4&5. Poverty and Inequality

ECON 181
Poverty and Inequality.

WARNING: The slides are NOT lecture notes. You still need to read the assigned papers.
Econ 181: Inequality and Poverty
October 10, 2011
Contents
1 Poverty 1.1 1.2 Poverty measures . . . . . . . . . . . . . . . . . . . . . 3 4
Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . 10 15
2 Inequality 2.1 2.2 2.3 2.4 2.5 2.6 2.7
Some preliminary information (WDR, 2006) . . . . . . 16 Measuring inequality . . . . . . . . . . . . . . . . . . . 20 Lorenz curve . . . . . . . . . . . . . . . . . . . . . . . 27 Other measures . . . . . . . . . . . . . . . . . . . . . . 35 Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Kuznetss curve . . . . . . . . . . . . . . . . . . . . . . 43 Is economic growth pro-poor? . . . . . . . . . . . . . . 44
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Poverty
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1.1
Poverty measures
Concepts Poverty line: a critical threshold below which individuals are declared to be poor. The threshold could refer to income, consumption or access to goods and services. Nutrition-based lines: the amount of money needed to guarantee minimum consumption of calories.
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Key issues 1. Overall consumption or item-by-item consumption (e.g., enough for for food but not for clothing.) 2. Absolute vs. relative: how can we compare dierent needs in dierent countries? 3. Households vs individuals. Consumption is observed at the household level and we usually dont know how it is distributed. why do we need a poverty line? Say poverty line is $1 per day. How dierent are individuals with $1.01 and those with 99 cents? Read the article by A. Deaton (2006).
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Measures Let denote y income (or expenditure), m the average income, p the poverty line. If yi < p, then individual i is poor. Consider a country with N individuals. The rst measure is to count how many poor are in a country: how many indiv. earn less than p. However, we want to account for the total number of people living in this country. Hence, the Poverty Head-count (PHC) is N 1(yi <p) P HC = i=1 N , 1(A) = 1 if A is true and 0 otherwise.
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PHC is a widely used. However, there are some problems. 1. Consider two countries with the same PHC and with p = 100. In one country all the poor earn $99 each and in the second they all earn $50 each. Can we still say that both countries are equally poor? 2. Consider this poverty alleviation policy. Lets tax the very poor and give the revenues to the ones just below the poverty line so they can escape poverty. The main problem with PCH is that it does not account for the extent of the poverty.
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To solve this problem we can use the Income Gap (IG). It measures the average gap in poverty (p yi ) relative to the poverty line N pyi 1 IG = N i=1 ( p )1(yi < p) This measure its also used but its less popular. Problems 1. Consider two countries with the same IG and with p = 100. In one country all the poor earn $40 each and in the second half the poor earn $20 and the other half makes $60. Can we still say that both countries are equally poor?. 2. Consider a transfer from the very poor to the less poor such that they escape poverty. Will IG be the same after the transfer? 3. Consider the same transfer but now the less poor do not escape poverty, will IG be the same?
Econ 181: Inequality and Poverty October 10, 2011 8
To solve this problems Foster, Greer and Thorbecke proposed what is now known as the FGT index N pyi 1 P = N i=1 ( p ) 1(yi < p) The parameter could take dierent values. When = 0 then P0 = P HC. When = 1 then P1 = IG. An interesting case is when = 2. Thus P2 takes into account the distribution among the poor. P2 then solves all the problems described above. However, P2 is not very commonly used.
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1.2
Evidence
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10
SSA is the region with the highest PHC.
Figure 2: Poverty measures by region 1981-2004 (a) Headcount index

60 50 SSA 40 30 20 LAC 10 MNA
Econ 181:
% living below $1 a day
SAS EAP
ECA 1990
October 1995 10, 2011 2000
0 Inequality and Poverty 1980 1985
2005
11
in Africa the levels are going back to 1981.

