IDefining inequality, equity and poverty

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ECONOMIC INEQUALITY/CHAPTER 6 7
Introduction I-Defining inequality, equity and
poverty A-Definitions B-Measures II-Inequality,
why should we care? A-Intrinsic
features B-Functional features (effect on
development) C-Growth and equity as compatible
objectives III-What kinds of policies are
required to reduce poverty A-Do poor benefit from
economic growth B-Policies to level the playing
field
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Features of the distribution of income within a
country

• Dudley Seers' (1969) definition of development
• Development occurs with the reduction and
  elimination of poverty,
• inequality and unemployment within a growing
  economy.
• Poverty reduction has become the main goal of
  development
• efforts (Poverty Reduction Strategy Paper PRSP
  Approach and
• Millennium Development Goals MDG frameworks
  in most
• international agencies).
• However, intense debate about the elements that
  should be at the
• center of any sensible poverty reducing strategy
  revolve around
• (a). a focus on growth only or on pro-poor growth
• (b). what policies to reduce inequality (wealth,
  income, access to opportunities)

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Potential interrelations in a unified framework
Chapters 1-4 focus
Chapters 6 7
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Policies tax policy
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Definitions

• Equity Following the 2006 World Bank(WB) report
  Equity defined based on 2 principles
• 1. Equal opportunity. The outcome of a persons
  life, in its many dimensions, should reflect
  mostly his or her efforts and talents, not his or
  her background (endowment and process)
• 2. Avoidance of absolute deprivation
• Inequality
• a. Corresponds to the first item of Equity
• b. Relates to the distribution of income/wealth
  across a population
• 2 dimensions Inequality of outcomes vs of
  opportunities
• 1. Predetermined circumstancessuch as gender,
  race, family background, or country of birthas
  markers for unequal opportunities.
• 2. Determine much more than just future earnings.
  Has impact on education and health, thus
  affecting the capacity of individuals to engage
  in economic, social, and political life.

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Wealth matters for the immunization of children
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Measures

• Four criteria for good measurement
• 1. Anonymity-permutations of incomes among people
  should not matter for inequality judgments.
• 2. Scale independence principle (Relative Income
  Principle) only relative incomes shares matter.
• 3. Population independence principle- population
  size doesnt matter, i.e.- all that matters are
  proportions of the population that earn different
  levels of income.
• 4. Dalton principle if one income distribution
  can be achieved from another by constructing a
  sequence of regressive transfers, then the former
  distribution must be deemed more unequal than the
  latter.

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Measures of inequalitySize distributions
Decile any of the 9 values that divide the
sorted data into 10 equal parts, so each part
represents 1/10th Quintile 1/5th or 20 of a
given amount.
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Measuring inequality Measures of
inequalityLorenz curves
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Measures of inequalityGini coefficients and
aggregate measures of inequality
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Issues with the Lorenz Curve (and Gini
coefficient)

• Advantages Satisfies all axioms simple and
  informative picture of the
• income distribution
• Disadvantages it can happen that the Lorenz
  curves for two countries/societies cross. In this
  case, the Lorenz curves cannot be used to compare
  income distributions i.e. we cannot say which
  distribution is more (or less) equal
• This is more likely to happen for a pair of
  countries that have similar
• distributionsthus, the Lorenz Curve cannot be
  used to make meaningful
• comparisons of similar distributions

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Measures

• Absolute poverty the extent of absolute poverty
  as the number
• of people who are unable to command sufficient
  resources to
• satisfy basic needs (below 1 a day absolute
  poverty line Yp)
• Measures
• Headcount H number of people below Yp
• Headcount index H / total population (N)
• Total poverty gap (TGP) the total amount of
  income necessary
• to raise every people below the poverty line up
  to that line

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Measures
Total poverty gap (TPG) income of person i, where
Yp is the absolute poverty line and Yi is income
of person i
Average poverty gap TGP/ total
population Normalized poverty gap TGP/ absolute
poverty line Average income shortfall TGP/
population under absolute poverty line Normalized
income shortfallAv income shortfall/ abs poverty
line
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Other measures for absolute poverty

• 1. Foster-Greer-Thorbecke measure
• Increasingly used as standard poverty measure by
  IFIs because of its
• sensitivity to the depth of poverty. With a2
  called P2 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
• 2. Human Poverty Index (UNDP, 1997) poverty
  measured in terms of the
• three key deprivations
• Life expectancy
• Basic education
• Economic provisioning

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Inequality, why should we care?

