Oppsummeringsdokument for econ217:

Poverty and vulnerability:

What does being poor mean? There are different approaches:
- Poverty is a atatement about people´s wellbeing (wellbeing meaning that a person
don´t have access to certain threshold of consumption, but can also include one´s
emotional and mental wellbeing).
- Poverty can also be tied to a spesicif types of consumption, like being foodpoor og
knowledge poor.
- Poverty can also be that pur living depends on whether we are capable of achieving
certain functionings ( access to adequate nutrition, good health, certain level of
ecucation etc) A general definition: An individual is poor if they do not have the
capability to obtain certain minimun levels of one or more of the functionings.
Definition: Poverty is the state of not having the financial resources available to afford basic
expenses such as food, housing, and clothing.

Vulnerability to poverty:
What does it mean that a person is vulnerbal to poverty?
To be vulnerable to poverty means that a person is likely to stay or fall into poverty in the
future with a high probability based o measures of observable charavteristivs and other
factors like how prone they are to various negative income shocks. This can be measured by
many different ways like future calorie consumption or future income. Mathematically we
do it with normal distribution, based on estimated expeteced future consumtion.
Chronically poor means if one is poor now and expected to remain poor in the future.
Consider the “dollar a day” poverty line (international poverty line for absolute poverty). A
chronic poor is someone whose long-term average income (“permanent income”) lies below
the poverty line. Chronic poor will typically have “low income generating capacity” Chronic
poverty is often referred to as “structural poverty”.
Being temporaraliy poor means: his/her income is below the poverty line now – but he/she
is expected to rise over the poverty line in the future. A temporarily poor (individual) will
have a long-term average income that is above the poverty line income. In poor countries,
temporary poverty is often caused by unforeseen (negative) income shocks due to, say, a
severe drought, or sudden illness of the major bread-winner in the family (- household
poverty).

Why do we study poverty?

A household’s current poverty status may not be a good indicator of the household’s
expected poverty in the future. Measures of vulnerability will allow us to formulate both ▪
ex-ante poverty policy – poverty prevention and ex-post poverty policy – poverty alleviation.

Ex- ante: Given adequate data, prior correlations between levels of consumption,
background characteristics and economic parameters, researchers are able to calculate the
probability that a person ś future income might fall below the poverty line. Why might this
be an advantage? • Using a vulnerability measure might help prevent poverty before it
appears, rather than trying to fix the problem after the fact. By identifying what causes
poverty, policy makers can fight the sources of poverty, instead of fighting poverty in itself.
This will be policy of poverty prevention. To help an individual not fall into poverty. • You
could argue that such ex-ante policies, if successful, could be more sustainable in the long
term, by preventing poverty and promoting growth. Could be introduction of drought
resistant seeds or investement in irrigation facilites. Generatres economic growth.

Ex-post: Ex post poverty measures (for example headcount index and poverty gap measures)
are only mediocre indicators on who will be poor in the future. Implementing policy to help
this group might not only be expensive and inefficient but might be done at the expense of
the persistent poor. Ex ante policy could be more efficient in that regard. Could be food- for
– work or emergency credit program.

Poverty traps:
If an individual is in a poverty trap, they can not escape poverty.

Health:

Health can be a potential source of poverty trap. The poor of this world are found to live in
unhygienic/unsanitary conditions. This will typically lead to sickness among workers, childern
ho miss school and mother who gives birth to sick babies. A lot of diseases, like malaria and
diarrhea are easily preventebal diseases – that´s why we call them low hanigg fruit.

A health trap story:

Ibu Emptat, wife of a basket weaver, had to borrow money from a local moneylender ($75)
when her husband fell ill and could not work. (The borrowed money was to cover medical
expenses and regular grocery bills). She could not meet the regular repayment obligations
due to husband’s income losses – this led to the outstanding loan getting larger with time.
(When the amount repaid in each period falls short of the required amount, the outstanding
loan becomes larger. This means that the required repayment for all future periods also
become larger). Ibu Emptat’s husband made gradual recovery, however, his capacity to work
and earnings did not fully recover. This meant that the family was gradually dragged into
even deeper poverty – from which the prospect of recovery remains extremely dim. - a
POVERTY TRAP!

