Chapter 5 Poverty, Inequality, and Development

Chapter 5 Poverty, Inequality, and Development

Background Extreme poverty remains widespread in the developing world. More than 1.2 billion people live on less than $1 per day at PPP, More than 2.8 billion, almost half the world s population, live on less than $2 a day. They suffer from undernutrition and poor health; have little or no literacy; live in environmentally degraded areas; have little political voice; and attempt to earn a meager living on small and marginal farm lands or in dilapidated urban slums. 5-2

Background Need to grow GNI but question is who to make it grow? The few or the many? Has implication for poverty and inequality. Many developing countries that had experienced relatively high rates of economic growth by historical standards discovered that such growth brought little in the way of significant benefits to the poor. 5-3

Background Elimination of widespread poverty and high and growing income inequality are at the core of all development problems. International initiatives at various times to eliminate poverty and inequality: Example; the MDGs. 5-4

Economic Growth, Income Distribution and Poverty: 7 Critical Questions 1. What is the extent of relative inequality, and how is this related to the extent of poverty? 2. Who are the poor, and what are their characteristics? 3. Who benefits from economic growth? 4. Does rapid growth necessarily cause greater income inequality? 5. Do the poor benefit from growth, and how much? 6. Are high levels of inequality always bad? 7. What policies can reduce poverty? 5-5

Measuring Inequality and Poverty Measuring Inequality Two principal measures: size (personal) and functional (factor share) distributions. Size distribution of income deals with individual persons or households and the total income they receive. Arrange individual or households by ascending incomes and then the total population is divided into distinct groups or sizes. Quintiles, deciles. Kuznets ratio - ratio of the incomes received by the top 20% to the bottom 40%. 5-6

Table 5.1 Typical Size Distribution of Personal Income in a Developing Country by Income Shares Quintiles and Deciles 5-7

Measuring Inequality and Poverty Lorenz Curve Using data from Table 5.1, we plot the number (cumulative percent) of income recipients on the horizontal axis and the cumulative percent (share) of total income received by each percentage of the population on the vertical axis. The Lorenz curve shows the actual quantitative relationship between the percentage of income recipients and the percentage of the total income they did in fact receive. 5-8

Figure 5.1 The Lorenz Curve 5-9

Figure 5.2 The Greater the Curvature of the Lorenz Line, the Greater the Relative Degree of Inequality 5-10

Measuring Inequality and Poverty Gini concentration ratio or Gini Coefficient. An aggregate measure of inequality. Obtained by calculating the ratio of the area between the diagonal and the Lorenz curve divided by the total area of the half-square in which the curve lies. Can vary anywhere from zero (perfect equality) to 1 (perfect inequality). Whenever one Lorenz curve lies above another, the upper curve signifies (unambiguously) a more equal income distribution than the lower curve. Whenever two Lorenz curves cross, we need more information or additional assumptions to determine which economy is more equal. 5-11

Figure 5.3 Estimating the Gini Coefficient 5-12

Figure 5.4 Four Possible Lorenz Curves 5-13

Measuring Inequality and Poverty An aggregate measure such as the Gini coefficient could be used to decide the matter. The Gini coefficient is among a class of inequality measures that satisfy 4 desirable properties: 1) anonymity; 2) scale independence; 3) population independence; and 4) transfer principle (Pigou-Dalton). Hence an income distribution with a larger Gini is more unequal. Other aggregate measures of inequality: Coefficient of variation, Theil index and other entropy measures. The Gini coefficient often used in studies of income and wealth distribution due to its convenient Lorenz curve interpretation. Lorenz curves can also be used to study inequality in the distribution of land, in education and health, and in other assets. 5-14

Measuring Inequality and Poverty Functional distributions Factor share distribution of income calculates the share of total national income that each of the factors of production (land labor, and capital) receives. Instead of looking at individuals as separate entities, it looks at, for example, the percentage of income that labor receives as a whole and compares it with the percentages of total income distributed in the form of rent, interest, and profit, received by land, financial capital and physical capital, respectively. Although specific individuals may receive income from all these sources, that is not a matter of concern for the functional approach. 5-15

Figure 5.5 Functional Income Distribution in a Market Economy: An Illustration 5-16

