Chapter 5

Chapter 5
Poverty,
Inequality, and
Development
Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Poverty, Inequality, and Development
Introduction
5.1 Measuring Inequality
5.2 Measuring Absolute Poverty
5.3 Poverty, Inequality, and Social Welfare
5.4 Absolute Poverty: Extent and Magnitude
5.5 Economic Characteristics of High-Poverty Groups
5.6 Growth and Poverty
5.7 Labour, the Functional Distribution of Income, and
Inclusive Development
5.8 Policy Options on Income Inequality and Poverty:
Some Basic Considerations

5-2
• Measuring Inequality
– Size distributions (quintiles, deciles)
– Lorenz curves
– Gini coefficients and aggregate measures of inequality

5-3
• Personal distribution of income (size distribution of

income) The distribution of income according to size
class of persons—for example, the share of total
income accruing to the poorest specific percentage or
the richest specific percentage of a population—
without regard to the sources of that income.
• Income inequality The disproportionate distribution of

total national income among households.

5-4
Table 5.1 Typical Size Distribution of Personal Income in a
Developing Country by Income Shares—Quintiles and Deciles

5-5
Figure 5.1 The Lorenz Curve
Lorenz curve A graph depicting the
variance of the size distribution of
income from perfect equality.
The numbers of income recipients are
plotted on the horizontal axis, not in
absolute terms but in cumulative
percentages.
For example, at point 20, we have the
lowest (poorest) 20% of the
population; at point 60, we have the
bottom 60%; and at the end of the
axis, all 100% of the population has
been accounted for. The vertical axis
shows the share of total income
received by each percentage of the
population.
5-6
Figure 5.2 The Greater the Curvature of the Lorenz
Line, the Greater the Relative Degree of Inequality
• The more the Lorenz line curves away from the diagonal (line of
perfect equality), the greater the degree of inequality represented.
• Because no country exhibits either perfect equality or perfect
inequality in its distribution of income, the Lorenz curves for
different countries will lie somewhere to the right of the diagonal
in Figure (b)

5-7
Figure 5.3 Estimating the Gini Coefficient
Gini coefficient An aggregate
numerical measure of income
inequality ranging from 0 (perfect
equality) to 1 (perfect inequality). It 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 diagram. The higher the
value of the coefficient, the higher the
inequality of income distribution; the
lower it is, the more equal the
distribution of income.
Lowest score 0.24
Highest score 0.63

5-8
Figure 5.4 Four Possible Lorenz Curves

5-9
5.2.1 Income 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.
• Total poverty gap (TPG) The sum of the difference

between the poverty line and actual income levels of
all people living below that line.
5-10
• Measuring Absolute Poverty
Headcount Index: H/N
– Where H is the number of persons who are poor and N
is the total number of people in the economy
– Total poverty gap:
TPG   (Yp  Yi )
H
i1
– Where Yp is the absolute poverty line; and Yi the

income of the ith poor person

5-11
Figure 5.6 Measuring the Total Poverty
Gap

5-12
Average poverty gap (APG):
TPG
APG 
N
– Where N is number of persons in the economy
– TPG is total poverty gap
– Note:normalized poverty gap, NPG = APG/Yp

5-13

Average income shortfall (AIS):
TPG
AIS 
H
– Where H is number of poor persons
– TPG is total poverty gap
 Normalized income shortfall, NIS = AIS/Yp
– Note:

5-14
The Foster-Greer-Thorbecke (FGT) index: A class of
measures of the level of absolute poverty.

1 H  Yp  Yi 
P 
N
 
i 1  Yp


– N is the number of persons, H is the number of poor
persons, and α ≥0 is a parameter
– When α=0, we get the headcount index measure
– When α=2, we get the “P2” measure

5-15
Example
N=10, Yp =10
Income (2,3,4,5,7,10,15,18,20,21)
Calculate (FGT) index (P2)?

5-16
5.2.2 Multidimensional Poverty Measurement
In the multidimensional poverty approach, a poor person is
identified through what is called the “dual cutoff method”:
1. Cutoff levels within each dimension (analogous to falling
below a poverty line for example $1.25 per day for
income poverty);
2. Cutoff in the number of dimensions in which a person
must be deprived (below a line) to be deemed
multidimensionally poor.
Understanding Multidimensional Poverty - YouTube

5-17
5.3 Poverty, Inequality, and Social
Welfare
• What’s So Bad about Extreme Inequality?
1. Extreme income inequality leads to economic
inefficiency.
2. Extreme income disparities undermine social
stability and solidarity.
3. Extreme inequality is generally viewed as
unfair

5-18
Welfare
1. Economic inefficiency
• The higher the inequality, the smaller the proportion of
people that can qualify for a loan
• Unable to educate children or start and expand a business
• Savings are low among the upper and lower classes. The
richest use capital flight for their savings.
• These savings are drained from the economy, an inefficient

use of resources

5-19
Welfare
• 2. Undermines Social Stability and Solidarity
• High levels of inequality strengthen the political power of
the rich.
• High levels of inequality increase violent crime rates
• High levels of inequality facilitate rent-seeking, a

misallocation of resources that could lead to faster growth.
• High inequality may also lead the poor to support populist

policies that can be self-defeating.
5-20
3. Viewed as unfair
John Rawls idea;
- Before you were born into this world, you had a chance
to select the overall level of inequality among the
earth’s people but not your own identity.
- The veil of ignorance.
- Most would vote for some inequality.

