Effect of Economic Growth on Poverty

Dissertation Brief

1. Significance of Problem

Economic growth is often considered one of the most effective tools for reducing poverty (Masato Hayashikawa, 2009). The prominent example is China. It has been estimated that more than 500 million people lifted out of poverty during the past 30 years while the country is having annual growth rate around 10% (World Bank, 2013a). However, it is the case only if the poor can get some benefits from this growth. There are quite a few counterexamples of countries with relatively high growth rate but the poor do not benefit much from economic growth such as in Philippines or in some African countries (Gyimah-brempong, 2002; Internasyonal, 2012). Instead, only few elites would receive most of the benefit in this case.

It is undeniable that the decrease in poverty is good for the welfare of society. Poverty can cause crime, disorders and violence (F. Bourguignon, 2001). Since economic growth can have different effects on poverty reduction, the quality of growth does matter. Growths in some countries are intrinsically pro-poor while others are more pro-rich. In order to know how to make the growth more pro-poor, first we would need to know where the pro-poor growth tends to happen. It would also be useful to learn from the countries that suffer from exclusive growth or growth that only benefit few elites.

In this study, cross-country pattern of distributional effects of economic growth will be determined. In order to see which region has the most to the least pro-poor growth, the regression of poverty on economic growth and additional determinants of poverty will be conducted. Then, there will be analysis and comparisons among regions looking at what explain this pattern of pro-poor growth in different regions.

2. Research Objective

The objectives of the research paper are to

• Understand more complete implications of poverty and growth
• Identify determinants of poverty and their relationship with poverty
• Find out how pro-poor the growth is in each region by using panel data to analyze the effect of growth on poverty reduction.
• Find some pattern of pro-poor growth on a global scale
• Analyze and compare pro-poor growth in different regions and look for some explanations on factors that bring about more pro-poor growth than others.

3. Literature review and hypothesis

Even though there are several definitions of the word “pro-poor growth”, it can be broadly defined as the growth that disproportionately increase income of the poor, reduce poverty and inevitably followed by decrease in inequality (Klasen, 2007; Page, 2005; Ravallion, n.d.). The basic intuition of creating pro-poor growth is that the economic growth should be induced in the sectors where poor people work such as in agriculture or to where they live (Klasen, 2007). In practice, nonetheless, it is more difficult to bring economic growth to those areas or sectors as they tend to be less productive than their rich counterparts. Thus, some people have proposed to maximized economic growth with redistribution through taxation and benefit transfers. This proposed measure would also work if transfer system is efficient; significant and does not reduce incentive for people to work which are quite difficult in many countries.

However, the effect of growth on poverty depends on various factors. According to one study (Ravallion, n.d.), initial inequality and changing income distribution are 2 main factors causing different effects of economic growth on poverty reduction. Given a certain positive growth rate, if the initial inequality is high, the benefit from growth to the poor is likely to be low. On the other hand, if there is a recession, high initial inequality would mean that the poor is expected to be less affected. The changing income distribution can also influence inequality and poverty reduction. In many developing countries, the geographic and sectorial growth underlies the changes in distribution. (Ravallion, n.d.).

In this study, we will look at the effect of growth on poverty by using panel data analysis and see which countries have growth that are relatively pro-poor. In order to examine this, the dependent variable is poverty headcount ratio at national poverty line (percentage of population) as a proxy for poverty and the required independent variable is the economic growth. Furthermore, the additional determinants of poverty are needed to avoid omitted variable bias. One empirical study (Tsai, 2006) has proposed 4 main economic and non-economic determinants of poverty in developing countries, namely 1) economic development and openness 2) geographical and demographical factors 3) good governance and war 4) social protection and human capital. However, this paper will use panel data analysis, the factors that fix overtime such as geographical variables will be eliminated. The main related variables that will be used in this paper are reviewed as following.

Effect of growth on poverty

Economic growth is overwhelmingly considered to be good for poverty reduction (François Bourguignon, 2003; OECD, n.d.; Roemer & Gugerty, 1997). Without positive economic growth, we cannot expect to see poverty reduction (Ravallion, n.d.).Growth and poverty have a negative relationship. More growth would bring about decrease in poverty. However, the issue depends on how significant is the effect of growth to poverty or how pro-poor the growth is. This is the main research question of this study on cross-countries data over a certain period of time.

Effect of trade openness on poverty

Trade openness is calculated by trade (sum of exports and imports) to GDP ratio (OECD, 2011). It is often used to measure the important of international transaction and degree of openness of the economy. Generally, international trade is considered to be beneficial for country’s development and reduce poverty. Since trading with the global market can reduce the price of consumer goods and create new economic opportunities (Masato Hayashikawa, 2009), it is normally perceived as a welfare enhancement mechanism. This is the reasons why we have World Trade Organization (WTO) to facilitate trade and reduce unnecessary trade barriers.

Effect of demographic factor on poverty

Demographic factors can play an important role on poverty. Malthusian theory of population and recent study have mentioned that if there is a high population growth, it would cause an increase in poverty due to parents having more burden to support bigger family and the living standards tend to decline (Ran Abramitzky & Fabio Braggion, n.d.). This can also be seen in many low-income countries (mainly in Africa) tend to have high population growth and relatively large family size (Cleland et al., 2006).

