Poverty, Inequality, and Development

Introduction: Seven Critical Questions

This chapter explores the relationship between poverty, inequality, and economic development by
addressing seven key questions:

1. What is the extent of relative inequality, and how is this related to the extent of poverty?
2. Who are the poor?
3. Who benefits from economic growth?
4. Does rapid growth necessarily cause greater income inequality?
5. Do the poor benefit from growth?
6. Are high levels of inequality always bad?
7. What policies can reduce poverty?

Measuring Inequality and Poverty

Measuring Inequality

Size Distributions: This approach categorizes the population into groups (e.g., quintiles or deciles)
and examines the share of total income received by each group.
Quintiles: The population is divided into five equal groups.
Deciles: The population is divided into ten equal groups.
Table 5.1 provides an example of a typical size distribution of personal income in a developing
country, showing the percentage of total income held by different deciles and quintiles.
Lorenz Curves: A graphical representation of the size distribution of income.
It plots the cumulative percentage of income recipients on the x-axis against the cumulative
percentage of income they receive on the y-axis.
The "line of equality" represents a perfectly equal distribution where 20% of recipients receive
20% of the income, 40% receive 40%, and so on.
The further the Lorenz curve bends away from the line of equality, the greater the degree of
income inequality (Figure 5.1 and 5.2).
Gini Coefficients: A numerical measure of inequality derived from the Lorenz curve.
It is calculated as the ratio of the area between the line of equality and the Lorenz curve (area A)
to the total area under the line of equality (area BCD).
A Gini coefficient of 0 represents perfect equality, while a coefficient of 1 (or 100%) represents
perfect inequality (Figure 5.3).

1/6
 Functional Distributions (Factor Share Distribution): This approach examines how income is
distributed among the factors of production (e.g., labor, capital, land). Figure 5.5 illustrates how wages
and profits might be distributed based on the marginal product of labor.

Measuring Absolute Poverty

Absolute poverty refers to a state of deprivation where individuals lack the basic necessities for survival.
Various indices are used to measure it:

Headcount Index (H ): The proportion of the population whose income is below the absolute poverty
line (Yp ).
​

Number of poor people (H)

Formula: H = Total population (N)
​

Total Poverty Gap (TPG): The sum of the income shortfalls of all poor individuals from the poverty
line.
H
Formula: TPG = ∑i=1 (Yp − Yi ) where Yi is the income of the i-th poor person and Yp is the
​ ​ ​ ​ ​

poverty line.
Figure 5.6 illustrates the concept of the poverty gap.
Average Poverty Gap (APG): The total poverty gap divided by the total population.
TPG
Formula: APG = N
​

Normalized Poverty Gap (NPG): The APG divided by the poverty line, indicating the average shortfall
as a proportion of the poverty line.
APG
Formula: NPG = Yp
​

Average Income Shortfall (AIS): The total poverty gap divided by the number of poor people.
TPG
Formula: AIS = H
​

Normalized Income Shortfall (NIS): The AIS divided by the poverty line.
AIS
Formula: NIS = Yp ​
​

Foster-Greer-Thorbecke (FGT) Index (Pα ): A class of poverty measures that can be adapted to
​

different levels of sensitivity to poverty.

α
∑i=1 ( Yp )
1 N Yp −Yi
Formula: Pα = for Yi < Yp , and 0 otherwise.
​ ​

N
​ ​ ​ ​ ​ ​

When α = 0, it becomes the Headcount Index (P0 = H ). ​

When α = 1, it is related to the Average Poverty Gap.

When α = 2, it is the Squared Poverty Gap, which is more sensitive to the depth of poverty.

The Multidimensional Poverty Index (MPI)

The MPI goes beyond income to measure poverty by considering deprivations across multiple dimensions.

2/6
 Methodology:
It uses a dual cutoff: first, identifying deprivation within specific indicators (e.g., health,
education, standard of living), and second, determining a threshold number of deprivations a
person must experience to be considered multidimensionally poor.
The MPI typically focuses on health, education, and standard of living, with each dimension
carrying equal weight (one-third).
Indicators:
Health: Child mortality, malnutrition.
Education: Lack of schooling, children out of school.
Standard of Living: Lack of electricity, unsafe water, inadequate sanitation, inadequate
flooring, unimproved cooking fuel, lack of certain assets.
Interaction of Deprivations: The MPI accounts for the compounded harm of experiencing multiple
deprivations simultaneously, recognizing that capabilities are complements as well as substitutes.
Computation: The MPI is often expressed as the product of the headcount ratio (H , the proportion
of people living in multidimensional poverty) and the average intensity of deprivation (A, the average
percentage of weighted indicators for which poor households are deprived). This is known as the
adjusted headcount ratio (H × A).
Advantages: The MPI can reveal different poverty patterns than income poverty alone. Table 5.2
shows how country rankings can differ significantly between income poverty and MPI measures.

