Chapter 5

Economic Development
Thirteenth Edition
Chapter 5
Poverty, Inequality, and
Development
Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Distribution, Poverty, and
Development: Eight Critical Questions
1. How can we best measure inequality and poverty?
2. What is the extent of relative inequality in developing
countries; how is this related to the extent of poverty?
3. Who are the poor, and what are their economic
characteristics?
4. What determines the nature of economic growth—that
is, who benefits from economic growth, and why?

Distribution, Poverty, and Development:
Eight Critical Questions (Cont.)
5. Are rapid economic growth and more equal income
distribution compatible or conflicting objectives?: Is
rapid growth achievable only at a cost of greater
income inequality or can lessening income disparities
contribute to higher growth rates?
6. Do the poor benefit from growth, and does this depend
on the type of growth a developing country
experiences? What might be done to help the poor
benefit more?
7. What is so bad about extreme inequality?
8. What kinds of policies are required to reduce the
magnitude and extent of absolute poverty?
A Capabilities and Distribution-Based Social
Welfare Framework
• Generally, we may think of welfare as a function, W = W(Y, E, H, M,
Other…),
• Where Y=standard of living, E=Education, H=Health, M=Empowerment,
and Other represents additional factors representing important
capabilities
• Income, health, and education indicators are averages; but distribution
also matters
• We focus most on Y (income, or permanent income from wealth, or
broadly living standards), through frameworks such as:
– Growth models
– More complex constraints on growth including coordination failures
– Growth diagnostics

A Capabilities and Distribution-Based Social
Welfare Framework (Continued)
• Here, we first consider the distribution of Y, expanding from averages to
address:
– (Relative) Inequality of Income
– (Absolute) Income Poverty

5.1
MEASURING
INEQUALITY

Measuring Relative Inequality
• Size distributions (quintiles, deciles)
• Lorenz curves
• Gini coefficients and other aggregate measures of
inequality

• Personal distribution of income (size distribution
of income) The distribution of income according to size
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.
• Quintile: A 20% proportion of any numerical quantity. A
population divided into quintiles would be divided into five
groups of equal size.
• Decile: A 10% portion of any numerical quantity; a
population divided into deciles would be divided into ten
equal numerical groups.

• Income inequality: The disproportionate distribution of total
national income among households.
• Lorenz curve: A graph depicting the variance of the size
distribution of income from perfect equality.
• Gini coefficient: An aggregate numerical measure of income
inequality ranging from 0 (perfect equality) to 1 (perfect
inequality). It is measured graphically by dividing the area
between the perfect equality line and the Lorenz curve by
the total area lying to the right of the equality line in a Lorenz
diagram. The higher the value of the coefficient, the higher
the inequality of income distribution; the lower it is, the
more equal the income distribution.

Table 5.1
Typical Size Distribution of Personal Income in a
Developing Country by Income Shares—Quintiles and
Deciles

Figure 5.1
The Lorenz Curve

Figure 5.2
The Greater the Curvature of the Lorenz Line,
the Greater the Relative Degree of Inequality

Figure 5.3
Estimating the Gini Coefficient

A Brief Review: Desirable Properties for
Inequality Measures
• Anonymity: Does not depend on who has higher income
• Scale independence: Does not depend on the size of the
economy
– What happens if everyone’s income goes up by 25%?
• Population independence: not based on the number of
recipients
• Transfer principle - transfer income from a richer to a
poorer person, resulting in distribution being more equal
– What if transfers so much that these people “trade
places?”

