Poverty and Inequality
This chapter will consider the economics behind poverty and income inequality. Poverty could be described as a state of being poor, having an insufficient amount of a ‘good’such as income. Inequality relates to a difference in circumstances such as the incomes of the richest in comparison with the poorest. Inequality in itself does not suggest poverty.
For economic inequality, the main metric is the disparity in wealth distribution across society. The GINI Coefficient, which uses statistical dispersion to show the distribution of wealth between a country’s citizens. Inequality can be caused by employment and associated wage factors, with some sectors attracting higher remuneration than others. This is a reflection of the relative contribution of labour to the overall profitability of the business and the balance between the supply and demand for different skills, experience and qualifications. Another driver of inequality has been the increase in the asset values such as housing, which is generally held by older citizens with current prices excluding younger buyers.
The Lorenz Curve can be used to show the extent of income inequality within a country, allowing suitable comparisons to be made over time. The example in Diagram 1 shows how that in 2011, 20% of the population only held a 5% share of total national income and that their position has worsened since 1980.
The concept of poverty can be quite broad and subjective, but the World Bank takes an income approach considering anyone earning less than $1.90 per day as being in poverty. However, such a metric obviously depends on the cost of living in each country and factors such as inflation: someone earning $1.90 in the USA may be considered much poorer in relative terms than someone in the Democratic Republic of Congo. Ultimately, if wages do not keep pace with price increases in the economy concerned then living standards will decrease.
Relative poverty can be seen when the average income is below a certain level, such as stating that anyone earning less than 50% of the national average income is living in poverty. Economic growth could decrease relative poverty by providing the conditions for greater employment and higher wages, but if this growth is unequal across society then it could exacerbate the income inequality that exists (it could be argued that this is the situation presented in Diagram 1).
Absolute poverty is when incomes are below the level needed to maintain a basic standard of living so that people cannot afford to eat, keep warm or have adequate shelter. Economic growth should decrease absolute poverty by increasing incomes (providing that the population concerned is able to move to areas of improving employment opportunities), although those concerned may remain in relative poverty.
The poverty line denotes the number of people who fall below a designated income in relation to an agreed demographic. Diagram 2 shows the poverty line for the US, based on those with a combined income of less than $24.339 for a family of two adults and two children:
(US Census Report, 2016)
Poverty is clearly not constrained to less developed countries and therefore also exists in the world’s richest countries. To address this, economic development approaches must be sustainable, balanced and have a long-term focus to both increase growth and productivity to address poverty concerns. Increased productivity would ensure that workers earn more for the business, allowing the business to pay them more.
Economic Growth may reduce poverty and income inequality if:
- It provides accessible employment opportunities.
- The wages of the lowest paid rise faster than those of the highest paid.
- Minimum wage levels are increased.
- The Government provides social security payments to support the poorest members of society (e.g. unemployment benefits, sickness pay and pensions).
- Economic growth creates opportunities for the lowest paid workers.
Economic Growth may not reduce poverty and income inequality if:
- Key opportunities are created mainly for those who are highly-skilled and educated, meaning that the poorest do not benefit. This could increase inequality.
- There is an increased number of part-time/ flexible roles in the economy, which may not provide the security needed for workers to be guaranteed a set wage.
- Increases in welfare benefits are linked to indices that do not support the poorest in society e.g. if linked to inflation and wage growth is higher than inequality will increase.
From this, it can be seen that economic growth in isolation will not resolve income inequality, poverty and employment issues.
A poverty trap occurs when poverty persists from generation to generation and is reinforced unless positive action is taken to address it. Such a situation is created when an economic system requires a significant amount of various forms of capital to earn enough to escape poverty. When individuals lack this capital and find it difficult to acquire it, the cycle becomes self-reinforcing.
To overcome poverty, many countries have put in place policies designed to act as a safety net. These can include unemployment benefits, pensions, income support for those with children, social housing provision and disability/sickness payments for those who cannot work.
A vital component of any poverty reduction plan is sustainable economic growth, providing the country with more jobs, and higher incomes for workers. The focus should be on providing workers with long-term increases in income coupled with job security. The Solow Growth Model argues that long-term economic growth can only be supported by either an expansion of the labour force or increased productivity from workers. However, even with this dynamic, relative poverty in the economy may increase.
