Chapter 4 Econ. Dev.

Poverty, Inequality and Development

No society can surely be flourishing and happy, of which by far the greater part of the
numbers are poor and miserable.
Adam Smith, 1776

Viewed through the lens of human development, the global village appears deeply
divided between the streets of the haves and those of the have-nots.
United Nations Development Programme, Human Development Report, 2006

Social protection directly reduces poverty and helps make growth more pro-poor.
Organization for Economic Cooperation Development, 2010

The coincidence of severe and persistent poverty and hunger indicates the presence of
poverty traps-conditions from which individuals or groups cannot emerge without the
help of others.
International Food Policy Research Institute, 2007

The World Bank Group has adopted two new goals: ends extreme poverty by 2030 and
boost shared prosperity by maximizing income growth for the poorest 40 percent in
every country.
Jim Yong Kim, President, World Bank, 2013

 The most important measures of poverty and inequality used by development

economists satisfy properties that most observers would agree are of fundamental
importance.
 Some important principles of effective poverty policies are considered, together
with some initial examples of programs that have worked well in practice.
4.1 Measuring Inequality
 We define the dimensions of income distribution and poverty problems and identify
some similar elements that characterize the problem in many developing nations.
 Economists usually distinguish between two principal measures of income
distribution for both analytical and quantitative purposes: the personal or size
distribution of income and the functional factor share distribution of income.
 Personal distribution income (size distribution income) - the distribution of
income according to size class of persons-for example, the share total income
accruing to the poorest specific percentage or the richest specific percentage of
population-without regard to the sources of that income. Is the measure most
commonly used by economists, It simply deals with individual persons or
households and the total income they receive.
 Quintile - a 20% proportion of any quantity. A population divided into quantiles
would be divided into five groups of equal size.
 Decile – a 10% portion of any numerical quantity; a population divided into deciles
would be divided into ten equal numerical groups.
 Income inequality – the disproportionate distribution of total national income
among households.
 Lorenz curve – graph depicting the variance of the size distribution of income
from perfect equality. It shows the actual quantitative relationship between the
percentage of income recipients and the percentage of the total income they did in
fact receive during a given year.
Gini Coefficient and Aggregate Measures of Inequality
 Named after the Italian statistician who first formulated it in 1912.
 Gini Coefficient - an aggregate numerical measure of income inequality ranging
from 0 (perfect equality) to 1 (perfect inequality). It is measured graphically by
dividing the area between the perfect equality line and the Lorenz curve by the
total area lying to the right of the equality line in a Lorenz diagram. The higher the
value of the coefficient is, the higher the inequality of income distribution; the
lower it is, the more equal the distribution of income.
Functional Distribution
 Functional distribution of income (factor share distribution of income) – the
distribution of income to factors of production without regard to the ownership of
the factors.
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 Factors of production – resources or inputs required to produce a good or a
service, such as land, labor, and capital.
4.2 Measuring Absolute Poverty
 Absolute poverty – the situation of being unable or barely able to meet the
subsistence essentials of food, clothing, and shelter.
 Headcount index – the proportion of a country’s population living below the
poverty line.
 Total poverty gap(TPG) – the sum of the difference between the poverty line and
actual income levels of all people living below the line.
 Foster-Greer-Thorbecke (FGT) index – a class of measures of the level of
absolute poverty.
 Multidimensional Poverty Measurement – poverty cannot be adequately
measured with income alone, as Amartya Sen ‘s capability framework makes
apparent.
 As always, the first step in measuring poverty is to know which people are poor. In
the multidimensional poverty approach, a poor person is identified through what is
called the
“dual cutoff method”: first, the cutoff levels within each of the dimensions
(analogous to falling below poverty line such as ֆ1.25 per day if income poverty
were being addressed). Second, the cutoff of the number of dimension s in which a
person must be deprived (below the line) to be deemed multidimensionally poor.
4.3 Poverty, Inequality, and Social Welfare
 What’s so bad in extreme inequality?
1. Extreme income inequality leads to economic inefficiency.
2. Extreme income disparities undermine social stability and solidarity.
3. Extreme inequality is generally viewed as unfair.
Dualistic Development and shifting Lorenz curves: Some stylized typologies
 As introduced by Gary Fields, Lorenz curve may be used to analyzed three
limiting cases of dualistic development:
1. Modern-sector enlargement growth typology
- Two-sector economy develops by enlarging the size of its modern sector
while maintaining constant wages in both sectors.
2. Modern-sector enrichment growth typology
- Economy grows but such growth is limited to a fixed number of people in the
modern sector, with both the number of workers and their wages held
constant in the traditional sector.
3. Traditional-sector enrichment growth typology
- All of the benefits of growth are divided among traditional-sector workers,
with little or no growth occurring in the modern sector.
Kuznets’s Inverted-U Hypothesis
 Simon Kuznets suggested that in the early stages of economic growth, the
distribution of income will tend to worsen, only at later stages will it improve”.
