CHAPTER 5

POVERTY, INEQUALITY
AND DEVELOPMENT
Based on : Economics Development
By Todaro & Smith

Presented by : ASMITA NAFIATI

Linkage Bappenas XII
QUESTIONS to be addressed:
1.what is the extent of relative inequality in developing
countries and how to measure it?
2.who are the poor and what are their characteristics?
3.How are economic growth and inequality related,
does rapid growth increase or reduce inequality?
4.Do the poor benefit from growth and how much?
5.Is inequality bad? Can arguments against inequality be
made from purely efficiency perspective?
6.Policies related to inequality and absolute poverty.
 Size distributions (quintiles, deciles)

Measuring Lorenz curves

Inequality
Gini coefficients

Functional distributions
 Measuring
Inequality Size distributions
Personal distribution of income (size distribution of income) :
The distribution of income according to size class of person
For example, the share of total income accruing to the poorest specific percentage
or the richest specific percentage of a population.

Quintile : A 20% proportion of any numerical quantity. A population divided into

quintiles would be divided into 5 group of equal size

Decile : A 10% proportion of any numerical quantity, a population divided into

deciles would be divided into 10 equal numerical group

Income inequality : The disproportionate distribution of total national income

among households.
Measuring
Inequality Lorenz curves
A graph depicting the variance of the size distribution of income from perfect
equality
The Lorenz curve shows the actual quantitative
relationship between the percentage of income
recipients and the percentage of the total income they
did in fact receive during a given year.
Measuring Gini Coefficients
Inequality

Gini Coefficient is an aggregate

numerical measure of income
inequality ranging from 0 (perfect
equality) to 1 (perfect inequality).

The higher the value of the

coefficient is, the higher the
inequality of income distribution;
the lower it is, the more equal the
distribution of income.
• Gini Coefficient has some nice properties which is why it is most commonly
used to measure income inequality in development economics :
- Anatomity : GC does not depend on who is who (just their income level)
- Scale independence : if we measure income in different units, GC remains
the same. If the economy rich on average or poor on average does not matter
too.
- Population size independence – GC is units free : if we clone each person
into 2, each with the same income as the original person, GC remains the
same.
- Transfer principle : holding all else constant, if we transfer some income
from a richer person to poorer person, GC declines (the resulting income
distribution is more equal).
Measuring Functional Distribution
Inequality

The distribution of income to

factors of production without
regard to ownership of the factors.

Factors of production : Resources or

inputs required to produce a good
or a service, such as land, labor,
and capital.
ABSOLUTE POVERTY
The situation of being unable or only barely able to meet
the subsistence essentials of food, clothing and shelter.
The number of people who are unable to command
sufficient resources to satisfy basic needs.
The number or “headcount”, H, of those whose income
below the total poverty line, Yp. - Headcount index
Total Poverty Gap
The sum of difference
between the poverty line
and actual income levels of
all people living below the
line

Where
Yp is the absolute poverty line,
Yi is income of person
POVERTY, INEQUALITY, AND
SOCIAL WELFARE
•What’s so bad about inequality?
Extreme inequality results in :
- Economic inefficiency
- Social instability and conflict
Most of us as a part of our value system, view
inequality as unfair
Welfare Function
W = W(Y,I,P)

Where
W = Social welfare
Y = national income
I = degree of inequality
P = degree of absolute poverty
Classifications of cases of dualistic development by common characteristics :
Traditional sector enrichment
all of the benefits of growth are divided among traditional-sectors workers, with little or no
growth occurring in the modern sectors

Modern sector enrichment

the economy grows but such growth is limited to a fixed number of people in the modern
sectors

Modern sector enlargement

the two sectors economy develops by enlarging the size of modern sector while maintaining
constant wages in both sectors

certain policies may cause inequality to increase initially but may make
everyone better off and reduce inequality in the long run
Kuznets’ inverted-U hypothesis
• The hypothesis states that in early stages
of growth, inequality will increase only to
fall at later stages, leading to an inverted-
U shaped relationship between per capita
national income and measures of
inequality
• Explanations for the hypothesized
relationship point to the nature of
structure change
• The validity of the relationship remains
emphirical question. There is significant
evidence to suggest that increase in per
capita income does not have to paired
with worsening inequality.
Growth and Inequality
• There is no obvious relationship between economic growth rates
and measures of inequality
• Who participates often determines whether growth leads to a
reduction or increase in 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
ABSOLUTE POVERTY : EXTENT AND
MAGNITUDE
• Multidimensional Poverty Index (MPI)
A poverty measure that identifies the poor using dual cutoffs
for levels and numbers of deprivations, and then multiplies the
percentage of peopleliving in poverty time the percent of
weighted indicators for which poor households are deprived on
average.
The index’s creators report that they selected the three
dimensions : health, education, and standard living.
Growth and Poverty
• Impact on per capita growth
• Limited saving and investment by rich in poor countries
• Impact on productivity
• Lack of home demand
• Incentives for public participation in the development
process
ECONOMIC CHARACTERISTICS OF
POVERTY GROUPS
• Rural Poverty
poor are disproportionately located in rural areas (Table 5.6) – about 80% of
people below poverty line are in rural areas (mostly in subsistence
agriculture – 2/3) but often urban bias in terms of development policy seems
focus on rural areas and agriculture in particular is necessary
• Women and poverty
poor households are usually female-headed. But females have less access to
education, credit,jobs, etc and often live in more deprived areas. Within
families, females often get fewer resources. Often, nutrition-improvement
programs work better if targeted at women.
• Ethnic minorities, indigenous populations, and poverty

over-represented among the poor

• People in the poor countries

It should be noted that the poor come from poor countries
POLICY OPTIONS ON INCOME INEQUALITY
AND POVERTY :
Some Basic Considerations
• Areas of intervention
o Change the functional distribution
- give more income to labor and less to capital
o Change asset and skill inequality : the sources of income inequality
- Land reform; microcredit; basic education
o Make taxes more progressive
o Poverty reduction programs : direct transfers or subsidies for food,
education, health, etc.
• Policy option
o Changing relative factor prices
 traditional-sector workers have very low incomes and
minimum-wage laws are seldom enforced
 Artificially high modern-sector wages (due to unions or
laws) reduce the growth of the modern sector,
condemning more people to poverty and exclusion
 Market-determined wages (which would be lower) in the
modern sector would increase employment and incomes
for the poor.
 Market-determined cost of capital (which would be
higher) would encourage firms to hire workers rather
than buy capital.
o Transfer payments and public provision of goods and
services
 Make sure it’s targeted to the poor
 Prevent the poor from becoming dependent on it…
but encourage appropriate risk taking
 Discourage switching from work to program
 Avoid resentment by nearly-poor-but-not-enough
who are working
o “Workfare” is better than welfare if it :
 Does not undermine incentives for acquiring human
capital needed for private sector jobs
 Increase net benefits – including externalities
 Is difficult to identify the needy withoutwork
requirement
 There are relatively few poor people
 There less social stigma / political resentment from
workfare
o The need for a ‘package’ of policies
 A policy or set of policies designed to correct factor price
distortions
 A policy or set of policies designed to bring about far-
reaching structural changes in the distribution of assets,
power and access to education and associated income-
earning (employment) opportunities.
 A policy or set of policies designed to modify the
progressive taxes and transfers ; safety net
 A set of targeted policies to directly improve the well-
being of the poor and their communities .