Figure 5.4
Four Possible Lorenz Curves

The Functional Distribution of Income
• “Functional” income distribution is based on shares of national
income of each factor of production (labor, capital, and land)
• Focuses on (wage) share of labor as a whole, in contrast to
distributions as rent, interest, and profit
• Specific individuals may receive income from all sources; but the
functional approach is not based on individuals
• Traditional neoclassical approach: assumes competition; supply
and demand curves assumed to determine prices of each factor
• Each factor is then paid what it contributes to national output:
• Supply of, and demand for, labor determine market wages
• The (average) wage multiplied by total employment is a measure
of total wage payments, also called the total wage bill
• Figure 5.13 provides a simple diagrammatic illustration for labor
Figure 5.13
Functional Income Distribution in a Market
Economy: An Illustration

Labor and Inclusive Development:
The Quality of Jobs
• Most people receive income primarily from labor, that
is, from the work that they do
• Approximately 3.3 billion people currently work
• But having work does not mean having a wage
• In most developing countries, a minority of labor
income is from conventional “jobs”
• Close to half engaged in self-employment
• Wage labor often low-productivity work, with irregular
incomes

The Broad Importance of High- Quality Jobs
• Work is the way most people get most of their income,
and where they spend much of their time
• The type of work a person does largely constrains their
possibilities of getting future higher income
• Broadly, jobs help people gain and maintain capabilities
• Skills and attitudes people develop at jobs affect [how
others perceive] their capabilities in other spheres
• People with jobs that develop multiple capabilities are
more engaged in civic affairs
• Thus, high inequality in labor markets can serve to
magnify other forms of inequalities
5.2
MEASURING
POVERTY

Desirable Properties for Poverty Measures
• Anonymity
• Population independence
• Monotonicity
• Distributional sensitivity

Monotonicity and Distributional Sensitivity
• Monotonicity principle: If you add income to someone below the
poverty line, all other incomes held constant, poverty falls
• Distributional sensitivity principle: if you transfer income from a poor
person to a richer person (even if the “richer” person is also below the
poverty line), the resulting economy is deemed strictly poorer.
• These principles clarify what is lacking in some widely used measures
• Looking ahead, the headcount ratio (fraction below the poverty line)
satisfies anonymity and population independence, but not full
monotonicity; and it fails on distributional sensitivity
• The simple headcount (the number who are poor) fails even to satisfy
the population independence principle

Measuring Absolute Poverty
• Absolute poverty: The situation of being unable or

only barely able to meet the subsistence essentials of
food, clothing, and shelter.

• Headcount Index: H/N

– Where H is the number of persons who are poor and N is
the total number of people in the economy; H/N is the
fraction who are poor
• Does not meet desirably properties and accordingly
is likely to cause incentive problems:

Unintended Policy Incentives of Using
Headcount Measures
• When agencies are told their mission includes poverty reduction…
• Measuring poverty by headcount or fraction poor creates incentive to
report improvements in these measures; this plausibly focuses efforts
toward those closer to poverty line
• Circumstantial evidence:
– Incumbent politicians frame poverty progress in terms of headcount or
fraction – staff would anticipate and want favorable results - by this
measure - to report
– Government policy exhibits “urban bias,” e.g. emphasizing job creation
for the poor in cities - who are closer to the poverty line
– NGOs work near main roads or district towns, easier-to-reach; if so,
people assisted are less poor on average
– MFIs (Micro-Finance Institutions) have focused commonly on the
richest of the poor

• Total poverty gap: The sum of the difference

between the poverty line and the actual income
levels of all people living below that line.
H
TPG = ∑ (Yp − Yi )
i=1
- Where Yp is the absolute poverty line; and Yi the income

of the ith poor person

Measuring the Total Poverty Gap

• Average poverty gap (APG):
TPG
APG =
N
– Where N is number of persons in the economy
– TPG is total poverty gap

Measuring Absolute Poverty (Cont.)
• Average income shortfall (AIS): the average amount by
which the income of a poor person falls below the
poverty line.
TPG
AIS =
H
– Where H is number of poor persons

– TPG is total poverty gap

Measuring Absolute Poverty (Cont.)
• The Foster-Greer-Thorbecke (FGT) index: A class
of measures of the level of absolute poverty.
α
1 "$ Y p − Yi %'
H
Pα = ∑$
N i=1 # Y p '&
– N is the number of persons, H is the number of poor persons,

and a ≥0 is a parameter
– When a =1, we get the headcount index measure
– When a =2, we get the “P2” measure

