Poverty, Inequality, and Development

1. Poverty, Inequality, and Development Chapter 6

2. Voices of the Poor • http://go.worldbank.org/H1N8746X10

3. Centesimus Annus • 34. It would appear that, on the level of individual nations and of international relations, the free market is the most efficient instrument for utilizing resources and effectively responding to needs. But this is true only for those needs which are "solvent", insofar as they are endowed with purchasing power, and for those resources which are "marketable", insofar as they are capable of obtaining a satisfactory price. But there are many human needs which find no place on the market. It is a strict duty of justice and truth not to allow fundamental human needs to remain unsatisfied, and not to allow those burdened by such needs to perish. It is also necessary to help these needy people to acquire expertise, to enter the circle of exchange, and to develop their skills in order to make the best use of their capacities and resources. Even prior to the logic of a fair exchange of goods and the forms of justice appropriate to it, there exists something which is due to man because he is man, by reason of his lofty dignity. Inseparable from that required "something" is the possibility to survive and, at the same time, to make an active contribution to the common good of humanity.

4. Poverty across countries

5. Inequality across countries

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

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

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

9. Poverty, Inequality, and GNP per capita • There’s no simple relation between poverty/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 changes. • There might be a complicated relation, involving the interaction of many factors.

10. Poverty, Inequality, and GNP per capita • Inequality is probably determined by • history • social cleavages, • politics and government policies • Careful statistical/econometric analysis is necessary to identify the effect of each factor.

12. The Growth Controversy: Seven Critical Questions • What is the extent of relative inequality, and how is this related to the extent of poverty? • Who are the poor? • Who benefits from economic growth? • Does rapid growth necessarily cause/require greater income inequality? • Do the poor benefit from growth? • Are high levels of inequality always bad? • What policies can reduce poverty?

13. The Growth Controversy: Seven Critical Questions • Inequality and poverty need to be defined carefully if we want to • Compare countries to each other; • Assess progress in fighting them; • What kind of policies/incentives need to be designed. • What kinds of growth improve welfare? • What are the main things to be done?

14. Measuring Inequality and Poverty • Measuring Inequality • Size distributions • Lorenz curves and Gini coefficients • Functional distributions

15. Measuring Inequality and Poverty • Measuring Inequality • size distributions • How much income does household X earn? • Sort people according to income and put them 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.

16. Household The Kuznets ratio: the ratio of the share of income of the highest 20% divided by the share of income of the lowest 40%.

17. Measuring Inequality and Poverty • Measuring Inequality • Lorenz curves • Arrange population according to the share of income they receive, from lowest to highest. • Calculate cumulative percentages (the lowest 5%, the lowest 45%, etc.) • Plot the cumulative percentage of households against the cumulative percentage of the income they earn. http://mysite.avemaria.edu/gmartinez/Courses/ECON320/xls/Lorenz_Curve.xls

18. The Lorenz Curve

19. The Greater the Curvature of the Lorenz Line, the Greater the Relative Degree of Inequality

20. Four Possible Lorenz Curves Which is the least unequal country? Which is the most unequal? Can we rank them all?

21. Measuring Inequality and Poverty • Measuring Inequality • Gini coefficients (an aggregate measure of inequality) • It’s a quantitative measure of how far a society 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 the perfect-equality curve.

22. Estimating the Gini Coefficient http://mysite.avemaria.edu/gmartinez/Courses/ECON320/pdf/CalculationGini.pdf

23. The Gini Coefficient • The Gini coefficient is interesting because • It’s anonymous: it doesn’t treat some people as better than others, it just reports their income. • It’s scale-independent: measuring income in dollars or in rupees doesn’t change it. • It’s population-independent: changing the amount of people but keeping income distribution constant doesn’t change it. • It follows the transfer principle: transferring income from a richer to a poorer person (without changing their order) improves it. • The coefficient of variation (stdev/mean) also follows these principles.

24. Measuring Inequality and Poverty • Measuring Inequality • Functional Distributions • What is the income that goes to each kind of factor of production? That is, what is the labor share in income? What is the profit-rent-interest share in income?

25. Functional Income Distribution in a Market Economy: An Illustration According to this theory, incomes are determined by demand for the input (and therefore by it’s marginal productivity) and by its supply. Non-market influences (or market imperfections) are ignored.

