CHAPTER FIVE

INCOME INEQUALITY, POVERTY AND DEVELOPMENT

5.1. Introduction
Despite significant improvements over the past half century, extreme poverty remains wide spread in the
developing world. Close to one billion people on less than a dollar a day at purchasing power parity and
some 2.7 billion (over 40% of the world’s population) live on less than dollar 2 a day.

The 1970, witnessed a remarkable change in public and private perceptions about the ultimate nature of
economic activity. In both rich and poor countries, there was a growing disenchantment with the idea that
unyielding pursuit of growth was the principal economic objective of society. In the developed countries,
the major emphasis seemed to shift toward more concern for the quality of life, a concern manifested
mainly in the environmental movement.

In the poor countries, the main concern focused on the question of growth versus income distribution. That
development required a higher GNP and faster growth rate was obvious. The basic issue, however, was
(and is) not only how to make GNP grow but also who would make it grow, the few or the many. If it were
the rich, it would most likely be appropriated by them, and poverty and inequality would continue to
worsen. But if it were generated by the many, they would be its principal beneficiaries, and the fruits of
economic growth would be shared more evenly.

Objectives:
This chapter provides information on the relationship between economic growth, income distribution and
poverty and at the end you will able to understand and answer the following critical points:
 The extent of relative inequality in developing countries, and how is this related to the extent of
absolute poverty
 Identifying the poor and their economic characteristics
 Understand the contributions and measures of income inequality
 What determines the nature of economic growth and who benefits more?
 Are rapid economic growth and more equitable distributions of income compatible or conflicting
objectives for low-income countries?
 What kinds of policy options are required to reduce the magnitude and extent of absolute poverty?

5.2. Inequalities of income: Concepts and Measurement

Income inequality indicates the extent to which distribution of income in an economy differs from that of
equal shares among the population. It is concerned with relative variations in standards of living in the
whole population. Discussions on inequality focus mainly on the more easily observed inequalities in
outcomes such as income, expenditure, employment and education.

Economists usually distinguish between two principal measures of income distribution for both analytic
and quantitative purposes.
- The personal or size distribution of income
- The functional or distributive factor share distribution of income.
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 4.1.1. Size Distributions
The personal or size distribution of income is the measure most commonly used by economists. It simply
deals with individual persons or households and the total income they receive. The way in which that
income was received is not considered. What matters is how much each earns irrespective of whether the
income was derived solely from employment or came also from other sources such as interest, profits,
rents, gifts or inheritance. Moreover, the locational (urban or rural) and occupational sources of the income
(e.g. agriculture, manufacturing, commerce, services) are neglected. Economists and statisticians, therefore,
like to arrange all individuals by ascending personal incomes and than divided the total population in to
distinct groups or sizes. A common method is to divide the population in to successive quintiles (fifths) or
deciles (tenths) according to the ascending income levels and then determine what proportion of the total
national income is received by each income group.
Table 4.1 Typical size distribution of personal income in a developing country by
Income shares (Quintiles & Deciles)
Personal income Share in total income (%)- column 3
Individuals ( column 1) (Money Units) -column 2 Quintiles Deciles
1 0.8
2 1.0 1.8
3 1.4
4 1.8 5 3.2
5 1.9
6 2.0 3.9
7 2.4
8 2.7 9 5.1
9 2.8
10 3.0 5.8
11 3.4
12 3.8 13 7.2
13 4.2
14 4.8 9.0
15 5.9
16 7.1 22 13.0
17 10.5
18 12.0 22.5
19 13.5
20 15.0 51 28.5
Total(National Income) 100.0 100 100.0
NB: Measure of inequality = total of bottom 40% to 20% = 14/51 = 0.28

The total or national income of all individuals amounts to 100 units and is the sum of all entries in column
2. In column 3, the population is grouped in to quintiles of four individuals each. The first quintile
represents the bottom 20% of the population on the income scale. This group receives only 5% (i.e. a total
of 5 money units) of the national income. The second quintile (individuals 5 - 8) receives 9% of the total
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income. Alternatively the bottom 40% of the population (quintiles 1 plus 2) is receiving only 14% of the
income, while the top 20% (the fifth quintile) of the population receives 51% of the total income.

A common measure of income inequality that can be derived from column 3 is the ratio of the incomes
received by the bottom 40% and top 20% of the population. This ratio is often used as a measure of the
degree of inequality between the two extremes of very poor and very rich in a country. In our example,
this inequality ratio is equal to 14 divided by 51, or approximately 1 to 3.7 or 0.28.

To provide a more detailed breakdown of the size distribution of income, deciles (10%) shares are listed in
column 4. We see, for example, that the bottom 10% of the population (the two poorest individuals) is
receiving only 1.8% of the total income, while the top 10% (the two richest individuals) receives 28.5% of
the total income.
Lorenz Curve: The Lorenz curve shows the actual quantitative relationship between the percentages of
income recipients and the percentage of the actual income they did in fact receive during, say, a given year.

As usual, we have the vertical axis and horizontal axis in the above diagram. On the horizontal axis, the
number of income recipients is plotted, not in absolute terms but in cumulative percentages. For example,
at point 20 we have the lowest (poorest) 20% of the population at point 60 we have the bottom 60%, and at
the end of the axis all 100% of the population has been accounted for. The vertical axis shows the share of
total income received by each percentage of the population; it also is cumulative up to 100% meaning that
both axes are equally long.
The entire figure is enclosed in a square; a diagonal line (00’) is drawn from the lower left corner (the
origin) of the square to the upper right corner. At every point on the diagonal 00’ the percentage of income
received is exactly equal to the percentage of income recipients, for example, at point X, which is the
point half way the length of the diagonal line, represents 50% of the income being distributed to exactly
50% of the population. Similar, at the three quarter point on the diagram, 75% of the income would be
distributed to 75% of the population. In other words, the diagonal line 00’ is representative of "perfect
equality" in size distribution of income.

