eco paper 12pages

Development Economics Inequality and poverty

Readings: Chapter 6 in Perkins et al.

University of Miami Professor: Salvador Ortigueira

Inequality: different variables ● Income inequality

– Hard to measure for subsistence farmers in poor countries

– Not what we directly care about

● Wealth inequality – Higher than income and consumption inequality

● Consumption inequality – Measured by household expenditures – Best indicator of welfare

Measuring inequality Frequency distribution (or histogram) → Figure 6.1 ● Contains all information... ● … but does not deliver an indicator (i.e. one

number) measuring inequality. ● Skewed to right, long right tail. ● Fact: Income and consumption are roughly log-

normally distributed in most countries.

Measuring inequality Size distribution of x (income, wealth etc.) → Table 6.1 ● Share of x that goes to poorest 20%, second-

poorest 20% etc. ● Full equality: each group gets 20% of x ● Usually: quintiles (20% groups), but also: deciles

(10%), percentiles (1%) ● Gives us better comparison of inequality than

frequency distribution... ● … but still no single index.

Lorenz curve ● Generalizes size distribution ● Arrange households by levels of x on horizontal

axis ● For given level X, plot cumulative share of x earned

by households with x≤X on vertical axis. ● Example: For income 1,000$, calculate which

fraction of total U.S. Income is accounted for by households earning 1,000$ or less.

Lorenz Curve (2) ● Perfect equality: 45-degree line ● Perfect inequality: traces horizontal axis up to 100,

then shoots up to 100. ● If country A's Lorenz curve is always above

country B's curve, country A is more equal. ● If Lorenz curves intersect: ambiguous → still no single indicator!

Indicators of inequality ● Ratio of

– income share of top 20% – to income share of bottom 20% (or 40%)

● Gini coefficient (most common): Ratio of – area between Lorenz curve and 45-degree line – to area under 45-degree line (→ perfect-equality Lorenz

curve)

● → Gini=0 for perfectly equal society, ● Gini=1 if one household has all income.

Gini coefficients in reality ● Range from 0.25 to 0.60 ● → see table 6-2 ● Large variation within continents/regions... ● … but some clear patterns:

– High inequality in South America and southern Africa – Low inequality in South Asia – Low inequality in transition economies – Low inequality in rich countries (except U.S.)

Growth and inequality ● First hypothesis: Kuznets curve (Simon Kuznets,

1950s) – Inequality first rises as country industrializes... – ...then decreases as the country gets richer.

● Mechanism proposed by Kuznets: – First: Income distributed equally in agricultural

economy. – As some individuals transition to industrial sector,

they earn more → more inequality. – When all have switched, equality is restored.

Lewis's labor-surplus model → Another theory that predicts a Kuznets curve ● Two-sector model: agriculture and industrial ● Phase 1: Modern sector draws on surplus labor

from agriculture ● → low wages, high profits for firm owners ● Phase 2: When surplus labor is absorbed, have to

pay higher wages to employ workers ● → Profits fall, inequality falls

Lewis's labor-surplus model (2) ● Need inequality to have growth: Entrepreneurs

invest only if lured by high profits in phase 1. ● Attempts to re-distribute (too early) may stifle

growth

● → Kuznets' and Lewis's ideas influential until 1980s

Other theories Could inequality also be a drag on growth? ● Credit constraints:

– Poor people have no collateral → no credit – Worthwhile investments not undertaken.

● Political economy: – Very rich have power to kidnap political process – Policies that cement position of rich but hurt growth:

protection of industries, tariffs

● But: also see the reverse, see Venezuela

Kuznets curve: data ● Cross-sectional studies until 1980s supported

Kuznets curve. ● → Crucial assumption: all countries follow same

development process. ● But: More recent time-series studies provide

evidence against Kuznets curve – In some countries inequality rises with growth, in

others it falls – Striking persistence in inequality.

● → Figure 6-3

Kuznets curve: data (2) How could cross-sectional studies find inverted-U

shape? ● Coincidence: Latin America (high inequality) had

middle income ranking when studies were done. ● Cautionary tale for drawing inference from cross-

sectional data.

Causes of inequality

What, if not growth, explains variation in inequality across countries?

● Policy: – Income re-distribution, education policies. – Discrimination (e.g. apartheid in South Africa)

increases inequality.

● History: – Asset re-distribution after wars (e.g. in South Korea)

can reduce inequality. – Transition economies: Started with low inequality after

communism (then rising)

Causes of inequality (2)

● Economics: prevalent industries/technologies – Mineral wealth → higher inequality – Plantation farming (e.g. Latin America) → higher

inequality – Rice farming better suited for families (e.g. East Asia)

→ lower inequality

Measuring poverty

● Absolute poverty lines: – money needed to buy a basket of elementary goods

● Relative poverty lines: – 50% (or 40%, 60%) of the median income in a society

● → A growing economy whose Lorenz curve remains the same experiences... – … a reduction in absolute poverty,... – … but no reduction in relative poverty.

