CHAPTER 5

POVERTY, INEQUALITY, AND DEVELOPMENT

The following are the critical points relating to economic growth, income distribution,
and poverty to be examined:
 The extent of inequality in developing countries and how it is related to the
extent of absolute poverty;
 Who are the poor and what are their economic characteristics;
 The nature of economic growth- who benefits from it and why;
 The rapid economic growth and more equal distributions of income- compatible
or conflicting objectives for low-income countries? Is rapid growth achievable
only at the cost of greater inequalities in the distribution of income, or can a
lessening of income disparities contribute to higher growth rates;
 Helping the poor to benefit more
 The downside of extreme inequality
 Policies required to reduce the magnitude and extent of absolute poverty

What is INEQUALITY?
Inequality or economic inequality refers to the difference between the rich and
poor, the haves and have-nots – it is shown by people’s different positions within the
economic distribution – wealth, pay, and income.
What is POVERTY?
Poverty refers to the state or condition in which people or communities lack the
financial resources and essentials for a minimum standard of living. As such, their basic
human needs cannot be met.
Ⅰ. Measuring Inequality and Poverty

Measuring Inequality

Personal distribution of income (size distribution of income)

 The distribution of income according to the size class of persons without regard
to the sources of that income.

Size Distributions are usually used by economists that deal with individual
persons or households and the total incomes they receive regardless of how it is
received, meaning it concerns only how much income was received.

 Quantile- A 20% proportion of any numerical quantity. A population divided into

quintiles would be divided into five groups of equal size.
 Decile- A 10% portion of any numerical quantity; a population divided into
deciles would be divided into ten equal numerical groups.

Income Inequality is the disproportionate distribution of total national income among

households.

Measuring Income Inequality

1. Lorenz curve

 A graph depicting the variance of the size distribution of income from perfect
equality.The more the Lorenz line curves away from the diagonal (line of perfect
equality), the greater the degree of inequality represented. The greater the
 degree of inequality, the greater the bend and the closer to the bottom
horizontal axis the Lorenz curve will be.

2. Gini coefficient (Gini Concentration Ratio)

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.

Functional distribution of income (factor share distribution of income)/ The

Theory of Functional Income

 The distribution of income to factors of production without regard to the

ownership of the factors.
 Inquires into the percentage that labor receives as a whole and compares this
with the percentages of the total income distributed in the form of rent, interest,
and profit
Factors of production- resources or inputs required to produce a good or a
service, such as land, labor, and capital.

Measuring Absolute Poverty

Absolute poverty is the situation of being unable or only barely able to meet the
subsistence essentials of food, clothing, and shelter.

Extent of absolute poverty relies on the number of people who are unable to
command sufficient resources to satisfy basic needs.

1. Headcount index is the proportion of a country’s population living below the

poverty line.
3. Total poverty gap (TPG) is the sum of the difference between the poverty line
and the actual income levels of all people living below that line. This is calculated
to raise everyone below the poverty line.

Formula in Calculating Total Poverty Gap (TPG)

Where:

= person’s income

= absolute poverty line

Formula in Calculating Average Poverty Gap (APG)

Where:

TPG= Total Poverty Gap

N= Total Population

3. The Foster-Greer-Thorbecke Index

  A class of measures of the level of absolute poverty.

Formula
Where:

= person’s income

= poverty line
N= population

The Newly Introduced Multidimensional Poverty Index

Multidimensional Poverty Index (MPI) is 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 percent of weighted indicators for
which poor households are deprived on average.

The ACWI (Ahluwalia-Chenery Welfare Index) is the valuing increases in income

for all individuals but also assigns a higher weight to income gains by lower-income
individuals than to gains by higher-income individuals.

Ⅱ. POVERTY, INEQUALITY, AND SOCIAL WELFARE

What’s So Bad about Extreme Inequality?

 Leads to economic inefficiency- at any given average income, the higher the
inequality, the smaller the fraction of the population that qualifies for a loan or
other credit.
 Disparities undermine social stability and solidarity
 Generally viewed as unfair

Dualistic Development and Shifting Lorenz Curves: Some Stylized Typologies

1. Traditional-sector enrichment typology- growth results in higher income, a

more equal relative distribution of income, and less poverty. Traditional sector
enrichment growth causes the Lorenz curve to shift uniformly upward and closer
toward the line of equality.
2. Modern-sector enrichment growth typology- growth results in higher
incomes, a less equal relative distribution of income, and no change in poverty.
Modern-sector enrichment growth causes the Lorenz curve to shift downward
and farther from the line of equality.
3. Lewis-type modern-sector enlargement growth- absolute incomes rise and
absolute poverty is reduced, but the Lorenz curves will always cross, indicating
that we cannot make any unambiguous statement about changes in relative
inequality: It may improve or worsen.

Kuznets’s Inverted-U Hypothesis

Simon Kuznets suggested that in the early stages of economic growth, the
distribution of income will tend to worsen; only at later stages it will improve. This
observation came to be characterized by the “inverted-U” Kuznets curve.

Kuznets curve is a graph reflecting the relationship between a country’s income

per capita and its equality of income distribution.

Growth and Inequality

 Character of economic growth is the distributive implications of economic growth
as reflected in such factors as participation in the growth process and asset
ownership.