Barriers exist which may prevent some workers from benefitting from such growth such as an inability to access the training and education needed to secure employment in the roles offered. Also, the ability to increase productivity will depend on the industry in which the worker is in - for example, increased productivity through automation may actually reduce employment opportunities.
When considering sustainable development, external environmental factors must also be addressed. Major development in one area of the economy can actually increase poverty and income inequality in other sectors and regions. For example, oil extraction and exploitation in some countries may have increased overall GDP, but this may be at the expense of significant pollution which destroys the income base of rural/agricultural workers. This has been described as the ‘Tragedy of the Commons’, an economic theory which considers how one self-interested actor in the economy can deplete/ spoil the resource for all other actors (Forster Lloyd, 1833). Externalities - where a cost or benefit arises that affects a party not directly involved in the decision or activity - must be considered.
The Marginal Abatement Cost (MAC) refers to the cost of reducing one unit of pollution. Taxation methods are used to take forward regulation and legislation designed to overcome the damage caused by pollution. Such taxes increase business costs, encouraging them to be less polluting in order to remain competitive. This can be seen as important in addressing poverty and income inequality, as improved corporate social responsibility reduces the risk of poorer communities being adversely affected by business operations.
The Coase theorem assumes that under perfectly competitive markets with zero transaction costs an efficient set of inputs/ outputs are selected regardless of how property rights are divided. When property rights are involved in the process, then the parties will move towards a mutually beneficial and efficient outcome. One party may offer funds to another party to compensate for the activities they undertake, thereby minimising income inequality.
However, the operating environment is shaped by regulation and legislation which can both support and undermine this model. For example, people adversely affected by urban development may be entitled to statutory compensation in order to maintain their income levels and quality of life. Some countries require developers to support the funding of social infrastructure (e.g. roads, street lighting, community centres and public transport) as a part of planning approval in order to ensure that all elements of society receive some benefit from the investment undertaken. Unfortunately, such mechanisms may not always be applied effectively and may not even exist in some countries.
Governments are able to intervene in markets in order to try and address wage and income inequality. In the UK, the introduction of the National Minimum Wage seeks to increase the income of the lowest paid workers by legislating for increases that are above the rate of inflation. Measures have also been taken to highlight wage disparity within businesses (through increased transparency in corporate reporting) in order to increase stakeholder and shareholder pressures when those at the top of a company earn incomes that far exceed the wage levels of their poorest workers. Other policies include increasing access to training and education opportunities for unemployed workers, incentives to businesses to invest in more deprived areas and locating public sector employment opportunities in areas with fewer private sector enterprises.
Migration can reduce global inequality and poverty. In the EU, many of the newer members have been able to increase access to work for their populations whilst also addressing skills shortages in other nations. Whilst such migration can be seen as mutually beneficial, it can be argued that those countries experiencing most labour immigration can experienced depressed wage rates (due to economic disparities between countries) which could increase poverty and income inequality. Also, such migration can increase skills shortages in some countries as key workers look to secure more lucrative opportunities elsewhere. When these workers are education or medical professionals, this could exacerbate the nature of the poverty trap being experienced by some citizens in the country ‘exporting’ this labour.
Ultimately, migration increases the pool of labour and increases competitiveness. It supports the evolution of business clusters (a geographical concentration of interconnected businesses) which can increase productivity (e.g. London as an international financial centre).
Poverty can be considered in absolute or relative terms. Relative poverty considers national or regional comparisons and considers specific income levels deemed acceptable whilst absolute poverty considers when it is impossible to meet basic needs such as food, shelter and heating. Poverty traps can develop, particularly when large sectors of society have limited access to financial capital or other assets.
Economic growth can reduce absolute poverty, but it may not necessarily reduce relative poverty and can actually increase income inequality. To reduce relative poverty, the wages of those earning the least need to increase faster than the national average. Government policies and associated legislation and regulation can help to address these issues, such as the establishment of a welfare system and setting minimum wage requirements.
Productivity is a key factor in addressing poverty and income inequality. Essentially, a more productive worker should be able to secure a higher wage. Again, Government policies can support this aspiration (such as increasing access to training and education), but capital investment and market access is also required. Migration may also prove beneficial, both in terms of increasing productivity and addressing access to employment opportunities.
Overcoming income inequality may be harder than poverty given the control that a small proportion of the country has over a larger proportion of assets in that country. Also, actions taken to secure economic growth and development may not necessarily benefit all elements of society and issues such as pollution can increase income inequality and poverty for those affected.
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