Growth and Poverty Reduction: Pro-poor growth?

Growth and Poverty Reduction: Pro-poor growth?

Lecture Outline (i) What is pro-poor growth? (ii) What are the Theoretical Under-pinning of Pro-Poor Growth? (iii) Methodology (iv) Evidence of pro-poor growth? (v) Policies for pro-poor growth: 1970s vs. present?

(i) What is pro-poor growth? Definition of Pro-Poor Growth: “…growth that leads to significant reductions in (absolute) poverty” (OECD 2001, and UN 2000) – italics added in brackets. Too broad for economists since what definition of poverty do researchers use? Kraay (2004) makes this point in his World Bank Working Paper No. 3225, “When is Growth Pro-Poor?”

A basic idea from the works of White and Anderson (2001) and Kakwani and Pernia (2000) is that any increase in growth should benefit the poor more than the rich. This really is “inequality-reducing” growth rather than pro-poor growth – is concerned with relative poverty. The question is, “Should new growth benefit the poor more, thus increasing their incomes and thus reducing inequality, whilst the rest of society sees little income improvement?”

If, ‘Yes’ to this then could have the issue of national income increasing by 5% but income of the poor increasing by 7%: whereas there could be a possibility of growth for the poor of 7% when national income increased by 10%. The poor in the second scenario are absolutely better off, but are relatively worse-off compared to the non-poor: In the first scenario the poor are absolutely worse-off compared to scenario 2, but are relatively better off.

(Q) So which one is better? (A) In poor countries better absolute improvements preferred to relative improvements, at least initially….. Problem with the above ‘inequality-reducing’ scenario is that we do not know whether following an inequality-reducing growth plan will result in lower growth or higher growth. So we want to have improvements in both absolute levels of income (absolute poverty tackled) and relative levels of income (relative income of poor improves and income inequality declines?).

Formalising these issues has been undertaken by White and Anderson (2001) White and Anderson (2001): 3 definitions of pro-poor growth (1) The poor’s share of incremental income exceeds their current share. This means that the incremental increase in the level of income to the poor>incremental increase in the level of income for all of society,

Where the numerator represents change in income of the poor, the denominator is the change in income of society and represents the income share of the poor in the last time period, t-1.

So, There is a relative improvement of the poor. This can be shown diagrammatically,

Changes in Y, between t and t-1 change in Y for non-poor between t-1 and t Y, T growth change in Y for the poor between t-1 and t: If then pro-poor growth. t-1 t Time

The problem with definition (1) is that the poor’s share can increase slightly and the richest 10% or 15% can still cream off much more and this is pro-poor growth. E.g. If poorest 20% have 5% of income and the richest 20% have 40% of income then if in every extra $1 the poorest get 10cents and the richest 30cents then still have PPG. If in the above then White and Anderson (2001, pp. 269) coin the phrase anti-poor growth (APG).

(2) The second definition brings into the equation the share of people in a country who are defined as ‘poor’. Formally, Where the P term represents the share of poor people/households in the country. What the equation is saying is that the increase in the share of the poor’s income>share of the number of poor in the country’s population.

Can be re-arranged so that, These represent average income levels of the poor and of society, and can be further simplified to,

The change in average income of poor>change in average income of society. Problem with definition 2 is that it is too restrictive and under this definition few countries actually have pro-poor growth.

Definition 3 Take an ‘international’ norm of median income shares of the bottom 20% and 40% (can choose any %). Issue here is that “if the poor’s share currently exceeds the international norm then their share of incremental income can be less than their current share and thus qualify as PPG” (ibid, pp. 269).

Another Definition of Pro-Poor Growth: “…focuses on accelerating the rate of income growth of the poor and thus increase the rate of poverty reduction” (Ravallion and Chen, 2003) Pro-Poor Growth = F(GDP growth) Changes in income equality have an ambiguous effect on pro-poor growth since can impact on GDP growth. Thus, if pro-poor growth is to accelerate then need to accelerate growth but also need to enhance and make poor households aware of the opportunities growth generates. Hence there is no one agreed definition of what PPG actually is….hence a huge debate as to whether PPG has occurred or not!!

