Econ 121 Notes (PDF)

DEVELOPMENT ECONOMICS Voices of the Poor 1. No say in public, feelings of inferiority, no progress and no Questions the class seeks to answer:...

DEVELOPMENT ECONOMICS Voices of the Poor 1. No say in public, feelings of inferiority, no progress and no Questions the class seeks to answer: clothing Why do living conditions differ so 2. Illness, humiliation, and shame. drastically for people across different Cripples, not needed by anyone, and countries and regions, with some so wants to be rid of poor and others so rich? 3. Life is precarious. Why are there huge disparities also 4. No medicine in health, nutrition, education, freedom of choice, women’s Poverty is more than a lack of income. It is autonomy, environmental quality, inherently multidimensional, as is economic market access, security, and voice? development. Why is output per worker many times higher in some countries Economics and Economic Development compared to others? Studies Why are public services insufficient, Economies are social systems corrupt in some countries; effective 1. Interdependent relationships: in others? economic and non-economic factors Why have some formerly poor Success or failure of development policy countries made so much progress 1. Importance of taking account of and others so little? institutional and structural variables Why have child illness and death along with more traditional economic rates fallen so much in the world, variables and what can be done in places where they remain far higher than Four Stylized Living Standards Strata average? 1. Poorest a. Majority live below USD 1.9 Tenants b. Often living in the remote 1. Substantial - even dramatic - rural areas progress in growth and poverty c. Majority of the food is grown reduction in the developing world in and consumed the last quarter century. d. Shelter and furnishings often 2. International economic relations are made by those who use them less one-sided but also more fragile e. Few passable roads 3. The scale of challenges for particularly in the rain season sustainable economic development f. Young children attend school and ending poverty remains irregularly; may be difficult to enormous access a. Persistence of violent conflict g. No hospitals, no electricity b. Environmental impact connection 4. Inclusive Growth, and the drive to h. No improved water supplies zero poverty - not a simple matter of i. Malnourished and suffering continuing along a trend line from multiple conditions  2. Second-lowest Strata Development is more concerned with being a. Likely to live in an urban area able to go to the next level. What matters or per-urban area fundamentally is not what a person has b. Employment is likely to be but what the person can be and is. informal c. Water is still unsafe but more Disparities between income and accessible advantages are due to factors including: d. Improved housing but still 1. Personal heterogeneities subject to elements 2. Environmental Diversities 3. Second-Highest Strata 3. Variations in social climate a. More accessible safe water 4. Intra-household problems b. Each person in the household probably has a Measuring individual well-being by levels of smartphone consumption of goods and services c. Uses improved sources of confuses the role of commodities by cooking food regarding them as ends in themselves 4. Richest rather than as means to an end a. House full of consumer goods Measuring well-being with utility is not a b. Central plumbing sufficient improvement over measuring c. Separate and safe rooms consumption to capture the meaning of d. Good medical care development. Utility comes from the e. Choose from a variety of functioning of the commodities you careers consume. Measures of Development A person’s own valuation of what kind of life Traditional Measures would be worthwhile is not necessarily the 1. GNI same as what gives pleasure to that person. 2. Income per capita 3. Utility of that income? Sen’s Approach: New Economic View of Development 1. The Central Role of Women 1. Leads to improvement in wellbeing, a. Biggest impact on more broadly understood development, societies must empower and invest in Amartya Sens “Capabilities” Approach women 1. Functionings as an achievement 2. Three Objectives of Development 2. Capabilities as freedoms enjoyed in a. Increase availability of terms of functionings life-sustaining goods 3. Development and happiness b. Raise levels of living 4. Well being in terms of being well and c. Expand range of economic having freedoms of choice and social choices 5. “Beings and Doings” a. Being healthy b. Being well-clothed Millennium Development Goals It’s not a question of going to other 2000-2015 countries asking for capital then hoping it 1. Eradicate Extreme Poverty and works. That doesn’t mean productivity. Hunger 2. Achieve Universal Primary Population Growth and Economic Education Development: Causes, Consequences, 3. Promote Gender Equality and and Controversies Empower Women 4. Reduce Child Mortality 5. Improve Maternal Health 6. Combat HIV/AIDS, Malaria and Other Diseases 7. Ensure Environmental Sustainability 8. Global Partnership for Development Critique: Developed countries seem to play a small role in reaching these goals and sometimes even contradict these goals. Sustainable Development Goals 2015-2030 1. No Poverty 