Income Inequality and Poverty

Chapter 18

Poverty is local problem

• Anti-Programs often financed locally

• Relative poverty defined locally

• People tend to congregate by income group

• Interjurisdictional competition may favor high-income people over the poor

•

Poverty defined

• Households maximize utility given constraints– Financial constraints– Lack of time– Imposed by society– Imposed by oneself

• Poverty is insufficient command over resources

Budget constraint for a low-income household

Causes of Poverty

• Side effects of choices of individuals to maximize their utilities– Insufficient human capital– Preference for psychic income

• Myopic behavior of dysfunctional individuals– Drug or alcohol abuse

• Limited opportunities– Poor parents, teen mothers

• Antipoverty programs themselves. – Welfare dependency– Unintended consequences of programs

Income distributions

• Functional distribution: based on allocation of a firm’s revenue– Euler’s theorem: in perfectly competitive

markets, Wage = MRPLabor, Interest=MRPCapital,Land rent =MRPland. Remainder = normal profit

• Size distribution: proportion of income units in each income group

• Income Unit: individual, family, household

Components of Income• Included

– Earned income– Cash transfer payments

• Ignored– Imputed rent (the opportunity cost of living in one’s

own home)– Unearned income (inheritances, insurance payments,

capital gains, household production)– Taxes or in-kind transfers– Regional cost-of-living differences

Appropriate Time Length

• Appropriate time length to measure a flow of income? – Monthly—may be too short (Professors on 9-

month contract on government assistance for 3 months??)

– Annual—may ignore income mobility of entrepreneurs in volatile industries

– Lifetime earnings—may be too long (after funeral)

Measuring income inequality

• Lorenz curve measures the cumulative proportion of the population on the horizontal axis and a cumulative measure of income or wealth on the vertical axis.

• Perfect equality: Lorenz curve is 45° line

• Perfect inequality: Lorenz curve is backward L along horizontal line and right axis

Lorenz curves

Gini Coefficient

• A is the area between the line of perfect equality and the Lorenz curve under study.

• B represents the area below the Lorenz curve but above the curve of complete inequality.

• 0 Gini coefficient 1: – G = 0 for curve of perfect equality (since A = 0).– G = 1 for complete inequality (since B = 0).

BA

AG

Using Gini

• When regions with smallest coefficients are praised, the research implies that equality is optimal.– Incentive for excellence?– Diminishing social marginal utility of income

(Fear that a minority group improves financially at expense of majority)

Setting poverty lines

• Absolute poverty: one is poor if the income is insufficient to cover the most elementary survival needs. – Benefit: can compare the extent of poverty over time or space. – Problem: define “survival need,” – Poverty cut-offs necessary; Being poor is an answer to a

true/false question.

• Relative poverty : arbitrarily defines the lowest percentage of the income distribution or of median income as the poverty line. – A person’s needs are relative to what others in their society

have.

Setting absolute poverty line in U.S.

• Minimum cost of adequately nutritious diet multiplied by 3 to account for all other expenses.

• Problems:– No minimum required caloric intake to fit everyone.– Current surveys show that poor spend lower

proportion of their income on food than before– Components of threshold level of income have not

changed since 1965

• Equivalence scales: the incremental cost of maintaining various sizes of income units.

Equivalence Tables

• Current equivalence tables found at http://www.census.gov/hhes/www/poverty/threshld.html

Defining Relative Need

• Arbitrarily define some proportion of median income as poverty line

• Based on survey of society’s concept of “need.”

Minimum Income

• The Minimum Income Question :• “What do you consider as an absolute minimum

net income for a household such as yours? We should like to know an income amount below which you wouldn’t be able to make ends meet.

• “About ______________ per week/month/year.• Please underline the length of time you refer to.”

Income Evaluation• Income Evaluation Question is worded:• “In the circumstances of your household, which

monthly disposable income would you regard as

Very bad _________

Bad _________

Insufficient _________

Sufficient _________

Good _________

Very good _________

Perception of adult necessities

• One link to the survey is: http://news.bbc.co.uk/2/shared/spl/hi/programmes/more_or_less/transcripts/annex.txt

Poverty indices

• Ideal index has two characteristics– Allows comparisons across space and over time.– A proportionate change in all incomes should not

affect regional cost of living index • Head count: proportion of people living below

the poverty line • Depth of poverty: measures the additional

income necessary to move an income unit up to the poverty line.

• Poverty gap: aggregation of individual differences between each one’s income and the respective poverty line

Measuring the depth of poverty

• Welfare ratio: ratio of family’s income to its poverty threshold

• Income deficit (surplus): how many dollars a family or household’s income is below (above) its poverty threshold

Comparing localities

• Deprivation index measures the size a locality’s disadvantage relative to that of some benchmark (county, state, or nation) that includes that locality.

• No standardized index.

