Economics of Income
Inequality and Poverty
Fahrettin Yagci
Bosphorus University
EC 48R.01, Spring 2013
Share of US income (including capital gains) held by the top
one percent (dotted line) and top 0.5 percent (straight line)
Finance & Development, September 2011
“Occupy Wall Street” Protestors
OECD “Growing Unequal” Graphic
The Cover of “The Cost Of Inequality”
“The Winner-Take-All Society” Cover
Another Winner-Take-All Graphic
Course Outline
1. Global trends in poverty alleviation
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In developing countries (absolute and relative poverty)
In OECD countries (relative poverty, material
deprivation)
2. Global trends in income inequality
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Within countries (Gini coefficient, percentile ordering)
Between countries (international inequality)
Global inequality (Gini coefficient)
3. Why do we care about poverty/inequality
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Social justice (4 theories of justice)
Stable high economic growth (inclusive growth)
Classification of Countries (footnote)
OECD – Organization for
Economic Co-Operation and
Development (footnote)
• Rich countries’ club, established in
1961, 34 members
• Some developing country members:
Turkey, Chile, Israel, Korea
• Undertakes extensive research,
disseminates results
• New invitees: Russia, China, India,
Brazil, Indonesia, South Africa
Outline (cont.)
4. Theories of income distribution
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Emphasis on equity in economic literature
Classical theories (Ricardo, Marx)
Keynesian theory (Kaldor)
Marginal productivity theory
Outline (cont.)
5. Causes of poverty and inequality
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Institutional framework: varieties of
capitalism
Power structure: poverty/inequality trap
Skill-biased tech change, globalization,
geography, discrimination
Opportunity gaps (education, health,
credit)
Structure of the labor market
Outline (cont.)
6. Policies to reduce poverty and inequality
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Strategic choice: re-distribution with or without
growth, distribution of outcome or opportunities
Pro-poor growth: empowerment and inclusion
Access to assets and opportunities
Affirmative action (gender, ethnicity, etc)
Public policy: taxation, social security and
welfare programs
Regional development
Outline (cont.)
7. Poverty and inequality in Turkey
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Data sources, existing work
Main trends in poverty and inequality
Regional distribution of income
Public policy
Causes of declining poverty and inequality
Global trends in poverty alleviation
• Definition of poverty: “pronounced
deprivation in well-being”. It is linked to
access to essential goods and services.
• Poverty can be defined in terms of
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Income
Consumption
Essential services (education, health …..)
Multi-dimensional (UNDP’s multidimensional
poverty index)
Global trends in poverty alleviation
• Poverty measures
1. Headcount index (HCI): percentage of
population below poverty line (minimum level
of income to be able to purchase basic
necessities. Each country has its own national
poverty line, expressed in local currency in
constant prices.
Weaknesses of HCI. It ignores (i) intensity of
poverty, (ii) differences of income among poor,
(iii) changes in income among poor, if they
remain below the poverty line.
Global trends in poverty alleviation
• Poverty measures
2. Poverty gap (PG): average of gaps between
poverty line and actual incomes of poor. It shows
how far, on average, the poor are from the poverty
line.
Sum of PGs: minimum level of targeted income
transfers to poor for lifting the to poverty line
3. Poverty gap index (PGI): PG as a percentage of
poverty line. This measures poverty intensity.
Global trends in poverty alleviation
• Poverty measures
– Poverty line: $120, 2 of 5 people are below
poverty line
Global trends in poverty alleviation
• Data for poverty and inequality analysis
– Data collection: household or living conditions
surveys (all sources of income, expenditure
composition, taxes paid, transfers received).
– Large databanks: World Bank
(data.worldbank.org/topic/poverty), OECD
(stats.oecd.org), UN University
(www.wider.unu.edu), and Luxembourg Income
Study (www.lisdatacenter.org)
– Data adjustment for household size: calculate per
capita household income for equivalent adults.
Global trends in poverty alleviation
• Data for poverty and inequality analysis
– Methods for calculating equivalent adults
• OECD modified method: assign value of 1 to
household head, of 0.5 to each additional adult, and of
0.3 for each child. Resulting total is equivalent adults
• Square root method: square root of the number of
members of the household is equivalent adults.
– Household income per equivalent person is
ranked from richest to poorest, and used to
calculate the poverty and inequality indicators.
