ED: Income Distribution in the World purpose only.

Transcript ED: Income Distribution in the World purpose only.

ED 2013.6.11

ED: Income Distribution in the World

* Some parts of this note are summaries of the references for teaching purpose only.

Semester: Spring 2013 Time: Friday 9:00~12:00 am Class Room: No. 322 Professor: Yoo Soo Hong Office Hour: By appointment Mobile: 010-4001-8060 E-mail: [email protected]

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Nations of the World, Classified by GNI Per Capita

Source: Data from Atlas of Global Development. Collins Bartholomew, 2010.

The Basic Question Why are they so poor ?

”Colonial” / historical

explanations



Climate

  

Overpopulation Lack of motivation They are happy enough..

Barriers



Natural resources

 

Bad institutions, Law and order Wrong policies ”Radical” explanations

 

Exploitation dependence Constraints



Savings and capital

 

Forex Human capital Policy recommendations… Activities …

Classification of Economies by Region and Income, 2010

Classification of Economies by Region and Income, 2010 (continued)

Equity and Development

 Inequalities in income, in health, and in education outcomes have long been a stark fact of life in many developing countries.

When such inequalities in outcomes arise from unequal opportunities, there are both intrinsic and instrumental grounds for concern.

 Because inequalities in opportunity are often accompanied by profound differences in influence, power, and social status – whether at the level of individuals or groups – they have a tendency to persist. Because it leads to an inefficient use of resources and to less effective institutions, inequity is harmful to long-term development. There is a legitimate role for public action in the promotion of fairness and in the pursuit of equity. 7

Kuznets’ Inverted U-Curve Hypothesis (Between Inequality and Growth)

Equity level Traditional of income society distribution Early stage Interim stage Later stage Advanced (high income) economy Stage of economic development or per capita GNP

Kuznets (“Economic Growth and Income Inequality”, American Economic Review, 1955, Vol. 45, pp. 1-28) found empirical evidence that growth and income inequality were correlated through an inverted-U shape.

The ‘Kuznets’ curve



Inequality



Per capita GNP

Poverty across countries

Country (in order of increasing GNP per capita) Bangladesh Kenya Sri Lanka Indonesia Philippines Jamaica Paraguay Costa Rica Malaysia Brazil % of Population below $1 a day 29.1

26.5

6.6

7.7

14.6

3.2

19.5

6.9

<2 9.0

Inequality across countries

Country (in order of increasing GNP per capita) Bangladesh Kenya Sri Lanka Indonesia Philippines Jamaica Paraguay Costa Rica Malaysia Brazil United States The Poorest 40% get … % of income 22.9

10.1

22.0

20.4

15.5

16.0

8.2

12.8

12.9

8.2

16.1

Ratio of Highest 20% to lowest 20% 4.0

18.3

4.4

5.1

8.4

8.2

27.1

12.9

11.7

25.7

8.5

Poverty, Inequality, and GNP Per Capita

 There’s no simple relation between poverty/inequality and per capita income.

Inequality (high or low) seems to be very persistent; but it typically changes (up or down) when output per capita changes.

There might be a complicated relation, involving the interaction of many factors.

 Inequality is probably determined by history social cleavages, politics and government policies  Careful statistical/econometric analysis is necessary to identify the effect of each factor.

The Growth Controversy: 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/require greater income inequality?

- Do the poor benefit from growth?

- Are high levels of inequality always bad?

- What policies can reduce poverty?

 Inequality and poverty need to be defined carefully if we want to Compare countries to each other; Assess progress in fighting them; What kind of policies/incentives need to be designed.

What kinds of growth improve welfare?

What are the main things to be done?

Measuring Inequality and Poverty

 Measuring Inequality – Size distributions – Lorenz curves and Gini coefficients – Functional distributions  Size distributions – How much income does

household

X earn?

– Sort people according to income and put them in major groups.

– Ignore differences in the source of income (or capabilities, for example) – A quartile is a fourth (25%) of the population; a decile is a tenth; a quintile is a fifth.

 Lorenz curves – Arrange population according to the share of income they receive, from lowest to highest.

– Calculate

cumulative

percentages (the lowest 5%, the lowest 45%, etc.) – Plot the

cumulative

percentage of households against the

cumulative

percentage of the income they earn.

 The Gini coefficient is interesting because It’s anonymous: it doesn’t treat some people as better than others, it just reports their income.

It’s scale-independent: measuring income in dollars or in rupees doesn’t change it.

It’s population-independent: changing the amount of people but keeping income distribution constant doesn’t change it.

It follows the transfer principle: transferring income from a richer to a poorer person (without changing their order) improves it.

The coefficient of variation (stdev/mean) also follows these principles.

Measuring Inequality and Poverty

 Measuring Inequality Functional Distributions What is the income that goes to each kind of factor of production? That is, what is the labor share in income? What is the profit-rent-interest share in income?

Measuring Poverty

 Poverty is Lack of income Lack of drinking water Lack of access to health care Lack of protection against adverse shocks 18

Measuring Poverty

 Measuring Absolute Poverty - The Absolute Poverty Headcount H simply adds the number of people whose income is below an agreed upon poverty line.

The Headcount index H/N divides this number by the population.

The international poverty line is $1 a day, but adjustment to local conditions can lead to a different number.

Measuring the Poverty Gap

The “poverty gap” is different but H or H/N would be the same.

