Unit 8 Economic dynamics: Financial and environmental crises

8.3 Application: A real-world poverty trap

Why are some people poor? Is it because they make poor choices or don’t work hard enough? Or is it not about them, but instead about their situation: their lack of opportunity?

The question is hotly debated, those in one camp saying that the poor have to change and others in another camp objecting that, no, it is the situation—the structure of the economy—that needs to change. Any person, those in the second camp say, including those who today are well off—would end up poor if they found themselves in the situation of those with low incomes. And if a poor person today were catapulted into a different situation—winning a lottery, for example—they would remain well off. Those who argue that it is the situation that explains why people are poor, not something about the poor themselves, say that the poor are trapped in poverty. Figure 8.4 provides an example.

It would be good if facts could help to resolve the debate, but it is hard to do this. To get the right facts, we would have to experiment with moving people around in the income distribution—some poor becoming well off and some rich becoming poor—and then returning later to check if they return to their initial situation—the once poor falling back into poverty—or instead, as the poverty trap idea suggests, they remain in their new situation. But we cannot really do that, can we?

Amazingly, we can. And it has been done, at least the part about taking some people out of poverty and documenting what happens in the long run. (Clearly, there would be ethical and practical issues about moving people in the other direction.)

In 2007 a team of economists randomly selected 3,276 very poor women in Bangladesh to receive a major asset, a cow (worth about 500 US dollars).¹ These women were working for others, paid the equivalent in real buying power of about 30 US cents per hour. The better-off women in their villages did not work for others. They tended cows, making higher incomes selling milk and manure (for fertilizer). Few of the ultra-poor women receiving the cow had attended school, and only 7% of them were able to read and write.

Later Clare Balboni and co-authors followed up with these women to find out if they had slipped back into abject poverty or had sustained a higher income. If on average they continued to do well, then we would take this as evidence of a poverty trap.

What Balboni and her colleagues found is that among the ultra-poor women who received the asset (the cow), those who already had a bit of wealth—a shed, or a cart, perhaps—were more likely to have increased their wealth (above the value of the cow), while those entirely without wealth before receiving the cow had lost wealth, many selling the cow to make ends meet. This is exactly as the tipping point model predicts.

The authors even estimated what we would call the poverty trap dynamics curve (PTDC), shown in Figure 8.6. In this diagram, the wealth plus the transfer (the value of the cow) for women in 2007 is shown on the horizontal axis. On the vertical axis is the wealth of the same women in 2011. The 45-degree line shows a situation where wealth is the same in both years. A woman whose wealth was higher in 2011 than in 2007 would be represented by a point above the 45-degree line and vice versa. The lowest intersection is the stable equilibrium that is a poverty trap and the intersection at $514 is the unstable tipping point, similar to the top of the ‘hill’ in the earlier figures.

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https://www.core-econ.org/macroeconomics/08-financial-environmental-crises-03-real-world-poverty-trap-application.html#figure-8-6

Figure 8.6 The poverty trap dynamics curve (PTDC).

Women who had, for example, $100 of assets prior to the transfer, so that their total assets (including the cow) in 2007 were $600, had almost $800 in assets four years later (reading up from 600 on the horizontal axis to the wealth curve).

The distribution of wealth in these villages shown in Figure 8.7 is the result of the wealth dynamics shown in Figure 8.6. The height of the curve at each level of wealth shows the fraction of the population with the indicated level of wealth. The figure shows that many families have considerable wealth, while some are very poor, with very few in between. The tipping point in the wealth dynamics (Figure 8.6) is very close to the low point in the income distribution curve (Figure 8.7) at about 400 US dollars (note the dollar measurements on the horizontal axis—it is a ratio scale). This follows from the fact that we have a tipping point at about this wealth level: we’d expect few people to be found near it, just as the figure shows. The reason is that just as gravity pushes the ball down the hill, we’d expect people to gain wealth if they were a bit above the tipping point and to lose wealth if they were below, which is what the economists found.

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https://www.core-econ.org/macroeconomics/08-financial-environmental-crises-03-real-world-poverty-trap-application.html#figure-8-7

Figure 8.7 Distribution of income in the treatment group. The horizontal axis is a ratio scale so that the distance between 100 and 400 (the latter being four times the former) is the same as the distance between 400 and 1,600 (also four times).

The authors conclude: ‘there is a wealth threshold below which people are stuck in a poverty trap, where their initial wealth (rather than their abilities or traits) keep them in poverty.’ They suggest that the mechanism underlying the tipping point is that ‘there is a minimum scale of operation required for profitable and sustainable livestock production […] slightly higher than just the value of the animal. […] a household who already owns a cart will be able to sell livestock products such as milk and manure at distant markets at better prices, thus generating a higher income.’ Because poor families cannot borrow to buy a cart (and a very tiny cart that they might be able to afford would be useless) the result is a poverty trap that locks the poorest into the worst occupations.