Week 9: Poverty, Inequality, and Economic Development

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Week 9: Wednesday• Why are some countries rich and others poor? What can governments do to

address problems of economic development in poor countries? (finish up on policy responses next week)

• Case of Mexico: how to explain its economic performance?

• “Political Economy Forum” podcast “Victor Menaldo: The End of Capitalism” & “Asli Cansunar: Economic Perceptions and Policy Preferences”

• Quiz section: discuss Mexico

• Discussion questions due Friday

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What about Inequality?• Poverty is an absolute measure:

• Measures of inequality--or the distribution of income and assets--are relative… Gini index

• They capture the income of some individual or group compared to others (across countries, groups within a country, individuals within a group, etc.)

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Inequality of What?• As with our discussion of poverty, the measurement and analysis of inequality

need not be limited to income but can include: • Inequality of assets or wealth

• Inequality in the distribution of services (and related opportunities)

• Inequality in health, education or other physical quality-of-life measures or outcomes

• One thing we know about regimes and how they distribute – not going to be perfectly equal across most democratic and non-democratic regime types; lots of “favoritism” and biases in terms of how distribution occurs to ensure regime survival (ethnicity)

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Inequality: the Old Wisdom & Modernization• Is inequality necessarily bad for growth?

• Old Wisdom:

- the early stages of growth are (inevitably) associated with rising inequality…

- …as workers are pulled out of low-productivity, low-wage agriculture into higher-productivity modern sector employment

• Rising inequality and falling poverty can coexist

• But over time, inequality will then fall because• More and more workers pulled out of agriculture into the modern sector

(industrialization) growth will raise all incomes

• Welfare states emerge that equalize income through transfers to poorer citizens (unemployment insurance, food stamps, housing or energy subsidies, disability insurance, social security and pensions) but only after industrialization 5

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New Views of Inequality• How well do people even understand levels of inequality and distribution of income?

(Cansunar podcast – people misperceive themselves relative to others and therefore they often support policies in surprising ways – eg, otherwise rich people want to tax the rich)

• Inequality does not “naturally” go away; countries continue to differ

• More unequal countries appear to grow less rapidly than more equal ones…

• Why does this happen? Mechanisms in dispute, but perhaps:• Inequality in income and (other) assets is associated with unequal investment in human capital

(particularly education) and inequality in other government services that lowers growth• Inequality biases political processes in ways that are not only unfair, but also inefficient (think about

“who distributes”) and continue to favor some and not others• Large transfers to the wealthy, like tax cuts, do not “trickle down” to the middle and lower ends of

income distribution• Inequality breeds social and political resentments that reduce investment or even outright conflict

So who governs? could have big implications for inequality, poverty, and growth!

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Growth: Convergence and Divergence in the World

• “The rich are getting richer and the poor are getting poorer” – is this true?

• Modern world: growth of free(er) markets and liberalism/capitalism (for more definition, Menaldo podcast)

• Can’t only look at national measures, but also the world distribution of income• The distribution of income across countries: the concepts of convergence and

divergence

• Are differences in incomes across countries getting narrower (convergence) or wider (divergence)?

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Global Growth Over the Very Long Run(Annual average per capita GDP)

1-1000 CE 0.00

1000-1500 0.05

1500-1820 0.05

1820-1870 0.54

1870-1913 1.30

1913-1950 0.88

1950-1973 2.92

1973-2001 1.41 9

Per Capita GDP: 1820-2001 (1990 Dollars)

0

5,000

10,000

15,000

20,000

25,000

30,000

1820 1870 1913 1950 1973 2001

0

5,000

10,000

15,000

20,000

25,000

30,000

Western Europe

Latin America

Africa

World

Japan

US

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“Divergence, Big Time”

1870 1960 1990

Per capita income of

US

2063 9895 18054

Per capita of 17

advanced capitalist

countries

1757 6689 14845

Average of

developing countries

740 1579 3296

Per capita income of

poorest country

250 (estimated as

lower bound)

257 (Ethiopia) 399 (Chad)

Ratio, US to poorest 8.7 38.5 45.2

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Divergence or Convergence: the Long Run• Over the very long-run, we see a process of “divergence, big time”

• Divergence is the result of very long-run historical processes

• In rich countries, industrialization, free markets, capitalism (Menaldo podcast)

• In the poor countries, factors that inhibited a similar transition or “poverty traps” (often planned economies, too much govtintervention, cronyism/mercantilism)

• Small differences matter: a country that starts at $250 GDP per capita and grows 100 years at

• 1 percent, $676;

• 3 percent, $4804;

