POVERTY, INCOME INEQUALITY AND INCOME DISTRIBUTION AND MOBILITY

According to the World Bank;

“Poverty is hunger. Poverty is lack of shelter. Poverty is being sick and not being able to see a
doctor. Poverty is not having access to school and not knowing how to read. Poverty is not
having a job, is fear for the future, living one day at a time.

Poverty has many faces, changing from place to place and across time, and has been
described in many ways. Most often, poverty is a situation people want to escape. So
poverty is a call to action -- for the poor and the wealthy alike -- a call to change the world
so that many more may have enough to eat, adequate shelter, access to education and
health, protection from violence, and a voice in what happens in their communities.”

Poverty is a state or condition in which a person or community lacks the financial resources
and essentials for a minimum standard of living. Poverty means that the income level from
employment is so low that basic human needs can't be met. Poverty-stricken people and
families might go without proper housing, clean water, healthy food, and medical attention.

Consequences of Poverty

Access to good schools, healthcare, electricity, safe water, and other critical services remains
elusive for many and is often determined by socioeconomic status, gender, ethnicity, and
geography. For those able to move out of poverty, progress is often temporary. Economic
shocks, food insecurity, and climate change threaten their gains and may force them back
into poverty.

Poverty is a difficult cycle to break and often passed from one generation to the next. Typical
consequences of poverty include alcohol and substance abuse; less access to education;
poor housing and living conditions, and increased levels of disease. Heightened poverty is
likely to cause increased tensions in society, as inequality increases. These issues often
lead to rising crime rates in communities affected by poverty.

Poverty and Children

The impact that poverty has on children is substantial. Children who grow up in poverty typically
suffer from severe and frequent health problems while infants born into poverty have an
increased chance of low birth weight, which can lead to physical and mental disabilities. In
some impoverished countries, poverty-stricken infants rarely live beyond one year. Those
who live may have hearing and visions problems.

As a result, children in poverty tend to miss more school due to sickness and endure more
stress at home. Homelessness is particularly hard on children since they often have little to
 no access to healthcare and lack proper nutrition—which often results in frequent health
issues.

Battling Poverty

The United Nations and the World Bank are major advocates in reducing world poverty. The
World Bank has an ambitious target of eradicating poverty by 2030. Some of the actionable
plans to eliminate poverty include the following:

 Installing wells that provide access to clean drinking water

 Educating farmers on how to produce more food
 Constructing shelter for the poor
 Building schools to educate disadvantaged communities
 Providing enhanced access to better health care services by building medical clinics
and hospitals

For poverty to be eradicated as the World Bank has set out to do, communities, governments,
and corporations would need to collaborate to implement strategies that improve living
conditions for the world’s poor.

Theories of poverty

Classical and neoclassical

Classical traditions view individuals as largely responsible for their own destiny, choosing in
effect to become poor (e.g. by forming lone-parent families). The concept of ‘sub-cultures
of poverty’ implies that deficiencies may continue over time, owing for example to lack of
appropriate role models, and that state aid should be limited to changing individual
capabilities and attitudes (i.e. the laissez-faire tradition).

Neoclassical theories are more wide ranging and recognise reasons for poverty beyond
individuals’ control. These include lack of social as well as private assets; market failures
that exclude the poor from credit markets and cause certain adverse choices to be rational;
barriers to education; immigrant status; poor health and advanced age; and barriers to
employment for lone-parent families.

Looking at the classical and neoclassical approaches together, their main advantages reside
in the use of (quantifiable) monetary units to measure poverty and the readiness with which
policy prescriptions can be put into practice. They also highlight the influence of incentives
on individual behaviour as well as the relationship between productivity and income.
Criticism of these approaches highlights their overemphasis on the individual (without, for
instance, taking into account links with the community) and the focus on purely material
means to eradicate poverty.

Keynsian/Neoliberal

Even though the neoliberal school led by the new-Keynesians also adopts a money-centred,
individual stance towards poverty, the importance assigned to the functions of the
government allows for a greater focus on public goods and inequality. For instance, a more
equal income distribution can facilitate the participation of disadvantaged groups of society
in the type of activities that are deemed essential under broader notions of poverty. On the
other hand, new-Keynesians are in line with neoclassical economists in their belief that
overall growth in income is ultimately the most effective element in poverty removal.

Publicly provided capital (including education) has an important role to play, with physical and
human capital believed to be the foundation for economic prosperity. Unlike the classical
approach, unemployment, viewed as a major cause of poverty, is largely seen as
involuntary and in need of government intervention to combat it. Excessive inflation, high
sovereign debt and asset bubbles are other macroeconomic factors, besides weak
aggregate demand, believed to cause poverty.

Marxian/radical

By suggesting radical changes in the socio-economic system, Marxian economists and other
radical theorists highlight the possibility that economic growth alone may be insufficient to
lift poor people out of (relative) poverty, because those who belong to certain classes may
not reap any of the benefits of overall income growth. Similarly, by emphasising the concept
of class, it provides a shift in perspective, focusing on group (rather than individual)
characteristics, with individuals’ status considered dependent on the socio-economic
environment in which they live.

Nevertheless, adequacy of income remains a key factor. Within a capitalist system, alleviation
of poverty may require minimum wage laws, action to eliminate dual labour markets, and
antidiscrimination laws (seen as one of the most effective anti-poverty strategies). The
exploitation of the poor by the rich groups in society may also occur via the quality of the
environment; for example, the poor tend to suffer most from air pollution (normally
generated by the wealthier groups) given their residential location. A further contribution of
Marxian/radical economists is the sense that poverty is a moral as well as a technical issue.
This is often lacking in more mainstream economic frameworks, except when they (e.g.
Sen) integrate political theories of justice in their analytical framework.

Social exclusion and social capital

Another strand of the literature stresses the interrelation between social exclusion, social
capital and the occurrence of poverty and recognises the importance of the structural
characteristics of society and the situation of certain groups. Social exclusion and social
 capital theories are, among all the reviewed approaches, arguably the ones that focus most
on understanding the intrinsic processes that allow deprivation to arise and persist.
Nevertheless, the wide definition of poverty considered under these theories comes at the
cost of being less precisely defined and more challenging to quantify and address by policy.

Income Inequality

Income Inequality is the extent at which household income is unevenly distributed amongst
a population. In other words, it also refers to the gap in income between who can be considered
the rich of the population as opposed to the income of those who can be considered the poor
of a population.

Income inequality in the Philippines is the extent to which income, most commonly
measured by household or individual, is distributed in an uneven manner in the Philippines.
The difference of income between the rich and the poor could cause tension in society and
political instability

In fact, according to World Bank Country Director Motoo Konishi, the Philippines had become a
"rising tiger" in East Asia. However, at the same time, during the 2010-2011 fiscal year, the
increase in the wealth of the richest families in the Philippines, amounting to 47.39%, comprised
76.5% of the GDP increase for that year.[5] Thus, the benefits of this economic growth has not
yet trickled down to the poorer segments of the population, as seen with the malnutrition, and
poverty that continue to plague the country despite the fact that the economy seems to be
growing.

According to data gathered in 2009, the poorest 20% of the population only had a share of 4.45%
of the national income.This shows that the distribution of wealth is uneven in the Philippines for
the data shows that the poorest 20% earned 14,022 pesos while the richest 20% of 176,863
pesos.

Gini Index

The Gini coefficient is also known as Gini index or Gini Ratio. It measures the degree of inequality
in the distribution of family income in a country.[7] A Lorenz curve plots the cumulative
percentages of total income received against the cumulative number of recipients, starting with
the poorest individual or household. The Gini index measures the area between the Lorenz curve
and a hypothetical line of absolute equality, expressed as a percentage of the maximum area
under the line.[8] If income distribution were more nearly equal, the index would be lower or nearer
to zero; if income distribution were more unequal, the index would be higher or nearer to 100.
Zero indicates perfect equality, while 100 indicates perfect inequality.

Palma Ratio

The Palma ratio is an alternative measure of inequality based on the work of Gabriel Palma. It is
ratio of the top 10% of population’s share of gross national income (GNI), divided by the poorest
40% of the population’s share of GNI.[9] Palma suggests that distributional politics relates mainly
to the struggle between the rich and poor, and who the middle classes side with.[10]

The Palma ratio could be a good comparison to the Gini coefficient measurement, and could cater
the disadvantages of the commonly used Gini.

Income Mobility

Income mobility describes the ability of people to partake in socio-economic opportunities created
by economic growth.

In a policy note and a discussion paper released at the Philippine Institute for Development
Studies, we report on our independent work examining movements in the incomes and
expenditures of households surveyed by the PSA during the period 2003 to 2009.

An estimated 75.15% of the population in 2003 was non-poor, and, of which 66.88% remained
non-poor but 8.28% became poor in 2006.

