Chapter 5

Poverty,
Inequality, and
Development

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The Growth Controversy:
Seven Critical Questions
• What is the extent of relative inequality, and
how is this related to the extent of poverty?
• Who are the poor?
• Who benefits from economic growth?
• Does rapid growth necessarily cause
greater income inequality?
• Do the poor benefit from growth?

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The Growth Controversy:
Seven Critical Questions
• Are high levels of inequality always bad?
• What policies can reduce poverty?

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Measuring Inequality and
Poverty
• Personal distribution of income (size
distribution of income) The distribution of
income according to size class of persons—
for example, the share of total income
accruing to the poorest specific percentage
or the richest specific percentage of a
population— without regard to the sources
of that income.
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Measuring Inequality and
Poverty
• Measuring Inequality
– Size distributions (quintiles, deciles)

• Lorenz curve: A graph depicting the variance of the size

distribution of income from perfect equality.

• Gini Coefficient: It is measured graphically by dividing

• the area between the perfect equality line and the Lorenz curve by the total
area lying to the right of the equality line in a Lorenz diagram.

• Functional distributions: The distribution of income to

factors of production without regard to the ownership of the factors

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

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Kuznets Ratio:

• A common measure of income inequality that can be

derived from column 3 is the ratio of the incomes received
by the top 20% and bottom 40% of the population. This
ratio, sometimes called a Kuznets ratio after Nobel laureate
Simon Kuznets, has often been used as a measure of the
degree of inequality between high- and low-income groups
in a country

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Figure 5.1 The Lorenz Curve

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

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Figure 5.4 Four Possible Lorenz
Curves

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Figure 5.3 Estimating the Gini
Coefficient

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 Criterion for Measuring
Inequality

There are 4 criterions for inequality measurement:

1.Anonymity Principle
2.Population Principle
3.Relative Income Principle
4.The Dalton Principle
Anonymity Principle: simply means that our measure of inequality
should not depend on who has the higher income; for example, it should not
depend on whether we believe the rich or the poor to be good or bad people.
The Scale Independence Principle: The scale independence
principle means that our measure of inequality should not depend on the
size of the economy or the way we measure its income; for example, our
inequality measure should not depend on whether we measure income in
dollars or in cents or in rupees or rupiahs or for that matter on whether the
economy is rich on average or poor on average.
The population independence principle is somewhat similar; it states that
the measure of inequality should not be based on the number of income
recipients. For example, the economy of China should be considered no
more or less equal than the economy of Vietnam simply because China has
a larger population than Vietnam.
The Dalton Principle states that in an income distribution, a
regressive transfer will lead to increased inequality.
Figure 5.5 Functional Income
Distribution in a Market Economy: An
Illustration

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Measuring Inequality and
Poverty
• Measuring Absolute Poverty
– Headcount Index
– Total poverty gap

TPG  i 1 (Yp  Yi )
H

– Where Yp is the absolute poverty line

– Yi is income of person I

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Figure 5.6 Measuring the Total
Poverty Gap

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Measuring Inequality and
Poverty

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criteria for a desirable
poverty measure
• There are criteria for a desirable poverty
measure that are widely accepted by
development economists:
• 1-the anonymity
• 2-population independence
• 3- monotonicity
• 4-distributional sensitivity principles.

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• The role of anonymity as a criterion for a
desirable poverty measure indicates that the
measure should not depend on the identity or
characteristics of the individuals being
measured. In other words, a poverty measure
should be "anonymous" in the sense that it
treats all individuals or households in the same
way, regardless of their personal attributes, such
as age, gender, race, or any other characteristic.

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• 2. Our measure of the extent of poverty
should not depend on who is poor or on
whether the country has a large or small
population.
• 3. The monotonicity principle: means that if
you add income to someone below the
poverty line, all other incomes are held
constant,poverty can be no greater than it
was.
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• 4. The distributional sensitivity principle:
states that, other things being equal, if you
transfer income from a poor person to
a richer person, the resulting economy
should be deemed strictly poorer.

