Unit 4 : Poverty and Inequality

Source : Todaro, M. P., & Smith, S. C. (2020). Economic Development. Pearson UK

Ch.5. Poverty , Inequality and Development

▪ So far we have understood that despite significant improvements over the past half century, extreme
poverty remains widespread in the developing world
▪ This section carries out the in-depth examination of the problems of poverty and of highly unequal
distributions of income.
▪ development requires a higher gross national income (GNI), and sustained growth of the income .
However, it is important to understand not only how to make it grow but also who will make it grow ?
▪ if it were generated by the many ( the masses and not just by the rich) , they would be its principal
beneficiaries, and the fruits of economic growth would be shared more evenly
▪ To understand the entire scenario we will study the following sections :
i. Measuring Inequality
ii. Measuring absolute poverty
iii. Poverty , inequality and Social welfare
iv. Absolute Poverty : Extent and magnitude
v. Economic characteristics of high Poverty groups
vi. Policy Options on Income Inequality and Poverty: Some Basic Considerations
vii. Summary and Conclusions: The Need for a Package of Policies
 Section 1: Measuring Inequality
We try to understand dimensions of income distribution
and poverty : How to measure it ?
i. Personal Distribution/ Size Distribution of income
ii. Function Distribution/ Factor Share distribution of
Income
Using Personal Distribution of Income / Size distribution
of income
• deals with individual persons or households and the
total incomes they receive: how much each earns
irrespective of the way this income is earned ( whether
rural, urban, agriculture, industry, etc.)
• Arrange individuals in order of rising incomes and divide
the population into different group: Quintiles(fifths),
Deciles(tenths) : this data will give how much income is
being received by bottom tenth of population or bottom
fifth of the population OR say, top tenth or top fifth of
the population
▪ Look at the table for example: Total or national income
of all individuals amounts to 100 units
▪ The first quintile represents the bottom 20% of the
population on the income scale.
▪ The first Decile represents the bottom 10% of the Source: Todaro and Smith, Economic Development, Ch.5. Poverty , Inequality and Development
population
▪ A common measure of inequality can be understood,
Kuznet’s Ratio = ratio of incomes received by top group
and bottom group of population
 Section 1: Measuring Inequality ( contd.)
Another way to look at income inequality: Lorenz curve is a graph depicting the variance of the size distribution of
income from perfect equality

Source: Todaro and Smith, Economic Development, Ch.5. Poverty , Inequality and Development

▪ X-axis: numbers of income recipients in cumulative percentage

▪ Y-axis: share of total income received by each percentage of population
▪ A every point on that diagonal, the percentage of income received is exactly equal to the percentage of
income recipients: Perfect Income Equality
▪ Curved line shows how unequal the income distribution is – the more outward the curve, the more is the
inequality
 Section 1: Measuring Inequality ( contd.)
Gini Coefficients / Gini concentration ratio
= ratio of the area between the diagonal and the Lorenz curve divided by the total area of the half-square in which the curve lies
= shaded area A DIVIDED by the total area of the triangle BCD
Perfect Equality= 0 ; Perfect inequality= 1
▪ Why is Gini Coefficient , an aggregate measure of
inequality desirable ?
▪ Because it satisfies the following 4 properties:
i. Anonymity: should not depend on who has the
higher income
ii. Scale independence: should not depend on the
size of the economy or the way we measure its
income
iii. Population independence : should
not be based on the number of income recipients.
iv. Transfer: if we transfer some income from a
richer person to a poorer person the resulting new
income distribution is more equal.
▪ coefficient of variation (CV), which is simply the
sample standard deviation divided by the sample
mean, is another measure of inequality that also
satisfies the four criteria.
Source: Todaro and Smith, Economic Development, Ch.5. Poverty , Inequality and Development
 Example: Lorenz Curves

% of income
Graphically
▪ Red Lorenz Curve: 25% of Mathematically
population earns 25% of 75
total national income ( NO ▪ Red Lorenz Curve: (Extreme case)
inequality/ perfect equality) ➢ Gini coefficient=0..
▪ Blue Lorenz Curve: 25% of ➢ Perfect equality
population earns LESS THAN 50 ▪ Blue Lorenz Curve ,
25% of income i.e. 12% of ➢ Say, Gini Coefficient= 0.3= 30%
total national income ( ➢ Higher inequality than Red
inequality has increased 25
▪ Green Lorenz Curve
from before) ➢ Say, Gini Coefficient= 0.3= 30%
▪ Green Lorenz Curve: 25% of 12 ➢ Higher Inequality than Blue
population earns MUCH ▪ Perfect inequality (extreme case)
LESS THAN 25% of income 1 ➢ Gini Coefficient = 1=100%
i.e. only 1% of total national 0 25 50 75 % of pop.
income ( inequality has
increased from before)
 Unit 4 : Poverty and Inequality
Source : Todaro, M. P., & Smith, S. C. (2020). Economic Development. Pearson UK
Ch.5. Poverty , Inequality and Development