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 O’
100

90

80
Percentage of income

Line of Equality
I.
70

60 X
H.

50 G.

F.
40 E. .
Lorenz Curve
D.
B. C.
30 A.

0 10 20 30 40 50 60 70 80 90 100
20
Percentage of income recipients
Fig. 4.1 Lorenz Curve
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In figure 4.1 we have plotted this Lorenz curve using the deciles data contained to each of the 10 deciles
groups. The more the Lorenz line curves is away from the diagonal (perfect equality), the greater the
degree of inequality represented. The extreme case of perfect inequality ( i.e. a situation in which one
person receives all of the national income while ever body else receives nothing) would be represented by
the congruence of the Lorenz curve with the bottom horizontal and right hand vertical axes. Because no
country exhibits either perfect equality or perfect inequality in its distribution of income, the Lorenz curves
for different countries will lie somewhere to the right of the diagonal in Figure4.1. The greater the degree
of inequality, the greater the bend and the closer to the bottom horizontal axis the Lorenz curve will be.
Two representative distributions are shown in Figure 4.2, one for a relatively equal distribution (Figure
4.2a) and the other for a more unequal distribution (Figure 4.2b).

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 Fig 4.2: Degree of income inequality and nature of Lorenz curves
of
%100

100
100

% of Income
% of Income0

Line of equality Line of equality

income

Lorenz Curve Lorenz Curve

0
0

100 100
% of Population % of Population

a. relative equal distribution b. relatively unequal distribution

Gini Coefficient (GC)

Gini coefficient is the most common indicator for measuring inequality in household income or
consumption. To analyze the distribution of income, it utilizes the notion of the Lorenz curve, a cumulative
frequency curve that compares the distribution of a specific variable (e.g. income) with the uniform
distribution that represents equality.
It is very convenient short hand summary measure of the relative degree of income inequality in a country
and can be obtained by calculating the ratio of the area between the diagonal and the Lorenz curve divided
by the total area of the half square in which the curve lies. This is shown below.

In figure 4.3 the ratio of the shaded area A to the total area of the triangle BCD is known as the Gini
concentration ratio or more simply as the Gini coefficient, named after the Italian statistician who first
formulated it in 1912.

D
Area of A
Line of Equality G.C. = Area BCD
% of Income

Area b/n the equality Line ∧ Lorenz Curve

A = Area of the triangle below the equality line

B C
% of Population
Lorenz Curve
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Gini coefficients are aggregate inequality measures and can vary any where from 0 (perfect equality) to 1
(perfect inequality). Gini coefficients for countries with highly unequal income distributions typically lies
between 0.50 and 0.70 while for countries with relatively equitable distributions, it is on the order of 0.20
to 0.35.
4.1.2. Functional Distribution
The second common measure of income distribution used by economists, the functional or factor share
distributions of income, attempts to explain the share of total national income that each of the factors of
production (land, labour and capital) receives. Instead of looking at individuals as separate entities, the
theory of functional income distribution inquires into the percentage that labour receives as a whole and
compares this with the percentages of total income distributed in the form of rent, interest, and profit (i.e.
the return to land and financial and physical capital). Although specific individuals may receive income
from all these sources, that is not a matter of concern for the functional approach.
A sizable body of theoretical literature has been built up around the concept of functional income
distribution. It attempts to explain the income of a factor of production by the contribution that this factor
makes to production. Supply and demand curves are assumed to determine the unit prices of each
productive factor. When these unit prices are multiplied by quantities employed on the assumption of
efficient factor utilization, we get a measure of the total payment to each factor. The traditional theory of
functional income distribution can be illustrated using the figure 4.4 below under the following
assumptions:
Assumptions:
 There are only two factors of production (capital which is fixed and labor which is only variable
factor)
 Both work under perfect market assumption
Therefore, under perfect market assumption, the demand for labor will be determined by labor’s marginal
product in which additional labor will be hired up to the point where the value of their marginal product
equals their real wage. However, in accordance with the principle of diminishing marginal products, this
demand for labor will be a declining function of the numbers employed.

R SL

Wage rate Profit

WE E

Wages
D L=MPL
0 LE
Employment

Figure 4.4: Functional Income Distribution in a Market economy

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DL is negatively sloped demand curve for labor and S L is also the traditional upward sloping labor supply
curve, then, the equilibrium wage will be equal to W E and the equilibrium level of employment will be L E.
Total national out which equals total national income will be represented by the area 0REL E. This national
income will be distributed in two shares:
 0WELE going to workers in the form of wages and
 WERE remaining as capitalist profit and it is the return to the owners of capital.
Hence, in a competitive market economy with constant returns to scale production function, factor prices
are determined by factor supply and demand curves, and factor shares always combine to exhaust the total
national product. Income is distributed by function, laborers are paid wages, owners of land receive rents,
and capitalists obtain profits.

The functional theory, however, is greatly diminished by its failure to take into account the important role
and influence of non-market forces such as power in determining these factor prices.

5.3 Inequality and Absolute Poverty

5.3.1. Inequality: Variations among Countries

In LDCs the concern is alleviation of absolute poverty and inequality among the poor is a critical factor in
understanding the depth of poverty and the impact of market and policy changes on the poor. Giving much
concern and priority on income inequality among these above the poverty line is crucial for the following
three reasons:
 Extreme income inequality leads to economic inefficiency: this partly because at any given
average income, the higher the inequality, the smaller the fraction of the population that qualifies
for a loan or other credit.
 Extreme income disparity undermines social stability and solidarity: worse, high inequality
strengthens the political power of the rich and hence their economic bargaining power.
 Extreme inequality is generally viewed as unfair: higher income inequality reflects unfair
distribution of resources of the economy.
Countries have different income distributions as measured by the quintile distribution and table 4.2 reveals
income inequality situation of 10 selected countries.
Table 4.2: Some Income Distribution Estimates, 2000s
lowest Quintile Highest Year
Country 10% 1st 2nd 3 rd
4 th
5 th
10%