Measuring Poverty

 Measuring Absolute Poverty The Human Poverty Index (UNDP) • • • Deprivation of life (percentage whose life expectancy is below 40%) Deprivation of education (percentage of illiterate people) Deprivation of economic provisioning (percentage without access to health care and safe water plus percentage of underweight under-5 children) 21

Measuring Poverty

 Measuring Absolute Poverty – Is “$1 a day” too low?

– Is “$2 a day” too low?

 Lots of people live between “$1 a day” and “$2 a day”, and although there are fewer people below “$1 a day”, the proportion of people living under “$2 a day” hasn’t fallen much.

Measuring Poverty

 Measuring Absolute Poverty • – How about “$15 a day” as the standard to say that someone is poor?

If “$15 a day” makes your poor in the US, why should you be non-poor if you make “$10 a day” in Zambia?

• – How about using income rather than consumption, and national accounts rather than surveys?

The number of poor people seem to be much fewer.

50 40 30 20 10 0 0 100 90 World In c ome Distribu tion , ＰＰＰ , 1 9 9 0 an d 2 0 0 3

World income distribution, PPP, 1990 and 2003

80 70 60 C hina India C hina 20 40 India 2003 Gini = 0.533

60 1990 Gini = 0.587

80 100 24

Gini Coefficients, East Asia, 1961-2005 0.55

0.50

0.45

0.40

0.35

0.30

Thailand Philippines Singapore Malaysia CHINA Vietnam Indonesia S. Korea 0.25

1955 1960 1965 1970 1975 1980 1985 1990

Stodder: Financial Transition

1995 2000 2005 2010

Country China Cambodia Vietnam Laos Ukraine Lithuania Estonia Belarus Russia Romania Bulgaria Slovakia Hungary Czech Rep.

Poland Growth 2000-05 9.6

8.9

7.5

6.2

8.0

7.8

7.5

6.2

5.8

5.0

4.9

4.1

3.5

3.2

Gini Coef.

44.0

40.0

36.1

37.0

31.0

32.5

33.0

30.4

40.5

28.8

31.6

25.8

26.9

27.3

34.1

Stodder : Financial Transition

Two Transitions on Income Distribution

 East-Asian:  Growth and Equality  Inversely Correlated  East-European:  No Clear Pattern 26

Characteristics of the Developing World: Diversity with in Commonality

1 . Lower levels of living and productivity 2 . Lower levels of human capital (health, education, skills) 3 . Higher Levels of Inequality and Absolute Poverty – Absolute Poverty – World Poverty 4 . Higher Population Growth Rates – Crude Birth rates 5 . Greater Social Fractionalization 6 . Larger Rural Populations but Rapid Rural-to-Urban Migration

7 . Lower Levels of Industrialization and Manufactured Exports 8 . Adverse Geography – Resource endowments 9 .Underdeveloped Financial and Other markets --Imperfect markets – Incomplete information 10 .Colonial Legacy and External Dependence – Institutions – Private property – Personal taxation – Taxes in cash rather than in kind

How Low-Income Countries Today Differ from Developed Countries in Their Earlier Stages

• Eight differences – Physical and human resource endowments – Per capita incomes and levels of GDP in relation to the rest of the world – Climate – Population size, distribution, and growth – Historic role of international migration – International trade benefits – Basic scientific/technological research and development capabilities – Efficacy of domestic institutions

Poverty Inequality Social

Welfare

 What’s so bad about inequality?

– Extreme income inequality leads to inefficiency.

 Lack of access to credit leads to underfinancing of good productive opportunities.

 Since the middle-class has the highest average and marginal saving rates, income inequality leads to lower saving and investment.

– Extreme income inequality leads to inefficient allocation of assets.

 Overemphasis on higher education to the detriment of basic education.

 Inefficiently large farms next to inefficiently small farms.

Poverty Inequality Social Welfare

 What’s so bad about inequality?

• – Extreme income inequality leads to political and social instability The poor try revolution while the rich try corruption and rent-seeking to retain power.

• – Most people think it’s unfair.

Rawls’s “veil of ignorance.” – A sense of unfairness lowers welfare .

Poverty Inequality

Social Welfare

 What’s so bad about inequality?

– St. Augustine on the Preferential Option for the Poor – God does not demand much of you. He asks back what he gave you, and from him you take what is enough for you. The superfluities of the rich are the necessities of the poor. When you possess superfluities, you possess what belongs to others. (Exposition on Psalm 147, 12).

Poverty Inequality

Social Welfare

 What’s so bad about inequality?

– CIC: 2444 "The Church's love for the poor . . . is a part of her constant tradition." This love is inspired by the Gospel of the Beatitudes, of the poverty of Jesus, and of his concern for the poor. Love for the poor is even one of the motives for the duty of working so as to "be able to give to those in need.” It extends not only to material poverty but also to the many forms of cultural and religious poverty.

Poverty Inequality Social Welfare

 So is inequality bad?

– Kuznets’s inverted-U hypothesis – Historically, he found that inequality falls and then rises as countries develop – The reasons may be complicated… – …and the validity of the hypothesis is an empirical question.

Poverty Inequality Social

Welfare

 Growth and inequality • – High overall growth may or may not be accompanied by improved income for the poorest 40%.

Low growth may or many not lead to low growth of the incomes of the poor.

– The poor almost always share in (some of) the benefits of growth.

– But whether growth leads to less inequality depends on who does the growing.

