Chapter 5

Poverty,
Inequality, and
Development
 Distribution and Development: Eight
Critical Questions

• How can we best measure inequality and

poverty?
• What is the extent of relative inequality in
developing countries; how is this related to
the extent of poverty?
• Who are the poor, and what are their
economic characteristics?
• What determines the nature of economic
growth—that is, who benefits from
economic growth, and why?

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 Distribution and Development: Seven
Critical Questions
• Are rapid economic growth and more equal income
distribution compatible or conflicting objectives?: Is
rapid growth achievable only
at a cost of greater income inequality or can
lessening income disparities contribute to higher
growth rates?
• Do the poor benefit from growth, and does this
depend on the type of growth a developing country
experiences? What might be done to help the poor
benefit more?
• What is so bad about extreme inequality?
• What kinds of policies are required to reduce the
magnitude and extent of absolute poverty?

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 5.1 Measuring Inequality

• Measuring Inequality
– Size distribution of income (quintiles, deciles)
– Lorenz curves
– Gini coefficients and aggregate measures of
inequality
– The Ahluwalia-Chenery Welfare Index (ACWI)

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

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 Figure 5.1 The Lorenz Curve

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 Figure 5.2 The Greater the Curvature of the
Lorenz Line, the Greater the Relative Degree of
Inequality

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 Figure 5.3 Estimating the Gini
Coefficient

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 Figure 5.4 Four Possible Lorenz Curves

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 Desirable Properties for
Inequality Measures
1. Anonymity: The inequality measure should not depend on who
earns the income. It should be impartial, regardless of whether the
rich are individuals, corporations, or government entities.
2. Scale Independence: The inequality measure should not be
affected by the overall size of the economy. A country with a larger
economy should not automatically appear more unequal than a
smaller one.
3. Population Independence: The inequality measure should not be
affected by the number of income recipients. A country with a larger
population should not appear more unequal simply because it has
more people.
4. Transfer Principle (Pigou-Dalton Principle): If income is
transferred from a richer person to a poorer person without
changing their relative rankings, inequality should decrease. This
principle ensures that redistributive policies effectively reduce
inequality.

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 The Ahluwalia-Chenery Welfare Index
(ACWI)
• The Ahluwalia-Chenery Welfare Index (ACWI) is a measure
developed by Montek Ahluwalia and Hollis Chenery to
assess economic welfare while considering both income
growth and income distribution.
• Unlike traditional measures like GDP per capita, which only
focus on total income, the ACWI incorporates income
inequality by giving more weight to income gains for poorer
individuals and less weight to gains for the wealthy.
• This index is particularly useful for evaluating whether
economic growth is benefiting the poor or simply increasing
income concentration among the rich.

where G weighted index of growth of social welfare, gi the growth

rate of income of the ith quintile, and wi the “welfare weight” of the
ith quintile
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 5.2 Measuring Absolute Poverty

• Absolute poverty refers to a condition in which

individuals are unable to meet the basic necessities
required for survival, such as food, shelter, and
clothing. Unlike relative poverty, which compares
income levels within a society, absolute poverty is
assessed using a fixed international standard.
• One of the most widely recognized measures of
absolute poverty is the international poverty line,
which is currently set at $1.90 per day in terms of
Purchasing Power Parity (PPP). This threshold is
designed to account for differences in the cost of living
across countries, ensuring a universal benchmark for
poverty assessment

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 5.2 Measuring Absolute Poverty

• Headcount Index (Ratio): 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:

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

income of the ith poor person

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 Figure 5.5 Measuring the Total
Poverty Gap

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 5.2 Measuring Absolute Poverty

• Average poverty gap (APG):

TPG
APG =
N

– Where N is number of persons in the economy

– TPG is total poverty gap
– normalized poverty gap, NPG = APG/Yp

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 5.2 Measuring Absolute Poverty

• Measuring Absolute Poverty

– Average income shortfall (AIS):

TPG
AIS =
H
– Where H is number of poor persons
– TPG is total poverty gap
– Note: Normalized income shortfall, NIS = AIS/Yp

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 5.2 Measuring Absolute Poverty

• The Foster-Greer-Thorbecke (FGT) index:

– Pα = FGT poverty measure

– N is the number of persons
– H is the number of poor persons
– Yp = Poverty line
– Yi = income of individual I
– α = Sensitivity parameter (determines how much weight
is given to the poorest individuals)

