Chapter 5 Poverty and Income Distribution

Developing countries need to return to a strong growth path. They also desperately need to reduce poverty. But where
should countries begin? Should they set their sights entirely on boosting per capita income and productivity, or focus on
actions to improve conditions for the poor? Recent research findings suggest yet again the importance of growth in reducing
poverty. They also demonstrate how pro-poor initiatives in turn can propel economic growth. When economic growth is
measured by survey mean income (consumption), there is a strong statistical relationship between growth and poverty
reduction. When economic growth is measured by GDP per capita, the statistical relationship between growth and poverty
reduction is not as strong. Economic growth tends to raise incomes for all members of society, including the poor. Economic
growth is the most powerful instrument for reducing poverty and improving the quality of life in developing countries. The
extent to which growth reduces poverty depends on the degree to which the poor participate in the growth process and
share in its proceeds.

Income Distribution & Economic Growth

In economics, income distribution covers how a country's total GDP is distributed amongst its population. Economic theory
and policy have long seen income and its distribution as a central concern. Classical economists such as Adam Smith
(1723–1790), Thomas Malthus (1766–1834), and David Ricardo (1772–1823) focused their attention on the distribution of
income between the primary factors of production (land, labor and capital). Modern economists have also addressed issues
of income distribution, but have focused more on the distribution of income across individuals and households. Important
theoretical and policy concerns include the balance between income inequality and economic growth, and their often,
inverse relationship.
The concept of inequality is distinct from that of poverty. Income distribution & inequality metrics are used by social
scientists to measure the distribution of income & inequality among the participants in a specific country or of the world in
general. While different theories may try to explain how income inequality comes about, income inequality metrics simply
provide a system of measurement used to determine the dispersion of incomes. The Lorenz curve can represent the
distribution of income within a society. The Lorenz curve is closely associated with measures of income inequality, such as
the Gini coefficient.
How quickly growth reduces poverty depends both on the initial income distribution and how it evolves over time. In
societies with more unequal distributions the same growth rate makes far less of a dent in poverty. Latin America and the
Caribbean, for example, have some of the widest income disparities in the world. Given these initial levels of inequality, the
region would have to post a 3.4 percent annual growth rate in per capita income (twice that recorded in the past decade), on
average, in order to halve the percentage of people living on less than two dollars a day (in purchasing power parity) by
2015.
How efficiently average growth will reduce poverty also depends on how the income distribution shifts as the economy
grows. In Mexico, for example, per capita real income rose by 4.8 percent annually between 1996 and 1998, but there was
virtually no change in extreme poverty. Yet in Costa Rica, where per capita real income edged up by barely 1 percent
annually between 1990 and 1998, poverty was reduced significantly.
Which growth pattern is the most pro-poor? A recent study on India found that growth has a greater impact on poverty when
it is concentrated in rural areas and the initial education and infrastructure conditions are more favorable. Generally, a sole
focus on maximizing per capita income growth may be less than successful in reducing poverty if the growth bypasses
geographic areas or sectors in which the poor are concentrated, or fails to make intensive use of the most abundant factor
of production available to the poor, namely, unskilled labor. This is more than twice the 1.5 percent average per capita
growth recorded in the past decade, and would call for annual per capita growth rates of between 2 percent and 6 percent
depending on the country.
In sum, economic growth is a crucial factor in poverty reduction, but the level of inequality and its evolution affect its impact
on poverty. We now offer theoretical and empirical evidence suggesting that the causation runs in the opposite direction as
well; that is, reducing poverty can help boost economic growth rates.

International Measurements of Distribution Inequality

There are problems and limitations in the measurement of inequality. There is a large gap between the national accounts
(which focus on macroeconomic totals) and inequality studies (which focus on distribution). The lack of a comprehensive
measure about how the pretax income differs from the post-tax income makes it hard to assess how government
redistribution effects inequality. There is no clear view on how long-run trends in income concentration are shaped by the
major changes in woman's labor force participation.
The Gini coefficient is an accurate and reliable index for measuring income distribution on a country-to-country level. The
Gini index measurements go from 0 to 1 (1 being perfect inequality and 0 being perfect equality). The world Gini index is
measured at 0.52 as of 2016. Several organizations, such as the United Nations (UN), the US Central Intelligence Agency
(CIA) and the World Bank have measured income inequality by country using the Gini Index.

Causes of Economic Inequality & Ways of Reducing Income Inequality

Causes of income inequality and of levels of equality/inequality include: labor economics, tax policies, other economic
policies, labor union policies, Federal Reserve monetary policies & fiscal policies, the market for labor, abilities of individual
workers, technology and automation, education, globalization, gender bias, racism, and culture. The following ways are
usually employed to reduce income Inequality:
 Taxes - Progressive income taxation prescribes higher tax rates for high income earners than for low-income
earners. In effect, the poor pay less on taxes and keep a larger percentage of their income compared to the rich.
The government uses the tax collected for the necessary and beneficial activities of society as a whole. Since a
large part of the tax collected comes from the rich, the beneficial activities for society as a whole reduces the
inequality twice.
 In-kind transfers - Cash aids to the poor may not be the best solution to solving inequality. In-kind transfers such
as food stamps or directly giving food packs may be a better alternative to ensuring that the poorest receive the
benefits.
 Housing subsidies - Rent and upkeep of housing form a large part of spending for lower income families. Housing
subsidies are designed to help the poor obtain adequate housing.
 Welfare and Unemployment benefits - This involves actual money given to the poor along with the discretion of
how to use this benefit. This will work only if we assume that the recipients are rational & can make decisions for
their best interest. However, the unemployment benefits do not motivate the unemployed to find jobs, since they
have no obligations and receive money for nothing.

