Development Economics 355

Lecture Notes
Todaro-Smith ch. 5 notes

Poverty, Inequality and Development
* slideshow on poverty and inequality over time (Gapminder)
http://www.gapminder.org/downloads/human-development-trends-2005/
* More facts & figures:
- close to 1 bln people live on less than $1 per day, 2005
- 2.7 bln live on less than $2 per day
- poverty correlated with malnutrition, low literacy, little political voice, social exclusion
* elimination of extreme poverty as a development goal (Millenium Development Goals
adopted by UN in 2000) – see Economist table on current progress. 1990: 46% of world
population (2.4 bln people) living on less than $1.25 a day; 2008: 27% (1.8 bln people).
* inequality – the distribution of income within a country. Here we focus on economic
inequality but of course there are broader problems of power, prestige, gender, religion, etc.
* QUESTIONS to be addressed:
1. what is the extent of relative inequality in developing countries and how to measure it?
2. who are the poor and what are their characteristics?
3. How are economic growth and inequality related, does rapid growth increase or reduce
inequality?
4. Do the poor benefit from growth and how much?
5. Is inequality bad? Can arguments against inequality be made from purely efficiency
perspective?
6. Policies related to inequality and absolute poverty.
MEASURING INEQUALITY
* How to measure? The Lorenz curve
- order population by increasing income (in practice use quintiles (fifths) or deciles (tenths))
– Table 5.1 gives example. Note: here the source of income does not matter, just the
magnitude.
Measure 1: can take the ratio (so-called “Kuznets ratio”)
income received by the richest 20% / income received by poorest 40%
in Table 5.1 this is 51/14 = 3.64. Or could have taken top 20% divided by bottom 20% - ratio
of 10.2!
- deciles give even more detailed measure of the income distribution (and inequality)
- LORENZ CURVE: can take the above idea to the maximum detail possible and plot % of
population vs. % of total income (people ordered by increasing incomes) – Figure 5.1.
- each point (A-I) on fig. 5.1 corresponds to one decile of the population.
- the line connecting these points is called the Lorenz curve (LC)

e. * NOTE: GC is by construction a number between 0 and 1. * GC is an aggregate measure of inequality that can be obtained as (see fig. perfect equality will produce a LC which is a straight line. . opposite is true for LC further away from the 45-degree line (closer to the bottom and right sides of the box) – figure 5.a LC closer to the 45-degree line corresponds to more equal society. 100% (all) people receive 100% (all) of total income .g. Gini coefficient * The LC is a very detailed measure of inequality but hard to use in practice. and the richest person will have 100% . what fraction of income labor vs.anonymity: GC does not depend on who is who (just their income level) . .GC is units-free. but its factor share distribution (functional inequality). i. If the economy rich on average or poor on average does not matter too.2. poorest 10% would receive 10% of total income.g. * GC = 0 corresponds to perfect equality. more detailed information on inequality in a country. a flat line at 0. Functional inequality * sometimes important to know not only the size of income a person has. the 45-degree line.realistically we’re in between: the LC is an increasing line (Why?) and convex (i.a vertical line). working at minimum wage. . Alternatively. * this is where the GINI COEFFICIENT measure of inequality comes in.population size independence . The LC is a right-angled curve. two societies can have different GCs but their LCs cross – how to rank? * GC has some nice properties which is why it is most commonly used to measure income inequality in development economics: . GC declines (the resulting income distribution is more equal). * Caution: GC is an aggregate measure – two different LCs can have same GC (but then they must cross) (Explain why). GC remains the same.3) as the ratio of the shaded area A (the area between the LC and the 45-degree line) and the total area BCD.if all people had equal income.scale independence: if we measure income in different units. capital receive. if we clone each person into 2.how about if one person had all the income in the country? Then all but the richest person (99. each with the same income as the original person.thus. if we transfer some income from a richer person to a poorer person. GC remains the same. poorest 20% will receive 20% of total income etc. . etc. . May be important for policy: e.NOTE: 0% of people receive 0% of total income. . .. * gives additional.e.99% on the horizontal axis will have 0 income. E. increasing at an increasing rate) (WHY?). GC = 1 corresponds to perfect inequality. would be nice to somehow aggregate the information carried by it into a single number we can compare across countries.transfer principle: holding all else constant. if a person receives a certain income as unemployment pay vs. 5.

