Understanding the Economics of Poverty Traps and Persistent Poverty
Persistent poverty poses a significant development concern, with appropriate policy responses depending on causal mechanisms such as slow growth, unique poverty equilibria, or avoidable traps. Various mechanisms contribute to poverty persistence, requiring careful theorizing and empirical analysis. Theoretical illustrations explore scenarios without poverty traps, with unique dynamic equilibria, and with multiple equilibria. Policy implications range from accelerating progress to targeted interventions to prevent phenomena like geographic traps or discrimination-based traps.
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THE ECONOMICSOF POVERTY TRAPS AND PERSISTENT POVERTY: POLICYAND EMPIRICAL IMPLICATIONS Christopher B. Barrett and Michael R. Carter Seminar at University of California at Riverside May 24, 2012
Motivation Persistent poverty is a 1st order development concern. What to do about it? - depends crucially on the causal mechanism(s): * slow, steady growth from low base? * immutable poverty (unique low eqln)? * avoidable state (low level eqln trap)? - challenge of sorting structure from stochasticity The fact that appropriate policy response to persistent poverty turns on the causal mechanism necessitates both careful theorizing and thoughtful empirics.
Various Mechanisms Poverty Traps: any self-reinforcing mechanism which causes poverty to persist (Azariadis and Stachurski 2004, p. 33) A range of structural mechanisms (co-)exist - Individual/hh-level - Meso-/macro-scale - Inter- or intra-generational - Single or multiple equilibrium Consider some simple theoretical illustrations of basic options
Theory Basics Persistent poverty w/o a poverty trap Welfare Dynamics With Unconditional Convergence Welfare Dynamics With Conditional Convergence Welfare dynamics w/single non-poor dynamic equilibrium Well-beingt+1 Interpretation: Slow, neoclassical growth from a low base convergence clubs ? W* Pov. line Policy implications: perhaps intervene to accelerate progress, but not necessary. Well-beingt W0 W*
Theory Basics Poverty trap w/unique dynamic equilibrium Welfare Dynamics With Unconditional Convergence Welfare Dynamics With Conditional Convergence Welfare dynamics w/single poor dynamic equilibrium Interpretation: Can include geographic poverty traps, physical/cognitive disability traps, discrimination based traps, low-level institutional traps, etc. Well-beingt+1 Well-beingt+1 W* Pov. Pov. line line Policy implications: Intervene to prevent phenomena (e.g., early childhood programs, infrastructure investments in LFAs). Humanitarian social protection transfers. W* Well-beingt Well-beingt W0 W0 W* W*
Theory Basics Poverty trap w/multiple dynamic equilibrium Nonlinear path dynamics with multiple stable dynamic equilibria and at least one unstable dynamic equilibrium (threshold effects) Well-beingt+1 Chronic poverty region Transitory poverty region Interpretations: Multiple equilibria, short-lived interventions can have permanent consequences. Many candidate mechanisms: - Big push coordination failures - Nutritional poverty traps - Multiple financial mkt failures - Nontradable inputs (e.g., soils) ` Policy implications: High returns to properly targeted interventions, including redistributive measures. Well-beingt
MFMF Model One useful fairly general poverty trap model Multiple financial markets failures (MFMF): max dt t=0 subjectto: xit(Ait,qt) = F(Ait,ai)+(1-t)qtAit F(Ait,ai)=max[Fh(Ait,ai),F (Ait,ai)] cit xit Ait+1=xit-cit u cit ( ) c,AE0 Where c = consumption, x = income, A = assets, = ability, = discount rate, = asset shock, = depreciation rate, Fh= high technology (w/fixed cost),F = low technology (no fixed cost). MFMF assumption: no borrowing and no insurance options available.
MFMF Model Key implications of MFMF model: 6 M icawber Threshold Ait 4 Asset Stock, Single Equilibrium, Single Equilibrium Not Chronically Poor Poverty Trap 2 M ultiple Equilibrium Poverty Trap 0 Intrinsic Ability, Figure 1: Multiple and Single Dynamic Equilibria in Ability-Asset Space
MFMF Model Key direct implications of MFMF model: 1) Endowments are expected fate. 2) Risk matters and shocks have permanent consequences 3) SE and ME poverty traps can co-exist 4) Systemic change matters A burgeoning literature looks for ME poverty traps based on 1 and 2. That search is complicated by 3-4.
MFMF Model Key behavioral implications of MFMF model: 1) Asset smoothing in response to shocks 2) Highly nonlinear risk taking patterns 3) Multplier effect of small, targeted asset transfers 4) Crowding-in effects of risk reduction measures Some papers have been looking at these behavioral implications that may be more fruitful than testing the direct implications of the MFMF model.
Empirical Testing The challenges of direct tests (the search for threshold effects in welfare dynamics): 1) Which poverty trap? Fail to find ME doesn t mean there isn t a SE poverty trap. 2) Disentangling true state dependence from heterogeneity is very difficult. Example: education 3) Lucas critique and underlying parameter instability 4) Econometric challenges: sparse data around thresholds; can easily appear as heteroskedasticity with positively autocorrelated errors; centering of data and estimating distant equilibria, etc. 5) Asset index construction sensitivity Etc., etc.
Empirical Testing An alternative: Indirect (behavioral) testing: 1) Tests for asset smoothing: Hoddinott (2006 JDS), Barrett et al. (2006 JDS), Carter & Lybbert (JDE in press) 2) Implications for informal credit: Santos & Barrett (JDE 2011) 3) Implications for herder behavior (Toth AJAE r&r) 4) Smallholder fertilizer application behavior (Marenya and Barrett 2009 Ag Econ, AJAE)
Summary Understanding why poverty persists for long periods of time is a key project in dev t econ 1) Need to recognize there exist many candidate theories and major challenges in empirical testing among those theories. 2) But need to get it right in order to identify and design interventions appropriate to context. 3) Next generation of work will focus more on behavioral tests and less on direct tests for thresholds in well-being dynamics.
Thank you Thank you for your time, interest and comments!