In 2003, about a quarter (24.85%) of the population was poor, of which 16.95% remained poor
but 7.90% became non-poor in 2006. Thus, between 2003 and 2006, poverty inflows were
practically equal to outflows for the entire population. That is, the share of the population that was
non-poor and that became poor (8.28%) was practically equal to the share of the population that
was poor that became non-poor (7.90%).

Of an estimated 20.5 million poor persons in 2003, 6.5 million moved out of poverty, but 6.8 million
moved into poverty.

A recent study by Martinez et al. (2014) on the distribution of expenditures suggests that almost
half of the households experienced mobility in their expenditures from 2003 to 2009. About half
(51%) of households that started in extreme (expenditure) poverty in 2003 moved up the
expenditure ladder, but 77% of households that started non-poor moved down the expenditure
distribution.

In general, Filipinos have experienced income and expenditure movements. Another paper about
to be published by Martinez and his co-researchers found that approximately 11% of Filipino
households experienced slow expenditure movements, 31% experienced consistently upward
expenditure movements, 24% noted consistent downward expenditure movements, and 34%
observed highly fluctuating expenditures.

All these studies conclude that there is volatility in the income and expenditure distribution, and
that roughly the same number of households experienced upward and downward movements in
income or expenditure.
Consequently, while there is significant income mobility in the Philippines, there is a strong
offsetting force: for every household that experienced upward income mobility, there is
approximately one household that experienced downward income mobility.

There is also a strong offsetting force over time because a significant fraction of Filipinos
experienced income volatilities, with income growth being followed by income reductions (and
vice-versa). Together, these factors contribute to the lack of changes in poverty rates and income
inequality at the aggregate-level.

Policy Options

Every administration has had its own fagship anti-poverty program with different combinations of
these measures. Over 1965-1986, the Marcos administration had Presidential Decree (PD) 27,
Samahang Nayon, Masagana 99, feeding programs, and BLISS mass housing. The 1986-1992
Aquino administration had the Comprehensive Agrarian Reform Program (CARP), community-
based resource management, the National Livelihood Program (NLP), and Tulong sa Tao
Program. The 1992-1998 Ramos administration had the expansive Social Reform Agenda (SRA)
with the minimum basic needs (MBN) approach, prioritizing benefciaries of the country’s 20
poorest provinces. It was also during this time that local governments and civil society were more
aggressively brought in as avowed stakeholders.

The short-lived 1998-2001 Estrada administration’s fagship anti-poverty effort Current

Responses: Anti-Poverty Programs was the Lingap Para sa Mahirap (LINGAP), which aimed to
provide a broad package of interventions to the 100 poorest families in every city and province.
This was implemented by the National Anti-Poverty Commission (NAPC), created by the previous
Ramos government, and local governments.

The 2001-2010 Arroyo administration’s centrepiece effort was the Kapit-Bisig Laban sa
Kahirapan-Comprehensive Integrated Delivery of Social Services (KALAHI-CIDSS), for the
delivery of basic services with inclusive community-driven planning and budgeting, and the Self-
Employment Assistance-Kabuhayan (SEA-K).

The sponsored program for poor families under the health insurance program PhilHealth was also
greatly expanded to cover the 4.8 million poorest families nationwide. The 4Ps CCT program was
piloted in 2007 and formally started in 2008. The 2010- 2016 Aquino administration greatly
expanded the 4Ps to become its fagship anti-poverty program. The SEA-K was continued astride
the new Payapa at Masaganang Pamayanan Program (PAMANA), which focused on 218 largely
armed confict-affected municipalities in 43 provinces of the country.

Anti-poverty measures are commonly fragmented and dispersed. The fragmentation does not
stem merely from lack of coordination of projects in specifc areas or target groups, or lack of
coordination by agencies involved, nor even by being of such small scales that they do not overlap
with each other. The most important sense of their fragmentation is in their being disparate efforts
that are not anchored on a coherent overall macroeconomic strategy. Thus, fragmentation is
resolved most of all by ensuring that all the conventional anti-poverty measures support, advance,
and complement larger macroeconomic goals, aside from providing immediate welfare gains.

If anything, anti-poverty measures have been further undermined by increasingly being organized
along market-based lines. In recent decades, they have functioned only to mitigate the worst
impacts of economic backwardness and crisis, and, paradoxically, have had the effect of making
poverty-inducing policies more politically feasible.

Development plans

The government’s main economic policies cover foreign trade and investment, monetary and
fnancial, fscal, and various regulatory policies. These policies interact and cumulatively defne the
parameters of economic activity in the country. Government decisions shape the economy by
promoting certain activities more than others, and by determining how the benefts from
production, exchange, and distribution are allocated. The state is historically and currently the
foremost institution of economic governance, including in the era of neoliberal globalization where
it has operated to further the interests of capital

POPULATION

Population Growth Theories

Theory # 1. The Malthusian Theory of Population

The first population growth theory was published by Thomas Robert Malthus, an English cleric,
and scholar, in the year 1798 in his book titled, An Essay on the Principle of Population.

The Malthusian Theory of Population is a theory of exponential population growth and

arithmetic food supply growth.

In this theory, he believed that the population would be controlled to balance the food supply with
the population level through preventative and positive checks which would lead to the
Malthusian catastrophe.

He theorized that populations grew in geometric progression. A geometric progression is a

sequence of numbers where each term after the first is found by multiplying the previous one by
a fixed and a non-zero number called the common ratio.

He also stated that as arithmetic progression has a direct relationship with food production. An
arithmetic progression is a sequence of numbers such that the difference between the two
consecutive terms is constant.

From this theory it is believed that populations will grow faster than the supply of food and
this will lead to a shortage of food.
The imbalance between food supply and population growth in the form of natural disasters such
as floods and earthquakes and human-made actions such as wars and famines would be
corrected. Malthus also suggested using preventative measures which include family planning,
late marriages, and celibacy.

These checks would lead to the Malthusian catastrophe, which would bring the population level
back to a ‘sustainable level.’

Some Criticisms of the Malthusian Theory of Population

1. Population Growth

2. Food Production (Failed to foresee the Opening up of New Areas)

3. Neglected the Manpower Aspect in Population

4. Increase in Population the Result of declining Death Rate

5. Preventive Checks do not pertain to Moral Restraint

6. Positive Checks not due to Overpopulation

Theory # 2. The Optimum Theory of Population

Propounded by Edwin Cannan, The optimum theory of population was in his book Wealth
(1924) and popularized by Robbins, Dalton and Carr-Saunders.This theory does not establish
relationship between population growth and food supply but is concerned with the relation
between the size of population and production of wealth.

The optimum population is the ideal population which combined with the other available resources
or means of production of the country will yield the maximum returns or income per head.

The concept of optimum population defined differently by:

1. Robbins defines it as “the population which just makes the maximum returns possible is
the optimum population or the best possible population.”
2. Carr-Saunders defines it as “that population which produces maximum economic welfare”.
3. Dalton, “Optimum population is that which gives the maximum income per head.” If we
were to examine these views, we find that Dalton’s view is more scientific and realistic
which we follow.

This theory is based on the following assumptions:

1. The natural resources of a country are given at a point of time but they change over time.
2. There is no change in techniques of production.

3. The stock of capital remains constant.

4. The habits and tastes of the people do not change.

5. The ratio of working population to total population remains constant even with the growth of
population.

6. Working hours of labour do not change.

7. Modes of business organisation are constant.

Given these assumptions, the optimum population is that ideal size of population which provides
the maximum income per head. Any rise or diminution in the size of the population above or below
the optimum level will diminish income per head.

Given the stock of natural resources, the technique of production and the stock of capital in a
country, there is a definite size of population corresponding to the highest per capita income.
Other things being equal, any deviation from this optimum-sized population will lead to a reduction
in the per capita income.

If the increase in population is followed by the increase in per capita income, the country is under-
populated and it can afford to increase its population till it reaches the optimum level. On the
contrary, if the increase in population leads to diminution in per capita income, the country is over-
populated and needs a decline in population until the per capita income is maximized.

The optimum point for the country today, may not be the same for tomorrow if the stock of natural
resources increases and the optimum point will be higher than before. Thus, the optimum is not
a fixed but a movable point.

The optimum theory of population is superior to the Malthusian theory on the following
grounds:

(1) The Malthusian law is a general study of the population problem while The optimum theory is
superior to the Malthusian theory because it studies the population problem in relation to the
economic conditions of a particular country.

(2) Malthus had a narrow vision. Cannan, on the other hand, had a much wider outlook.

(3) The Malthusian theory is a static concept and The optimum theory is a dynamic one.

(4) The Malthusian doctrine is simply theoretical and is devoid of all practical considerations. On
the other hand the optimum theory is very practical.
(5) Malthus was so much obsessed by the fear of over-population. The optimum population theory
allays all such fears of the Malthusians by stressing the fact that increasing population increases
the labour force which helps raise the optimum expansion of the country’s natural resources.

(6) Malthus was essentially a pessimist.The optimum theory adopts an optimistic and realistic
attitude towards the problem of population.