• Intrinsic reasons for caring about inequality of
  opportunities and unfair
• processes
• 1-Violation of a sense of fairness
• 2-Consistent with most moral and religious
  teachings
• 3-Coherent with experimental evidence
  (philosopher John Rawls) uncertainty
• called the "veil of ignorance.
• Functional features (effect on development)
  Three stylized facts to start with
• 1-Greater poverty reduction can be expected with
  economic growth if inequality
• is low different leverage effect
• 2-Rich elites are known to spend much of their
  incomes on imported luxury
• goods (capital flight)
• 3-Aspirations, savings and inequality saving
  rate depends on the level of income

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Functional features (effect on development)
Why should we care?
1-Effect of unequal opportunities when markets
are imperfect Lead to wasted productive
potential and to an inefficient allocation of
resources. If capital markets worked perfectly,
there would be no relation between investment and
the distribution of wealth anyone with a
profitable investment opportunity would be able
to either borrow money to finance it. Galor and
Zeira (1993) complementarily between physical
and human capital in context of credit
constraints induces that inequality will
adversely affect growth prospects by reducing
the number of individuals who are able to invest
in human capital. Aghion et al. (1999) in case
of decreasing returns with respect to individual
capital investments, credit imperfections lead to
the concentration of investment in fewer richer
people (with a lower marginal return to
investment) detrimental to growth
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Why should we care? Functional features (effect
on development)

• 2-Adverse consequence of inequality for the
  quality of institutions a society develops
  sub-case 1
• Central argument unequal power leads to
  formation of institutions that
• perpetuate inequalities in power, status, and
  wealth- typically bad for
• investment, innovation, and risk-taking that
  underpin long-term growth.
• Latin America effect absence of land reform
  (contrary to Japan, Taiwan,
• South Korea, China) Huge plantations run few
  families eager to protect their
• Power.
• 2-Adverse consequence of inequality for the
  quality of institutions
• a society develops sub-case 2
• Central argument inequalities result in voting
  for redistribution(Alesina and
• Rodrick, 1994)

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Inequality, why should we care?
2-Adverse consequence of inequality for the
quality of institutions a society develops
sub-case 3 Central argument inequality fuels
sociopolitical instability (Alesina and Perotti,
1996) (i) highly unequal societies create
incentives for individuals to engage in
activities outside normal markets, such as crime,
etc and (ii) sociopolitical instability
discourages accumulation because of current
disruptions and future uncertainty. This approach
would also imply that growth increases as
inequality falls.
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Inequality, why should we care?

• 3. Growth and equity as compatible objectives
• Trade-off between redistribution and growth
  policies
• Asset expropriations
• High marginal tax rates create disincentives to
  work
• 4. Dichotomy between policies for growth and
  redistribution is false as
• evidenced by previous section growth and
  inequality reduction can go hand
• in hand
• The distribution of opportunities and the growth
  process are jointly
• determined by the character of economic growth
  and accompanying
• measures

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What kinds of policies are required to reduce
poverty

• A-Do poor benefit from economic growth
• Consensus that poor benefit from average growth
  income increases
• However not enough the question is whether it
  benefits more than
• proportionally to the poor is the growth
  pro-poor?
• Lack of consensus 2 broad definitions of
  pro-poor growth
• a. Growth rate of the income of the poor should
  be greater than the average
• growth rate (relative) inequality would fall
• b. The share of the poor in the income increase
  should be at least as large as
• their population share (absolute) inequality
  would fall
• Empirical findings
• a. on average unitary relationship between
  economic growth and progress
• among the poor (Dollar and Kraay, 2001)

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Do poor benefit from economic growth?
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Do poor benefit from economic growth?
Empirical findings -however a lot of
heterogeneity that is hardly explained by
either the level of initial income (no Kuznetss
inverted-U effect) or growth rhythm.
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Do poor benefit from economic growth?

• Empirical findings-no miracle solution what is
  crucial is that either reforms
• or accompanying policies improve the life of the
  poorest
• women
• rural, agricultural population
• minorities
• Policies to level the playing field
• Two levels
• 1. Domestic policies (though function of country
  context)
• 2. International Policies for greater global
  equity, in terms of access to markets, resource
  flows, and governance.
• Domestic policies 5 broad areas
• 1. Correct distortions on factor prices in favor
  of labor utilization
• 2. Redistribute asset ownership
• a. provision of education and health services to
  poor
• b. land reform -micro-credit

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Market Capitalization controlled by the top 10
families in selected countries, 1996
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Policies to level the playing field

• Domestic policies 5 broad areas
• 3. Reduce assets and incomes at the upper levels
  through progressive
• taxation
• 4. Direct transfer payments and safety nets
  -food subsidies -social
• protections
• 5. Ensure fairness in markets as well as access
  to justice, land, and
• Infrastructure.
• International Policies for greater global equity,
  in terms of
• access to markets, resource flows, and
  governance
• a. more equitable rules for the functioning of
  global markets (functioning of global markets for
  labor, goods, ideas, and capital.)
• b. more effective participation of poor countries
  in global rule-setting processes more actions to
  help build and maintain the endowments of poor
  countries and poor people (infrastructure,
  institutions) through aid