• 5 percent, $32,875. 12

Global Poverty• The growth of free markets in the modern world is associated with massive

gains in human betterment (including income) overall (Menaldo podcast on thinkers who review this; GDP by a factor of 30 from 1820, or 2,990% increase, doubling of income every few decades)

• Poverty does remain in some regions, countries, or for some people

• Poverty has declined because of overall growth during recent decades…

• But most of this has to do with the economic performance of India and China

• Other regions have not fared as well, but in general, things are improving…

• Modern political economist do not just attribute this to democracy on its own, but also liberalism/capitalism (“sustained modern growth” per Menaldo)

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Trends in Absolute Poverty 1981-2005:

Headcount Index

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What to Know on Economic Growth• The growth-poverty nexus: growth leads to a reduction in poverty that appears strong

across most countries…

• Differences in growth explain “divergence big time” and aggregate reduction in world poverty

• But relationship is not perfect

• In some countries, incomes of poor grow more rapidly, implying falling inequality, particularly where government pursue aggressive policies on employment and/or wages (Seattle’s minimum wage debate)

• In some countries, incomes of poor grow more slowly than average incomes, implying worsening inequality (but still growth, eg Mexico)

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Growth Theory: the Basics

• GDP as output (think of a factory or farm): what will make it grow?

• The proximate causes: capital, labor, and technology (economic endowments)

1) Capital.

• Investment takes place in more--and/or better--physical capital (plant and equipment, machines)

• For poor, can be something “small” like a wheelbarrow, sewing machine or inventory (and can help make the use of land more productive)

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Growth Theory2) Labor

• The quantity of hours worked increases (through labor force growth or participation)

• The quality of labor improves (through investment in education and training or experience, low skill vs. high skill): human capital

3) Technology• Innovation: we discover new processes/techniques for making existing

products…

• …and develop altogether new ones (Schumpeter, Menaldo)

• We become more productive in translating inputs into outputs

• First, Second, Third and now “Fourth” Industrial Revolution per Menaldo?

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Growth Theory: the Puzzle • But why does investment in physical and human capital and innovation

vary across countries?

• Factors driving economic growth (or stagnation=a lack of growth):

• Natural resources and physical location (“landlocked” vs. sea access)

• How productive is the land

• Population

• Institutions (“governance” and policies: why do some countries adopt more liberal or less liberal policies?)

• Poverty traps: the extreme poor cases that never seem to grow

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I. Resource Endowments and Geography• Natural resource abundance leads to higher growth

• Sachs and Warner (1995) first test idea• indicator is share of natural resources exports/GDP

• they find negatively correlated with growth, so resources bad?

• “Resource curse” examples• Richly endowed: Nigeria, Ghana, Iran, Burma, Argentina, Venezuela, Mexico

• Poorly endowed: small European economies, Korea, Taiwan, Hong Kong, Singapore

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Resource Endowments• Why? Economics and politics both matter!

• The discovery of natural resources can create booms that distort patterns of investment: investment in resources vs. other sectors, including manufacturing

• Natural resource rich countries have lower tax bases, governments are therefore less accountable and more corrupt, also problem of currency distortions by a single export commodity (“Dutch Disease”)

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Resource Endowments and Geography• But the issue might not be resource abundance but underlying geography

• Landlocked countries face particular problems, “bad neighbors”

• Bad Neighbors for Mexico?

• Mountainous countries and also those with few navigable rivers or natural harbors (Afghanistan!)

• From equator to 30 degrees latitude incomes are lower than North of 40 degrees latitude…

• …with global warming/climate change making it worse…. (although this has not been true historically, Europe vs. Africa in the 15th century)

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Gray: arid. Red and orange are very high and high vulnerability 22

Policy Issues• For resource curse

• Managing natural resource price fluctuations through savings

• Improving “governance”

• The “Norway” miracle of investing national income from oil back into social safety net (Alaska cuts everyone a check!)

• How has Mexico managed resources? What is a “curse” and can it be overcome?

• For countries in vulnerable climates• The importance of investment in land management, irrigation, and crop

varietals that are more hardy

• Resettlement: the island countries (Maldives is sinking!), Lake Chad basin

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II. Population: the “Malthusian Catastrophe”• As GDP growth occurs (good crops growing), population also rises pushing income

per capita back down toward subsistence (good crops consumed by more people)…

• Famines and constraints on resources ultimately reduce population…and (perversely) push average incomes back up (“boom/bust” cycle)

• A stable—low income—equilibrium: zero-income growth and stable population size prior to late middle-ages / early modern period

• Only in modern world have income and population both appeared to grow together, but this is historical precedent (and population may be slowing again!)

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Population• Higher population at a given GDP obviously means lower per capita GDP (by

arithmetic);• But does higher population growth mean lower economic growth? • Widely studied

• For 1945-1980 no relationship, with perhaps some small negative effects 1980-present

• What is going on?