Absolute Poverty: Extent and Magnitude

 Poverty: some progress (1987-1998) – The share of people living under $1 a day fell in most regions of the world; remained the same in some; and only rose in the ex-communist countries.

– This is in spite of population growing from 5 billion to 6 billion, with pop. growth concentrated in poor countries.

Poverty in the Developing World Is Shifting toward South Asia and Sub-Saharan Africa

Absolute Poverty: Extent and Magnitude

 Growth and poverty – “Growth is bad for the poor. They are marginalized from modernization, so inequality rises and even absolute poverty may rise as jobs disappear.” – “Poverty/Inequality-reduction programs are bad for growth. Redistribution curtails incentive for saving and work.” – “The poor save a surprisingly large proportion of their income. And extra income for the poor is invested into better nutrition, education, health.”0 41

Absolute Poverty: Extent and Magnitude

 Growth and poverty – Growth comes from taking advantage of profitable opportunities. If the poor can’t invest because they don’t have access to credit, fewer profitable opportunities will be taken. Then poverty/inequality-reduction is good for growth.

– Unlike the elites of the Industrial Revolution, today’s Third-World elites are not high savers and do not devote large resources to improving the productivity of their business concerns.

Absolute Poverty: Extent and Magnitude

 Growth and poverty – Poverty and destitution lead to unproductive workers.

– Higher incomes for the poor create a strong domestic market.

– Poverty/Inequality reduction generates support for development policies and programs.

Is Growth Good for the Poor?

No, if it’s Jobless - Is growth labor-intensive?

Ruthless - Does inequality worsen?

Voiceless Does democracy expand?

– Rootless • Are people able to retain their cultural identity?

– Futureless • Does growth squander resources for future generations?

Is Growth Good for the Poor?

 Yes, if it is accompanied by • • • – Expanded opportunity Are the losers compensated by the winners?

Is competition open and fair?

Are services (education, health, transportation, communication) good and reliable?

• – Macroeconomic stability Are the costs of stabilization worth the benefits?

– Specialization in the country’s comparative advantage 45

Growth and the Poor

 Higher average income levels are associated with higher income for the poor .

Growth and the Poor cont’d

 Higher average income growth is associated with higher income growth for the poor.

Global Inequality

 Measures – Unweighed • Lesotho and China get the same weight – Population-weighed • More populous nations get more weight, but people are assumed to have identical incomes.

– Global Household surveys.

Global Inequality

 Measures – Unweighed Global inequality has been getting worse: dominated by lots of countries in Sub-Saharan Africa and Latin America.

– Population-weighed Global inequality has been getting better: dominated by China, India, and East Asia – Global Household surveys Inequality seems worse because of US, China, and India.

Human Development Index

• Recent efforts have tried to come up with an indicator that summarizes several different “dimensions” of welfare • The most well-known example is the Human Development Index (HDI), developed by the United Nations Development Program (UNDP) • The HDI combines measures of income, education (enrollment ratio and literacy), and health (life expectancy), into a single measure • The HDI is a relative index: the value for each country is between 0 and 1; it conveys the relative position of a given country in the overall development schedule • For example, a country with income per capita equal to $9,000, life expectancy at birth equal to 71, adult literacy equal to 75%, and enrollment ratio equal to 98% would have an HDI equal to 78 • Countries are classified into different “development groups” according to the value of their HDI

Holistic Measures of Living Levels and Capabilities

• • • • • Health Life Expectancy Education HDI as a holistic measure of living levels • HDI can be calculated for groups and regions in a country – HDI varies among groups within countries – HDI varies across regions in a country – HDI varies between rural and urban areas

Commonality and Diversity: Some Basic Indicators

Human Development Disparities within Selected Countries

Human Development Disparities within Selected Countries (continued)

2009 Human Development Index for 24 Selected Countries (2007)

2009 Human Development Index Variations for Similar Incomes (2007)

Holistic Measures of Living Levels and Capabilities

•

The New Human Development Index

•

Introduced by UNDP in November 2010

Characteristics of the Developing World: Diversity within Commonality 1.

Lower levels of living and productivity

Lower levels of human capital (health, education, skills)

Higher Levels of Inequality and Absolute Poverty – Absolute Poverty – World Poverty

Higher Population Growth Rates – Crude Birth rates

Shares of Global Income, 2008

Number of People Living in Poverty by Region, 1981 – 2005

Within-Country Inequities

 Direct quantification of inequality of opportunity is difficult - one analysis of Brazil provides an illustration. Earnings inequality in 1996 was divided into one share attributable to four predetermined circumstances that lie beyond the control of individuals earnings between workers.

—race, region of birth, parental education, and paternal occupation at birth, and a residual share. These four circumstances account for around one-quarter of overall differences in  Other determinants of opportunity are equally predetermined at birth, for example, gender, family wealth, or the quality of primary schools. Because such variables are not included in the inequality “decomposition,” the results here can be seen as lower-bound estimates of inequality of opportunity in Brazil.

 Unfortunately, predetermined circumstances determine much more than just future earnings. Education and health are of intrinsic value and affect the capacity of individuals to engage in economic, social, and political life.  Yet children face substantially different opportunities to learn and to lead healthy lives in almost all populations, depending on asset ownership, geographic location, or parental education, among others. E.g. how access to a basic package of immunization services differs for the rich and the poor across countries (figure 1).

Source:

World Development Report 2006

There is substantial inequality in access between, for example, Egypt, where almost everyone is covered (on the left), and Chad, where more than 40 percent some countries as they are across all nations in the sample.