Table 1: Poverty measures for $1 a day
(a) Percentage of population Region East-Asia and Pacific (EAP) Of which China Eastern-Europe+Central Asia (ECA) Latin America+Caribbean (LAC) Middle East+North Africa (MNA) South Asia (SAS) Of which India Sub-Saharan Africa (SSA) Total Total excl.China (b) Number of people 1981 57.73 63.76 0.70 10.77 5.08 49.57 51.75 42.26 40.14 31.35 1984 39.02 41.02 0.51 13.07 3.82 45.43 47.94 46.20 32.72 29.69 1987 28.23 28.64 0.35 12.09 3.09 45.11 46.15 47.22 28.72 28.75 1990 29.84 32.98 0.46 10.19 2.33 43.04 44.31 46.73 28.66 27.14 1993 25.23 28.36 3.60 8.42 1.87 36.87 41.82 45.47 25.56 24.58 1996 16.14 17.37 4.42 8.87 1.69 36.06 39.94 47.72 22.66 24.45 1999 15.46 17.77 3.78 9.66 2.08 34.92 37.66 45.77 22.10 23.54 2002 12.33 13.79 1.27 9.09 1.69 33.56 36.03 42.63 20.13 22.19 2004 9.05 9.90 0.94 8.64 1.47 30.84 34.33 41.10 18.09 20.70
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Comparing dierent measures. Table 3.3 Poverty in 21 African Countries Using National Poverty Lines, 1990s
Indicator Headcount ratio (percent) Poverty gap (percent) Squared poverty gap (percent) Mean expenditure (dollars a person per year) Mean poverty line (dollars a person per year)
Source: Ali 1999.
Rural 56 23 13 409 325
Urban 43 16 8 959 558
Overall 52 22 12 551
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...and an example from Ivory Coast (1985-1988)
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Inequality
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2.1
Some preliminary information (WDR, 2006)
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Figure 1 Wealth matters for the immunization of children

