CHAPTER FIVE

INCOME INEQUALITY,
POVERTY AND
DEVELOPMENT:
INTERCONNECTION
S
 Distribution, Poverty and
Economic Growth
Fair distribution of income and wealth is one of the concerns
of development economics.
Policy makers are worried about the distribution of income
for various reasons.
Reducing inequality is important because it has an impact on
other economic features. For example, inequality in wealth
and income might lead to reduce the possibility of overall
growth, by increasing violence and crime.
If we reduce inequality in education and health then the
quality of labor force may be improved. This will increase
productivity and growth.
So, development economics is interested not only on how
much people earn, but how do people earn it.
 Measurement of Income Inequality
There are two measures of income distribution.
a. Personal or size distribution of income, and
b. Functional or factor share distribution of income
a) Size Distributions of Income
The personal or size distribution of income is the
measure, most commonly used by economists.
It simply deals with individual persons or
households and the total income they receive.
The way in which that income received is not
considered.
 Con’t
Personal distribution of income is the distribution of
income according to size or 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.
What matters is how much each earns irrespective of
whether the income was derived solely from
employment or came from other sources such as
interests, profits, rents, gifts or inheritance.
Moreover, the locational (urban or rural) and
occupational (e.g. agriculture, manufacturing,
commerce, services) sources of income are neglected.
 Con't
Economists and statisticians, therefore, like to
arrange all individuals in ascending order of personal
incomes and then divided the total population in to
distinct groups or sizes.
A common method is to divide the population in to
successive quintiles (fifths) or deciles (tenths)
according to ascending income levels and then
determine what proportion of the total national
income is received by each income group.
Con’t
 Con't
The total national income of all individuals
amounts to 100 units and is the sum of all entries
in column 2.
In column 3, the population is grouped in to
quintiles of four individuals each.
The first quintile represents the bottom 20% of
the population on the income scale. This group
receives only 5% (i.e. a total of 5 money units)
of the national income.
The second quintile (individuals 5 - 8) receives
9% of the total income.
 Con't
Alternatively the bottom 40% of the population
(quintiles 1 plus 2) is receiving only 14% of the
income, while the top 20% ( the fifth quintile) of the
population receives 51% of the total income.
A common measure of income inequality that can be
derived from column 3 is the ratio of the incomes
received by the bottom 40% and the top 20% of the
population.
This ratio is often used as a measure of the degree of
inequality between the too extremes of very poor and
very rich in a country. In the above example, this
inequality ratio is equal to 14 divided by 51, or
approximately 1 to 3.7 or 0.28.
 Con't
To provide a more detailed breakdown of size
distribution of income, deciles (10%) shares
are listed in column 4. We see, for example,
that the bottom 10% of the population (the two
poorest individuals) is receiving only 1.8% of
the total national income, while the top 10%
(the two richest individuals) receives 28.5% of
the total income.
 Lorenz Curve
Another common way to measure a personal income
statistics is to construct Lorenz Curve.
 Con't
As usual, we have the vertical axis and horizontal
axis in the above diagram. On the horizontal axis,
the number of income recipients is plotted, 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; it
is also cumulative up to 100% meaning that both
axes are equally long.
 Con't
At every point on the diagonal line the
percentage of income received is exactly
equal to the percentage of income recipients.
For example, the point halfway along the
length of the diagonal represents 50%
of the income being distributed to
exactly 50% of the population.
The Lorenz curve shows the actual
quantitative relationship between the
percentages of income recipients and the
percentage of the actual income they receive
during, say, a given year.
 Con't
The more the Lorenz curves is away from the
diagonal (perfect equality), the greater the
degree of inequality is represented.
The extreme case of perfect inequality (i.e. a
situation in which one person receives all of
the national income while everybody else
receives nothing) would be represented by the
congruence of the Lorenz Curve with the
bottom horizontal and right hand vertical axes.
 Con’t
 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.
The greater the degree of inequality, the
greater the bend and the closer to the bottom
horizontal and vertical axes the Lorenz curve
will be.
Fig. The Greater the Curvature of the Lorenz Line, the
Greater the Relative Degree of Inequality
 Gini Coefficient
A final and very convenient short hand
summary measure of the relative degree of
income inequality in any country can be
obtained by calculating the ratio of the area
between the diagonal and the Lorenz curve
to the total area of the half square in which
the lorenz curve lies.
Fig Estimating the Gini Coefficient
 Con’t
In the above diagram the ratio of the shaded area:
A to the total area of triangle BCD is known as the
Gini concentration ratio or more simply the Gini
coefficient.
Gini coefficients are aggregate inequality measures
and can vary any where from 0 (perfect equality)
to 1 (perfect inequality). Gini coefficients for
countries with highly unequal income distributions
typically lies between 0.50 and 0.70 while for
countries with relatively equitable distributions, it is
on the range of 0.20 to 0.35.
 Con't
Gini index can also be calculated as the
area between perfect equality (Y = X) and
the Lorenz curve:
1
G (t ) 2 * (t  Lorenz (t )dt
0
 Con't
Example: What is the Gini Index for a
country that has a Lorenz curve of
L(t) = t2 ?
Solution : 1
G 2 * (t  t 2 ) dt
0