Deprivation Index (Fieldhouse and Tye)

• Group 1:– Lacking access to bath or shower;– Lacking access to an inside toilet;– Living in non-self-contained accommodations.

• Group 2:– Lack of access to car;– Living in a household where no person is in paid work

(reflects lack of resources);– Living in a rented accommodation;– Living in a house with no central heating.

Deprivation Index (Fieldhouse and Tye)

• Group 3:– Living in a household with more than one

person per room (measures overcrowding);– Being unemployed, or being in a family whose

head is unemployed.

Who are the poor?

• Child poverty– Long-run: childhood poverty affects health and educational

attainment– Success of adults is closely related to their parent’s educational

achievement– Poor physical environment increases probability of serious

illness

• Family structure– Lone mothers (feminization of poverty)– Large families– Young mothers

• Racial differences• Discrimination

Discrimination

• Exists if a person receives lower wages than others who have the same experience, education, and training.

• Types of discrimination: – employer discrimination, – employee discrimination, – customer discrimination, and – statistical discrimination

Employer discrimination

• Becker: Firms that do discriminate must have some market power. They are willing to forgo some profits to exercise their “taste for discrimination.”

• Less employer discrimination in urban areas with many different employment opportunities than in rural areas with monopsony labor markets.

Employer Discrimination

Employee discrimination

• Employees perceive that a certain group of potential workers are incompetent and refuse to work with them.

• North Country Trailer:

• http://www.youtube.com/watch?v=7E_ifqj1rAQ

Customer Discrimination

• A firm’s customers refuse to be served from a certain type of employee. – Women in auto parts stores, – Women mechanics, – Males in housewares

Statistical Discrimination

• Employers use gender and race as low-cost screening devices to find the most reliable person for the job.

• Illegal according to Title VII of the Civil Rights Act of 1964 to compensate, limit, segregate, or in other ways classify employees because of statistical patterns.

Urban Underclass

• Wilson (1987): asserted that some people are poor because they choose a way of life that keeps them poor.

• Dysfunctional behavior is Intergenerational– Voluntary joblessness, – Criminal behavior – Welfare dependency. – Single-parent families,

• Out-migration of middle-class role models isolates “hard core” poor

Urban Underclass

• Controversial Theory: – Difficult to define. – How do we explain why it mainly pertains to

African-American males?

• Massey and Denton (1993), Leonard (1998) or Sánchez-Jankowski (1999) could not empirically support the hypothesis that an underclass exists.

Attitudes, Self-Worth, Incentives

• Akerlof and Kranton: explain success or failure by the person’s sense of self and interdependent utility functions. – Lack of self-confidence imposes undue

constraints keep people poor.– Concern about reactions of others limits

choice set.

Attitudes, Self-Worth, Incentives

• Interdependent utility functions exist when one person chooses to link his or her welfare with the action of others. – Parents’ utility depends on the success or

failure of their child– Some students harass their classmates for

getting good grades, because the classmates’ success devalues the harassers’ utility.

Attitudes, Self-Worth, Incentives

• In general, members of a minority that identify with the dominate culture and succeed are threats to those who refuse to identify with the dominate culture.– The minorities who succeed by the rules of

the dominate culture also threaten less successful members of that.

Poverty Dynamics

• Temporary poverty– Regional business cycles

• Long-term poverty– Illness and disability– Structural unemployment when human capital

investment seems impractical– Discrimination– Attitudes, lack of self-confidence

Obstacles to Income Mobility

• From education system– Inadequate funding because of low tax base

• From labor market– Discrimination– Impact of business cycles inconsistent over

time, space, and quintiles of income distribution

Fight against Poverty

• Four components of current welfare system in US– Food Stamps– Medical Assistance– Temporary Assistance for needy families

(TANF)– Earned Income Tax Credit (EITC)

Income distribution policies

• May be public good because of a potential free-rider problem. – Individuals migrate toward jurisdictions whose

public policies maximize their own well-being (Tiebout hypothesis).

– Areas that try to help “their” poor attract new poor households.

Income distribution policies

• However, public giving is not optimal. – Public redistribution efforts crowd out private

giving. – Public giving provides smaller psychic

benefits (warm glow) to the taxpayer-donor than private giving does.

– Okun’s leaky bucket: $9.51 to government increases disposable income of poor by $1

Welfare to Work

• Prevailing explanations of the causes of poverty and unemployment: – if you pay people to be inactive there will be

more inactivity.

• Welfare-to-work policies now in effect in the US, the UK, Australia, and New Zealand.

Welfare to Work

• Clinton Welfare Reform act: Personal Responsibility and Work Opportunity Reform Act of 1996 (PRWORA) – Returned welfare to state control, with partial

federal funding through largely unrestricted block grants and various types of welfare-to-work policies.

– Emphasized marriage and child support to discourage out-of-wedlock pregnancies and to encourage formation of two-parent families.