Preview: Measuring Poverty - Income or
Multidimensional Indicators?
• Given that we are measuring poverty with income, we have good
measures that satisfy desirable properties
• If must have a single indicator, income has advantages e.g. clarity,
flexibility
• But in general, is measuring income sufficient?
• Following Amartya Sen’s capability approach, it is apparent that,
in general, poverty needs to be conceptualized – and so
measured – in a multidimensional way
• The new MPI is the best-known effort to do so – we return to it
soon…

5.3
POVERTY, INEQUALITY AND
SOCIAL WELFARE

Poverty, Inequality, and Social Welfare
• What’s So Harmful for Economic Development about
Extreme Inequality?
• Dualistic Development and Shifting Lorenz Curves:
Some Stylized Typologies
– Traditional-sector enrichment (see Figure 5.7)
– Modern-sector enrichment (see Figure 5.8)
– Modern-sector enlargement (see Figure 5.9)

What’s So Harmful about Extreme Inequality?
3 Factors
• Extreme income inequality leads to economic inefficiency:
– Smaller fraction of population qualifies for credit e.g. for business or
school
– Overall rate of saving in the economy tends to be lower: Highest rate
of marginal savings usually found among the middle classes.
– Inequality may lead to an inefficient asset allocation
– High inequality of land ownership inefficient because most efficient
scales for farming are family and medium-size farms.
– The result can be a lower average income and a lower rate of
economic growth when inequality is high.
– Moreover, these factors in turn often beget still more inequality

What’s So Harmful about Extreme Inequality?
3 Factors (Continued)
• Extreme disparities undermine social stability and
solidarity
– High inequality strengthens political power of the rich, and
thus concentrates economic and social bargaining power
– High inequality facilitates rent seeking
• Finally, extreme inequality is generally viewed as unfair.
– John Rawls’ thought experiment: uncertainty behind the “veil
of ignorance.”

Table 5.2
Selected Income Distribution Estimates
Source: Based on World Bank, World Development Indicators, 2010. (Washington, D.C.: World Bank, 2010), tab. 2.9.

Table 5.3
Income and Inequality in Selected Countries
Source: Data from World Bank, World Development Indicator Tables, 2018 (Washington, D.C.: World Bank, 2018), tabs. WV.1 and 1.3, accessed 16 June 2019.

• Dualistic Development and Shifting Lorenz Curves:

Some Stylized Typologies
– Traditional sector enrichment (see Figure 5.7)
– Modern sector enrichment (see Figure 5.8)
– Modern sector enlargement (see Figure 5.9)

• Traditional sector enrichment: in which all of the benefits of
growth are divided among traditional-sector workers, with little
or no growth occurring in the modern sector (Sri Lanka, and the
state of Kerala in southwestern India).
• Modern sector enrichment: in which the economy grows but
such growth is limited to a fixed number of people in the modern
sector, with both the numbers of workers and their wages held
constant in the traditional sector (Latin American and African
economies).
• Modern sector enlargement: in which the two-sector
economy develops by enlarging the size of its modern sector
while maintaining constant wages in both sectors (East Asian
economies such as China, South Korea, and Taiwan).
Figure 5.6
Improved Income Distribution under the
Traditional-Sector Enrichment Growth Typology

Figure 5.7
Worsened Income Distribution under the
Modern-Sector Enrichment Growth Typology

Figure 5.8
Crossing Lorenz Curves in the Modern-Sector
Enlargement Growth Typology

Kuznets’ Inverted-U Hypothesis
• The inverted-U is consistent with modern sector
enlargement growth, but not traditional or modern
sector enrichment growth

Figure 5.9
The “Inverted-U” Kuznets Curve

Figure 5.10
Kuznets Curve with Latin American Countries
Identified
Source: Fields, Gary S. (2001), Distribution and Development: A New Look at the Developing World, Cambridge, M.A.: MIT Press, ch. 3, p. 46. © 2001 Massachusetts Institute of Technology, by
permission of The MIT Press.