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 5.2 Measuring Absolute Poverty
• The Foster-Greer-Thorbecke (FGT) index:

The value of α determines the type of poverty measure being used:

1.When α=0→ Headcount Ratio (P0)
• Measures the proportion of the population below the poverty line.
• Limitation: It does not consider how far below the poverty line people
are.
2.When α=1 → Poverty Gap Index (P1)
• Measures the average income shortfall of the poor relative to the
poverty line.
• An alternative formula that can be derived for P1 is given by P1 =
(H/N)*(NIS), that is, the headcount ratio (H/N) times the normalized
income shortfall (NIS).
3.When α=2 → Squared Poverty Gap Index (P2)
1. Measures poverty severity by giving greater weight to those farthest
below the poverty line.
2. It is useful for evaluating extreme poverty.

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 5.2 Measuring Absolute Poverty

• Multidimensional Poverty Measurement

– The Capability Approach (Amartya Sen’s
Framework)
• Poverty is not just a lack of income but a deprivation of
basic capabilities, such as access to education,
healthcare, and a decent standard of living.
• This approach emphasizes that individuals need more
than just money to achieve well-being.
– The Alkire-Foster Method (Multidimensional
Poverty Index - MPI)
• Developed by Sabina Alkire and James Foster, this
method extends the Foster-Greer-Thorbecke (FGT)
Index to multiple dimensions.

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 5.2 Measuring Absolute Poverty
– The Alkire-Foster Method (Multidimensional Poverty
Index - MPI)
• It uses a dual cutoff method:
– First, it sets threshold levels for individual indicators (e.g., years
of schooling, nutrition levels).
– Second, it determines how many deprivations a person must
experience before being considered multidimensionally poor
– Multidimensional Poverty Headcount Ratio (HM) and
Adjusted Headcount Ratio (M0)
• HM (Headcount Ratio): The proportion of people who are
considered poor in multiple dimensions.
• M0 (Adjusted Headcount Ratio): A more refined measure that
considers both the number of poor people and the intensity
of their poverty.
– Dimensional Monotonicity Property
• If a poor person becomes deprived in an additional dimension
(e.g., losing access to healthcare), the overall poverty
measure should reflect an increase in poverty.
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 5.3 Poverty, Inequality, and
Social Welfare
• What is it About Extreme Inequality That’s So
Harmful to Economic Development?
– Key Reasons Why Extreme Inequality is Harmful
• Inefficiency in Economic Growth
• Weakens Social Stability and Political Systems
• Creates Unfair and Unjust Societies
• Reduces Long-Term Growth and Innovation
– we will write welfare (W) as W = W (Y, I, P)
• where Y is income per capita and enters our
welfare function positively
• I is inequality and enters negatively
• P is absolute poverty and enters negatively.

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 5.3 Poverty, Inequality, and
Social Welfare

• Dualistic Development and

Shifting Lorenz Curves
– Three Growth Typologies and Their
Impact on the Lorenz Curve:
•Modern-Sector Enlargement Growth
•Modern-Sector Enrichment Growth
•Traditional-Sector Enrichment Growth

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 5.3 Poverty, Inequality, and
Social Welfare

• Modern-Sector Enlargement Growth

– Occurs when the modern sector expands, absorbing
more workers while wages remain stable in both
sectors.
– This aligns with the Lewis Model of Development,
where surplus labor from agriculture shifts to
industry.
– Impact on Inequality: The Lorenz Curve shifts,
and inequality may initially rise but later improve as
more workers move to the modern sector.
– Example: The economic transformation of East
Asian countries like China, South Korea, and Taiwan.

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 Figure 5.8 Crossing Lorenz Curves in the
Modern-Sector Enlargement Growth Typology

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 5.3 Poverty, Inequality, and
Social Welfare

• Modern-Sector Enrichment Growth

– Economic growth benefits only a fixed number
of workers in the modern sector, while wages
and employment in the traditional sector remain
stagnant.
– Impact on Inequality: The Lorenz Curve
moves downward, indicating greater income
inequality.
– Example: Many Latin American and African
economies, where wealth concentrates among
the elite while rural populations see little
benefit.

