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Poverty, Inequality, and

Development
Poverty, Inequality, and Development

• Outline:
– Measurement of Poverty and Inequality
– Economic characteristics of poverty groups
– Why is inequality a problem?
– Relationship between growth and inequality
– Relationship between growth and poverty
Poverty, Inequality, and Development
• Introduction and Importance
– Absolute poverty and indicators
– Economic characteristics of the poor
– Policy options for addressing poverty
Measuring Inequality and Poverty

• Measuring Inequality:
– Personal or size distribution of income deals
with the individual persons or households and
the total income they receive

– Functional or factor share distribution of


income uses the share of total national income
that each of the factors of production receives
Measuring Inequality
• Personal or size distribution of income
– Quintiles and Deciles
– Lorenz Curve
– Gini Coefficients
– Coefficient of Variation (CV)
Measuring Inequality
• Quintiles and Deciles
– Divide the population into successive quintiles
or deciles according to ascending income levels
and then determine the proportion of N.I
received by each income group
– Common measure of income inequality is the
ratio of incomes received by the top 20% and
bottom 40% of the population
Calculating Income Quintiles
Individual Income
A 5000
B 10000
C 18000
D 15000
E 500
F 200
G 3000
H 1000
I 800
J 20000
Steps involved in calculating quintiles
• Step1: Sort the values from the lowest to the
highest
• Step2: Calculate the total values for all cases
• Step3: Sum up all the incomes
• Step4: Calculate total amount in each quintile
• Calculate each quintile as percentage of total
amount in step3
Calculating Income Quintiles
Income Step1 Step2 Step3 Step4 Step5 Quintile
5000 200 200 73500 700 1% 1st
10000 500 500
18000 800 800 1800 2% 2nd
15000 1000 1000
500 3000 3000 8000 11% 3rd
200 5000 5000
3000 10000 10000 25000 34% 4th
1000 15000 15000
800 18000 18000 38000 52% 5th
20000 20000 20000
Exercise: Calculate the Quintile
Individual Income
A 1000
B 100
C 200
D 200
E 400
F 900
G 1200
H 700
I 500
J 200
Answer
Income Share of Quintile in income Quintiles
300 6% 1st

400 7% 2nd

900 17% 3rd

1600 30% 4th

2200 41% 5th


Measuring Inequality

• Lorenz curves
– Show the actual quantitative relationship
between the percentage of income recipients
and the percentage of total income they
received during a time period (year)
– Depict the variance of the size distribution of
income from perfect equality
Measuring Inequality
• Gini coefficient
– Is measured graphically by dividing the area
between the perfect equality line and the
Lorenz curve by the total area lying to the right
of the equality line in a Lorenz curve diagram
– Ranges in value from 0 (perfect equality) to 1
(perfect inequality)
– Satisfies the properties of anonymity, scale
independence, population independence, and
transfer principles
Figure 6.3 Estimating the Gini
Coefficient
Measuring Inequality
• Coefficient of Variation (CV)
– Is sample SD divided by the sample mean also
satisfies the properties of anonymity, scale
independence, population independence, and
transfer principles
• Functional distribution
• Second common measure of income distribution
• Attempts to explain the share of total national
income that each factor of production receives
Measuring Inequality
• Supply and demand curves are assumed to
determine the unit prices of each productive
factor.
• Unit prices multiplied by the quantities
employed by each factor yields total payment to
each factor
• All inequality measures are measuring relative
income distribution
Measuring Absolute Poverty

• A situation where a population or sections


of the population are able to maintain
minimum levels of living (IPL)
• Absolute poverty is measured using
– Headcount (H)
– Headcount Index (H/N)
– Poverty Gap (total income shortfall)
Measuring Absolute Poverty
• Headcount
• Number of people whose incomes fall below
the absolute poverty line
• The poverty line is set at a level that remains
constant in real terms
• To do this, define an adequate basket of food,
based on nutritional requirements, and cost it
• Add other expenditures such as shelter,
clothing and medical care to determine the
poverty line
Measuring Absolute Poverty
Measuring Absolute Poverty
– Average poverty gap

TPG
APG 
H
where H is number of persons
TPG is total poverty gap
Measuring Absolute Poverty

• The Human Poverty Index (HPI) is used by the


UNDP and measures poverty as three key
deprivations- survival, knowledge, and economic
provisions
• Survival: fraction of people unlikely to live beyond
40 years of age
• Knowledge: % of illiterate adults
• Economic: % of people without safe drinking
water plus % of children who are underweight
Characteristics of Poverty Groups

• Rural poverty
• Women and poverty
• Ethnic minorities and poverty
Why is inequality bad?

• Extreme inequality leads to economic


inefficiency and curtails growth
• Extreme inequality undermines social
stability and solidarity
• Extreme inequality is viewed as unfair
Figure 6.10 The “Inverted-U”
Kuznets Curve
Kuznets’ Inverted- U Hypothesis
• In the early stages of growth, distribution of
income will tend to worsen, where as in
later stages it will improve
• Reasons for the inverted- U curve not given
• Evidence indicates that the inverted U-
hypothesis does not hold Taiwan, S. Korea,
Costa Rica, etc)
Relation between economic growth and
inequality
• Does growth affect the level of inequality?
– No consensus
• Does initial inequality affect growth?
– Negative relation between growth and initial
inequality in income (refer to Why is inequality bad?)
– Positive relation between growth and initial inequality
(only Forbes found this relation)
– Initial inequality in assets and human capital
negatively affects growth (as it hurts the poor the
most)
• The main flow of causation appears to be initial
inequality hampering growth and not the other way
round.
Relation between economic growth and
poverty
• Traditionally, it was considered that there is
trade-off between growth and poverty.
• Why are similar rates of growth associated with
different rates of poverty reduction?
– Redistribution of growth benefits reduces poverty
– Initial inequality in income enhances poverty
– Sectoral composition of growth (agriculture versus
modern, rural versus urban)
• Efforts to reduce poverty lead to higher growth and
higher growth leads to reduction in poverty.
Policy Options-
• Altering the functional distribution of income
through policies designed to change relative
factor prices
– Removal of factor price distortions
• Modifying the size distribution through
progressive redistribution of asset ownership
– Redistribution policies such as land reform
• Reducing the size distribution at the upper levels
through progressive income and wealth taxes
– Direct progressive income taxes
– Indirect taxes
• Direct transfer payments and the public
provision of goods and services
– Workfare programs superior to welfare and
handouts.