Some Criticisms:

(1) No Evidence of Optimum Level

(2) Impossible To Measure Optimum Level

(3) Optimum Level Vague

(4) Neglects the Distributional Aspect of increase in Per Capita Income

(5) No Place in State Policies

(6) Does not explain Determinants of Population Growth

(7) The theory fails to explain the nature of an optimum path of population growth

(8) It does not explain how the optimum level once reached is maintained

Theory # 3. The Theory of Demographic Transition

The theory of demographic transition is based on the actual population trends of advanced
countries of the world. According to this theory, every country passes through four- or five
(debated)- stage different stages of population growth.

Stage 1

This stage has been called high population growth potential stage. It is characterised by high and
fluctuating birth and death rates which will almost neutralize each other. People mostly live in rural
areas and their main occupation is agriculture which is in the stage of backwardness. The tertiary
sector consisting of transport, commerce banking and insurance is underdeveloped.

All these factors are responsible for low income and poverty of the masses. Social beliefs and
customs play an important role in keeping birth rate high. Death rate is also high because of
primitive sanitation and absence of medical facilities. People live in dirty and unhealthy
surroundings.
As a result, they are disease ridden and the absence of proper medical care results in large
deaths. The mortality rate is highest among the poor. Thus, high birth rates and death rates remain
approximately equal over time so that a static equilibrium with zero population growth prevails.

Stage 2

It is called the stage of Population Explosion. In this stage the death rate is decreasing while the
birth rate remains constant at a high level. Agricultural and industrial productivity increases,
means of transport and communication develops. There is great mobility of labour. Education
expands. Income also increases. People get more and better quality of food products. Medical
and health facilities are expanded.

During the stage economic development is speeded up due to individual and government efforts.
Increased use of better technology, mechanization and urbanisation takes place. But there is no
substantial change in the men, attitude of the people and hence birth rate stays high i.e., economic
development has not yet started affecting the birth rate.

Due to the widening gap between the birth and death rates, population grows at an exceptionally
high rate and that is why it has been called the population explosion stage. This is an “Expanding”
stage in population development where population grows at an increasing rate, as shown in figure,
with the decline in death rate and no change in birth rate.

Stage 3

It is also characterised as a population stage because the population continues to grow at a fast
rate. In this stage, birth rate as compared to the death rate declines more rapidly. As a result,
population grows at a diminishing rate. This stage witnesses a fall in the birth rate while the death
rate stays constant because it has already declined to the lowest minimum. Birth rate declines
due to the impact of economic development, changed social attitudes and increased facilities for
family planning. Population continues to grow fast because death rate stops falling whereas birth
rate though declining but remains higher than death rate.

Stage 4

It is called the stage of stationary population. Birch rate and death rate are both at a low level and
they are again near balance. Birth rate is approximately equal to death rate and there is little
growth in population. It becomes more or less stationary at a low level.

Stage 5 (Debated)

Some scholars delineate a separate fifth stage of below-replacement fertility levels. Others
hypothesize a different stage five involving an increase in fertility. The United Nations Population
Fund (2008) categorizes nations as high-fertility, intermediate-fertility, or low-fertility. The United
Nations (UN) anticipates the population growth will triple between 2011 and 2100 in high-fertility
countries, which are currently concentrated in sub-Saharan Africa. For countries with intermediate
fertility rates (the United States, India, and Mexico all fall into this category), growth is expected
to be about 26 percent. And low-fertility countries like China, Australia, and most of Europe will
actually see population declines of approximately 20 percent.

Causes and Consequences of High Fertility Rate

The fertility rate of a society is a measure noting the number of children born. The fertility number
is generally lower than the fecundity number, which measures the potential number of children
that could be born to women of childbearing age. Sociologists measure fertility using the crude
birthrate (the number of live births per 1,000 people per year).

In the six decades since 1950, fertility has fallen substantially in developing countries. Even so,
high fertility—defined as five or more births per woman over the reproductive career—
characterizes 33 countries. High fertility poses health risks for children and their mothers, detracts
from human capital investment, slows economic growth, and exacerbates environmental threats.

In recent years demographic concerns have shifted increasingly to the consequences of fertility
decline, such as population aging, and to other demographic phenomena such as urbanization.
Although high fertility persists in some countries, based on global experience since 1950 there is
good reason to expect that these countries too will eventually experience substantial fertility
decline. But uncertainty remains as to how rapidly that decline will occur, what policies and
programs can accelerate decline, and whether fertility will fall to low levels (i.e., less than 2.5
births per woman) in all countries.

The high-fertility countries lag in many development indicators, as reflected for example in their
rate of progress toward achievement of the Millennium Development Goals (MDGs). These
countries have also received less development assistance for population and reproductive health
than countries more advanced in their transitions to lower fertility, and the assistance they did
receive increased only marginally from 1995 to 2007, a period during which commitments to both
health and HIV/AIDS rose substantially.

High fertility is defined as a total fertility rate (TFR) of 5.0 or higher. The TFR represents the
average lifetime births per woman implied by the age-specific fertility rates prevailing in one
historical period. There are micro- and macro-level demographic concomitants of a high TFR. At
the micro level, they include a relatively high incidence of births of order five and above, a
relatively high fraction of women experiencing pregnancies of order five and above, and a greater
likelihood of short inter-pregnancy intervals. At the macro level, the main demographic feature is
relatively rapid population growth rate (and corresponding rapid growth in the size of successive
birth cohorts). These micro- and macro-level demographic features have consequences that have
been identified in a large body of research.

Consequences/Implications of High Fertility

Child health: The risk of mortality in infancy and early childhood is greater for higher-order births
and closely spaced births, and when the mother is over age 40.
Maternal health: The risk of maternal mortality is greater at higher parities, and younger and older
ages. Moreover, fertility decline reduces the lifetime risk of maternal death simply by reducing the
average number of pregnancies each woman experiences.

Child schooling: Children from large families attain less schooling. And successively larger birth
cohorts—a feature of high fertility societies—detract from the quality of schooling by diluting the
expenditure per pupil. Economic growth: An exogenous drop in fertility raises productive output
in the long run. And the association between population growth and economic growth has become
more negative since the 1980s.

Demographic dividend: Fertility decline assists economic growth via favorable changes in the
age-structure—the “demographic dividend” of a larger concentration of the population in the
working ages, thereby increasing per capita productivity. The “demographic dividend” contributed
substantially to economic growth in East Asia and Latin America in the period since 1960.

Natural environment: High fertility (and the resulting population growth) is a direct and proximate
cause of looming shortages of fresh water in many countries. Population growth has also
contributed to global warming—the contribution may be as much as one-third—and fertility
reduction via expanded family planning services is among the more cost-effective strategies for
restraining global warming.

At the macro level, the impact of high fertility on other outcomes could be channeled through the
size of the population (implications for the natural environment), the rate of population growth
(implications for budgets), or the age distribution of the population (implications for economic
productivity). At the household and individual level, high fertility means not only a large number
of births by the end of most women’s reproductive careers, but also typically a high incidence of
pregnancies at young ages, of unplanned and unwanted pregnancies, and of closely-spaced
pregnancies, all of which can affect household and individual welfare.

Consequences for Health (Child and Maternal)

Children from higher-order births are known to be at greater risk of dying during infancy and early
childhood. One comparative analysis (Mahy 2003) of Demographic and Health Survey (DHS)
data examines risk of death during four intervals: neonatal (0–4 weeks), infant (0–1 year), early
childhood (1–4 years), and under-five (0–5 years). Birth orders 2 and 3 show the lowest rates. By
comparison, at orders 7+ neonatal mortality is 43 percent higher and early childhood mortality is
11 percent higher.

Maternal mortality is also more likely at higher pregnancy orders. Some of the best evidence
comes from the surveillance system data in Matlabthana, Bangladesh. These data reveal that
women with five or more pregnancies have a significantly higher risk of dying due to maternal
causes. Women at pregnancy orders five and six suffer roughly 50 percent higher mortality. This
differential persisted even as mortality declined from high levels in the 1970s to much lower levels
in the 2000s (Chen et al. 1974; DaVanzo et al. 2004).
There is a further, less noticed return from avoiding high fertility: since pregnancy is an absolute
requirement for maternal mortality, fewer pregnancies lowers the lifetime risk (Campbell and
Graham 2006). This is one reason why a recent modeling exercise for India concludes that family
planning would be the most effective intervention for reducing pregnancy-related mortality (Goldie
et al. 2010).

Consequences for Human Capital Investment

Child health is one critical human capital investment; the research summarized above suggests
that high fertility per se places children at higher health risk. The impact of high fertility on a second
critical human capital investment, formal schooling, is considered next. This topic is bedeviled by
the likely endogeneity of fertility decisions: under the quantity-quality trade-off model originally
articulated by Gary Becker, parents consciously decide to have fewer children in order to invest
more per child, with investment in schooling salient. Policy to lower fertility is as much an effort to
encourage reproductive-age couples to make this choice as it is an effort to reduce the prevalence
of large sibling-sets that are obstacles to the schooling of their members.

