Chapter 5: Poverty, Inequality and Development

ECONOMICS OF
GROWTH &
DEVELOPMENT
ECON F244

Dr. Rahul Arora (IC)

Assistant Professor,
Department of Economics & Finance,
BITS Pilani, Pilani Campus
[email protected]
Mob: +91 – 7607481292

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Background design of slides is taken from the presentation slides of Salvatore:
Copyright ©2015 Pearson Education, Inc. All rights reserved International Economics, 10th Edition © 2013 John Wiley & Sons, Inc.
 Inequality & Poverty: Introductory Lines

 To grow, growth of GNI is must – Is this the only thing ?

 Need to think about the contribution of economic agents. Isn’t it ?

 Need to think about the share of economic agents in GNI. Isn’t it ?

Main central problems discussed everywhere are:

 Widespread poverty
 High income inequality

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 Critical Questions about the Relationship
among Eco. Growth, Income Distribution, &
Poverty
1. How can we best measure inequality and poverty?
2. What is the extent of relative inequality in developing countries;
how is this related to the extent of poverty?
3. Who are the poor, and what are their economic characteristics?
4. What determines the nature of economic growth—that is, who
benefits from economic growth, and why?
5. Are rapid economic growth and more equal income distribution
compatible or conflicting objectives for low-income countries? Or
Is rapid growth achievable only at a cost of greater income
inequality or can lessening income disparities contribute to higher
growth rates? 3
 Critical Questions about the Relationship
among Eco. Growth, Income Distribution, &
Poverty
6. Do the poor benefit from growth, and does this depend on the
type of growth a developing country experiences? What might be
done to help the poor benefit more?
7. What is so bad about extreme inequality?
8. What kinds of policies are required to reduce the magnitude and
extent of absolute poverty?

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 Measuring Inequality – Definition

Relative Inequality and Absolute Inequality

 Relative income inequality refers to the average disproportionality of
income, whereas absolute inequality conceptualizes income differences in
money terms (Goda, 2016)
 One can also define relative inequality in terms of ‘How Much Income one
Group has Relative to another Group, e.g. Income of Richest 20% relative to
Income of Poorest 40%’
Example –
 Person A had an income of US $1 a day and person B had an income of $10 a
day in year 2001. After 10 years, person A has income of $8 a day and the
second person has $80 a day. In this example, if we focus on ‘absolute’
differences, inequality has gone up, however, ‘relative’ differences suggests
that inequality between these two people has remained the same.
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 Measuring Inequality – Methods to Measures

1. The personal or Size distributions (quintiles, deciles)

 Measures the percentage of national income to which have access each
part of the population. Generally interpreted as a direct measure of
welfare. In order to avoid unclear distinctions (upper, middle, lower
class etc.) the population is divided in quintiles of deciles
1.1 Kuznets Ratio
1.2 Lorenz curves
1.3 Gini coefficients & Aggregate measures of inequality
2. Functional distributions
 This measures the percentage of national income dedicated to each
factor of production : Land, Labor, Capital

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

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 Figure 5.1 The Lorenz Curve
 Lorenz curve is a graph
depicting the variance of
the size distribution of
income from perfect
equality

 Rank households
(persons) from lowest
income to highest
 X-axis: Cumulative
percentage of persons
 Y-axis: Cumulative
percentage of income

 Gini coefficient: Area

between diagonal and
Lorenz curve multiplied
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by 2 8
 Figure 5.2 The Greater the Curvature of the
Lorenz Line, the Greater the Relative
Degree of Inequality

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 Figure 5.3 Estimating the Gini
Coefficient
 High income inequality is
generally 0.5-0.7

 Low income inequality is

generally situated around
0.2-0.35

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 Figure 5.4 Four Possible Lorenz
Curves
 Economy A is more equal
than economy D

 B and C cross each other –

It is possible that these two
income distributions result
in similar GINI coefficients

 In such cases, one must

visualize the curves in
order to qualitatively
compare economies, as
they are quantitatively very
similar

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Limitations of Gini Coefficient
 Incapable of differentiating different kind of
inequalities.
 Intersecting Lorenz curve may reflect
different pattern of income distribution but
very similar Gini coefficient
 Highly sensitive to the middle part of the
income spectrum

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Other Measures
 Coefficient of Variation
 Atkinson Index
 Generalised Entropy Index
 Kakawani Progressivity Index
 Proportion of total Income Earned
 Robin Hood Index
 Decile Ratio
`
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 Figure 5.5 Functional Income Distribution in
a Market Economy: An Illustration

 It measures the percentage of

national income dedicated to
each factor of production: Labor
(wages), Land (Rent), Capital
(Interest), Organizer (Profit/loss)

