Poverty Lines

Michael Lokshin DECRG-PO The World Bank

Poverty Lines

1. The welfare ratio 2. The theoretical ideal 3. Practice: Objective poverty lines 4. Practice: Subjective poverty lines 5. Recommendations for practice 2 Poverty lines

1.

The welfare ratio

 Add up expenditure on all commodities consumed (with imputed values at local market prices) and  Deflate by a poverty line that might depend on household size, composition, and location/date) 3  The “real expenditure” or welfare ratio is:

Y i



j m

  1

P Q ij ij Z i

where

P ij

is a price paid for good

j

by household

i Q ij

is a quantity of good

j

consumed by household

i

Poverty lines



2. The theoretical ideal

Poverty line should be absolute in the space of welfare:  Two individuals with the same level of welfare are treated similarly  Poverty line should satisfy the weak Pareto principle that states that a welfare gain cannot increase poverty  The ideal poverty line is the minimum cost of achieving a reference level of welfare by a given household:

Z i



i

,

i

,

w

) 

P i

are the prices paid by a household

i

for goods 

X i

are household characteristics that could affect household’s welfare 4 

Z w

is is the reference level of utility Poverty lines

The theoretical ideal

Linear approximation of the expenditure function:

Z i



j m

  1

P ij

  

ij

, 

P ij i

,

w

)  

w



j m

  1

P Q ij ij

where

Q ij

is the consumption of good the reference welfare level

Z w j

that brings household

i

to 5 Poverty lines

Common issues in Practice

 Identification of consumer’s cost function from demand behavior  Are there goods that should be included in the consumption aggregate but not the poverty line (“qat” in Yemen?)  Identification of external effects (interdependence). Utility depends on own consumption and relative position.

 “Absolute” versus “relative” poverty? Is there really a difference? “Absolute” in the space of welfare can mean “relative” in the commodity space (Ravallion and Chen, 2009) 6 Poverty lines

Calibration of poverty lines to supplementary welfare data

 Imperfect welfare indicator

W i

for household

I

7  Examples:  Food share  Nutritional/Health status  Self-rated welfare ( Cantril’s scale)  Perceived consumption adequacy  Income

Y i

and other welfare-relevant characteristics Poverty line could be derived from estimating:

W i

 

Y i

 

X i

 

i

(   0) Poverty lines

8

“Absolute” vs. “relative” poverty?

 Welfare depends on relative income: 

W i



i i

,

Y i

)

M M

is mean income in a country. The reference level of utility:  

Z w



Z

)

M

Thus, the poverty line is absolute in welfare space, but is “relative” in the consumption space – the poverty line is a function of mean income:

Z

 , )

w

For a poverty line to be absolute in the space of welfare (that is yield

Z w

) the commodity-based poverty line

Z

rising. have to rise as

M

is Poverty lines

Poverty lines for different countries

9 Poverty lines

Poverty rates for different countries

10 Poverty lines

3. Practice: Objective Poverty Lines



Cost of Basic Needs

(CBN) method: • Poverty line is a cost of a bundle of goods deemed sufficient for basic needs.

• Food-share version of CBN : Poverty line is a cost of the food energy requirement 

Food-Energy Intake

(FEI) method: • Find expenditure or income at which food-energy requirements are met on average for each region/socio-economic group 11 Poverty lines

Problems to be aware of

 Defining “basic consumption needs”  Setting food energy requirements: problems with variability of activity levels; multiple equilibrium.

 Setting basic non-food consumption needs  Consistency in terms of welfare:  Is the same standards of living being treated the same way in different subgroups of the poverty profile?  Is the definition of welfare consistent with the definition of poverty? Should some goods purchased by the poor be included into the poverty bundle?

 How sensitive are the rankings in a poverty profile to these choices?

12 Poverty lines

Consistency of Poverty Lines

Rice Corn Vegetables Meat

% of calories from food

Urban 50 10 20 20 Rural 40 40 10 10 13  Two bundles yield same food energy intake, but the “urban” bundle is almost certainly preferable to the rural bundle  The standard of living at the urban poverty line is higher than at the rural line  These two poverty lines are inconsistent providing different welfare levels Poverty lines

Difference in the cost per capita

 Food Consumption and Cost of a calorie by quintile

Expenditure Quintile

3 4 Lowest 2 Highest

Percentage of expenditure on food

70 65 60 54 47

Calories per capita, per day

1,591 1,855 2,020 2,160 2,751

Cost per calorie

0.68

0.79

0.87

1.00

1.38

14 Poverty lines

Example 2: Food-energy intake Method

Different sub-groups attain food energy requirements at different standards of living, in terms of real consumption expenditures. 15 Poverty lines

Food intake, kcal/day

2100

16

Zr

Rural Urban Income

Allowing for differences in relative prices

 Ideally we only want to adjust the poverty bundle for differences in relative prices  The problem is how to implement this ideal in practice  The identification problem remains  Key thing: To control for welfare differences 17 Poverty lines

Allowing for differences in relative prices 1.

Parametric demand models

: If we know the parametric utility function then or we can figure it out from demand behavior then use this to determine the cost of the reference welfare level in each region

2.

  

Numerical methods

: Look at consumption behavior of poorest x% nationally in each region of the country Cost the consumption bundle of that group in each region Calculate the poverty rate nationally and iterate if the answer differs too far from x 18 Poverty lines

Methods of Setting Poverty Lines Do Matter!