A large literature looks at the impact of fertility (number of siblings) on schooling outcomes in
developing countries (see thorough reviews in Lloyd 1994, Kelley 1996, Lloyd 2005). The
literature consists largely of multivariate analyses of household-level data. Most of these studies
find that children from large families attain less schooling, an outcome usually attributed to
resource dilution (i.e., less financial and time investment per child).

Consequences for Economic Growth

In general, there is a negative correlation between fertility and economic growth. This simple
correlation, however, cannot be regarded as revealing the true causal relationship between fertility
and economic growth. Economists now recognize that to assess the effect of fertility (and
concomitant population growth rates) on economic growth one must take account of the
population’s age structure. Three age-strata are distinguished: children (pre-working-age);
working-age adults; and the elderly. This categorization is applied to a stylized yet typical fertility
transition that unfolds in three phases. In Phase I, fertility is high, and therefore the population is
young (i.e., a relatively large fraction are children); where mortality has declined, this makes the
population even younger on average. In Phase II, fertility has begun to decline, resulting in
successively smaller birth cohorts and a bulge in the population in the working ages (due to high
fertility in the past). In Phase III, lower fertility has persisted for decades and the population
becomes markedly older (i.e., a relatively large fraction are elderly).

The notion of a “demographic dividend” follows from this typical historical pattern of fertility
transition. In fact, two “dividends” can be identified (Lee and Mason 2006). In Phase II there is
growth, sometimes rapid, in the fraction of the population that is working-age; or, equivalently,
there is a decline in the dependency ratio (the ratio of children and elderly to those of working-
age). Everything else being equal, this relatively excessive weighting of the working-age
population results in increased productivity per capita for the population as a whole and, therefore,
in increased economic growth (Bloom and Williamson 1998, Bloom et al. 2003, Lee and Mason
2006). (Whether output per worker also grows is less certain; see Kelley and Schmidt (2005).)
This phase ends when sustained lower fertility leads to a relatively smaller labor force and a return
to higher dependency ratios. The increased productivity per capita during this phase is the “first
dividend.” Note that this dividend cannot be realized without a decline from high fertility; formal
demographic models demonstrate that high fertility societies are necessarily characterized by
high youth dependency. Note also that the opportunity to take advantage of this dividend is
fleeting, although in some countries it may extend for as long as five decades; hence the term
“demographic window.”

A second dividend can be induced by the aging of the population if this age-structure change
generates an incentive to save. As the elderly become more numerous in relative terms and if
individuals recognize this demographic fact, confidence that adequate old-age support will be
provided by state or kin mechanisms may wane. This in turn generates an incentive for individuals
to accumulate assets that they may draw on once they retire from the labor force. The
consequence is higher savings rates, which, all else being equal, produce increased economic
growth. This is the “second dividend” (Bloom et al. 2003, Lee and Mason 2006). In contrast to the
first dividend, the second dividend is not a direct consequence of fertility decline and it can last
indefinitely.

Consequences for the Natural Environment

The research base is less conclusive regarding the impact high fertility has on the natural
environment than it is regarding the impact on economic growth. In part this reflects the relative
infancy of systematic research on this issue. In fact, this is a cluster of issues, since various
aspects of the natural environment, such as land, air, fresh water, biodiversity, and global
warming, must be distinguished. It is also clear that the effect of fertility and other demographic
factors on the natural environment is heavily conditioned by institutional factors such as land-
tenure regulations and agricultural practices and by consumption patterns, and that the effect
varies markedly across regions and even between localities. These are the conclusions from
many global and national studies, such as Heilig’s (1997) assessment of land-use change in
China. High fertility and population growth is an overarching factor whose effects on the natural
environment may be profound but difficult to calculate with precision.

Causes/Determinants of High Fertility

Vigorous scholarly investigation of the determinants of fertility in low-income settings extends

back to the 1960s, and this has produced a rich theoretical and empirical literature. For the
purpose of developing policies and programs to reduce fertility in the remaining high fertility
societies, one can reasonably protest that while the amount of knowledge about fertility
determinants is extensive it is undifferentiated. It is a challenge to distill a few key lessons from
this overwhelming body of research.

At issue is whether and when couples are prepared to exercise deliberate control over their
childbearing via fertility regulation behavior (contraception, induced abortion). This includes
limiting childbearing to a small number, that is, less than four children. Fertility regulation behavior
is posited as a direct function of two constructs, namely motivation to regulate and cost of
regulation.

Motivation to regulate in turn is determined by the demand for children (e.g. desired number of
children) in relation to the current supply of children; when the current supply matches or exceeds
the demand for children, there is motivation to take actions to avoid becoming pregnant. Note that
motivation is driven primarily by the demand for children but is also affected by biological factors,
themselves conditioned by social and cultural factors, and that these biological factors affect the
pace of childbearing (i.e. supply of children) once a woman becomes physically capable of
conceiving.

The more rapid the pace, the more likely a woman will at any given moment have a stock of
children that matches or exceeds her desired number. Age at first birth and inter-pregnancy
intervals (as determined by postpartum behaviors) are direct determinants of the supply of
children. Cost of regulation is broadly defined to include not only costs of accessing family
planning services (financial, time) but other social and psychic costs, including concern about
detrimental health side-effects due to contraceptive methods. Child survival rates can influence
the motivation to regulate by affecting both the stock of living children and the demand for children.

Economic and social factors bear on both the motivation to regulate fertility, primarily through the
demand for children, and the cost of regulation; the former has received far more attention in the
literature. Population policies may be intended to affect either the motivation to regulate, by
influencing the demand for children, or the cost of regulation, whereas family planning programs
are designed mainly to reduce the cost of regulation. At the same time, there has been a lively
debate about whether programs can also affect the demand for children (see Freedman 1997).

Determinants of High Fertility

High demand for children: The demand for children is high in most of the remaining high fertility
countries

(especially in Central and West Africa).

Unmet need for family planning: And yet many of the high fertility countries have moderate to high
levels of unmet need for family planning—the prevalence typically ranges from one-fifth to one-
third of married women.

Age at first union: Age at first union is relatively young in most high fertility societies (less than
age 20 on average). Several years delay would contribute to fertility decline, and it would have
other health and socioeconomic benefits.

Mortality: Improved child survival is perhaps the most powerful stimulant of fertility decline. In
contrast, increased mortality due to the HIV-pandemic is having minimal overall impact on rates
of fertility and population growth.

Education: Formal schooling is second only to mortality as a determinant of fertility.

Income: By contrast, income is a relatively weak predictor of fertility decline, net of mortality and
education. Poor economic performance is not in itself an obstacle to fertility decline.

Obstacles to contraception: Non-access obstacles (cultural, social, psychic) appear to be robust

in some settings but are not well quantified.

Family planning services: The evidence on access obstacles is less ambiguous: in diverse
settings expanded provision of family planning services has had an impact on fertility, typically
10%–25% net reduction in fertility.

Supply of Children

A fundamental direct determinant of the pace of childbearing after the onset of the biological
capacity to reproduce is the age at first birth, which in turn is typically heavily determined by the
age at entrance to a formal union. Contemporary high fertility countries are characterized by early
age at first union and a resulting early age at first birth.

More generally, it is usually assumed that substantial fertility decline does not come about due to
changes in the spacing of births—i.e., a lengthening of interbirth intervals—but, rather, will only
occur when there is widespread adoption of behaviors, usually contraception, intended to
terminate childbearing after a certain number of living children has been attained (Van De Walle
1992).

Timaeus and Moultrie (2008) have challenged this presumption, demonstrating in analysis of
survey data from South Africa that postponement of births has contributed substantially to the
country’s fertility decline. Whether the same could be replicated elsewhere in Africa is uncertain;
if this potential exists, it has direct implications for the formulation of population policy and
programs in the large number of high- fertility countries that are African.

Motivation: Mortality Change

The high fertility countries are characterized by relatively poor child survival. According to United
Nations estimates for the period 2000–2005, in two-thirds of these countries the infant mortality
rate exceeded 100 deaths per 1,000 births, a level observed in only one of the countries with a
TFR below 5.0.

At the individual level, a complex of biological and behavioral factors ties individual fertility to infant
and child mortality. Physiologically, the death of an infant affects subsequent fertility by leading to
a sudden termination of breastfeeding, triggering resumption of menses and ovulation, and
leaving the woman exposed to the risk of conceiving again.