Bangladesh 3.7 8.6 12.1 15.6 21 42.7 27.9 2000

Brazil 0.9 2.8 6.4 11 18.7 61.1 44.8 2004

China 1.6 4.3 8.5 13.3 21.7 51.9 34.9 2004
Colombia 0.74 2.48 6.2 10.6 18.05 62.67 46.9 2003
Costa Rica 1 3.5 8.2 13.1 21.2 54.1 37.4 2003
Guatemala 0.9 2.9 7 11.6 19 59.5 43.4 2002
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 India 3.6 8.1 11.3 14.9 20.4 45.3 31.1 2005
Jamaica 2.1 5.3 9.2 13.2 20.6 51.6 35.8 2004
Peru 1.3 3.7 7.7 12.2 19.7 56.7 40.9 2003
Zambia 1.2 3.6 7.9 12.6 20.8 55.1 38.8 2004
Total 17.04 45.28 84.5 128.1 201.15 540.67 381.9
Average 1.7 4.5 8.5 12.8 20.1 54.1 38.2
Japan 4.8 10.6 14.2 17.6 22 35.7 21.7 1993
Source: World Bank, World Development Indicator, 2007; Cited in Todaro and Stephen, 2009

The figures in the above table (table 4.2) give a first approximation of the magnitude of income inequality
in these developing countries. For example, we see from the last row that by averaging income shares for
different percentile groups among all 10 countries, on average the poorest 20% of the population receives
only 1.7 of the income; and the highest 10% and 20% receive 38.2 and 54.1% respectively. By contrast,
in a developed country like Japan, the poorest 20% receives a much higher 4.8% of the income while the
richest 10% and 20% get only 21.7% and 35.7% respectively.

Income distribution is measured in three ways as the total share of income received by the poorest 40% of
the population, as the ratio of the share going to the richest 20% divided by that of the poorest 20% and as
measured by the Gini coefficient.

Table 4.3 provides data on income distribution in relation to per capita GNP for a sample of 10 developing
countries.

Table 4.3 Per Capita Income and Inequality in Developing Countries, 2000s
Country GNP per capita Income Share of Ratio of Highest Gini
1996 (US $) Lowest 40% of 20% to Lowest Coefficient
Households 20%
Bangladesh 260 22.9 4.0 0.28
Kenya 320 10.1 18.3 0.58
Sri Lanka 740 22.0 4.4 0.30
Indonesia 1080 20.4 5.1 0.34
Philippines 1160 15.5 8.4 0.43
Jamaica 1600 16.0 8.2 0.41
Paraguay 1850 8.2 27.1 0.59
Costa Rica 2640 12.8 12.9 0.47
Malaysia 4370 12.9 11.7 0.48
Brazil 4400 8.2 25.7 0.60
Source: World Bank, World Development Report, 2000
What clearly emerges from table 4.3 is that per capita incomes are not highly correlated with any of our
three measures of inequality. For example, we see that Sri Lanka has only one-sixth the per capita income
of Brazil, but its three inequality measures are much less pronounced than Brazil’s. Its Gini coefficient is

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0.30 compared to Brazil's 0.60. Similarly, Paraguay, with income seven times higher than that of
Bangladesh, shows much greater inequality. Conversely, Malaysia, with a 1996 per capita income that is
65% higher than Costa Rica, has inequality measures that are not much different. We can conclude,
therefore, that there is no apparent relationship between levels of per capita income and the degree of
income concentration over relevant range of LDC incomes.

5.3.2. Absolute poverty: Extent and magnitude

So far, we have been looking at relative income shares. Now let's switch our attention from relative
income shares of various percentile groups within a given population to the more significant question of the
extent and magnitude of absolute poverty in developing countries. It is difficult to arrive at a tight estimate
of the extent of global poverty at any point in time. Major world bank reports issued within a couple of
years of each other have provided estimates of $1-a-day head count index that differ by tens of millions
people.
In 2007, Global Monitoring Report, the World Bank estimated that the number of people living in extreme
poverty was just under one billion in 2004. The incidence of extreme poverty is very uneven around the
developing world. It is very high in both South Asia with about 31% below $1 per day, and in Sub-Saharan
Africa, with 41% live under extreme poverty.

The prospect for ending poverty depends critically on two factors:

 The rate of economic growth and
 The level of resources devoted to poverty programs and the quality of these programs
What is absolute poverty?
Absolute poverty is meant to represent a specific minimum level of income needed to satisfy the basic
physical needs of food, clothing and shelter in order to ensure continued survival. We defined the extent of
absolute poverty as the number of people who are unable to command sufficient resources to satisfy basic
needs. They are counted as the total number living below a specified minimum level of real income (an
international poverty line).

Absolute poverty may be measured by the number or head count of those whose incomes fall below the
absolute poverty line. A problem, however, arises when one recognizes that those minimum subsistence
levels will vary from country to country and region to region, reflecting different physiological as well as
social and economic requirements. Economists have therefore tended to make consultative estimates of
world poverty in order to avoid unsubstantiated exaggerations of the problem. One common methodology
has been to establish an international poverty line at say, a constant $370 (based for example, on the value
of the 1985 dollar) and then attempt to estimate the purchasing power equivalent of money in terms of
developing country's own currency.

The international poverty line knows no boundaries, is independent of the level of national per capita
income, and takes into account differing price level by measuring poverty as anyone living on less than $1
a day in PPP dollars. In many respects simply counting the number of people below an agreed on poverty
line can have its limitations.

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5.3 Poverty, Inequality, and Social Welfare
Does the pursuit of economic growth along traditional GNP maximizing lines tend to improve, worsen, or
have no necessary effect on the distribution of income and the extent of poverty in developing countries?
Unfortunately, economists do not possess any definitive knowledge of the specific factors that affect
changes in the distribution of income over time for individual countries. Simon Kuznets, to whom we owe
so much for his pioneering analysis of the historical growth pattern of contemporary developed countries,
has formulated the relationship between distribution of income & growth, known as the inverted U
hypothesis

a) What’s So Bad about Extreme Inequality?