The functional or factor share distribution of income:

▪ explains the share of total national income that each of the factors of production (land, labor, and capital) receives
▪ Percentage that labor receives as a whole and compares this with the percentages of total income distributed in the
form of rent, interest, and profit
▪ How to calculate the total factor payment of each factor? :
▪ Supply and demand curves are assumed to determine the unit prices of each productive factor
▪ When these unit prices are multiplied by quantities employed on the assumption of efficient (minimum-cost) factor
utilization, we get a measure of the total payment to each factor
▪ Ahluwalia-Chenery Welfare Index (ACWI): How to assess the characteristic of equality in growth ?
One can value increases in income for all individuals but to assign a higher weight to income gains by lower-income
individuals than to gains by higher-income individuals
 Section 2: Measuring Absolute Poverty
▪ Absolute poverty The situation of being unable or only barely able to meet the subsistence essentials of food, clothing,
and shelter.
▪ Headcount index: The proportion of a country’s population living below the poverty line. Absolute poverty is used with
this measure.
= H/ N
where H: those whose incomes fall below the absolute poverty line, Yp ( stays constant in REAL terms)
N: Total Population
▪ Total poverty gap (TPG): The sum of the difference between the poverty line and actual income levels of all people living
below that line. (severity of poverty in the country.. Relative poverty)
TPG = (Yp – Y1)+ (Yp – Y2)+ (Yp – Y3)+… +(Yp – YH)…..
where H : those whose incomes fall below the absolute poverty line, Yp
▪ A good poverty measuring variable:
➢ should not depend on who is poor or on whether the country has a large or small population;
➢ Monotonicity: should not depend on who is poor or on whether the country has a large or small population
➢ distributional sensitivity principle : other things being equal, if you transfer income from a poor person to a richer person, the
resulting economy should be deemed strictly poorer
 Section 2: Measuring Absolute Poverty
Foster-Greer-Thorbecke (FGT) index : satisfies all the criteria for an ideal poverty measurement index

▪ P0 ( where α =0) = H/ N. This Is also the Head Count ratio

▪ P1 ( where α= 1) = (H/N) X (NIS) where NIS: Normalised income shortfall = NIS = AIS/Yp = (TPG/H)/Yp
According to P1, Poverty goes up whenever either the fraction of people in poverty goes up or the fractional
income deficits (poverty depth) go up (or both)
▪ P2 ( where α= 2) =(H/N)[NIS2+ (1-NIS)2(CVp)2]. It is also called squared poverty gap index. It is useful
because of its sensitivity to the depth and severity of poverty

▪ Multidimensional Poverty Measurement :

➢ According to Amartya Sen’s capability framework, Poverty cannot be adequately measured with
income alone.
➢ The FGT measures are adjusted with a multidimensional approach
➢ Proxy measures called indicators are often used for specific dimensions
 Section 3. Poverty, Inequality, and Social Welfare
Understanding the negative impacts of extreme inequality among those above poverty line: relative poverty
• Extreme income inequality leads to economic inefficiency
• Extreme income disparities undermine social stability and solidarity
• Extreme income disparities are generally unfair
Dualistic Development: Analysis through Lorenz curves
• Growth through enlargement of Modern Sector: economy develops by enlarging the size of its modern sector while
maintaining constant wages in both sectors. Similar to the historical growth pattern of Western developed nations and, to
some extent, the pattern in East Asian economies such as China, South Korea, and Taiwan: incomes rise and absolute
poverty is reduced, but the i.e. Lorenz curves will always cross, so can’t say whether inequality falls or rises
• Growth through enrichment of Modern Sector: economy grows but such growth is limited to a fixed number of people in
the modern sector, with both the numbers of workers and their wages held constant in the traditional sector. This roughly
describes the experience of many Latin American and African economies: higher incomes, a less equal relative
distribution of income, and no change in poverty i.e. Lorenz curve shifts downwards
• Growth through enrichment of Traditional Sector: benefits of growth are divided among traditional-sector workers, with
little or no growth occurring in the modern sector. This process roughly describes the experiences of countries whose
policies focused on achieving substantial reductions in absolute poverty even at very low incomes and with relatively low
growth rates, such as Sri Lanka, and the state of Kerala in southwestern India. : a more equal relative distribution of
income, and less poverty I,e, Lorenz curve shifts upwards
What does it mean ? Kuznets’s Inverted-U Hypothesis
Relationship between a country’s income per capita and its inequality of income distribution
➢ in the early stages of economic growth, the distribution of income ( inequality of incomes)
will tend to worsen;
➢ In later stages the distribution of income will improve i.e. inequality will fall
Possible Reasons:
➢ Early growth may be concentrated in the modern industrial sector, where employment is
limited but wages and productivity are high: structural change
➢ generated by a steady process of modern-sector enlargement growth as a country develops
from a traditional to a modern economy
➢ returns to education may first rise as the emerging modern sector demands skills and then
may fall as the supply of educated workers increases and the supply of unskilled workers Source: Todaro and Smith, Economic Development, Ch.5. Poverty , Inequality and
falls: Probably consistent with a sequential process of economic development Development