Measuring Inequality and Poverty Measuring Absolute Poverty The extent of absolute poverty is defined as the number of people who are unable to command sufficient resources to satisfy basic needs. They are counted as the total number living below a specified minimum level of real income an international poverty line. That line knows no national boundaries, is independent of the level of national per capita income, and takes into account differing price levels. Measures poverty as anyone living on less than $1 a day or $2 per day in PPP dollars. 5-17

Measuring Inequality and Poverty Poverty headcount: number, H, of those whose incomes fall below the absolute poverty line, Yp. Headcount Index: H/N Where H is the number of persons who are poor and N is the total number of people in the economy Poverty line is set at a level that remains constant in real terms so we can chart progress on an absolute level over time. 5-18

Measuring Inequality and Poverty International poverty line not necessarily acceptable in local poverty calculations. For national poverty calculations the poverty line is determined using an adequate basket of food based on nutritional requirements from medical studies of required calories, protein, and micronutrients. Using a local household survey data, one can identify a typical basket of food purchased by households that just barely meet these nutritional requirements. Add other expenditures for basic needs, such as clothing, shelter, and medical care, to determine the local (national) absolute poverty line. 5-19

Measuring Inequality and Poverty Total poverty gap: measures the total amount of income necessary to raise everyone who is below the poverty line up to that line. Found by adding up the amounts by which each poor person s income, Yi, falls below the absolute poverty line, Yp. TPG H (Y p Y i ) i 1 Where Y p is the absolute poverty line; and Y i the income of the ith poor person 5-20

Figure 5.6 Measuring the Total Poverty Gap 5-21

Measuring Inequality and Poverty Average poverty gap (APG): APG TPG N Where N is number of persons in the economy TPG is total poverty gap Normalized poverty gap, NPG = APG/Y p also called Poverty Gap Index (measures depth of poverty). Measure is unit-less and lies between 0 and 1; useful for comparisons across countries or across time. 5-22

Measuring Inequality and Poverty Measuring Absolute Poverty Average income shortfall (AIS): average amount by which the income of a poor person falls below the poverty line. AIS TPG H Normalized income shortfall, NIS = AIS/Y p 5-23

Measuring Inequality and Poverty We are often interested in degree of income inequality among the poor, such as the Gini among those who are poor, for policy purposes. The most desirable measures of poverty would also be sensitive to the distribution of income among the poor. 4 desirable properties of poverty measures widely accepted by development economists: Anonymity Population independence Monotonicity Distributional sensitivity 5-24

Measuring Inequality and Poverty The Foster-Greer-Thorbecke (FGT) index: P 1 H Yp Y i N i 1 Y p N is the number of persons, H is the number of poor persons, and α 0 is a parameter When α=0, we get the headcount index measure When α=1, we get the P 1 measure, i.e. poverty gap or depth of poverty. When α=2, we get the P 2 measure, i.e. squared poverty gap or severity of poverty. Gives greater weight to persons farther from poverty line. P2 measure is increasingly used as a standard poverty measure by the World Bank and most other development agencies and also in empirical work because of its sensitivity to the depth and severity of poverty. 5-25

Measuring Inequality and Poverty Human Poverty Index (HPI) Introduced by UNDP in its 1997 Human Development Report. Want to broaden the dollar-a-day World Bank measure. Analogous to HDI. Human poverty should capture 3 key deprivations: Of life (% of people unlikely to live beyond 40 years of age) Of basic education (% of adults who are illiterate) Of overall economic provisioning (% of people w/o access to health services & safe water plus % children under 5 who are underweight). HPI for 95 countries in 2004 report ranked these countries from lowest to highest HPI. Low HPI is good and higher HPI is reflective of greater deprivation. Rankings differed substantially in many cases from the WB s income poverty rankings and the UNDP s own HDI rankings. 5-26

Poverty, Inequality, and Social Welfare What s So Bad about Extreme Inequality? Most people agree that absolute poverty is bad and should be eradicated (e.g. in all religions, government policies, development assistance); Do you agree? But how about inequality? Should relative inequality be a concern? (incl. among those above the poverty line) We must be equally concerned with inequality among those above the poverty line for 3 reasons. 5-27