Throughout this chapter, we are assuming that social welfare depends positively on the level of
income per capita but negatively on poverty and negatively on the level of inequality, as these terms
have just been defined. The problem of absolute poverty is obvious. No civilized people can feel
satisfied with a state of affairs in which their fellow humans exist in conditions of such absolute human
misery, which is probably why every major religion has emphasized the importance of working to
alleviate poverty and is at least one of the reasons why international development assistance has the
nearly universal support of every democratic nation. But it may reasonably be asked, if our top priority
is the alleviation of absolute poverty, why should relative inequality be a concern? We have seen that
inequality among the poor is a critical factor in understanding the severity of poverty and the impact
of market and policy changes on the poor, but why should we be concerned with inequality among
those above the poverty line?
There are three major answers to this question. First, extreme income inequality leads to economic
inefficiency. This is partly because at any given average income, the higher the inequality, the smaller
the fraction of the population that qualifies for a loan or other credit. Indeed, one definition of relative
poverty is the lack of collateral. When low-income individuals (whether they are absolutely poor or
not) cannot borrow money, they generally cannot adequately educate their children or start and
expand a business. Moreover, with high inequality, the overall rate of saving in the economy tends to
be lower, because the highest rate of marginal savings is usually found among the middle classes.
Although the rich may save a larger dollar amount, they typically save a smaller fraction of their
incomes, and they almost always save a smaller fraction of their marginal incomes. Landlords,
business leaders, politicians, and other rich elites are known to spend much of their incomes on
imported luxury goods, gold, jewelry, expensive houses, and foreign
travel or to seek safe havens abroad for their savings in what is known as capital flight. Such savings
and investments do not add to the nation’s productive resources; in fact, they represent substantial
drains on these resources. In short, the rich do not generally save and invest significantly larger
proportions of their incomes (in the real economic sense of productive domestic saving and
investment) than the middle class or even the poor. 13 Furthermore, inequality may lead to an
inefficient allocation of assets. High inequality leads to an overemphasis on higher education at the
expense of quality universal primary education, and this in turn begets still more inequality in
incomes. Moreover, high inequality of land ownership—characterized by the presence of huge
latifundios (plantations) alongside tiny minifundios that are incapable of supporting even a single
family—also leads to inefficiency because the most efficient
scales for farming are family and medium-size farms. The result of these factors can be a lower
average income and a lower rate of economic growth when inequality is high.
The second reason to be concerned with inequality above the poverty line is that extreme income
disparities undermine social stability and solidarity.
Also, high inequality strengthens the political power of the rich and hence their economic bargaining
power. Usually this power will be used to encourage outcomes favorable to themselves. High
inequality facilitates rent seeking, including actions such as excessive lobbying, large political
donations, bribery, and cronyism. When resources are allocated to such rent-seeking behaviors, they
are diverted from productive purposes that could lead to faster growth.
Even worse, high inequality makes poor institutions very difficult to improve, because the few with
money and power are likely to view themselves as worse off from socially efficient reform, and so they
have the motive and the means to resist it. Of course, high inequality may also lead the poor to
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support populist policies that can be self-defeating. Countries with extreme inequality, such as El
Salvador and Iran, have undergone upheavals or extended civil strife that have cost countless lives
and set back development progress by decades. In sum, with high inequality, the focus of politics
often tends to be on supporting or resisting the redistribution of the existing economic pie rather than
on policies to increase its size.

Finally, extreme inequality is generally viewed as unfair. The philosopher John Rawls proposed a
thought experiment to help clarify why this is so. Suppose that before you were born into this world,
you had a chance to select the overall level of inequality among the earth’s people but not your own
identity. That is, you might be born as Bill Gates, but you might be born as the most wretchedly poor
person in rural Ethiopia with equal probability. Rawls calls this uncertainty the “veil of ignorance.” The
question is, facing this kind of risk, would you vote for an income distribution that was more equal or
less equal than the one you see around you? If the degree of equality had no effect on the level of
income or rate of growth, most people would vote for nearly perfect equality. Of course, if everyone
had the same income no matter what, there would be little incentive to work hard, gain skills, or
innovate. As a result, most people vote for some inequality of income outcomes, to the extent that
these correspond to incentives for hard work or innovation. But even so, most vote for less inequality
than is seen in the world (or in virtually any country) today. This is because much of the inequality we
observe in the world is based on luck or extraneous factors, such as the inborn ability to kick a football
or the identity of one’s great-grandparents.

For all these reasons, for this part of the analysis we will write welfare, W, as
W = W(Y, I, P)
where Y is income per capita and enters our welfare function positively, I is inequality and enters
negatively, and P is absolute poverty and also enters negatively. These three components have
distinct significance, and we need to consider all three elements to achieve an overall assessment of
welfare in developing countries. (A similar framework can be applied to health and education.)

b) Kuznet’s inverted U hypothesis

In his inverted U curve, Simon Kuznets has suggested that in the early stages of economic growth, the
distribution of income will tend to worsen, where as at later stages it will improve. This observation came
to be characterized by the "inverted U” Kuznets curve because a longitudinal (time series) plot of changes
in the distribution of income - as measured, for example, by the Gini coefficient - seemed, when per capita
GNP expanded to trace out the inverted U shaped curve, as shown in figure 5.4 below.

0.75

0.5
Gini Coefficient

0.35

0.25
0
GNI Per capital

Fig 4.4. The “Inverted U” Kuznets Curve

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Explanations as to why inequality seemed first to worsen during the early stages of economics growth
before eventually improving are numerous. They almost always relate to the nature of structural change
early growth may, in accordance with the Lewis model be concentrated in the modern industrial sector,
where employment is limited, but wages and productivity are high.

The Kuznets curve could be generated by a steady process of modern sector enlargement growth as a
country develops from a traditional to a modern economy. The income gap between modern and traditional
sectors may widen quickly at first before beginning to converge. Inequality in the expanding modern
sector may be much greater than inequality in the stagnant traditional sector. Income transfers from the
rich to the poor and poverty reducing public expenditures are more difficult to undertake by governments
in very low-income countries.

c) Income inequality and Economic Growth

A countries’ economic growth may be defined as a long term rise in capacity to supply increasingly diverse
economic goods to its population, this growing capacity based on advancing technology and the
institutional and ideological adjustments that it demands. There are two arguments with respect to growth
and income distribution.
a. The traditional Argument: Factor shares, saving and Economic growth.
Although much of economic analysis has been strangely silent on the relationship between economic
growth and the resulting distribution of income, a large body of theory in essence asserts that highly
unequal distributions are necessary conditions for generating rapid growth.

