka Indonesia Philippines Jamaica Paraguay Costa Rica Malaysia Brazil % of Population below $1 a day

29.1 26.5 6.6 7.7 14.6 3.2 19.5 6.9 <2 9.0

Inequality across countries

Country (in order of increasing GNP per capita) Bangladesh Kenya Sri Lanka Indonesia Philippines Jamaica Paraguay Costa Rica Malaysia Brazil United States The Poorest 40% get % of income 22.9 10.1 22.0 20.4 15.5 16.0 8.2 12.8 12.9 8.2 16.1 Ratio of Highest 20% to lowest 20% 4.0 18.3 4.4 5.1 8.4 8.2 27.1 12.9 11.7 25.7 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



Theres 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.

Household

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

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

Hous hol s 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

I come 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5

Cummul e Cumulati ti e Cumulati e of Cummulati e ercent e ercent e of Percentage of income earned Househol s income earned 5% 5. % 10% 10.0% 15% 15.0% 20% 20.0% 25% 25.0% 30% 30.0% 35% 35.0% 40% 40.0% 45% 45.0% 50% 50.0% 55% 55.0% 60% 60.0% 65% 65.0% 70% 70.0% 75% 75.0% 80% 80.0% 85% 85.0% 90% 90.0% 95% 95.0% 100% 100.0%

Percentage of income earned

100.0%

90.0%

80.0%

70.0%

60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0% 5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

95% 100%

Households 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Income 0.80 1.00 1.40 1.80 1.90 2.00 2.40 2.70 2.80 3.00 3.40 3.80 4.20 4.80 5.90 7.10 10.50 12.00 13.50 15.00

Cumulative Cumulative Percentage of Percentage of Households income earned 5% 0.8% 10% 1.8% 15% 3.2% 20% 5.0% 25% 6.9% 30% 8.9% 35% 11.3% 40% 14.0% 45% 16.8% 50% 19.8% 55% 23.2% 60% 27.0% 65% 31.2% 70% 36.0% 75% 41.9% 80% 49.0% 85% 59.5% 90% 71.5% 95% 85.0% 100% 100.0%

Percentage of income earned

100.0%

90.0%

80.0%

70.0%

60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%

Households 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Income 0.80 1.12 1.57 2.20 3.07 4.30 6.02 8.43 11.81 16.53 23.14 32.40 45.36 63.50 88.90 124.45 174.24 243.93 341.50 478.10

I=1.4^H rescaled so that H1s income is 0.8 (Divide all incomes by H1s income, 1.4, and multiply them all by 0.8)

Cummulati Cumulati e e Cumulati e Percentage of Percentage of Percentage of income earned Households income earned 5% 0.0% 10% 0.1% 15% 0.2% 20% 0.3% 25% 0.5% 30% 0.8% 35% 1.1% 40% 1.6% 45% 2.4% 50% 3.3% 55% 4.7% 60% 6.7% 65% 9.4% 70% 13.2% 75% 18.5% 80% 25.9% 85% 36.4% 90% 51.0% 95% 71.4% 100% 100.0%

Percentage of income earned

100.0%

90.0%

80.0%

70.0%

60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0% 5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

95% 100%

100.0%

90.0%

80.0%

70.0%

60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0% 5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

95% 100%

100.0%

90.0%

80.0%

70.0%

60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0% 5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

95% 100%

100.0%

90.0%

80.0%

70.0%

60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0% 5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

95% 100%

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) Its a quantitative measure of how far a society is from being perfectly equal.


Calculate the area between the perfectequality 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/C ourses/ECON 320/pdf/Calcu lationGini.pdf

The Gini Coefficient



The Gini coefficient is interesting because

  

Its anonymous: it doesnt treat some people as better than others, it just reports their income. Its scale-independent: measuring income in dollars or in rupees doesnt change it. Its population-independent: changing the amount of people but keeping income distribution constant doesnt 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 its 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

TPG ! i !1 (Yp  Yi )
H

where

Yp is the absolute poverty line Yi is income of person i

Measuring Poverty


Measuring Absolute Poverty



Average poverty gap

TPG APG ! H
where H is number of persons under poverty line TPG is total poverty gap

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

NPG !

H i !1

(Y p  Yi )

NY p

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 doesnt change it, ceteris paribus), monotonicity (making a person richer wont 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

1 PE ! N


Yp  Yi Y i !1 p
H

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

P2 ! ( H / N ) NPG  (1  NPG ) (CV p )

2 2

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 hasnt 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



Whats 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



Whats 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



Whats 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. Rawlss veil of ignorance.


Most people think its unfair.



A sense of unfairness lowers welfare.

Poverty, Inequality, and Social Welfare



Whats 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



Whats 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? Kuznetss 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 theres no invertedU pattern. The evolution of inequality over time is most often due to sociopolitical factors.

Plot of Inequality data for selected countries

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

Long-Term Economic Growth and Income Inequality, 1965-1996

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 SubSaharan 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 cant invest because they dont 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, todays 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 its


Jobless


Rootless


Is growth laborintensive?


Are people able to retain their cultural identity? Does growth squander resources for future generations?

Ruthless


Futureless


Does inequality worsen? Does democracy expand?

Voiceless


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? Are the costs of stabilization worth the benefits?

Macroeconomic stability


Specialization in the countrys comparative advantage

Growth and the Poor

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

Growth and the Poor contd

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

Population-weighed


Global Household surveys.

Global Inequality


Measures


Unweighed


Global inequality has been getting worse: dominated by lots of countries in SubSaharan Africa and Latin America. Global inequality has been getting better: dominated by China, India, and East Asia. Inequality seems worse because of US, China, and India.

Population-weighed


Global Household surveys