5-21
Welfare
For these 3 reasons, we write Welfare as:
W = w(Y, I, P)
Where: Y = income per capita (positive)
I = Inequality (negative)
P = Absolute poverty (negative)
*we need to consider all 3 elements to achieve an overall assessment of welfare in

developing countries.

5-22
Welfare
• Dualistic development and shifting Lorenz curves
• Lorenz curves may be used to analyse 3 limiting cases of
dualistic development:
1) Modern sector enlargement growth typology.
2) Modern sector enrichment growth typology
3) Traditional sector enrichment growth typology

5-23
Modern Sector Modern Sector Traditional Sector
Enlargement Enrichment Enrichment
- The economy develops - Growth limited to a - All benefits of growth
by enlarging the fixed number of are divided among
modern sector while people in the modern traditional sector
maintaining constant sector. workers, with little or no
wages in both sectors. growth occurring in the
- Number of workers modern sector
- Depicted by the Lewis and wages are held
Model (previously constant in the - Example: the Indian
covered). traditional sector. state Kerala and Sri
Lanka who prioritized
- Examples: historical - Examples: the decreasing absolute
growth pattern of experience of Latin poverty.
Western developed American and African
nations and, to some countries.
extent, the pattern in
East Asian economies
such as China, South
Korea, and Taiwan.
Figure 5.8 Crossing Lorenz Curves in the Modern-
Sector Enlargement Growth Typology
Why do they cross?
- The poor who remain in the traditional
sector receive the same income as
before. Their incomes are now a smaller
proportion of all incomes. So the new
Lorenz curve, L2, lies below the old
Lorenz curve, L1, at the lower end of
the income distribution scale.
- Modern-sector worker receives the same

absolute income as before, but now the
share received by the richest income
group is smaller, so the new Lorenz
curve lies above the old one at the
higher end of the income distribution
scale.
- Therefore, somewhere in the middle of
the distribution, the old and new Lorenz
curves must cross
5-25
Figure 5.6 Improved Income Distribution under the
Traditional-Sector Enrichment Growth Typology

5-26
Welfare
• Kuznets’ Inverted-U Curve A graph reflecting the relationship
between a country’s income per capita and its inequality of
income distribution
• He suggested that in the early
stages of economic growth, the
distribution of income will
worsen before later improving.
HOW?
 Modern sector enlargement
 Education
Figure 5.10 The “Inverted-U” Kuznets Curve

5-27
Welfare
• Growth and Inequality
• Character of economic growth: The distributive

implications of economic growth as reflected in such
factors as participation in the growth process and asset
ownership.
• It is not necessary for inequality to increase for higher

growth to be sustained

5-28
Welfare

5-29
5.3 Absolute Poverty: Extent and
Magnitude
Figure 5.12 Global and Regional Poverty Trends 1981 to 2010

5-30
Table 5.4 Poverty Incidence in Selected Countries

5-31
5.4.1 The Multidimensional Poverty Index
(MPI)
• MPI: A poverty measure that identifies the poor
using dual cutoffs for levels and numbers of
deprivations, and then multiplies the percentage of
people living in poverty times the percentage of
weighted indicators for which poor households are
deprived on average.

5-32
(MPI)
• MPI Indicators
• Health - two indicators with equal weight - whether any child has died
in the family, and whether any adult or child in the family is
malnourished –weighted equally (each counts as one-sixth toward the
maximum deprivation in the MPI)
• Education - two indicators with equal weight - whether no household
member completed 5 years of schooling, and whether any school-aged
child is out of school for grades 1 through 8 (each counts one-sixth
toward the MPI).
• Standard of Living, equal weight on 6 deprivations (each counts as
1/18 toward the maximum): lack of electricity; insufficiently safe
drinking water; inadequate sanitation; inadequate flooring; unimproved
cooking fuel; lack of more than one of 5 assets – telephone, radio, TV,
bicycle, and motorbike.
5-33
(MPI)
• MPI Indicators

5-34
(MPI)
• Interaction of the deprivations?
• Building the index from household measures up to the aggregate
measure (rather than using already-aggregated statistics), MPI
approach takes account of multiplied or interactive harm
(complementarity) done when multiple deprivations are experienced
by the same individual or family
• In essence, the approach assumes that an individual’s lack of
capability in one area can to a degree be made up for by other
capabilities—but only to a degree. (Put differently, capabilities are
treated as substitutes up to a point but then as complements.)