Within-Country Inequities (Cont.)

 Inequalities of opportunity are transmitted across generations. The children of poorer and lower-status parents face inferior chances in education, health, incomes, and status. This starts early. - In Ecuador, three-year-old children have similar test scores for vocabulary recognition and are close to a standard international reference population. But by the time they are five, all have faltered relative to the international reference group, except for those in the richest groups and with the highest levels of parental education (figure 2).

Income Distribution

• •  Income represents a FLOW Income per week, month, year, etc.

Income can be in the form of: – Wages – Rents – Dividends – Interest – Pensions – Benefit payments – Income from self employment – Inheritance   Income can be earned income (from employment, etc.) or Unearned income – inheritance, benefit payments, pensions, etc.

Employment and Income Distribution

– Fundamentally the problem of the “underdeveloped” countries is not merely that of low or unequal distribution of final incomes but also that of unequal participation in the process of economic activity. – Although unemployment is not the only source of poverty, providing more productive employment would considerably alleviate poverty. – The measurement of unemployment, and its low-income, low-productivity counterpart underemployment, provides a detailed view of some of the most pressing problems of poor countries. – Their emphasis on wage employment and neglect of self-employment and unpaid family employment reflects their origins in developed countries.

– Redistribution of human capital and land seems an especially appropriate policy for low-income countries. 64

Income Distribution

Redistribution of Income

Global Income Inequality (Between-Country Inequality)

Global income inequality has steadily increased over the long run until the onset of rapid economic growth in China and India in the 1980s (Figure 3).

Figure . A long-run diverging trend in income inequality begins to reverse because of growth in China and India Source:

World Development Report 2006

Importance of Equity for Development

 The interconnections and resilience of these inequalities imply that some groups have consistently inferior opportunities —economic, social, and political —than their fellow citizens.  Most people feel that such egregious disparities violate a sense of fairness, particularly when the individuals affected can do little about them. This is consistent with the teachings of much political philosophy and with the international system of human rights.

 Important as these intrinsic reasons are for caring about inequality of opportunities and unfair processes, the instrumental relationship between equity and development, with particular emphasis on two channels: the effects of unequal opportunities when markets are imperfect, and the consequences of inequity for the quality of institutions a society develops.

Importance of Equity for Development (Cont.)

 With imperfect markets, inequalities in power and wealth translate into unequal opportunities, leading to wasted productive potential and to an inefficient allocation of resources  Markets often work imperfectly in many countries, whether because of intrinsic failures —such as those associated with asymmetric information —or because of policy-imposed distortions. Microeconomic case studies suggest that an inefficient allocation of resources across productive alternatives is often associated with differences in wealth or status.

Importance of Equity for Development (Cont.)

 Economic and political inequalities are associated with impaired institutional development.

 The second channel through which inequity affects long-run processes of development is the shaping of economic and political institutions. - Institutions determine the incentives and constraints people face and provide the context in which markets function. - Different sets of institutions are the outcome of complex historical processes that reflect the interests and structure of political influence of different individuals and groups in a society.

- In this view, there will be social conflict over the institutions of society and incentives for people who control power to shape institutions in ways that benefit them.

Improving the Distribution of Opportunities

Wealth to us is not mere material, but an opportunity for achievement. -Thucydides, 460-400 B.C.     The main asset of most poor people is their human capital. Investing in the human capital of the poor is a powerful way to augment their assets, redress asset inequality, and reduce poverty. Access to good quality education is important in that it enhances people’s capabilities to generate income. This is not enough, however. To be more productive, they need to be able to combine their human capital with other productive assets, such as land and equity capital, and with job opportunities in an open market. For growth to have an impact on poverty, the assets of the poor, especially their human capital, need to be augmented and distributed more equitably. Yet inequality in education and health outcomes is staggeringly high, reflecting market failures and underinvestment in the human capital of the poor. Asset distribution represents the distribution of opportunities and is a precondition for individual productivity and income. While redistributing existing assets and incomes is politically difficult, building new assets such as human capital is widely accepted. 71

Potential Benefits of Education

 Education and good health improve people’s ability to shape their lives— strengthening their functioning in society and contributing to their welfare directly.  Educating women not only increases their income-earning capacity, but also improves their reproductive health, lowers infant and child mortality, and benefits both current and future generations. Investing in human capital is crucial for economic growth, poverty reduction, and environmental protection.  The benefits of investing in human capital are well known, but some of the linkages with other dimensions of development —security, social justice, and sustainability —are better understood today than they were 10 years ago.

Investing in people can protect workers and improve security —an important aspect of quality of life.

 Education and good health increase the poor’s ability to cope with changes in their environment. They allow them to switch jobs and provide some protection against economic downturns and financial crises 72

Potential Benefits of Education (Cont.)

 Investment in human capital, if well distributed and targeted to the poor, can facilitate social inclusion.  Better education and health services to vulnerable, often excluded groups, such as those who are illiterate, disabled, elderly, chronically ill, or separated by language barriers, can help them overcome social obstacles and increase their productivity.

 Investing in people may also help protect the environment. With more education, people can assimilate more information and employ instruments to protect the environment and better manage resources.

