poverty reduction through economic growth: some issues

POVERTY REDUCTION THROUGHECONOMIC GROWTH: SOME ISSUES

ANDREW MCKAY�

CREDIT and Department of Economics, University of Nottingham, UK

Abstract: In broad terms, reduction in poverty can come about through redistributions

among households at an existing level of average income, or through growth in average

incomes, or through a combination of the two. However, both theoretical and empirical

considerations suggest that growth of average household incomes is likely to be neces-

sary to achieve sustained long-term poverty reductions. But the pattern of this growth is

important; clearly a growth pattern where the bene®ts accrue disproportionately to the

richest in a society will have less poverty impact than one where the bene®ts are equally

distributed or biased towards the poor. This is likely to be particularly important in

countries where growth is likely to be slow. This paper re¯ects on the relationship

between growth in household incomes, inequality and poverty. # 1997 by John Wiley &

Sons, Ltd.

J. Int. Dev. 9: 665±673 (1997)

No. of Figures: 0. No. of Tables: 1. No. of References: 16.

1 INTRODUCTION

While poverty reduction is clearly an issue of raising the income levels of the poor on asustainable basis, there are many di�erent ways of trying to achieve this. In broadterms, though we can think of poverty reduction coming about through growth orincome redistribution or both. However, whatever emphasis one places on theimportance of redistribution, it seems clear that growth in mean incomes must play acrucial role in achieving sustained poverty reduction in developing countries. Declin-ing per capita incomes in many developing countries over the 1980s, especially inAfrica, must explain a lot of the increases in poverty in those countries over thatdecade.

At the same time, the point has long been recognized that economies can grow atrapid rates in aggregate without the poor necessarily sharing in this process; thisindeed was the major motivation underlying the monumental study Redistributionwith Growth (Chenery et al., 1974). A number of di�erent growth strategies can be

� Correspondence to: Andrew McKay, Department of Economics, University of Nottingham, UniversityPark, Nottingham NG7 2RD, UK.

CCC 0954±1748/97/040665±09$17.50# 1997 by John Wiley & Sons, Ltd.

Journal of International Development: Vol. 9, No. 4, 665±673 (1997)

pursued, some of which may include the poor more e�ectively than others (Liptonand van der Gaag, 1993; de Janvry and Sadoulet, 1993). But does the pursuit of amore equitable pattern of growth compromise the rate of growth which can beobtained? If there is a su�ciently strong reason to believe that growth and inequalityare positively associated with each other then this may well be a valid concern.

This paper is intended simply to re¯ect on some of these issues in a bit more depth inthe light of recent literature. While these issues have been considered in the develop-ment literature for some time, it is not clear that they have been answeredconvincingly; certainly, they remain important questions today. Section 2 considershow changes in poverty can be explained in terms of the growth and redistribution ofhousehold incomes, and emphasizes the importance of growth in driving manychanges in poverty. Section 3 then considers the fundamental question of therelationship between growth and inequality; will faster growth necessarily beaccompanied by increased inequality? Section 4 concludes.

2 GROWTH AND REDISTRIBUTION COMPONENTS OF CHANGES

IN POVERTY

For the purposes of this discussion, it is assumed that an individual's standard ofliving is measured based on an appropriate measure of the total income orexpenditure of the household to which they belong (referred to as income for shortfrom now on). Given a suitable poverty line, z, this information can be used tocompute summary indices of poverty. While many such indices exist, the Pa class ofpoverty indices (Foster et al., 1984) is widely used in empirical work. If yi representsthe standard or living of individual i, and individuals have been ranked from thepoorest (i � 1) to the richest (i � n, where n is the total number considered) then theindex can be represented as

Pa � 1

n

Xqi�1

z ÿ yiz

� �awhere, additionally, q is the number of individuals classi®ed as poor (i.e. for whomyi < z), and a is a non-negative parameter re¯ecting the weight placed on the depth ofpoverty (see, for example, Lipton and Ravallion, 1996, for more details). In short,increased values of a imply increased relative weight on the poorest among the poor.

