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Lecture 5 Inequality and Poverty Reduction:
Social Objectives and Policy Options
Course on Poverty and Inequality Analysis
Module 5: Inequality and Pro-Poor Growth
Francisco H. G. Ferreira
DECRG
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Roadmap
1. Introduction
2. Evidence that Inequality Matters
3. Policy Options
4. Conclusions
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1. IntroductionPoverty vs. Inequality
• Poverty and inequality are different things.
• Poverty measures can be seen as negative social welfare functions, truncated at z. Everyone tends to agree that poverty should be reduced.
• It is less obvious that we ought to pursue inequality reduction for its own sake. Nevertheless, there may be both intrinsic and instrumental reasons why high inequality is undesirable.
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1. IntroductionInequality may be a bad thing for…
• Intrinsic reasons: – Social Welfare Functions may be concave.– Individual welfare may have a relative component.– Inequality of Opportunities may be judged unfair.
• Instrumental reasons:– Inequality Reduces Growth
• Imperfect credit or insurance markets• Political economy malfunctions
– Inequality slows down poverty reduction, even at a given rate of growth
– Inequality leads to more conflict / violence
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1. IntroductionBut inequality may be a good thing because:
- to the extent that outcomes differ based on effort, it may help provide incentives for greater effort and output, i.e. more efficiency.
- If policies aimed at reducing it have high costs in terms of disincentives to:
- Work- Accumulate capital, physical or human
- Either because returns are lower (taxation)- Or because property rights have become uncertain
(expropriation)
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1. IntroductionUtilitarianism with Concave Social Welfare Functions
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The FOCs imply that:
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But note: this result does not include any incentive effects, in the shape of incentive compatibility constraints; and assumes identical utility functions.
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1. Introduction A Relative Component in Welfare?
• What if with ?
• Easterlin (1974) – evidence that long-run growth does not measurably improve happiness in rich countries.
• Dupor & Liu (AER 2003), “Jealousy and Equilibrium Overconsumption”.
• Luttmer (QJE, 2005), “Neighbors as Negatives: relative earnings and wellbeing” -- evidence of effect of mean neighborhood income on subjective welfare.
• Kingdon’s evidence on negative effect of racial mean income on subjective welfare in South Africa.
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1. IntroductionBeyond Utilitarianism: Other Legitimate Social
Objectives
Figure 1: Different Choices Along an “Advantage Possibility Frontier”
O 2
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O 1
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Note: Figure 1 is a reproduction of Box Figure 4.1 in WDR 2006 and, as acknowledged there, is drawn
from Buchanan (1976), through Atkinson and Stiglitz (1980).
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1. IntroductionInequality of Opportunities
• What if inequality in outcomes were not what people objected to, but inequality in opportunities?
• Dworkin (1981), Roemer (1998), WDR 2006.• Outcomes are a function of circumstances and efforts: y = y (c, e).
Society ought to ensure a level playing field, so that across types (defined by exogenous circumstances):
• In fact, since levels matter too, and taking into account an aversion of extreme deprivation in outcomes, the WDR 2006 proposes something like:
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subject to
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2. Evidence that Inequality MattersCursory Evidence on Perceptions of Fairness
Figure 1 .2: P erceptions of fa irness of the incom e d istribution in Latin Am erica
0% 20% 40% 60% 80% 100%
Venezue la
U ruguay
Peru
Paraguay
Panam a
N icaragua
M exico
H onduras
G uatem ala
E l Sa lvador
Ecuador
C osta R ica
C olom bia
C hile
B razil
Bo liv ia
A rgentina
Average
Very fa ir Fair U nfa ir Very unfa ir
* Source: Latinbarom eter (2001). R esponses to the question: "D o you th ink that the incom e distribution is … ?"
See also experimental evidence that people value fairness per se. E.g. Fehr and Schmidt (QJE, 1999), Fehr and Gachter (AER, 2000)
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2. Evidence that Inequality MattersBasic opportunities are very unequally distributed
Source: WDR 2006
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2. Evidence that Inequality MattersUnequal opportunities often lead to wasted
productive potential
1. The risk-adjusted opportunity cost of capital is often higher for poorer entrepreneurs (WDR 2006, Ch. 5).
2. Adopting lucrative innovations often has an initial cost that, in the absence of functioning capital markets, may discourage the poor from taking advantage of them. (e.g. pineapple cultivation in Ghana, Goldstein and Udry, 1999).
3. Stigma may lead to underperformance by subordinate groups (e.g. Hoff and Pandey, 2004).
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2. Evidence that Inequality Matters This may be reflected in reduced-form relationships
between asset inequality and growth.
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2. Evidence that Inequality Matters Even for a given growth rate, income inequality
hampers poverty reduction.
Source: WDR 2006
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3. Policy OptionsClarity on objectives and constraints
• Alternative policy objectives:– To reduce poverty.– To maximize the opportunities of the least
advantaged group (“leveling the playing field”)
• Policy Constraints:– Budget constraints.– Administrative capacity constraints.– Participation and incentive compatibility (i.e.
“incentive” constraints).– Ethical or political policy choice constraints.