 This measure has little

relevance because it does not
take into account substantial
non-market forces that can
greatly distort factor prices
(such as collective bargaining)
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 Desirable Properties for Inequality
Measures
 Anonymity – measure should not depend on who has higher
income; e.g. whether we believe the rich or poor to be good or bad
people
 Scale independence – Inequality measures should not depend on size
of the economy – one wants a measure of income dispersion not
magnitude
 Population independence principle – an inequality measure should
not be based on the number of income recipients
 Transfer principle – all other incomes constant, if transfer income
from a richer to a poorer person (not so much that the poorer person
is now richer than the originally rich person), resulting new income
distribution is more equal
Gini coefficient satisfies all four properties; so does the coefficient of
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 Measuring Absolute Poverty

Absolute Poverty – The situation of being unable or only barely able to

meet the subsistence essentials of food, clothing, and shelter..

Headcount Index:

Where H is the number of persons who are poor and N is the total
number of people in the economy

Major limitation
 It counts all people living under below poverty line as if their incomes were
the same

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 Measuring Absolute Poverty: Poverty Gap
Measures
Total Poverty Gap (TPG)

Where Yp is the absolute poverty line; and Yi the income of the ith poor
person

 It measures the total amount of income necessary to raise everyone who is

below the poverty line up to that line

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 Measuring the TPG: Figure 5.6

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 Measuring Absolute Poverty: Poverty Gap
Measures – Per Capita Measure
Average Poverty Gap (APG)

Normalized Poverty Gap – Unit free Measure

Where Yp is the absolute poverty line and N is the total number of

people in the economy

 This provides a cross-country-comparable indicator of the per-capita poverty

gap in a given economy

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 Measuring Absolute Poverty: Absolutely Poor
Specific Measure
Average Income Shortfall (AIS)

Normalized Income Shortfall (NIS) – Unit free Measure

Where Yp is the absolute poverty line and H is number of poor persons

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 Measuring Absolute Poverty: The Foster-Greer-
Thorbecke (FGT) index
FGT Index

Where, N is the number of persons, H is the number of poor persons,

and α ≥0 is a parameter

Depending upon the value of this index takes on different forms

 When α=0; we get the headcount index measure

 When α=1; we get the “P1” measure which is NPG
 When α=2, we get the “P2” measure

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 Desirable Properties for Poverty
Measures
 Anonymity
 Population independence
 Monotonicity
 Distributional sensitivity
 Plus: the Focus Principle
P2 measure has these properties

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 Basic Indices of Human Development

The Global Multidimensional Poverty Index (MPI) –

 It identifies multiple deprivations at the household level in
health, education and standard of living
 It uses micro data from household surveys, and—unlike the
Inequality-adjusted Human Development Index—all the
indicators needed to construct the measure must come from
the same survey
For calculations, see HDR 2022, Technical Notes, UNDP

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Human Development Report 2019, UNDP
 Basic Indices of Human Development

Human Development Index (HDI) – New HDI in chapter 2

 It is a summary measure of achievements in three key
dimensions of human development:
 a long and healthy life
 access to knowledge and
 a decent standard of living

 The HDI is the geometric mean of normalized indices for each

of the three dimensions

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Human Development Report 2019, UNDP
 Basic Indices of Human Development

Inequality Adjusted Human Development Index (IHDI) –

 It adjusts the HDI for inequality in the distribution of each
dimension across the population
 It is computed as a geometric mean of inequality-adjusted
dimensional indices
 It is equal to the HDI when there is no inequality across people
but falls below the HDI as inequality rises
 In this sense, the IHDI measures the level of human
development when inequality is accounted for
For calculations, see HDR 2019, Technical Notes, UNDP 25
Human Development Report 2019, UNDP
 Basic Indices of Human Development

Gender Development Index (GDI) –

 It measures gender inequalities in achievement in three basic
dimensions of human development: health, measured by
female and male life expectancy at birth; education, measured
by female and male expected years of schooling for children
and female and male mean years of schooling for adults ages
25 years and older; and command over economic resources,
measured by female and male estimated earned income
For calculations, see HDR 2022, Technical Notes, UNDP

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Human Development Report 2019, UNDP
 Basic Indices of Human Development

Gender Inequality Index (GII) –

 It reflects gender-based disadvantage in three dimensions—
reproductive health, empowerment and the labor market
 It shows the loss in potential human development due to
inequality between female and male achievements in these
dimensions.
 It ranges from 0, where women and men fare equally, to 1,
where one gender fares as poorly as possible in all measured
dimensions
For calculations, see HDR 2022, Technical Notes, UNDP 27
Human Development Report 2019, UNDP
 Poverty, Inequality, and Social
Welfare
What’s so bad about inequality?

