1. Poverty, Inequality, and Development
Chapter 5
Poverty, Inequality, and Development

2. The Growth Controversy: Seven critical questions
What is the extent of relative inequality, and how is this related to
the extent of poverty?
Who are the poor?
Who benefits from economic growth?
Does rapid growth necessarily cause greater income inequality?
Do the poor benefit from growth?
Are high levels of inequality always bad?
What policies can reduce poverty?

3. Measuring income inequality and poverty
Two Measures of Income Distribution:
Personal (size) distribution of income.
Functional (factor share) distribution of income.

4. Measuring income inequality and poverty
Personal (size) distribution of income:
Focuses on individual households and total incomes they receive
Does not consider the way in which such incomes are earned
Divides population into quintiles (fifths) or deciles (tenths) with
respect to income levels to determine what proportion of national
income is received by each group

5. Table 5.1: Typical size distribution of personal income in a developing country by income shares-quintiles and deciles

6. Measures of Income Inequality
1. Kuznet’s Ratio:
Ratio of incomes received by top 20 percent to incomes received
by bottom 40 percent of the population.
The larger the Kuznet’s ratio the more unequal the income.

7. Figure 5.1: The Lorenz curve

8. Measures of Income Inequality
2. Lorenz Curve:
Shows the actual quantitative relationship between percentage of income
recipients and percentage of national income they receive.
The more the Lorenz curve shifts away from the line of equality the greater
the degree of income inequality.

9. Figure 5.2: The Greater the curvature of the Lorenz line, the greater the relative degree of inequality.
Brazil
60%
South Africa
Ruanda
50%
United States
40%
France
33%

10. Figure 5.3: Estimating the Gini coefficient

11. Measures of Income Inequality
3. Gini Coefficient:
Ratio of the area between the line of equality and the Lorenz curve
to the total area of the half square in which the Lorenz curve lies.
Varies between 0 (perfect equality) and 1 (perfect inequality).
The larger the Gini coefficient the more unequal the income.

12. Measuring income inequality and poverty
Two Measures of Income Distribution:
Personal (size) distribution of income.
Functional (factor share) distribution of income.

13. Measuring income inequality and poverty
Factor share distribution of income:
National income equals the sum of:
total wages received by the entire labor force.
total rents received by all land owners.
total profits received by all physical capital owners.
total interest payments to all financial capital owners.
Determines the share of total (national) income that each factor
of production (i.e. land, labor, capital) receives.

14. Figure 5.5: Functional income distribution in a market economy: an illustration.

15. Measuring income inequality and poverty
Factor share distribution of income:
How to calculate total income received by a certain productive
factor (i.e. labor)?
Observe demand and supply curves to determine the unit
equilibrium price and quantity of each factor.
Multiply unit price by quantity employed to calculate the total amount
paid to each factor.

16. Measuring Income Inequality
Kuznet’s ratio.
Lorenz curve.
Gini coefficient.

17. Measuring Poverty Absolute Poverty:
Number of people who are unable to obtain sufficient resources
to satisfy basic needs (i.e. food, clothing, shelter)
Those who live below a specific minimum income level
(i.e. international poverty line)

18. Measuring Poverty 1. Headcount Index:
Headcount index equals the number of those whose incomes fall
below the absolute poverty line (i.e. 1$ / day or equivalently
365$ / year).
headcount index equals the headcount taken as a fraction of the
population (i.e. H/N).
The larger the headcount index the greater the fraction of society
living in absolute poverty.

19. Measuring Poverty 2. Total Poverty Gap:
Measures the total amount of income required to raise everyone
who is below the poverty line up to that line.
Total poverty gap is a more comprehensive measure of absolute
poverty than headcount index.
5-19

20. Figure 5.6: Measuring the total poverty gap.

21. Measuring Poverty 3. Human Poverty Index (by UNDP):
Human poverty should be measured in terms of three key
deprivations:
Of life (fraction of people unlikely to live beyond 40 years of age).
Of basic education (percentage of adults who are illiterate).
Of economic provisions (percentage of people without access to
safe water and percentage of children who are underweight for
their age).

22. Measuring Poverty 3. Human Poverty Index (by UNDP)
Human poverty index measures the fraction of the population that
is adversely affected by three key deprivations.
In comparing two countries, the smaller the value of HPI the better.

23. Measuring Inequality and Poverty
Measuring Absolute Poverty:
Total poverty gap.
Where Yp is the absolute poverty line.
Yi is income of person I.

24. Measuring Inequality and Poverty
Measuring Absolute Poverty
Average poverty gap
Where H is number of persons
TPG is total poverty gap

25. Measuring Inequality and Poverty
Measuring Absolute Poverty:
Foster-Greer-Thorbecke measure.

26. Poverty, inequality, and social welfare
What’s so bad about inequality?
Dualistic development and shifting Lorenz curves: some stylized
typologies:
Traditional sector enrichment (see Figure 5.7).
Modern sector enrichment (see Figure 5.8).
Modern sector enlargement (see Figure 5.9).

