Income Inequality and Poverty

1. Income Inequality and Poverty Chapter 18 1

2. Poverty is local problem • Anti-Programs often financed locally • Relative poverty defined locally • People tend to congregate by income group • Interjurisdictional competition may favor high-income people over the poor 2

3. Poverty defined • Households maximize utility given constraints • Financial constraints • Lack of time • Imposed by society • Imposed by oneself • Poverty is insufficient command over resources 3

4. Budget constraint for a low-income household 4

5. Causes of Poverty • Side effects of choices of individuals to maximize their utilities • Insufficient human capital • Preference for psychic income • Myopic behavior of dysfunctional individuals • Drug or alcohol abuse • Limited opportunities • Poor parents, teen mothers • Antipoverty programs themselves. • Welfare dependency • Unintended consequences of programs 5

6. Income distributions • Functional distribution: based on allocation of a firm’s revenue • Euler’s theorem: in perfectly competitive markets, Wage = MRPLabor, Interest=MRPCapital,Land rent =MRPland. Remainder = normal profit • Size distribution: proportion of income units in each income group • Income Unit: individual, family, household 6

7. Components of Income • Included • Earned income • Cash transfer payments • Ignored • Imputed rent (the opportunity cost of living in one’s own home) • Unearned income (inheritances, insurance payments, capital gains, household production) • Taxes or in-kind transfers • Regional cost-of-living differences 7

8. Appropriate Time Length • Appropriate time length to measure a flow of income? • Monthly—may be too short (Professors on 9-month contract on government assistance for 3 months??) • Annual—may ignore income mobility of entrepreneurs in volatile industries • Lifetime earnings—may be too long (after funeral) 8

9. Measuring income inequality • Lorenz curve measures the cumulative proportion of the population on the horizontal axis and a cumulative measure of income or wealth on the vertical axis. • Perfect equality: Lorenz curve is 45° line • Perfect inequality: Lorenz curve is backward L along horizontal line and right axis 9

10. Lorenz curves 10

11. Gini Coefficient • A is the area between the line of perfect equality and the Lorenz curve under study. • B represents the area below the Lorenz curve but above the curve of complete inequality. • 0  Gini coefficient  1: • G = 0 for curve of perfect equality (since A = 0). • G = 1 for complete inequality (since B = 0). 11

12. Using Gini • When regions with smallest coefficients are praised, the research implies that equality is optimal. • Incentive for excellence? • Diminishing social marginal utility of income (Fear that a minority group improves financially at expense of majority) 12

13. Setting poverty lines • Absolute poverty: one is poor if the income is insufficient to cover the most elementary survival needs. • Benefit: can compare the extent of poverty over time or space. • Problem: define “survival need,” • Poverty cut-offs necessary; Being poor is an answer to a true/false question. • Relative poverty : arbitrarily defines the lowest percentage of the income distribution or of median income as the poverty line. • A person’s needs are relative to what others in their society have. 13

14. Setting absolute poverty line in U.S. • Minimum cost of adequately nutritious diet multiplied by 3 to account for all other expenses. • Problems: • No minimum required caloric intake to fit everyone. • Current surveys show that poor spend lower proportion of their income on food than before • Components of threshold level of income have not changed since 1965 • Equivalence scales: the incremental cost of maintaining various sizes of income units. 14

15. Equivalence Tables • Current equivalence tables found at http://www.census.gov/hhes/www/poverty/threshld.html 15

16. Defining Relative Need • Arbitrarily define some proportion of median income as poverty line • Based on survey of society’s concept of “need.” 16

17. Minimum Income • The Minimum Income Question : • “What do you consider as an absolute minimum net income for a household such as yours? We should like to know an income amount below which you wouldn’t be able to make ends meet. • “About ______________ per week/month/year. • Please underline the length of time you refer to.” 17

18. Income Evaluation • Income Evaluation Question is worded: • “In the circumstances of your household, which monthly disposable income would you regard as 18

19. Perception of adult necessities • One link to the survey is: http://news.bbc.co.uk/2/shared/spl/hi/programmes/more_or_less/transcripts/annex.txt 19

20. Poverty indices • Ideal index has two characteristics • Allows comparisons across space and over time. • A proportionate change in all incomes should not affect regional cost of living index • Head count: proportion of people living below the poverty line • Depth of poverty: measures the additional income necessary to move an income unit up to the poverty line. • Poverty gap: aggregation of individual differences between each one’s income and the respective poverty line 20

21. Measuring the depth of poverty • Welfare ratio: ratio of family’s income to its poverty threshold • Income deficit (surplus): how many dollars a family or household’s income is below (above) its poverty threshold 21

22. Comparing localities • Deprivation index measures the size a locality’s disadvantage relative to that of some benchmark (county, state, or nation) that includes that locality. • No standardized index. 22

