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Poverty, Inequality, and

Development

Chapter 6

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Centesimus Annus

34. It would appear that, on the level of individual nations and ofinternational relations, the free marketis the most efficient instrumentfor utilizing resources and effectively responding to needs. But this istrue only for those needs which are "solvent", insofar as they are

endowed with

purchasing power, and for t

hose resources w

hic

hare"marketable", insofar as they are capable of obtaining a satisfactory

price. But there are many human needs which find no place on themarket. It is a strict duty of justice and truth not to allow fundamentalhuman needs to remain unsatisfied, and not to allow those burdenedby such needs to perish. It is also necessary to help these needypeople to acquire expertise, to enter the circle of exchange, and todevelop their skills in order to make the best use of their capacities

and resources. Even prior to the logic of a fair exchange of goodsand the forms of justice appropriate to it, there exists somethingwhich is due to man because he is man, by reason ofhis lofty dignity.Inseparable from that required "something" is the possibility tosurvive and, at the same time, to make an active contribution to thecommon good ofhumanity.

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Poverty across countriesCountry(in order of increasing GNP percapita)

% 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 19.5Costa Rica 6.9

Malaysia

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Inequality across countriesCountry(in order of increasingGNP per capita)

The Poorest 40% get % of income

Ratio of Highest 20% tolowest 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 27.1Costa Rica 12.8 12.9

Malaysia 12.9 11.7

Brazil 8.2 25.7

United States 16.1 8.5

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

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

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Poverty, Inequality, and GNP per

capita

Theres no simple relation betweenpoverty/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 c

hanges.

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

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The GrowthControversy:Seven Critical Questions

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

Who are the poor? Who benefits from economic growth?

Does rapid growth necessarilycause/require greater income inequality?

Do the poor benefit from growth? Are high levels of inequality always bad?

What policies can reduce poverty?

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The GrowthControversy:Seven Critical Questions

Inequality and poverty need to bedefined carefully if we want to Compare countries to each other; Assess progress in fighting them;

What kind of policies/incentives need tobe designed.

What kinds of growth improve welfare?

What are the main things to be done?

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Measuring Inequality andPoverty

Measuring Inequality

Size distributions

Lorenz curves and Gini coefficients

Functional distributions

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size distributions

How much income does householdX earn?

Sort people according to income and putthem 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.

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The Kuznets

ratio:

the ratio of

the share ofincome of the

highest 20%

divided by

the share ofincome of the

lowest 40%.

Household

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Lorenz curves

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

Calculate cumulative percentages (the lowest5%, the lowest 45%, etc.)

Plot the cumulative percentage ofhouseholdsagainst the cumulative percentage of theincome they earn.

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

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Hous hol s I come

Cummul ti e

ercent eof

Househol s

ercent eof

incomeearned

1 5 5% 5. %2 5 10% 10.0%

3 5 15% 15.0%

4 5 20% 20.0%

5 5 25% 25.0%

6 5 30% 30.0%

7 5 35% 35.0%

8 5 40% 40.0%9 5 45% 45.0%

10 5 50% 50.0%

11 5 55% 55.0%

12 5 60% 60.0%

13 5 65% 65.0%

14 5 70% 70.0%15 5 75% 75.0%

16 5 80% 80.0%

17 5 85% 85.0%

18 5 90% 90.0%

19 5 95% 95.0%

20 5 100% 100.0%

Cumulati ePercentageofincomeearned

Cumulati e Cummulati ePercentageofincomeearned

Cumulati e Cumulati ePercentageofincomeearned

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Percentage of income earned

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

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

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Households Income Percentage of Households

Cumulative CumulativePercentage ofincome earned

1 0.80 5% 0.8%2 1.00 10% 1.8%3 1.40 15% 3.2%4 1.80 20% 5.0%5 1.90 25% 6.9%6 2.00 30% 8.9%7 2.40 35% 11.3%

8 2.70 40% 14.0%9 2.80 45% 16.8%

10 3.00 50% 19.8%11 3.40 55% 23.2%12 3.80 60% 27.0%13 4.20 65% 31.2%

14 4.80 70% 36.0%15 5.90 75% 41.9%16 7.10 80% 49.0%17 10.50 85% 59.5%18 12.00 90% 71.5%19 13.50 95% 85.0%20 15.00 100% 100.0%

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0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