Figure 5.11
Plot of Inequality Data for Selected Countries
Source: Gary S. Fields, Distribution and Development: A New Look at the Developing World (Cambridge, Mass.: MIT Press, 2001), ch. 3, p. 44. © 2001 Massachusetts Institute of Technology, by permission
of The MIT Press.

Absolute Poverty: Extent and Magnitude.
• Progress on Extreme Poverty

– Clear progress on $1.25-a-day headcount
– Less clear progress on $2.00-per-day headcount (see
Figure 5.14)
– Incidence of extreme poverty is uneven
• Relationship between Growth and Poverty
– Association between growth and poverty reduction
– When it is inclusive, growth reduces poverty
– Lower extreme poverty may also lead to higher growth

Regional Poverty Incidence, 2013
Region Headcount Ratio Poverty Gap Squared Poverty Gap (%)
(%)
Regional Aggregation
at $1.25 per Day
East Asia and the Pacific 0.53 0.17 0.06
Europe and Central Asia 0.67 0.18 0.14
Latin America and the 3.16 1.74 1.36
Caribbean
Middle East and North Survey Data is too low, result is suppressed
Africa Coverage the
South Asia 2.0 0.28 0.07
Sub-Saharan Africa 22.59 7.57 3.62
Total 4.63 1.49 0.75
Regional Aggregation
at $2 per Day
East Asia and the Pacific 4.34 0.82 0.27
Europe and Central Asia 2.46 0.66 0.30
Latin America and the 5.83 2.75 1.91
Caribbean
Middle East and North Survey Data is too low, result is suppressed
Africa Coverage the
South Asia 17.98 3.47 1.02
Sub-Saharan Africa 43.59 17.26 9.17
Total 16.11 4.27 2.02

Figure 5.12
Global and Regional Poverty Trends, 1981–2015
Global and Regional Poverty Trends, 1981-2015
2,5
People living on less than $1.9

per day, Other High Income
Countries
2
People living in Poverty (billions)
People living on less than $1.9 People living on less than $1.9
1,5 per day, Sub-Saharan Africa
per day, Middle East & North
Africa

per day, Latin America &
1 Caribbean

per day, Europe and Central Asia
per day, South Asia
0,5
per day, East Asia and Pacific
0
1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2010 2011 2012 2013 2015
( based on 2011 PPP & $1.9/day poverty line)

Income Poverty Incidence at $1.25 per day, and Gini Coefficient,
Selected Countries, 2010–2014 data
Country Year Per Capita Monthly Income (2011 Headcount Ratio Poverty Gap Squared Poverty Gini Index
PPP) (%) (%) Gap (%) (%)
Bangladesh 2010 109.03 2.17 0.28 0.06 32.13
Benin 2011 82.42 27.64 7.33 2.85 43.44
Brazil 2014 563.57 2.15 1.11 0.84 51.48
Burkina Faso 2014 83.83 12.64 2.14 0.55 35.30
China- Rural 2013 290.41 0.44 0.10 0.05 33.97
China-Urban 2013 373.40 0.15 0.07 0.06 36.69
Cote d’Ivoire 2008 119.31 14.17 4.57 2.10 43.18
Guatemala 2014 257.19 3.17 1.01 0.49 48.66
Honduras 2014 236.33 7.76 3.08 1.85 50.64
India- Rural 2011 95.84 4.23 0.62 0.16 31.13
India- Urban 2011 146.66 2.08 0.28 0.07 39.01
Indonesia- Rural 2014 133.13 0.59 0.05 0.01 31.91
Indonesia- Urban 2014 191.32 0.79 0.08 0.01 42.77
Madagascar 2012 46.66 58.82 23.34 12.17 42.65
Mexico 2014 341.5 1.02 0.22 0.07 48.21
Mozambique 2008 59.56 46.16 17.28 8.84 45.58
Nicaragua 2014 288.89 1.53 0.49 0.25 47.05
Nigeria 2009 75.86 31.56 10.66 5.00 42.97
Pakistan 2013 134.53 0.45 0.04 .01 30.69
Peru 2014 424.12 0.87 0.22 .09 44.14
Philippines 2012 174.01 2.62 0.40 .10 43.04
Rwanda 2013 82.57 34.84 10.6 4.46 50.44
Senegal 2011 95.98 16.64 4.84 2.16 40.29
Source: World Development Indicators