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 Figure 5.7 Worsened Income Distribution
under the Modern-Sector Enrichment Growth
Typology

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 5.3 Poverty, Inequality, and
Social Welfare

• Traditional-Sector Enrichment Growth

– Growth is concentrated in the traditional
sector, improving incomes for rural workers but
with little modern-sector expansion.
– Impact on Inequality: The Lorenz Curve shifts
upward, leading to a more equal income
distribution and a reduction in absolute poverty.
– Example: Countries like Sri Lanka and the state
of Kerala (India), which have focused on social
programs to improve welfare despite low
economic growth

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 Figure 5.6 Improved Income Distribution
under the Traditional-Sector Enrichment Growth
Typology

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 5.3 Poverty, Inequality, and
Social Welfare

• Kuznets’ Inverted-U Hypothesis

– This is proposed by Simon Kuznets,
suggests that in the early stages of
economic growth, income inequality
tends to worsen, but at later stages, it
improves. This relationship forms an
inverted U-shaped curve when plotting
inequality (e.g., Gini coefficient)
against per capita income

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 Figure 5.10 The “Inverted-U” Kuznets
Curve

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 5.3 Poverty, Inequality, and
Social Welfare

• Why Does Inequality Initially Rise?

– During the early stages of economic
development:
• Economic growth is often concentrated in the modern
industrial sector, where productivity and wages are
high.
• The traditional agricultural sector remains stagnant
with lower incomes.
• As a result, inequality increases because only a
small portion of the population benefits from growth.
• This pattern aligns with Lewis’s Dual-Sector Model,
where surplus labor from the agricultural sector
gradually moves to the industrial sector.

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 5.3 Poverty, Inequality, and
Social Welfare

• Why Does Inequality Decline in Later

Stages?
– As development progresses:
• More workers transition to higher-paying jobs in the
modern sector.
• Education levels rise, reducing income disparities.
• Governments implement redistributive policies (e.g.,
taxation, social welfare).
• This leads to a more equal income distribution,
causing the downward slope of the inverted U-
shaped Kuznets curve

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 Table 5.2 Selected Income Distribution
Estimates

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 Figure 5.11 Kuznets Curve with Latin
American Countries Identified

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 Figure 5.12 Plot of Inequality Data for
Selected Countries

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 Table 5.3 Income and Inequality in
Selected Countries

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 5.3 Poverty, Inequality, and
Social Welfare

• Growth and Inequality

• Growth Does Not Necessarily Increase Inequality
• Between the 1960s and 1990s, East Asia experienced
an average per capita growth of 5.5%, while
Africa's per capita income declined by 0.2%.
• Despite this stark contrast in economic growth, Gini
coefficients in both regions remained largely
unchanged.
• This suggests that economic growth alone does not
automatically lead to increased or decreased
inequality—it depends on how income is distributed.

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 5.3 Poverty, Inequality, and
Social Welfare
• The Importance of the "Character" of Growth
• The effect of economic growth on inequality
depends on multiple factors, such as:
• Who participates in economic expansion (e.g., rural
vs. urban populations).
• Which sectors grow fastest (e.g., agriculture vs.
industry).
• Institutional and policy frameworks that either reduce
or reinforce inequality.
• For example, economies that invest in broad-
based education, land reform, and social
programs tend to experience more equitable
growth.
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 5.3 Poverty, Inequality, and
Social Welfare

• Sustaining High Growth Without

Worsening Inequality
• Some countries have achieved rapid growth
without extreme inequality by adopting
inclusive policies, such as:
• Progressive taxation to redistribute wealth.
• Investment in public education to improve workforce skills.
• Rural development programs that help lift the poor out of
poverty.
• This shows that growth does not have to come
at the expense of equity—policies play a crucial
role in shaping the impact of development
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 5.4 Absolute Poverty: Extent and
Magnitude
Measuring Absolute Poverty
• The most used measure of absolute poverty is the
international poverty line, set at $1.90 per day
(Purchasing Power Parity - PPP) by the World Bank.
• Some countries also use higher thresholds, such as
$3.20 or $5.50 per day, to account for variations in the
cost of living.
Global Poverty Trends
• Significant reductions in poverty have been observed
in regions like East Asia and the Pacific, largely due to
rapid economic growth in countries like China and
Vietnam.
• However, Sub-Saharan Africa and parts of South Asia
continue to experience high poverty rates, with many
people still living in extreme deprivation.
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 5.4 Absolute Poverty: Extent and
Magnitude

• Poverty Depth and Severity

– Beyond measuring the number of poor people, economists
assess how far below the poverty line people fall.
– The Poverty Gap Index measures the average shortfall
from the poverty line, while the Squared Poverty Gap
Index gives more weight to the poorest individuals.
• Challenges in Reducing Poverty
– Some key obstacles to poverty reduction include:
• Limited access to education and healthcare, which
prevents people from improving their economic situation.
• Persistent economic inequality, where the benefits of
growth are not equally distributed.
• Environmental and climate challenges, such as droughts,
floods, and other natural disasters, which disproportionately
affect poor communities.