• Complex dynamics between economic growth and population growth• contra Malthus, as GDP increases (over some threshold) family size goes down

rather than up• …the so-called “demographic transition” (look at Mexico on next slide)

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The Demographic Transition

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Population

• Population growth might be good

• Population and labor force growth can contribute to economic growth (per simple growth models),

• if population can be absorbed into productive employment, for example, in non-Malthusian societies with ongoing technological innovation

• If population does not push against local resource constraints

• Large concentrations of population--for example in cities and urban civilizations--appear to be associated with innovation (the genius principle, Seattle!)

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Population• If aggregate population is not associated with growth one way or the other,

family size may still affect poverty

• Low income households have larger average family sizes, which can:

• Place burdens on mothers

• Reduce resources available for children

• Create localized environmental stress, for example on commons (land, water, fisheries)

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Policy Issues• Availability of family planning and contraception

• Fertility appears to fall with: • Access to primary health care as well as family planning

• Basic education, and particularly of women and girls

• Social insurance with respect to sickness and old age (children as insurance)

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III. Institutions and Governance• In last 20 years, a shift in attention from government policy to institutions of

government and which institutional matrix more likely produces the best policy environment

• A function of “inputs” (taxation, regulation, other instruments) and “outputs” (how the government spends, redistributes wealth/resources)

• Sustainable development goals: look at world economy, global society, and physical environment: SDGs socially inclusive and environmentally sustainable economic growth requires “good governance” at local, national, and international level

• Good governance: the problem of circularity• Countries that do well are “well-governed” (think about “who governs?”)• Good governance: strong rule of law, low corruption (are often already rich?)• “Boom” and “bust” of good/bad governance in Mexico? Is that “lagging” or

“leading” economic indicator?

• Two possibilities• property and contracting rights, often called “rule of law”, rules that protect

investments and investors (includes business, workers, individuals), key to liberalism• Democracy! Yup, we’re back! Democracy and capitalism/liberalism go hand in hand

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Property Rights and Growth• Property rights: the ability of individuals to use, transfer and reap returns on

property (are these secure in Mexico? For whom?)

• Contracting rights: ability to enforce contracts (are these secure in Mexico? For whom?)

• Violations of property rights from:• Expropriation by governments (nationalization, confiscatory taxation): the

predatory state (Mexico?), violation of liberalism!• Corruption/waste (ahem!)• Crime and extortion (seriously?)• Weak legal protections: police and courts that don’t function (hello!)

• Growth will be higher if individuals can reap the gains from investments and risks that they take requires secure property rights (who in Mexico has em?)

• Therefore, lack of growth may be *not enough liberalism* as too much of free markets

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Property Rights and the Poor• Does strong enforcement of property favor only the rich and those that

have property and large amounts of capital? Is liberalism just a rigged game?

• Not necessarily!• The poor are adversely affected by weak property rights, too, for example land

tenure and housing in urban slums (Mexico)

• The poor are also adversely affected by lack of contracting rights and ability to engage in small business (including access to credit)

• The poor do not have access to justice: predatory police and lack of access to courts and dispute settlement (Mexico)

• The rich can get richer while the poor also get richer (Mexico?)

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Property Rights• Macro evidence

• Countries with better property rights grow more rapidly

• …with interesting exceptions such as China

• Micro evidence

• Granting squatters/slum dwellers property rights, then comparing investment, work, income, health, and other outcomes leaders to higher income and reductions in poverty

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Democracy and Growth• Does democracy lead to higher growth via liberal economic policies? The

“electoral connection” may create conditions that are:• Better able to protect property rights

• Better investment in human capital and social services

• Better “social capital” and higher levels of participation

• Does the “electoral connection” operate in Mexico? If so, how?

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Economist Democracy Index 2010Lighter countries, more democratic

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Democracy and Growth • A number of tests, but still debated (remember neo-modernization?)

• But if democracies and authoritarian regimes perform about the same:

- authoritarian regimes adopting liberal policies (eg. China, Saudi Arabia)

- democratic consolidation much more likely in rich countries

- the range of performance is much wider in authoritarian regimes:

• “miracles” such as China, Korea and Taiwan (in the 1960s and 1970s)

• But also the worst disasters, such as Haiti, Romania, Zaire, Cambodia, North Korea

• What of “hybrid” regimes (like Mexico under the PRI)

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Summary on Growth• Growth is important in alleviating poverty in any given economy

• And differences in growth rates over time are an important determinant of the distribution of income across countries (divergence or inter-country income inequality)

• Many factors could increase or decrease growth – from physical endowments, to features of the population, to political institutions and regime type, not just one factor

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Questions?

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