Effect of good governance on poverty

The effect of good governance on poverty is rather evident. It reflects the efficiency of the government providing public goods, law and order to the country (Nyong’o, 2001). Broadly speaking, this includes the important aspect like corruption and quality of the government. Hence, the good governance should have negative relationship with poverty meaning that the better the country’s governance, the less the poverty should be.

Effect of war and conflict on poverty

Wars and conflicts are bad for the country’s development. Businesses and developments can be disrupted. During the wars or violent conflicts, productive and human capital are often destroyed or wasted (Justino, 2010). This could cause significant increase in poverty especially in the area affected. Therefore, the effect of war on poverty is positive. If there is a rise in war and conflict intensity, it would generally cause to an increase in poverty in the country.

Effect of social protection and human capital enhancement on poverty

Social protection policies and human capital enhancement such as generous social security benefit, universal healthcare and free or easy access to education are generally beneficial to the poor more than the rich (Tsai, 2006). One of the reasons why poor people stay poor is because they lack of opportunities and capitals. Hence, these social protection policies can be very helpful in enhancing equal opportunities for the poor. As the result, the higher level of social protection and human capital enhancement countries have, the lower their level of poverty should be.

4. Scope of research and research question

The coverage of this study is to focus on the effect of growth on poverty in developing countries. This excludes all the OECD countries, small oil-rich countries and small islands because the effect of growth on poverty reduction in those countries should not be comparable to typical developing countries. Moreover, in order to adjust the difference in cost of living in various countries, the relative national poverty line is used. This will help capturing poverty in different countries better than absolute poverty line.

The general consensus regarding economic growth and poverty is that growth have significant effects in reducing poverty (OECD, n.d.; Roemer & Gugerty, 1997). However the effects are different for each countries and regions. Thus, the main question of this study is to find out which geographical group of developing countries has the most and the least effective pro-poor growth and analyze why this region has the more pro-poor growth than others and what they did to bring about their growth.

5. Data and methodology

With the limited data especially on the annual percentage of poor people in each country, the panel data analysis will be conducted. Developing countries will be grouped into 10 regions; North Africa, Sub-Saharan Africa, East Asia, North Asia, West & Central Asia, South & Southeast Asia, Caribbean Islands, Central America, Oceania and South America. Then I will run panel regressions of the Poverty headcount ratio at national poverty line (percentage of population) from World Bank on the growth rate and other various determinants of poverty for countries. Based on literature reviews (Tsai, 2006), the main structure of determinants of poverty could be “1.economic development and openness 2.geographical and demographic disadvantages 3.regime characteristics and war 4.social policy and human capital enhancement.”

Yet, this study will focus on the effect of growth on poverty (Pro-poor growth). Additional to including growth as an dependent variable in this regression, there are some adjustments from the (Tsai, 2006) reviewed regression in order to adapt to this context and for the data availability .

Data on poverty head count ratio at national poverty line as percentage of population (Y) can be retrieved from World Bank. It is the percentage of population under the national poverty line. National poverty line can be calculated from population weighted subgroup from the household surveys (World Bank, 2013b)

Annual GDP growth (X₁) or economic growth is the changes in overall output level of countries which can be retrieved from World Bank.

For openness index (X₂), share of trade (export and import) as percentage of GDP from World Bank will be used as a proxy. This paper will use variable “openness” instead of “Economic development and openness” as it is aligned with standard openness index definition (Alan V. Deardorff, 2010) which captures the importance of international trade of the country. Some aspects of economic development are already captured by economic growth.

Demographic factor will be based on population growth (X₃). The traditional notion since the Malthusian law of population and current population study (McNicoll, 1999) have agreed that high population growth would lead to increase in poverty. Dataset on population growth is available from World Bank data.

Regime characteristics will be captured from The Country Policy and Institutional Assessment(CPIA) qualityof public administration rating (X4) (World Bank, n.d) which is the measurement of public administration efficiency from World Bank rated from 1 (lowest) to 6 (highest).

Battle-relateddeaths (X₅) are the number of people died due to war or battle-related conflict used as proxies of war data from World Bank. This includes all deaths from fighting in battle field, isolated incident, and guerrilla warfare from both militaries and civilians.

Lastly, for social policy and human capital enhancement, The Country Policy and Institutional Assessment(CPIA) building human resources rating (X₆) will be used. It measures the level of public policies and services that affect health and education of the people in the country (World Bank, n.d) rated from 1 (lowest) to 6 (highest)..

To sum up, the regression equation would bePovertyheadcount ratio at nationalpovertyline (Y) = Growth rate (X₁) +openness(X₂) + population growth (X₃)+ CPIAqualityof public administration rating (X₄)+Battle-relateddeaths (X₅)+ CPIA building human resources rating (X₆).

The main result is the coefficients of growth rate of the 10 regions. If the coefficients of growth rate have big influence on the decrease of povertyheadcount ratio at nationalpovertyline, the growth coefficient should be significant with negative sign. The bigger of the absolute value for coefficient of growth rate would mean that the more growth affects percentage of people under poverty line, in other word, growth is more pro-poor (given that it is significant with negative sign and).

References

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