The basic economic argument to justify large income in equalities was that high personal and corporate
incomes were necessary conditions of saving, which made possible investment and economic growth
through a mechanism such as the Harrod-Domar model. If the rich save and invest significant portions of
their incomes while the poor spend all their income on consumption goods, and if GNP growth rates are
directly related to the proportion of national income saved, then apparently an economy characterized by
highly unequal distributions of income would save more and grow faster than one with a more equitable
distribution of income. Eventually, it was assumed, national and per capita incomes would be high enough
to make sizable redistributions of income possible through tax and subsidy programs. But until such a time
is reached, any attempt to redistribute incomes significantly would serve only to lower growth rates and
delay the time when a larger income pie could be cut up into bigger slices for all population groups.
b. Counterargument
There are five general reasons why many development economists believe the foregoing argument to be
incorrect and why greater equality in developing countries may in fact be a condition for self-sustaining
economic growth.
1. Sizable inequality and widespread poverty create conditions in which the poor have no access to
credit, are unable to finance their children's education, and, in the absence physical or monetary
investment opportunities, have many children as a source of old-age financial security. Together
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 these factors cause per capita growth to be less than what it would be if there was greater equality.
2. Common sense supported by a wealth of recent empirical data, bears witness to the fact that unlike
the historical experience of the now developed countries, the rich in contemporary poor countries
are not noted for their frugality or for their desire to save and invest substantial proportions of their
incomes in the local economy. Instead, landlords, business leaders, politicians, and other rich elites
are known to spend much of their incomes on imported luxury goods, gold, jewelry, expensive
houses, and foreign travel or to seek safe havens abroad for their savings in the form of capital
flight. Such savings and investments do not add to the nation's productive resources; in fact, they
represent substantial drains on these resources in that the income so derived is extracted from the
sweat and toil of common, uneducated, and unskilled laborers. In short, the rich do not necessarily
save and invest significantly larger proportions of their incomes (in the real economic sense of
productive domestic saving and investment) than the poor. Therefore, a growth strategy based on
sizable and growing income inequalities may in reality be nothing more than an opportunistic myth
designed to perpetuate the vested interests and maintain the status quo of the economic and political
elites of Third World nations, often at the expense of the great majority of the general population.
Such strategies might better be called "anti developmental.”

3. 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. Strategies to raise the incomes and levels of living of, say,
the bottom 40% would therefore contribute not only to their material well-being but also to the
productivity and income of the economy as a whole.
4. Raising the income levels of the poor will stimulate an overall increase in the demand for locally
produced necessity products like food and clothing, whereas the rich tend to spend more of their
additional incomes on imported luxury goods. Rising demand for local goods provides a greater
stimulus to local production, local employment, and local investment. Such demand thus creates the
conditions for rapid economic growth and a broader popular participation in that growth.
5. A more equitable distribution of income achieved through the 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. By contrast, wide income disparities
and substantial absolute poverty can act as powerful material and psychological disincentives to
economic progress. They may even create the conditions for an ultimate rejection of progress by
the masses of frustrated and politically explosive people, especially those with considerable
education.

We can conclude, therefore, that promoting rapid economic growth and reducing poverty and inequality
are not mutually conflicting objectives.

5.4 Economic Characteristics of High-Poverty Groups

So far we have painted a broad picture of the income distribution and poverty problem in developing
countries. We argued that the magnitude of absolute poverty results from a combination of low per
capita incomes and highly unequal distributions of that income. Clearly, for any given distribution of
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income, the higher the level of per capita income, the lower the numbers of the absolutely poor. But
higher levels of per capita income are no guarantee of lower levels of poverty. An understanding of
the nature of the size distribution of income is therefore central to any analysis of the poverty problem
in low-income countries.
But painting a broad picture of absolute poverty is not enough. Before we can formulate effective
policies and programs to attack poverty at its source, we need some specific knowledge of these high
poverty groups and their economic characteristics.

a) Rural Poverty
Perhaps the most valid generalizations about the poor are that they are disproportionately located in
rural areas, that they are primarily engaged in agricultural and associated activities, that they are
more likely to be women and children than adult males, and that they are often concentrated among
minority ethnic groups and indigenous peoples. Data from a broad cross section of developing nations
support these generalizations. We find, for example, that about two-thirds of the very poor scratch out
their livelihood from subsistence agriculture either as small farmers or as low-paid farmworkers. Some
of the remaining one-third are also located in rural areas but engaged in petty services, and others are
located on the fringes and in marginal areas of urban centers, where they engage in various forms of
self-employment such as street hawking, trading, petty services, and small-scale commerce. On the
average, we may conclude that in Africa and Asia, about 80% of all target poverty groups are located
in the rural areas, as are about 50% in Latin America. Some data for specific countries are provided in
Table 5.7.

It is interesting to note, in light of the rural concentration of absolute poverty, that the majority of
government expenditures in most developing countries over the past several decades has been
directed toward the urban area and especially toward the relatively affluent modern manufacturing
and commercial sectors.

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Whether in the realm of directly productive economic investments or in the fields of education, health,
housing, and other social services, this urban modern-sector bias in government expenditures is at the
core of many of the development problems. We need only point out here that in view of the
disproportionate number of the very poor who reside in rural areas, any policy designed to alleviate
poverty must necessarily be directed to a large extent toward rural development in general and the
agricultural sector in particular

b) Women and Poverty

Women make up a substantial majority of the world’s poor. If we compared the lives of the inhabitants
of the poorest communities throughout the developing world, we would discover that virtually
everywhere, women and children
experience the harshest deprivation. They are more likely to be poor and malnourished and less likely
to receive medical services, clean water, sanitation, and other benefits. 34 The prevalence of female-
headed households, the lower earning capacity of women, and their limited control over their spouses’
income all contribute to this disturbing phenomenon. In addition, women have less access to
education, formal-sector employment, social security, and government employment programs. These
facts combine to ensure that poor women’s financial resources are meager and unstable relative to
men’s.