The Multidimensional Poverty Index (MPI)
• Identification of poverty status through a dual cutoff:
• First, cutoff levels within each dimension (analogous to falling
below a poverty line for example $1.25 per day for income
poverty);
• Second, cutoff in the number of dimensions in which a person
must be deprived (below a line) to be deemed
multidimensionally poor.
• MPI focuses on deprivations in health, education, and standard
of living; and each receives equal (that is one-third of the overall
total) weight.

MPI Indicators
• Health - two indicators with equal weight - whether any child has
died in the family, and whether any adult or child in the family is
malnourished –weighted equally (each counts as one-sixth toward
the maximum deprivation in the MPI)
• Education - two indicators with equal weight - whether no
household member completed 5 years of schooling, and whether
any school-aged child is out of school for grades 1 through 8 (each
counts one-sixth toward the MPI)
• Standard of Living, equal weight on 6 deprivations (each counts as
1/18 toward the maximum): lack of electricity; insufficiently safe
drinking water; inadequate sanitation; inadequate flooring;
unimproved cooking fuel; lack of more than one of 5 assets –
telephone, radio, TV, bicycle, and motorbike

Interaction of the deprivations?
• Building the index from household measures up to the
aggregate measure (rather than using already-aggregated
statistics), MPI approach takes account of multiplied or
interactive harm (complementarity) done when multiple
deprivations are experienced by the same individual or family
• The MPI approach assumes an individual’s lack of capability in
one area can only to a degree be made up by other capabilities
– capabilities are treated as substitutes up to a point but then as
complements

Computing the MPI
• The MPI for the country (or region or group) is then computed
• A convenient way to express the resulting value is H*A, i.e.,
• The product of the headcount ratio H (the percent of people
living in multidimensional poverty), and the average intensity of
deprivation A (the percent of weighted indicators for which poor
households are deprived on average)
• The adjusted headcount ratio HA is readily calculated
• HA satisfies some desirable properties. Important example -
• Dimensional monotonicity: If a person already identified as poor
becomes deprived in another indicator she is measured as even
poorer - not the case using a simple headcount ratio

Multidimensional poverty tells a different
story than income poverty
• The results showed that knowing income poverty is not enough if
our concern is with multidimensional poverty
• Multidimensionally, Bangladesh is substantially less poor - but
Pakistan substantially poorer - than would be predicted by income
poverty
• Ethiopia is far more multidimensionally poor, and Tanzania much
less so, than predicted by income poverty
• Most Latin American countries e.g. Brazil rank worse on
multidimensional poverty than on income poverty; but Colombia’s
income and MPI poverty ranks are about same