2. Zero Hunger The lesser development in the country, the 3. Good health and well–being greater the population growth. This is 4. Quality education explained through the fact that if one has 5. Gender equality many children, it becomes increasingly 6. Clean water and sanitation difficult to ensure they receive the adequate 7. Affordable and clean energy and optimal amount of resources. As your 8. Decent Work and Economic Growth population growth rate stabilizes, it is a 9. Industry, Innovation, and good sign of more development. Infrastructure 10. Reduced inequalities 11. Sustainable cities and communities 12. Responsible consumption and production 13. Climate action 14. Life below water 15. Life on land 16. Peace, justice, and strong institutions 17. Partnerships for the Goals Most of the population is really in Asia and Stages: the Pacific. Europe and North America have 1. High Birthrates and death rates a smaller population but they control most of 2. Continued high birthrates and the economic assets of the world. declining death rates 3. Falling birthrates and death rates, Population Momentum eventually stabilizing Lower fertility rates but high birth rates. High birth rates cannot be altered A country that invests in fewer people ends overnight… It isn’t magic. up having more returns in the form of savings ending up with a larger proportion Even if the number of children a woman can of working age people. Resulting in greater have is lower, there are still a lot of women resources that can be reinvested into the who can give birth. future. To stop population momentum, you have to Malthusian Population Trap delay the pregnancies of women. So keep The idea that rising population and women busy either through jobs or diminishing returns to fixed factors result in opportunities. Increase the activity in the low levels of living. economy, focus on careers, marry late. Population growth tends to expand in times Population Demographic Transition and of plenty but will eventually reach a point Dividends where it outstrips the available resources to sustain it. This results in a decline in the standard of living and a return to subsidence levels. Women cannot get pregnant at 0 per capita income as they would be too hungry and even if they did, kids would die young due to hunger Demographic Transition refers to when nations shift from high birth and death rates to low birth and death rates as societies attain more technology, education, and development. Nations that are less like pyramids have At Point T, that is where famine and war more women in the workforce. begins, You need to maintain your population growth rate and therefore be at the stable equilibrium point S. To ensure that diminishing returns do not Having more children results in lesser cost happen you need to increase or shift your of production in the production function. technology and education. You can never have too much technology or education as it Price Effect: raises your ceiling - productivity. With new If the cost of quality education is very high, technology, resources can be augmented to you would want more children because yield higher outputs for less. It shifts the there is a higher chance one of them may total income growth rate up - leaving the succeed eventually. population trap. That said, the cost of raising children, including education and the opportunity cost of a mother's time, should influence family size. If we can make quality schooling more affordable and approachable, people will invest in quality over quantity. That can then give them a higher chance to succeed economically. Substitution Effect: When the price of children relative to other As you develop, the opportunity cost of time goods increases, families may substitute goes higher. If there is Jollibee, it’s a good other goods for children, reducing family sign of development. You would rather size. spend time on your career over cooking. Bargaining Models: Recent research highlights that household The Microeconomics Household Theory decisions are not unitary. Men and women of Fertility may have different preferences, leading to This theory suggests that families make bargaining within the household. Women's rational economic decisions about the increased bargaining power, often through number of children they have based on education and employment, can lead to income, the cost of raising children, and lower fertility rates. preferences for other goods. Income Effect: Higher household income generally increases the demand for children, as they are considered normal goods. However, in low-income societies, children are often valued for their economic contributions, such as labor and future financial support. Empirical Evidence: Rationale for Population Policy Studies show that higher female education 1. Coordination Failures and employment opportunities correlate with lower fertility rates. Improved child survival Copper & John, 1988, QJE. Module 2.11. rates also reduce the need for larger families to ensure a desired number of 𝑁 surviving children. Initial Benefit 𝐶𝑡−1 = ∑ 𝐶𝑛 𝑡−1 𝑛=1 1 Demand Function for Children We will now have the reaction function: There is a price to having children. You must ensure you have enough resources to properly and adequately provide for their needs. You want your children to not be stupid