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 Figure 5.13 Global and Regional Poverty
Trends, 1981–2010

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 Table 5.4 Income Poverty
Incidence in Selected Countries

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 The Multidimensional Poverty Index
(MPI)

• 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.

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 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.

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 Interaction of the deprivations?

• Each of these dimensions is weighted equally, and

within them, various indicators are assigned
specific weights.
• A person is classified as multidimensionally poor if
they experience deprivations in at least one-third
of the weighted indicators.
• The MPI for the country (or region or group) is
then computed
• A convenient way to express the resulting value is:
MPI=H×A

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 Computing the MPI

• 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).
• The adjusted headcount ratio HA is readily
calculated
• 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.
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 Multidimensional poverty tells a
different story than income poverty
• The results showed that knowing income poverty is
not enough if our concern is with multidimensional
poverty.
• Multidimensionally, Bangladesh is substantially less
poor - but Pakistan substantially poorer - than
would be predicted by income poverty
• Ethiopia is far more multidimensionally poor, and
Tanzania much less so, than predicted by income
poverty.
• Most Latin American countries e.g. Brazil rank
worse on multidimensional poverty than on income
poverty; but Colombia’s income and MPI poverty
ranks are about same.
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 Table 5.5 Multidimensional Poverty Index
for Selected Countries

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 5.5 Economic Characteristics of
High-Poverty Groups

• Children and Poverty

• Children represent a large portion of the
global poor, particularly in developing
countries.
• Many children suffer from malnutrition, lack of
education, and poor healthcare, which can
lead to a cycle of poverty as they grow older.
• Child poverty is often higher in rural areas
compared to urban centers due to limited
access to services and economic
opportunities

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 5.5 Economic Characteristics of
High-Poverty Groups

• Women and Poverty

• Women face greater economic disadvantages
due to gender discrimination in employment,
wages, and access to resources.
• The concept of “feminization of poverty” refers
to the fact that women, especially single
mothers, are more likely to be poor than men.
• Barriers such as unequal property rights, lack
of education, and unpaid domestic labor
contribute to women's higher poverty rates​

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 5.5 Economic Characteristics of
High-Poverty Groups
• Ethnic Minorities, Indigenous
Populations, and Poverty
• Indigenous communities and ethnic minorities
often face systemic discrimination and
exclusion, resulting in higher poverty rates.
• Many of these groups lack access to basic
services, land, and economic opportunities,
further widening inequalities.
• Policies addressing indigenous poverty often
focus on land rights, cultural recognition,
and inclusive economic programs
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 Table 5.8 Indigenous Poverty in Latin America

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 Workfare

• Workfare, such as a Food for Work Program,

represents a better policy than welfare when
these criteria are met:
– The program does not reduce incentives for the
poor to acquire human capital and other assets
– There are greater net benefits of the program’s
work output
– It is harder to screen the poor without a workfare
requirement
• Poor workers have lower opportunity cost of
time (so the economy loses little output
when they work in the program)
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 Workfare

• Non-poor workers have higher opportunity

cost of time (so they are unlikely to
participate to get the benefits)
• The fraction of the population living in
poverty is smaller (so the extra costs of a
universal welfare scheme would be high)
• There is less social stigma of visible workfare
participation, so the poor do not suffer
humiliation or be deterred from needed work
(otherwise, a discreet welfare transfer may
be preferable)
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 5.6 Policy Options on Income Inequality
and Poverty: Some Basic Considerations

• Areas of Intervention:
– Altering the functional distribution
– Mitigating the size distribution
– Moderating (reducing) the size distribution at
upper levels
– Moderating (increasing) the size distribution at
lower levels

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

• Policy options
– Changing relative factor prices
– Progressive redistribution of asset ownership
– Progressive taxation
– Transfer payments and public provision of goods
and services

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 5.7 Summary and Conclusions: The
Need for a Package of Policies

• Policies to correct factor price distortions

• Policies to change the distribution of assets, power,
and access to education and associated
employment opportunities
• Policies of progressive taxation and directed
transfer payments
• Policies designed to build capabilities and human
and social capital of the poor

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