Is the Kuznet’s Hypothesis True ?

▪ Argument that the Kuznets sequence of increasing and then declining inequality is inevitable
▪ Taiwan, South Korea, Costa Rica, and Sri Lanka to demonstrate that higher income levels can be accompanied by falling and not rising inequality. It all
depends on the nature of the development process
▪ But it is also possible that Higher PCY are not necessarily related with levels of inequality e.g. Ethiopia has low PCY and maybe that is why low
inequality; on the contrary Zamibia and Mozambique have high inequality with low PCY; Latin America has experienced risen incomes but still
inequality is very high.
▪ Thus, one can see that there is no particular tendency for inequality to change in the process of economic development.
▪ Infact, Inequality seems to be a rather stable part of a country’s socioeconomic makeup, altered significantly only as a result of a substantial upheaval
or systematic policies.
▪ inequality can be gradually reduced through well-implemented policies to promote pro-poor growth over time. With regressive policies, inequality
may rise over time.
 Section 4: Absolute Poverty: Extent and Magnitude
▪ A crucial issue in measuring poverty at the global level: determining the most appropriate cut-off income for extreme poverty
▪ No matter how high the poverty figures go after updating the poverty line, but it did not change the conclusion that the number in poverty has been falling
markedly since 1990, most conspicuously due to progress in China.
▪ Thus, the MDG of halving $1.25 per day poverty was close to having been met by 2010; estimates show that this goal had been met – and indeed exceeded – by
the end of 2013.
▪ The incidence of extreme poverty is very uneven around the developing world
▪ Household survey–based estimates are regarded as the most accurate ways to estimate poverty incidence.
▪ 2010: poverty incidence is very high in both South Asia, with about 40% below $1.25 per day, and in sub-Saharan Africa, with 51% below.
▪ But poverty severity is far higher in sub-Saharan Africa: sub-Saharan Africa has shown far less progress than other developing regions.
▪ But between 1981 and 2010, the average income of the extremely poor hardly increased in sub-Saharan Africa, remaining near an appalling 70 cents per person
per day.
Chronic Poverty
▪ Research suggests that approximately one-third of all people who are income poor at any one time are chronically (always) poor.
▪ The other two-thirds are made up of families that are vulnerable to poverty and become extremely poor from time to time.
▪ These may be divided between families usually poor but occasionally receiving enough income to cross the poverty line and families usually non-poor but
occasionally experiencing a shock that knocks them temporarily below the poverty line.
▪ India and Sub-Saharan Africa are footholds of chronic poverty in the world
▪ Ultrapoverty differs from conventional poverty in terms of depth (degree of deprivation), length (duration of time), and breadth (the number of dimensions, such
as illiteracy and malnutrition)
▪ The prospect for ending poverty depends critically on two factors:
➢ the rate of economic growth—provided it is undertaken in a shared and sustainable way
➢ the level of resources devoted to poverty programs and the quality of those programs.
 Section 4: Absolute Poverty: Extent and Magnitude