A lot of the prevention against malaria or other diseases in poorer countries are described as
low hangig fruit because it is very easy to get ahold of.

If you invest in malaria prevention, you get benefits in terms of lower probability of
contracting the disease (private benefits). Your action also generates positive externalities on
others, i.e., if you are not infected then you cannot be the source of infection of others (social
benefits). If you start using a bed net, this will not only reduce your chance of getting
infected, but it will also contribute to reducing the chance of others getting infected.
Therefore, this is a positive externality; your actions have positive impacts not only on
yourself, but also on society.

Because of this, many economists argue that this makes it a case for subsidizes.

Even though the benefits of preventive measures against malaria are well known, many poor
have no willingness to pay for it. One’s willingness to pay or demand for a (durable) good
such as mosquito-nets will depend on how one evaluates the current and future benefits
(accruing to oneself) from using the good. Many experts (read textbook) have suggested that
the willingness to pay for bed-nets among people in general and the poor in particular (in
Africa) is only a fraction of the estimated benefits. Possible reasons for it can be that poor are
general too occupied with survival in the current period and less concerned about the future
Can also be because people do not wish to dwell on the possibility of their own future
misfortune, possiblility of falling ill in the future. That is, people in general tend to pay less
attention to the cost of future misfortune. From earlier discussion, we know that poor are
known to show little interest in preventive health measures, such as, paying for water
purification, buying bednets, etc. – they are more willing to spend on curative health care
once they fall ill

However, when a person du become ill it is then easier for one to evaluate the possible losses
from illness, that is, possible loss of income from missing work, etc. If, for example, the
principal breadwinner of the family falls ill, the consequences can be very serious (especially
among poor families) - whole family faces possibility of starvation. This may explain the high
demand for curative medical care.

A case for subsidizing?

Pro subsidizing: The poor often have a very low willingness to pay for bed nets. One can
therefore make a case for free or highly subsidized bed nets. If they are given for free, or have
a very low price, this might increase the number of people buying and using them. Jeffrey
Sachs argues that if you give out free bed nets for a period of time, people will learn the
benefits from using them. They may eventually be willing to pay for a bed net the next time
they need one. The figure above presents a (theoretical) case for why one should subsidize
bed-nets. In this question we are not asked to discuss empirical evidence, but I have provided
you with some pros and cons for you to understand the matter better and some additional
empirical findings�
Con subsidizing: William Easterly argues that we should charge full price for bed nets. There
are three effects that are particularly relevant: - Sunk costs: It does not matter how much you
have paid for an item when it comes to use. Your cost is already sunk. If you pay more for an
item, you might value the item more. - Selection effect: If you hand out things for free, people
who do not intend to use the item might get it. This is a waste of resources. - Entitlement
effect: If you get something for free today, you will expect to get it for free in the future as
well

To know how much to subsidize, we need to know:

- How price elastic is the demand for bednets?
- Will people use them if they get them for free?

The problem of the countrerfractial.

Risk means that an event or a decision has a several different outcomes, each with it´s own
probability. We often say that that poor peoples income is more risky

Institutions:
An institution is a costum or a tradition that has existed for a long time and is accepted as an
important part of a particular society. Can rrefer to mechanism which govern the behavoir of
a set of individuals with a given community. It is important to discuss institutions in poorer
countries, because bad institutions can provent good policies for poverty alleviation. Good
institutions, called inclusive institutions, are insitutions who:
- Inclusive economic institutions: defence of private property, contracts, and security.
State support for markets through the creation of public services and respect for free
competition. Access to education for all.
- Inclusive political institutions: rule of law and pluralism in participation in political
institutions.
Insitutions hyphothesis: claims that it is the manmade institutions and how we organize
society that explains discrepancies in wealth across the world. A country can be very wealthy
in terms of natural resources, but if the country is corrupt it doesn’t help because they will
ectract the profit and keep it for themselves.