 Kuznets curve – a graph reflecting the relationship between a country’s income
per capita and its inequality of income distribution.
 Character of economic growth – the distributive implications of economic
growth as reflected in such factors are participation in the growth process and
asset ownership.
4.4 Absolute Poverty: Extent and Magnitude
 Multidimensional Poverty index (MPI)- a poverty measure that identifies
the poor using dual cutoffs for levels and numbers of deprivations, and then
multiplies the percentage of people living in poverty times the percent of
weighted indicators for which poor households are deprived on average.
Growth and Poverty
 There are at least five reasons why policies focused toward reducing poverty
levels need not lead to a slower rate of growth-and indeed could help to
accelerate growth.
1. Widespread poverty creates conditions in which the poor have no access
to credit.
2. The rich in many contemporary poor countries are generally not noted for
their frugality of for their desire to save and invest.
3. Low income and low level of living for the poor, which are manifested in
poor health, nutrition, and education, can lower their economic
productivity and thereby lead directly and indirectly to a slower-growing
economy.
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4. Raising the income levels of the poor will stimulate an overall increase in
the demand for locally produced necessity products.
5. A reduction of mass poverty can stimulate healthy economic expansion by
acting as a powerful material and psychological incentive to widespread
public participation in the development process.
4.5 Economic Characteristics of High-Poverty Groups
 Rural poverty – Most valid generalization about the poor is that they are
disproportionately located in rural areas, that they are primarily engaged in
agricultural and associated activities, that they are more likely to be women
and children that adults males, and that they are often concentrated among
minority ethnic groups and indigenous peoples.
 Women and Poverty – women make up a substantial majority of the
world’s poor. If we compared the lives of the inhabitants of the poorest
communities throughout the developing world, we would discover that
virtually everywhere women and children experience the harshest
deprivation. They are more likely to be poor and malnourished and less likely
to receive medical services, clean water, sanitation and other benefits.
Ethnic Minorities, Indigenous Populations, and Poverty
 A final generalization about the incidence of poverty in the developing world is that
it falls especially heavily on minority ethnic groups an indigenous population.
 40 % of the world’s nation-states have more than five sizable ethnic populations,
one or more of which faces serious economic, political and social discrimination.
Poor Countries
 It should be noted that the poor come from the poor countries. Although this may
seem like trivial observation, it is actually a useful note of optimism.
 The negative relationship between poverty and per capita income suggests that if
higher incomes can be achieved, poverty will reduce, if only because of the greater
resources that countries will have available to tackle poverty problems and the
growth of civil society and the voluntary sector.
4.6 Policy Options on Income Inequality and Poverty: Some Basic
Considerations
Areas of Intervention
 We can identify four broad areas of possible government policy intervention, which
corresponds to the following four major elements in the determination of
developing economy’s distribution income.
1. Altering the functional distribution
2. Mitigating the size distribution
3. Moderating (reducing) the size distribution at the upper levels
4. Moderating (increasing) the size distribution at the lower levels
Altering the Functional Distribution of Income through Relative Factor Prices
 Altering the functional distribution is a traditional economic approach. It is argued
that as a result of institutional constraints and faulty government policies, the
relative price of labor in the formal, modern, urban sector is higher than what
would be determined by the free interplay of the forces of supply and demand.
Modifying the Size Distribution through Increasing Asset of the Poor
 The ultimate cause of the unequal distribution of personal incomes in most
developing countries is the unequal and highly concentrated patterns of asset
ownership (wealth) in these countries.
 Asset of ownership – the ownership of land, physical capital (factories, buildings,
machinery, etc.), human capital, and financial resources that generate income for
owners.
 Redistribution of policies – policies geared to reducing income inequality and
expanding economic opportunities in order to promote development, including
income tax policies, rural development policies, and publicly financed services.
 Land reform – a deliberate attempt to reorganize and transform existing agrarian
systems with the intention of improving the distribution of agricultural incomes and
thus fostering rural development.
Progressive Income and Wealth Taxes
 Progressive income taxes – a tax whose rate increase with increasing personal
incomes.
 Regressive Tax – a tax structure in which the ratio of taxes to income tends to
decrease as income increases.
 Indirect taxes – taxes levied on goods ultimately purchased by consumers,
including customs duties (tariffs), excise duties, sales taxes, and export duties.
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Direct Transfers Payments and the Public Provision of Goods and Services
 Public consumption – all current expenditures for purchases of goods and
services by all levels of government, including capital expenditures on national
defense and security.
 Subsidy – a payment by the government to producers or distributors in an
industry to prevent the decline of that industry, to reduce the prices of its
products, or to encourage age hiring.
 Workforce program – a poverty alleviation program that requires program
beneficiaries to work in exchange for benefits, as in a food-for-work program.