26. Measuring Poverty

27. Measuring Poverty • Poverty is • Lack of income; • Lack of drinking water • Lack of access to health care • Lack of protection against adverse shocks

29. Measuring Poverty • Measuring Absolute Poverty • The Absolute Poverty Headcount H simply adds the number of people whose income is below an agreed upon poverty line. • The Headcount index H/N divides this number by the population. • The international poverty line is $1 a day, but adjustment to local conditions can lead to a different number.

30. Measuring the Poverty Gap The “poverty gap” is different but H or H/N would be the same.

31. Measuring Poverty • Measuring Absolute Poverty • Total poverty gap where Yp is the absolute poverty line Yi is income of person i

32. Measuring Poverty • Measuring Absolute Poverty • Average poverty gap where H is number of persons under poverty line TPG is total poverty gap

33. Measuring Poverty • Measuring Absolute Poverty • The Normalized Poverty Gap is the Total Poverty Gap divided by the product of the poverty line and the population

34. Measuring Poverty • Measuring Absolute Poverty • Foster-Greer-Thorbecke measure • Is a very general form of poverty measure that satisfies • anonymity (no person is worth more than another), • population independence (a larger population doesn’t change it, ceteris paribus), • monotonicity (making a person richer won’t decrease the index) and • distributional sensitivity (taking income away from a poor person makes the poverty index worse).

35. Measuring Poverty • Measuring Absolute Poverty • Foster-Greer-Thorbecke measure • If a=2, you get a measure that is extremely sensitive to the depth and severity of poverty. Coefficient of variation of incomes of the poor

36. Measuring Poverty • Measuring Absolute Poverty • The Human Poverty Index (UNDP) • Deprivation of life (percentage whose life expectancy is below 40%) • Deprivation of education (percentage of illiterate people) • Deprivation of economic provisioning (percentage without access to health care and safe water plus percentage of underweight under-5 children)

37. Measuring Poverty • Measuring Absolute 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 fewer people below “$1 a day”, the proportion of people living under “$2 a day” hasn’t fallen much.

38. 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 “$10 a day” in Zambia? • How about using income rather than consumption, and national accounts rather than surveys? • The number of poor people seem to be much fewer.

39. Poverty, Inequality, and Social Welfare • What’s so bad about inequality? • Extreme income inequality leads to inefficiency. • Lack of access to credit leads to underfinancing of good productive opportunities. • Since the middle-class has the highest average and marginal saving rates, income inequality leads to lower saving and investment.

40. Poverty, Inequality, and Social Welfare • What’s so bad about inequality? • 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.

41. Poverty, Inequality, and Social Welfare • What’s so bad about inequality? • Extreme income inequality leads to political and social instability • The poor try revolution while the rich try corruption and rent-seeking to retain power. • Most people think it’s unfair. • Rawls’s “veil of ignorance.” • A sense of unfairness lowers welfare.

42. Poverty, Inequality, and Social Welfare • What’s so bad about inequality? • St. Augustine on the Preferential Option for 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).

43. Poverty, Inequality, and Social Welfare • What’s so bad about inequality? • CIC: 2444 "The Church's love for the poor . . . is a part of her constant tradition." This love is inspired by the Gospel of the Beatitudes, of the poverty of Jesus, and of his concern for the poor. Love for the poor is even one of the motives for the duty of working so as to "be able to give to those in need.” It extends not only to material poverty but also to the many forms of cultural and religious poverty.

44. Poverty, Inequality, and Social Welfare • Dualistic development and shifting Lorenz curves: some stylized typologies • modern sector enlargement • modern sector enrichment • traditional sector enrichment

45. Improved Income Distribution under the Traditional-Sector Enrichment Growth Typology Sri Lanka, Kerala (India). Low growth by great struggle against poverty.

46. Worsened Income Distribution under the Modern-Sector Enrichment Growth Typology Latin America, Africa Growth only in modern sector: unchanged proportion of traditional sector workers.

47. Crossing Lorenz Curves in the Modern-Sector Enlargement Growth Typology OECD, East Asia The poor get richer as they become modern-sector workers, increasing the share of the middle class. Those who are left in the traditional sector get a smaller share of income. With careful math, one can show that the Gini coefficient will first worsen and then improve.

48. Poverty, Inequality, and Social Welfare • So is inequality bad? • Kuznets’s inverted-U hypothesis • Historically, he found that inequality falls and then rises as countries develop. • The reasons may be complicated… • …and the validity of the hypothesis is an empirical question.

49. The “Inverted-U” Kuznets Curve

50. Kuznets Curve with Latin American Countries Identified Circles represent Latin America: without them there’s no inverted-U pattern. The evolution of inequality over time is most often due to sociopolitical factors.