Geography hypotheissi: claims that the clima and geographic location of a country
determines the technology and the incentives of workers in a society. IN other words, it is
the nature that decides the growth.

Which hypothesis is correct? If the geography determines a country´s income, then countries
that were rich before will be rich now. However, if institutions are more important, we will
observe changes in income when institutions change

Acemoglu used a natural experiment to determine which hypothesis is correct , used

historical data from European colonization powers they comperaed levels of wealth over
time. They found little corrulation bwtween being rich 500 years ago and rich today. Many of
the richest countries in the 1500s are among the poorest today – a lot because europeens
created extractive institutions for their own gain.

- The data from Acemoglu et. al suggest that colonies with good institutions prospered
while the ones with bad institutions declined.strong positive correlation between the
how well property rights are protected in 1985-95, (- quality of institutions -) and the
average wellbeing of the citizens (in 1995). This (finding) support the “institution
hypothesis”.
- Chart 2 shows the colonies that are highly urbanized (now) are also most prosperous
(now). WHY? ▪ In modern era, urbanization goes hand-in-hand with industrialization.
Highly industrialized countries are also more urbanized and richer that less urbanized
countries. ▪ In pre-industrial societies, urbanization was possible only if agriculture
was extremely productive and produced sufficient surplus to support urban population.
- a “reversal of fortune”. Another indicator of wellbeing in 1500 was population
density. Here, data from the old colonies show that countries (colonies) that were
highly densely populated (e.g., India, Bangladesh, Egypt, Ethiopia) and rich before
colonization (1500) have become poor, and colonies that were sparely populated and
poor then (Canada, Australia, USA) are now among the richest.
 Banerjee and Duflo argue in “Poor Economics” that good institutions are neither “sufficient”
(and in some cases) nor necessary for good governance outcome. What are these arguments?

However, Banerjee and Duflo argue that good institutions is not a guarantee for good
outcomes, and bad institutions is not a guarantee for the opposite. While reforming the
largeinstitutional systems often can be difficult and time consuming, small changes in
institutionson a smaller level can lead to big changes. Banerjee and Duflo introduce an
example from the electoral system in Brazil. Brazil used tohave a complex paper ballot.
Voters would have to be able to read and write to vote; they were presented with a long list of
names and would then have to write the name of the candidate they would like to vote for. In
Brazil, roughly 25% of adults are somewhat illiterate. Therefore, in the average election,
almost one fourth of the votes were not valid and therefore not counted. When electronic
voting was introduced in some municipalities inthe late 1990s, the voters were presented with
a picture of the candidate they had chosen before validating their choice. This led to an 11%
decrease in invalid votes in the municipalities with electronic voting systems. The increase in
valid votes mainly stemmed from the poor and less educated, and these in turn were then able
to vote for candidates withpolicies targeted at the poor. This small change in voting systems,
led to a larger proportionof the poor’s voices being heard, without changing the large
institutions in Brazil. Furthermore, this demonstrates that even though Brazil’s election was
democratic (a good institution), the election wasn’t implemented in the best possible way to
ensure representation. Hence, good institutions are not always enough to ensure good
outcomes.
Primacy of institutions -> withput good institutions policies are useless.

Corruption:

Lafont uses the principal agent framework to discuss how corruption arises. Think of
“primitive” village community in a poor country, with a benevolent chief or administrator.
The village chief performs following tasks (all by him/herself):  Monitors the behaviour of
the community members  Can punish bad behaviour of members  Can collect taxes in
order to provide the community with public goods/services, for example, roads, schools, etc.
As the village grows, the chief needs to delegate the tasks (she used to perform herself) to
others: Now, monitoring the behaviour of citizens is done by police, levying taxes is done by
tax collectors, and so forth.
The chief is the principal, and those who work on behalf of the chief are intermediaries, and
citizens are agents. Delegation of duties causes asymmetric information bwtween the chief
and the intermediaries. If the intermediaries observe bad behavoir by citizens, the chief does
not find out unless the intermediaries make an official report. This deligation creates
discetion, and this creaes slope for side contracting(bribe). ( se mer på dette)
A link between corruption and development:

