5. Development, poverty & distribution 0

Overview Poverty and income distribution How do growth and structural change affect poverty? Southeast Asian data 1

2 What is poverty? Absolute: “Earnings insufficient to obtain the minimum necessities for the maintenance of merely physical efficiency” Ex: Caloric requirements; minimum expenditures Relative: “Where basic physical wants have been met, poverty is a matter of deviation from social and economic norms” Ex: lowest 20% of income earners Which definition do you think is most relevant to low- income countries?

3 Household poverty measures Define: R h = real income of a household z = poverty line in $ Household poverty gap: g h = z – R h if R h < z = 0 if R h ≥ z A household h is poor if g h > 0 Intensity of poverty increases with g If g h > g k then household k is less poor than h

4 Aggregate poverty measures Let N = population; q = proportion with g h > 0 Headcount poverty measure: H = q*N Counts all poor, but ignores intensity (size of g h ) Aggregate poverty gap: In $, where g h = (z – R h )). Captures intensity of poverty Distributionally sensitive poverty gap: Gives higher weight to larger poverty gap When will these measures give contrasting views of aggregate poverty?

Headcount poverty Indonesia Malaysia Philippines52 Thailand Indonesia6432 Malaysia1711 Philippines3633 Thailand810 At national poverty line At $US1/day What happened to Thailand? See later slides

6 Inequality measures B A Income Population (ranked by income) 100% 0% Line of perfect equality 1. Lorenz curve 2. Gini ratio = A/(A+B)

7 Inequality trends in SE Asia

8 Dimensions of disparities

9 Other dimensions of inequality Regional Differences within rural areas, e.g. between Central and NE Thailand; Java and Outer Islands of Indonesia; northern vs. central and southern Philippines. Regional income variation frequently reflects differences in resource endowments, climate & rainfall, or complementary inputs such as infrastructure. Demographic Gender; ethnicity (e.g. indigenous Malay vs. Chinese in Malaysia) Functional Labor vs. capital incomes (vs. land, etc.) Consumers vs. producers of major items such as food * Why does income distribution change?

10 Does growth cause inequality? Ricardian model Ricardo: Due to diminishing returns, growth of labor force against ‘fixed’ land constraint will cause growth to slow Increasing scarcity of land will concentrate income in hands of landowners Labor surplus model If only capitalists save, then all new income accrues to non-labor for as long as labor supply to industry is perfectly elastic Neoclassical two-sector model Continuing intersectoral labor transfers raise share of new income earned by labor * Transition from labor surplus to labor-scarce economy implies inequality will initially rise, then diminish

11 Patterns of inequality and growth Kuznets: growth-inequality relationship is non-linear Due to transfer of population between low-income, low- inequality rural areas (ag. sector) and high-income, high inequality urban areas (industry) Total inequality consists of ‘within’ and ‘between’ components Growth causes changes in both ‘within’ and ‘between’ inequality --> “Inverse U” of inequality as economy expands Both growth and structural change contribute to inverse U shape of inequality-growth relationship

12 Analyzing inequality Real household income, inclusive of taxes and transfers: where R h = real income; w·L h = labor earnings; r·K h = capital earnings; T h = transfers; CPI h = consumer price index. Changes in R h may involve all RHS terms An inequality measure such as the ratio of 10th (highest) decile to 1st (lowest) = R 10 /R 1 evolves according to Endowment growth rates and the inter-household distribution of endowments Wages and returns on other factors Consumer prices and household-specific budget shares Policies, such as transfers and taxes

Special role of the labor market Labor mobility spreads gains from growth Ownership of labor cannot be concentrated Migration allows labor to find its highest value use Remittances “share” migrants gains with those left behind Restrictions on labor mobility reduce poverty alleviation Segmented labor markets (ho khau, credit constraints) lead to wide wage gaps – sign of disequilibrium Show with 2-sector labor market diagram 13

14 Questions from growth-inequality theories Is Kuznets’ “Inverse-U” trend inevitable? Will the benefits of growth ‘trickle down’ to the poor? Will some groups be left behind in the course of development, and if so, for how long? If group-specific inequality is transitory, are redistributive policies necessary? Could some forms of inequality act as a drag on growth? E.g. What if the poor vote for higher taxes on the wealthy?

15 How robust are the equity and poverty effects of growth? Policy reforms and external shocks can alter distribution E.g. world market shocks affecting relative agricultural and non- agricultural prices Crises can also alter income distribution substantially Philippines in : distributional improvement in an era of “shared poverty”. Poverty alleviation may also be vulnerable to shocks Post-OPEC II, 1980s (next slide) Asian Economic Crisis, NB Poverty is a special case of inequality (we consider only the welfare of those whose incomes fall below a predetermined level, the poverty line)

16 Poverty, growth & adjustment in 1980s

17 Source: Swinkels and Turk (2004) Poverty and inequality in Vietnam

18 Source: Swinkels and Turk (2004) Poverty and inequality in Vietnam

19 Source: Swinkels and Turk (2004) Trends in poverty incidence (H)

20 Source: Swinkels and Turk (2004) Trends in severity of poverty (G)

21 Things we know: growth, poverty, income distribution Aggregate economic growth reduces aggregate poverty; faster growth reduces it faster Aggregate growth also changes structure of production and with it, distribution of factor returns Extent of poverty/inequality gain depends on labor mobility Initial income distribution is skewed SEA’s colonial inheritance included large income disparities Income distribution may get worse before it improves Some groups may be left behind in during early growth Policies aimed at ensuring particular structural or income distribution outcomes are usually not costless in terms of growth Industrial promotion; income redistribution