ECONOMICS

Poverty, Inequality, and Development

5.1 Measuring Inequality
Size or personal distribution of income
• Lorenz curves
• Gini coefficients and aggregate measures of
inequality
Functional or distributive factor share distribution
of income
 Size or Personal Distribution
 Most commonly used by economists.
 Deals with individual persons or households and the
total incomes they receive.
 What matters is how much they earns irrespective of
where it came from.
Table 5.1 Typical Size Distribution of Personal Income in a Developing Country by
Income Shares—Quintiles and Deciles
 Kuznets Ratio
• Measure of the degree of inequality between
high- and low- income groups in a country.

• Top 20% will be divided by the bottom 40%

•51/14 = 3.64
Lorenz Curve of Income Distribution

•Depicting the variance of the

size distribution of income
from perfect equality.
Lorenz Curve of Income Distribution

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Figure 5.2 Lorenz Curve of Income Distribution
The greater the curvature of the Lorenz Curve, the greater is the
degree of income inequality
Improved Income Distribution

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Worsened Income Distribution

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Gini Coefficients
• An aggregate numerical measure of income inequality
ranging from 0 to 1.
• Measured 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.
Figure 5.4 Four Possible Lorenz Curves
Figure 5.3 Estimating the Gini Coefficient
4 Highly Desirable Properties

1. Anonymity Principle
2. Scale Independence Principle
3. Population Independence Principle
4. Transfer Principle
Functional Income Distribution
• Attempts to explain the share of total
national income that each of the factors of
production receives.

• Functional income distribution = Wages as

a percentage of Profits
Figure 5.5 Functional Income Distribution in a Market Economy: An
Illustration
5.2 Measuring Absolute Poverty

Headcount Index
Total Poverty Gap
Foster-Greek-Thorbecke Index
Multi-dimensional Poverty Measurement
Absolute Poverty
• Defined as the situation of being unable or only barely able to meet
the subsistence essential of food, clothing, and shelter.

• We can defined Absolute Poverty as the total number of or

“Headcount” ’H’ of those income fall below a specified minimum
level of real income- an international poverty line- Yp
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.

• We defined the Headcount Index as the

proportion of a country’s population living below
the poverty line.
Total Poverty Gap (TPG)
• Measures the total amount of income necessary to
raise everyone who is below the poverty line up to
that line.

• Yp is the absolute poverty line; and Yi is the income of

the ith poor person
Figure 5.6 Measuring the Total Poverty
Gap
Average poverty gap (APG):

• Where N is number of persons in the economy

• TPG is total poverty gap
• Note: normalized poverty gap, NPG = APG/Yp
Normalized Poverty Gap (NPG)
Often we are interested in the size of the poverty gap in relation
to the poverty line, so we would use as our income shortfall measure
the normalized poverty gap.

NPG = APG
Yp
This measure lies between 0 and 1 and so can be useful when we want
a unit less measure of the gap for easier comparisons.
Average Income Shortfall (AIS)
• Poverty gap divided by the headcount of the poor.
AIS = TPG
H
• The AIS tells us the average amount by which the income of a poor
person falls below the poverty line.
Normalized Income Shortfall (NIS)
•Average Income Shortfall divided by the poverty line.

NIS = AIS
Yp
Foster-Greer-Thorbecke (FGT) Index
-often called the Pa poverty measures is given by

• 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
The Multidimensional Poverty Measurement

 Identification of poverty status through a dual cutoff:

• First, cutoff levels within each dimension (analogous to falling below a
poverty line for example $1.25 per day for income poverty);
• Second, cutoff in the number of dimensions in which a person must be
deprived (below a line) to be deemed multidimensionally poor.

 MPI focuses on deprivations in health, education, and standard of living;

and each receives equal (that is one-third of the overall total) weight.
MPI Indicators
 Health (1/3)
• Whether any child has died in the family. (1/6)
• Whether any adult or child in the family is malnourished. (1/6)

 Education (1/3)
• Whether not even one household member has completed five years
of schooling. (1/6)
• Whether any school-age child is out of school for grades one
through eight. (1/6)
MPI Indicators
 Standard of Living (1/3)
• lack of electricity (1/8)
• insufficiently safe drinking water (1/8)
• inadequate sanitation (1/8)
• inadequate flooring (1/8)
• unimproved cooking fuel (1/8)
• lack of more than one of 5 assets – telephone, radio, TV,
bicycle, and motorbike. (1/8)
Computing the MPI
The MPI for the country (or region or group) is then computed
• A convenient way to express the resulting value is H*A, i.e.,
• The product of the headcount ratio H (the percent of people living in
multidimensional poverty), and the average intensity of deprivation A
(the percent of weighted indicators for which poor households are
deprived on average).
• HA satisfies some desirable properties. Important example -
Dimensional monotonicity: If a person already identified as
poor becomes deprived in another indicator she is measured
as even poorer - not the case using a simple headcount ratio.
Table 5.2 MPI Rankings and Poverty Headcounts for
Selected Countries
5.3 Poverty, Inequality, and Social
Welfare
• What’s So Bad about Extreme Inequality?
• Dualistic Development and Shifting Lorenz
Curves: Some Stylized Typologies
• Traditional sector enrichment (see Figure 5.7)
• Modern sector enrichment (see Figure 5.8)
• Modern sector enlargement (see Figure 5.9)
• Kuznet’s Inverted U-Hypothesis
• Growth and Inequality
What’s So Bad about Extreme
Inequality?
1. Extreme Income Inequality leads to ECONOMIC
INEFFICIENCY.
• Rich do not generally save and invest larger proportions
of their income.
• Inequality may lead to an inefficient allocation of assets
2. It undermines social stability and solidarity.
• With high inequality, the focus of politics often tends to be on
supporting or resisting the redistribution of the existing economic pie
rather than on policies to increase its size
3. Extreme Inequality as unfair.
Welfare Function