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

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Households Income

Cummulati e

Percentageof

Households

Percentageof

incomeearned

1 0.80 5% 0.0%

2 1.12 10% 0.1%

3 1.57 15% 0.2%

4 2.20 20% 0.3%

5 3.07 25% 0.5%

6 4.30 30% 0.8%

7 6.02 35% 1.1%

8 8.43 40% 1.6%9 11.81 45% 2.4%

10 16.53 50% 3.3%

11 23.14 55% 4.7%

12 32.40 60% 6.7%

13 45.36 65% 9.4%

14 63.50 70% 13.2%15 88.90 75% 18.5%

16 124.45 80% 25.9%

17 174.24 85% 36.4%

18 243.93 90% 51.0%

19 341.50 95% 71.4%

20 478.10 100% 100.0%

I=1.4^H

rescaled so

that H1s

income is

0.8

(Divide all

incomes

by H1s

income,

1.4, andmultiply

them all by

0.8)

Cumulati e Cumulati ePercentageofincomeearned

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0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

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

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0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

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

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0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

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

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The Greater the Curvature of theLorenz Line, the Greater the Relative

Degree of Inequality

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Four Possible Lorenz Curves

Which is the

least unequalcountry?

Which is the

most unequal?

Can we rankthem all?

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Measuring Inequality and Poverty


Gini coefficients (an aggregate measure

of inequality)

Its a quantitative measure ofhow far asociety 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 theperfect-equality curve.

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Estimating the Gini Coefficient

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

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Measuring Inequality and Poverty


Functional Distributions

What is the income that goes to eachkind of factor of production? That is,what is the labor share in income? Whatis the profit-rent-interest share in income?

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Functional Income Distribution in aMarket Economy: An Illustration

According to this theory, incomes

are determined by demand for theinput (and therefore by its

marginal productivity) and by its

supply.

Non-market influences (or marketimperfections) are ignored.

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Measuring Poverty

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Measuring Poverty

Poverty is

Lack of income;

Lack of drinking water

Lack of access to health care

Lack of protection against adverse

shocks

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Measuring Poverty

Measuring Absolute Poverty

The Absolute Poverty Headcount H

simply adds the number of people whoseincome is below an agreed upon povertyline.

The Headcount index H/Ndivides thisnumber by the population.

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

lead to a different number.

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Measuring the Poverty Gap

The poverty gap is different but H or

H/N would be the same.

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Measuring Poverty


Total poverty gap

where Yp is the absolute poverty lineYi is income of person i

TPG Y Y p iiH

! ! ( )1

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Measuring Poverty


The Normalized Poverty Gap is the Total

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

p

H

i ip

NY

YYNPG

!

!

1

)(

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Measuring Poverty

Measuring Absolute Poverty Foster-Greer-Thorbecke measure

Is a very general form of poverty measurethat satisfies anonymity (no person is worth more than another),

population independence (a larger populationdoesnt change it, ceteris paribus),

monotonicity (making a person richer wontdecrease the index) and

distributional sensitivity (taking income away from apoor person makes the poverty index worse).

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Measuring Poverty


Foster-Greer-Thorbecke measure

IfE=2, you get a measure that is extremelysensitive to the depth and severity of poverty.

!

!

H

i p

ip

Y

YY

NP

1

1

E

E

? A2222 )()1()/( pCVNPGNPGNHP !Coefficient of variation of incomes of the poor

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Measuring Poverty

Measuring Absolute Poverty The Human Poverty Index (UNDP)

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

Deprivation of education (percentage ofilliterate people)

Deprivation of economic provisioning(percentage without access to health careand safe water plus percentage ofunderweight under-5 children)

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Measuring 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 fewerpeople below $1 a day, the proportion of

people living under $2 a day hasnt fallenmuch.

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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 $10a day in Zambia?

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

fewer.

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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 productiveopportunities.

Since the middle-class has the highestaverage and marginal saving rates, incomeinequality leads to lower saving andinvestment.

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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.

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St. Augustine on the Preferential Optionfor

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).

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CIC: 2444 "The Church's love for the poor . . .

is a part ofherconstant tradition." This loveis inspired by the Gospelofthe Beatitudes, of

the poverty ofJesus, andofhis concernfor

the poor. Love for the pooris evenone ofthe

motives for the duty ofworking so as to "be

able togive to those inneed. It extends not

only to material poverty but also to the many

forms ofcultural and religious poverty.

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Welfare Dualistic development and shifting

Lorenz curves: some stylized

typologies modern sector enlargement

modern sector enrichment

traditional sector enrichment

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Improved Income Distributionunder the Traditional-SectorEnrichment Growth Typology

Sri Lanka,

Kerala (India).

Low growth

by great

struggle

against

poverty.

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Crossing Lorenz Curves in

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Crossing Lorenz Curves inthe Modern-Sector

Enlargement GrowthTypology

OECD, EastAsia

The poor get richeras they become

modern-sector

workers, increasing

the share of the

middle class.Those who are left in

the traditional sector

get a smallershare

of income.

With carefulmath, one can

show that the

Gini coefficient

will first

worsen andthen improve.

