Absolute and relative poverty

• Absolute poverty — income below the level needed to afford the basic necessities of life: food, shelter, clean water, clothing. It is measured against a fixed standard that does not change with the average income of the country. The World Bank's international extreme-poverty line is $2.15 a day (2017 PPP).
• Relative poverty — income below a level defined relative to the rest of that society. In the UK the standard measure is below 60% of median household income. It captures the inability to participate in the normal life of your society.

The crucial consequence: because relative poverty is defined against the median, it is really a measure of inequality in the bottom half. Economic growth alone cannot eliminate it — if everyone's income doubled overnight, absolute poverty would collapse but relative poverty would be completely unchanged. Only a change in the distribution reduces relative poverty. Get this into your essay and you are straight into the top band.

Other measures: the UN's Multidimensional Poverty Index looks beyond income to health, education and living standards — recognising that poverty is not only about money.

The relative poverty line

What happens in a boom?

What causes poverty — and what changes it?

• Unemployment — the single biggest driver of poverty in an advanced economy. Note also that much UK poverty is now in-work poverty: low pay, part-time and insecure hours.
• Low pay and low skills — poor education and training cap earning power (low MRP).
• Poor health and disability — reduce the ability to work.
• The generosity and design of benefits — the level of the safety net, and the unemployment/poverty trap where high benefit withdrawal rates destroy the incentive to work.
• Regressive taxation — indirect taxes such as VAT take a larger share of a poor household's income.
• Inflation — particularly food and energy inflation, which hits the poorest hardest because these are a larger share of their spending.
• In developing countries: conflict, corruption, weak property rights, primary-product dependency, lack of infrastructure and lack of access to credit.

Absolute poverty in the world is falling fast: the share of the world's population living in extreme poverty has fallen from around 36% in 1990 to under 10% today — driven overwhelmingly by growth in China and India. That is the strongest single piece of evidence for the pro-globalisation case.

Wealth inequality vs income inequality

• Income — wages, salaries, interest, rent, profit, benefits. Measured per week/year.
• Wealth — property, pensions, shares, savings, physical possessions. Measured at a moment.

Wealth is always distributed far more unequally than income, for three reasons: wealth is accumulated over a lifetime (so it compounds); it is inherited across generations; and it generates income of its own (rent, dividends, capital gains), so those with wealth get more income and can accumulate still more. In the UK the Gini for wealth is far above the Gini for income.

Piketty's argument in one line: when the rate of return on capital (r) exceeds the growth rate of the economy (g), wealth grows faster than incomes, and inherited wealth comes to dominate. That is an argument that capitalism has an inbuilt tendency to concentrate wealth unless offset by policy.

Stock or flow?

The Lorenz curve

The Lorenz curve plots the cumulative % of the population (poorest first, on the x-axis) against the cumulative % of total income they receive (y-axis).

The Gini coefficient

The Gini turns the Lorenz curve into a single number.

Since A + B is the whole triangle under the 45° line, and the axes run 0–1, A + B = 0.5. So in practice:

• Gini = 0 — perfect equality (the Lorenz curve is the 45° line; A = 0).
• Gini = 1 — perfect inequality (one person has all the income).
• Real economies: roughly 0.25 in the Nordic countries, around 0.35 in the UK, around 0.40 in the USA, above 0.60 in South Africa.

Limitations: the Gini is a single number — two countries with the same Gini can have completely different Lorenz curves (one unequal at the top, one at the bottom). It says nothing about absolute living standards (a very poor country can have a low Gini). It usually measures income, not wealth, and it ignores the informal economy and benefits in kind such as the NHS.

Calculate the Gini coefficient

Reading the Gini

The quintile ratio

Causes of income and wealth inequality

Within countries:

• Wage differentials — differences in MRP, skill and the elasticity of labour supply (Theme 3.5).
• Unemployment — no earned income at all.
• Ownership of wealth-generating assets — property and shares generate income, so wealth begets income begets wealth.
• Inheritance — wealth passes across generations, entrenching the distribution.
• The tax and benefit system — how progressive it is. This is the state's main lever.
• Skill-biased technological change and globalisation — raising the premium on high skills and hollowing out mid-skill jobs.

Between countries: differences in the stock of physical and human capital, in institutions (property rights, rule of law, corruption), in access to credit and technology, in infrastructure, and the legacy of colonialism and conflict.

Does development reduce inequality?

The Kuznets curve hypothesis: as a country industrialises, inequality first rises (a few move into higher-paid urban industrial work while most stay in low-paid agriculture) and then falls as the workforce shifts, education spreads and the state builds a welfare system.

Evaluate it hard. Kuznets is a hypothesis, not a law. Inequality in the US and UK has risen since 1980 despite both being highly developed — the opposite of what the curve predicts. Rising inequality at high income levels is better explained by skill-biased technological change, globalisation, the decline of trade unions, and less progressive taxation. Development does not automatically deliver equality; policy does.

Is some inequality useful?

The significance of capitalism for inequality

Capitalism — private ownership of the means of production, with resources allocated by the price mechanism — has a structural relationship with inequality. The spec asks you to weigh both sides.

Capitalism generates inequality because:

• Private ownership of capital means returns flow to those who already own assets. Wealth compounds (Piketty: r > g).
• Wages are set by MRP and scarcity, not need, so a footballer earns far more than a nurse.
• Monopoly and monopsony power allow firms to earn supernormal profit and suppress wages.
• Inheritance transmits advantage across generations, weakening social mobility.

But capitalism also reduces poverty because:

• The profit motive drives innovation, productivity and growth — and growth is what lifted a billion people out of absolute poverty.
• It creates employment and, through growth, a larger tax base to fund redistribution.
• Inequality is not fixed by the system: Sweden and the USA are both capitalist, yet their Ginis differ enormously. That difference is created by policy — progressive taxation, benefits, free education and healthcare, minimum wages.

The judgement to reach: capitalism appears to create a strong tendency towards inequality, but the extent of inequality in any capitalist country is a political choice, exercised through the tax and benefit system. And there is an equity–efficiency trade-off: aggressive redistribution can blunt incentives and cause capital flight, so the optimal amount of redistribution is not infinite.

Which concept is this?

Tap a statement, then tap the concept it illustrates.

Match the term to its meaning

Tap a definition on the left, then its term on the right.

The limits of the Gini

The big ideas to know

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