 Better-educated women have healthier and, in many cases, fewer children, thereby reducing demographic pressure on natural resources and the environment. Investing in people improves human rights and social justice, which provides direct satisfaction.  Basic education enables the poor to learn about their civil and political rights; to exercise those rights by voting and running for office; and to voice their concerns, seek legal redress, and exercise public oversight. That helps in building institutions, improving governance, and fighting corruption.

Potential Benefits of Education (Cont.)

 These benefits are far from automatic. Many studies show that additional years of education per person increase real output or growth rates.  More government spending on education, if misallocated, might contribute little to poverty reduction and instead increase inequality and rent seeking.

Quantity is Not Enough – Quality Matters

 Since 1980, developing countries have invested substantial amounts of public resources in education services. In the 1990s, more than three quarters of school-age children in developing countries were enrolled in schools, up from less than half in the 1960s. Illiteracy rates dropped from 39 to 30 percent between 1985 and 1995.

 Progress has been uneven across regions. Enrollment rates fell in Sub Saharan Africa: the proportion of 6 –11 year olds enrolled in schools dropped from 59 percent in 1980 to 51 percent in 1992.  Lack of access to basic education remains a major challenge in many countries. Increasing public spending is desirable, but not sufficient for the following reasons.

Consequences of Poor Quality

 Low-quality schooling disproportionately hurts the poor and limits their future earning opportunities. In Latin America, most students from low-income families attend public schools, which offer half the hours of instruction and cover only half the curriculum compared with the private schools.  The higher the family’s income, the greater the aversion to public schools. Estimates based on household surveys from Latin America show that students from lower-income deciles received an inferior primary education.

Quality and Quantity: A Tradeoff?

 Improvements in quality complement the expansion of access to education. If poor children can go only to low-quality schools, they have few opportunities to obtain high-paying jobs and parents are disinclined to send them to school.  When education coverage is not universal, the best strategy is to focus on policy interventions that raise demand for both the quantity and the quality of education.

 However, with growing populations and tight budgets, the synergies of quantity and quality can turn into tradeoffs, especially if the quality measures 75 selected are not closely linked with student learning.

Causes of Inequality in Education

 Disparities in education is one of many aspects of poverty, but they are also associated with misallocation of public investment, war, wealth gaps, gender gaps, social exclusion, and economic crises.  Wealth Gaps  The education difference between the richest and poorest groups reached as high as 10 grades in India. Similar disparities in education attainment are found in Latin America.

Years of Schooling for 25-Year-Olds from Rich and Poor Households in Latin America  One implication of this large wealth gap is that demand for education is not independent of other endowments.  Providing access to education (supply) is not sufficient. Addressing many structural and social inequalities influencing demand, such as gender gaps and the distribution of other productive assets such as land (discussed later), is important as well.

Note: Numbers next to bars are the gaps(in years of schooling) between rich and poor. The surveys for Argentina include only Greater Buenos Aries. 76 Source: IDB (1998, p.27)

Causes of Inequality in Education (Cont.)

 Social Exclusion People who are excluded from mainstream society are less likely to be educated. Social exclusion changes human behavior and reduces the demand for schooling in inner cities of the United States. - One reason that students drop out of school is because their peers have dropped out. In Bolivia, the inability of parents to speak Spanish is associated with higher mortality rates for children under two years old. In India, members of scheduled castes have higher mortality rates than other groups.

 Gender Gaps The pattern of educational attainment is affected by gender as well as by other factors, such as income of the provinces, rural-urban differences in income, and family background. Though on the decline, gender discrimination persists in China’s rural areas.

 The correlation is strong between inequality in education and gender gaps in literacy.  While educational inequality declined, gender inequality accounted for much of the remaining disparities in educational attainment. Reducing gender 78 gaps in education is crucial to addressing the inequality in education.

Consequences of Unequal Education Outcomes

 A society cares about the unequal distribution of education because it directly affects human welfare. Unequal distribution of education is both a source and a consequence of poverty and social exclusion.

 Poor children who drop out of school eventually form a core of disadvantaged citizens who will be left out of mainstream economic and social life. Unless such people can obtain training later in life to find a meaningful job, poverty reduction and social inclusion will remain out of reach.

 Unlike land and physical capital, which are tradable across firms and individuals, education and skills are not perfectly tradable. As a consequence, both the distribution and level of education enter the production function and affect the level and growth of output.

 The distribution of education also holds strong implications for the poverty reducing impact of growth. The poverty reducing association of growth varied according to initial conditions: growth contributed less to poverty reduction in states with initially lower literacy rates, farm productivity, and rural standard of living relative to urban areas.

Improving the Efficacy of Public Spending

  Allocate More Public Spending to the Education of the Poor The composition of government expenditures on education and health influences human development outcomes. Public spending needs to concentrate on areas where market failure is pervasive and where positive spillover is largest: in primary and secondary schooling, especially for the poor.  Given limited public resources, the balance needs to shift more toward investments in primary and secondary education. Additionally, the private sector and public-private partnerships should be encouraged to provide higher education where market failure is minimal.

Improving the Efficacy of Public Spending (Cont.)

 Improve the Mix of Public and Private Spending - The most effective public-private mix depends on the extent of market failures and a variety of other factors. Higher education is crucial for technological progress and productivity growth, but it can be considered a private good, because most of the returns can be internalized by individuals and firms. Whereas primary and secondary education have large spillover effects that are not fully captured by individuals and firms. Thus while government has a direct role in primary and secondary education, it needs to encourage private investments and public-private partnerships in higher education.  Decentralize Decision-making and Encourage Participation - How decisions are made also affects the efficacy of public services. Where institutional capacity is low, public spending on centrally planned and organized interventions is likely to be ineffective. Many countries are moving to decentralized decision-making to better match expenditures to local needs.