27. Figure 5.7: Improved income distribution under the traditional-sector enrichment growth typology

28. Figure 5.8: Worsened income distribution under the modern-sector enrichment growth typology.

29. Figure 5.9: Crossing Lorenz Curves in the modern-sector enlargement growth typology

30. Poverty, Inequality, and Social Welfare
Kuznets’ Inverted-U Hypothesis:
In early stages of economic growth, distribution of income tends
to worsen (gap between rich and poor widens).
Only at later stages of growth, income distribution will improve
(gap narrows).

31. Figure 5.10: The “inverted-U” Kuznets curve

32. Poverty, Inequality, and Social Welfare
Kuznets’ Inverted-U Hypothesis:
Validity of inverted-U hypothesis is an empirical question (data).
Empirical results are ambiguous.

33. Figure 5.11 Kuznets curve with Latin American countries identified

34. Table 5.2: Selected income distribution estimate.

35. Table 5.3: Income and inequality in selected countries

36. Figure 5.12: Plot of inequality data for selected countries

37. Poverty, Inequality, and Social Welfare
Growth and inequality

38. Figure 5.13: Long-term economic growth and income inequality (1965-1996)

39. Figure 5.14: Change in inequality in selected countries, with or without growth

40. Absolute Poverty: extent and magnitude
Extreme Poverty:
$1-a-day headcount shows some progress.
Incidence of extreme poverty is uneven.

41. Table 5.5: Poverty incidence in selected countries

42. Table 5.5: Poverty incidence in selected countries

43. Main Question: Growth and Poverty
Are the reduction of poverty and economic growth conflicting
objectives?
Two lines of thought:
Traditional View.
Alternative View.

44. Growth and Poverty Traditional View:
Poverty reduction and growth are incompatible goals.
Public expenditures necessary for the reduction of poverty* lead
to reduced growth rates via lower public savings.
Income / asset redistribution from rich to poor generates slower
growth via lower private savings.
Poor tends to spend additional income on primary needs*
rather than save it.

45. Alternative View: Growth and Poverty
Poverty reduction and growth are complementary objectives.
Widespread poverty creates conditions in which the poor have
No access to credit.
No credit  No home / car / tuition loans  Lower aggregate
demand.

46. Growth and Poverty Empirical Evidence:
Data favor the alternative view.
China experienced high growth rates and large reductions in
extreme poverty.
Headcount index fell from 64 percent to 10 percent.

47. Economic characteristics of poverty groups
Four main generalizations about the poor:
Disproportionately located in rural areas.
80% of poor in Asia and Africa live in rural areas.
Primarily engaged in agricultural and related activities.
Two thirds of the world’s poor earn their living from agriculture
either as small-scale farmers or low-paid farm workers.

48. Economic characteristics of poverty groups.
Four main generalizations about the poor:
More likely to be women and children than adult males.
Women and children are more likely to be malnourished and less
likely to receive medical services, clean water, and sanitation
benefits.
Heavily concentrated among ethnic minorities or indigenous
populations.
Being indigenous raises the chances that an individual will be
undernourished, illiterate, unemployed, and in poor health.

49. Table 5.6: Poverty (rural versus urban)

50. Table 5.7: Indigenous poverty in Latin America

51. The Range of Policy Options: Some basic considerations
Question:
What economic, social, and other policies (or institutional changes)
can developing country governments adopt to reduce poverty while
sustaining economic growth?
There are four broad areas of potential government policy
intervention.

52. The Range of Policy Options: Some basic considerations
Areas of government policy intervention:
Altering the functional income distribution (distribution of national
income among factors contributing to production) via policies
designed to change relative factor prices.
Factor prices (i.e. price of capital relative to price of labor) work as
incentives for employers.
Correcting factor price distortions (i.e. elimination of minimum wage
laws) help lower relative price of labor and raise that of capital.
With relatively cheaper labor, employers will demand more labor
and less capital, which generates more wage paying jobs for the
poor.

53. The Range of Policy Options: Some basic considerations
Areas of government policy intervention:
Modifying the personal income distribution (distribution of national
income among citizens) via redistribution of assets / wealth.
Over 90 percent of productive and financial resources (i.e. physical
capital, land, financial and human capital) are controlled by the rich.
Alleviate the concentrated control of assets via redistribution
policies (i.e. land reform).

54. The Range of Policy Options: Some basic considerations
Areas of government policy intervention:
Reducing the size distribution at upper income levels via
progressive income / wealth taxes.
Rich is required to pay a progressively larger percentage of their
total income in taxes than poor.
Tax burden is designed to fall most heavily on upper income
groups.

55. The Range of Policy Options: Some basic considerations
Areas of government policy intervention:
Increasing the size distribution at lower income levels via direct
transfer payments or public provision of goods and services.
Tax-financed direct transfers (i.e. cash) or public services
(i.e. public health projects in rural villages, provision of electricity
and clean water to remote rural areas, etc).

56. Case Study: Bangladesh