Poverty, Inequality, and Social Welfare

What's So Bad About Extreme Inequality?

Extreme inequality can hinder social welfare by:

Limiting opportunities for the poor.

Potentially leading to social instability.
Distorting political processes.

Dualistic Development and Shifting Lorenz Curves

This concept describes different patterns of economic growth and their impact on income distribution:

Traditional Sector Enrichment: Growth benefits the poor in the traditional sector, potentially
improving the overall income distribution (Figure 5.7).
Modern Sector Enrichment: Growth primarily benefits the wealthy in the modern sector, worsening
income distribution (Figure 5.8).
Modern Sector Enlargement: Growth expands the modern sector, drawing in labor and potentially
improving distribution, though the Lorenz curve may cross itself (Figure 5.9).

3/6
Kuznets' Inverted-U Hypothesis

This hypothesis suggests that income inequality initially rises during the early stages of economic
development (as people move from low-income rural areas to higher-income urban areas) and then falls as
the economy matures and more inclusive policies are implemented.

Figure 5.10 illustrates this inverted-U relationship, with the Gini coefficient on the y-axis and GNI per
capita on the x-axis.
However, empirical evidence (Figures 5.11 and 5.12, Table 5.4) shows that this relationship is not
universally observed, and many countries, particularly in Latin America, exhibit high inequality even at
higher income levels.

Growth and Inequality

Association between Growth and Poverty Reduction: Economic growth is generally associated with
poverty reduction, but its impact depends on its "inclusiveness."
Inclusive Growth: Growth that benefits all segments of society, including the poor, leads to more
significant poverty reduction.
Lower Extreme Poverty and Higher Growth: Some evidence suggests that reducing extreme
poverty can also contribute to higher economic growth.
Figure 5.13 shows differing trends in economic growth and income inequality across regions like East
Asia, Latin America, and Sub-Saharan Africa.

Absolute Poverty: Extent and Magnitude

Progress on Extreme Poverty: There has been significant progress in reducing extreme poverty
(defined as living on less than $1.25 a day), particularly in East Asia. However, progress has been
slower for those living on between $1.25 and $2.00 a day (Figure 5.14).
Regional Differences: Poverty incidence varies significantly by region, with Sub-Saharan Africa and
South Asia having the highest rates of poverty (Table 5.5).
Country-Specific Data: Table 5.6 provides detailed poverty statistics (headcount ratio, poverty gap,
squared poverty gap, Gini index) for various countries at different poverty lines.

Economic Characteristics of High-Poverty Groups

Certain groups are disproportionately affected by poverty:

Rural Poverty: Poverty is often more concentrated in rural areas due to lower incomes, limited access
to services, and reliance on agriculture (Table 5.7).

4/6
 Women and Poverty: Women often face greater challenges in accessing education, healthcare, and
economic opportunities, contributing to higher poverty rates among female-headed households.
Ethnic Minorities and Indigenous Populations: These groups frequently experience systemic
discrimination, leading to lower incomes, reduced access to resources, and higher poverty rates (Table
5.8).

Policy Options on Income Inequality and Poverty

Policies to address poverty and inequality can be categorized by their focus:

Altering the Functional Distribution: Influencing the share of income going to different factors of
production (e.g., changing relative factor prices).
Mitigating the Size Distribution:
At Upper Levels: Progressive taxation, reducing excessive wealth concentration.
At Lower Levels: Transfer payments, public provision of goods and services, land reform,
increasing access to education and employment.
Specific Policy Tools:
Changing Relative Factor Prices: Policies that make labor relatively cheaper than capital can
encourage employment.
Progressive Redistribution of Asset Ownership: Land reform, promoting broader ownership
of capital.
Progressive Taxation: Taxing higher incomes and wealth at higher rates.
Transfer Payments and Public Provision: Social safety nets, welfare programs, provision of
education, healthcare, and housing.
Workfare Programs: Providing employment in exchange for wages, often for public works.

Summary and Conclusions: The Need for a Package of Policies

Effective strategies for reducing poverty and inequality require a comprehensive approach that includes:

Policies to correct factor price distortions and promote employment.

Policies to redistribute assets, power, and access to education and opportunities.
Progressive taxation and targeted transfer payments.
Policies aimed at building the capabilities and human and social capital of the poor.

Concepts for Review

Absolute poverty
Asset ownership
Character of economic growth

5/6
Decile
Disposable income
Factor share distribution of income
Factors of production
Functional distribution of income
Gini coefficient
Headcount index
Income inequality
Indirect taxes
Kuznets curve
Land reform
Lorenz curve
Multidimensional Poverty Index (MPI)
Personal distribution of income
Progressive income tax
Public consumption
Quintiles
Redistribution policies
Regressive tax
Size distribution of income
Subsidy
Total poverty gap (TPG)
Workfare programs
Foster-Greer-Thorbecke (FGT) index

6/6