Topic 2: Persistent poverty, Market Failure, Coordination and Poverty Traps
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Persistence of poverty - Observables
What you find in societies that suffer from persistence of poverty is that GDP isn’t enough to
asses countries, it is important to look at low physical capital per person, undernutrition,
under-par educational attainments, limited access to sanitation, safe water and housing,
high population growth rates, high infant mortality rates. All these parameters are features
of underdevelopment rather than explanations.
Evidence of persistence poverty
Poor → malnourished → less productive → earn less → malnourished (Dasgupta and Ray,
1986; Banerjee and Mullainathan, 2008). This is a scarcity level argument, I am poor cause I
started poor.
The poor save less because they discount the future more heavily and that is why they stay
poor (Moav, 2002)
The poor have no collateral → lenders not willing to lend → poor cannot expand their small
businesses or acquire skills or afford education for their children. (Banerjee and Newman,
1993, Galor and Zeira, 1993, Ghatak and Jiang, 2002)
Introduction
The poor are like the non-poor in terms of potential they just live and work in more adverse
external environments, markets don’t work they’re friction driven and inefficient.
Nothing wrong with the external environment. The second argument would be that poor
people behave differently than the rest. Their markets are scarcity-driven, therefore they
will behave in a different way although their external environments are the same.
1 scarcity-driven
Growth theory (an explanation of growth and poverty traps)
How does a person or economy grow
richer?
You need resources (skills, capital, land)
and convert them into output or income.
Furthermore savings, and investment are
key to growth.
Diminishing returns due to some fixed
factor which slows down the growth rate
(e.g. supervision time)
Solow-growth model: k is capital, s is
savings rate and π is profit.
Empirical Growth theory literature -
Explanations:
Increase the rate of savings (or
investment) or decrease the population growth rates
These studies offer convergence.
, Countries with a low relative capital have high marginal return to capital. Controlling for
savings rates, poorer countries will grow faster and catch up. Factors that systematically
affect marginal addition to per-capita income is a potential explanation.
This theory literature has important implications for the way we think about development.
First, it limits our search for deep explanations. It fails to explain inter-country variation
countries could be more corrupt than another, or more democratic, or have a more
hardworking cultural ethic. Also different societies have some intrinsic difference in their
willingness — or ability — to save, or to procreate. Growth theory is therefore valid but not
deep, we can’t stop there.
Why low incomes provoke low savings rates? Might underdevelopment be a cause of high
population growth rates? Is corruption just as much an outcome as a cause?
May lead to weak shallow policies
Main lessons from Growth Theory
Lesson 1: Convergence. Being poor is no handicap in the long run. History does not matter.
Lesson 2: There is no long-run growth without technological progress.
Lesson 3: (for closed economy version) With capital markets, all we need to keep track of is
total capital stock of the economy as far as income is concerned.
Without capital markets, how capital is distributed will affect output in the short run, but
not in the long run.
Persistent differences across countries must be pinned down to differences in innate
abilities of the people, its natural resources, attitudes regarding thrift, enterprise. One must
have permanent policy measures in place (e.g., tax incentives to encourage savings) to do
anything about it.
Economists have proposed many theories of persistence of poverty. A lot of these are
variations on the theme of a vicious cycle.
Explanations for poverty traps
External frictions
Capital market frictions and indivisibilities: The idea here is that in order to get on the
growth path you needed a big chunk of investment to start with, by borrowing money for
example or foreign aid. If countries were not able to surpass this capital threshold they
would be stuck in this vicious cycle.
Human capital frictions: if human capital is a key
variable in addition to capital in production - so
societies were there are casts like in India or
countries where women can’t access the
working industries. Or if there is no market for
human capital, because of nepotism or
corruption. Both these things will have adverse
effects on human capital. No single friction is
sufficient to trap individuals in poverty.