Multidimensional Poverty Index (MPI): poverty measure that identifies the poor using dual cut-offs for levels and numbers of
deprivations, and then multiplies the percentage of people living in poverty times the percent of weighted indicators for which poor
households are deprived on average.; incorporates three dimensions at the household level: i) health, ii) education, and iii) wealth
Why do we need a Multidimensional concept? :
i. Income is imperfectly measured
ii. Advantages provided by a given amount of income greatly differ, depending on circumstances
2010 the Human Poverty Index was replaced by MPI: negative interaction effects when people have multiple deprivations
➢ Health indicators:
i. Child mortality in the family
ii. Malnutrition of any adult/child in the family
Rather than using already aggregated
➢ Education Indicators:
statistics in an index, the approach
i. No of people who have not completed even 5 years of schooling
takes into account the multiplied or
ii. whether any school-age child is out of school for grades one through eight interactive harm done when multiple
➢ Standard of living indicators- six deprivations are considered deprivations are experienced by
i. lack of electricity, individuals in the same family.
ii. insufficiently safe drinking water
iii. inadequate sanitation
iv. inadequate flooring,
v. unimproved cooking fuel
vi. lack of more than one of five assets—telephone, radio, television, bicycle, and motorbike or similar vehicle.
 Section 4: Absolute Poverty: Extent and Magnitude
Relation between Poverty reduction and growth acceleration China’s Evidence of poverty reduction and economic growth :
View 1: conflicting ➢ Over the past 30 years, China has experienced the highest
growth rate in the world and also the most dramatic
➢ rapid growth is bad for the poor because they would be bypassed and reductions in poverty. This did not occur merely as a result of
marginalized by the structural changes of modern growth. high growth. Policies actively encouraged modern-sector
➢ public expenditures required for the reduction of poverty would entail a enlargement
reduction in the rate of growth. ➢ China has worked with the World Bank and other
View 2: may be complementary development agencies to improve its poverty reduction
programs; long-standing efforts to provide at least minimal
➢ widespread poverty creates conditions in which the poor have no access to education and health care for its people as a firm foundation
credit. So access to credit would actually allow opportunities for for long-term progress.
employment and entrepreneurship which can help growth
Richer countries: tend to have low levels of absolute poverty;
➢ the rich in many contemporary poor countries are generally not noted for through one means or another ; people who live in rich countries
their frugality or for their desire to save and invest substantial proportions tend to escape from poverty
of their incomes in the local economy
Developing countries, there is evidence that countries with
➢ low incomes and low levels of living for the poor, which are manifested in faster overall rates of per capita income growth also tend on
poor health, nutrition, and education, can lower their economic average to have faster rates of per capita income growth among
productivity and thereby lead directly and indirectly to a slower-growing those in the bottom quintile of the income distribution
economy
There may not be a clear relation between growth and poverty
➢ raising the income levels of the poor will stimulate an overall increase in reduction but they may be compatible objectives
the demand for locally produced necessity products. This spurs local
production and there for growth
➢ a reduction of mass poverty can stimulate healthy economic expansion by
acting as a powerful material and psychological incentive to widespread
public participation in the development process
Countries where poverty has been reduced the most tend to have had
sustained growth; at the same time, however, growth does not guarantee
 Section 5: Economic Characteristics of High-Poverty Groups
Group 1:
Rural Poverty: On the average, we may conclude that in Africa and Asia, about 80% of all target poverty groups are located in the rural
areas, as are about 50% in Latin America (street hawking, trading, petty services, and small-scale commerce; agricultural and associated
activities)
Reason for persistent rural poverty: urban modern-sector bias in government expenditures is at the core of many of the development
problems
Solution: disproportionate number of the very poor who reside in rural areas, any policy designed to alleviate poverty must necessarily
be directed to a large extent toward rural development in general and the agricultural sector in particular

Group 2:
Women and Poverty: Women make up a substantial majority of the world’s population; virtually everywhere women and children
experience the harshest deprivation; recorded female-male sex ratios are so much below their expected values, primarily in Asian
countries, that well over 100 million girls and women are said to be “missing.”- gender bias
Reason for persistent female poverty:
i. Low prevalence of female-headed households;
ii. lower earning capacity of women, and their limited control over their spouses’ income all contribute to this disturbing phenomenon:
wage differentials and discrimination in access to resource and work place
iii. have less access to education, formal-sector employment, social security, and government employment programs.
iv. Strong bias in access to opportunities and basic living and medical facilities
v. limited control of a woman over household income and resources
vi. In general, women in female-headed households have less education and lower incomes.
 Section 5: Economic Characteristics of High-Poverty Groups
Group 3: Group 4:
Ethnic Minorities, Indigenous Populations, and Poverty Poor Countries: negative relationship between poverty
and per capita income i.e. if higher incomes can be
it falls especially heavily on minority ethnic groups and
achieved, poverty will be reduced
indigenous populations
But high level of absolute poverty can also retard a
one or more of which faces serious economic, political,
country’s growth prospects: vicious cycle of poverty
and social discrimination: losing out in the competition
for limited resources and job opportunities. Solutions observed: antipoverty and social safety net
programs’ expansion
Evidence that : majority of indigenous groups live in
extreme poverty and that being indigenous greatly higher national incomes greatly facilitate poverty
increases the chances that an individual will be reduction, while at the same time, poverty still need to
malnourished, illiterate, in poor health, and be addressed directly.
unemployed.