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Chapter 5. Poverty, Inequality, and Development. 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?
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Chapter 5 Poverty, Inequality, and Development
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 greater income inequality? • Do the poor benefit from growth? • Are high levels of inequality always bad? • What policies can reduce poverty?
Measuring income inequality and poverty Two Measures of Income Distribution: • Personal (size) distribution of income. • Functional (factor share) distribution of income.
Measuring income inequality and poverty Personal (size) distribution of income: • Focuses on individual households and total incomes they receive • Does not consider the way in which such incomes are earned • Divides population into quintiles (fifths) or deciles (tenths) with respect to income levels to determine what proportion of national income is received by each group
Table 5.1: Typical size distribution of personal income in a developing country by income shares-quintiles and deciles
Measures of Income Inequality 1. Kuznet’s Ratio: • Ratio of incomes received by top 20 percent to incomes received by bottom 40 percent of the population. • The larger the Kuznet’s ratio the more unequal the income.
Measures of Income Inequality 2. Lorenz Curve: • Shows the actual quantitative relationship between percentage of income recipients and percentage of national income they receive. • The more the Lorenz curve shifts away from the line of equality the greater the degree of income inequality.
Figure 5.2: The Greater the curvature of the Lorenz line, the greater the relative degree of inequality.
Measures of Income Inequality 3. Gini Coefficient: • Ratio of the area between the line of equality and the Lorenz curve to the total area of the half square in which the Lorenz curve lies. • Varies between 0 (perfect equality) and 1 (perfect inequality). • The larger the Gini coefficient the more unequal the income.
Measuring income inequality and poverty Two Measures of Income Distribution: • Personal (size) distribution of income. • Functional (factor share) distribution of income.
Measuring income inequality and poverty Factor share distribution of income: • National income equals the sum of: • total wages received by the entire labor force. • total rents received by all land owners. • total profits received by all physical capital owners. • total interest payments to all financial capital owners. • Determines the share of total (national) income that each factor of production (i.e. land, labor, capital) receives.
Figure 5.5: Functional income distribution in a market economy: an illustration.
Measuring income inequality and poverty Factor share distribution of income: How to calculate total income received by a certain productive factor (i.e. labor)? • Observe demand and supply curves to determine the unit equilibrium price and quantity of each factor. • Multiply unit price by quantity employed to calculate the total amount paid to each factor.
Measuring Income Inequality • Kuznet’s ratio. • Lorenz curve. • Gini coefficient.
Measuring Poverty Absolute Poverty: • Number of people who are unable to obtain sufficient resources to satisfy basic needs (i.e. food, clothing, shelter) • Those who live below a specific minimum income level (i.e. international poverty line)
Measuring Poverty 1. Headcount Index: • Headcount index equals the number of those whose incomes fall below the absolute poverty line (i.e. 1$ / day or equivalently 365$ / year). • headcount index equals the headcount taken as a fraction of the population (i.e. H/N). • The larger the headcount index the greater the fraction of society living in absolute poverty.
Measuring Poverty 2. Total Poverty Gap: Measures the total amount of income required to raise everyone who is below the poverty line up to that line. Total poverty gap is a more comprehensive measure of absolute poverty than headcount index. 5-19
Measuring Poverty 3. Human Poverty Index (by UNDP): • Human poverty should be measured in terms of three key deprivations: • Of life (fraction of people unlikely to live beyond 40 years of age). • Of basic education (percentage of adults who are illiterate). • Of economic provisions (percentage of people without access to safe water and percentage of children who are underweight for their age).
Measuring Poverty 3. Human Poverty Index (by UNDP) • Human poverty index measures the fraction of the population that is adversely affected by three key deprivations. • In comparing two countries, the smaller the value of HPI the better.
Measuring Inequality and Poverty Measuring Absolute Poverty: • Total poverty gap. • Where Yp is the absolute poverty line. • Yi is income of person I.
Measuring Inequality and Poverty Measuring Absolute Poverty • Average poverty gap • Where H is number of persons • TPG is total poverty gap
Measuring Inequality and Poverty Measuring Absolute Poverty: • Foster-Greer-Thorbecke measure.
Poverty, inequality, and social welfare • What’s so bad about 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).
Figure 5.7: Improved income distribution under the traditional-sector enrichment growth typology
Figure 5.8: Worsened income distribution under the modern-sector enrichment growth typology.
Figure 5.9: Crossing Lorenz Curves in the modern-sector enlargement growth typology
Poverty, Inequality, and Social Welfare Kuznets’ Inverted-U Hypothesis: • In early stages of economic growth, distribution of income tends to worsen (gap between rich and poor widens). • Only at later stages of growth, income distribution will improve (gap narrows).
Poverty, Inequality, and Social Welfare Kuznets’ Inverted-U Hypothesis: • Validity of inverted-U hypothesis is an empirical question (data). • Empirical results are ambiguous.
Figure 5.11 Kuznets curve with Latin American countries identified
Poverty, Inequality, and Social Welfare • Growth and inequality
Figure 5.13: Long-term economic growth and income inequality (1965-1996)
Figure 5.14: Change in inequality in selected countries, with or without growth
Absolute Poverty: extent and magnitude Extreme Poverty: • $1-a-day headcount shows some progress. • Incidence of extreme poverty is uneven.
Growth and Poverty Main Question: • Are the reduction of poverty and economic growth conflicting objectives? • Two lines of thought: Traditional View. Alternative View.
Growth and Poverty Traditional View: Poverty reduction and growth are incompatible goals. • Public expenditures necessary for the reduction of poverty* lead to reduced growth rates via lower public savings. • Income / asset redistribution from rich to poor generates slower growth via lower private savings. • Poor tends to spend additional income on primary needs* rather than save it.
Growth and Poverty Alternative View: Poverty reduction and growth are complementary objectives. • Widespread poverty creates conditions in which the poor have No access to credit. • No credit No home / car / tuition loans Lower aggregate demand.
Growth and Poverty Empirical Evidence: • Data favor the alternative view. • China experienced high growth rates and large reductions in extreme poverty. • Headcount index fell from 64 percent to 10 percent.
Economic characteristics of poverty groups Four main generalizations about the poor: • Disproportionately located in rural areas. • 80% of poor in Asia and Africa live in rural areas. • Primarily engaged in agricultural and related activities. • Two thirds of the world’s poor earn their living from agriculture either as small-scale farmers or low-paid farm workers.
Economic characteristics of poverty groups. Four main generalizations about the poor: • More likely to be women and children than adult males. • Women and children are more likely to be malnourished and less likely to receive medical services, clean water, and sanitation benefits. • Heavily concentrated among ethnic minorities or indigenous populations. • Being indigenous raises the chances that an individual will be undernourished, illiterate, unemployed, and in poor health.