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Welfare So is inequality bad?

Kuznetss inverted-U hypothesis

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

The reasons may be complicated

and the validity of the hypothesis is anempirical question.

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The Inverted-U KuznetsC

urve

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Kuznets Curve with Latin

AmericanC

ountries Identified

Circles represent

LatinAmerica:

without themtheres no inverted-

U pattern.

The evolution of

inequality over

time is most oftendue to

sociopolitical

factors.

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Plot of Inequality data for

selected countries

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Welfare Growth and inequality

Highoverallgrowth may or may not be

accompanied by improved income for thepoorest 40%.

Low growth may or many not lead to low growth of theincomes 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.

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Long-Term Economic Growth and

Income Inequality, 19

65-199

6

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Absolute Poverty: Extent and

Magnitude

Poverty: some progress (1987-1998)

The s

hare of people living under $1 a dayfell in most regions of the world; remained

the same in some; and only rose in theex-communist countries.

This is in spite of population growing from5 billion to 6 billion, with pop. growthconcentrated in poor countries.

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Where Poverty Has Fallen,

and Wh

ere It Has Not

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Poverty in the Developing World IsShifting toward South Asia and Sub-

Saharan Africa

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Magnitude Growth and poverty

Growth is bad for the poor. They are

marginalized from modernization, so inequalityrises and even absolute poverty may rise as jobsdisappear.

Poverty/Inequality-reduction programs are bad forgrowth. Redistribution curtails incentive for saving

and work. The poor save a surprisingly large proportion of

their income. And extra income for the poor isinvestedinto better nutrition, education, health.

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Magnitude

Growth and poverty

Growth comes from taking advantage of profitable

opportunities. If the poor cant invest becausethey dont have access to credit, fewer profitableopportunities will be taken. Thenpoverty/inequality-reduction is good for growth.

Unlike the elites of the Industrial Revolution,todays Third-World elites are not high savers anddo not devote large resources to improving theproductivity of their business concerns.

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Magnitude

Growth and poverty

Poverty and destitution lead tounproductive workers.

Higher incomes for the poor create astrong domestic market.

Poverty/Inequality reduction generatessupport for development policies andprograms.

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Is Growth Good for the Poor?

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No, if its

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 futuregenerations?

Human Development Report, UNDP

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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 wort

hthe benefits?

Specialization in the countrys comparativeadvantage

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Growth and the Poor

Higher

average

incomelevels are

associated

with higher

income for

the poor.

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Growth and the Poor contd

Higher

average

incomegrowth is

associated

with higher

income

growth forthe poor.

Economic Characteristics of

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Economic Characteristics ofPoverty Groups

Rural Poverty

There are fewer income, health,

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

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Economic Characteristics of

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Economic Characteristics ofPoverty Groups

Women and poverty Poorhouseholds are usually female-headed.

But females have less access to education,

credit, jobs, etc., and often live in more deprivedareas.

Within families, females often get fewerresources.

Often, nutrition-improvement programs workbetter if targeted at women.

Ethnic minorities, indigenouspopulations, and poverty

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Policy Options

The Range of Policy Options:

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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 assetand skillinequality: the sources ofincome inequality. Land reform; microcredit; basic education

Make taxes more progressive.

Poverty reduction programs: direct transfers orsubsidies for food, education, health, etc.


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Policy options

Changing relative factor prices

Traditional-sector workers have very lowincomes and minimum-wage laws are seldomenforced.

Artificially high modern-sector wages (due to

unions or laws) reduce the growth of themodern sector, condemning more people topoverty and exclusion.

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Policy options

Transfer payments and public provision

of goods and services Make sure its targeted to the poor.

Prevent the poor from becoming dependenton it but encourage appropriate risk taking.

Discourage switching from work to program. Avoid resentment by nearly-poor-but-not-

enough who are working.


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Policy options workfare is better than welfare if it

Does not undermine incentives for acquiringhuman capital needed for private sector jobs

Increases net benefits includingexternalities

Is difficult to identify the needy without work

requirement There are relatively few poor people

There less social stigma / political resentmentfrom workfare

Poverty Declines as National

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Poverty Declines as NationalIncome Rises


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g y pSome Basic Considerations

The need for a package of policies

Eliminate price distortions: more

efficiency, more employment and lesspoverty

Structural change in asset ownership

Progressive taxes and transfers; safetynet

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Global Inequality

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Global Inequality

Measures

Unweighed

Lesotho and China get the same weight Population-weighed

More populous nations get more weight, butpeople are assumed to have identical

incomes. Global Household surveys.

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Global Inequality

Measures Unweighed

Global inequalityhas 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.

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ECO 320 ch06 (1)

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