The value of the Pa index at a point in time t can be completely characterized basedon the following information (Datt and Ravallion, 1992): the poverty line, z; the meanvalue (over the whole distribution) of the standard of living measure, mt , and asuitable parameterization of the Lorenz curve for the whole distribution. This last,capturing the inequality of the distribution, will be a function in general; forconvenience it is represented here as Lt. Thus, the poverty index can be written as:

Pz

mt;Lt

� �:

Assuming a ®xed absolute poverty line, if a given poverty index is computed at twopoints in time, any change in its value must re¯ect either a change in mean income,m, or a change in its distribution (as represented by L), orÐas will be the case in

J. INT. DEV. VOL. 9: 665±673 (1997) # 1997 by John Wiley & Sons, Ltd.

666 A. McKay

generalÐa combination of the two. Hence, it is a standard procedure in comparingpoverty indices at two points in time to decompose the observed changes into acomponent re¯ecting changes in the level of mean income in the society as a whole(the growth component), and another re¯ecting the impact of redistribution (theredistribution component); as this is not an exact decomposition there is also aresidual component (Datt and Ravallion, 1992):

Pt�1 ÿ Pt � G�t; t � 1; r� � D�t; t � 1; r� � R�t; t � 1; r�where the comparison is between period t and t � 1, r is the reference period (whichmay or may not be the same as t or t � 1, and G(.),D(.) and R(.) represent the growth,redistribution and residual components respectively.

More precisely, the ®rst term on the right-hand side of the decompositionrepresents the e�ect of the change in mean income between period t and t � 1, at anunchanged distribution of income (as represented by the Lorenz curve in the referenceperiod r):

G�t; t � 1; r� � Pz

mt�1;Lr

� �ÿ P

z

mt;Lr

� �:

The second term of the decomposition then represents the e�ect of the change inthe distribution of income between period t and t � 1, as captured by the movementin the Lorenz curve, at a constant level of mean income (mr, that of the referenceperiod r); this is thus the redistribution e�ect:

D�t; t � 1; r� � Pz

mr;Lt�1

� �ÿ P

z

mr;Lt

� �:

The third (residual) term is neither a pure change in mean income nor a pureredistribution e�ect, but rather an interaction e�ect; in many cases it is anyway quitesmall (although this is not always the case).1

Clearly, changes in mean income can rarely be expected to occur without changesin the Lorenz curve (distribution), and redistributions of income cannot realisticallybe expected to occur at an unchanged mean income. Moreover, changes in meanincome cannot necessarily be considered as being independent of distributionalchanges, nor conversely. But this is not the point; the decomposition indicates therelative importance of the change in the level of mean household income, and thechange in its distribution, in explaining the observed changes in poverty. And thedecomposition is meaningful as long as the (not easily interpreted) residual term issmall relative to the other components.2

An increase in mean income in a society, at an unchanged distribution, mustnecessarily lead to a reduction in poverty. Similarly, one might imagine that areduction in inequality, at a given mean income, will also lead to a reduction inpoverty. While this is certainly the most likely outcome, it is not necessarily so;exceptions can arise for poverty indices which do not take account of distributionamong the poor (for example, the Pa class of poverty indices with a � 0 or 1) when

1 See Datt and Ravallion (1992) for more details on this decomposition procedure.2 This is frequently so in empirical work, though not always. Datt and Ravallion (1992) discuss theinterpretation of the residual component in more detail. More generally, note that the decomposition relieson the accuracy of the functional representation of the Lorenz curve.

# 1997 by John Wiley & Sons, Ltd. J. INT. DEV. VOL. 9: 665±673 (1997)

Poverty Reduction Through Economic Growth 667

the poverty line is greater than the mean level of income. This apparently perversepossibility, however, does not a�ect the validity of the above decomposition, whichstill computes the impact of the redistribution on poverty, no matter whether theredistribution term is capturing an increase or a decrease in inequality.

For illustrative purposes, Table 1 gives some estimates derived from various studiesof the change in mean income and redistribution components of changes in poverty,as measured by Pa poverty indices, for selected developing countries. The tableillustrates a variety of cases. According to the results presented there, Urban India ischaracterized by signi®cant reductions in each of the poverty indices over the period1977/78±88; in all cases this re¯ects the bene®cial e�ects of growth in mean incomes.The growth in mean incomes is accompanied by increased inequality, to some extentqualifying the bene®cial e�ect of growth on poverty. In Brazil poverty increasesmarginally over the period considered. For each index, the bene®cial e�ect of thegrowth in mean incomes on poverty is more than o�set by a large, adverse redistri-butional e�ect, i.e. a large increase in inequality. The results for CoÃ te d'Ivoire indicateaverage increases in each of the poverty indices over the period 1985±88, an increasewhich predominantly re¯ects a sharp decline in mean incomes. The redistributionale�ect has a positive impact on poverty, re¯ecting reducing inequality, but it is muchtoo small to counteract the impact on poverty of the sharp decline in mean incomes.