Percentage not covered 70
60
50
40
Poorest
30
20
10
Wealthiest
Source: Authors own calculations from Demographic Health Survey (DHS) data Note: * indicates that the poorest quintile have higher access to childhood immunization services than the wealthiest quintile. The continuous orange line represents the overall percentage of children without access to a basic immunization package in each country, while the endpoints indicate the percentages for the top and the bottom quintile of the asset ownership distribution.
E Jor gypt dan Co (*) lom b Rw ia and a So uth Peru Afr ic Ke a nya Ma law i Bra Zam zil bia Vie (*) tna Tur m k Gu ate ey ma Tan la z Ind ania Tur km ones eni sta ia Mo n (*) roc c Gh o ana Ph Benin ilip Ba pine ngl s ad Co esh mo ro Bo s Pa livia r Ka zak agua y hst an (*) Bu Yem rkin en a Ca Faso me ro Ug on and a Ma India uri tan ia Ha iti Ce ntr Tog al A fric Ethi o opi an a R Ma epub dag lic Mo asc zam ar biq u Gu e ine a Ca Mali mb o Pa dia kis ta Eri n tre a Nig er Ch ad
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Figure 2 Opportunities are determined early Cognitive development for children ages three to ve in Ecuador differs markedly across family backgrounds
Wealthiest and poorest quartiles Median score 110 100 90 80 70 60 40 50 60 Age in months 70 Poorest 25th% Wealthiest 25% Maternal education Median score 110 100 90 80 70 60 40 50 60 Age in months 70 12 or more years
05 years
Source: Paxson and Schady (2005). Note: Median values of the test of vocabulary recognition (TVIP) score (a measure of vocabulary recognition in Spanish, standardized against an international norm) are plotted against the childs age in months. The medians by exact month of age were smoothed by estimating fan regressions of the median score on age (in months), using a bandwidth of 3.
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Adjusted infant mortality rates by maternal education Probability of dying in the first year 0.15
0.12
0.09 Years of maternal education 10th percentile or 0 year 25th percentile or 2 years 50th percentile or 5 years 75th percentile or 10 years 90th percentile or 11 years 0.00 1978
0.06
0.03
1982
1986
1990
1994
1998
Source: Paxson and Schady (2004).
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2.2
Measuring inequality
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Initial ideas Suppose we have two people only. Clearly, a 50-50 division is equal. A 90-10 or 10-90 are clear unequal distributions. Consider now the case we three individuals. Which distribution is more unequal, 22-22-56 or 20-30-50? We hence need some criteria to rank distributions. That is, we need a set of goals for any inequality measure.
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Four criteria 1. Anonymity principle. Ethical arguments require that it doesnt matter who earns the income. If Nthabiseng makes R100 a week and Pieter R500, the inequality should be the same if Nthabiseng now makes R500 and Pieter only R100. All we care about if the ranking of income (yi ): y1 y2 . . . yn
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2. Population principle. Cloning the entire population (with their corresponding income) should not alter inequality. The size of the population shouldnt matter in order to measure inequality. Comparing the income distribution over n people and other with same income but twice (2n) the population should lead to the same inequality measure.
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3. Relative income principle. It shouldnt matter whether income is expressed in dollars, rands or metacais. If we multiply the income of all individuals by = 0 inequality should remain unchanged. That is, the inequality on an income distribution of (10,20,40) should be the same as the one from (1000,2000,4000.) All that matter are shares of total income.
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4. The Dalton principle. Dalton (1920)s principle suggest that transfer from poor individuals to richer ones should increase inequality. That is, taking money from a person with income yi to another one with income yj yi increases inequality. This is also called a regressive transfer.
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We can now formalize these four criteria as follows. Let the income distribution of income (y1 y2 . . . yn ). and let I(y1 , y2 , . . . , yn ) a measure of inequality. 1. Anonymity: the function I does not vary with a permutation on the income distribution of individuals {1,2,. . . ,n}. 2. Population principle: I(y1 , y2 , . . . , yn ) = I(y1 , y2 , . . . , yn ; y1 , y2 , . . . , yn ) 3. Relative income principle: I(y1 , y2 , . . . , yn ) = I(y1 , y2 , . . . , yn ) 4. Dalton principle: for > 0, I(y1 , y2 , . . . , yn ) < I(y1 , . . . , yi , . . . , yj + , . . . , yn )
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2.3
Lorenz curve
Before looking at some alternative inequality measure, lets start with a graphical device. The Lorenz curve relates the share of total income held by x% of the population. In gure 6.4, point A shows that the income of share of the bottom 20% of the population is 10%. Point B say that the bottom 80% holds 70% of total income. Put dierently, the rich 20% enjoys 30% of total income.
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Ray, D. (1998)
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Consider the case when income is equally distributed 1 (everybody enjoys the same n th of total income). The Lorenz curve in such case will be equal to the diagonal, the bottom 20% of pop. enjoys 20% of total income Hence, the x% of population enjoys x% of total income. Consider the opposite case, where all the income is held but only person. The Lorenz curve is at until it hits 100% of the population where it becomes vertical. Given two Lorenz curves, the one closest to the diagonal has less inequality (for all points).
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L(2) is more or less unequal than L(1)?
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Does the Lorenz curve satisfy the four criteria for inequality? In homework 2 you will have a chance to answer this question in detail. There is one problem with Lorenz comparisons. When a pair the curves cross we cannot rank them using the Lorenz criteria.
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We cannot rank L(2) and L(1). Why?
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Examples: 1
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Examples: 2
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2.4
Other measures
Consider a population with n individuals. Person i has an income equal to yi Lets dene the mean income as n 1 n i=1 yi We will consider four alternative measure of inequality commonly found in the literature
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The range The range (R) is dened as the gap between the richest (yn ) and the poorest (y1 ) income (expressed in terms of the average income) Recall than income is sorted from the lowest to highest income R=
1 (yn
y1 )
Inequality increases when the gap increases. Note that this measure does not take into account the incomes between the richest and the poorest. If the second poorest person transfer money to the second richest one, the inequality will remain intact. Does this satisfy the Dalton principle?
The Kuznets ratios Introduced by Simon Kuznets. The idea is to compare the share of income of the top x% of the population and the bottom z%. For example, you can compare the income of the top 10% and the one of the bottom 20%. Bigger ratios indicate higher inequality. Does this satisfy the Dalton principle?
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The coecient of variation It is the ratio between the standard deviation () and the mean (). n 1 2 C = , where = n i=1 (yi ) . Does this satisfy the Dalton principle?.
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The Gini coecient This measure is related to the Lorenz curve. The Gini coecient is the ratio
M M +S
(see next graph.)
The Gini coecient satises all the criteria supported by the Lorenz curve. That is, when inequality is higher, M will be bigger and the Gini coecient will be higher.
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M
S
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2.5
Evidence
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Inequality in SSA is the highest, except for LA.