Poverty, Inequality, and Social Welfare 1. Economic efficiency: income inequality can lead to inefficiencies Credit markets a poor person with a great business idea but no collateral the idea will never be implemented a loss to society; Education; if costly (and there always is an opportunity cost even if no fees) poor parents may not educate their smart children who may otherwise become doctors, inventors, etc. loss to society. Saving rate if many poor people overall saving rate in the economy can be very low (less domestic resources to invest in the economy). Farming - large farms run by hired labor may be unproductive due to incentive problems; smaller, family-run farms usually more productive. However, large farms can be even more productive by using machines. 5-28

Poverty, Inequality, and Social Welfare 2. Political and social stability Higher levels of inequality may undermine political and social stability; inequality makes the rich richer, raises their power and can lead to outcomes that further exacerbate inequality. High inequality can facilitate rent seeking (incl. excessive lobbying, political donations, bribery, cronyism). Resources devoted to such activities are unproductive. Hard to make reforms and changes: the losers are typically the rich who have the power. On the other hand, lots of poor can also lead to populist (redistribution) policies that are also bad for the economy in the longer run (e.g. nationalizations, unaffordable social policies). With more inequality focus of politics is mostly on redistribution rather than increasing the size of the pie. 5-29

Poverty, Inequality, and Social Welfare 3. Moral and fairness objections to inequality Rawls veil of ignorance criterion: what level of inequality would you vote for before being born. Most people vote for some intermediate amount. Can (some) inequality be good? If perfect equality there are no incentives to work, study, etc. No reward for effort. Example: if on average society is poor (say average income y) and there are fixed costs to set up a business of F > y then if all people are equally rich no one can set up business (e.g. adopt modern technology) and the economy stays in subsistence. However, if there were some people with income > F (and, of course, many with income < F in order to maintain the same average y) then those rich people can adopt the modern technology and eventually the economy may grow and escape the subsistence state. 5-30

Poverty, Inequality, and Social Welfare Dualistic Development and Shifting Lorenz Curves: Some Stylized Typologies Gary Fields distinguishes among 3 stylized development typologies. Traditional sector enrichment (see Figure 5.7) all benefits of growth goes to traditional-sector workers with little or no growth occurring in modern sector (Sri Lanka, 60s and 70s; state of Kerala, India). Modern sector enrichment (see Figure 5.8) economy grows but growth is limited to a fixed number of people in the modern sector (typical of experience of LA and African countries). Modern sector enlargement (see Figure 5.9) two-sector economy develops by enlarging the size of its modern sector while maintaining constant wages in both sectors (historical pattern of Western developed nations). 5-31

Figure 5.7 Improved Income Distribution under the Traditional-Sector Enrichment Growth Typology 5-32

Figure 5.8 Worsened Income Distribution under the Modern-Sector Enrichment Growth Typology 5-33

Figure 5.9 Crossing Lorenz Curves in the Modern- Sector Enlargement Growth Typology 5-34

Poverty, Inequality, and Social Welfare The 3 typologies offer different predictions about what will happen to inequality with growth. under modern sector-enrichment, inequality would rise steadily; under traditional-sector enlargement, inequality would fall steadily; under modern-sector enlargement, inequality first rises and then falls. In this case, we would not be concerned about the temporary rise in inequality because in addition to being temporary, it would be reflecting a process in which citizens are, one by one, achieving incomes above the poverty line. Conclusion: these observations tells us that we have to qualify our conclusion that inequality is bad. In some cases inequality may increase on a temporary basis due to changes that will eventually make everyone better off and ultimately lower inequality. 5-35

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. Inverted-U shaped relationship between income distribution (measured by say the Gini) and per capita GNI. 5-36

Figure 5.10 The Inverted-U Kuznets Curve 5-37

Poverty, Inequality, and Social Welfare Possible causes? structural change as in the Lewis model where early growth may be concentrated in the modern industrial sector where employment is limited but wages high(modern-sector enlargement?). returns to education may increase as modern sector expands, and then fall as supply of highly skilled increases but that of unskilled falls. Kuznets himself did not specify mechanism by which inverted-u hypothesis is supposed to occur. But traditional- and modern-sector enrichment would tend to pull inequality in opposing directions; net effect on inequality is ambiguous. The validity of the Kuznets curve remains an empirical question. 5-38