(ii) What are the Theoretical Under-pinning of Pro-Poor Growth? Gunnar Myrdal in 1920s and 1930s India argued that initial income inequality was an important factor in improving the quality of people and hence productivity. Ravallion and Datt (2002) report larger absolute poverty-household income elasticities in countries with lower gini indices.

(ii) What are the Theoretical Under-pinning of Pro-Poor Growth? The idea here is that any growth that does occur is likely to benefit more people if income inequality is low in the first place. (Q) So what then determines income inequality? Assets – particularly land in LDCs Education Networks Rural-Urban Property Rights, Legal System

(ii) What are the Theoretical Under-pinnings of Pro-Poor Growth? Cont… The 1970s… In the 1970s the ‘Redistribution with Growth’ development economists believed in the inverted-U hypothesis of Kuznets. Kuznets inverted-U of growth and inequality: Stage 1: low per capita income level, low income inequality. Stage 2: per capita income increases with development, income inequality rises. Stage 3: gets to a point where per capita income increases with continued development, income inequality declines.

Evidence from Ahluwalia (1976) supports the Kuznets hypothesis, by simply regressing inequality onto income and income-squared: He found that as economic growth increased so income inequality increased ( ) but at a decreasing rate ( ): however unsure where the turning point is! Growth Growth Inequality Leads to

The Redistribution with Growth economists argued (in line with Kaldor’s growth model) that inequality caused growth since the rich had a higher marginal propensity to save. Also Lewis’s model of economic development with unlimited labour supply was consistent with rising income inequality through profits of entrepreneurs growing more quickly than wages.

Empirical Rejection of Kuznets, 1980s-1990s… Rejected in Bruno, Ravallion and Squire, (1996) since much of the empirical evidence of the 1970s and 1980s was flawed, and studies were actually capturing between-country effects not within-country effects. By using panel estimates country-specific effects, time effects and joint country and time effects are captured and the Kuznets U-shaped curve disappears. Studies find that between-country effects are causing the inverted-U shape and that for some countries (e.g. India) the relationship between inequality and income is simply U-shaped: Inequality high, then low, then high again as growth increases. Bruno, Ravallion and Squire (1996) Equity and Growth in Developing Countries, Policy Research Working Paper No. 1563, World Bank. Available online via google books

Currently whilst the theoretical debate continues as to whether economic growth causes income inequality to change, the empirical evidence is stacking up against a correlation in the first place. E.g. Deininger and Squire (1996), Chen and Ravallion (1997), Easterly (1999), Dollar and Kraay (2002) and Deaton (2005). According to Fields (1989, 2001), Method should be looking at country-specific analysis – when Fields (1989) looked at 70 growth spells across 20 countries he found that inequality rose in 10 countries, decreased in 11 and remained unchanged in 1. “…income inequality increased in about half the growth spells and declined in the other half.” (World Bank, 2005, pp.17)

New Theories of Pro-Poor Growth? Initial income inequality feeds into poor growth or greater income equality positively affects growth rates. Based largely on the conflicting progress of East Asia (e.g. South Korea and Taiwan) and Latin America. Latin America: notoriously unequal in income distribution (Brazil regularly found to have the highest Gini coefficient). High Initial Inequality Low Growth

This means that any growth benefits the rich only and tends to be skills-biased and capital intensive, thus the poor have no chance of getting a piece of the expanding pie: relative poverty increasing. The income inequality also means that consumption is relatively low since the rich have low MPC which negatively effects AD and growth.

East-Asia growth of the 1960s and beyond has seen no conflict between growth and income distribution, meaning income inequality remains constant as growth increased. (Q) Is there a theory that can explain this? (1) The mechanism given for this ‘income inequality-neutral’ path is that low initial income inequality results in more evenly distributed economic growth. The reason is that consumption expenditure patterns are similar amongst the poor for goods which they themselves produce hence generating demand for these labour-intensive products: hence mass consumption takes off rather than consumption being driven by the minority. (2) Also the case that savings of the poor can be channelled if appropriate investment opportunities are in evidence.

(iii) Methodology Dominant Method - Cross-Country Studies (Time Series and Panels). Has growth affected absolute poverty, relative poverty and been pro-poor or not.

