1. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 5 Poverty, Inequality, and Development

2. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-2 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?

3. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-3 The Growth Controversy: Seven Critical Questions 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?

4. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-4 Measuring Inequality and Poverty Two principal measures of income distribution: Personal or size distribution of income Functional or distributive factor share distribution of income

5. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-5 Measuring Inequality and Poverty Size Distributions: A common method: quintiles or deciles A common measure: ratio of the incomes received by the top 20% and bottom 40% (called Kuznets Ratio) Lorenz curve and Gini concentration ratio or Gini coefficient

6. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-6 Table 5.1 Typical Size Distribution of Personal Income in a Developing Country by Income Shares—Quintiles and Deciles

7. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-7 Figure 5.1 The Lorenz Curve

8. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-8 Figure 5.2 The Greater the Curvature of the Lorenz Line, the Greater the Relative Degree of Inequality

9. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-9 Figure 5.3 Estimating the Gini Coefficient

10. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-10 The Gini Coefficient G: 0, perfect equality, to 1, perfect inequality Highly unequal: between 0.5 and 0.7 Relatively equal: 0.2 to 0.35

11. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-11 Figure 5.4 Four Possible Lorenz Curves

12. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-12 Lorenz Criterion One Lorenz curve lies above another Lorenz curve, the economy corresponding to the upper Lorenz curve is more equal than that of the lower curve, e.g. A and D. Whenever two Lorenz curves cross, e.g. B and C, we need more information or additional assumptions. E.g. on “poverty” ground: curve B represents a more equal economy. But others, might select C on the ‘middle class ground”.

13. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-13 Measuring Inequality and Poverty Functional Distributions : The share of total national income that each of the factors of production (land, labor, and capital) receives

14. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-14 Figure 5.5 Functional Income Distribution in a Market Economy: An Illustration

15. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-15 Measuring Inequality and Poverty Measuring Absolute Poverty – Headcount Index = H/N = %age of the poor – Total poverty gap: aggregate shortfall of all the poor from the specified poverty line – WhereY p is the absolute poverty line – Y i is income of person i – H = no. of the poor; and N= no. of the population

16. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-16 Figure 5.6 Measuring the Total Poverty Gap

17. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-17 Measuring Absolute Poverty – Average poverty gap (APG) = TPG/N – Average income shortfall (AIS) = TPG/H, the average amount by which the income of a poor person falls below the poverty line

18. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-18 Measuring Absolute Poverty – Normalized poverty gap (NPG)=APG/Y p = TPG/(NY p ), the fraction of the total income needed to support all people living at the poverty line, lies between 0 and 1. – Normalized income shortfall (NIS)= AIS/Y p = TPG/(HY p ), poverty gap ratio, denoting the percentage shortfall of the average income of the poor from the poverty line

19. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-19 Measuring Absolute Poverty – Foster-Greer-Thorbecke measure

20. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-20 Measuring Absolute Poverty Foster-Greer-Thorbecke measure P 0 = (1/N) H = H/N, poverty incidence P 1 = 1/N (TPG/Y p ) = NPG, poverty gap P 2 = (H/N) [NIS 2 + (1-NIS) 2 (CV p ) 2 ], poverty severity CV p = Coefficient of Variation of incomes among the poor

21. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-21 Measuring Absolute Poverty – The Human Poverty Index (HPI) Deprivations of: life basic education overall economic provisioning

22. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-22 Poverty, Inequality, and Social Welfare What’s so bad about inequality? – Extreme inequality leads to economic inefficiency – Extreme income disparities undermine social stability and solidarity – Extreme inequality is considered unfair.

23. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-23 Poverty, Inequality, and Social Welfare Dualistic development and shifting Lorenz curves: some stylized typologies – Traditional sector enrichment (see Figure 5.7) all benefits of growth are divided among traditional- sector workers, less poverty inequality would fall steadily focused on achieving substantial reductions in poverty Sri Lanka

24. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-24 Poverty, Inequality, and Social Welfare – Modern sector enrichment (see Figure 5.8) growth is limited to a fixed number of people in the modern sector higher income, less equal relative distribution of income, no change in poverty Many Latin American and African economies

25. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-25 Poverty, Inequality, and Social Welfare – Modern sector enlargement (see Figure 5.9) absolute incomes rise absolute poverty reduced Lorenz curves will always cross, if this type is predominant, inequality worsens before getting better

26. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-26 Figure 5.7 Improved Income Distribution under the Traditional-Sector Enrichment Growth Typology

27. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-27 Figure 5.8 Worsened Income Distribution under the Modern-Sector Enrichment Growth Typology

28. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-28 Figure 5.9 Crossing Lorenz Curves in the Modern-Sector Enlargement Growth Typology

29. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-29 Poverty, Inequality, and Social Welfare Kuznets’ inverted-U hypothesis “In the early stages of economic growth, the distribution of income will tend to worsen; only at later stages it will improve.”

30. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-30 Figure 5.10 The “Inverted-U” Kuznets Curve

31. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-31 Table 5.2 Selected Income Distribution Estimate

32. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-32 Table 5.3 Income and Inequality in Selected Countries

33. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-33 Figure 5.11 Kuznets Curve with Latin American Countries Identified

34. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-34 Figure 5.12 Plot of Inequality Data for Selected Countries

35. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-35 Poverty, Inequality, and Social Welfare Growth and inequality higher growth rates do not necessarily worsen the distribution of income the character of economic growth (how it is achieved, who participates, which sectors are given priority, etc) that determines the nature of the distributional benefits

36. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-36 Figure 5.13 Long-Term Economic Growth and Income Inequality, 1965-1996

37. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-37 Figure 5.14 Change in Inequality in Selected Countries, with or without Growth

38. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-38 Absolute Poverty: Extent and Magnitude Extreme Poverty – $1-a-day headcount shows some progress – Incidence of extreme poverty is uneven

39. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-39 Table 5.4 Regional Poverty Incidence, 2004

40. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-40 Table 5.5 Poverty Incidence in Selected Countries

41. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-41 Table 5.5 Poverty Incidence in Selected Countries (continued)

42. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-42 Absolute Poverty: Extent and Magnitude Growth and poverty – Complementarity – Five reasons, policies focusing toward reducing poverty levels need not lead to a slower rate of growth (i)Reducing poverty, improving access to credit (i) The rich in current poor countries are generally not noted for becoming ‘capitalist’ (i) Raising incomes and levels of living of the poor would also contribute to productivity and income of the economy as a whole

43. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-43 Absolute Poverty: Extent and Magnitude Growth and poverty (iv) Raising incomes of the poor will stimulate the demand for locally produced goods (v) Reduction of mass poverty can stimulate healthy economic expansion by acting as a powerful material and psychological incentive to widespread public participation

44. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-44 Economic Characteristics of Poverty Groups Rural Poverty Women and poverty (See chapter 8 for more detail) Ethnic minorities, indigenous populations, and poverty

45. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-45 Table 5.6 Poverty: Rural versus Urban

46. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-46 Table 5.7 Indigenous Poverty in Latin America

47. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-47 The Range of Policy Options: Some Basic Considerations Areas of intervention – Altering the functional distribution – Mitigating the size distribution – Moderating (reducing) the size distribution at upper levels – Moderating (increasing) the size distribution at lower levels

48. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-48 The Range of Policy Options: Some Basic Considerations Policy options – Changing relative factor prices – Progressive redistribution of asset ownership – Progressive taxation – Transfer payments and public provision of goods and services

49. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-49 Summary and Conclusions: The Need for a Package of Policie s Policies to correct factor price distortions Policies to change the distribution of assets, power, and access to education and associated employment opportunities Policies of progressive taxation and directed transfer payments Policies designed to build capabilities and human and social capital of the poor

50. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-50 Case Study: Bangladesh

51. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-51 Concepts for Review Absolute poverty Asset ownership Character of economic growth Deciles Disposable income Elasticity of factor substitution Factor-price distortions Factor share distribution of income Factors of production Foster-Greer- Thorbecke (FGT) index Functional distribution of income

52. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-52 Concepts for Review (cont’d) Gini coefficient Headcount index Human Poverty Index Income inequality Indirect taxes Kuznets curve Land reform Lorenz curve Neoclassical price- incentive model Personal distribution of income Poverty gap Progressive income tax

53. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-53 Concepts for Review (cont’d) Public consumption Quintiles Redistribution policies Regressive tax Size distribution of income Subsidy Workfare programs

54. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-54 Appendix 5.1: Appropriate Technology and Employment Generation: The Price Incentive Model Choice of techniques Factor Price distortions and appropriate technology Possibilities of Labor-Capital substitution

55. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-55 Figure A5.1.1 Choice of Techniques: The Price Incentive Model

56. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-56 Appendix 5.2: The Ahluwalia-Chenery Welfare Index Constructing poverty-weighted index of social welfare

57. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 5-57 Table A5.2.1 Income Distribution and Growth in the Twelve Selected Countries