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• The headcount ratio measure satisfies
anonymity, population independence, and
monotonicity, but it fails on distributional
sensitivity. The simple headcount fails even
to satisfy the population independence
principle

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Measuring Inequality and
Poverty
• Measuring Absolute Poverty
– Foster-Greer-Thorbecke measure


1 H  Yp  Yi 
P 
N
 
i 1  Yp



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The P2 poverty measure /
squared poverty gap index
• It has become a standard of income
poverty measure used by the World Bank
and other agencies, and it is used in
empirical work on income poverty because
of its sensitivity to the depth and severity of
poverty.
• Mexico uses the P2 poverty measure to
allocate funds for education, health, and
welfare programs for the poor
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Multidimensional Poverty
Measurement
• Poverty cannot be adequately measured
with income alone, as Amartya Sen’s
capability framework.
• To fill this gap, Sabina Alkire and James
Foster have extended the FGT index to
multiple dimensions

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• In the multidimensional poverty approach, a
poor person is identified through what is
called the “dual cutoff method”:
• 1. first, the cutoff levels within each of the
dimensions (analogous to falling below a
poverty line such as $1.25 per day if income
poverty were being addressed).
• 2. second, the cutoff of the number of
dimensions in which a person must be
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Poverty, Inequality, and Social
Welfare
• What’s so bad about inequality?
– social welfare depends positively on the level of
income per capita but negatively on poverty and
negatively on the level of inequality.
• why should we be concerned with inequality
among those above the poverty line?

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• There are three major answers to this
question.
• First, extreme income inequality leads to
economic inefficiency
• The second reason to be concerned with
inequality above the poverty line is that
extreme income disparities undermine
social stability and solidarity.
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• Finally, extreme inequality is generally
viewed as unfair.

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Dualistic Development and
Shifting Lorenz Curves
• some stylized typologies
– Traditional sector enrichment (see Figure 5.7)
• Growth results in higher income, a more equal relative
distribution of income, and less poverty.
– Modern sector enrichment (see Figure 5.8)
• Growth results in higher incomes, a less equal relative
distribution of income, and no change in poverty.
– Modern sector enlargement (see Figure 5.9):absolute
• incomes rise and absolute poverty is reduced, but the Lorenz
curves will always cross, indicating that we cannot make any
unambiguous statement about changes in relative inequality

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Figure 5.7 Improved Income
Distribution under the Traditional-
Sector Enrichment Growth Typology

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Figure 5.8 Worsened Income
Distribution under the Modern-Sector
Enrichment Growth Typology

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Figure 5.9 Crossing Lorenz Curves in
the Modern-Sector Enlargement
Growth Typology

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Kuznets’ inverted-U
hypothesis:
• Simon Kuznets suggested that in the early
stages of economic growth, the distribution
of income will tend to worsen; only at later
stages will it improve

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Figure 5.10 The “Inverted-U”
Kuznets Curve

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Absolute Poverty: Extent and
Magnitude
• Extreme Poverty
– $1-a-day headcount shows some progress
– Incidence of extreme poverty is uneven

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Absolute Poverty: Extent and
Magnitude

• Growth and poverty :There are at least five

reasons why policies focused toward
reducing poverty levels need not lead to a
slower rate of growth—and indeed could
help to accelerate growth:
• First, widespread poverty creates conditions
in which the poor have no access to credit

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• Second: the rich in many contemporary
poor countries are generally not noted for
their frugality or for their desire to save and
invest substantial proportions of their
incomes in the local economy

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• Third, the low incomes and low levels of
living for the poor, which are manifested
• in poor health, nutrition, and education, can
lower their economic productivity and
thereby lead directly and indirectly to a
slower-growing economy.

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• Fourth, raising the income levels of the poor
will stimulate an overall increase in the
• demand for locally produced necessity
products like food and clothing

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• Fifth, a reduction of mass poverty can
stimulate healthy economic expansion by
• acting as a powerful material and
psychological incentive to widespread public
participation in the development process.

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Economic Characteristics of
Poverty Groups
• Rural Poverty
• Women and poverty (See chapter 8 for
more detail)
• Ethnic minorities, indigenous populations,
and poverty

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Table 5.6 Poverty: Rural versus
Urban

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Table 5.7 Indigenous Poverty in
Latin America

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The Range of Policy Options:
Some Basic Considerations
• Areas of intervention
– Altering the functional distribution
– Mitigating the size distribution
– Moderating (reducing) the size distribution at
upper levels
– Moderating (increasing) the size distribution at
lower levels

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The Range of Policy Options:
Some Basic Considerations

• Policy options
– Changing relative factor prices
– Progressive redistribution of asset ownership
– Progressive taxation
– Transfer payments and public provision of
goods and services

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Summary and Conclusions: The
Need for a Package of Policies
• Policies to correct factor price distortions
• Policies to change the distribution of assets,
power, and access to education and
associated employment opportunities
• Policies of progressive taxation and directed
transfer payments
• Policies designed to build capabilities and
human and social capital of the poor

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