children. You will always want quality children. If the spending is bigger in normal times, the initial benefit is bigger. Therefore the average person would have something like 𝐶0 creating optimism. It follows logically that lower fertility is where 1. More female nonagricultural employment at higher wages This therefore means that they will spend at 2. Raised women’s education, role, 𝐶1 and income must be at 𝐶1. and status 3. Expanded schooling opportunities with lowered real costs 4. Increases in family income levels 5. Reduction in infant mortality, better health care 6. Development of old-age and social security plans If good things keep happening then I 3. Imperfect Information increase my spending until I reach the best 4. Financial Market Failures equilibrium. Blue line. Basic Indicators of Development: Real What if it’s the opposite and people don’t Income, Health, and Education spend much out of fear. In practicing thrift, the summation will constantly lead C to 1. Gross National Income drop. This is what is known as 2. Gross Domestic Product Coordination Failure. Red line. 3. Purchasing Power Parity a. Might end up being higher Happens all the time in Climate Change. than the usual exchange You think you’re small individually so you do rates nothing. 7 Billion think that. Now nothing b. Comparing the price of the has changed. basket of goods across different countries Holistic Measures of Living Levels and Capabilities 1. Income 2. Health - Life Expectancy 3. Education 4. Trad. HDI a. Income index + Life Expectancy + Education b. Can be adjusted through policy 5. New Human Development Index (NHDI) a. What we want then is a more If you have a bigger stimulus package, it lifts comprehensive description of everyone to a higher coordination failure. development Think WW1. Then when a bigger spending b. Income ≠ Life Expectancy ≠ occurs like that of WW2, it moves you form Education the higher coordination failure to that of C*. i. Philippines vs Vietnam. We have 2. Environmental Impact higher income but Vietnam has higher More children means more use of basic education, the latter resources. Since educating a lot of children will be more is expensive and there is an immediate developed opportunity cost, more basic resources are 3 consumed inefficiently. c. 𝐼𝑛𝑐𝑜𝑚𝑒 𝑥 𝐿𝑖𝑓𝑒 𝐸𝑥𝑝𝑒𝑐𝑡𝑎𝑛𝑐𝑦 𝑥 𝐸𝑑𝑢𝑐𝑎𝑡𝑖𝑜𝑛 d. This means that if even one aspect is zero, everything is zero. Are living standards converging across c. Restriction of coercive, countries? fraudulent and A great divergence followed by the industrial anti-competitive behavior revolution d. Constraining the power of elites 2 Reasons for (re-)Convergence e. Conflict Management - Diminishing returns to capital 3. Other institutions provide improved - Diffusion of ideas across countries, coordination; social insurance; and skip trial and error and grow fast predictable macroeconomic stability while catching up (Latecomers 4. Good institutions may both, cause advantage) development, and improve as a result of development Convergence is not very convincing a. A strong institution can however. This may be a result of the fact quickly adapt to problems that different economies have different before and during they levels of technology, education, and happen and not after efficiency. It really depends on policy and how the government wishes to steer the direction of the economy. Whether it wants to create and upgrade our own value chains. It is a matter of creating the necessary conditions. Three General Types of Colonial Institutions Nature and Role of Economic Institutions Settler 1. Institutions provide “Rules of the Large numbers of colonizers migrated to a Game” of economic life colonized region with the intention of 2. Salient institutions include the making the land its permanent home thus nature and extent of: replicating European societal structures. a. Property Rights They were typically seen as extensions of b. Contract Enforcement the homeland rather than foreign land. Often lead to high inequality between colonizer and indigenous people. Plantation 2. To identify the causal variable x (e.g. Characterized by large-scale agricultural inequality) on outcome variable y (e. production, typically for the colonizer’s g. income), by understanding how respective market. instrument z affects y by seeing how it affects x. Cash Crops included sugar, tobacco cotton, a. z > x > y coffee, and other things. It relied heavily on 3. An instrument has no independent forced labor which typically lead to slavery effect on the outcome variable of and deep racial social divisions. interest Only a small population of the elite Classic Theories of Economic Growth colonizers would live here thus there was and Development little investment in creating enduring social infrastructure. There are four (4) approaches of Economic Development Examples would be the Southern United 1. Linear-stages-of-growth model States and the Carribean. a. Rostow’s Stages of Growth i. Posits that there are Exploitation multiple stages of The focus of this type of institution was to growth maximize the economic value of the ii. Production first colonizing power by extracting the natural iii. Do we sacrifice resources, the strategic location, or use as consumption for cheap labor. Deep racial social divisions. production? How do we know what stage There was no intent to