Poverty in developing countries
• Two most widely used poverty concepts
for developing countries
– Absolute poverty. Population below the
absolute poverty line (minimum threshold
income below which people are considered
poor in absolute terms)
– Relative poverty: Population below relative
poverty line, which is set at a constant
proportion (40%, 50%, 60%) of the median
income
Poverty in developing countries
• Three poverty related international projects
1. World Bank. Assists member countries to conduct
household surveys, maintains a large databank,
finances poverty related projects.
www.worldbank.org/en/topic/poverty
Poverty in developing countries
• Three poverty related international projects
2. UNDP’s annual Human Development Report
(HDR). Information for 170 countries. Part of this
report is Human Development Index (HDI) – a
composite index based on life expectancy,
schooling, and per capita GNI. Countries are
ranked and grouped in 4 categories: very high,
high, medium, and low human development. UNDP
also publishes Gender Inequality Index,
Multidimensional Poverty Index, and InequalityAdjusted HDI, and country and regional reports.
hdr.undp.org
Poverty in developing countries
• Three poverty related international projects
3. UNDP-monitored Millennium Development Goals
(MDG): introduced in 2000, includes 8 goals that all UN
members agreed to try to achieve by 2015: (i) eradicate
extreme poverty and hunger, (ii) achieve universal
primary education, (iii) promote gender equality and
empower women, (iv) reduce child mortality, (v) improve
maternal health, (vi) combat HIV/AIDS, malaria and
other diseases, (vii) ensure environmental sustainability,
and (viii) develop a global partnership for development.
International finance and aid institutions finance projects
and reform programs to achieve these goals.
www.unmillenniumproject.org
Poverty in developing countries
• Progress in poverty alleviation
– National poverty lines cannot be used for
international comparison (local currency, varied in
definition and level)
– World Bank introduced international absolute
poverty line in 1990 at $1 a day at 1990
purchasing poverty (PPP). In 2008, it raised the
absolute poverty line to $1.25 at 2005 PPP and
introduced a second absolute poverty line at $2.00
a day for higher income countries.
– It also calculates poverty for $4.0, and $5.0 a day
for developing countries with higher income.
Poverty in developing countries
• Progress in poverty alleviation
– Purchasing power parity (PPP). Alternative
exchange rate used for converting data in other
currencies into US$. How to calculate PPP? World
Bank calculate PPP for 120 countries
• Collect price data for a reference set of goods and
services (102 products) for developing countries and the
US.
• Calculate weighted average price (WAP) for all countries
using consumption shares as weights
• PPP for country I = WAP(i)/WAP(us)
• Suppose reference set has only one product, big mac
PPP (TR) = TL6.70/$4.20 = 1.57
Poverty in developing countries
• Figure 1: Percentage of population living on less that
$1.25 a day, 2008
Poverty in developing countries
Poverty in developing countries
Poverty in developing countries
Figure 2. Progress in elimination of absolute poverty, all DCs
Poverty in developing countries
Figure 3. Progress in reduction in absolute poverty, regions
Poverty in developing countries
Poverty in developing countries
Figure 4. Number of people in absolute and relative poverty in DCs
Poverty in developing countries
Progress in alleviation of poverty (1981-2008) -- summary
1. Except a few countries in Africa absolute poverty at $1.25 was
reduced from 52% of population to 22%. 1.29 billion people are
still live on less than $1.25 a day. In 2015, population below
$1.25 is projected to be 16% of population.
2. Progress was uneven. China shows the most dramatic reduction,
from 84% to 13%. Progress in the rest of developing countries
was modest, from 41% to 25%.
3. In terms of number of people, about 640 million people were
lifted out of absolute poverty – all in China. In the rest of the
developing countries, number of people below $1.25 slightly
increased because of high population growth relative to the GDP
growth.
Poverty in developing countries
Progress in alleviation of poverty (1981-2008) – summary (cont.)
4. Progress has been much slower at $2 a day, from 70% to 43%.
This is largely due to China – from 98% to 30%. Progress in the
rest of the developing countries has been only from 59% to 47%.
5. In terms of number of people, about 580 million people have
been lifted out of absolute poverty in China. In the rest of the
developing countries, number of people below $2 has increased
by 464 million.
6. Progress in relative poverty has been limited – being a fixed
proportion of the median income it is tied to income inequality.
China’s progress was from 86% to 41% compared to the rest of
the developing countries from 55% to 49%. In China, people
below the relative poverty line fell by about 300 million while in
other developing countries increased by about 660 million.
Poverty in developing countries
Poverty-related foreign assistance (some major
organizations in 4 groups)
1. International financial institutions
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World Bank (WB), European Bank of Reconstruction
of Development (EBRD), African Development Bank
(AfDB), Asian Development Bank (ADB), InterAmerican Development Bank (IADB).
