Development Economics 355 Lecture Notes Todaro-Smith ch. 5 notes Poverty, Inequality and Development * slideshow on poverty and inequality over time (Gapminder) http://www.gapminder.org/downloads/human-development-trends-2005/ * More facts & figures: - close to 1 bln people live on less than $1 per day, 2005 - 2.7 bln live on less than $2 per day - poverty correlated with malnutrition, low literacy, little political voice, social exclusion * elimination of extreme poverty as a development goal (Millenium Development Goals adopted by UN in 2000) – see Economist table on current progress. 1990: 46% of world population (2.4 bln people) living on less than $1.25 a day; 2008: 27% (1.8 bln people). * inequality – the distribution of income within a country. Here we focus on economic inequality but of course there are broader problems of power, prestige, gender, religion, etc. * QUESTIONS to be addressed: 1. what is the extent of relative inequality in developing countries and how to measure it? 2. who are the poor and what are their characteristics? 3. How are economic growth and inequality related, does rapid growth increase or reduce inequality? 4. Do the poor benefit from growth and how much? 5. Is inequality bad? Can arguments against inequality be made from purely efficiency perspective? 6. Policies related to inequality and absolute poverty. MEASURING INEQUALITY * How to measure? The Lorenz curve - order population by increasing income (in practice use quintiles (fifths) or deciles (tenths)) – Table 5.1 gives example. Note: here the source of income does not matter, just the magnitude. Measure 1: can take the ratio (so-called “Kuznets ratio”) income received by the richest 20% / income received by poorest 40% in Table 5.1 this is 51/14 = 3.64. Or could have taken top 20% divided by bottom 20% - ratio of 10.2! - deciles give even more detailed measure of the income distribution (and inequality) - LORENZ CURVE: can take the above idea to the maximum detail possible and plot % of population vs. % of total income (people ordered by increasing incomes) – Figure 5.1. - each point (A-I) on fig. 5.1 corresponds to one decile of the population. - the line connecting these points is called the Lorenz curve (LC) - NOTE: 0% of people receive 0% of total income; 100% (all) people receive 100% (all) of total income - if all people had equal income, poorest 10% would receive 10% of total income, poorest 20% will receive 20% of total income etc. - thus, perfect equality will produce a LC which is a straight line, the 45-degree line. - how about if one person had all the income in the country? Then all but the richest person (99.99% on the horizontal axis will have 0 income, i.e. a flat line at 0, and the richest person will have 100% - a vertical line). The LC is a right-angled curve. - realistically we’re in between: the LC is an increasing line (Why?) and convex (i.e. increasing at an increasing rate) (WHY?). - a LC closer to the 45-degree line corresponds to more equal society, opposite is true for LC further away from the 45-degree line (closer to the bottom and right sides of the box) – figure 5.2. Gini coefficient * The LC is a very detailed measure of inequality but hard to use in practice, would be nice to somehow aggregate the information carried by it into a single number we can compare across countries. * this is where the GINI COEFFICIENT measure of inequality comes in. * GC is an aggregate measure of inequality that can be obtained as (see fig. 5.3) as the ratio of the shaded area A (the area between the LC and the 45-degree line) and the total area BCD. * NOTE: GC is by construction a number between 0 and 1. * GC = 0 corresponds to perfect equality; GC = 1 corresponds to perfect inequality. * Caution: GC is an aggregate measure – two different LCs can have same GC (but then they must cross) (Explain why). Alternatively, two societies can have different GCs but their LCs cross – how to rank? * GC has some nice properties which is why it is most commonly used to measure income inequality in development economics: - anonymity: GC does not depend on who is who (just their income level) - scale independence: if we measure income in different units, GC remains the same. If the economy rich on average or poor on average does not matter too. - population size independence - GC is units-free; if we clone each person into 2, each with the same income as the original person, GC remains the same; - transfer principle: holding all else constant, if we transfer some income from a richer person to a poorer person, GC declines (the resulting income distribution is more equal). Functional inequality * sometimes important to know not only the size of income a person has, but its factor share distribution (functional inequality). E.g. what fraction of income labor vs. capital receive. * gives additional, more detailed information on inequality in a country. May be important for policy: e.g. if a person receives a certain income as unemployment pay vs. working at minimum wage, etc. POVERTY – measurement * the inequality measures give idea about relative poverty (how much income people in a country have relative to each other) * here: absolute poverty – the number of people unable to satisfy some basic needs *basic idea: define a “poverty line” (PL) – minimum amount of income (PPP adjusted) that can be used to compare poverty internationally; typically $1 a day or $2 a day. Headcount (the nr of people below the PL) and headcount index (ratio) – the proportion of people below PL from the whole population. * headcount – H (e.g. 5 mln people), headcount index is H / N (e.g. 10%) * why poverty line? Simple. But there are issues: e.g. it matters if most people are right below it, or far from it (policy bias can result from that, explain) * to