Case Study 3

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Chapter 5 Poverty, Inequality, and Development

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Distribution and Development: Eight Critical Questions

How can we best measure inequality and poverty?

What is the extent of relative inequality in developing countries; how is this related to the extent of poverty?

Who are the poor, and what are their economic characteristics?

What determines the nature of economic growth—that is, who benefits from economic growth, and why?

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Distribution and Development: Seven Critical Questions

Are rapid economic growth and more equal income distribution compatible or conflicting objectives?: Is rapid growth achievable only at a cost of greater income inequality or can lessening income disparities contribute to higher growth rates?

Do the poor benefit from growth, and does this depend on the type of growth a developing country experiences? What might be done to help the poor benefit more?

What is so bad about extreme inequality?

What kinds of policies are required to reduce the magnitude and extent of absolute poverty?

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5.1 Measuring Inequality

Measuring Inequality

Size distributions (quintiles, deciles)

Lorenz curves

Gini coefficients and aggregate measures of inequality

Functional distributions

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Desirable Properties for Inequality Measures

Anonymity: measure should not depend on who has higher income; e.g. whether we believe the rich or poor to be good or bad people

Scale independence: inequality measures should not depend on size of the economy – want a measure of income dispersion

Population independence principle: an inequality measure should not be based on the number of income recipients

Transfer principle - all other incomes constant, if transfer income from a richer to a poorer person (not so much that the poorer person is now richer than the originally rich person), resulting new income distribution is more equal.

Gini coefficient satisfies all four properties; so does the coefficient of variation (CV), and some others

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Table 5.1 Typical Size Distribution of Personal Income in a Developing Country by Income Shares—Quintiles and Deciles

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Figure 5.1 The Lorenz Curve

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Figure 5.2 The Greater the Curvature of the Lorenz Line, the Greater the Relative Degree of Inequality

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Figure 5.3 Estimating the Gini Coefficient

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Figure 5.4 Four Possible Lorenz Curves

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Figure 5.5 Functional Income Distribution in a Market Economy: An Illustration

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5.2 Measuring Absolute Poverty

Headcount Index: H/N

Where H is the number of persons who are poor and N is the total number of people in the economy

Total poverty gap:

Where Yp is the absolute poverty line; and Yi the income of the ith poor person

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Desirable Properties for Inequality Measures

Desirable properties for poverty measures:

Anonymity

Population independence

Monotonicity

Distributional sensitivity

Plus: the Focus Principle

As we will see, P2 has these properties

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Figure 5.6 Measuring the Total Poverty Gap

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Average poverty gap (APG):

Where N is number of persons in the economy

TPG is total poverty gap

Note: normalized poverty gap, NPG = APG/Yp

5.2 Measuring Absolute Poverty

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Measuring Absolute Poverty

Average income shortfall (AIS):

Where H is number of poor persons

TPG is total poverty gap

Note: Normalized income shortfall, NIS = AIS/Yp

5.2 Measuring Absolute Poverty

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The Foster-Greer-Thorbecke (FGT) index:

N is the number of persons, H is the number of poor persons, and α ≥0 is a parameter

When α=0, we get the headcount index measure

When α=2, we get the “P2” measure

5.2 Measuring Absolute Poverty

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The Newly Introduced Multidimensional Poverty Index

5.2 Measuring Absolute Poverty

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Measuring Poverty: Income or Multidimensional?

Given that we are measuring poverty with income, we have good measures that, like P2, satisfies desirable properties

If must have a single indicator, income has advantages e.g. clarity, flexibility

But in general is measuring income sufficient?

Following Amartya Sen’s capability approach, it is apparent that, in general, poverty needs to be conceptualized – and so measured – in a multidimensional way

We will return to this with the new MPI

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5.3 Poverty, Inequality, and Social Welfare

What’s So Bad about Extreme Inequality?