Demand for Children: Economic and Social Determinants

A vast literature examines the effect on fertility of economic and social factors, from both a macro-
level and a micro-level perspective. The most prominent factors are income (e.g., GDP per
capita), urbanization, and educational attainment.
Fertility is almost always lower in urban as compared to rural areas. So too is the demand for
children (e.g., desired number of births) lower in urban areas. The urban-rural differential typically
persists with controls for confounding variables such as educational attainment. Urbanization
figures less prominently in empirical analyses of fertility decline, in part because generally it
changes far more gradually than fertility. Angeles (2010) estimates a significant net effect of
urbanization on fertility decline that is smaller in magnitude than the effects of mortality decline
and educational increase but larger in magnitude than the effect of income growth. With very few
exceptions, research in developing countries reveals an inverse relationship between the amount
of formal schooling and fertility.

Demand for Children: Current Patterns in High Fertility Countries

Scholars and policymakers examine fertility declines in the past for lessons that can be applied
to the remaining high-fertility societies. A key concept is unmet need for family planning. This
describes the condition of wanting to avoid pregnancy (temporarily or indefinitely) but not
practicing family planning. That is, the concept of unmet need juxtaposes reproductive desires
and behaviors; it is nonuse of contraception conditional on a desire to postpone or terminate
childbearing.

It follows that if decline in the demand for children is a requirement, then fertility decline in the
remaining high-fertility societies will be especially sensitive to changes in factors such as mortality,
schooling, and urbanization that are known to be strong correlates of fertility demand. The
inference is that these factors will be even more decisive for fertility decline in the remaining high-
fertility societies than they were for fertility declines in the past. But change in these factors is not
easily accomplished, and hence additional policy levers must be sought.

Costs of Fertility Regulation

Non-access obstacles to contraceptive use— the social and psychic factors that figure heavily in
anecdotal accounts of unmet need for contraception—are rarely investigated with rigor. Where
they have been given due consideration, they have been shown to explain a considerable portion
of the unexplained unmet need (see review in Casterline and Sinding 2000). Social barriers (e.g.,
husbands, in-laws) and fear of health side-effects predominate in some societies. At present there
is almost no systematic research on the non-access obstacles in the high fertility societies, but it
would be surprising if such obstacles are not of some significance.

Policy Options

The synopsis of the report presented above, and especially the review of the major determinants
of fertility (previous section), provides a framework for considering policy options. Over the years
a range of policy options for promoting fertility decline have been suggested, encompassing not
only family planning programs but also human capital investment (health, schooling) not to
mention interventions that would promote gender equity and empower women. Many of the
policies are desirable on multiple grounds and not only for their fertility consequences.
The underlying fertility determinant targeted by the policies varies. Some measures, such as
education, are directed at reducing the demand for children. Others, such as encouragement of
later start of childbearing, influence fertility by reducing exposure to the risk of conception. Finally,
family planning services are designed to address the costs of regulating fertility, and hence might
be expected first to reduce unwanted fertility. Judging from the cumulative experience of the past
five decades, effective implementation of any one of these measures can contribute to fertility
decline. However, the high-fertility countries that have been the focus of this review have tried
few if any of these interventions.

Family planning is one intervention many have tried, though often with indifferent commitment
and insufficient resources The most effective interventions will be those that are tailored to the
nature of the reproductive regime, in particular whether the demand for children is high or low and
whether or not there is substantial unmet need for family planning. One might conclude from the
evidence presented above that the first order of business in most of the high-fertility countries is
the implementation of policies that reduce the demand for children.

In such settings improved access to reproductive health services may be insufficient; instead
there must also be multisectoral interventions that will, among other outcomes, reduce the
demand for children. But effective interventions that are also affordable within current resource
constraints are difficult to identify. Substantial improvement in child survival and mass schooling
(with attendant labor force opportunity upon graduation) would probably drive down desired family
size, but collectively these are extremely expensive. Developing alternative, more affordable
policies to reduce the demand for children is of high priority, and no doubt will require some
imagination.

Most immediately, providing family planning services remains a relatively inexpensive and
targeted fertility reduction policy. While the demand for children is high in these countries, there
is also unmet need for family planning, as indicated by survey data and by the high incidence of
induced abortion in some countries. Addressing this unmet need is desirable on health grounds
and imperative if women and men are to have the ability to make voluntary and informed decisions
about fertility. Addressing the unmet need would also translate into fertility reduction –
demographic survey data indicate potential for small to modest reduction in most of the high
fertility countries. Whether the demand for children will be downwardly responsive to improved
capacity to exercise fertility control remains an untested possibility.

Information campaigns and population education that deliberately target high desired family size
could reinforce this possibility and are clearly mandated in this set of countries, and in fact are
already integral to most family planning programs. They might also accelerate fertility decline
where it is already underway. Explicit and visible political commitment at the highest level comes
with no financial cost and would reinforce the information and education messages. Together,
these efforts could set off a virtuous circle in which initial fertility limitation generates incentives
for further fertility limitation, thereby reducing the demand for children.

When this dynamic is operative, the public cost of effective fertility policy can fall dramatically.
This stands as the most promising scenario for the high fertility countries, and it begins with
relatively affordable investment in reproductive health services that address unmet need for family
planning while also improving maternal and child health.

Policy and programs must also be responsive to the marked inequalities in reproductive health
outcomes that are endemic in most of these countries. The demand for children is generally higher
among the poor, as noted in the literature review above. Unmet need is a more complicated
matter, because it is a function of both the demand for children and contraceptive behavior.

UNEMPLOYMENT AND INFLATION

Unemployment and its Impact

Unemployment, also referred to as joblessness, occurs when people are without work and are
actively seeking employment. During periods of recession, an economy usually experiences high
unemployment rates. There are many proposed causes, consequences, and solutions for
unemployment.

Types of Unemployment

● Classical: occurs when real wages for jobs are set above the market-clearing level. It
causes the number of job seekers to be higher than the number of vacancies.
● Cyclical: occurs when there is not enough aggregate demand in the economy to provide
jobs for everyone who wants to work. Demand for goods and services decreases, less
production is needed, and fewer workers are needed. Occurs when there is not enough
aggregate demand in the economy to provide jobs for everyone who wants to work. In an
economy, demand for most goods falls, less production is needed, and less workers are
needed. With cyclical unemployment, the number of unemployed workers is greater that
the number of job vacancies.
● Structural: one of the main types of unemployment within an economic system. It focuses
on the structural problems within an economy and inefficiencies in labor markets.
Structural unemployment occurs when a labor market is not able to provide jobs for
everyone who is seeking employment. There is a mismatch between the skills of the
unemployed workers and the skills needed for the jobs that are available. It is often
impacted by persistent cyclical unemployment. For example, when an economy
experiences long-term unemployment individuals become frustrated and their skills
become obsolete. As a result, when the economy recovers they may not fit the
requirements of new jobs due to their inactivity.
● Frictional: It is the time period between jobs when a worker is searching for or transitioning
from one job to another. Frictional unemployment is always present to some degree in an
economy. It occurs when there is a mismatch between the workers and jobs. The
mismatch can be related to skills, payment, work time, location, seasonal industries,
attitude, taste, and other factors. Frictional unemployment is influenced by voluntary
 decisions to work based on each individual’s valuation of their own work and how that
compares to current wage rates as well as the time and effort required to find a job..
● Hidden: the unemployment of potential workers that is not taken into account in official
unemployment statistics because of how the data is collected. For example, workers are
only considered unemployed if they are looking for work so those without jobs who have
stopped looking are no longer considered unemployed.
● Long-term: usually defined as unemployment lasting longer than one year.

Measuring Unemployment

Unemployment is calculated as a percentage by dividing the number of unemployed individuals

by the number of all individuals currently employed in the workforce. The final measurement is
called the rate of unemployment.

Effects of Unemployment

When unemployment rates are high and steady, there are negative impacts on the long-run
economic growth. Unemployment wastes resources, generates redistributive pressures and
distortions, increases poverty, limits labor mobility, and promotes social unrest and conflict. The
effects of unemployment can be broken down into three types:

● Individual: people who are unemployed cannot earn money to meet their financial
obligations. Unemployment can lead to homelessness, illness, and mental stress. It can
also cause underemployment where workers take on jobs that are below their skill level.
● Social: an economy that has high unemployment is not using all of its resources efficiently,
specifically labor. When individuals accept employment below their skill level the
economies efficiency is reduced further. Workers lose skills which causes a loss of human
capital.
● Socio-political: high unemployment rates can cause civil unrest in a country.

The Natural Unemployment Rate

The natural unemployment rate, sometimes called the structural unemployment rate, was
developed by Friedman and Phelps in the 1960s. It represents the hypothetical unemployment
rate that is consistent with aggregate production being at a long-run level. The natural rate of
unemployment is a combination of structural and frictional unemployment. It is present in an
efficient and expanding economy when labor and resource markets are at equilibrium. The natural
unemployment rate occurs within an economy when disturbances are not present.