A disproportionate number of the ultra-poor live in households headed by women, in which there are
generally no male wage earners. Because the earning potential of women is considerably below that
of their male counterparts,
women are more likely to be among the very poor. In general, women in female-headed households
have less education and lower incomes. Furthermore, the larger the household, the greater the strain
on the single parent and
the lower the per capita food expenditure.

A portion of the income disparity between male- and female-headed households can be explained by
the large earnings differentials between men and women. In addition to the fact that women are often
paid less for performing similar tasks, in many cases they are essentially barred from higher-paying
occupations.
In urban areas, women are much less likely to obtain formal employment in private companies or
public agencies and are frequently restricted to illegal, low-productivity jobs. The illegality of
piecework, as in the garment industry, prevents it from being regulated and renders it exempt from
minimum wage laws or social security benefits. Even when women receive conventional wage
payments in factory work, minimum wage and safety legislation may be flagrantly ignored. Similarly,
rural women have less access to the resources necessary to generate stable incomes and are
frequently subject to laws that further compromise earning potential. Legislation and social custom
often prohibit
women from owning property or signing financial contracts without a husband’s signature. With a few
notable exceptions, government employment or income-enhancing programs are accessible primarily
if not exclusively by men, exacerbating existing income disparities between men and women.

But household income alone fails to describe the severity of women’s relative deprivation. Because a
higher proportion of female-headed households are situated in the poorest areas, which have little or
no access to government sponsored
services such as piped water, sanitation, and health care, household members are more likely to fall ill
and are less likely to receive medical attention. In addition, children in female-headed households are
less likely to be enrolled in school and more likely to be working in order to provide additional income.

The degree of economic hardship may also vary widely within a household. We have already
discussed the fact that GNI per capita is an inadequate measure of development because it fails to
reflect the extent of absolute poverty. Likewise, household income is a poor measure of individual
welfare because the distribution of income within the household may be quite unequal. In fact, among
the poor, the economic status of women provides a better indication of their own welfare, as well as
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that of their children. Existing studies of intrahousehold resource allocation clearly indicate that in
many regions of the world, there exists a strong bias against females in areas such as nutrition,
medical care, education, and inheritance. Moreover, empirical research has shown that these gender
biases in household resource allocation significantly reduce the rate of survival among female infants.
This is one reason why recorded female-male sex ratios are so much below their expected values,
primarily in Asian countries, that 100 million girls and women are said to be “missing.” The favor
shown toward boys in part reflects the fact that men are perceived to have a greater potential for
contributing financially to family survival. This is not only because well-paying employment for women
is unavailable but also because daughters are often married to families outside the village, after which
they become exclusively responsible to their in-laws and thus cease contributing to their family of
origin.

The extent of these internal biases is strongly influenced by the economic status of women. Studies
have found that where women’s share of income within the home is relatively high, there is less
discrimination against girls, and
women are better able to meet their own needs as well as those of their children. When household
income is marginal, most of women’s income is contributed toward household nutritional intake. Since
this fraction is considerably smaller
for men, a rise in male earnings leads to a less than proportionate increase in the funds available for
the provision of daily needs. It is thus unsurprising that programs designed to increase nutrition and
family health are more effective when targeting women than when targeting men. In fact, significant
increases in total household income do not necessarily translate into improved nutritional status. The
persistence of low levels of living among women and children is common where the economic status
of women remains low.

Women’s control over household income and resources is limited for a number of reasons. Of primary
importance is the fact that a relatively large proportion of the work performed by women is
unremunerated—for example, collecting firewood and cooking—and may even be intangible, as with
parenting. Women’s control over household resources may also be constrained by the fact that many
women from poor households are not paid for the work they perform in family agriculture or business.
For example, in Mexico, it has been estimated that 22.5% of women in the agricultural sector and
7.63% of women in the nonagricultural sectors work full time without pay. These figures are greatly
understated in that they do not include women who work part time in family production. It is common
for the male head of household to control all funds from cash crops or the family business, even
though a significant portion of the labor input is provided by his spouse. In addition, in many cultures,
it is considered socially unacceptable for women to contribute significantly to household income, and
hence women’s work may remain concealed or unrecognized.
These combined factors perpetuate the low economic status of women and can lead to strict
limitations on their control over household resources.

Development policies that increase the productivity differentials between men and women are likely
to worsen earnings disparities as well as further erode women’s economic status within the household.
Since government programs to alleviate poverty frequently work almost exclusively with men, they
tend to exacerbate these inequalities. In urban areas, training programs to increase earning potential
and formal-sector employment are generally geared to men, while agricultural extension programs
promote male-dominated crops, frequently at the expense of women’s vegetable plots. Studies have
shown that development efforts can actually increase women’s workload while at the same time
reduce the share of household resources over which they exercise control. Consequently, women and
their dependents remain the most economically vulnerable group in developing countries.

The fact that the welfare of women and children is strongly influenced by the design of development
policy underscores the importance of integrating women into development programs. To improve
living conditions for the
poorest individuals, women must be drawn into the economic mainstream. This would entail
increasing female participation rates in educational and training programs, formal-sector employment,
and agricultural extension programs. It is also of primary importance that precautions be taken to
ensure that women have equal access to government resources provided through schooling, services,

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employment, and social security programs. Legalizing informal-sector employment where the majority
of the female labor force is employed would also improve the economic status of women.

The consequences of declines in women’s relative or absolute economic status has both ethical and
long-term economic implications. Any process of growth that fails to improve the welfare of the people
experiencing the greatest hardship, broadly recognized to be women and children, has failed to
accomplish one of the principal goals of development. In the long run, the low status of women is
likely to translate into slower rates of economic growth. This is true because the educational
attainment and future financial status of children are much more likely to reflect those of the mother
than those of the father. Thus, the benefits of current investments in human capital are more likely to
be passed on to future generations if women are successfully integrated into the growth process. And
considering that human capital is perhaps the most important prerequisite for growth, education and
enhanced economic status for women are critical to meeting long-term development objectives.