make the colony a we are in? permanent settlement for the colonizers. b. Harrod-Domar Growth Thus, virtually no infrastructure was Model (AK Model) created for these colonies and the i. A = fixed factor, K = extraction of resources left them further Capital crippled. ii. Every economy must save a proportion of Colonial powers and institutions that are its national income to extracting in nature, reduce and mitigate the replace worn-out or growth of development. impaired capital goods. The evolution of institutions then have the iii. Any net additions to greatest impact on the development of capital stock in the countries form of new investment will bring An approach to Addressing Causality: about corresponding Instrumental Variables increases in the flow 1. Addressing causality by searching of GDP for an instrumental variable  iv. A country must first surplus labor is define its presumed to exist capital-output ratio ii. Wages in the 1. A ratio that traditional sector are shows the presumed to be equal units of capital to average product. required to 1. The land produce a unit owner will first of output get the share 2. 𝑐 = ∆𝐾 of the output ∆𝑌 based on what 3. ∆𝐾 = 𝑐∆𝑌 they inputted. 4. 𝐼 = ∆𝐾 = 𝑐∆𝑌 = 2. Whatever is 5. 𝑐∆𝑌 = 𝑠𝑌 left is divided ∆𝑌 𝑠 6. 𝑌 = 𝑐 among the ∆𝑌 𝐺 𝑠 workers. 7. = − δ 𝑌 𝑐 iii. Main Goal: Transfer 8. A lower c those in traditional means a more sector to that of the efficient use of modern urban sector resources We subtract δ from the 6th equation to count for depreciation where δ would equal the depreciation rate Criticisms of the Stages Model 1. Savings and investment is necessarily a condition for accelerated growth but alone not sufficient 2. You need more factors, not just capital to increase your economic growth a. Population b. Transformation in Sectors Criticisms of the Lewis Model c. Education Inconsistent to what Microeconomics has taught us 2. Theories and patterns of structural change Wages = Marginal Product of Labor a. Lewis Two-Sector Models i. General Model for Wages to maximize profit must be equal to development where the MPL. Resources are limited. People can the existence of be efficient with all the knowledge but poor therefore they are not irrational. They can’t 3. The International-Dependence implement any changes to the way they do Revolution things because they do not have the a. Main theme is that there are resources in the form of capital. power dynamics at play in the economy. You therefore need to increase public b. False-Paradigm Model goods like education to give them more i. Pitfalls of using opportunities. You have to consider human foreign advisors who capital and not simply assume that it is a misapply matter of labor surplus. developed-country models Rate of labor transfers and employment c. The dualistic-development creation may not be proportional to rate of thesis modern sector capital accumulation i. Superior and inferior elements can coexist Questionable assumption of surplus in labor d. Criticisms and limitations in rural areas and full employment in urban, i. Accumulating and of diminishing returns in modern counterexample; the industrial sector, at least in some cases framework does little to show how to Institutional factors have a small (if any) achieve development role in this approach in a positive sense 4. Neoclassical, free market Empirical Patterns of development “counterrevolution” a. Challenging the Statist Some processes are very typical but not Model: Free Markets, Public universal; so these are often referred to as Choice, and Market-Friendly “stylized facts”: Approaches - Switch from agriculture to industry i. Free Market - Rural-urban migration and Approach urbanization ii. Public choice - Steady accumulation of physical and Approach human capital iii. Market-friendly - Population growth first increasing approach and then decreasing with decline in b. Main Arguments family size i. Denies efficiency of intervention ii. Points up state owned enterprise failures iii. Stresses government failures  iv. Urges reliance upon If we are to have a 1% growth in K (capital) the “magic of the and technology is constant, then dY/Y = marketplace” θ 𝑥 (1%) and therefore output increases but v. Associated with the it is less than 1% growth as there is Solow model of diminishing marginal productivity of governance. capital (K). Average output still increases, 1. Traditional per capita income increases, welfare still Neoclassical increases, so we support investment either Growth way. Theory 2. The If we are to have a 1% growth in N (labor) interactions of and technology is constant, then dY/Y = the inputs (1 − θ) x 1%. It is greater than 0% but less matter the than 1%. As labor increases, output most increases but there is diminishing marginal productivity of labor. That said, Solow General Growth Model if there are more laborers who have to share the same machine, the per capita 𝑑𝑌 𝑑𝐴 𝑑𝐾 𝑑𝑁 = + θ + (1 − θ) output decreases. Formal argument for 𝑌 𝐴 𝐾 𝑁 population management. Where: If there is 1% growth in technology, dY/Y is the growth rate of output education, etc. then dY/Y = 1%. dY/Y = dA/A is the growth rate of technology dA/A. There is no such thing as θ is the share of capital diminishing marginal returns on dK/K is the growth rate of capital (machine) technology or education. Output per capita (1-θ) is