W=W(Y,I,P)
where
Y= Income per Capita and enters positively
I= Inequality and enters negatively
P= Absolute Poverty and enters negatively
Dualistic Development and Shifting Lorenz Curves:
Some Stylized Typologies
 Traditional-Sector Enrichment
All benefits of growth are divided among traditional-sector workers,
with little or no growth in modern sector.

 Modern-Sector Enrichment
Limited growth to a fixed number of people in the modern sector,
with both the numbers of workers and their wages are held constant.

 Modern-Sector Enlargement
Enlarging size of modern sector while maintaining constant wages in
both sectors.
Figure 5.7 Improved Income Distribution under the Traditional-Sector
Enrichment Growth Typology

Higher income,
more equal
relative
L2
distribution of
income, L1
reduction in
poverty.
 Figure 5.8 Worsened Income Distribution under the Modern-Sector
Enrichment Growth Typology

Higher income,
less equal relative
distribution of
income, no
change in
absolute poverty.
L1 L2
Figure 5.9 Crossing Lorenz Curves in the Modern-Sector Enlargement
Growth Typology

Absolute income rise

and absolute poverty is
reduced but the Lorenz
Curve will always cross,
indicating that we
cannot make any
unambiguous statement
about inequality.
The “Inverted-U” Kuznets Curve

• Simon Kuznet suggested that in early stages of

economic growth, the distribution of income will tend
to worsen; only at later stages will it improve.

• It is a longitudinal (time-series) plot of changes

in the distribution of income.
Figure 5.10 The “Inverted-U” Kuznets Curve
 Evidence on Kuznets Curve

• Cross country evidence supports the hypothesis

• Time series data show some countries have been

able to grow and improve income distribution at
the same time
Table 5.2 Selected Income Distribution Estimates
Table 5.3 Income and Inequality in Selected Countries
Growth & Inequality, 1965-1996

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 5.4 Absolute Poverty: Extent and Magnitude
MULTIDIMESIONAL POVERTY INDEX (MPI)

Health
Whether any child has died in the family. (1/6)
Whether any adult or child in the family is malnourished. (1/6)

Education
Whether not even one household member has completed five years of
schooling. (1/6)
Whether any school-age child is out of school for grades one through
eight. (1/6)
Standard of Living
- lack of electricity (1/18)
- insufficiently safe drinking water (1/18)
- inadequate sanitation (1/18)
- inadequate flooring (1/18)
- unimproved cooking fuel (1/18)
- lack of more than one of 5 assets – telephone, radio, TV,
bicycle, and motorbike. (1/18)
CHRONIC POVERTY
• Research suggests that approximately one – third of all people
who are income poor at any one time are chronically (always)
poor.

• The other two thirds are made up of families that are

vulnerable to poverty and become extremely poor from time to
time.
GROWTH AND POVERTY

• A rapid growth is bad for the poor because they would

be bypassed and marginalized by the structural
changes of modern growth.
5.5 Economic Characteristics of High-Poverty Groups

• Rural poverty
• Women and poverty
• Ethnic minorities, indigenous populations, and poverty
Table 5.7 Poverty: Rural versus Urban
Indigenous Poverty in Latin America

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5.6 Policy Options on Income Inequality and Poverty: Some Basic
Considerations

1. Altering the functional distribution of income through relative

factor prices
2. Modifying the size distribution through increasing assets of the
poor
3. Progressive Income and Wealth Taxes
4. Direct Transfer Payments and the Public Provision of Goods and
Services
Altering The Functional Distribution Of Income Through Relative Factor Prices

- Traditional economic approach

- Institutional constraints and faulty government policies
resulted to a higher relative price of labor in the formal,
modern and urban sector than what would be determined
by the free interplay of the forces of supply and demand.
- Correcting factor prices
 Modifying The Size Distribution Through Increasing Assets Of The Poor

 The ultimate cause of unequal distribution of personal

income in developing countries is the unequal and highly
concentrated patterns of asset ownership(wealth).
 Reducing the concentrated control of assets, the unequal
distribution of power and the unequal access to educational
and income-earning opportunities.
 Progressive Income and Wealth Taxes

• To improve the living standards of the bottom 40%,

any national policy must secure sufficient financial
resources to transform paper plans to program
realities.
The major source of such development finance is the
direct and progressive taxation of both income and
wealth.
Direct Transfer Payments and the Public Provision of Goods and Services

4 Significant Problems that Require Attention

1. Resources are limited.
2. Beneficiaries become unduly dependent on the poverty
programs.
3. Beneficiaries become diver : people who are productively
engaged in alternative economic activities to participate in the
poverty program instead.
4. Poverty policies are often limited by resentment from the
nonpoor.