Laffont argues that overall corruption in a society will increase with development, up until a
point where the level of development is so high that corruption starts to decrease, giving the
relationship the look of an ‘inverted U’. The figure below provides an illustration.
For very low levels of development, society is more primitive. Consider a small, poor village.
Transactions are few, and the community is transparent (everyone knows everyone). The
availability of bribable interactions is limited, and such activities are easily monitored by
those in charge. As society develops and becomes more complex, the number of transactions
increase. The separation between those governing and those governed is also increasing,
supplying the need for intermediaries. Those in charge cannot monitor everyone’s activity,
which gives access to corruptive behavior. With increasing development and complexity, we
therefore expect corruption to increase. What happens at X? Laffont argues that when a
society reaches a certain point in development the need to abate the corruption problem
emerges. When income is high enough, resources are available to fight corruptive behavior,
for example through well-established institutions like a court system. It may also become
apparent that in order to continue to grow, corruption must be limited as it can be thought of
as a barrier for growth. A major transformation to democracy may create opportunities
forcorruopton, as it takes time to know a new system and devise rules to control corruption.

Policies for fighting poverty:

Microcredit:

Does microcredit work?

1. Evidence based on survey data

o Two interview groups: a group of borrowers (treated group) and a group of non-borrowers
(control group)
o Researchers will compare the changes in the income/consumption expenditure of the two
groups after a year or two from the time the

treated group first received loans

o Researchers conclude that microcredit works if the treated group on average has a larger
(positive) change in income/consumption (statistically significant) than the control group.
o See slide 6 research by Khandker and Pitt (found that microcredit has a significant positive impact on the baseline indicators of wellbeing;
consumtion, schooling and health expenditure) § And critique: unobserved differences such as hidden talents

2. Evidence based on experimental data

o One of the aim for the experimental data method is to solve the problem that may be caused by “unobserved” differences between people (-
as in the survey data analysis)
o Research method (Randomized Control Trials, RCT)
   Researchers go to a village where no microfinance existed before and invite the poor
to apply for loans. The researchers will generate a score for each applicant based on
his background (sosio-economic and demographic information). The score will
indicate how deserving of a loan an applicant is. The researchers then decide on a cut-
off score; everyone above the cut-off is eligible for a loan.
 The researchers pick all applicants that scored just under, and then randomly offer half
of this group credit (the other half do not get an offer)àconsumption
expenditure/income of these two groups are compared after one/two years
 Have solved the problem of unobserved characteristics; group that was divided in two
was very similar, and then we did a random assignmentàno reason to think that
everyone with hidden talents would end up in one of the groups
• In the survey data method, the random assignment of credit is not possible. Because by the time of the survey, the subjects had
either taken a loan or they had not. Banerjee: Found that there is no evidence that people are over-borrowing and falling into debt
traps! People in the treated areas were more likely to start a business and more likely to buy durable goods, e.g., bicycle,
television, etc. than the control areas.

Banerjee also found that those who did not start new business were consuming more in the
treated area. However, those who started business were consuming less (cutting down
consumption of non-essential goods).

- One explanation is that the business owners wished to put more of their money into the
business.

Graduation program:
This program provides the targeted/selected poor with (i) productive assets, (ii) training and
support (mentoring), (iii) temporary cash/consumption support, (iv) access to savings
accounts, and (v) health information and services.
They select a target group, and a great deal of effort is given to selevting the poorest
households. A free transfer of a substantial amount of asset (equivalent of 10-12 sheep) to
each household participating in the program, for about a year. Saving are a core part of the
program, and are encouraged to save and are provided with a bank account. They are
mentored quite heavily, which surves the purpose of accountability (making sure that the
house holds are carrying out the important tasks required in running their businesses, and also
provide encouragement. Data from an evaluation of this program show two interesting
outcomes: Three years after joining the program, (i) the participants on average show a very
large increase in the amount saved; (ii) The participants on average have significantly
increased their borrowing activities with micro-credit institutions

Savings:
Big push effect. Typically, small/marginal help has no lasting effect on poor’s wellbeing. A
large assistance can help break the vicious circle (- assuming these poor were trapped in a
vicious circle) ❑ Transfer of a large productive asset means households have a source of non-
labour income. This provides insurance against future risk of starvation ❑ Data show that
there was significant improvements in self-reported happiness and reduction of mental stress
among the participants. ❑ Lower stress level certainly helps make better decision ❑ These
effects allow households to take a longer view of life. Recall our earlier discussion on savings.
It is much easier to fulfill one’s savings goals if one is more optimistic about the future.