Multi-dimensional Poverty Index, Data from 2008–2015
Country Survey Year MIP Percent Poor Thousands Poor Poverty Intensity
Bangladesh 2014 0.196 41.3 65,648 47.4
Brazil 2014 0.021 5.3 10,908 40.6
Burundi 2010 0.454 80.8 7,642 56.2
Bolivia, Plurinational
State of 2008 0.089 20.5 1,963 43.7
Burkina Faso 2010 0.535 84.0 13,131 63.7
Cambodia 2014 0.146 33.0 5,061 44.3
Colombia 2010 0.022 5.4 2,472 40.9
Congo, Republic of 2011/12 0.181 39.7 1,702 45.7
Cote d'Ivoire 2011/12 0.310 58.7 12,397 52.8
Dominican Republic 2014 0.034 8.8 919 38.5
Egypt 2014 0.014 3.6 3,186 38.1
Ethiopia 2011 0.564 87.3 78,476 64.6
Ghana 2014 0.156 33.7 9,021 46.2
Guinea 2012 0.459 75.1 8,735 61.1
Haiti 2012 0.248 49.4 5,083 50.3
Honduras 2011/12 0.072 15.8 1,225 45.7
India 2005/06 0.283 53.7 624,593 42.9
Indonesia 2012 0.066 15.5 38,362 52.7
Kenya 2014 0.187 39.9 17,904 47.0
Lao People's
Democratic Republic 2011/12 0.174 34.1 2,209 50.9
Liberia 2013 0.374 71.2 3,059 52.5
Mali 2012/13 0.457 77.7 12,885 58.9
Mexico 2012 0.011 2.8 3,418 38.8
Madagascar 2008/09 0.357 66.9 13,707 53.3
Malawi 2013/14 0.265 56.0 9,350 47.4
Mozambique 2011 0.389 69.6 17,412 55.9
Nepal 2014 0.126 28.6 8,054 44.2
Nigeria 2013 0.303 53.2 92,023 56.8
Pakistan 2012/13 0.230 44.2 80,041 52.1
Peru 2012 0.043 10.5 3,167 41.0
Philippines 2013 0.052 11.0 10,745 47.3
Rwanda 2014/15 0.259 53.8 6,101 48.1
Senegal 2014 0.309 56.9 8,348 54.3
Sierra Leone 2013 0.464 81.0 5,005 57.3
South Africa 2012 0.044 11.1 5,865 39.5
Tanzania, United
Republic of 2010 0.332 65.6 29,927 50.7
Timor-Leste 2009/10 0.360 68.1 720 52.9
Uganda 2011 0.367 69.9 23,955 52.5
Viet Nam 2013/14 0.029 7.1 6,584 40.7
Yemen 2013 0.236 45.9 11,713 51.4

“Why Multidimensional Poverty?”

5.4
ECONOMIC CHARACTERISTICS OF
HIGH-POVERTY GROUPS

Economic Characteristics of High-Poverty Groups
• Rural poverty
• Women and poverty
• Ethnic minorities, indigenous populations, and poverty
• Disproportionately children

Poverty, Rural vs Urban - Percentage below poverty line
Region and Survey Year Rural Population Urban Population National Population
Country (%) (%) (%)
Sub-Saharan
Africa
Benin 2011 39.7 31.4 36.2
Burkina Faso 2014 47.5 13.7 40.1
Cameroon 2014 56.8 8.9 37.5
Malawi 2010 56.6 17.3 50.7
Tanzania 2011 33.3 15.5 28.2
Uganda 2012 22.4 9.6 19.5
Zambia 2010 77.9 27.5 60.5
Poverty:
Asia Rural
Bangladesh
India
2010
2011
25.2
25.7
21.3
13.7
31.5
21.9
vs
Indonesia 2014 14.2 8.3 11.3 Urban
Uzbekistan 2013 -- -- 14.1
Vietnam 2014 18.6 3.8 13.5
Latin America
Bolivia 2015 -- -- 38.6
Brazil 2014 -- -- 7.4
Dominican 2015 -- -- 32.4
Republic
Guatemala 2014 76.1 42.2 59.3
Honduras 2014 65.0 61.0 62.8
Mexico 2014 62.4 50.5 53.2
Peru 2015 -- -- 21.8

Table 5.6
Indigenous Poverty in Latin America
Sources: Data for the left side of the table from Psacharopoulos, George, and Patrinos, Harry A. (1994), ‘Indigenous people and poverty in Latin America,’ Finance and Development, 31: 41, used with
permission; data for the right side of the table from Gillette Hall and Harry A. Patrinos, eds., Indigenous Peoples, Poverty, and Human Development in Latin America, 1994–2004 (New York: Palgrave
Macmillan, 2006).