Poverty Headcount %

Urban Rural Indonesia FEI method CBN method Tunisia FEI method CBN method 16.8

10.7

7.3

3.5

14.3

23.6

5.7

13.1

19 Poverty lines

20

“World Bank” Method: Cost per calorie HHID

1001 1001 1001 1002 1002 1002 1002 1002 1003 1003 1003

Food items

Milk Bread Meat Bread Butter Milk Sugar Potatoes Meat Beans Veg. Oil

Caloric content per 1 kg

100 200 600 200 1200 100 700 300 600 500 450

Quantity purchased (kg)

0.5

1.0

0.3

1.0

0.2

0.5

1.0

5.0

0.7

0.5

0.3

Total Price paid ($)

1.4

3.0

5.0

1.5

4.0

1.5

4.2

7.3

7.0

2.2

3.4

40.5

Caloric value 50 200 180 200 240 50 700 1500 420 250 135 3925 Cost per calorie $0.010

21

“World Bank” Method: Cost per calorie

HHID Food items Caloric content per 1 kg Quantity purchased (kg) Price paid ($) Caloric value Cost per calorie

1001 1001 1001 1002 1002 1002 1002 1002 1003 1003 1003 Milk Bread Meat Bread Butter Milk Sugar Potatoes Meat Beans Veg. Oil 100 200 600 200 1200 100 700 300 600 500 450 0.5

1.0

0.3

1.0

0.2

0.5

1.0

5.0

0.7

0.5

0.3

1.4

50

3.0

5.0

1.5

4.0

1.5

4.2

7.3

7.0

200 180 200 240 50 700 1500 420

2.2

3.4

250 135 Mean cost per calorie 0.022

0.007

0.016

$0.015

“World Bank” Method: Cost of a calorie

 Pick a nutrition requirement:  2100 Kcal per day (

NR

)  Select a group of households around the poverty line  Usually take 2 nd to 5 th deciles of expenditure distribution  Calculate the total spending of these households on food (

FS

).

 Calculate the total caloric content of these purchases (

TC

)  Calculate the cost of a calorie for this group:

CC=FS/TC

 Calculate the cost of food poverty line as:

FPL = NR∙CC=NR∙FS/TC

22 Poverty lines

Estimating Cost per Calorie

Fourth decile Expected location of povery line Second decile 23 Poverty lines Households ranked by income/expenditure

24

Is the width of the band important? Case of dual prices

Price of a calorie/ goods Price(mean) 2.01

2.05

2.45

3.25

5

Supermarket

2 Z 1

Market Income

25

Is the width of the band important? Case of multiple prices

Price(mean) Price of a calorie/ goods 3.75

3.65

3.50

3.45

5

Supermarket Local store

2 Z 1

Street vendor Market Income

“World Bank” Method: Lower poverty line

 Adjust Food Poverty Line for non-food expenditures 

LPL:

Select a group of households whose

total expenditure

is equal (close) to Food Poverty Line  Estimate average share of non-food consumption

S L

consumption expenditure in their total  Calculate:

LPL = FPL/(1- S L )

 Example:

FPL = $50, S L =0.2 → LPL = $50/(1-0.2)=62.5

26 Poverty lines

“World Bank” Method: Upper poverty line



UPL:

Select a group of households whose equal to Food Poverty Line

food expenditure

is  Estimate average share of non-food consumption in their total consumption expenditure

S U

 Calculate:

UPL = FPL/(1- S U )

 Example:

FPL = $50, S u =0.35 → UPL = $50/(1-0.35)=76.9

27 Poverty lines

Non-food adjustment diagram

28 Poverty lines

Updating poverty lines over time

 Once poverty line is established, it is important to update it correctly for the new time period  It is incorrect to recalculate poverty lines every year: by doing that we would use relative poverty lines (similar to urban/rural example)  Two ways to go:  update old poverty line using new prices. That would answer the question: “How many people can afford the old basket now?”  update new poverty line using old prices. That would answer the question: “How many people could afford the new basket in the past?” 29 Poverty lines

4. Practice: Social Subjective Poverty Line Minimum Income Question

(MIQ): “What income do you consider to be absolutely minimal, in that you could make ends meet with less?” 30 Poverty lines

Practice: Social Subjective Poverty Line

 Latent individual welfare

W i W i

 :

Y i

  

X i

 

i

 Derive the Social Subjective poverty line as:

Z s

 1  

X

  In practice

W i

can be approximated as:  MIQ (OLS)  Consumption adequacy questions (Ordered Probit)  Economic ladder questions (Ordered Probit) 31 Poverty lines

Examples of subjective welfare questions for Jamaica and Nepal

 Respondents asked whether their food, housing and clothing expenditures were adequate for their family needs.

 The implied subjective poverty lines are robust to alternative methods of dealing with other components of expenditure  The aggregate poverty rates accord closely with the poverty rates based on poverty lines derived with CBN method.

 However, the geographic and demographic poverty profiles differ substantially from those based on “objective” poverty lines 32 Poverty lines

Poverty rates based on subjective and objective poverty lines:

33  self rated poverty lines are higher than official poverty lines  subjective poverty rates are also higher than the official (income) poverty rates Poverty lines

5. Recommendations

 The WB recommends using objective, absolute poverty lines in developing countries  Usually, several poverty lines are calculated. For example, Lower and Upper poverty lines in the WB method  Always conduct sensitivity analysis. Test the degree to which the results are sensitive to the choice of poverty lines. This can be done by repeating the calculations for different lines and comparing results 34 Poverty lines