As feminist development economists have often expressed it, official poverty programs cannot simply
“add women and stir.” Women-centered poverty strategies often require us to challenge basic
assumptions. The harsher conditions for women and women’s crucial role in a community’s escape
from poverty mean that involvement of women cannot be left as an afterthought but will be most
effective if it is the first thought—and the consistent basis for action—when addressing poverty.

c) Ethnic Minorities, Indigenous Populations, and Poverty

A final generalization about the incidence of poverty in the developing world is that it falls especially
heavily on minority ethnic groups and indigenous populations. Some 40% of the world’s nation-states
have more than five sizable ethnic populations, one or more of which faces serious economic, political,
and social discrimination. In recent years, domestic conflicts and even civil wars have arisen out of
ethnic groups’ perceptions that they are losing out in the competition for limited resources and job
opportunities. The poverty problem is even more serious for indigenous peoples, whose numbers
exceed 300 million in over 5,000 different groups in more than 70 countries. Although detailed data
on the relative poverty of minority ethnic and indigenous peoples is difficult to obtain (for political
reasons, few countries wish to highlight these problems), researchers have compiled data on the
poverty of indigenous people in Latin America. The results clearly demonstrate that a majority of
indigenous groups live in extreme poverty and that being indigenous greatly increases the chances
that an individual will be malnourished, illiterate, in poor health, and unemployed. For example, the
research showed that in Mexico, over 80% of the indigenous population is poor, compared to 18% of
the nonindigenous population. Table 5.8 shows that similar situations exist in countries such as

Bolivia, Guatemala, and Peru situations exist in countries such as Bolivia, Guatemala, and Peru (not to
mention Native American populations in the United States and Canada). Moreover, a 2006 World Bank
study confirmed that all too little progress is being made. Whether we speak of Tamils in Sri Lanka,
Karens in Myanmar, Untouchables in India, or Tibetans in China, the poverty plight of minorities is as
serious as that of indigenous peoples.

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 4.5. The Range of Policy Options: Some Basic Considerations
Once we saw poverty, growth and income inequality in LDCs, and now in this topic we will see some
policy options that help to improve the stated problems with respect to the explained area of interest.

Developing countries that aim to reduce poverty and excessive inequalities in their distribution of income
need to know how best to achieve their aim. What kinds of economic and other policies might LDC
governments adopt to reduce poverty and inequality while maintaining or even accelerating economic
growth rates? As we are concerned here with moderating the size distribution of incomes in general and
raising the income levels of, say, the bottom 40% of the population in particular, it is important to
understand the various determinants of the distribution of income in an economy and see in what ways
government intervention can alter or modify their effect.
a. Areas of Intervention
We can identify four broad areas of possible government policy intervention, which correspond to the
following four major elements in the determination of a developing economy's distribution of income:
1. Functional distribution: the returns to labor, land, and capital as determined by factor prices,
utilization levels, and the consequent shares of national income that accrues to the owners of each
factor.
2. Size distribution: the functional income distribution of an economy translated into a size distribution
by knowledge of how ownership and control over productive assets and labor skills are concentrated
and distributed throughout the population. The distribution of these asset holdings and skill
endowments ultimately determines the distribution of personal income.
3. Moderating (reducing) the size distribution at the upper levels through progressive taxation of
personal income and wealth. Such taxation increases government revenues and converts a market- and
asset-determined level of personal income into a fiscally corrected "disposable" personal income. An
individual or family's disposable income is the actual amount available for expenditure on goods and
services and for saving.
4. Moderating (increasing) the size distribution at the lower levels through public expenditures of tax
revenues to raise the incomes of the poor either directly (e.g., by outright money transfers) or
indirectly ,for instance, through public employment creation or the provision of free or subsidize a
primary education and health care for both men and women. Such public policies raise the real income
levels of the poor above their market-determined personal income levels.
b. Policy Options
Third World governments have many options and alternative possible policies to operate in the four broad
areas of intervention just outlined. Let us briefly identify the nature of some of them.
Altering the Functional Distribution of Income through Policies Designed to Change Relative
Factor Prices
Altering the functional distribution represents the traditional economic approach. It is argued that as a
result of institutional constraints and faulty government policies, the relative price of labor (basically, the
wage rate) is higher than what would be determined by the free interplay of the forces of supply and
demand. For example, the power of trade unions to raise minimum wages to artificially high levels (higher
than those that would result from supply and demand) even in the face of widespread unemployment is

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often cited as an example of the "distorted" price of labor. From this it is argued that measures designed to
reduce the price of labor relative to capital (e.g., through market-determined wages in the public sector or
public wage subsidies to employers) will cause employers to substitute labor for capital in their production
activities. Such factor substitution increases the overall level of employment and ultimately raises the
incomes of the poor, who typically possess only their labor services.

However, it is often also correctly pointed out that the price of capital equipment is "institutionally" set at
artificially low levels (below what supply and demand would dictate) through various public policies such
as investment incentives, tax allowances, subsidized interest rates, overvalued exchange rates, arid low
tariffs on capital goods imports such as tractors and automated equipment. If these special privileges and
capital subsidies were removed so that the price of capital would rise to its true "scarcity" level, producers
would have a further incentive to increase their utilization of the abundant supply of labor and lower their
uses of scarce capital. Moreover, owners of capital (both physical and financial) would not receive the
artificially high economic returns they now enjoy. Their personal incomes would thereby be reduced.

Because factor prices are assumed to function as the ultimate signals and incentives in any economy,
correcting these prices (Le., lowering the relative price of labor and raising the relative price of capital)
would not only increase productivity and efficiency but would also reduce inequality by providing more
wage paying jobs for currently unemployed or underemployed unskilled and semiskilled workers. It would
also lower the artificially high incomes of owners of capital. Removal of such factor-price distortions
would therefore go a long way toward combining more growth, efficiently generated, with higher
employment, less poverty, and greater equality.

