Archive for the ‘Poverty Alleviation’ Category

Backwash and Spread Effect

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What are the causes and consequences of ‘backwash’ and ‘spread’ effects? What type of public policies can correct any imbalances between the two effects, inter-regionally within a country

Once economic and social forces occur in favored region, development produce tendencies toward disequilibrium, the differences in living standards may persist and even widen over time. Myrdal propose hypothesis of circular and cumulative causation, means once an economy obtains a growth advantage it will tend to keep it. Development proceeding more rapidly in certain region than other. The cumulative movements which tend to economically weaken region were termed backwash effects. Those caused by labor migration, capital movements, and trade. In free market, capital will tend to move to the site where prospective returns are highest.  Thus capital, labor, technology, and entrepreneurship will migrate together. The benefit of trade will accrue to the host region. As the results, the region experiencing the rapid growth will be able to increase its competitive advantage over the relatively lagging regions, the improvement in transportation, communication, education, healthcare facilities.

Myrdal also argues the spread effect or positive externalities, that such a new growth stimulus might induce other region, such as increased demand for backward areas product, diffusion of technology and knowledge. However, the spread effects are weaker than backwash effect, and interregional differences remain widen.

Hirchman argues that policies must be designed to reduce polarization and to strengthen spread effect. Type of public policies to imbalance between those two effect inter regionally within the country are: (i) fiscal policy, wealth taxes for redistribution of wealth and income; (ii) institutional reform against corruption, corruption is critical issue in development country. The World Bank defines corruption as the abuse of public office for private gain, including bribery, threats, and kickbacks. The existence of licenses, permits, regulations, subsidies, and taxes in the hand of politician or government officials, are open opportunity for corruption. The state has an obligation to reduce bureaucracy and regulation to allow markets to flourish. Corruption creates high cost economy because the cost in time, effort, and money in setting up business in developing countries are high with delay and inefficiency in bureaucracy.  Corruption discourages business, higher proportion of business operates outside the law, so the tax also lower, and corruption become acute. In the context of backwash effect, corruption affect distribution of allocation resource, when industry can get privileges to choose any place they want to operate their business, regardless the development planning for allocation of resources; (iv) balance between agriculture and industry, placing labor-intensive industry in rural area to attract circular cumulative causation in rural area, reduce rural-urban migration, and eradicate poverty both in rural and urban.

How Can Development Worsen Inequality (for some) ?

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How can development worsen inequality and destitution (for some)? What role can public policy play in mitigating these negative impacts?

The development process tends to apply industrialization as the engine of growth. This is to be expected for increasing returns to scale in industry, both static economies of scale when mass production of commodities can be produced at lower average cost and dynamic economies of scale which are reductions in cost or increases in revenue per unit that arise from repeated and continuous production activity over time. The transformation of economies from a primary agricultural into industrial country comes with widening disparities in the personal distribution of income in the early stage, because some people are more industrious than others to accumulate wealth, opportunity and skill are not equal for all.  The work of Adelman and Morris shows that for developing countries inequality increases up to a certain stage of development and then declines, graphically showing an inverted U-shape similar to the work of Kuznets for developed countries.

Intensive industrialization strategy for development can worsen inequality and destitution along with these conditions: (i) inevitable dualism3 in geographic, technological, and social; (ii) urban bias4 in the allocation of investment resource. There have been many causes of urban bias; domestic cause of urban bias including colonial inheritance, severe market failures in agriculture, relatively weak political voice of rural poor. International cause of urban bias including relatively strong political voice of developed countries, Washington Consensus diminish attention to agricultural development.; (iii) inequality in the distribution of education facilities, particularly lack of facilities in rural areas where the poorest are concentrated; (iv) disguise rural unemployment, rural underemployment, open unemployment in urban areas created by rural-urban migration;  (v) a shortage of investment resources and inappropriate technical choices.  In this process, the degree of inequality in the developing countries appears largely due to the higher share of income received by the richest, and the vast mass of population is left behind. Rural and urban poverty are still widespread.