Ways of Looking at Inequality

Standard economic theory stipulates that inequality increases over time as a country develops, & decreases when a certain
average income is attained. This theory is known as the Kuznets curve after Simon Kuznets. However, many prominent
economists disagree that inequality increases as a country develops. Further, empirical data on the proclaimed subsequent
decrease of inequality is conflicting.
There are two ways of looking at income inequality:
 Intra-country Inequality – Is inequality within a nation. According to intra-country inequality at least in the OECD
(Organization for Economic Co-operation and Development) countries, a May 2011 report by OECD stated that the
gap between rich and poor within OECD countries (most of which are "high income" economies) "has reached its
highest level for over 30 years, and governments must act quickly to tackle inequality".
 Inter-country Inequality - Is inequality between countries. Scholars disagree about whether inter-country income
inequality has increased, remained stable, or decreased. Milanovic emphasized this debate by showing that when
countries’ GDP per capita incomes are unweighted by population, income inequality increases, but when they are
weighted inequality decreases. This has much to do with the recent average income rise in China and to some
extent India, who represent almost two-fifths of the world. Notwithstanding, inter-country inequality is significant. For
instance, the bottom 5% of US income distribution receives more income than over 68% of the world. Of the 60
million people that make up the top 1% of income distribution, 50 million of them are citizens of Western Europe,
North America or Oceania. In a presentation, Hans Rosling showed the distribution & change in income of various
nations over the course of a few decades together with other factors such as child survival and fertility rate. As of
2018, Albania had the smallest gap in wealth distribution with Zimbabwe having the largest gap in wealth
distribution.

Ways Poverty Can Hinder Growth

Poverty can dampen growth when market imperfections (market failures, incomplete or uncompetitive markets) combine
with investment indivisibilities, fixed costs, and strategic complementarities. In particular the following factors hinder
economic growth:
 Investment Capacity Constraints - Investment is critical for growth and to escape from poverty. Since fixed costs
and indivisibilities are the norm, the poor may run into problems when they wish to invest because they are unable
to come up with enough cash savings of their own, and they usually find themselves shut out of lending markets.
Low-income levels are a fundamental reason why the poor cannot save enough money to finance productive
investments. The poor run up against yet another obstacle when they want to borrow: steep transaction costs and
high interest rates that make credit a losing proposition. An analysis of various microfinance institutions showed
that those that are financially sustainable have nominal interest rates ranging from 30 percent to 50 percent.
Actions to foster the development of financial institutions and services that truly serve the needs of the poor are a
potential growth booster as well. In some cases, subsidies to help defray fixed costs for equipment, machinery and
human capital can be a more efficient approach to encourage the poor to invest more. Also, actions to lessen the
moral hazard and adverse selection problem would help: for example, bolstering property rights for the poor, land
market reforms to give poor people readier access, and further development of institutional vehicles such as group
credit.

 Constraints for Human Capital Development - Human capital, in its broadest sense, comprises people's
educational attainment, their health and nutrition. There is solid evidence associating more schooling and better
nutrition with higher income and with enhanced productivity. Education may generate other important externalities
that can indirectly propel growth. For instance, how well a mother is educated is crucial for her children's learning
and hence for human capital accumulation in the family. The investment may hold little appeal for poor families
primarily because of the opportunity cost of children and young people who could be working in their homes or
bringing in outside paychecks. Hence the importance of education and health interventions both on the supply side
(such as public spending on infrastructure and improvements in service and quality) and on the demand side for
these services, for instance subsidies tied to investment in human capital for the poor (two examples are Mexico's
Progresa program now called Oportunidades , and Brazil's Bolsa Escola grants). Just as crucial are early-
 intervention programs in health and nutrition and basic infrastructure investment (running water, electricity,
transportation) because of the synergies at work between sound nutrition and people's ability to use new learning
technologies (distance learning institutes, distance high-school education). Reforms to overhaul the institutional
apparatus for social services delivery need to make sure that the poor have access to these services.

 Poverty, Social Instability and Social Ills - Another channel through which poverty can stall growth is by way of its
relationship with social and political equilibria. Where social injustice is pervasive and people have no say in the
political process poverty can trigger social upheaval and, ultimately, the kind of sustained violence that puts the
brakes on growth. We know from the evidence that poverty and inequality associated with geographic, ethnic,
racial and gender factors take an economic toll on society at large that thwarts a country's growth potential.
Likewise, the frustration that poverty breeds can trigger dysfunctional behavior and social ills (crime, alcoholism,
drug addition, domestic violence, early pregnancy), that trap the poor and exact high economic costs as well.

Symbiotic Relationship of Growth & Poverty Reduction

Recent growth theory has posited various links between poverty, social and political instability, and growth. This being the
case, initiatives targeted at reducing poverty and fostering social mobility do more than benefit individuals and society at
large; they can enhance an entire nation's growth potential.
In sum, clearly economic growth is good for the poor. As important, reducing poverty is good for growth. Rather than being
alternative paths, pro-growth actions and those directly targeted at improving the lives of the poor are very often mutually
reinforcing. The more this complementarity is tapped the more effective economic growth can be in reducing poverty. And
the more countries do to eliminate constraints that are keeping the poor from being active, constructive partners in society,
the greater the potential for growth and efficiency.

Poverty, Income Distribution, and Economic Policy in the Philippines

Income distribution in the Philippines is highly uneven, and poverty rates are higher than in other ASEAN countries. In
addition, although the poverty rate has declined over time, the rate of decline has been lower than in other countries, and
income inequality has been persistent. These facts are due to historically slow economic growth, owing in part to poor
policies, as well as to past failures to reduce structural impediments to a more equal distribution of income. Despite reforms
in recent years, it will likely take some time to erase the effects of past policies.