Increased microcredit:
The ultra-poor are known to have limited sources of income. Typically, they do not won any
asset, such as milk-cows or egg-laying hens, with which to generate income, ( - read also
Lecture 9 for discussions on this). Should the ultra-poor households borrow from microcredit,
the funds for repayment must come from the income/profits of the businesses they start with
the borrowed money. Suppose, in a given period, the repayment is due but the business fails
to generate any income ( - note that all businesses are risky -). How will the poor repay? The
fear of not being able to repay (- default -) and the subsequent negative consequences of
default, is what deters many ultra-poor from participating in microcredit. For a less-poor
borrower, the occasional lack of income from the business project is not a problem when it
comes to meeting repayment obligation. He/she can always sell a few of her chickens in order
to repay. Ownership of an income generating asset means that the participating households
(i.e., those participating in Graduation Program) have now expanded their sources of income.
Having access to some non-labour income means that it will now be easier for a household to
meet repayment obligation should they borrow from microcredit. This could prompt these
households to become active in credit market

While the pilotrs show that the participants are significantly better off compared to their
situation before joining the pogram, there is no evidende that the program csan bring
people out of poverty. Critiques of the program:
- Involves a lot of administration

Cash transfers:
This essentially means that you give people cash (- a one time transfer -), and then leave them
alone. The program typically involves a one time transfer of a “large” amount of cash.
However, the transfers may also be given in a number of instalments over a short period of
time, e.g., a year. The goal is to help the poor invest in income generating activities. Sulaiman
et al. collected data on a large number of existing cash transfer programs – the transfers varied
between $84-$480.
Blattman et al. (2014) conducted an evaluation of a cash transfer program (- a one time
transfer of $382 per participant -) for poor unemployed youth in Uganda.  The program
included some skill training but no supervision. Participants had on average reached eighth
grade at school and earned just under $1 a day. The grant was meant as a start-up capital for
own business, self-employment activity. (Randomized assignment of grants, RCT)  The
treatment group after 4 years had 57% more business assets, 38% higher earnings and 17%
more hours worked.

It is thought to be a reduction of imidiate poverty.

Poor are at a disadvantage relative to the rich when partaking in regular economic activities –
it is more expensive for the poor! (Not a level playing field!!)  It costs poor more to borrow
money due to their low education, lack of assets as collateral, etc.  Risk-taking poses more of
a danger to the poor than the nonpoor. The cost of a failed project is much higher for the poor.
 A cash transfer can be looked upon as a compensation for the high opportunity costs of
participating in economic activities by the poor in everyday life

Cash tranfers as a policy for economic growth:

 1- Individual or household level – provides a form of insurance and the poor are more
willing to tinvest in modern farming techniqes, spend more time looking for good
jobs. Can also work as a start. Up capital for entrepreneurship
2- Lokcal – poor will typically spend a lot of money in the local shops, shich gives the
economy a bost
3- National level – higher demand for local goods will call for a higher procution.

Cash transfers and intergenerational poverty link

Empirical evidence suggests that children are main beneficiaries of cash transfers, irrespective
of the type of transfers.

Evidence suggests that cash transfers lead to:

  Improved nutrition
  Health standards (of family members and especially children) are raised better
nutrition, increased ability to visit clinics and having more money for medicine
 -  Education standards are raised because children are better fed and are sent to school.
Better nutrition can also lead to higher cognitive ability
à cash transfers as such can break the intergenerational poverty link and help
prevent future poverty