Dualistic Development and Shifting Lorenz Curves: Some Stylized Typologies

Traditional-sector enrichment (see Figure 5.7)

Modern-sector enrichment (see Figure 5.8)

Modern-sector enlargement (see Figure 5.9)

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Figure 5.7 Improved Income Distribution under the Traditional-Sector Enrichment Growth Typology

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Figure 5.8 Worsened Income Distribution under the Modern-Sector Enrichment Growth Typology

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Figure 5.9 Crossing Lorenz Curves in the Modern-Sector Enlargement Growth Typology

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5.3 Poverty, Inequality, and Social Welfare

Kuznets’ Inverted-U Hypothesis

The inverted-U is consistent with modern sector enlargement growth, but not traditional or modern sector enrichment growth

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Figure 5.10 The “Inverted-U” Kuznets Curve

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Table 5.2 Selected Income Distribution Estimates

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Figure 5.11 Kuznets Curve with Latin American Countries Identified

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Figure 5.12 Plot of Inequality Data for Selected Countries

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Table 5.3 Income and Inequality in Selected Countries

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5.3 Poverty, Inequality, and Social Welfare

Growth and Inequality

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5.4 Absolute Poverty: Extent and Magnitude

Progress on Extreme Poverty

Clear progress on $1.25-a-day headcount

Less clear progress on $2.00-per-day headcount (see Figure 5.14)

Incidence of extreme poverty is uneven

Relationship between Growth and Poverty

Association between growth and poverty reduction

When it is inclusive, growth reduces poverty

Lower extreme poverty may also lead to higher growth

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5.4 Absolute Poverty: Extent and Magnitude

Poor health, nutrition, and education lowers economic productivity of people in poverty, leading directly and indirectly to slower growth

Higher income for the poor raises demand for locally produced goods

Often, the poor lack access to credit, which constrains entrepreneurship, children’s education, and fertility reduction

Social exclusion/injustice associated with poverty also leads to bad government policies that can reduce growth

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Figure 5.13 Global and Regional Poverty Trends, 1981–2010

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Table 5.4 Regional Poverty Incidence, 2010

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The Multidimensional Poverty Index (MPI)

Identification of poverty status through a dual cutoff:

First, cutoff levels within each dimension (analogous to falling below a poverty line for example $1.25 per day for income poverty);

Second, cutoff in the number of dimensions in which a person must be deprived (below a line) to be deemed multidimensionally poor.

MPI focuses on deprivations in health, education, and standard of living; and each receives equal (that is one-third of the overall total) weight.

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MPI Indicators

Health - two indicators with equal weight - whether any child has died in the family, and whether any adult or child in the family is malnourished –weighted equally (each counts as one-sixth toward the maximum deprivation in the MPI)

Education - two indicators with equal weight - whether no household member completed 5 years of schooling, and whether any school-aged child is out of school for grades 1 through 8 (each counts one-sixth toward the MPI).

Standard of Living, equal weight on 6 deprivations (each counts as 1/18 toward the maximum): lack of electricity; insufficiently safe drinking water; inadequate sanitation; inadequate flooring; unimproved cooking fuel; lack of more than one of 5 assets – telephone, radio, TV, bicycle, and motorbike.

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Interaction of the deprivations?

Building the index from household measures up to the aggregate measure (rather than using already-aggregated statistics), MPI approach takes account of multiplied or interactive harm (complementarity) done when multiple deprivations are experienced by the same individual or family

The MPI approach assumes an individual’s lack of capability in one area can only to a degree be made up by other capabilities – capabilities are treated as substitutes up to a point but then as complements.

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Computing the MPI

The MPI for the country (or region or group) is then computed

A convenient way to express the resulting value is H*A, i.e.,

The product of the headcount ratio H (the percent of people living in multidimensional poverty), and the average intensity of deprivation A (the percent of weighted indicators for which poor households are deprived on average).