 t 2 t3  1
G 2 * 
 2  3  
  0

 1 1
G 2 *     0
 2 3
1
G 0.333
3
 summary
A Gini coefficient is a numerical statistics used to
measure income inequality within the society
which lies between zero and one.
 A Gini coefficient equal to one implies perfect
income inequality while that of zero indicates
perfect income equality. However, in reality there
is neither perfect income equality nor perfect
income inequality, that is why it lies between 0 and
1.
A high Gini coefficient shows income is
concentrated among a few while a low Gini shows
more equitable distribution of income.
 Con't
The Gini coefficient is interesting because
It is anonymous: it doesn't treat some people as
better than others, it just reports their income.
It is scale-independent: measuring income in
dollars or in rupees doesn't change it.
It is population-independent: changing the
amount of people but keeping income distribution
constant doesn't change it.
It follows the transfer principle: transferring
income from a richer to a poorer person (without
changing their order) improves it.
b) Functional Distribution
This is also referred to as factor share distribution of
income.
It is the distribution of income to factors of production without
regard to their ownerships.
It explains the share of total national income that each factor
of production (labor, capital and land) receives.
Instead of looking at individuals as separate entities, functional
distribution inquiries into the percentage that labor receives as
a whole and compares this with the percentages of total
income distributed in the form of rent, interest, and profit (i.e.
the returns to land, and financial and physical capital).
Although specific individuals may receive income from all
these sources, that is not the concern of functional
distribution approach.
 Con't
 It attempts to explain the income of a factor of production by
the contribution that this factor makes to production.
 Supply and demand curves are assumed to determine the unit
prices of each productive factor.
 When these unit prices are multiplied by quantities employed
on the assumption of efficient (minimum-cost) factor utilization,

we get a measure of the total payment to each factor.

 For example, the supply of and demand for labor are assumed
to determine its market wage.
 When this wage is then multiplied by the total level of
employment, we get a measure of total wage payments, also
sometimes called the total wage bill.
 Measuring Poverty
Measuring Absolute Poverty
Absolute poverty: is the situation of being unable or only barely
able to meet the subsistence essentials of food, clothing, shelter
and minimum education.
Extent of absolute poverty: can be defined as the number of
people who are unable to command sufficient resources to
satisfy the basic needs.
They are counted as the total number living below a specified
minimum level of real income—an international poverty line.
 The Absolute Poverty Headcount, H: simply adds the number of people
whose income is below an agreed upon poverty line.
 The Headcount Index, H/N: divides the headcount by the population.
 The international poverty line is $1 a day, but adjustment to local
conditions can lead to a different number.
Con’t
 Con't
Total Poverty Gap, TPG: is the sum of the difference
between the poverty line and actual income levels of
all people living below that line (below poverty line).
Even though in both countries A and B, 50% of the
population falls below the same poverty line, the
TPG in country A is greater than in country B.
Therefore, it will take more of an effort to eliminate
absolute poverty in country A.
 Con't
The TPG is the extent to which the
incomes of the poor lie below the
poverty line i.e. it is found by adding
up the amounts by which each poor
person's income: Yi, falls below the
absolute poverty line: Yp as follows:
TPG i 1 (Yp  Yi )
H
 Con’t
On a per capita basis, the Average
Poverty Gap, APG: is found by dividing
the TPG by the total population (N):
TPG
APG =
N
 Con’t
Often we are interested in the size of the
poverty gap in relation to the poverty line,
so we would use it as our income shortfall
measure the normalized poverty gap.
The Normalized Poverty Gap, NPG: is the
Total Poverty Gap divided by the product
of the poverty line and the population as:

H
(Yp  Yi )
NPG  i 1

NY p
Or NPG = APG/
Yp
This measure lies between 0 and 1,
and so can be useful when we want a
unit free measure of the gap for
 Con’t
Another important poverty gap
measure is the Average Income
Shortfall, AIS: which is the total
poverty gap divided by the headcount
of the poor:
AIS = TPG/H.
• The AIS tells us the average amount by
which the income of poor person falls
below the poverty line. This measure
can also be divided by the poverty line
to yield a fractional measure, the
Normalized Income Shortfall, NIS:
NIS = AIS/ Y .
Foster-Greer-Thorbecke Measure, FGT
Foster-Greer-Thorbecke, FGT index: is a class of
measures of the level of absolute poverty; which is
given by:

1 H  Y p  Yi 
P 
N
 

i 1  Y


p 
Where, Yi is the income of the ith poor person, Yp is the
poverty line, and N is the population.
Depending on the values of α, the Pα index takes on
different forms.
1. If α = 0, the numerator is equal to H, and we get the
headcount ratio, H/N.
2. If α = 1, we get the normalized poverty gap: NPG =
 Con't
3. If α = 2, the impact on measured
poverty of a gain in income by a poor
person increases in proportion to the
distance of the person from the
poverty line.
For example, raising the income of a
person from a household living at
half the per capita poverty line by,
say, one dollar per day would have
five times the impact on poverty
reduction as would raising by the
same amount the income of a person
 Con't
If α = 2, the resulting measure: P2,
can be rewritten as