In each of these three examples the growth and redistributional e�ects operate inopposite directions, i.e. growth and inequality appear to be positively correlated overthe period considered. In India and Brazil the bene®cial e�ects of growth in meanincomes on poverty are reduced (and swamped in Brazil) by increasing inequality; inCoÃ te d'Ivoire reductions in inequality partly cushion the impact of declining meanincomes on poverty in a recession/decline situation. However, it is not clear to whatextent this is indicative of a more general trend within these countries (for example,

Table 1. Decomposition of changes in poverty indices over time into growth and redistribu-tional components. (Sources: Urban India: Datt and Ravallion (1992, Table 5); Brazil: Datt

and Ravallion (1992, Table 7); CoÃ te d'Ivoire: Grootaert (1995).)

Total change Growth e�ect Distribution Residual(%) (%) e�ect (%) (%)

Urban India 1977/78±88

P0 ÿ9:68 ÿ12:41 1.11 1.62

P1 ÿ3:71 ÿ5:00 1.39 ÿ0:10P2 ÿ2:02 ÿ2:40 0.67 ÿ0:29

Brazil 1981±88

P0 0.01 ÿ4:49 4.46 0.04

P1 0.64 ÿ2:34 3.19 ÿ0:21P2 0.62 ÿ1:42 2.31 ÿ0:27

CoÃte d'Ivoire 1985±88

P0 19.9 16.9 ÿ6:0 5.0

P1 4.4 7.9 ÿ3:2 ÿ0:3P2 1.8 4.4 ÿ0:7 ÿ0:7

Notes:1P0, P1, P2 refer to changes in the values of Pa class of poverty indices for a � 0, 1, 2 respectively.2Negative values denote reductions in poverty, positive values increases.


668 A. McKay

would the relationship still hold if mean incomes had moved the other way?), andmuch less so more generally.

Finally, based on the same decomposition of changes in poverty, it is possibleto compute elasticities of poverty indices with respect to a distributionally neutralchange in mean income (see, e.g., Ravallion and Huppi, 1991). The magnitude ofthese elasticities will depend on various factors, including on the level at which thepoverty line is set. However, computation for a number of countries reveals highmagnitudes for this elasticity, in the range of 1.5±4.0 for the Pa index with a � 1, andhigher for a � 2. Where these magnitudes apply, distributionally neutral growth inincomes will have signi®cant impacts on values of poverty indices; equally distribu-tionally neutral declines in incomes can lead to large increases in poverty indices.

This illustrates the potential contribution of distributionally neutral growth inhousehold incomes to poverty reduction. This is not to deny that redistribution alsohas a role to play, but there must be severe limits to what can be achieved byredistribution in the absence of growth. In particular, growth in household incomes islikely to be essential for long-term poverty reduction. But this will be much lesse�ective if growth is highly skewed towards the richest households. It may then havevery little impact on poverty, and it is even possible that its impact is adverse, as in theexample of Brazil above. We must now turn to the question of the relationshipbetween growth and inequality, with the aim of seeing what types of growth patternsmay be e�ective at attaining poverty reduction.

3 INEQUALITY AND GROWTH

In reality, growth in household incomes is rarely distributionally neutral. Indeed,much of the controversy surrounding the issue of the relationship between inequalityand growth re¯ects the concern that the pursuit of growth may lead to increasinginequality (and relatedly, that a redistribution policy may act so as to restrain growth).The examples considered in the previous section are consistent with this concern. Butis this necessarily the case? What is the nature of the relationship between growth inhousehold incomes and inequality?

There are well-known theories about the relationship between income distributionand the growth of per capita GDP. For our purposes what we ideally need to examineis the relationship between income distribution and household income per head ratherthan GDP. The two may be related, and this relationship may be closer in low incomedeveloping countries than in developed countries, but they are not the same thing.3

First, however, we consider what we know about the relationship between overalleconomic growth (de®ned as growth in GDP or in GDP per capita) and incomedistribution.

As noted above, it is widely believed that growth in per capita GDP (or GNP) isgenerally associated with increasing inequality, at least for low income countries. Thepopular hypothesis ®rst advanced by Kuznets (1955), of an inverted U relationship

3 The reason why economic growth in developing countries may show a closer relationship to growth inhousehold incomes is due to the number of households engaged in self-employment activities in developingcountries. Thus, many production activities in fact occur in the household sector. Consequently, at the riskof generalizing, in developing countries (appropriately de®ned) household income may bear a closerrelationship to overall GNP/GDP than is the case in developed countries.



between economic growth and inequality, is not inconsistent with this; it simplyintroduces a threshold beyond which inequality begins to fall with increases in GDP.

