Economics of Poverty Traps and Persistent Poverty: An Asset-based Approach Michael R. Carter University of Wisconsin Christopher B. Barrett Cornell University January 2005 American Economic Association annual meetings Philadelphia

Why We Need An Asset-Based Approach to Poverty Analysis The ‘Washington Consensus’ reforms constitute an implicit theory of structural poverty transitions: 1.Getting Prices Right should raise returns on unskilled labor, poor households’ primary asset; 2.Getting Institutions Right by securing property rights should enhance asset accumulation by poor households; 3.Deregulation should enhance financial access of poor households, further boosting accumulation But, has it worked? Very hard to gauge using conventional, flow-based approaches to poverty analysis that look only at (potentially transitory) outcomes.

Evolving Views of Poverty Successive generations of poverty analysis 1 st : static income/expenditure analysis (headcount, poverty gap, FGT measures) 2 nd : dynamic income/expenditure analysis (chronic/transitory poverty distinction) 3 rd : static asset poverty analysis (structural/stochastic poverty distinction) 4 th : dynamic asset poverty analysis

Asset-Based View of Poverty Transitions Stochastic churning (B to u(A’’)) from Poverty: Structural via accumulation (A’ to A”) Structural via higher returns (u(A’) to C)

Poverty Traps and the Dynamic Asset Poverty Threshold Will structurally poor move ahead over time? Lessons from empirical macroeconomics – “twin peaks”, “divergence big time” or “convergence”? Key question: do returns to productive assets (land, labor, etc.) increase in wealth? Such a relationship could exist due to: –Increasing returns to scale in income generating process –Minimum investment levels/indivisibilities –Uninsured risk

Locally Increasing Returns and Multiple Livelihood Equilibria Marginal return on assets A*2A*2 A*1A*1 Utility ASAS A Asset Poverty Line Income Poverty Line Assets L1 L2 U* H U* L No problem if perfect financial markets exist. But if not, what savings strategies are feasible below A S ?

A t =A 0 (dynamic equilibrium) ASAS Static Asset Poverty Line Dynamic Asset Poverty Line A* 2 A* 1 A* Utility Figure 3: The Dynamic Asset Poverty Line A Income Poverty Line Initial Assets L1 L2 Next Period’s Assets U* H U* L A 4th Generation View Poverty Trap Dynamic Asset Poverty Line (Micawber Threshold)

Empirical Strategies to Identify Dynamic Asset Poverty Thresholds Need to find threshold in asset space where dynamics bifurcate. Challenges: - highly nonlinear dynamics - sparse data around unstable eql’n - multidimensional asset space Efforts to date: - Lybbert et al EJ, Barrett et al. 2004, Adato et al all use nonparametric methods based on single asset or asset index. Need to improve on these methods

Dynamic Poverty Measures Two natural extensions of FGT class: Predicted flow dynamics version: Asset gap version:

Implications for Persistent Poverty Reduction Strategies An asset-based approach permits - identification of minimum asset bundles necessary for hhs to engineer own growth - natural integration of safety net strategies with poverty reduction strategies - prioritization of efforts to rectify mechanisms of financial and social exclusion

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