Method I – Cross-Country Studies White and Anderson (2001): find a negative relationship between growth and income growth of the poor: i.e. growth negatively effects the portion/share of income the poorest of the population get.

Back to the pro-poor question and for this see White and Anderson (2001) Regress changes in income of the poor as a share of changes in total income of country, and changes in share of income of the poor, onto a number of regressors that include, change in GDP per capita, change in trade openness dummy, change government expenditure as share of GDP, change in political rights and civil liberties, and change in life expectancy. Why 2 dependent variables? Dependent variable 1 can be affected by outliers represented by large changes in incomes of the poorest groups when total income for the country has increased. Changes in the poor’s share of income gets around this issue.

White and Anderson (2001) – (cont…) Find that variations in the poor’s share of incremental income (Dependent variable 1) is very large for growth rates<4% some incremental shares are negative and very large. Confirms our expectations. However using dependent variable 2 find that,

Regression results for Change in Share of Income (poorest 40% and poorest 20% - t-tests in brackets DQ40 DQ20 Constant -0.001 0.000 (-0.76) (-0.40) Growth (if improves) -0.056 -0.011 (-2.03) (-1.03) Change in Political Freedom (if worsens) -0.006 -0.002 (-1.97) (-1.53) Trade Openness (-0.94) (-1.30) Change in Urban (more urbanisation) 0.003 0.002 (2.41) (3.41) Change in life expectancy (greater life expectancy) (-1.85) (-1.57)

Note: (1) Positive coefficient means an increase in the explanatory variable will have a positive impact on the poor’s share of GDP, i.e. improve the poor’s share of GDP Find that growth negatively impacts on the poor – only the poorest 40% though. Implication is there is a trade-off between growth and distribution which contradicts World Bank thinking. Less political freedom bad for the poor. Increased urbanisation good for the poor

Dollar and Kraay (2002, 2004): find a positive relationship between growth and growth of incomes of the poor. The Model The key thing is the coefficient on This represents the elasticity of income of the poorest quintile with respect to mean income. Control for 4 policy interventions that are likely to positively contribute to PPG: (1) primary educational attainment (2) public spending on health and education, (3) labour productivity in agriculture relative to rest of economy and (4) formal democratic institutions. Find none of these factors impact on PPG in their cross-country survey.

That the coefficient on log GDP of the country is NOT significantly different from 1…..NO evidence that % change in GDP is different from % change in GDP of poorest 20%. They cannot “reject the hypothesis that incomes of the poor on average rise equiproportionately with average incomes” (pp. 198), See next slide for Table 5 that confirms this.

Growth and Poverty Reduction: Pro-poor growth
Growth and Poverty Reduction: Pro-poor growth? Figure 4, Dollar and Kraay (2004).

Finds that changes in inequality and changes in income are not correlated. (Word of warning given by authors and by others is that cross-country comparisons are subject to a lot of measurement error and that country-specific studies are required for a clearer picture – What the World Bank has done). Dollar and Kraay (2004), Economic Journal paper in special edition of linkages between trade, development and poverty.

Whilst not explicitly looking at income inequality Dollar and Kraay findings are consistent with headcount poverty declining more in those countries with more equitable distributions of income. Example from Klasen (2003). Since Dollar and Kraay are looking at proportionate income changes of the average and the poorest quintile then clearly if income inequality is lower in a country then the proportionate increase in income will lead to a greater reduction in absolute poverty.

Barro (2000) tests the Kuznets hypothesis again with a panel of countries. Regresses growth rate per capita output onto variables that theoretically are predicted to determine growth, e.g. log of per capita GDP, rule-of-law index, democracy (or freedom) index, investment/GDP, years of schooling. Then includes a gini coefficient index.

Model 1 Model 2 Model 3 Growth rate is the dependent variable here. When the gini index is introduced linearly there is no relationship with growth (0.000) – Model 1. When the gini index is interacted with log(GDP) – a proxy for economic development – then we see a negative relationship between income inequality and growth (-0.328) but that when log(GDP) is higher the relationship is actually positive (0.043) – Model 2. Implication is that at lower levels of log(GDP) income inequality does significantly impact on growth rates.