Reducing Unemployment

There are two main strategies for reducing unemployment –

 ● Demand side policies to reduce demand-deficient unemployment (unemployment
caused by recession)
● Supply side policies to reduce structural unemployment / (the natural rate of
unemployment)

Demand side policies are critical when there is a recession and rise in cyclical unemployment.
(e.g. after 1991 recession and after 2008 recession)

1. Fiscal Policy

Fiscal policy can decrease unemployment by helping to increase aggregate demand and the rate
of economic growth. The government will need to pursue expansionary fiscal policy; this involves
cutting taxes and increasing government spending. Lower taxes increase disposable income (e.g.
VAT cut to 15% in 2008) and therefore help to increase consumption, leading to higher aggregate
demand (AD).

With an increase in AD, there will be an increase in Real GDP (as long as there is spare capacity
in the economy.) If firms produce more, there will be an increase in demand for workers and
therefore lower demand-deficient unemployment. Also, with higher aggregate demand and strong
economic growth, fewer firms will go bankrupt meaning fewer job losses.

Keynes was an active advocate of expansionary fiscal policy during a prolonged recession. He
argues that in a recession, resources (both capital and labour) are idle. Therefore the government
should intervene and create additional demand to reduce unemployment.

2. Monetary policy

Monetary policy would involve cutting interest rates. Lower rates decrease the cost of borrowing
and encourage people to spend and invest. This increases AD and should also help to increase
GDP and reduce demand deficient unemployment.

Also, lower interest rates will reduce the exchange rate and make exports more competitive.

In some cases, lower interest rates may be ineffective in boosting demand. In this case, Central
Banks may resort to Quantitative easing. This is an attempt to increase the money supply and
boost aggregate demand.

Supply side policies deal with more micro-economic issues. They don’t aim to boost overall
aggregate demand but seek to overcome imperfections in the labour market and reduce
unemployment caused by supply side factors. Supply side unemployment includes:

● Frictional
● Structural
● Classical (real wage)
1. Education and training.

The aim is to give the long-term unemployed new skills which enable them to find jobs in
developing industries, e.g. retrain unemployed steel workers to have basic I.T. skills which help
them find work in the service sector. – However, despite providing education and training
schemes, the unemployed may be unable or unwilling to learn new skills. At best it will take
several years to reduce unemployment.

2. Reduce the power of trades unions.

If unions can bargain for wages above the market clearing level, they will cause real wage
unemployment. In this case reducing the influence of trades unions (or reducing Minimum wages)
will help solve this real wage unemployment.

3. Employment subsidies.

Firms could be given tax breaks or subsidies for taking on long-term unemployed. This helps give
them new confidence and on the job training. However, it will be quite expensive, and it may
encourage firms to just replace current workers with the long-term unemployment to benefit from
the tax breaks.

4. Improve labour market flexibility.

It is argued that higher structural rates of unemployment in Europe is due to restrictive labour
markets which discourage firms from employing workers in the first place. For example, abolishing
maximum working weeks and making it easier to hire and fire workers may encourage more job
creation. However, increased labour market flexibility could cause a rise in temporary employment
and greater job insecurity.

5. Stricter benefit requirements.

Governments could take a more pro-active role in making the unemployed accept a job or risk
losing benefits. After a certain period, the government could guarantee a public sector job (e.g.
cleaning streets). This could significantly reduce unemployment. However, it may mean the
government end up employing thousands of people in unproductive tasks which is very
expensive. Also, if you make it difficult to claim benefits, you may reduce the claimant count, but
not the International Labour force survey. See: measures of unemployment

6. Improved geographical mobility.

Often unemployed is more concentrated in certain regions. To overcome this geographical

unemployment, the government could give tax breaks to firms who set up in depressed areas.
Alternatively, they can provide financial assistance to unemployed workers who move to areas
with high employment. (e.g. help with renting in London)
Inflation and its Impact

Inflation and unemployment are the two most talked-about words in the contemporary society.

These two are the big problems that plague all the economies.

Almost everyone is sure that he knows what inflation exactly is, but it remains a source of great
deal of confu-sion because it is difficult to define it unam-biguously.

1. Meaning of Inflation:

Inflation is often defined in terms of its supposed causes. Inflation exists when money supply
exceeds available goods and services. Or inflation is attributed to budget deficit financing. A deficit
budget may be financed by the additional money creation. But the situation of monetary expansion
or budget deficit may not cause price level to rise. Hence the difficulty of defining ‘inflation’.

Inflation may be defined as ‘a sustained upward trend in the general level of prices’ and not the
price of only one or two goods. G. Ackley defined inflation as ‘a persistent and appreciable rise in
the general level or aver­age of prices’. In other words, inflation is a state of rising prices, but not
high prices.

It is not high prices but rising price level that con-stitute inflation. It constitutes, thus, an over-all
increase in price level. It can, thus, be viewed as the devaluing of the worth of money. In other
words, inflation reduces the purchasing power of money. A unit of money now buys less. Inflation
can also be seen as a recurring phenomenon.

While measuring inflation, we take into ac-count a large number of goods and services used by
the people of a country and then cal-culate average increase in the prices of those goods and
services over a period of time. A small rise in prices or a sudden rise in prices is not inflation since
they may reflect the short term workings of the market.

It is to be pointed out here that inflation is a state of disequilib-rium when there occurs a sustained
rise in price level. It is inflation if the prices of most goods go up. Such rate of increases in prices
may be both slow and rapid. However, it is difficult to detect whether there is an upward trend in
prices and whether this trend is sus-tained. That is why inflation is difficult to define in an
unambiguous sense.

Let’s measure inflation rate. Suppose, in December 2007, the consumer price index was 193.6
and, in December 2008, it was 223.8. Thus, the inflation rate during the last one year was

223.8- 193.6/ 193.6 x 100 = 15.6

As inflation is a state of rising prices, de-flation may be defined as a state of falling prices but not
fall in prices. Deflation is, thus, the opposite of inflation, i.e., a rise in the value of money or
purchasing power of money. Disinflation is a slowing down of the rate of inflation.

2. Types of Inflation:

As the nature of inflation is not uniform in an economy for all the time, it is wise to distin-guish
between different types of inflation. Such analysis is useful to study the distribu-tional and other
effects of inflation as well as to recommend anti-inflationary policies. Infla-tion may be caused by
a variety of factors. Its intensity or pace may be different at different times. It may also be classified
in accordance with the reactions of the government toward inflation.

Thus, one may observe different types of inflation in the contemporary society:

A. On the Basis of Causes:

(i) Currency inflation:

This type of infla-tion is caused by the printing of cur-rency notes.

(ii) Credit inflation:

Being profit-making institutions, commercial banks sanction more loans and advances to the
public than what the economy needs. Such credit expansion leads to a rise in price level.

(iii) Deficit-induced inflation:

The budget of the government reflects a deficit when expenditure exceeds revenue. To meet this
gap, the government may ask the central bank to print additional money. Since pumping of
additional money is required to meet the budget deficit, any price rise may the be called the deficit-
induced inflation.

(iv) Demand-pull inflation:

An increase in aggregate demand over the available output leads to a rise in the price level. Such
inflation is called demand-pull in-flation (henceforth DPI). But why does aggregate demand rise?
Classical economists attribute this rise in aggre-gate demand to money supply. If the supply of
money in an economy ex-ceeds the available goods and services, DPI appears. It has been
described by Coulborn as a situation of “too much money chasing too few goods.”

Keynesians hold a different argu-ment. They argue that there can be an autonomous increase in
aggregate de-mand or spending, such as a rise in con-sumption demand or investment or
government spending or a tax cut or a net increase in exports (i.e., C + I + G + X – M) with no
increase in money sup-ply. This would prompt upward adjust-ment in price. Thus, DPI is caused
by monetary factors (classical adjustment) and non-monetary factors (Keynesian argument).
DPI can be explained in terms of Fig. 4.2, where we measure output on the horizontal axis and
price level on the vertical axis. In Range 1, total spending is too short of full employment out-put,
YF. There is little or no rise in the price level. As demand now rises, out-put will rise. The economy
enters Range 2, where output approaches towards full employment situation. Note that in this
region price level begins to rise. Ul-timately, the economy reaches full em-ployment situation, i.e.,
Range 3, where output does not rise but price level is pulled upward. This is demand-pull in-flation.
The essence of this type of in-flation is that “too much spending chas­ing too few goods.

Demand-Pull Inflation

(v) Cost-push inflation:

Inflation in an economy may arise from the overall increase in the cost of production. This type of
inflation is known as cost-push inflation (henceforth CPI). Cost of pro-duction may rise due to an
increase in the prices of raw materials, wages, etc. Often trade unions are blamed for wage rise
since wage rate is not completely market-determinded. Higher wage means high cost of
production. Prices of commodities are thereby increased.

A wage-price spiral comes into opera-tion. But, at the same time, firms are to be blamed also for
the price rise since they simply raise prices to expand their profit margins. Thus, we have two
im-portant variants of CPI wage-push in-flation and profit-push inflation.