the share of labor and welfare per capita income increases the dN/N is the growth rate of population. Also most. It is a full 1%. Biggest growth is (n) technology. There is no increase in the input so no return of scales but there is a Improvements in technology or education better input. are always good for the economy but cannot concretely or quantitatively be Technology > Capital > Population. tweaked or adjusted. Population makes the economy grow by increasing activity but not the per capita Capital (machine) and labor share capital income. because they can be quantitatively measured. Solow Residual If we are to have a 1% growth in K + N 𝑑𝐴 𝑑𝑦 𝑑𝑘 (capital and labor) and technology is 𝐴 = 𝑦 − θ 𝑘 constant, then dY/Y = 1%. Constant Returns to Scale - if capital and labor We now have a mathematical answer, not doubles, then output also doubles. an economic answer. Technology is whatever is left over from the things we can’t explain anymore. The Solow model 2. But, you still need theory to interpret argues technology is the most important but data, avoid cart-before-horse we don’t know what it is exactly. Making policies. it hard to manipulate or adjust. Dependency 1. Existing international relations, trade, investment can place constraints on pattern of Solow Equilibrium equation development 2. But, growing number of sf(k*) = (δ + n ) k* counter-examples of stronger versions of dependency theory; Where: good performance of “globally” 1. sf(k*) is savings per worker integrated countries. 2. δk* is the amount of capital (per worker) needed to replace Market Fundamentalism depreciating capital 1. Governments fail 3. nk* is the amount of capital (per 2. But, markets also fail in developing worker) that needs to be added due countries; East Asia shows that to population (labor force) growth. government intervention can be constructive. Contemporary Model of Development and Underdevelopment Coordination Economic Agents must be coordinated, to make everyone else better off. To achieve higher social welfare, coordination and cooperation is needed. Contributions and Limitations of the Game theory Four Schools Policies are made to incentives people to Capital Fundamentalism take similar actions and work together. 1. Points up importance of investment, and of efficiency of capital allocation 2. Investment may be necessary but is not sufficient. Broader context matters. Structural/Empirical Patterns of Development 1. Careful empirical evidence can remove theories from contention The S-shaped function is called the “Private Many Development Economists have Rational Decision Function” which illustrates concluded that several market failures work how economic agents respond to their to make development difficult to initiate - external environment based on leading to a coordination failure. expectations. To illustrate this, think of a developing This is because in these cases, agents economy that wants to industrialize but observe what they expected to observe. the industries are fragmented. Suppose that firms expected no other firms to make investments, but some firms did The Steel Sector is waiting for the anyway (implying a positive vertical Automobile Sector to demand steel. intercept in the dia-gram). But then, seeing that some firms did make investments, it Meanwhile the Automobile Sector is waiting would not be reasonable to continue to for the supply of steel to go up or price of expect no investment! steel to go down before they invest. The different points at which the S Function The pecuniary externality here is that meets the 45 degree line are an equilibrium because no one has initiated, the price of point. steel remains high and there is no incentive for the steel sector to scale up to lower Big Push Theory costs. Leadership is needed to reach a higher point of equilibrium. Problems with a “Super- Entrepreneur” - Capital market failures Big push model: some points to keep in - Cost of monitoring managers - mind asymmetric information - Communication failures The three wage levels are examples of what - Limits to knowledge might prevail in a given economy; They are - Lack of any empirical evidence that NOT a succession of three wages over time would suggest this is possible The diagram is only one easy-to-depict Big Push Mechanisms illustration among several reasons why a - Raising total demand big push might be needed - Reducing fixed costs of later entrants The point is NOT that the problem of - Redistributing demand to alter industrialization is commonly that workers periods when other industrializing demand too high wages - that might be firms sell unusual; - Shifting demand towards manufacturing goods (usually Pecuniary Externalities produced in urban areas) A positive or negative spillover effect on an - Help defray costs of essential agent’s costs or revenues. infrastructure(a similar mechanism can hold when there are costs of  training, and other shared O-Ring production analysis setup: intermediate inputs) details - Kremer’s concept of q is quite Further Problems of Multiple Equilibria flexible, interpretations may include - (def) a condition in which more than a quality index for characteristics of one equilibrium exists. THese the good equilibria sometimes may be ranked, - …..