The adjusted headcount ratio HA is readily calculated

HA satisfies some desirable properties. Important example -

Dimensional monotonicity: If a person already identified as poor becomes deprived in another indicator she is measured as even poorer - not the case using a simple headcount ratio.

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Multidimensional poverty tells a different story than income poverty

The results showed that knowing income poverty is not enough if our concern is with multidimensional poverty.

Multidimensionally, Bangladesh is substantially less poor - but Pakistan substantially poorer - than would be predicted by income poverty

Ethiopia is far more multidimensionally poor, and Tanzania much less so, than predicted by income poverty.

Most Latin American countries e.g. Brazil rank worse on multidimensional poverty than on income poverty; but Colombia’s income and MPI poverty ranks are about same.

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Table 5.5 Income Poverty Incidence in Selected Countries

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Table 5.5 Income Poverty Incidence in Selected Countries (continued)

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Table 5.6 Multidimensional Poverty Index, Data for 2007–2011

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5.5 Economic Characteristics of High-Poverty Groups

Rural poverty

Women and poverty

Ethnic minorities, indigenous populations, and poverty

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Table 5.7 Poverty: Rural versus Urban

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Table 5.8 Indigenous Poverty in Latin America

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Workfare

Workfare, such as a Food for Work Program, represents a better policy than welfare when these criteria are met:

The program does not reduce incentives for the poor to acquire human capital and other assets

There are greater net benefits of the program’s work output

It is harder to screen the poor without a workfare requirement

Poor workers have lower opportunity cost of time (so the economy loses little output when they work in the program)

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Workfare

Non-poor workers have higher opportunity cost of time (so they are unlikely to participate to get the benefits)

The fraction of the population living in poverty is smaller (so the extra costs of a universal welfare scheme would be high)

There is less social stigma of visible workfare participation, so the poor do not suffer humiliation or be deterred from needed work (otherwise, a discreet welfare transfer may be preferable)

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5.6 Policy Options on Income Inequality and Poverty: Some Basic Considerations

Areas of Intervention:

Altering the functional distribution

Mitigating the size distribution

Moderating (reducing) the size distribution at upper levels

Moderating (increasing) the size distribution at lower levels

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Policy options

Changing relative factor prices

Progressive redistribution of asset ownership

Progressive taxation

Transfer payments and public provision of goods and services

5.6 Policy Options on Income Inequality and Poverty: Some Basic Considerations

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5.7 Summary and Conclusions: The Need for a Package of Policies

Policies to correct factor price distortions

Policies to change the distribution of assets, power, and access to education and associated employment opportunities

Policies of progressive taxation and directed transfer payments

Policies designed to build capabilities and human and social capital of the poor

Some specific programs covered in later chapters include: conditional cash transfers (Chapter 8); agricultural extension (Chapter 9); and micro-finance (Chapter 15, and Chapter 11 cases)

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Concepts for Review

Absolute poverty

Asset ownership

Character of economic growth

Decile

Disposable income

Factor share distribution of income

Factors of production

Foster-Greer-Thorbecke (FGT) index

Functional distribution of income

Gini coefficient

Headcount index

Income inequality

Indirect taxes

Kuznets curve

Land reform

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Concepts for Review (cont’d)

Lorenz curve

Multidimensional poverty index (MPI)

Personal distribution of income

Progressive income tax

Public consumption

Quintiles

Redistribution policies

Regressive tax

Size distribution of income

Subsidy

Total poverty gap (TPG)

Workfare programs

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Appendix 5.1: Appropriate Technology and Employment Generation: The Price Incentive Model

Choice of techniques

Factor Price distortions and appropriate technology

Possibilities of Labor-Capital substitution

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Figure A5.1.1 Choice of Techniques: The Price Incentive Model

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Appendix 5.2: The Ahluwalia-Chenery Welfare Index

Constructing poverty-weighted index of social welfare

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Table A5.2.1 Income Distribution and Growth in 12 Selected Countries

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