Poverty, Inequality, and Social Welfare Evidence of Kuznets Curve? Income shares (see Table 5.3). Poorest 20% vs richest 20% for very poor and very rich countries. Different shares contrary to prediction. Per capita income and degree of inequality (Gini). Large differences is Gini for same income-group countries. Cross-section (country) studies (see Figure 5.11). There many middle-income countries in Latin America and the region is noted for the highest average inequality in the world. U-shape tends to disappear when Latin American identity is controlled for. Is the Kuznets curve seen in the data a mere statistical fluke? i.e. Latin American countries just happened to have both a middle level income and high income inequality? 5-39

Table 5.3 Selected Income Distribution Estimates 5-40

Table 5.4 Income and Inequality in Selected Countries 5-41

Figure 5.11 Kuznets Curve with Latin American Countries Identified 5-42

Figure 5.12 Plot of Inequality Data for Selected Countries What happens over time? Selected individual country analysis shows curve holds for Brazil. In contrast some countries (Hong Kong and Singapore) show U- shape (Figure 5.12). Confirms the Latin America effect. 5-43

Poverty, Inequality, and Social Welfare Growth and Inequality: Is there a relationship? Evidence does not reveal any strong relationship between GNI growth and the distribution of income. Long-term growth and income inequality 1965-1996; no clear pattern to be seen. (Figure 5.13) East-Asia grew a lot, inequality stayed constant; LA grew little, inequality increased a little; SSA didn t grow, inequality increased slightly. 5-44

Figure 5.13 Long-Term Growth and Income Inequality 5-45

Poverty, Inequality, and Social Welfare It is the character of growth that matters: how it is achieved, who participates, which sectors are given priority, what institutional arrangements are designed and emphasized, etc. that determine the degree to which that growth is or is not reflected in improved living standards for the very poor. It is not mere rapid growth per se that determines the nature of its distributional benefits. 5-46

Poverty, Inequality, and Social Welfare Absolute Poverty: Extent and Magnitude Progress on Extreme Poverty Clear progress on $1.25-a-day headcount Less clear progress on $2.00-per-day headcount (see Figure 5.14) Most significant gains in East Asia. See Figure 5.14. Incidence of extreme poverty is uneven. Poverty in developing world shifting toward South Asia and SSA. Global commitment towards eradicating poverty; MDG of halving poverty by 2015. 5-47

Figure 5.14 Global and Regional Poverty Trends 5-48

Table 5.5 Regional Poverty Incidence, 2005 5-49

Table 5.6 Poverty Incidence in Selected Countries 5-50

Table 5.6 Poverty Incidence in Selected Countries (continued) 5-51

Poverty, Inequality, and Social Welfare Growth and Poverty Association between growth and poverty reduction. When it is inclusive, growth reduces poverty. World Bank stated in its 1990 report: Discussions of policy toward the poor usually focus on the trade-off between growth and poverty. But the review of country experience suggests that this is not a critical tradeoff. With appropriate policies, the poor can participate in growth and contribute to it, and when they do, rapid declines in poverty are consistent with sustained growth. Dollar and Kraay (2002): Growth is good for the poor. average incomes of the poorest 20% of society rise proportionately with average incomes (note this does not mean the poor gain the same absolute amount of income as the rich!) 5-52

Poverty, Inequality, and Social Welfare Dollar and Kraay show cross-country evidence that the higher the PCI in the country the higher average incomes of the poor; i.e. the poverty gap falls as the overall income per capita in the economy rises. The elasticity of poverty reduction from growth depends on: the average level of income (distance from the PL) the level of inequality! (if inequality grows as average GDP grows poverty may not fall!) Bad news for countries with high inequality and low income! 5-53

Economic Characteristics of High-Poverty Groups Who are the poor? Of course the poor come from poor countries. Rural poor are disproportionately located in rural areas (Table 5.7) about 80% of people below PL are in rural areas (mostly in subsistence agriculture) others located on the fringes and in marginal areas of urban centers involved in low pay and low skill self-employment such as street-hawking, trading, petty services, and smallscale commerce. But often urban bias in of development policy. Seems focus on rural areas and agriculture in particular is necessary. 5-54