In countries with corrupt and predatory governments, however, decentralizing decision-making may not be the answer. Empowering people to influence policy through democratization and a greater role for civil society, and encouraging 81 greater participation of the community and families are steps in the right direction.

Making Education More Productive

 Distribute Land more Equitably The poor are not just income poor; they also lack assets. In agrarian economies, disadvantaged households are usually landless or land poor. Income inequality also seems to be associated with inequality in landholding , although data on land ownership is weak.

 Land reform has many benefits for growth and poverty reduction. In societies where a large segment of the population does not have access to the productive resources of the economy, strong demand for redistribution gives rise to civil unrest.

The basic idea is that the state gives qualified, landless people a grant or a subsidized loan to buy land. This market-assisted approach differs from fully compensated land reform in two ways: there are neither explicit targets for land distribution nor fixed time schedules. In addition, the reforms are demand driven; people who want the land most will come forward to buy it.

 Some researchers contend that market-assisted land reform has advantages, especially if combined with microcredit, extension programs, and complementary actions that facilitate agricultural cooperatives and contract farming.

While it is still too soon to reach definitive conclusions on the costs and benefits of these reforms, some other studies have found that this approach benefits large elevated prices.

Making Education More Productive (Cont.)

 Distribute Equity Capital and Foster Competition  Privatization offers additional opportunities for redistributing equity. Because public enterprises were built using tax revenues, a certain proportion of the equity shares can justifiably be distributed or sold at a discount to taxpayers during privatization. Properly designed privatization programs can reduce asset inequality and poverty.

Privatization entails efficiency gains as well as social losses, and society must maintain a balance between the efficiency gains and social losses (and compensate the losers), if the gains are to be sustainable.

 To compensate those who suffer losses as a result of privatization, equity shares in lieu of severance pay could be distributed to laid-off workers, or other forms of income transfers could be financed by taxation.

- Competition and regulation are vital for a market economy. The efficiency of a market economy depends on both private property and competitive markets, but many developing and transition economies lack both. Before and during privatization, competition and a regulatory framework must be introduced 83



Making Education More Productive (Cont.)

Combine Human Capital with Opportunities in Open Markets - The impact of trade openness on long-term growth thus depends on how well people can absorb and use the information and technology accompanying trade and foreign investment.

Increases in the stock of human capital tend to accelerate growth during market reforms and under an outward-oriented economic structure, but in their absence, education has no significant impact on growth. The growth effect of an interaction between openness and education was robust.

 Protect Workers against Shocks The urban poor usually lack adequate human capital for all but unskilled work. With increased openness and globalization, job opportunities for unskilled workers have become more scarce and incomes more volatile.

The problem is exacerbated by labor market distortions and weak labor market institutions that further hamper labor market adjustments. Labor market distortions need to be checked: the existence of child labor and distorted wage structures discourage demand for education.  Governments need to help build labor market institutions and provide the labor market information that the poor need. 84

Leveling the Economic and Political Playing Fields

 An equity lens enhances the poverty reduction agenda. When societies become more equitable in ways that lead to greater opportunities for all, the poor stand to benefit from a “double dividend.” - First, expanded opportunities benefit the poor directly, through greater participation in the development process. - Second, the development process itself may become more successful and resilient as greater equity leads to better institutions, more effective conflict management, and a better use of all potential resources in society, including those of the poor. Resulting increases in economic growth rates in poor countries will, in turn, contribute to a reduction in global inequities. 85

Leveling the Economic and Political Playing Fields

 An equity lens adds three new – or at least often neglected – perspectives to development policymaking: - The best policies for poverty reduction could involve redistributions of influence, advantage, or subsidies away from dominant groups. While, such equity-enhancing redistributions (of power, or access to government spending and markets) can often be efficiency-increasing, possible tradeoffs need to be assessed in the design of policy. The dichotomy between policies for growth and policies specifically aimed at equity is false. 86

Leveling the Economic and Political Playing Field

  The role of public action in leveling the economic and political playing field under four main headings. Three of the headings concern domestic policies: investing in human capacities; expanding access to justice, land, and infrastructure; and promoting fairness in markets. The fourth turns to policies for greater global equity, in terms of access to markets, resource flows, and governance. The detailed, specific policy advice always needs to be developed at the country – or even subnational – level. Everything that is said below therefore retain some level of generality and should be interpreted accordingly, and cautiously. Human Capacities: Early childhood development, Schooling, Health, Risk Management Justice, land, and infrastructure: Building equitable justice systems, Toward greater equity in access to land, Providing infrastructure equitably Markets and the macroeconomic: Financial markets, Labor markets, Product markets, Macroeconomic stability The global arena 87

Implications: Equity and Development

    Bringing equity to the center of development builds on and integrates the major emphases in development thinking of the past 10 to 20 years – on markets, on human development, or governance, and on empowerment

The plea for a more level playing field in both the politics and the economies of developing countries serves to integrate the World Bank’s twin pillars of building an institutional climate conducive to investment and empowering the poor. By ensuring that institutions enforce personal, political, and property rights for all, including those currently excluded, countries will be able to draw on much larger pools of investors and innovators, and be much more effective in providing services to all their citizens. Greater equity can, over the long term, underpin faster growth. This can be helped by greater fairness in the global arena, not least through the international community’s meeting its commitments made at Monterrey. Faster growth and human development in poorer countries are essential to reducing global inequity and to reaching the Millennium 88 Development Goals.