Absolute poverty lines

● Amount determined by basket of basic goods, usually to satisfy minimum calorie intake.

● → Absolute measure. ● Need to adjust for price changes over time and

across regions. ● Note: some deprivations do not enter, e.g.

– safe water – health – education

1$-a-day poverty line

● Origin: 1990 World Development Report by World Bank

● Low-income countries had poverty lines of 275$- 370$ per year in 1985 PPP $

● → adopted 365$ per year, i.e. 1$ a day ● 1985: 1.12 billion people in absolute poverty

according to this measure. ● Updated for inflation and new PPP estimates: ● e.g. 1.25$ PPP in 2005

Assessing the extent of poverty

Once a poverty line (PL) is established: ● Simplest indicator: number of people below PL ● Headcount index (HI): ratio of those below PL to

total population ● Poverty gap (PG) measures severity of poverty:

● PG = [ (PL – MC) / PL ] * HI, ● where MC = mean consumption of those below PL.

Most recent World Bank data Source: see link on Blackboard Compare to Perkins: Table 6-3 (up to 2001) ● 850 household surveys from 130 developing

countries ● 1.23 million households interviewed ● Cover 90% of population in these countries ● Main poverty line: 1.25$ PPP in 1995 ● → average of national poverty lines of 10-20

poorest countries

Most recent World Bank data

● Based on consumption whenever possible (2/3 of cases, otherwise on income)

● 2$ a day: average poverty line of all developing countries.

● 22% of population in developing countries below 1.25$ in 2008 (was 52% in 1981).

● Millennium Development Goal 1 (halving incidence of extreme poverty) reached in 2010

Recent data: by region

● East Asia: Population below 1.25$ fell from 77% (1981) to 14% (2008).

● China: Almost 500 million people left extreme poverty since 1981.

● South Asia: 61% (1981) to 36% (2008) ● Sub-Saharan Africa: 51% (1981) to 47% (2008) ● Eastern Europe and Central Asia: Negative trend

reversed since 2000.

Recent data: progress, but...

● Still 1 billion people below 1.25$ in 2015. ● Below 2$: 2.59 billion (1981) to 2.47 billion (2008) ● → Formerly extremely-poor bunch up above 1.25$,

are still vulnerable!

Criticism of 1$-a-day poverty line

● Sharp cut-off: those just above 1$ are not counted. ● 1$ or 2$ a day is very little → still see high infant

mortality, stunting above this ● 1$ may be too low in less poor countries →

different prices etc. ● But: Some researchers (Sala-i-Martin) also find

less poverty using different methods ● → still, obtains same positive time trend

Who are the poor?

● Rural poverty rates higher than urban rates – Fewer opportunities – Lack of education and health care – More vulnerable to forces of nature

● Regional variation within countries ● Minorities often at greater risk:

– Ethnic minorities in Eastern Europe – Indigenous groups in Latin America – Low castes in India

Are women poorer than men?

● Fact: women often disadvantaged – Selective abortion, less health care – → “missing women” (Amartya Sen) – Some evidence that women's nutrition is worse (but

varies across countries and regions) – Receive less education (but trend is positive) – Women work more hours (when including house work) – Legal discrimination: no ownership to land, cannot

inherit etc.

Are women poorer than men? (2) But: ● Within-household allocation of consumption hard

to measure ● Compare women-headed households to others:

– Some do worse (widows in India, single female pension recipients in Eastern Europe)...

– … but some do better than average (unmarried women in urban settings, married women with husband who sends remittances from abroad).

Strategies to reduce poverty

World Bank: World Development Report 1990 ● Promote market-oriented growth

– More labor demand → more jobs for poor – Macro stability reduces vulnerability

● Direct basic health and education services to poor – Increases their productivity

● Develop social safety nets for those who are unable to work etc. (sick, disaster victims etc.)

Criticism of growth-centered poverty- reduction strategy

United Nations Development Program: The Human Development Report (1996)

● Jobless growth ● Ruthless growth: growth that mostly benefits the

rich ● Voiceless growth: growth, but “no extension of

democracy or empowerment” ● Rootless growth: loss of cultural identity ● Futureless growth: growth on expense of future

generations (environment etc.)