Policies and Programs
• Policy can:
‒ Reduce constraints on job creation, such as
building needed infrastructure,
‒ Ensure incentives do not hinder quality job
creation
‒ But reforming some laws – and even more so
norms – is more difficult
‒ Example: those discouraging women from working
‒ Programs for employment when jobs are scarce
can help, but need careful design and
implementation

5.5
GROWTH AND POVERTY

Poverty reduction may cause growth
• Inclusive growth can cause poverty reduction, directly and indirectly
• Less appreciated: Poverty reduction can cause growth and development, while
failure to address poverty can constrain prospects for development because:
• Although small, poverty income is part of total income
– Programs that raise productivity of poor directly even at small scale has
direct contribution to growth; but of course tiny increments because
incomes are so low; of course has an opportunity costs
• Poor health, nutrition, and education lowers economic productivity of people
in poverty, leading directly and indirectly to slower growth
• Often, the poor lack access to credit, which constrains growth, e.g.:
– Lost opportunities for entrepreneurship which may benefit society
– Leaves them unable to finance their children’s education, also limiting the
skilled labor force needed for development
– Incentives for high fertility as a source of old-age financial security
• Higher income for the poor raises demand for locally produced goods
• Social exclusion/injustice, which is associated with poverty, also likely causes
economic stagnation:
Social exclusion/injustice, associated with
poverty, likely causes economic stagnation
• Social exclusion/injustice, which is associated with poverty, also likely
causes economic stagnation in the long run
– Political and social reform needed to overcome constraints to access
to land, water, basic resource based livelihood opportunities
– Elite control of natural resources translates to social and political
power to protect elite interests that may be inconsistent with
modernization
– Inadequate voice for the poor who know their public goods needs
– Other features of a broader social justice agenda which as many
have pointed out is also a foundation of economic efficiency
– The poor may be susceptible or coercible to participating in civil
conflict
– Among its other benefits improved social justice may positively
contribute to growth
5.6
POLICY OPTIONS AND ON INCOME
INEQUALITY AND POVERTY:
SOME BASIC CONSIDERATIONS

Policy Options on Income Inequality and
Poverty: Some Basic Considerations
• Areas of Intervention:
– Altering the functional distribution
– Mitigating the size distribution
– Moderating (reducing) the size distribution at upper levels
– Moderating (increasing) the size distribution at lower levels

Policy Options on Income Inequality and
Poverty: Some Basic Considerations (Cont.)
• Policy options
– Changing relative factor prices
– Progressive redistribution of asset ownership
– Progressive taxation
– Transfer payments and public provision of goods and
services
• A focus on workfare vs welfare programs

Workfare vs Welfare? Basic cost effectiveness
considerations
• Workfare, such as a Food for Work Program, are more likely to
represent a better policy than welfare on a current program
efficiency basis when these criteria are met:
1. It is harder to screen the poor without a workfare requirement
2. Poor workers have lower opportunity cost of time (so the economy
loses little output when they work in the program)
3. Non-poor workers have higher opportunity cost of time (so they
are unlikely to participate to get the benefits)
4. The fraction of the population living in poverty is smaller (so the
extra costs of a universal welfare scheme would be high)
Note: Each of the above are factors in the efficiency tradeoff:
– All these factors must be accounted for together to determine
whether welfare or workfare is comparatively more efficient