Implications (Cont.)

      For growth to have an impact on poverty reduction, the assets of the poor must be augmented. This can be achieved either by investing in new assets, specifically, human capital, or by redistributing existing assets.

Inadequate investment in the human capital of the poor exacerbates and perpetuates poverty and income inequality. When the quality of schooling is low and educational inequality is high, the poor are hurt most because human capital is often their main asset.

Governments need to reallocate public expenditure toward basic education, while at the same time enabling the private sector and public-private partnerships to increase efforts in higher education.

Countries have compelling reasons to strengthen education at all levels. It can augment the poverty-reducing aspect of growth, in addition to improving welfare directly. It enables countries to participate effectively in the global economy.

Investing in education alone will not guarantee successful development or poverty reduction. To reduce poverty, countries need a multidimensional strategy centered on people.

There is the need to ensure access to education and health services and distribute them well; to facilitate fuller use of the human capital of the poor; and to empower the poor with land, equity capital, training, and job opportunities made possible by opening to international trade, investment, and ideas.

Appendix

Measurements of Income Distribution

 Lorenz Curve: - A curve showing the proportion of national income earned by a given percentage of the population.

- e.g what proportion of national income is earned by the top 10% of the population?

 Gini Coefficient - Enables more precise comparison of Lorenz Curves - The proportion of the area taken up by the Lorenz Curve in relation to the overall area under the line of equality 91

Poverty

,

Inequality

,

and GNP per capita

 There’s no simple relation between poverty/inequality and per capita income.

– Inequality (high or low) seems to be very persistent; but it typically changes (up or down) when output per capita changes.

– There might be a complicated relation, involving the interaction of many factors .

Poverty

,

Inequality

,

and GNP per capita

 Inequality is probably determined by – history – social cleavages, – politics and government policies  Careful statistical/econometric analysis is necessary to identify the effect of each factor.

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/require greater income inequality?

Do the poor benefit from growth?

Are high levels of inequality always bad?

What policies can reduce poverty?

The Growth Controversy: Seven Critical Questions

 Inequality and poverty need to be defined carefully if we want to – Compare countries to each other; – Assess progress in fighting them; – What kind of policies/incentives need to be designed.

 What kinds of growth improve welfare?

 What are the main things to be done?

Measuring Inequality and Poverty

 Measuring Inequality – Size distributions – Lorenz curves and Gini coefficients – Functional distributions  Measuring Inequality – size distributions • How much income does household X earn?

• Sort people according to income and put them in major groups.

• Ignore differences in the source of income (or capabilities, for example) • A quartile is a fourth (25%) of the population; a decile is a tenth; a quintile is a fifth.

The

“

Inverted-U

”

Kuznets Curve

Kuznets Curve with Latin American Countries Identified

 Circles represent Latin America: without them there’s no inverted U pattern.

 The evolution of inequality over time is most often due to sociopolitical factors.

Absolute Poverty: Extent and Magnitude

The Range of Policy Options: Some Basic Considerations

 Areas of intervention – Change the functional distribution • Give more income to labor and less to capital.

– Change asset and skill inequality: the sources of income inequality.

• Land reform; microcredit; basic education – Make taxes more progressive.

– Poverty reduction programs: direct transfers or subsidies for food, education, health, etc.

102

The Range of Policy Options: Some Basic Considerations

 Policy options – Changing relative factor prices • Market-determined wages (which would be lower) in the modern sector would increase employment and incomes for the poor.

• Market-determined cost of capital (which would be higher) would encourage firms to hire workers rather than buy capital.

103

The Range of Policy Options: Some Basic Considerations

 Policy options “workfare” is better than welfare if it • Does not undermine incentives for acquiring human capital needed for private sector jobs • Increases net benefits – including externalities • Is difficult to identify the needy without work requirement • There are relatively few poor people • There less social stigma / political resentment from workfare The need for a ‘package’ of policies Eliminate price distortions: more efficiency, more employment and less poverty Structural change in asset ownership Progressive taxes and transfers; safety net 104

Reference

International Bank for Reconstruction and Development/ the World Bank.

The World Development Report 2006: Income Inequality and Development. World Bank and Oxford University Press. 2005. Thomas, Vinod., et al. The Quality of Growth. World Bank and Oxford University Press. 2000.

Appendix

106

Measuring Inequality and Poverty

 Measuring Inequality Gini coefficients (an aggregate measure of inequality) It’s a quantitative measure of how far a society is from being perfectly equal.

Calculate the area between the perfect-equality curve and the actual curve. Divide that area by the total area under the perfect-equality curve.

107

Estimating the Gini Coefficient

108

Estimating the Gini Coefficient

109

 % of National Income

Lorenz Curve

 This line represents the situation if income was distributed equally. The poorest 10% would earn 10% of national income, the poorest 30% would earn 30% of national income.

 30%  10%  10%  30%  Percentage of Population 110

 % of National Income  20%  7%  30%

Lorenz Curve

 In this second example, the Lorenz curve lies further below the line of equality. Now, the poorest 30% only earn 7% of the national income.

 In this example, the poorest 30% of the population earn 20% of the national income.