Any-way, CPI stems from the leftward shift of the aggregate supply curve:

B. On the Basis of Speed or Intensity:

(i) Creeping or Mild Inflation:

If the speed of upward thrust in prices is slow but small then we have creeping inflation. What
speed of annual price rise is a creeping one has not been stated by the economists. To some, a
creeping or mild inflation is one when annual price rise varies between 2 p.c. and 3 p.c. If a rate
of price rise is kept at this level, it is con-sidered to be helpful for economic development. Others
argue that if annual price rise goes slightly beyond 3 p.c. mark, still then it is considered to be of
no danger.

(ii) Walking Inflation:

If the rate of annual price increase lies between 3 p.c. and 4 p.c., then we have a situation of
walking inflation. When mild inflation is allowed to fan out, walking inflation appears. These two
types of inflation may be described as ‘moderate inflation’.

Often, one-digit inflation rate is called ‘moder­ate inflation’ which is not only predict­able, but also
keep people’s faith on the monetary system of the country. Peoples’ confidence get lost once
moderately maintained rate of inflation goes out of control and the economy is then caught with
the galloping inflation.

(iii) Galloping and Hyperinflation:

Walking inflation may be converted into running inflation. Running inflation is danger-ous. If it is
not controlled, it may ulti-mately be converted to galloping or hyperinflation. It is an extreme form
of inflation when an economy gets shatter­ed.”Inflation in the double or triple digit range of 20,
100 or 200 p.c. a year is labelled “galloping inflation”.

(iv) Government’s Reaction to Inflation:

In-flationary situation may be open or suppressed. Because of anti-infla-tionary policies pursued

by the govern-ment, inflation may not be an embar-rassing one. For instance, increase in income
leads to an increase in con-sumption spending which pulls the price level up.

If the consumption spending is countered by the govern-ment via price control and rationing
device, the inflationary situation may be called a suppressed one. Once the government curbs
are lifted, the sup-pressed inflation becomes open infla-tion. Open inflation may then result in
hyperinflation.

3. Causes of Inflation:

Inflation is mainly caused by excess demand/ or decline in aggregate supply or output. Former
leads to a rightward shift of the aggregate demand curve while the latter causes aggregate supply
curve to shift left-ward. Former is called demand-pull inflation (DPI), and the latter is called cost-
push infla-tion (CPI). Before describing the factors, that lead to a rise in aggregate demand and
a de-cline in aggregate supply, we like to explain “demand-pull” and “cost-push” theories of
inflation.

(i) Demand-Pull Inflation Theory:

There are two theoretical approaches to the DPI—one is classical and other is the Keynesian.

According to classical economists or mon-etarists, inflation is caused by an increase in money

supply which leads to a rightward shift in negative sloping aggregate demand curve. Given a
situation of full employment, classi-cists maintained that a change in money supply brings about
an equiproportionate change in price level.

That is why monetarists argue that inflation is always and everywhere a monetary phenomenon.
Keynesians do not find any link between money supply and price level causing an upward shift in
aggregate demand.

According to Keynesians, aggregate demand may rise due to a rise in consumer demand or
investment demand or govern-ment expenditure or net exports or the com-bination of these four
components of aggreate demand. Given full employment, such in-crease in aggregate demand
leads to an up-ward pressure in prices. Such a situation is called DPI. This can be explained
graphically.

DPI: Shifts in AD Curve

Just like the price of a commodity, the level of prices is determined by the interaction of aggregate
demand and aggregate supply. In Fig. 4.3, aggregate demand curve is negative sloping while
aggregate supply curve before the full employment stage is positive sloping and becomes vertical
after the full employ-ment stage is reached. AD1 is the initial aggregate demand curve that
intersects the aggregate supply curve AS at point E1.

The price level, thus, determined is OP1. As ag-gregate demand curve shifts to AD2, price level
rises to OP2. Thus, an increase in aggre-gate demand at the full employment stage leads to an
increase in price level only, rather than the level of output. However, how much price level will
rise following an increase in aggregate demand depends on the slope of the AS curve.

(ii) Causes of Demand-Pull Inflation:

DPI originates in the monetary sector. Mon­etarists’ argument that “only money matters” is based
on the assumption that at or near full employment excessive money supply will in-crease
aggregate demand and will, thus, cause inflation.

An increase in nominal money supply shifts aggregate demand curve rightward. This enables
people to hold excess cash bal-ances. Spending of excess cash balances by them causes price
level to rise. Price level will continue to rise until aggregate demand equals aggregate supply.

Keynesians argue that inflation originates in the non-monetary sector or the real sector. Aggregate
demand may rise if there is an increase in consumption expenditure following a tax cut. There
may be an autonomous increase in business investment or government expendi-ture.
Government expenditure is inflationary if the needed money is procured by the gov-ernment by
printing additional money.

In brief, increase in aggregate demand i.e., in-crease in (C + I + G + X – M) causes price level to

rise. However, aggregate demand may rise following an increase in money supply gen-erated by
the printing of additional money (classical argument) which drives prices up-ward. Thus, money
plays a vital role. That is why Milton Friedman argues that inflation is always and everywhere a
monetary phenom-enon.

There are other reasons that may push ag-gregate demand and, hence, price level up-wards. For
instance, growth of population stimulates aggregate demand. Higher export earnings increase the
purchasing power of the exporting countries. Additional purchasing power means additional
aggregate demand. Purchasing power and, hence, aggregate de-mand may also go up if
government repays public debt.
Again, there is a tendency on the part of the holders of black money to spend more on
conspicuous consumption goods. Such tendency fuels inflationary fire. Thus, DPI is caused by a
variety of factors.

(iii) Cost-Push Inflation Theory:

In addition to aggregate demand, aggregate supply also generates inflationary process. As

inflation is caused by a leftward shift of the aggregate supply, we call it CPI. CPI is usu-ally
associated with non-monetary factors. CPI arises due to the increase in cost of produc-tion. Cost
of production may rise due to a rise in cost of raw materials or increase in wages.

However, wage increase may lead to an in-crease in productivity of workers. If this hap-pens,
then the AS curve will shift to the right- ward not leftward—direction. We assume here that
productivity does not change in spite of an increase in wages.

Such increases in costs are passed on to consumers by firms by rais-ing the prices of the
products. Rising wages lead to rising costs. Rising costs lead to rising prices. And, rising prices
again prompt trade unions to demand higher wages. Thus, an inflationary wage-price spiral starts.
This causes aggregate supply curve to shift leftward.

CPI Shifts in AS Curve

This can be demonstrated graphically where AS1 is the initial aggregate supply curve. Below the
full employment stage this AS curve is positive sloping and at full em-ployment stage it becomes
perfectly inelastic.

Intersection point (E1) of AD1 and AS1 curves determine the price level (OP1). Now there is a
leftward shift of aggregate supply curve to AS2. With no change in aggregate demand, this causes
price level to rise to OP2 and output to fall to OY2. With the reduction in output, employment in
the economy de-clines or unemployment rises. Further shift in AS curve to AS3 results in a higher
price level (OP3) and a lower volume of aggregate out-put (OY3). Thus, CPI may arise even
below the full employment (YF) stage.

(iv) Causes of Cost-Push Inflation:

It is the cost factors that pull the prices up-ward. One of the important causes of price rise is the
rise in price of raw materials. For in-stance, by an administrative order the govern-ment may hike
the price of petrol or diesel or freight rate. Firms buy these inputs now at a higher price. This leads
to an upward pres-sure on cost of production.

Not only this, CPI is often imported from outside the economy. Increase in the price of petrol by
OPEC com-pels the government to increase the price of petrol and diesel. These two important
raw materials are needed by every sector, espe-cially the transport sector. As a result, trans-port
costs go up resulting in higher general price level.
Again, CPI may be induced by wage-push inflation or profit-push inflation. Trade unions demand
higher money wages as a compen-sation against inflationary price rise. If in-crease in money
wages exceed labour produc-tivity, aggregate supply will shift upward and leftward. Firms often
exercise power by push-ing prices up independently of consumer de-mand to expand their profit
margins.

Fiscal policy changes, such as increase in tax rates also leads to an upward pressure in cost of
production. For instance, an overall in-crease in excise tax of mass consumption goods is
definitely inflationary. That is why govern-ment is then accused of causing inflation.

Finally, production setbacks may result in decreases in output. Natural disaster, gradual
exhaustion of natural resources, work stop-pages, electric power cuts, etc., may cause ag-gregate
output to decline. In the midst of this output reduction, artificial scarcity of any goods created by
traders and hoarders just simply ignite the situation.

Inefficiency, corruption, mismanagement of the economy may also be the other reasons. Thus,
inflation is caused by the interplay of various factors. A particular factor cannot be held responsible
for any inflationary price rise.

4. Effects of Inflation:

People’s desires are inconsistent. When they act as buyers they want prices of goods and
services to remain stable but as sellers they expect the prices of goods and services should go
up. Such a happy outcome may arise for some individuals; “but, when this happens, others will
be getting the worst of both worlds.”

