POVERTY, INCOME INEQUALITY AND ECONOMIC DEVELOPMENT

Financial Times reports (link) on the new measure of poverty proposed by economists from Oxford University. The authors suggested the modification of current measure of poverty which, defined by the World Bank in annually published World Development Report, is currently set at the thresold of $1.25 per day or less. The new measure proposed by economic researchers from Oxford University sets the definition of poverty in a more sophisticated framework based on the household availibility of access to clean water, education, health care and other durable and non-durable goods. The new method, called Alkire-Foster approach, incorporates the qualitative elements into the measurement of poverty.

Using the new method, the authors examined poverty rates in four Indian provinces and evaluated the approach in comparison to the existing income method which had been used in economic and policy analysis by the World Bank and other institutions of economic development. The authors found a significant divergence of poverty rates when measured in both methods. For instance, under Alkire-Foster approach, the poverty rate in Indian state Jharkhand is 50 percent higher compared to the rate of poverty measured under the income method. On the other hand, the authors of the new poverty measure have shown that in some Indian provinces such as Uttaranchal (link), the official measure of poverty highly over-estimates the effective poverty measure as defined by Oxford's Poverty and Human Development Initiative. The multidimensional worldwide poverty index is also availible on the web (link).

The intuitive question arising from the data and empirical research on poverty is whether higher economic growth in less developed countries boosts the growth of income per capita and what is the role of institutional characteristics in economic development. The authors of the abovementioned measure of poverty have shown that despite abundant economic growth in past years and falling income poverty rates, the share of population without access to clean water, sanitation and minimum required nutrition remained unchanged. The percentage of malnourished children in India decreased from 47 percent in 1998-98 to 46 percent 2005-06.

The theoretical and empirical literature on economic growth suggests that there is an inverse U-relationship between inequality and income per capita known as Kuznets curve (link). The intuition behind the relationship is simple. At the very low levels of income per capita, income inequality is low. Alongside the course of growing income per capita, income inequality steeply increases and, after reaching a maximum, it decreases as countries achieve higher levels of income per capita. The rate of income inequality is closely related to the evolution of economic policies over time. Wagner's law, discussed in one of the previous posts, states that government spending over time increases due to long-run income elastic demand for public goods and capture of the democratic system by the particular interest groups that pose a permanent pressure on the growth of government spending and resist the reversals of government expenditures by trading votes.

There's a wide array of disagreement among economists on the effect of income inequality on economic growth. Back in 2001, Joseph Stiglitz re-examined the East Asian economic miracle and concluded that the evidence from the period of high economic growth in East Asian countries suggests that income redistribution has a positive effect on economic growth (link). Stiglitz's argument is based on the income distribution in East Asian countries during the economic miracle. East Asian countries have been known for relatively even distribution of income demonstrated by high Gini index and relatively high income tax rates.

On the other hand, the empirical investigation of the initial conditions in East Asian countries before the economic miracle shows that the political influence of interest groups had been relatively weak compared to Western Europe after the World War 2 when the productivity growth stalled from early 1970s onwards. The relative weakness of interest groups and a stable judicial system, inherited from English common law tradition, enabled high economic growth in the longer run given an enduring stability of property rights protection and the rule of law. In such conditions, income redistribution had relatively little effect on economic growth since the empirics of East Asian miracle suggests that the sizeable proportion of growth in East Asian countries (Malaysia, Singapore, Korea and Taiwan) had been driven by technological progress, investment and export orientation. Considering export orientation, Rodrik et. al (2005) provided the evidence (link) on the positive effect of high-quality export orientation on economic growth. The productivity growth in East Asian countries between 1975 and 1990 had been a pure example of economic miracle defined by the share of growth that could not be explained by the contribution of labor and capital input. In Taiwan and Hong Kong (link), total factor productivity accounted for about 60 percent of output per capita growth. Between 1975 and 1990, in Singapore, output per capita had increased by 8.0 percent. Consequently, the resulting outcome of almost two decades of robust productivity growth had been a significant decrease in national poverty rates (link). The lowest poverty rate, as defined by the measures of home authorities, is in Taiwan where 0.95 of the population live below the poverty thresold.

The basic set of policies that alleviate extreme poverty such as providing access to clean water, nutrition, medical protection against HIV/AIDS and basic sanitary standards have a positive effect on the economic growth and the standard of living. However, the major cause of persistent under-development in Subsaharan and Tropical Africa is mostly the lack of institutional enforcement of property rights, the rule of law and independent judiciary. In spite of billions of USD of direct foreign aid, countries such as Zambia, Sierra Leone, Mali and Rwanda endure in persistent poverty and under-development. Esther Duflo, this year's recepient of John Bates Clark Award, has shown in several studies how field experiments can enlighten the understanding of incentives in least developed countries (link). Understanding the significance of incentives in reducing poverty is crucial to further examination of the relationship betwen income inequality and economic growth.