P2 ( H / N ) NIS 2  (1  NIS ) 2 (CV p ) 2 
Clearly, P2 increases whenever H/N,
NIS, or CVp increases.
Note from the formula that there is a
greater emphasis on the distribution
of income among the poor (CVp)
when the normalized income
shortfall is small and a smaller
emphasis when the NIS is large.
 Con't
P2 has become a standard of income
poverty measure used by the World
Bank and other agencies, and it is
used in empirical work on income
poverty because of its sensitivity to
the depth and severity of poverty.
Inequality, Growth and the Extent of Poverty
Simon Kuznets suggested that in the early
stages of economic growth, the distribution
of income will tend to worsen, while at the
later stage it will be improved. His
observation can be characterized by the
inverted “U” Kuznets curve.
 Con't
Reasons for inequality to worsen?
Early growth may, in accordance with the
Lewis model, be concentrated in the modern
industrial sector, where employment is
limited but wages and productivity are high.
The income gap between the modern and
traditional sectors may widen quickly at
first before beginning to converge.
Inequality in the expanding modern sector
may be much greater than inequality in the
stagnant traditional sector.
 Income transfers from the rich to the poor
and poverty-reducing public expenditures
are more difficult to be undertaken by
 Con't
Whether an economic growth benefits the
country in terms of reduction in inequality or
does not depend on the nature of
development process.
This is to mean:
 How economic growth is achieved?
 Which sectors are given priority?
 What institutional arrangements are
designed and emphasized that determine
the degree to which growth is or not
reflected in improved living standards for the
very poor?
 Clearly, it is not more the fact of rapid
growth that determines the nature of its
Growth versus Income Distribution
The debate about the relationship between
economic distribution takes many forms.
The key arguments are the traditional
argument and the counter argument.
a) The traditional Argument: Factor
Shares, Saving and Economic Growth
Although much of economic analysis has
been strangely silent on the relationship
between economic growth and the
resulting distribution of income, a large
body of theory in essence asserts that
highly unequal distributions are necessary
conditions for generating rapid growth.
 Con't
The basic economic argument to justify
large income inequalities is that high
personal and corporate incomes were
necessary conditions of saving, which
made investment and economic growth
possible.
If the rich save and invest significant
portions of their incomes while the poor
spend all their income on consumption
goods, and if GNP growth rates are
directly related to the proportion of
national income saved, then apparently
an economy characterized by highly
unequal distribution of income would
 Con't
b) Counterargument
Certain degree of redistribution can
enhance saving and push up growth rate.
Which the argument to follow depends
on the relationship between marginal
saving rate and the level of income.
Potentially we can have three types of
marginal saving rate:
i) Increasing marginal saving rate
ii) Decreasing marginal saving rate
iii) Constant marginal saving rate
 Con't
 If the marginal saving rate is increasing,
then reduction in inequality reduces the
volume of saving in the economy.
Similarly, if the marginal saving rate is
decreasing, the reduction in inequality
increases the saving rate in the economy.
In case of constant marginal saving,
inequality does not affect the rate of saving.
 The other basic counter arguments include:
Greater equality can create access to the poor to credit
that enable to finance their children's education
Richs in contemporary poor countries are not noted for
their frugality or for their desire to save and invest
substantial proportions of their incomes in the local
economy.
Equality may help to improve the health, nutrition, and
education condition of the poor which contribute not only
to their material well-being but also to the productivity
and income of the economy as a whole.
Raising the income levels of the poor will stimulate an
overall increase in the demand for locally produced
necessity products.
A more equitable distribution of income achieved through
the 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.
Economic Characteristics of Poverty Groups
Rural Poverty
The poor are disproportionately located in rural
areas, they are more likely to be women and
children than adult males.
Women and Poverty
Women and children experience the harshest
deprivation.
They are more likely to be poor and malnourished
but less likely to receive medical services, clean
water, sanitation, and other benefits.
All in all women are less fortunate in …
Ethnic Minorities, Indigenous Populations and
Poverty
Generally, the incidence of poverty in LDCs is
burdened heavily especially on minority ethnic
The Range of Policy Options: Some Basic Considerations

Areas of Intervention
We can identify four broad areas of
possible government policy
interventions, which correspond to the
following four major elements in the
determination of a developing economy's
distribution of income.
1. Altering the Functional
distribution: the returns to labor, land,
capital, etc, as determined by factor
prices, utilization levels, and the
consequent shares of national income
that accrue to the owners of each factor.
 Con't
2. Mitigating the size distribution: The
functional income distribution of an economy
translated in to a size distribution by knowledge of
how ownership and control over productive assets
3. Moderating (reducing) the size distribution
at the upper levels: through progressive taxation
of personal income and wealth.
4. Moderating (increasing) the size
distribution at the lower levels: through policy
expenditures of tax revenues to raise the incomes
of the poor either directly (e.g., by conditional and
unconditional cash transfers) or indirectly (e.g.,
through public employment creation such as local
infrastructure projects or the provision of primary
education and health care).
 Con't
 The need for a ‘package’ of policies
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
(James Speth).