Poverty Lines

1. PovertyLines Michael Lokshin DECRG-PO The World Bank

2. Poverty Lines • The welfare ratio • The theoretical ideal • Practice: Objective poverty lines • Practice: Subjective poverty lines • Recommendations for practice Poverty lines

3. 1. The welfare ratio • Add up expenditure on all commodities consumed (with imputed values at local market prices) and • Deflate by a poverty line that might depend on household size, composition, and location/date) • The “real expenditure” or welfare ratio is: • where Pij is a price paid for good jby household i • Qijis a quantity of good j consumed by householdi Poverty lines

4. 2. The theoretical ideal • Poverty line should be absolute in the space of welfare: • Two individuals with the same level of welfare are treated similarly • Poverty line should satisfy the weak Pareto principle that states that a welfare gain cannot increase poverty • The ideal poverty line is the minimum cost of achieving a reference level of welfare by a given household: • Pi are the prices paid by a household i for goods • Xiare household characteristics that could affect household’s welfare • Zwis is the reference level of utility Poverty lines

5. The theoretical ideal • Linear approximation of the expenditure function: • where Qij is the consumption of good j that brings household i to the reference welfare level Zw Poverty lines

6. Common issues in Practice • Identification of consumer’s cost function from demand behavior • Are there goods that should be included in the consumption aggregate but not the poverty line (“qat” in Yemen?) • Identification of external effects (interdependence). Utility depends on own consumption and relative position. •  “Absolute” versus “relative” poverty? Is there really a difference? “Absolute” in the space of welfare can mean “relative” in the commodity space (Ravallion and Chen, 2009) Poverty lines

7. Calibration of poverty lines to supplementary welfare data • Imperfect welfare indicator Wi for household I • Examples: • Food share • Nutritional/Health status • Self-rated welfare (Cantril’s scale) • Perceived consumption adequacy • Income Yiand other welfare-relevant characteristics Poverty line could be derived from estimating: Poverty lines

8. “Absolute” vs. “relative” poverty? • Welfare depends on relative income: • M is mean income in a country. The reference level of utility: • Thus, the poverty line is absolute in welfare space, but is “relative” in the consumption space – the poverty line is a function of mean income: • For a poverty line to be absolute in the space of welfare (that is yield Zw) the commodity-based poverty line Z have to rise as M is rising. Poverty lines

9. Poverty lines for different countries Poverty lines

10. Poverty rates for different countries Poverty lines

11. 3. Practice: Objective Poverty Lines • Cost of Basic Needs (CBN) method: • Poverty line is a cost of a bundle of goods deemed sufficient for basic needs. • Food-share version of CBN : Poverty line is a cost of the food-energy requirement • Food-Energy Intake (FEI) method: • Find expenditure or income at which food-energy requirements are met on average for each region/socio-economic group Poverty lines

12. Problems to be aware of • Defining “basic consumption needs” • Setting food energy requirements: problems with variability of activity levels; multiple equilibrium. • Setting basic non-food consumption needs • Consistency in terms of welfare: • Is the same standards of living being treated the same way in different subgroups of the poverty profile? • Is the definition of welfare consistent with the definition of poverty? Should some goods purchased by the poor be included into the poverty bundle? • How sensitive are the rankings in a poverty profile to these choices? Poverty lines

13. Consistency of Poverty Lines • Two bundles yield same food-energy intake, but the “urban” bundle is almost certainly preferable to the rural bundle • The standard of living at the urban poverty line is higher than at the rural line • These two poverty lines are inconsistent providing different welfare levels Poverty lines

14. Difference in the cost per capita • Food Consumption and Cost of a calorie by quintile Poverty lines

15. Example 2: Food-energy intake Method Different sub-groups attain food energy requirements at different standards of living, in terms of real consumption expenditures. Poverty lines

16. Food intake, kcal/day Rural Urban 2100 Income Zr Zu Z

17. Allowing for differences in relative prices • Ideally we only want to adjust the poverty bundle for differences in relative prices • The problem is how to implement this ideal in practice • The identification problem remains • Key thing: To control for welfare differences Poverty lines

