Poverty reduction takes longer when income inequality is greater

• Author: Anne Epaulard
• Position: IMF Institute
• Pages: 164-165

Page 164

Few would dispute that, on average, economic growth benefits the poor and that poverty reduction is a product of economic growth. However, data from developing and transition economies show that, for a given growth rate of per capita GDP, some countries achieve more poverty reduction than others.

Understanding why this is so can help countries identify which economic policies are most effective in reducing poverty. A new IMF Working Paper, "Macroeconomic Performance and Poverty Reduction," studies the link between growth and poverty reduction and concludes that there is no trade-off between them.

A recent empirical study of the relationship between the annual change in countries' poverty rates and their annual growth rates (see box, page 165, for details about the study) finds, as have many earlier studies, that, on average, growth reduces the poverty rate by the same amount that an economic downturn or crisis increases it. This result is important because it does not support the view that economic downturns hurt the poor more than growth helps them as a result of irreversibilities and the existence of poverty traps. According to this view, getting out of poverty is much more difficult than falling into it because of a potentially irreversible loss of wealth, health, or opportunity. A youth who drops out of school, never goes back, and thus never learns how to read is an example of irreversibility. Similarly, in a poverty trap, regardless of the growth rate, the poor never make it out of poverty because they lack basic skills or opportunities to participate in economic activity.

But even if the empirical evidence suggests that these effects are not strong, the simple relationship between growth and poverty reduction leaves unexplained a large part of the observed changes in poverty rates. How can the picture be completed?

Significance of income inequality

Apart from growth, both the initial level of development and initial income inequality explain a significant part of poverty reduction. This was shown by a test that was set up in which nothing was known about a country but its initial income distribution (measured by the Gini coefficient, a measure of income inequality, where the higher the number, the greater the level of inequality) and level of development (measured by real per capita GDP). Using...