The public policy plays important role in mitigating negative impacts on how it brings about structural changes in favor of industrial activities if growth and development is to be accelerated. There are necessities for public policy to concern for allocation of investment resources for basic social services, infrastructure, and investment in human capital (education) because education improves the quality of labor and has positive spillover effects.  The policy should accommodate choice of projects of which a high weight should be given to projects that raise the income of the poorest in the income distribution.

The government also play important role in financial markets to lower the cost of capital and direct credit to strategic sectors, policies to promote export and protect domestic industry.  The policy must pay attention in rural development that has been neglected in industrialization development strategy. The policy of active opposition to urban bias should be taken. Agriculture is generally labor intensive and skill extensive, so that agricultural growth creates additional employment with low entry barriers. When agricultural productivity rises, the food prices in rural and urban will be lower. Agricultural growth is importance for poverty reduction.  It obviously needs targeted investment in agricultural which is so far being under estimated.

3 Geographic dualism is gap between income per capita is concentrated in one area, technological dualism is difference in technological means between subsistence sector and other sectors, social dualism is different social customs between subsistence and money sector

4 for further reading Bezemer, Dirk and Headey, Derek, (2008), “Agriculture, Development, and Urban Bias“, MPRA Paper No.7026, posted 6 February 2008.

Measuring Poverty and Inequality

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There are several kinds of poverty and inequality measuring tools, here are three ways to measure poverty and two measures of income inequality.

The World Bank defines poverty as inability to attain minimum standard of living.  The first way to measure poverty is by defining poverty line or poverty threshold which measures minimum living standards based on per capita income that is sufficient to provide a minimum acceptable level of consumption. The way to set consumption based poverty line is by PPP method and the food energy method. The PPP method reflects the cost to individuals to buy goods or services in the domestic market as a dollar in US. The PPP does not deal with intercountry differences in nutrition; because the composition of consumption is very likely differ in different countries. To handle this problem, the food energy method is used which defines minimum calorie intake using nutritional values of consumption goods. However, it’s still problematic as people in different countries may choose different combination of foods which require different incomes to meet nutritional requirements.

In practice, the World Bank assigned poverty line $1.251 which means the minimum level of income deemed necessary to achieve standard of living. This value comes from income or consumption data survey, estimation of PPP level, and World Bank comparison program. From the value of poverty line, the number of people under the poverty line can be measured using head count index.  The head count index ignores the extent to which the poor fall below the poverty line.  The third way to measure poverty is poverty gap index which measures the depth or intensity of poverty, how far the poor are below the poverty line.

The most used inequality measure is Gini index as a ratio of two areas in Lorenz curve2 diagrams values between 0 and 1.  A low Gini coefficient indicates more equal income or wealth distribution, while high Gini coefficient indicates more unequal distribution. 0 corresponds to perfect equality and 1 corresponds to perfect inequality. The problem with Gini index are: the measure will give different result when applied to individuals instead of households; it measures in certain time, ignores life-span changes in income; in some societies people may have significant income in other forms than money as in subsistence farming, the value of these incomes is difficult to quantify, thus will yield different Gini index.

Another inequality measurement is Theil index which is a weighted average of inequality within subgroups, plus inequality among those subgroups, means that Theil index has decomposability that Gini index doesn’t have. The Theil index is always positive, individual contributions to the Theil index may be negative or positive. But Gini index is more popular than Theil for it’s depicted on Lorenz curve which is more intuitive to understand.

1 The latest update, announced in March 2008 is $1.25 per day based on the latest available international PPP comparison for the year 2005. For further information in World Bank Report 1990, 2008.

2 The Lorenz curve is a graphical representation of the cumulative distribution function of a probability distribution; It is often used to represent income distribution, where it shows for the bottom x% of households, what percentage y% of the total income they have. It was developed by Max O. Lorenz in 1905 for representing income distribution.