18. Allowing for differences in relative prices • Parametric demand models: If we know the parametric utility function then or we can figure it out from demand behavior then use this to determine the cost of the reference welfare level in each region • Numerical methods: • Look at consumption behavior of poorest x% nationally in each region of the country • Cost the consumption bundle of that group in each region • Calculate the poverty rate nationally and iterate if the answer differs too far from x Poverty lines

19. Methods of Setting Poverty Lines Do Matter! Poverty lines

20. “World Bank” Method: Cost per calorie Caloric value 50 200 180 200 240 50 700 1500 420 250 Cost per calorie 135 Total 40.5 3925 $0.010

21. “World Bank” Method: Cost per calorie Caloric value Cost per calorie 50 0.022 200 180 200 240 50 0.007 700 1500 420 250 0.016 135 Mean cost per calorie $0.015

22. “World Bank” Method: Cost of a calorie • Pick a nutrition requirement: • 2100 Kcal per day (NR) • Select a group of households around the poverty line • Usually take 2nd to 5th deciles of expenditure distribution • Calculate the total spending of these households on food (FS). • Calculate the total caloric content of these purchases (TC) • Calculate the cost of a calorie for this group: CC=FS/TC • Calculate the cost of food poverty line as: FPL = NR∙CC=NR∙FS/TC Poverty lines

23. Estimating Cost per Calorie Fourth decile Expected location of povery line Second decile Poverty lines

24. Is the width of the band important? Case of dual prices Price(mean) Price of a calorie/ goods 2.01 2.05 2.45 3.25 5 Supermarket 2 Market Z1 Income

25. Is the width of the band important? Case of multiple prices Price(mean) 3.75 Price of a calorie/ goods 3.65 3.50 3.45 5 Supermarket Local store Street vendor 2 Market Income Z1

26. “World Bank” Method: Lower poverty line • Adjust Food Poverty Line for non-food expenditures • LPL: Select a group of households whose total expenditure is equal (close) to Food Poverty Line • Estimate average share of non-food consumption SLin their total consumption expenditure • Calculate: LPL = FPL/(1- SL) • Example: FPL = $50, SL=0.2 → LPL = $50/(1-0.2)=62.5 Poverty lines

27. “World Bank” Method: Upper poverty line • UPL: Select a group of households whose food expenditure is equal to Food Poverty Line • Estimate average share of non-food consumption in their total consumption expenditure SU • Calculate: UPL = FPL/(1- SU) • Example: FPL = $50, Su=0.35 → UPL = $50/(1-0.35)=76.9 Poverty lines

28. Non-food adjustment diagram Poverty lines

29. Updating poverty lines over time • Once poverty line is established, it is important to update it correctly for the new time period • It is incorrect to recalculate poverty lines every year: by doing that we would use relative poverty lines (similar to urban/rural example) • Two ways to go: • update old poverty line using new prices. That would answer the question: “How many people can afford the old basket now?” • update new poverty line using old prices. That would answer the question: “How many people could afford the new basket in the past?” Poverty lines

30. 4. Practice: Social Subjective Poverty Line Minimum Income Question (MIQ): “What income do you consider to be absolutely minimal, in that you could make ends meet with less?” Poverty lines

31. Practice: Social Subjective Poverty Line • Latent individual welfare Wi: • Derive the Social Subjective poverty line as: • In practice Wican be approximated as: • MIQ (OLS) • Consumption adequacy questions (Ordered Probit) • Economic ladder questions (Ordered Probit) Poverty lines

32. Examples of subjective welfare questions for Jamaica and Nepal • Respondents asked whether their food, housing and clothing expenditures were adequate for their family needs. • The implied subjective poverty lines are robust to alternative methods of dealing with other components of expenditure • The aggregate poverty rates accord closely with the poverty rates based on poverty lines derived with CBN method. • However, the geographic and demographic poverty profiles differ substantially from those based on “objective” poverty lines Poverty lines

33. Poverty rates based on subjective and objective poverty lines: • self rated poverty lines are higher than official poverty lines • subjective poverty rates are also higher than the official (income) poverty rates Poverty lines

34. 5. Recommendations • The WB recommends using objective, absolute poverty lines in developing countries • Usually, several poverty lines are calculated. For example, Lower and Upper poverty lines in the WB method • Always conduct sensitivity analysis. Test the degree to which the results are sensitive to the choice of poverty lines. This can be done by repeating the calculations for different lines and comparing results Poverty lines