1. Economic Inefficiency
 A major problem with being poor, is lacking collateral. This fact
often prevents the poor from taking loans, and thus prevents them
from investing in such things as education for their children,
expansion of a micro-business, or in developing a new business
 At the same time, much of the economy's resources are concentrated
in the hands of a few very high-income individuals. These people are
much more prone than the lower and middle classes to spending on
imported luxury items, and investing outside of the country (capital
flight)
 Another macro-economic consideration is that unless tax system is
highly progressive, high income inequality results in low income tax
revenues. Also, it has been argued that progressive tax systems lead
to economic inefficiencies
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 Poverty, Inequality, and Social
Welfare
What’s so bad about inequality?

2. Political considerations
 When wealth becomes overly concentrated in a few hands, this has
also been shown to lead to policies which favor only a small
percentage of the population. This often comes at a cost for overall
social welfare, only making things worse
 High inequality strengthen the political power of the rich and hence
their economic bargaining power
 High inequality facilitates rent seeking including actions such as
lobbying, bribery, and large political donations

3. Unfair to the Society

 Extreme Inequality is generally viewed as unfair

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Economic Development and Welfare

 W = W(Y, I, P)

Welfare is a positive function of Y is income per

capita, negative function of I , inequality and P ,
poverty

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 Economic Development & Income Inequality

Dualistic development and some stylized typologies

 Traditional sector enrichment: all of the benefits of growth are
divided among traditional-sector workers, with little or no
growth occurring in the modern sector.
 Modern sector enrichment: the economy grows but such
growth is limited to a fixed number of people in the modern
sector, with both the numbers of workers and their wages held
constant in the traditional sector.
 Modern sector enlargement: the two-sector economy develops
by enlarging the size of its modern sector while maintaining
constant wages in both sectors (Lewis Model)

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 Economic Development & Income Inequality

Dualistic development and shifting Lorenz curves: some stylized

typologies
 Traditional sector enrichment– Poverty decreases, Inequality
decreases, Income increases

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 Economic Development & Income Inequality

Dualistic development and shifting Lorenz curves: some stylized

typologies
 Modern sector enrichment – Poverty unchanged, Inequality
increases, Income increases

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 Economic Development & Income Inequality

Dualistic development and shifting Lorenz curves: some stylized

typologies
 Modern sector enlargement– Poverty decreases, Income increases,
Inequality changes ambiguous

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 Economic Development & Income Inequality

Kuznets’s Inverted-U Hypothesis –

Explanation of Kuznets curve – A graph reflecting the

relationship between a country’s income per capita and its
inequality of income distribution

Relationship – Income inequality should rise then fall over the course of a
country's development

Conclusion – The inverted-U is consistent with modern sector

enlargement growth, but not with traditional or modern sector
enrichment growth

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 Figure 5.10 The “Inverted-U” Kuznets Curve

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 Economic Growth & Poverty Reduction

Relationship –
 When it is inclusive, growth reduces poverty
 Poor health, nutrition, and education lowers economic productivity
of people in poverty, leading directly and indirectly to slower
growth
 Higher income for the poor raises demand for locally produced
goods
 Often, the poor lack access to credit, which constrains
entrepreneurship, children’s education, and fertility reduction
 Social exclusion/injustice associated with poverty also leads to bad
government policies that can reduce growth

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 Economic Characteristics of High-Poverty
Groups

 Rural poverty
 Women and poverty
 Ethnic minorities, indigenous populations, and poverty

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 Policy Options on Income Inequality and
Poverty: Some Basic Considerations

Areas of Intervention –
 Altering the functional distribution
 Mitigating the size distribution
 Moderating (reducing) the size distribution at upper levels
 Moderating (increasing) the size distribution at lower levels
Policy Options –
 Changing relative factor prices
 Progressive redistribution of asset ownership
 Progressive taxation
 Transfer payments and public provision of goods and services
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Reference
Chapter 5 of – Todaro, M.P. and Smith, S.C. (2019). Economic Development. 12th Edition,
Pearson India Education Services Pvt. Ltd.

For Slide Material – Publically available online slides in a pdf form (copyrighted material of
Pearson Education, referred as follows:
• Copyright © 2009 Pearson Addison-Wesley. All rights reserved
• Copyright © 2015 Pearson Education, Inc. All Rights Reserved

Goda, Thomas. (2016). Global trends in relative and absolute income inequality. Ecos de
Economía, 20(42), 46-69. https://dx.doi.org/10.17230/ecos.2015.42.3

HDR (2019). https://hdr.undp.org/content/human-development-report-2021-22

Multidimensional Poverty Index

https://www.niti.gov.in/sites/default/files/2021-11/National_MPI_India-11242021.pdf

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