(wasn’t able to write the rest) in the sense that one is preferred over another, but the unaided market Bottleneck Effects will not move the economy to the - As workers reduce their (planned) preferred outcome skill investments, they further reduce - Inefficient advantages of level of skill in the economy, and incumbency thereby lower further the incentive to - Behavior and norms invest in skill - Linkages - inequality , multiple equilibria, and Kremer’s O-Ring Theory: Implications growth If the low-skilled firms are compensated by the same amount as those in high-skilled firms, when the worker that is high-skilled Kremer’s O-Ring theory: A Numerical moves to another country and works with Illustration their high-skilled workers, their income gets higher. Assumptions - Production modeled with strong 1. Firms tend to employ workers with complementarities among inputs similar skills for their various tasks - Positive assortative matching in 2. Workers performing the same task production earn higher wages in a high-skill firm than in a low-skill firm Simple illustration of the basic idea 3. Wages increase in q at an increasing rate, wages will be more than Suppose a (HR) department has 4 workers, proportionally higher in 2 “h” type, 2 “ L” type developed countries 4. When those around you have higher Strong complementarities are present when average skills, you have a greater output Q is determined by the product of the incentive to acquire more skills qualities, ie, Q= qi - qj 5. O-Ring effects magnify the impact of local production bottlenecks How to allocate for efficiency; {HL, LH} or because such bottlenecks have a {HH , LL} multiplicative effect on other (wasn't able to take notes of the rest) production 6. Bottlenecks also reduce the incentive for workers to invest in skills by lowering the expected return on these skills  3. Imitation can be rapid Economic Development as a. China making high-quality “Self-Discovery” alternatives of other There is a problem with information. inventions at a fraction of the Information externalities, the spillover of price information such as knowledge of a production process, we won’t fully know The Hausmann-Rodrik-Velasco Growth which countries have a comparative Diagnostic Framework advantage, Focus on a country’s most binding constraints on economic growth, avoid “one It’s difficult to specialize solely on one sector size fits all” in development policy. This because to maintain comparative advantage requires careful research to determine the is extremely difficult and as more and more most likely binding constraint. people are exposed to the good or service, other countries can copy and follow. There is no real incentive then to search for comparative advantage. This disputes the Big Push idea which picks and chooses the “winners” - since it’s possible they become the losers or become monopolies. Develop policies that spill-over from the very beginning. You start with the problem. Then you branch Industrial policy may help to identify true out to its potential causes, then the causes direct and indirect domestic costs of of those causes. potential products to specialize, by: Growth Diagnostics: Categories of “most 1. Encouraging exploration in first binding constraints” in decision tree stage 2. Encouraging movement out of Constraint categories are the boxes from inefficient sectors and into more which no further arrows emanate – 10 are efficient sectors in the second stage included Case Examples These 10 are fairly comprehensive; many 1. Uncertainty about produced specific constraints fit well within these efficiently categories a. India’s widely unexpected Example: natural disasters pose success in information immediate constraints, but if extended technology problems for the growth follow, government 2. Need for local adaptation of failure is likely the root problem - not the foreign technology initial shock of the disaster a. Shipbuilding in South Korea But potential additional independent “boxes” for constraint types that have been raised If a constraint is binding then: for consideration but are debatable could - The (shadow) price of the constraint include: should be high (high opportunity - Environment: if climate change and cost) ecological collapse threaten food - Movements in the constraint should security, or domestic degradation produce significant movements in leads to near un-livability of the the objective function major cities (lowering productivity, - Agents in the economy should be stopping investment…) attempting to overcome or bypass - Inability to resolve conflict the constraint - Social capital (or “cultural”) - Agents less intensive in that dimensions such as lack of trust constraint should be more likely to (e.g. in forming business survive and thrive, and vise versa. relationships, etc) - Suggested discussion exercise: Identifying other possible final boxes Poverty, Inequality, and Development Doing growth diagnostics (in practice) 8 Critical Questions: - Careful research is required to 1. How can we best measure inequality determine most likely binding and poverty? constraint; 2. What is the extent of relative - In practice, this is involved growth inequality in developing countries, diagnostics involves “economic and how is this related to the extent detective work” of absolute poverty? - To evaluate whether a proposed 3. Who are the poor, and what are their constraint is binding, a