typically $1 a day or $2 a day.g. can compute the per capita gap relative to the PL: * normalized poverty gap (NPG) = APG/Yp (a measure between 0 and 1) * average income shortfall (AIS) = TPG / H (on average by how much a poor person’s income falls below the PL) * normalized income shortfall (NIS) = AIS/Yp. can compute the * average poverty gap (APG) = TPG / N * or. Headcount (the nr of people below the PL) and headcount index (ratio) – the proportion of people below PL from the whole population.g.g.6).g. if high inequality means some are far away from the PL but also that a small change in policy of agricultural prices may bring many above it. * headcount – H (e.of overall economic provisioning (% of people without access to safe water + % of children underweight for their age) . 10%) * why poverty line? Simple.POVERTY – measurement * the inequality measures give idea about relative poverty (how much income people in a country have relative to each other) * here: absolute poverty – the number of people unable to satisfy some basic needs *basic idea: define a “poverty line” (PL) – minimum amount of income (PPP adjusted) that can be used to compare poverty internationally. But there are issues: e.of basic education (the % of adults who are illiterate) . can think of it as the amount of money per day needed to bring every poor person to the PL. 5 mln people). analogous to the human development index * UNDP argues poverty should be measured in terms of three deprivations: . * TPG = ∑ (Y i|Yi <Y p p − Yi ) where Yp is the poverty line income. Human poverty index (introduced by UNDP) * want to broaden the usual “income poverty” definition (e.of life (the % of people unlikely to live beyond 40 years of age) .g. * on per capita basis. the $1 a day PL by the World Bank). 5. headcount index is H / N (e. or far from it (policy bias can result from that. explain) * to measure the amount of poverty more precisely (instead of the binary measure of being below or above the PL) we use another measure: total poverty gap (TPG) * TPG measures the total amount of income necessary to lift everyone below the PL to that line (see fig. it matters if most people are right below it. Gini) – matters for policy. * can be also interested in the inequality among the poor (e.

etc. * hard to make reforms and changes: the ‘losers’ are typically the rich who have the power. lots of poor can also lead to populist (redistributionary) policies that are also bad for the economy in the longer run (e.g. * with more inequality focus of politics is mostly on redistribution rather than increasing the ‘size of the pie’. (more in ch. inventors. political and social stability * higher levels of inequality may undermine political and social stability. family-run farms usually more productive. Most people vote for some intermediate amount. Example 3: the saving rate – if many poor overall saving rate in the economy can be very low (less domestic resources to invest in the economy) Example 4: farming . Do you agree? * but how about inequality? Should relative inequality be a concern? (above the poverty line) 1. raises their power and can yield to outcomes that further exacerbate inequality. certain land reforms. economic efficiency: income inequality can lead to inefficiencies Example 1: credit markets – a poor person with a great business idea but no collateral – the idea will never be implemented – a loss to society. Tanzania perform better on HPI. Resources devoted to such activities are unproductive! Again – economic inefficiency. inequality would not matter (give examples). Nigeria. in all religions. for these countries poverty is bigger problem than income measures indicate. bribery. 2. Example 2: education. excessive lobbying. Nicaragua.g. * on the other hand.large farms run by hired labor may be unproductive due to incentive problems. large farms can be even more productive by using machines. nationalizations. smaller. if all markets are perfect. political donations. However. . Morocco 37 places worse. i. * in contrast. 11) 3. inequality makes the rich richer. INEQUALITY AND WELFARE * most people agree that absolute poverty is bad and should be eradicated (e. Bolivia. NOTE: for most of the above to be true we need some type of credit or other market inefficiency. moral and ‘fairness’ objections to inequality Rawls’ ‘veil of ignorance’ criterion: what level of inequality would you vote for before being born. POVERTY. * high inequality can facilitate rent seeking (incl. unaffordable social policies). if costly (and there always is an opportunity cost even if no fees) poor parents may not educate their smart children who may otherwise become doctors. all gov’t policies).* creates a measure both different from the standard PL and also from HDI.e. *Some examples: Cote d’Ivoire 26 places worse if poverty measured by HPI than in income. – loss to society. cronyism).