Setting aside the issue of whether or not such a threshold exists, the theoreticalbasis for thinking that growth and inequality in low income countries are positivelyassociated needs to be assessed, in particular to consider whether this is necessarilythe case. Certainly the positive relationship between growth and inequality may bejusti®ed in situations where development takes the form of an urban-based capital-intensive pattern of industrialization, with little or no emphasis on rural development,and where industrial growth generates very little employment. When this is the caseincomes will necessarily become increasingly unequal, because the newly createdincome accrues only to very small numbers. The magnitude of `trickle-down' to thepoor, and especially those in rural areas, may be very limited.

Such a characterization of development strategies, even if accurate in earlierdecades, does not appear to be a reasonable characterization in many developingcountries in the 1980s and 1990s. In an era of structural adjustment, as well as forother reasons, the scope for a development strategy based predominantly ondevelopment of a formal, modern industrial sector appears much more limited.Moreover, the neglect of the potential for growth in the traditional agricultural sector,and the almost total neglect of the urban informal sector, in which many urbanresidents work (and which appears to have grown signi®cantly in size over the last twodecades) no longer seems tenable. In a di�erent policy framework, should we stillexpect that pursuing growth will lead to increasing inequality?

In any case, the empirical evidence for the positive relationship between growth andinequality (and especially for the Kuznets relationship) is far from unambiguous,partly for methodological reasons. As there is little time series information onincome distribution in developing countries, most studies are based on cross-countryregressions. However, given the potential importance of country speci®c institutionalcharacteristics and policies, and the dynamic nature of the relationship beingconsidered, the appropriateness of this method must be open to serious question.What we are interested in here is the relationship between growth and inequality, in aparticular country, over time. Empirical evidence available from cross country studiesis not strong enough to support or reject any given view of the relationship betweengrowth and inequality over time.

Having said this, a number of recent developments in the literature on economicgrowth, as well as other considerations, give us reason to believe in a positiverelationship between economic growth and inequality in low income LDCs, andconceivably even in the full Kuznets relationship. Recent, so-called endogenoustheories of growth introduce a whole range of new factors into the determination ofeconomic growth, including human capital, innovations and externalities. Of moredirect relevance to the issues considered here, some recent studies have again posedthe question of the relationship between income growth and income distribution,notably studies by Galor and Zeira (1993), and by Aghion and Bolton (1992; 1994).Among other things, these models have the advantage of being more explicitly micro-based, i.e. using a concept of income closer to household income than to aggregateGDP. These studies show how, for instance, imperfections in credit markets canexacerbate inequality in household incomes, because the poor, wanting to undertakea given project, have to borrow at high rates of interest whilst the better o� canborrow more cheaply, or may not need to borrow at all, or may be able to act as


670 A. McKay

lenders. If access to credit is important in raising income levels (an assertion for whichthe evidence is mixed) then this could provide a justi®cation for a positive relationshipbetween growth and inequality in low income economies.

Galor and Zeira (1993) additionally assume that there are indivisibilities in theaccumulation of human capital which favour the rich relative to the poor. This fact iswell-known. In urban areas in particular, a certain minimum level of education maybe necessary for an individual to have access to wage employment in the formal sector(the jobs which are generally better remunerated); richer households may be betterplaced to make the necessary sacri®ces. For poor agricultural households in ruralareas, sending their children to school may have signi®cant opportunity costs, as wellas direct monetary costs, given that they might alternatively work on the householdfarm. The same applies to non-farm self-employment activities, such as informalcommerce. Many households in these circumstances, even if they perceive the bene®tsof education for their children, may be unable to make the sacri®ces necessary toa�ord it. Yet education may be the key to increased productivity in their currentactivity; it might also provide the children with the basis to search for more remuner-ative work elsewhere.

This argument can easily be broadened to look at all social services. Evidence frommany African countries, for instance, indicates that utilization of health andeducation facilities tends to increase with income, a ®nding which re¯ects more thanjust an urban±rural di�erential. Incidence analysis suggests that public spending inhealth and education bene®ts the non-poor disproportionately (e.g. World Bank,1995). Yet such facilities may play an important role in enabling households toparticipate in the process of growth; indeed this is an important element of the WorldBank's stated poverty alleviation strategies (World Bank, 1990; 1993). A critical issuehere is to understand whether the poor are making less use of such facilities throughchoice (a demand-side problem, which in turn might re¯ect their income levels andthe costs associated with using such facilities), or because they do not have e�ectiveaccess to them (a supply-side problem).