Ⅲ. Absolute Poverty: Extent and Magnitude

Growth and Poverty

Five reasons why policies focused toward reducing poverty levels need not
lead to a slower rate of growth

1. Widespread poverty creates conditions in which the poor have no access to

credit.
2. The rich in many contemporary poor countries are generally not noted for their
frugality or for their desire to save and invest.
3. The low incomes and low levels of living for the poor, which are manifested in
poor health, nutrition, and education, can lower their economic productivity and
thereby lead directly and indirectly to a slower-growing economy.
4. Raising the income levels of the poor will stimulate an overall increase in the
demand for locally produced necessity products.
5. 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.

Richer countries strongly tend to have low levels of absolute poverty.

Poverty reduction is possible without rapid growth. But whatever the causality, it is
clear that growth and poverty reduction are entirely compatible objectives.

Ⅳ. Economic Characteristics of High-Poverty Groups

For any given distribution of income, the higher the level of per capita income, the
lower the numbers of the absolutely poor. But higher levels of per capita income are no
guarantee of lower levels of poverty.

Rural Poverty
Perhaps the most valid generalizations about the poor are that:
 they are disproportionately located in rural areas;
 they are primarily engaged in agricultural and associated activities;
 they are more likely to be women and children than adult males; and
 they are often concentrated among minority ethnic groups and indigenous
peoples.

Women and Poverty

These facts combine to ensure that poor women’s financial resources are meager
and unstable relative to men’s.
 Households are headed by women.
 Income disparity between male- and female-headed households
 The extent of internal biases.
 Men are perceived to have a greater potential for contributing financially to
family survival.
 The work of performed by women is unremunerated and may even be
intangible.
 The increase the productivity differentials between men and women are likely
to worsen earnings disparities.
  The design of the development policy underscores the importance of
integrating women into development programs.

Ethnic Minorities, Indigenous Populations, and Poverty

A final generalization about the incidence of poverty in the developing world is that it
falls especially heavily on minority ethnic groups and indigenous populations.

Poor Countries

It should be noted that the poor come from poor countries. Among those that
are growing, at current growth rates, it would take decades to reach the levels of
income at which poverty tends to be eradicated. Higher national incomes greatly
facilitate poverty reduction, while at the same time, poverty still needs to be
addressed directly.

Ⅴ. Policy Options on Income Inequality and Poverty: Some Basic

Considerations

Areas of Intervention

What kinds of economic and other policies might governments in developing countries
adopt to reduce poverty and inequality while maintaining or even accelerating
economic growth rates?

Four major elements in the determination of a developing economy’s

distribution of income.

1. Altering the functional distribution

2. Mitigating the size distribution

3. Moderating (reducing) the size distribution at the upper levels through

progressive taxation of personal income and wealth.

Disposable income- The income that is available to households for spending and
saving after personal income taxes have been deducted.

4. Moderating (increasing) the size distribution at the lower levels through

public expenditures of tax revenues to raise the incomes of the poor either
directly or indirectly.

Altering the Functional Distribution of Income through Relative Factor Prices

Altering the functional distribution is a traditional economic approach. It is argued

that as a result of institutional constraints and faulty government policies, the
relative price of labor in the formal, modern, urban sector is higher than what would
be determined by the free interplay of the forces of supply and demand.

Modifying the Size Distribution through Increasing Assets of the Poor

 Asset ownership is the ownership of land, physical capital (factories, buildings,
machinery, etc.), human capital, and financial resources that generate income for
owners.
 Redistribution policies are policies geared to reducing income inequality and
expanding economic opportunities in order to promote development, including
income tax policies, rural development policies, and publicly financed services.
 Land reform is a deliberate attempt to reorganize and transform existing agrarian
systems with the intention of improving the distribution of agricultural incomes and
thus fostering rural development.

Progressive Income and Wealth Taxes

 Progressive income tax is a tax whose rate increases with increasing personal
incomes.
 Regressive tax is a tax structure in which the ratio of taxes to income tends to
decrease as income increases.
 Indirect taxes are taxes levied on goods ultimately purchased by consumers,
including customs duties (tariffs), excise duties, sales taxes, and export duties.

Direct Transfer Payments and the Public Provision of Goods and Services

Public consumption are all current expenditures for purchases of goods and
services by all levels of government, including capital expenditures on national
defense and security.
Subsidy is a payment by the government to producers or distributors in an industry
to prevent the decline of that industry, to reduce the prices of its products, or to
encourage hiring.
Workfare program is a poverty alleviation program that requires program
beneficiaries to work in exchange for benefits, as in a food-for-work program

Ⅵ. Summary and Conclusions: The need for a Package of Policies

Four basic elements of the Package of Policies

1. To correct factor price distortions
2. To bring about far-reaching structural changes
3. To modify the size distribution of income
4. to directly improve the well-being of the poor and their communities,

The task of ending extreme poverty is difficult, but is possible if we muster the
will. As noted by James Speth, the executive director of the United Nations
Development Program, “Poverty is no longer inevitable. The world has the
material and natural resources, the know-how and the people to make a
poverty-free world a reality in less than a generation. This is not woolly
idealism but a practical and achievable goal.”

Prepared by:
Cabanting, Gwyneth S.
Revadenera, Jan Laiza T.
Singun, Chester P.
BSA 1A- Group 5