5-35
Table 5.2 MPI Rankings and Poverty
Headcounts for Selected Countries

5-36
(MPI)
• Limitations of MPI
• The data is based on households rather than individuals
• Does not fully distinguish between past and present conditions
• It does not distinguish differences within households (such as who may use the
bicycle or whether the undernourished individuals are females)
• Proxies are imperfect; for example, nourishment does not capture micronutrient
deficiencies
• Sometimes a person has to be labelled nondeprived if data are missing, so the
numbers may understate poverty somewhat.
• Education considers only inputs such as enrolling or attending for six years, not
outputs such as being able to read or other indicators of education quality.
• The choice of basic assets is questionable; for example, even where a radio and
a simple bicycle are present. A women may have just one dress and the children
may sleep on a rough concrete floor.
5-37
5.5 Economic Characteristics of
High-Poverty Groups
• Rural poverty
• Children and Poverty
• Women and poverty
• Ethnic minorities, indigenous populations,
and poverty

5-38
5.6 Growth and Poverty
Reasons why policies focused toward reducing poverty levels need not lead to a
slower rate of growth—and indeed could help to accelerate growth.
1. Widespread poverty creates access in which the poor have no access to credit-
unable to finance children's education, also no investment opportunities therefore
people have more children for old age security
2. Wealth of empirical data bears witness to a fact not unlike the history of developed
countries- the rich do not tend to invest their income into the local economy
3. Low levels of income and living standard can lower productivity therefore affecting
growth- bad health, and education etc, create a less efficient workforce that
overtime effects output and therefore growth
4. Raising the income levels of the poor will stimulate demand for locally produced
necessities- higher income means more consumption of necessary goods and
therefore creates more demand.
5. A reduction of mass poverty can create psychological and material incentives for
participation in economic progress and stimulate economic growth- meaning that
reduced poverty will mean that more people are likely to afford necessary goods
and then progress to a point where they can afford luxuries and may become
impatient of current living standards and work harder in order to satisfy
consumption needs.
5-39
5.7 Labour, the Functional Distribution of
Income, and Inclusive Development
5.7.1 The Functional Distribution
• Functional distribution of income (factor share
distribution of income) The distribution of income
to factors of production without regard to the
ownership of the factors.
• Factors of production Resources or inputs

required to produce a good or a service, such as
land, labor, and capital.

5-40
Figure 5.13 Functional Income Distribution in a Market Economy:
An Illustration
The traditional neoclassical functional
theory is diminished by its failure to take
into account the important role and
influence of nonmarket forces such as
power in determining these factor
prices—for example, monopsony power
of employers, collective bargaining
between employers and trade unions in
setting modern-sector wage rates, and
monopoly power of wealthy landowners
and other elites to manipulate prices on
capital, land, and output to their own
personal advantage.

5-41
5.5 Policy Options on Income Inequality
and Poverty: Some Basic Considerations
• Areas of Intervention
1. Altering the functional distribution (increase the relative
price of labor: minimum wage, wage subsidies, tax
allowance, etc)
2. Mitigating the size distribution (increasing the asset
ownership of the poor, redistribution, land reform, etc).
3. Moderating (reducing) the size distribution at upper
levels (impose progressive income and wealth tax)
4. Moderating (increasing) the size distribution at lower
levels (give direct transfer payments to the poor, public
consumption, workfare programs, etc).
5-42

Chapter 5

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 5

Uploaded by

Copyright:

Available Formats

Chapter 5

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

• Personal distribution of income (size distribution of

• Income inequality The disproportionate distribution of

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

• Headcount index The proportion of a country’s

• Total poverty gap (TPG) The sum of the difference

– Where Yp is the absolute poverty line; and Yi the

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

5.2.1 Income Poverty

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

• Unable to educate children or start and expand a business

• These savings are drained from the economy, an inefficient

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

• High levels of inequality increase violent crime rates

• High levels of inequality facilitate rent-seeking, a

• High inequality may also lead the poor to support populist

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Where: Y = income per capita (positive)

P = Absolute poverty (negative)

*we need to consider all 3 elements to achieve an overall assessment of welfare in

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

2) Modern sector enrichment growth typology

3) Traditional sector enrichment growth typology

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

- Modern-sector worker receives the same

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Figure 5.10 The “Inverted-U” Kuznets Curve

• Character of economic growth: The distributive

• It is not necessary for inequality to increase for higher

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

• Factors of production Resources or inputs

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

Copyright © 2012 Pearson Addison-Wesley. All rights reserved.

You might also like