Table 5.7 Poverty: Rural versus Urban 5-55

Characteristics of High-Poverty Groups Women- women and children experience harshest deprivation; more likely to be undernourished; less likely to receive medical services, clean water, sanitation, etc.; less access to education, formal sector employment, social security. poorest segments in LDCs are in women-headed households. women paid less for same tasks but also effectively precluded (banned) from high-earning occupations. legislation and social customs often preclude women from owning property, businesses, signing contracts; this inequality also exists within households. strong intra-household bias against women in nutrition, medical care, education, inheritance: e.g. in India girls are 4 times more likely than boys to suffer from acute malnutrition; 40% less likely to be taken to hospital when ill. 5-56

Characteristics of High-Poverty Groups These gender biases are possible reason for high sex ratios (#men to #women) in some countries ( the missing women ) HICs.95-.98 (many LICs 1.02-1.08) China = 1.06; India = 1.06; Kuwait = 1.39; Canada =.98; USA =.97; France =.95; Japan =.96; Why? much work performed by women is unremunerated / intangible (parenting, housework) often socially unacceptable for women to contribute to money earning leads to their low bargaining power in the family programs: mostly oriented to men (agricultural extension services; job training) Much more needs to be done focusing on women (education, microfinance). 5-57

Characteristics of High-Poverty Groups Ethnic minorities, indigenous populations: over-represented among the poor. data difficult to obtain for political reasons, but see Table 5.7 for Latin America; e.g. in Mexico over 80% of indigenous population is poor vs. 18% of non-indigenous. 5-58

Table 5.8 Indigenous Poverty in Latin America 5-59

Policy Options on Income Inequality and Poverty: 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 Policy options Changing relative factor prices Progressive redistribution of asset ownership Progressive taxation Transfer payments and public provision of goods and services 5-60

Summary and Conclusions: The Need for a Package of Policies 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 5-61

Policies Human capital development determinant of growth and good for reducing inequality. increasing secondary enrollment matters (but quality of education is key!) increasing school enrollment for girls How to increase school enrollment? by increasing supply of schooling (but trade-off between quality and quantity of schools and teachers) by increasing demand for education (conditional transfer programs in Mexico, Brazil, etc. that encourage school enrollment) Rural development? Not all rural poor are farmers. land reforms. rural infrastructure (roads, electricity, water) transaction costs better connection to markets productivity enhancing technologies for small farmers (a new Green revolution for Africa?) food crops research extensions systems risk reduction devices for small farmers increasing non-farm employment. 5-62

Ghana: Facts on poverty and inequality 1991-2012 Poverty has declined over the last decades Non-monetary indicators improved as well High growth translated into poverty reduction Poverty depth has also decreased Inequality increased though, but remains relatively narrow comparing to other African countries. 5-63

Poverty more than halved between 1991 and 2012 55 50 45 40 35 30 25 20 1991 1998 2005 2012 Old line New line 5-64

Poor individuals are fewer in 2012 than in 1991 in almost all regions 1,400 1,200 1,000 800 600 400 200 0 Western Central Greater Accra Volta Eastern Ashanti Brong Ahafo Northern Upper East Upper West 1991 2012 5-65

Progress has gone beyond reduction in consumption poverty Rate 1988 1993 1998 2003 2008 2014 Infant mortality 77 66 57 64 50 41 Under-5 mortality 87 57 54 50 31 19 Vaccination a 54 62 69 79 84 Fertility 6.4 5.2 4.4 4.4 4.0 4.2 5-66

Growth in average consumption was the driving force of poverty reduction 5 0 Growth Inequality Poverty var -5-10 -15-20 -25-30 -35 1991-1998 1998-2005 2005-2012 5-67

Inequality in household consumption increased Measure 1991 1998 2005 2012 Gini 0.38 0.38 0.41 0.41 Theil 0.25 0.25 0.30 0.29 Mean 459.91 568.45 736.80 883.48 Median 352.66 438.04 559.44 655.60 Consumption shares Bottom 5 percent 1.11 1.00 0.79 0.82 Bottom 10 percent 2.71 2.42 2.08 2.13 Bottom 20 percent 6.82 6.21 5.65 5.63 Top 20 percent 44.78 44.47 46.59 46.94 Top 10 percent 29.16 28.17 30.75 30.43 Top 5 percent 18.52 17.41 19.95 19.17 5-68

