Economics of Poverty Traps and Persistent Poverty: An Asset-based Approach

1. Economics of Poverty Traps and Persistent Poverty: An Asset-based Approach January 2005 American Economic Association annual meetings Philadelphia

2. Why We Need An Asset-Based Approach to Poverty Analysis • The ‘Washington Consensus’ reforms constitute an implicit theory of structural poverty transitions: • Getting Prices Right should raise returns on unskilled labor, poor households’ primary asset; • Getting Institutions Right by securing property rights should enhance asset accumulation by poor households; • Deregulation should enhance financial access of poor households, further boosting accumulation • But, has it worked? • Very hard to gauge using conventional, flow-based approaches to poverty analysis that look only at (potentially transitory) outcomes.

3. Evolving Views of Poverty Successive generations of poverty analysis 1st: static income/expenditure analysis (headcount, poverty gap, FGT measures) 2nd: dynamic income/expenditure analysis (chronic/transitory poverty distinction) 3rd: static asset poverty analysis (structural/stochastic poverty distinction) 4th : dynamic asset poverty analysis

4. Asset-Based View of Poverty Transitions Stochastic churning (B to u(A’’)) from Poverty: Structural via accumulation (A’ to A”) Structural via higher returns (u(A’) to C)

5. Poverty Traps and the Dynamic Asset Poverty Threshold • Will structurally poor move ahead over time? • Lessons from empirical macroeconomics – “twin peaks”, “divergence big time” or “convergence”? • Key question: do returns to productive assets (land, labor, etc.) increase in wealth? • Such a relationship could exist due to: • Increasing returns to scale in income generating process • Minimum investment levels/indivisibilities • Uninsured risk

6. Utility L2 U*H Asset Poverty Line Income Poverty Line L1 Marginal return on assets U*L Assets A*1 AS A A*2 Locally Increasing Returns and Multiple Livelihood Equilibria No problem if perfect financial markets exist. But if not, what savings strategies are feasible below AS?

7. A 4th Generation View Figure 3: The Dynamic Asset Poverty Line Utility L2 U*H Dynamic Asset Poverty Line Income Poverty Line L1 U*L Static Asset Poverty Line Initial Assets A*1 A* AS A A*2 Poverty Trap Dynamic Asset Poverty Line (Micawber Threshold) At=A0 (dynamic equilibrium) Next Period’s Assets

8. Empirical Strategies to Identify Dynamic Asset Poverty Thresholds Need to find threshold in asset space where dynamics bifurcate. Challenges: - highly nonlinear dynamics - sparse data around unstable eql’n - multidimensional asset space Efforts to date: - Lybbert et al. 2004 EJ, Barrett et al. 2004, Adato et al. 2005 all use nonparametric methods based on single asset or asset index. Need to improve on these methods

9. Dynamic Poverty Measures Two natural extensions of FGT class: Predicted flow dynamics version: Asset gap version:

10. Implications for Persistent Poverty Reduction Strategies An asset-based approach permits - identification of minimum asset bundles necessary for hhs to engineer own growth - natural integration of safety net strategies with poverty reduction strategies - prioritization of efforts to rectify mechanisms of financial and social exclusion

11. Thank you!