measure the amount of poverty more precisely (instead of the binary measure of being below or above the PL) we use another measure: total poverty gap (TPG) * TPG measures the total amount of income necessary to lift everyone below the PL to that line (see fig. 5.6); can think of it as the amount of money per day needed to bring every poor person to the PL. * TPG = ∑ (Y i|Yi <Y p p − Yi ) where Yp is the poverty line income; * on per capita basis, can compute the * average poverty gap (APG) = TPG / N * or, can compute the per capita gap relative to the PL: * normalized poverty gap (NPG) = APG/Yp (a measure between 0 and 1) * average income shortfall (AIS) = TPG / H (on average by how much a poor person’s income falls below the PL) * normalized income shortfall (NIS) = AIS/Yp. * can be also interested in the inequality among the poor (e.g. Gini) – matters for policy, if high inequality means some are far away from the PL but also that a small change in policy of agricultural prices may bring many above it. Human poverty index (introduced by UNDP) * want to broaden the usual “income poverty” definition (e.g. the $1 a day PL by the World Bank); analogous to the human development index * UNDP argues poverty should be measured in terms of three deprivations: - of life (the % of people unlikely to live beyond 40 years of age) - of basic education (the % of adults who are illiterate) - of overall economic provisioning (% of people without access to safe water + % of children underweight for their age) * creates a measure both different from the standard PL and also from HDI; *Some examples: Cote d’Ivoire 26 places worse if poverty measured by HPI than in income; Morocco 37 places worse; i.e. for these countries poverty is bigger problem than income measures indicate; * in contrast, Nigeria, Nicaragua, Bolivia, Tanzania perform better on HPI. POVERTY, INEQUALITY AND WELFARE * most people agree that absolute poverty is bad and should be eradicated (e.g. in all religions, all gov’t policies); Do you agree? * but how about inequality? Should relative inequality be a concern? (above the poverty line) 1. economic efficiency: income inequality can lead to inefficiencies Example 1: credit markets – a poor person with a great business idea but no collateral – the idea will never be implemented – a loss to society; Example 2: 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. Example 3: the saving rate – if many poor overall saving rate in the economy can be very low (less domestic resources to invest in the economy) Example 4: 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. NOTE: for most of the above to be true we need some type of credit or other market inefficiency; if all markets are perfect, inequality would not matter (give examples). 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 yield 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! Again – economic inefficiency. * 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 (redistributionary) policies that are also bad for the economy in the longer run (e.g. certain land reforms, nationalizations, unaffordable social policies). * with more inequality focus of politics is mostly on redistribution rather than increasing the ‘size of the pie’. (more in ch. 11) 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. * ‘lifeboat problem’ arguments – if very poor, splitting resources unequally may be more efficient. * another 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. (think why) 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. EMPIRICAL EVIDENCE Growth and inequality – evidence * figure 5.13: long-term growth and income inequality 1965-1996; no clear pattern to be seen; East-Asia grew a lot, inequality stayed constant; LA grew little, inequality increased a little; SSA didn’t grow, inequality increased slightly *figure 5.14: increasing inequality in 77% of countries but unrelated to growth Growth and poverty – evidence * does economic growth disproportionately hurt the poor? * Dollar and Kraay (2002) share of income accruing to bottom 20% is not correlated with average income * claim: 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!) * pro-growth policies benefit poor as much as everyone else * criticism – all these things hold on average – across people and countries – may not be very informative for each separate country * 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! Who are the poor? (look at micro level before looking at policy) 1. rural – poor are disproportionately located in rural areas (Table 5.6) – about 80% of people below PL are in rural areas (mostly in subsistence agriculture – 2/3) * but often urban bias in terms of development policy * seems focus on rural areas and agriculture in particular is necessary 2. 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. - 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) 3. ethnic minorities * 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 4. people in the poor countries * seems obvious but important implication is that growth can help (see more below) POLICIES (see slides too) * do some policies maximize poverty reduction? * Dollar and Kraay – try different macro policy variables (rule of law, openness to trade, inflation stabilization) – find no or weak evidence in promoting poverty reduction * human capital – determinant of growth and good for reducing inequality * seems increasing secondary enrollment matters (but quality of education is key!) * Besley et al. – 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? Incentives vs. land parcelization (splitting land into small pieces) - rural infrastructure (roads, electricity, water) - transaction costs – better connection to markets What should work? - 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