The spatial divide has increased; poverty in 2012 has a rural northern face 5-69

Wa West (92.4) East Gonja (84.2) Builsa South (84.4) Adaklu (89.7) LDK & AMA Ghana Poverty Map: Poverty Incidence in districts Proportion of Population below poverty line of GHC1,314.00 Most districts in the 3 northern regions are among the poorest. Wa West, Adaklu, Builsa South, East Gonja are the poorest districts There are also pockets of poverty in regions in the south Least poor are La Dade Kotopon and AMA 5-70

Kumbun gu (12,596) KNW (9,17 2) Estimated number of Poor persons Wa West, (74,297) East Gonja, (112,130) Kpandai, (82,712 ) More poor persons in districts in the northern part of Ghana Highest in East Gonja, KMA, Kpandai, Wa West KMA, (88,935) La Dade, (2,348 La Dadekotopon (ranked 216 in P 0 ) but ranked 214 in terms number of poor persons ) 5-71

Bongo (54.4) Inequality: Extent to which welfare is distributed among the population Bawku West (57.9) Sunya ni (64.0) Garu Tempan e(54.8) Sunyani Municipal has the highest level of inequality (64.0) followed by Bawku West (57.9), Garu Tempane (54.8), Bongo (54.4) High levels in inequality in the two Upper regions and Middle or forest belt Districts in Northern region show a fair distribution of welfare Upper Manya (27.2) Upper Manya District has the least inequality (27.2) 5-72

Drivers of Success High GDP growth rates over the past two decades. Increased government development expenditures. The government continued with the implementation of poverty-related expenditures, and has also introduced special social intervention programmes aimed at increasing public expenditure on initiatives targeted at the poor and the vulnerable. Targeted social intervention programmes and social infrastructure provision particularly the Livelihood Empowerment against Poverty (LEAP), school feeding programme, national health insurance, capitation grant scheme and free health care for pregnant mothers. Improved infrastructure development particularly road networks in areas that are not well accessible. 5-73

Challenges To Poverty Reduction Increasing inequality: Ghana s Gini Coefficient, has risen from 41.9 percent in 2005/06 to 42.3 percent in 2012/13, an indication that increasingly, income is shared inequitably across the population. This level of inequality has adverse implications towards government s efforts at reducing poverty in the country (GSS, 2014). Limited inclusiveness of growth: The focus on the extractive sector and recently on the new oil and gas industry, which are capital-intensive do not have direct poverty reducing effect while agriculture sector which makes greater impact on poverty reduction is continually being relegated to the background (UNDP, 2015). Low productivity, especially in agriculture: Agriculture productivity can be improved. More effort is need to increase the levels of mechanisation and adoption of modern agricultural techniques (UNDP, 2015). 5-74

Challenges To Poverty Reduction Infrastructural constraint: Lack of adequate public services and supportive infrastructure to boost rural development. Rural areas which are the most impoverished are often constrained by basic infrastructure such as roads and electricity to help them take advantage of the economic activities available (UNDP, 2015). Low level of education of the workforce: GLSS 6 indicate that only 19 percent of Ghana s working-age population have had secondary education or better, while about 48 percent had completed basic education. This restricts access to highly skilled and better remunerated jobs (UNDP, 2015). Effects of climate change: Ghana s agriculture sectors is not fully mechanised. Farmers continue to depend on rains for their farming activities. The effects of climate change which include prolong periods of drought and extreme weather conditions will affect African countries the most. This can significantly plowback efforts made in food security thus poverty reduction. 5-75

Opportunities For Poverty Reduction Inclusive national development. Improvement in agriculture remains the sure bet to poverty reduction. Continued investment in physical/public infrastructure and social safety nets for the vulnerable is key. Education and provision of skill training for the youth. NOTE: Slides 63-76 are from World Bank/ISSER Workshop on Two Decades of Monitoring Poverty in Ghana held on 15 October 2015 at ISSER, University of Ghana, based on presentations by Jacqueline Anum (GSS), Vasco Molina (WB) and Felix Asante (ISSER). 5-76