2. UN Institutions
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UN Development Program (UNDP), UN Children’s
Fund (UNICEF), World Food Program (WFP), World
Health Organization (WHO), International Fund for
Agricultural Development (IFAD)
Poverty in developing countries
Poverty related foreign assistance (some major
organizations in four groups)
3. Major country aid agencies
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USA (USAID), UK (DFID), Canada (CIDA), EU
(Country indicative programs), Germany (KfW),
France (AfD), Denmark (DANIDA), Finland (FINIDA),
Norway (NORAD), Sweden (SIDA), Japan (JICA), etc.
4. Non-governmental organizations (NGO)
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Oxfam, Save the Children, Christian Aid, Action
Against Hunger, Habitat, Gates Foundation, etc.
Poverty in OECD countries
OECD uses two definitions of relative
poverty (or poverty)
1. Percentage of population below
relative poverty line (income threshold)
– 40%, 50% and 60% of median
income.
2. Non-income multidimensional poverty –
material deprivation
Poverty in OECD countries
• Figure 5: Relative poverty rates for different poverty lines in
OECD countries, late 2000s
Poverty in OECD countries
Figure 6: Change in relative poverty (50% threshold)
Poverty in OECD countries
Relative poverty summary
Relative poverty in mid-2000s
– Poverty rate: 6% (at 40% threshold), 11% (at 50%
threshold), and 17% (at 60% threshold). About
150,000 poor people at 50% threshold.
– Poverty is the lowest in Denmark, Sweden, Czech
Rep, and highest in Mexico, Turkey, and US,
whatever threshold used.
– Above OECD average: Nordic and Continental
European countries. Below average: Southern
European countries, Ireland, Japan, Korea.
Poverty in OECD countries
Relative poverty summary (cont.)
Change in relative poverty
– OECD average increased from 11% to 12.2 % from
mid-1980s to mid-2000s; close to 15 million people.
– Poverty increased in 16 countries. Largest
increase: Ireland (4.8 percentage points), Germany
(4.8), New Zealand (4.2).
– Poverty declined in 8 countries: Largest decline:
Belgium (4.1 percentage point), Mexico (3.2).
Poverty in OECD countries
2. Non-income multidimensional poverty (material
deprivation), defined in terms of a wide range of
variables, including:
– Being able to afford holidays away from home at least
one week a year,
– Delays in mortgage, rent, electricity, etc. payments,
– Being able to afford meat, chicken or fish (or
vegetarian equivalent) twice a week,
– Being able to maintain dwelling at an adequate
temperature during the cold months
Poverty in OECD countries
Material deprivation (cont.)
– How to measure? Share (or number) of people under
each variable,
– EU adopted this methodology. Work ongoing to adapt
it to Turkey.
– Not regularly estimated and published. Lack of
common harmonized surveys, difficulty to agree on the
right variables.
Global trends in income inequality
Inequality measures
– In terms of income, consumption, wealth, etc
– Gini coefficient
– Percentile ordering
Global trends in income inequality
Inequality measures: Gini coefficient (GC)
– Statistical dispersion measure with a value ranging from
zero (everyone has identical income) to 1 (all income
goes to only one person). Derived from Lorenz Curve. A
high value indicates higher inequality.
– GC=A/(A+B)
Global trends in income inequality
Inequality measures: Drawing the Lorenz curve
Global trends in income inequality
Inequality measures: Percentile ordering
– Share of household percentiles in total income. For
example, the richest 20% of population accounts for 50%
of income. Any percentile share; 10%, 5%, 1%. A
frequently used percentile measure is the richest 1%.
– Percentile ratio: P90/P10: the ratio of richest 10% to the
share of poorest 10%.
Global trends in income inequality
Inequality measures: income base, location
– Pre-tax/transfer (market distribution), post-tax/transfer
(reflects redistributive effects of fiscal and welfare
policies)
– Total population, urban population, rural population
Inequality within countries
Incidence of poverty: 4 groups, Gini coef., late 2000s
– Low inequality: Gini (0.20-0.29); 22 countries mostly in
Europe
– Medium inequality: Gini (0.30-0.39); 49 countries spread
in North America (US, Canada), Europe, Africa, and Asia
(India, Japan, Korea ….)
– High inequality: Gini (0.40-0.49); 38 countries spread in
South America, Africa, and Asia (Russia, China, ….)
– Very high inequality: Gini (over 0.50); 21 countries in
South America and South Africa.
Inequality within countries
Low inequality
Inequality within countries
Medium inequality
Inequality within countries
High inequality
Inequality within countries
Very high inequality
Inequality Traps
Interaction of political, economic, and sociocultural inequality and poverty