There may be many other senses in which the rich may have more favourable accessto important institutions than the poor. In many low-income developing countries,the available evidence indicates that the greatest number of the poor are engaged insmall-scale household agriculture, or, in some instances, working as agriculturallabourers. Agriculture has very often su�ered from the e�ects of urban bias, includinginter alia depressed prices for the food crops sold in the interest of urban consumers;heavy taxation of export crops; monopsonistic and ine�cient marketing boards towhich farmers are obliged to sell; an overvalued exchange rate. As consumers, farmhouseholds have often su�ered from the high prices of locally produced manufacturespromoted by the policy of import substituting industrialization (Bates, 1981).

Perhaps more importantly in the present context, the small-scale peasant sectormay su�er much more than large-scale agriculture if the environment for agricultureis unfavourable; large farms bene®t disproportionately from public policy inter-ventions, such as extension services, marketing agencies, sources of inputs, marketsthemselves and infrastructure. Apart from these policy issues, large farms are likely tobe better placed to bear the ®xed costs associated with producing, storing, trans-porting and marketing their output, and also may be able to sustain more easily theadverse e�ects of volatility in prices. The advantages of size (also an important bene®tin the credit market) may thus be reinforced by the policy environment, making the



situation very di�cult for small-scale peasant farmers, who may comprise signi®cantnumbers of the poorest.

The latter part of this section has identi®ed a number of aspects in which the large-scale, formal and non-poor may enjoy more favourable access to a number ofpotentially important economic institutions than the small-scale, informal and poor.In some instances this may re¯ect the inevitable advantages of size in economic terms,such as the ability to exploit economies of scale, in¯uence in markets and potentiallyalso in the political sphere, access to credit, diversi®cation of income sources, perhapssuperior information, etc. In others it may be a consequence of existing policy stances(e.g. urban bias) which could be reformed, or a problem the magnitude of whichcould be reduced by appropriate policy interventions (e.g. enabling poor householdsto have more e�ective access to credit markets). If these institutions (credit markets,social services, product markets, physical infrastructure etc.) matter in the determina-tion of economic growth, then those who have better access to them may be somewhatbetter placed to raise their income levels than those with less favourable access. If thisis true then it provides support for thinking that growth and inequality are positivelyassociated. But it also gives us reason to think that appropriate policy interventions,while perhaps not reversing the direction of the relationship between growth andinequality, might at least reduce the magnitude of the trade-o�.

4 CONCLUDING REMARKS

Sustained growth in household incomes, even if it is associated with increasinginequality, can nevertheless bring about poverty reduction (e.g. in the case of UrbanIndia above). Of course, for a given rate of economic growth, a distributionallyneutral or pro-poor pattern is preferable in terms of its impact on poverty. We haveperhaps some ideas of what elements might comprise such a distributionally neutralor pro-poor growth strategy. For example, it is likely to be labour intensive ratherthan capital intensive, and to place emphasis on raising education and skill levelsamong the poor. Clearly, though, this is an area where further theoretical andempirical work may be helpful in re®ning such strategies, which anyway might varyaccording to circumstances.

However, it may be that pursuing a more distributionally neutral pattern of growthmay in fact compromise the rate which can be attained. This raises the possibility thata more inequitable, though faster, rate of growth may achieve more poverty reductionthan a more equitable, but slower, growth pattern. These are issues that need to beconsidered in more depth. A good starting point is likely to be by considering theexperiences and policies of countries which have been successful in obtaining bothrapid growth and signi®cant poverty reduction, most obviously the successfuleconomies of East and South-East Asia.

ACKNOWLEDGEMENTS

This is a revised version of a paper presented at the Development Studies AssociationAnnual Conference, University of Reading, September 1996. I am grateful to partici-pants at the conference for their comments on the paper presented then, and to thosewho have provide very helpful comments subsequently: Walter Elkan, Tony Killick,


672 A. McKay

Oliver Morrissey, and an anonymous referee of this journal. Special thanks are dueto Walter Elkan, whose very detailed comments have been extremely helpful inrevising this paper. Of course, the usual disclaimer applies in all cases.

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