many with income < F in order to maintain the same average y) then those rich people can adopt the modern technology and eventually the economy may grow and escape the subsistence state. (think why) However. women - . rural – poor are disproportionately located in rural areas (Table 5.14: increasing inequality in 77% of countries but unrelated to growth Growth and poverty – evidence * does economic growth disproportionately hurt the poor? * Dollar and Kraay (2002) share of income accruing to bottom 20% is not correlated with average income * claim: average incomes of the poorest 20% of society rise proportionately with average incomes (note this does not mean the poor gain the same absolute amount of income as the rich!) * pro-growth policies benefit poor as much as everyone else * criticism – all these things hold on average – across people and countries – may not be very informative for each separate country * the elasticity of poverty reduction from growth depends on: . EMPIRICAL EVIDENCE Growth and inequality – evidence * figure 5.g. LA grew little. inequality stayed constant. splitting resources unequally may be more efficient.13: long-term growth and income inequality 1965-1996. SSA didn’t grow. of course. study. inequality increased slightly *figure 5.Can (some) inequality be good? * If perfect equality there are no incentives to work. no clear pattern to be seen.6) – about 80% of people below PL are in rural areas (mostly in subsistence agriculture – 2/3) * but often urban bias in terms of development policy * seems focus on rural areas and agriculture in particular is necessary 2. inequality increased a little. East-Asia grew a lot. * ‘lifeboat problem’ arguments – if very poor. No reward for effort. etc. * another example: if on average society is poor (say average income y) and there are fixed costs to set up a business of F > y then if all people are equally rich no one can set up business (e.the average level of income (distance from the PL) . if there were some people with income > F (and. adopt modern technology) and the economy stays in subsistence.the level of inequality! (if inequality grows as average GDP grows poverty may not fall!) * bad news for countries with high inequality and low income! Who are the poor? (look at micro level before looking at policy) 1.

poorest segments in LDCs are in women-headed households. Canada = . job training) * much more needs to be done focusing on women (education. housework) . openness to trade. Japan = . – increasing school enrollment for girls * How to increase school enrollment? . e. signing contracts.98.programs: mostly oriented to men (agricultural extension services. 18% of non-indigenous 4. but see Table 5. * this inequality also exists within households .much work performed by women is unremunerated / intangible (parenting. * why? . that encourage school enrollment) * rural development? . inflation stabilization) – find no or weak evidence in promoting poverty reduction * human capital – determinant of growth and good for reducing inequality * seems increasing secondary enrollment matters (but quality of education is key!) * Besley et al. clean water. in India girls are 4 times more likely than boys to suffer from acute malnutrition. less access to education. etc. less likely to receive medical services.strong intra-household bias against women in nutrition.39. education. more likely to be undernourished.women paid less for same tasks but also effectively precluded (banned) from high-earning occupations .often socially unacceptable for women to contribute to money earning – leads to their low bargaining power in the family . India = 1.06.06.g. .97. businesses.96. in Mexico over 80% of indigenous population is poor vs.by increasing supply of schooling (but trade-off between quality and quantity of schools and teachers) . medical care. France = . social security .by increasing demand for education (conditional transfer programs in Mexico. formal sector employment.08) China = 1. Kuwait = 1.g.HICs .these gender biases are possible reason for high sex ratios (#men to #women) in some countries (“the missing women”) . .women and children experience harshest deprivation.7 for Latin America.. Brazil.legislation and social customs often preclude women from owning property. sanitation.95.98 (many LICs – 1.not all rural poor are *farmers* . etc. 40 less likely to be taken to hospital when ill. ethnic minorities * over-represented among the poor * data difficult to obtain for political reasons.95-. inheritance e. USA = ..02-1. microfinance) 3. people in the poor countries * seems obvious but important implication is that growth can help (see more below) POLICIES (see slides too) * do some policies maximize poverty reduction? * Dollar and Kraay – try different macro policy variables (rule of law.

food crops research . electricity.land reforms? Incentives vs.. land parcelization (splitting land into small pieces) .extensions systems .productivity enhancing technologies for small farmers (a new Green revolution for Africa?) .increasing non-farm employment . water) .rural infrastructure (roads.risk reduction devices for small farmers .transaction costs – better connection to markets What should work? .