23. Deprivation Index (Fieldhouse and Tye) • Group 1: • Lacking access to bath or shower; • Lacking access to an inside toilet; • Living in non-self-contained accommodations. • Group 2: • Lack of access to car; • Living in a household where no person is in paid work (reflects lack of resources); • Living in a rented accommodation; • Living in a house with no central heating. 23

24. Deprivation Index (Fieldhouse and Tye) • Group 3: • Living in a household with more than one person per room (measures overcrowding); • Being unemployed, or being in a family whose head is unemployed. 24

25. Who are the poor? • Child poverty • Long-run: childhood poverty affects health and educational attainment • Success of adults is closely related to their parent’s educational achievement • Poor physical environment increases probability of serious illness • Family structure • Lone mothers (feminization of poverty) • Large families • Young mothers • Racial differences • Discrimination 25

26. Discrimination • Exists if a person receives lower wages than others who have the same experience, education, and training. • Types of discrimination: • employer discrimination, • employee discrimination, • customer discrimination, and • statistical discrimination 26

27. Employer discrimination • Becker: Firms that do discriminate must have some market power. They are willing to forgo some profits to exercise their “taste for discrimination.” • Less employer discrimination in urban areas with many different employment opportunities than in rural areas with monopsony labor markets. 27

28. Employer Discrimination 28

29. Employee discrimination • Employees perceive that a certain group of potential workers are incompetent and refuse to work with them. • North Country Trailer: • http://www.youtube.com/watch?v=7E_ifqj1rAQ 29

30. Customer Discrimination • A firm’s customers refuse to be served from a certain type of employee. • Women in auto parts stores, • Women mechanics, • Males in housewares 30

31. Statistical Discrimination • Employers use gender and race as low-cost screening devices to find the most reliable person for the job. • Illegal according to Title VII of the Civil Rights Act of 1964 to compensate, limit, segregate, or in other ways classify employees because of statistical patterns. 31

32. Urban Underclass • Wilson (1987): asserted that some people are poor because they choose a way of life that keeps them poor. • Dysfunctional behavior is Intergenerational • Voluntary joblessness, • Criminal behavior • Welfare dependency. • Single-parent families, • Out-migration of middle-class role models isolates “hard core” poor 32

33. Urban Underclass • Controversial Theory: • Difficult to define. • How do we explain why it mainly pertains to African-American males? • Massey and Denton (1993), Leonard (1998) or Sánchez-Jankowski (1999) could not empirically support the hypothesis that an underclass exists. 33

34. Attitudes, Self-Worth, Incentives • Akerlof and Kranton: explain success or failure by the person’s sense of self and interdependent utility functions. • Lack of self-confidence imposes undue constraints keep people poor. • Concern about reactions of others limits choice set. 34

35. Attitudes, Self-Worth, Incentives • Interdependent utility functions exist when one person chooses to link his or her welfare with the action of others. • Parents’ utility depends on the success or failure of their child • Some students harass their classmates for getting good grades, because the classmates’ success devalues the harassers’ utility. 35

36. Attitudes, Self-Worth, Incentives • In general, members of a minority that identify with the dominate culture and succeed are threats to those who refuse to identify with the dominate culture. • The minorities who succeed by the rules of the dominate culture also threaten less successful members of that. 36

37. Poverty Dynamics • Temporary poverty • Regional business cycles • Long-term poverty • Illness and disability • Structural unemployment when human capital investment seems impractical • Discrimination • Attitudes, lack of self-confidence 37

38. Obstacles to Income Mobility • From education system • Inadequate funding because of low tax base • From labor market • Discrimination • Impact of business cycles inconsistent over time, space, and quintiles of income distribution 38

39. Fight against Poverty • Four components of current welfare system in US • Food Stamps • Medical Assistance • Temporary Assistance for needy families (TANF) • Earned Income Tax Credit (EITC) 39

40. Income distribution policies • May be public good because of a potential free-rider problem. • Individuals migrate toward jurisdictions whose public policies maximize their own well-being (Tiebout hypothesis). • Areas that try to help “their” poor attract new poor households. 40

41. Income distribution policies • However, public giving is not optimal. • Public redistribution efforts crowd out private giving. • Public giving provides smaller psychic benefits (warm glow) to the taxpayer-donor than private giving does. • Okun’s leaky bucket: $9.51 to government increases disposable income of poor by $1 41

42. Welfare to Work • Prevailing explanations of the causes of poverty and unemployment: • if you pay people to be inactive there will be more inactivity. • Welfare-to-work policies now in effect in the US, the UK, Australia, and New Zealand. 42

43. Welfare to Work • Clinton Welfare Reform act: Personal Responsibility and Work Opportunity Reform Act of 1996 (PRWORA) • Returned welfare to state control, with partial federal funding through largely unrestricted block grants and various types of welfare-to-work policies. • Emphasized marriage and child support to discourage out-of-wedlock pregnancies and to encourage formation of two-parent families. 43