We may conclude that there is much merit to the traditional factor-price distortion argument and that
correcting prices should contribute to a reduction in poverty and an improved distribution of income. How
much it actually contributes will depend on the degree to which firms and farms switch to more labor-
intensive production methods as the relative price of labor falls and the relative price of capital rises. This-
is an important empirical question, the answer to which will vary from country to country. But some
improvement can be expected.
Modifying the Size Distribution through Progressive Redistribution of Asset Ownership
Given correct resource prices and utilization levels for each type of productive factor (labor, land, and
capital), we can arrive at estimates for the total earnings of each asset. But to translate this functional
income into personal income, we need to know the distribution and ownership concentration of these assets
among and within various segments of the population. Here we come to what is probably the most
important fact about the determination of income distribution within an economy: The ultimate cause of the
unequal distribution of personal incomes in most Third World countries is the unequal and highly
concentrated patterns of asset ownership (wealth) in these countries. The principal reasons why less than
20% of their population receives over 50% of the national income is that this 20% probably owns and
controls well over 90% of the productive and financial resources, especially physical capital and land but
also financial capital (stocks and bonds) and human capital in the form of better education. Correcting
factor prices is certainly not sufficient to reduce income inequalities substantially or to eliminate
widespread poverty where physical and financial asset ownership and education are highly concentrated.
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It follows that the second and perhaps more important line of policy to reduce poverty and inequality is to
focus directly on reducing the concentrated control of assets, the unequal distribution of power, and the
unequal access to educational and income-earning opportunities that characterize many developing
countries. A classic case of such redistribution policies as they relate to the rural poor, who comprise 70%
to 80% of the target poverty group, is land reform. The basic purpose of land reform is to transform tenant
cultivators into smallholders who will then have an incentive to raise production and improve their
incomes. But land reform may be a weak instrument of income redistribution if other institutional and price
distortions in the economic system prevent small farm holders from securing access to much needed critical
inputs such as credit, fertilizers, seeds, marketing facilities, and agricultural education. Similar reforms in
urban areas could include the provision of commercial credit at market rates (rather than through exploitive
moneylenders) to small entrepreneurs so that they can expand their 'business and provide more jobs to local
workers.

In addition to the redistribution of existing productive assets, dynamic redistribution policies could be
gradually pursued. For example, IDC governments could transfer a certain proportion of annual savings
and investments to low-income groups so as to bring about a more gradual and perhaps politically more
acceptable redistribution of additional assets as they accumulate over time. This is what is often meant by
the expression "redistribution from growth." Whether such a gradual redistribution from growth is any
more possible than a redistribution of existing assets is a moot point, especially in the context of very
unequal power structures. But some form of asset redistribution, whether static or dynamic, seems to be a
necessary condition for any significant reduction of poverty and inequality in most Third World countries.

Human capital in the form of education and skills is another example of the unequal distribution of
productive asset ownership. Public policy should therefore promote wider access to educational
opportunities (for girls as well as boys) as a means of increasing income-earning potential for more people.
This investment in human capital as a principal strategy for alleviating poverty has been widely promoted
(along with accelerating economic growth) by the World Bank in its various poverty reports, especially
World Development Report 1998/99: Knowledge for Development. But as in the case of land reform, the
mere provision of greater access to education is no guarantee that the poor will be any better off, unless
complementary policies-for example, the provision of more productive employment opportunities for the
educated-are adopted to capitalize on this increased human capital.

Reducing the Size Distribution at the Upper Levels through Progressive Income and Wealth Taxes
Any national policy attempting to improve the living standards oi the bottom 40% must secure sufficient
financial resources to transform paper plans into program realities. The major source of such development
finance is the direct and progressive taxation of both income and wealth. Direct progressive income taxes
focus on personal and corporate incomes, with the rich required to pay a progressively larger percentage of
their total income in taxes than the poor: Taxation on wealth (the stock of accumulated assets and income)
typically involves personal and corporate property taxes but may also include progressive inheritance taxes.
In either case, the burden of the tax is designed to fall most heavily on the upper-income groups.

Unfortunately, in many developing countries (and developed countries as well), the gap between what is
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supposed to be a progressive tax structure and what different income groups actually pay can be
substantial. Progressive tax structures on paper often turn out to be regressive taxes in practice, in that the
lower and middle- income groups pay a proportionately larger share of their incomes in taxes than the
upper-income groups. The reasons for this are simple. The poor are often taxed at the source of their
incomes or expenditures (by withholding taxes from wages, general poll taxes, or indirect taxes levied on
the retail purchase of goods such as cigarettes and beer). By contrast, the rich derive by far the largest part
of their incomes from the return on physical and financial assets, which often go unreported. They often
also have the power and ability to avoid paying taxes without fear of government reprisal. Policies to
enforce progressive rates of direct taxation on income and Wealth, especially at the highest levels, are what
are most needed in this area of redistribution activity.

Increasing the Size Distribution at the Lower Levels through Direct Transfer Payments and the
Public Provision of Goods and Services
The direct provision of tax-financed public consumption goods and services to the very poor is another
potentially important instrument of a comprehensive policy designed to eradicate poverty. Examples
include public health projects in rural villages and urban fringe areas, school lunches and preschool
nutritional supplementation programs, and the provision of clean water and electrification to remote
rural areas. Direct money transfers and subsidized food programs for the urban and rural poor, as well
as direct government policies to keep the price of essential foodstuffs low, represent additional forms of
public consumption subsidies. All these policies have the effect of raising the real personal income
levels of the very poor beyond their actual market -derived monetary incomes. Unfortunately, in the
1980s and 1990s, with the LDC debt crisis and the implementation of World Bank- and IMF-induced
structural adjustment programs, the first victims of mandated public expenditure retrenchments were
the rural and urban poor-especially women.

Summary
Poverty is the daily experience of developing countries. Around 41% of the population in Sub-Saharan
Africa is living below the poverty line (a dollar a day). The head count index helps to measure the extent of
absolute poverty in a country.

Income inequality in a country could be measured by Gini coefficient and Lorenz curves in which the later
is derived by plotting the percentage share of income on the vertical and percentage of population on the
horizontal axis and the diagonal line is line of equality. Size distribution and functional distribution of
income are the two principal measures of income distribution in an economy. In a certain economy,
poverty, growth and inequality can have feasible functional relations that Kuznets able to explain the
‘inverted U‘hypothesis between economic growth and income inequality. As a result of different
experiences have been exercised in relationship between these variables different policy options are
demanding to correct such challenges in LDCs.

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