Workfare vs Welfare: Human Capital Factors
• Another significant factor in a workfare vs welfare choice is that the program
does not reduce incentives for the poor to acquire human capital
– Note: This factor is largely addressed to incentivize school age children to not see
future workfare participation as an alternative to putting high effort into school
and continuing their education; a program design response might be very high
work hour requirements for participation as a deterrent – but cannot be so high
that those who later need the program do not participate.
• This is also a social efficiency design consideration, that can save expenditures
when viewed across time
• An additional consideration could be the incentive for adults to build skills –
this might require a different approach to program design
• A requirement might be participation in work activities that also build relevant
skills, or devoting part of work time to training
• Final note: Another strategy is to add requirements for school attendance if
used over time; if necessary, consider providing schooling on workfare site

Workfare vs Welfare: Other Factors
• Other factors to take into account in a workfare vs
welfare choice
– There are greater net benefits of the program’s work output
– There is less social stigma of visible workfare participation, so
poor are not humiliated or deterred from needed work
(otherwise, a discreet welfare transfer may be preferable)
– Alternatives available for disabled or others prevented from
taking part in the program
– Which can better encourage farmers and microentrepreneurs
to take favorable business bets (a functioning safety net),
other factors considered?

Applying Insights from Behavioral Economics
to Address Poverty
• Research findings: “Cognitive Tax of Poverty”
• Impact of poverty on anxiety and mental illness
• Implications for program design

A Hidden “Cognitive Tax of Poverty”
• Cognitive challenges increase with stress
• For the poor, sources of stress include financial worries, persistent noise, air
pollution, disrupted sleep, chronic pain
• Stress and environment-linked deficits in cognitive functions include focused
internal and external attention, inhibitory control, cognitive flexibility, planning
• Example: farmers in India perform worse during financial stress before harvest
than after harvest – equivalent to about ten IQ points
• “Bandwidth” problem: Focus on urgent financial problems leaves less cognitive
capability for other activities that would help break out of poverty, such as
– preventive health care
– adherence to drug regimens
– promptness for appointments
– attentiveness to their children
– management of family finances
– general work productivity
• Result: more difficult for poor to take actions to improve their conditions
Implications for poverty program design
• “Choice architecture”: Cognitive dimension in programs to help the poor
• Cognitive burden research shows importance of assistance for improving
capabilities of people to make good decisions
• Priority of timing programs and activities for when cognitive load on the
poor is likely to be lower
• Make interviews required for assistance less threatening and challenging
• Simplifying application forms and helping people fill them out
• Clarifying and improving roles of counselors
• Better nutrition improves cognitive (and physical) functioning
• Importance of addressing high incidence of anxiety, depression, and
other mental illness among the poor
• More emphasis on early development, non-cognitive skills
• The importance of being reminded – both explicit (e.g. sending
SMS/texts), and implicit (e.g. where assistance is available)
Conclusion: The Need for a Package of Policies
• Policies to correct factor price distortions
• Policies to change the distribution of assets, power, and access to
education and associated employment opportunities
• Policies of progressive taxation and directed transfer payments
• Policies to build capabilities and human and social capital of the poor
• Effects of minimum wage laws are more nuanced than once thought
• Policies to address cognitive burden of poverty
• Some of the specific programs examined in later chapters:
• Conditional and unconditional cash transfers (Chapter 8)
• Agricultural extension (Chapter 9)
• Nutrition (Chapters 8, 9, and Chapter 11 case studies)
• Microfinance (Chapter 15, and Chapter 11 case studies)

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Economic Development

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

• Absolute poverty: The situation of being unable or

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

• Headcount Index: H/N

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

• Total poverty gap: The sum of the difference

- Where Yp is the absolute poverty line; and Yi the income

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

• Average poverty gap (APG):

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

– Where H is number of poor persons

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

– N is the number of persons, H is the number of poor persons,

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

• Dualistic Development and Shifting Lorenz Curves:

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

• Progress on Extreme Poverty

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

People living on less than $1.9

People living on less than $1.9

People living on less than $1.9

Copyright © 2020, 2015 Michael P. Todaro and Stephen C. Smith

Source: World Development Indicators