K. Deininger, L. Squirer Journal of Deelopment Economics 57 (1998) 259287 Table 1 Decadal medians of Gini coefficients for the income distribution, by Region 19601990 1960s Eastern Europe South Asia OECD and high income East Asia and Pacific Middle East and North Africa Sub-Saharan Africa Latin America 22.76 31.67 32.86 34.57 41.88 49.90 53.00 1970s 21.77 32.32 33.04 34.40 43.63 48.50 49.86 1980s 24.93 32.22 32.20 34.42 40.80 39.63 51.00 1990s 28.60 31.59 33.20 34.80 39.72 42.30 50.00 263
Regions are ordered by increasing inequality in the 1990s. Source: Deininger and Squire 1996..
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2.6
Kuznetss curve
How does inequality respond to economic development? Kuznets hypothesis an inverted-U relation. Inequality is highest for countries with middle-income and lower for the rich and poor.
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2.7
Is economic growth pro-poor?
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Figure 4.3 Growth is the key to poverty reduction . . .

Change in log poverty headcount index (x100) 500
BUL
400
LVA
300 200
MLI
PER MDA ARG HUN POL LAO CIV PAR YEM VEN SVN TTO COL MNG ZWE BGD LSO SLV ROM GEO NER VNM NGA BWA HRV BDI NIC UGA ZAF RUS ZMB GHA 0 MDG UZB ETH EGYLKAIND BRA BOL BFA PHLHON MEX KEN TURPAN MAU ECU GMB DZA LTU SEN CMR GUY CHN URY ALB CRI AZE EST IDN PAK MAR IRN JAM KAZ TUN THA LYS
100 0 100 200 300 400 150 y = 2.3841x + 2.3517 t-stat = 9.30 R2 = 0.5225 N = 73 100
GTM
50
50
100
150
Change in log mean consumption or income between surveys (x100)

Source: WDR 2006.
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Figure 4.4 . . . and, on average, growth is distribution-neutral

Change in log Gini index (x100) 50 40 30 20 10 0 10 20 30 40 50 60 150 y = 0.0288x + 3.3717 t-stat = 0.515 R2 = 0.004 N = 73
LVA MLI NER NGA PAR CRI ZWE BDI SVN BWA LAO CHN BGD ARG GHA HUN HRV MDA LSO PHL MEX ECU PER NIC COL SLV CIV EGY GMB MDG IDN HON VNM URY AZEBRA MAR PAN GEO IND LTUALBUGA LYS PAK ROM TTO RUS CMR THA ZAF IRN TUR VEN TUN BFA MNG JAM DZA ZMB GUY YEM MAU KAZ BOL KEN SEN ETH POL EST
BUL
GTM
UZB
LKA
100 50 0 50 100 Change in log mean consumption or income between surveys (x100)
150
Source: WDR 2006.
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Sources
Lorenz curves come from Debraj Ray (1998) textbook. Inequality in South Africa: van der Berg et al (2005) Trends in poverty and inequality since the political transition. Inequality in SSA (tables 6 and 7) from by Tsikata, Y. (2001) Globalisation, Poverty and Inequality in Sub-Saharan Africa: A Political Economy Appraisal. Inequality in SSA (table 3.1) Okojie, C. and A. Shimeles (2006) Inequality in sub-Saharan Africa: a synthesis of recent research on the levels, trends, eects and determinants of inequality in its dierent dimensions. Recent trends in PHC: Chen, S. and M. Ravallion (2007) Absolute Poverty Measures for the Developing World, 1981-2004 World Bank.
FGT in Africa: Can Africa Claim the 21st Century? The World Bank Washington, D.C. FGT in Ivory Coast: Deaton (1997) The Analysis of Household Surveys.
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ECON 181

Poverty and Inequality.

Econ 181: Inequality and Poverty

October 10, 2011

2 Inequality 2.1 2.2 2.3 2.4 2.5 2.6 2.7

Econ 181: Inequality and Poverty

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

SSA is the region with the highest PHC.

Figure 2: Poverty measures by region 1981-2004 (a) Headcount index

% living below $1 a day

0 Inequality and Poverty 1980 1985

in Africa the levels are going back to 1981.

Econ 181: Inequality and Poverty

October 10, 2011

Rural 56 23 13 409 325

Urban 43 16 8 959 558

Econ 181: Inequality and Poverty

October 10, 2011

...and an example from Ivory Coast (1985-1988)

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Some preliminary information (WDR, 2006)

Econ 181: Inequality and Poverty

October 10, 2011

Figure 1 Wealth matters for the immunization of children

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Source: Paxson and Schady (2004).

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

October 10, 2011

Econ 181: Inequality and Poverty

4&5. Poverty and Inequality

4&5. Poverty and Inequality