Barro also finds evidence that Kuznets curve is alive and kicking. Income inequality first increases and then decreases with economic development (log(GDP)). However log(GDP) is not explaining the majority of the variation in income inequality across countries or across time.

Summary Still no consensus. Some find that changes in income are not correlated with changes in inequality means that any growth in income does not appear to have any impact on inequality and impacts positively on absolute poverty, (see Fields, 1989 and 2001). Dollar and Kraay (2002) find that growth of the country positively effects growth of income of the poor – implication is that growth is thus crucial for reducing absolute poverty and the number of absolutely poor. White and Anderson (2001) find that when dependent variable takes a ‘relative’ form that growth negatively effects the share the poorest in a country have of GDP. Barro (2000) finds that income inequality can impact on growth rates of very poor countries only.

(V) Policies for pro-poor growth? Killick (2002) mentions a wish list that would enhance pro-poor growth: (1) Land reform – NOT land grab. (2) Improved access by the poor to education and health - public sector, or public-private partnership? (3) Micro-credit schemes targeted on the poor – charity or public sector since is too risky for private sector to invest in! (4) Adoption of labour intensive techniques in production (5) Agricultural and rural development – very broad (6) Government expenditure on education and health - public sector? (7) Avoidance of macroeconomic crises – external factors that cannot be avoided, e.g. sustained food price increases caused by emerging economies changing their diet. (8) Investment in rural infrastructure – public sector, or public-private partnership? (9) Labour-intensive industrialisation

World Bank Report, pp.74. For Agriculture: Investments in infrastructure to connect the poor, e.g. telecommunications, roads, public transport. Strengthen property rights notably of women particularly regarding land Create incentive frameworks that do NOT discriminate against those economic activities the poor are already undertaking Improve technology for food-producers so can protect crop. Essential given urban food demand increases. Help poor households reduce and cope with risk which could encourage greater risk with more high-yielding crops – (Q) Are poor households risk-averse in gambling when times are good and risk-taking when times are bad?

For Non-agricultural poor: Designing labour market rules and regulations that “balances workers’ needs with employers’ needs”, (ibid, pp. 75) – is an issue in many Latin American countries where trade unions are strong, also the case in South Africa. Access to secondary and girls’ education important for poor households given the growing skill bias in non-agricultural employment – “falling fertility rates and rising female labor market participation is essential in a pro-poor growth strategy” (ibid, pp. 75). Quality of investment climate (assumed to be determined by macro and trade environment, as well as degree of labour market regulation) determine quantity and quality of employment. Improved infrastructure for the poor.

Factors that affect the success/failure of these World Bank policies include: Initial income and asset inequality – if high then can have negative impact on pro-poor growth. Must re-distribute…but how? Land reform not land grab, transfer payments in the form of state pensions to the poor. Importance of agriculture to the poor. Need to improve the efficiency of agriculture (e.g. technology, co-operatives, training, access to financial markets). Since agriculture is affected by climactic conditions there needs to be a risk management structure in place to protect poor farmers but which do encourage more risk-taking – (Q) Are poor farmers likely to be risk-takers? Delivery of services and capacity of institutions to deliver to the poor – issue of corruption.

References Dollar, D., and Kraay, A., (2002), “Growth is Good for the Poor”, Journal of Economic Growth, Vol 7, pp Fields, G., (1989) “Changes in Poverty and Inequality in Developing Countries”, World Bank Research Observer 4(2), Fields, G., (2001) Distribution and Development: A New Look at the Developing World, MIT Press. Kakwani and Pernia (2000) “What is pro-poor growth?”, Asian Development Review, Vol 18(1), 1-16. OECD 2001 “Rising to the Global Challenge: Partnership for Reducing World Poverty.” Statement by the DAC High Level Meeting, April 25-26, Paris Ravallion and Chen (2003) “Measuring Pro-Poor Growth.” Economic Letters Vol 78(1), p3-99. White and Anderson (2001) “Growth vs Redistribution: Does the pattern of growth matter?.”, Development Policy Review, Vol 19(3), World Bank, (2005), Pro-Poor Growth in the 1990s Lessons and Insights from 14 Countries.

Growth and Poverty Reduction: Pro-poor growth?

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Growth and Poverty Reduction: Pro-poor growth?

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