 The Lorenz Curve will show the extent to which equality exists. The greater the gap between the line of equality and the curve the greater the degree of inequality.  Percentage of Population 111

 % of National Income

Gini Coefficient

 The area bounded by the Lorenz Curve  The

total area under the line of equality

 Percentage of Population 112

Improved Income Distribution under the Traditional-Sector Enrichment Growth Typology

 Sri Lanka, Kerala (India).

 Low growth by great struggle against poverty.

113

Worsened Income Distribution under the Modern-Sector Enrichment Growth Typology

 Latin America, Africa  Growth only in modern sector: unchanged proportion of traditional sector workers.

114

Crossing Lorenz Curves in the Modern Sector Enlargement Growth Typology

   OECD, East Asia The poor get richer as they become modern sector workers, increasing the share of the middle class.

Those who are left in the traditional sector get a smaller share of income.

 With careful math, one can show that the Gini coefficient will first worsen and then improve.

115

The Lorenz Curve

116

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

117

Four Possible Lorenz Curves

- Which is the least unequal country? - Which is the most unequal?

- Can we rank them all?

118

The

“

Inverted-U

”

Kuznets Curve

119

Why Some Countries Fail to Thrive

The View of Sachs –

The most common explanation for why countries fail to achieve economic growth often focuses on the faults of the poor: poverty is a result of corrupt leadership and retrograde cultures that impede modern development.

–

Complex social or economic system has too many moving parts to presume that only one thing can go wrong. Problems can occur in different parts of the economy and can sometimes bringing the system to a near halt.

–

In economic growth, the following eight major categories of problems can cause an economy to stagnate or decline. Jeffrey D. Sachs claims that he has witnessed these kinds of disasters in many parts of the world and each has its own different appropriate course of treatment; therefore, a good diagnosis is crucial.

120

The Poverty Trap: Poverty Itself as a Cause of Economic Stagnation

– –

The key problem for the poorest countries is that poverty itself can be a trap. When poverty is very extreme, the poor do not have the ability by themselves-to get out of the mess. The poorest of the poor are too poor to save for the future and thereby accumulate the capital per person that could pull them out of their current misery. Physical Geography

– –

Many of the world’s poorest countries are severely hindered by high transport costs because they are landlocked; situated in high mountain ranges; or lack navigable rivers, long coastlines, or good natural harbors. Many Countries are trapped in arid conditions with low agricultural productivity or vulnerability to prolonged droughts. Most of the tropics have ecological conditions that favor killer diseases like malaria, schistosomiasis, dengue fever, and dozens of others.

121

Fiscal Trap

– –

Governments are critical to investing in public goods and services like primary health care, roads, power grids, ports, and the like. The government may lack the financial means to provide these public goods.

First, the population itself may be impoverished, so taxation of the population is not feasible. Second, the government may be inept, corrupt, or incapacitated, and thereby unable to collect tax revenues. Third, the government may already be carrying a tremendous load of debt, and must use its limited tax revenue to service the debt rather than to finance new investments. Governance Failures

– – – –

Economic development requires a government oriented toward development. The government has many roles to play. It must identify and finance the high-priority infrastructure projects, and make the needed infrastructure and social services available to the whole population, not just a select few. The government must create an environment conducive to investments by private business. Government must exercise self-restraint in demanding bribes and side payments.

122

Cultural Barriers

–

Even when governments are trying to advance their countries, the cultural environment may be an obstacle to development. Cultural or religious norms in the society may block the role of women, for example, leaving half of the population without economic or political rights and without education, thereby undermining half of the population in its contribution to overall development.

–

Cultural barriers may apply to religious or ethnic minorities. Social norms may prevent certain groups from gaining access to public services. Geopolitics

–

Trade barriers erected by foreign countries can impede a poor country’s economic development. These barriers are sometimes political, as when a powerful country imposes trade sanctions on a regime that it does not like.

–

These sanctions may aim to weaken or topple a despicable regime, but often they simply impoverish the population of the targeted country without toppling the regime.

123

Lack of Innovation

– – –

A huge difference exists between rich and poor countries in their tendency to innovate. Economic growth and innovation proceed in a mutually reinforcing process.

Over the span of two centuries, the innovation gap is certainly one of the most fundamental reason why the richest and the poorest countries have diverged, and why the poorest of the poor have not been able to get a foothold on growth. The rich move from innovation to greater wealth to further innovation; the poor do not. Demographic Trap

– – –

One reason for a poverty trap is a demographic trap, when impoverished families choose to have lots of children. These choices are understandable, yet the results can be disastrous. As with the other obstacles to economic growth, the demographic tarp is avoidable. Girls’ education would allow women to more easily join the labor force, increasing their earning power and the “cost” of staying home to bear children. Education, law, and social action can empower women to more easily make

124

fertility choices.



Basic Relationship of Capital Accumulation and Growth



Consumption



Economic growth



Population



growth and



depreciation



Impoverished



household



Tax payments



Household savings



Capital per person



Public investment



Public budget

125



The Poverty Trap



Impoverished



household



ZERO tax



payments



Basic needs



ZERO



Household savings



ZERO public investment



budget



Decline in



capital per person



(Negative)



Population growth and depreciation



The Role of ODA in Breaking the Poverty Trap



Negative



economic



growth

 

Impoverished household



Basic needs



Household



savings



Humanitarian



relief



Official development assistance



Budget



support



Economic



growth



Public



investm ent



Public budget



Economic growth



(Negative)



Population growth and depreciation

126