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Individual traits and preferences: tastes, talents, efforts, …
Endowments: Wealth, land, social group, family background,…
Outcomes: income, consumption, health, environment,…
Process: investment, schooling, market transactions, political process.
Opportunities
3. Policy OptionsOpportunities and socio-economic processes.
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3. Policy OptionsPolicy “entry points”
Box 1: Schematic Representation of Household Income Determination I (Z, w)
Investment in Human Capital P (X, Z, w) V(J) The Matching Function
D( p(X, Z, J), X, Z, J, w) Remuneration in the Labor Market G(, w) Household Formation
F(y) Redistribution H(y+t)
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3. Policy OptionsPolicies for Human Development (i)
Mental development of undersized children (low height for age):
The Jamaican Study
Source: Grantham-McGregor et al., 1991.
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3. Policy OptionsPolicies for Human Development (ii)
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3. Policy OptionsAccess to titled land (and functioning land
markets)
Source: WDR 2006
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3. Policy OptionsProgressive provision of access to
infrastructure and other government services.
Water sources and water price in Niger
Source: WDR 2006
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3. Policy OptionsThe incidence of public expenditures varies
dramatically across programs.
PROGRESA school
PROGRESA food
Health (SSA)
Primary education
Lower sec. education
School breakf. (DIF)
PROCAMPO
Tortilla (FIDELIST)
ALL (excl. Pensions)
Upper secondary education
Milk subsidy (LICONSA)
Active workers (IMSS)
Health (IMSS)
Electricity Subsidy
Tertiary education
Health (ISSSTE)
Active workers (ISSSTE)
Pensioners (IMSS)
GINI
Pensioners (ISSSTE)
-0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6
Concentration coefficients for programs in Mexico.
Source: de Ferranti et. al., 2004
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3. Policy OptionsFairness in Markets (i)
• Between the “extremes” of redistributing assets (ex ante) and incomes (ex post), there lies the realm of markets and institutions.
– Eliminate discrimination.– Combat segmentation.– Reduce barriers to entry.– With the exception of labor markets, where monopsony
arguments apply with special force, competition on the supply side is likely to be both equitable and efficient.
– Always mind the impact of policies on individual incentives to participate and produce.
– The distribution of power matters for how institutions work.
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3. Policy OptionsFairness in Markets (ii)
Subject to some basic principles, very different institutional designs are consistent with similar performance.
Source: WDR 2006
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3. Policy OptionsRedistribution of Incomes
• Social security systems generally much larger than social assistance in LDCs. – SSS typically ‘truncated’, reaching only formal sector
workers and excluding most of the poor.– In a context where labor productivity may be very low,
worry about disincentive effects.
• Conditional cash transfers (CCTs) have proved successful in negotiating both issues:– Targeted to poor families (means-tested)– Conditional on specific behavior by household members
(usually some investment in human capital, such as school attendance or child care)
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3. Policy OptionsRedistribution of Incomes: CCTs
– Examples:• Bolsa Família (Brazil)• Oportunidades (Mexico)• Cash for Education (Bangladesh)• PRAF (Honduras)• RPS (Nicaragua)• Familias en Acción (Colombia)
Figure 5-3: Distribution of eligible households by deciles and quintiles of income
decile PRAF
(Honduras) RPS
(Nicaragua) PROGRESA
(Mexico) SUF
(Chile) FFE
(Bangladesh)
1 22.1 32.6 22 2 42.5 55 39.5 67
3 66.9 70.2 51.9 4 79.5 80.9 62.4 88.8 48
5 88.6 89.6 70.9 6 93.5 94.3 80.5 97.2 7 97 97.1 87.8 8 97.3 99.1 93 99.8 9 97.7 99.8 98
10 100 100 100 100 100
Source: Coady & Morley (2002)
Incidence
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3. Policy OptionsRedistribution of Incomes: CCTs
• Impacts on Education
Program Program effect Age rangeMexico (PROGRESA-Oportunidades: rural areas)
2.7
(11.1)
1st-5th grade at baseline
(6th grade)
Nicaragua: RPS 17.7 Age 7-13
Honduras: PRAF 3.3 Age 6-12
Ecuador: BDH 10.0 Age 6-17
Colombia: Familias en Accion
2.1
(5.6)
Age 8-13
(age 14-17)
Brazil: Bolsa Escola 3.0 Age 10-15
Cambodia: Scholarships for girls
22-33 Secondary school
Bangladesh: stipends for girls
12.0 7th grade at baseline
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3. Policy OptionsThe international arena also matters.
• Trade: less distortion by rich countries
• Migration: greater scope for labor mobility
• Intellectual Property Rights: innovative solutions
• Aid: greater volume and effectiveness, fewer ties.
• Global Commons
Source: Lanjouw, 2004.
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4. Conclusions
• Public action should aim to level the playing field, by expanding access to opportunity to the least advantaged.
– Maximin in the space of opportunities implies growth with equity.
– Human freedoms are the paramount objectives of development.
– Individual incentives matter greatly. To attain prosperity, equity must be pursued within a framework of functioning markets.
– Efficiency – equity trade offs exist, but may be less pronounced when all the long-term benefits of fairness are recognized.