Data: growth and poverty reduction

Study: Dollar & Kray (2002), see fig. 6-7 ● Sample of countries, representative of world ● ~6-year spells from 1956 to 1999 ● Result: GDP increase of 1% associated with 1.2%

increase of poorest quintile (on average) ● → Growth usually good for poor ● But: Have fair number of cases of “ruthless

growth” (or immiserizing growth) ● → often in Latin America

Pro-poor growth

● Often cited as policy objective, ... ● … but no clear definition. ● What's meant: Growth that benefits the poor more

than the average person.

Arguments for poverty-focused development strategy

Why could it be desirable to focus especially on the poor (instead of total GDP growth)?

● Common view: an additional dollar is worth more to a poor than to a rich person

● → declining marginal utility, utilitarian criterion ● Market failures most relevant to the poor ● Poor are most deprived of capabilities, should

focus on them in capabilities-oriented approach to development.

Washington Consensus and poverty reduction (1)

Washington-Consensus policies sometimes criticized to hurt the poor:

● Market-determined wages of low-productivity workers are often very low

● Reduction in government spending can hurt poor (e.g. welfare programs)

● Cheap imports can replace goods produced by poor (e.g. cotton farmers in West Africa)

Washington Consensus and poverty reduction (2)

But: ● Budget deficits and poor monetary policy: Inflation

hurts the poor more than the rich ● Openness to trade:

– Poor country focuses on producing goods in which it has a comparative advantage

– → often labor-intensive, i.e. more low-skill jobs – → Wages increase over time (e.g. Asia)

● → Usually winners and losers from openness

How to improve opportunities for the poor?

Usually advocated: ● Basic education

– Increases productivity – Widens range of jobs available

● Health ● Spending on rural infrastructure

– Found to decrease poverty both in urban and rural areas

Controversial: land re-distribution

Income transfers

● Some individuals cannot participate in markets: the old, children, disabled etc.

● → Need transfers ● Usually two forms in developing countries:

– Regulation of food prices: distorting, also benefit the rich.

– Food-stamp programs: better-targeted, but harder to administer.

Safety nets ● Panel data: poverty is transitory rather than chronic ● Public employment schemes can alleviate poverty

temporarily – Work on public infrastructure – Low wages → target on very poor

● → Reduces variability of poor's income, found to be well-targeted and well-used.

Global inequality ● Inequality across countries is larger than inequality

within countries. – 15% of world population consumes 56% of world

output – Comparable to inequality in South Africa, Brazil

● Within-country inequality addressed by national policy-making.

Global inequality Should the reduction of between-country inequality

be a policy goal? ● To whom do people compare each other? This

often determines their perception of well-being ● → argument to focus on within-country inequality ● But: Absolute poverty should be a concern to

everybody (utilitarian criterion) ● → linked to between-country inequality

Measuring global inequality GDP-based measures: ● Compare GDP of all countries with equal

weighting – Does not account for country size – Appropriate for studies on link of countries policies and

growth

● Compare countries' GDP weighted by population – Does not account for within-country inequality

● → figure 6-8

Measuring global inequality GDP-based measures (figure 6-8): ● Unweighted Gini increased since 1980 ● Weighted Gini decreased continuously ● Reasons for discrepancy: ● Different growth experiences

– High growth in much of Asia – Low growth in Africa, Latin America, transition

economies

● Very large countries (China and India) grew

Measuring global inequality (2)

Household-based: Compute world Gini as if the world was a single country

● Advantage: Does not assume perfect income equality within-country as GDP-based measures do

● Problem: Need household surveys – Only available since 1980s – Some data issues

Measuring global inequality (3) Household-based world Gini is between 0.6 and 0.8 ● Higher than GDP-based Ginis ● Higher than usual country Ginis ● No consensus about trend from 1980-2000

● Visualization (also by region): Gapminder.org →

Downloads → Human Development Trends

Reducing global inequality Is it desirable to slow down rich countries' growth to

promote global equality? ● Would reduce global inequality if poor countries

kept growing. ● But: Might hurt poor countries' citizens

– Lower demand for poor countries' exports – Slower pace of technological progress on frontier →

poor countries can adapt fewer innovations

● → Growth is not a zero-sum game

Benefits of global-poverty reduction for rich countries

● Moral argument: relieve suffering ● Information age: poor people compare themselves

also to other nations' people. Potential for – High migration flows – Social unrest

● Improve global issues that can affect rich countries themselves: – Diseases: HIV/AIDS, avian flu etc. – Climate change

The end of poverty Jeffrey Sachs proposes global compact to end

absolute poverty by 2015 ● Rich nations commit to

– Keep markets open to exports from poor countries – Invest in global public goods (science, medicine,

agricultural technology) – Minimize impact of global warming on poor countries – Aid and debt forgiveness (controversial)

● Poor nations accountable for good governance and poverty-reduction efforts