growth economic characteristics? diagnostician looks for evidence on 4. What determines the nature o its implications. feconomic growth—that is,who - If the constraint is excessive benefits from economic growth, and taxation, we would expect high why? movement into the informal sector or 5. Are rapid economic growth and underground economy more equal distributions of income - If the constraint is infrastructure, we com- patible or conflicting objectives would expect significant congestion for low-income countries? To put it - If the constraint is education, expect another way, is rapid growth high rates of return to education achievable only at the cost of greater - In general, the analyst will look for inequalities in the distribution of economic behavior consistent with income, or can a lessening of agents trying to get around a income disparities contribute to constraint higher growth rates? 6. Do the poor benefit from growth, and does this depend on the type of  growth a developing country Gini Coefficient experiences? What might be done to Statistical measure that paints a picture of help the poor benefit more? the gap between the richest and poorest in 7. What is it about extreme inequality a country’s income or wealth. that is so harmful to economic development? Lorenz Curve 8. What kinds of policies are required to reduce the magnitude and extent of absolute poverty? 9. What has been learned about the psychological dimensions of poverty, and how can this research help us design and implement more effective poverty programmes? Desirable properties for measures of relative inequality The Lorenz curve show the actual Anonymity: quantitative relationship between the Should not depend on who has higher percentage of income recipients and th income; whether we believe the rich or poor percentage of the total income recipients to be good or bad people and the percental of total income they received during a given year. Scale independence: Inequality measures should not depend on The 45 degree line indicates complete the size of the economy, we want a equality. The curve is indicative of equity - measure of income dispersion, not its the closer to the 45 degree line, the more magnitude equitablevice versa. Population Independence Principle - The greater the curvature of the Inequality should not be based on the Lorenz line, the greater the relative number of income recipients. degree of inequality Transfer Principle All other incomes constant, if transfer income from a richer to a poorer person relating in a new income distribution that is more equal  3. Monotonicity a. If you add income to someone below the poverty line, all incomes constant, poverty falls 4. Distributional Sensitivity a. If you transfer income from a poor person to a richer person, the resulting economy shouldbe strictly poorer. To get the Gini Coefficient, you need to Government has a goal to make poverty solve for area A (through integration) and incidence single digit but that is immaterial divide that by the area of BCD. That will because it does not have all the ideal give you a fraction between 0 and 1. properties. Kuznets Inverted-U Hypothsis (Research Focus Principle (Amartya Sen) Potential) A good poverty measure will be based only When there is economic growth, it is natural on the incomes (wellbeing) of the poor, not to have greater inequality because growth the non-poor will be driven primarily by the productive sector. Measuring Absolute poverty Headcount index: H/N Where H is the number of persons who are poor and N is the total number of people in the economy; H/N is the fraction who are poor. Does not meet desirably properties and accordingly is likely to cause incentive problems Unintended policy incentives for using After a period of time, the Gini coefficient headcount measures will go back down as income is redistributed within the economy. When agencies are told that their missions include poverty reduction, it creastes an Desirable Properties for Poverty incentive to report improvements based on Measures headcounts Ideal Properties 1. Anonymity 2. Population Independence Circumstantial evidence The Measure lies between 0 and 1 and - Incumbent politicians frame poverty therefore is useful when we want a unitless progress in terms of headcount or measure of the gap to compare with other fraction – staff would anticipate and countries. want favorable results - by this measure - to report Foster-Greer-Thorbecke (FGT) Index: - Government policy exhibits “urban bias,” e.g. emphasizing job creation 1 𝐻 𝑌𝑝−𝑌𝑖 𝑎 for the poor in cities - who are closer 𝑃𝑎 = 𝑁 ∑ ( 𝑌𝑝 ) 𝑖=1 to the poverty line - Reports: NGOs work near main N is the number of persons, H is the number roads, or district towns, of poor persons, and 𝑎 ≥ 0 is a parameter easier-to-reach; if so, people assisted are less poor on average – When 𝑎 = 0 , we get the headcount index MFIs have focused commonly on the measure richest of the poor When 𝑎 = 2, we get the "𝑃2" measure - The MDG of “halving poverty” sent a signal: regions and countries compared in UN reports on this measure, without mention of P2 or usually to any other indicator Total Poverty Gap 𝐻 TPG = ∑ (𝑌𝑝 − 𝑌𝑖) 𝑖=1 Where: 𝑌𝑝 is the absolute poverty line 𝑌𝑖 is the income of ith person Average Poverty Gap 𝑇𝑃𝐺 APG = 𝑁 Where: N is the number of persons in the economy