When price level goes up, there is both a gainer and a loser. To evaluate the conse-quence of
inflation, one must identify the na-ture of inflation which may be anticipated and unanticipated. If
inflation is anticipated, peo-ple can adjust with the new situation and costs of inflation to the
society will be smaller.

In reality, people cannot predict accurately fu-ture events or people often make mistakes in
predicting the course of inflation. In other words, inflation may be unanticipated when people fail
to adjust completely. This creates various problems.

One can study the effects of unanticipated inflation under two broad head-ings:

(a) Effect on distribution of income and wealth; and

(b) Effect on economic growth.

(a) Effects of Inflation on Distribution of Income and Wealth:

During inflation, usu-ally people experience rise in incomes. But some people gain during inflation
at the ex-pense of others. Some individuals gain be-cause their money incomes rise more rapidly
than the prices and some lose because prices rise more rapidly than their incomes during inflation.
Thus, it redistributes income and wealth.

Though no conclusive evidence can be cited, it can be asserted that following catego-ries of
people are affected by inflation differ-ently:

(i) Creditors and debtors:

Borrowers gain and lenders lose during inflation because debts are fixed in rupee terms. When
debts are repaid their real value declines by the price level increase and, hence, creditors lose.
An individual may be interested in buying a house by taking loan of Rs. 7 lakh from an in-stitution
for 7 years.

The borrower now wel-comes inflation since he will have to pay less in real terms than when it
was borrowed. Lender, in the process, loses since the rate of interest payable remains unaltered
as per agree­ment. Because of inflation, the borrower is given ‘dear’ rupees, but pays back ‘cheap’
ru-pees. However, if in an inflation-ridden economy creditors chronically loose, it is wise not to
advance loans or to shut down business.

Never does it happen. Rather, the loan-giving institution makes adequate safeguard against the
erosion of real value. Above all, banks do not pay any interest on current account but charges
interest on loans.

(ii) Bond and debenture-holders:

In an economy, there are some people who live on interest income—they suffer most.
Bondhold-ers earn fixed interest income: These people suffer a reduction in real income when
prices rise. In other words, the value of one’s sav­ings decline if the interest rate falls short of
inflation rate. Similarly, beneficiaries from life insurance programmes are also hit badly by inflation
since real value of savings deterio-rate.

(iii) Investors:

People who put their money in shares during inflation are expected to gain since the possibility of
earning of business profit brightens. Higher profit induces own-ers of firm to distribute profit among
inves-tors or shareholders.

(iv) Salaried people and wage-earners:

Any-one earning a fixed income is damaged by in-flation. Sometimes, unionised worker

suc-ceeds in raising wage rates of white-collar workers as a compensation against price rise. But
wage rate changes with a long time lag. In other words, wage rate increases always lag behind
price increases. Naturally, inflation results in a reduction in real purchasing power of fixed income-
earners.
On the other hand, people earning flexible incomes may gain during inflation. The nominal
incomes of such people outstrip the general price rise. As a re-sult, real incomes of this income
group in-crease.

(v) Profit-earners, speculators and black marketers:

It is argued that profit-earners gain from inflation. Profit tends to rise during inflation. Seeing
inflation, businessmen raise the prices of their products. This results in a bigger profit. Profit
margin, however, may not be high when the rate of inflation climbs to a high level.

However, speculators dealing in business in essential commodities usually stand to gain by

inflation. Black marketers are also ben-efited by inflation.

Thus, there occurs a redistribution of in-come and wealth. It is said that rich becomes richer and
poor becomes poorer during infla-tion. However, no such hard and fast gener-alisation can be
made. It is clear that someone wins and someone loses during inflation.

These effects of inflation may persist if in-flation is unanticipated. However, the redistributive
burdens of inflation on income and wealth are most likely to be minimal if inflation is anticipated
by the people. With anticipated inflation, people can build up their strategies to cope with inflation.

If the annual rate of inflation in an economy is anticipated correctly people will try to protect them
against losses resulting from inflation. Workers will demand 10 p.c. wage increase if inflation is
expected to rise by 10 p.c.

Similarly, a percent-age of inflation premium will be demanded by creditors from debtors.

Business firms will also fix prices of their products in accordance with the anticipated price rise.
Now if the en­tire society “learn to live with inflation”, the redistributive effect of inflation will be
mini-mal.

However, it is difficult to anticipate prop-erly every episode of inflation. Further, even if it is

anticipated it cannot be perfect. In addi-tion, adjustment with the new expected infla-tionary
conditions may not be possible for all categories of people. Thus, adverse redistributive effects
are likely to occur.

Finally, anticipated inflation may also be costly to the society. If people’s expectation regarding
future price rise become stronger they will hold less liquid money. Mere hold-ing of cash balances
during inflation is unwise since its real value declines. That is why peo-ple use their money
balances in buying real estate, gold, jewellery, etc. Such investment is referred to as unproductive
investment. Thus, during inflation of anticipated variety, there occurs a diversion of resources
from priority to non-priority or unproductive sectors.

(b) Effect on Production and Economic Growth:

Inflation may or may not result in higher output. Below the full employment stage, inflation has a
favourable effect on production. In general, profit is a rising function of the price level. An
inflationary situation gives an incen-tive to businessmen to raise prices of their prod-ucts so as to
earn higher volume of profit. Ris-ing price and rising profit encourage firms to make larger
investments.

As a result, the multi-plier effect of investment will come into opera-tion resulting in a higher
national output. How-ever, such a favourable effect of inflation will be temporary if wages and
production costs rise very rapidly.

Further, inflationary situation may be as-sociated with the fall in output, particularly if inflation is
of the cost-push variety. Thus, there is no strict relationship between prices and output. An
increase in aggregate demand will increase both prices and output, but a supply shock will raise
prices and lower output.

Inflation may also lower down further pro-duction levels. It is commonly assumed that if
inflationary tendencies nurtured by experi-enced inflation persist in future, people will now save
less and consume more. Rising sav-ing propensities will result in lower further outputs.

One may also argue that inflation creates an air of uncertainty in the minds of business
community, particularly when the rate of in-flation fluctuates. In the midst of rising infla-tionary
trend, firms cannot accurately estimate their costs and revenues. That is, in a situa-tion of
unanticipated inflation, a great deal of risk element exists.

It is because of uncertainty of expected inflation, investors become reluc-tant to invest in their

business and to make long-term commitments. Under the circum-stance, business firms may be
deterred in in-vesting. This will adversely affect the growth performance of the economy.

However, slight dose of inflation is neces-sary for economic growth. Mild inflation has an
encouraging effect on national output. But it is difficult to make the price rise of a creep-ing variety.
High rate of inflation acts as a dis-incentive to long run economic growth. The way the
hyperinflation affects economic growth is summed up here. We know that hyper-inflation
discourages savings.

A fall in savings means a lower rate of capital forma-tion. A low rate of capital formation hinders
economic growth. Further, during excessive price rise, there occurs an increase in unpro-ductive
investment in real estate, gold, jewel-lery, etc. Above all, speculative businesses flourish during
inflation resulting in artificial scarcities and, hence, further rise in prices.

Again, following hyperinflation, export earn-ings decline resulting in a wide imbalances in the
balance of payment account. Often gallop­ing inflation results in a ‘flight’ of capital to foreign
countries since people lose confidence and faith over the monetary arrangements of the country,
thereby resulting in a scarcity of resources. Finally, real value of tax revenue also declines under
the impact of hyperinfla-tion. Government then experiences a shortfall in investible resources.

Thus economists and policymakers are unanimous regarding the dangers of high price rise. But
the consequence of hyperinfla-tion are disastrous. In the past, some of the world economies (e.g.,
Germany after the First World War (1914-1918), Latin American coun-tries in the 1980s) had been
greatly ravaged by hyperinflation.

The German inflation of 1920s was also catastrophic:

During 1922, the German price level went up 5,470 per cent. In 1923, the situation wors-ened;
the German price level rose 1,300,000,000 (1.3 billion) times. By October of 1923, the post-age
in the lightest letter sent from Germany to the United States was 200,000 marks. But-ter cost 1.5
million marks per pound, meat 2 million marks, a loaf of bread 200,000 marks, and an egg 60,000
marks! Prices increased so rapidly that waiters changed the prices on the menu several times
during the course of a lunch!! Sometimes, customers had to pay the double price listed on the
menu when they observed it first!!! A photograph of the period shows a German housewife starting
the fire in her kitchen stove with paper money and children playing with bundles of paper money
tied together into building blocks!

Currently (September 2008), Indian economy experienced an inflation rate of al-most 13 p.c.—an
unprecedented one over the last 16 or 17 years. However, an all-time record in price rise in India
was struck in 1974-75 when it rose more than 25 p.c. Anyway, peo-ple are ultimately harassed
by the high dose of inflation. That is why, it is said that ‘infla­tion is our public enemy number one.’
Rising inflation rate is a sign of failure on the part of the government.

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