Economics of Poverty Part II

Explain the cross-country growth regression model in Box 8.19.

A cross-country growth regression aims to see how an initial value of GDP affects a country's growth rate. If initial mean income has a negative coefficient (i.e. a high initial income is associated with a lower growth rate), then this suggests that there is conditional convergence where poor countries grow faster and catch up to rich countries (for a given set of initial conditions).

What is a geographic externality and how does it contribute to a geographic poverty trap?

A geographic externality is some feature of the geographic area that makes capital less (or more) productive. This is different to many poor people living in one area - a geographic externality is a feature of the surroundings (say, mountains which make it hard to build roads). Geographic externalities can lead to a geographic poverty trap, whereby people living in a particular area become stuck in poverty.

Explain the concept of a "poor institutions trap". What role did the Colonial powers play in creating institutions traps?

A poor institutions trap occurs when countries need a minimum level of institutional quality in order to reach the equilibrium with good institutions. Limited commitment argues that potential beneficiaries of better institutions have no credible means of compensating those currently in power. Thus, elites will find it optimal to block reforms, since they will likely lose from better institutions.

List some potential adverse incentive effects of a social safety net (SSN) program.

A social safety net program typically involves a direct transfer (usually income) to poor families. While the number of families covered by these types of programs is rising in the developing world, it seems that poorer countries are less effective in reaching the poor (could be as little as one-third of families in poorest quintile, though there is considerably variation across countries). However, the coverage rate for the poor does tend to exceed that of the population, suggesting that the poor are more likely to be receiving the benefits of these programs.

What is a "steady-state equilibrium"? What is a "stable equilibrium"?

A steady state equilibrium is an allocation that is constant over time. A stable equilibrium is similar to a steady state equilibrium, but is robust to slight perturbations. For example, if wealth is increased (or decreased) slightly, the wealth path should lead the individual or household back to the same point.

How do absolute and relative inequality measures tend to vary with economic growth rates? What about absolute and relative poverty measures?

Absolute inequality tends to increase with economic growth, while relative inequality does not. Growth in developing countries tends to be distribution neutral on average, which means that each percentile of the income distribution grows at the same rate (roughly). China, India and the US have seen increases in inequality, while other countries have seen decreases. Note that the correlation between total inequality and economic growth is relatively weak (only 0.116). Similarly, economic growth tends to decrease absolute poverty, but increases relative poverty (though this seems sensible given that as countries become richer, relative poverty becomes more of a concern).

Show that an exogenous increase in the rate of investment will increase the steady-state level of output in Solow-Swan model (Box 8.10).

An exogenous increase in the rate of investment will shift the investment curve upwards (though the y-intercept will still be at the origin). It will also shift total output upwards (again, the y-intercept will be at the origin). This will shift k* to the right, and increase in total output per worker.

What did the initial survey on NREGS reveal about awareness of the scheme?

An initial survey on NREGS revealed that public awareness about the scheme's rules and processes was low. An entertaining movie aimed to inform people about the scheme was created and shown in a random selection of villages. The movie was found to be successful in informing people about their rights under the scheme. However, it did not result in increased attendance, and there was heterogeneity in information retention.

What factors have constrained China's progress against poverty? What about India's poverty progress?

As discussed earlier, China has made huge gains in poverty reduction, with growth in the primary sector accounting for much of this. However, the pace of reduction could have been faster if the growth rates in rural areas had been the same as growth rates in urban areas (i.e. where secondary and tertiary sectors tend to exist). The lagging growth rates of the primary sector as compared to the aggregate growth rate constrained progress against poverty. India's path of poverty reduction has been much different. India's service sector has seemed to be the most poverty reducing, primarily due to the unequal distribution of agricultural resources in rural areas. While growth in the primary sector is poverty reducing for India, this sector has not experienced the same level as growth as other sectors.

How might credit market failure arise? Draw a graph that shows how borrowing constraints can lead to a poverty trap.

Asymmetric information is often a cause of credit market failure. Asymmetric information may arise when a lender cannot be sure of a potential borrower's ability (or willingness) to repay the loan. This can occur when a potential borrower cannot provide proof of income or collateral for the loan, for example. Borrowing constraints imply that an individual needs to have a certain amount of wealth (for collateral, say) before he will find someone to lend to him. This means that the recursion diagram in Box 8.11 will shift to the right, as in Box 8.14.

How has India differed from China in reducing poverty?

Both India and China are very large countries (both in population and geographic size) that have historically been very poor. However, India has not fared so well in terms of economic growth and poverty reduction as China has. The reason may be due to the differences in the initial conditions each country faced. India had a much more unequal distribution of land, and inequalities in both health and educational attainment. India's major reforms began in the early 1990s, and strong economic growth followed. However, there has been a strong divergence between mean incomes in urban and rural areas, with rural areas benefitting little from growth.

What empirical evidence is there on the link between urbanization and poverty reduction?

Both the Lewis model and the Harris-Todaro model link urbanization to higher wages and therefore lower rates of poverty. In Chapter 7, however, many countries have experienced an increase in the share of the urban population but little or no reduction in urban poverty. There is empirically a positive correlation between GDP per capita and the share of the urban population. There is also a negative correlation between the national headcount index and the urban share of the population, suggesting that urbanization is good for poverty reduction.

How did Brazil's economic reforms from the 1970s onwards affect poverty and inequality?

Brazil suffered from issues of hyperinflation, huge budget deficits, and trade distortions, and underwent major macroeconomic changes to address fundamental issues with its economy. Modest economic growth resulted, but with a smaller change in poverty than expected. Brazil's initial high inequality meant that the poor did not capture many of the gains from growth. However, Brazil has seen a decrease in overall inequality, including inequality between regions as well as urban and rural areas.

What is capital flight and how can you determine how much capital flight a country is experiencing?

Capital flight occurs when assets begin to flow out of a country, often in response to a crisis or shock. For example, a period of political instability may lead foreign investors to transfer their assets to a less risky environment. This has implications for the country's exchange rate (it will fall) and balance of payments. Capital flight can also be illegal, such as when a country's assets are taken outside the country (e.g. development aid that is captured by elites and kept in an overseas safe haven).

Describe the findings of Card and Krueger's study. What are some other effects (aside from employment) that a higher minimum wage rate might have?

Card and Krueger looked at the impact of a minimum wage increase in New Jersey, using Pennsylvania as a comparison. They found that a higher minimum wage actually increased employment. Other effects that minimum wage increases may have are decreasing poverty and inequality. There may be negative effects on owners of firms that employ minimum wage workers (as their inputs are now more expensive). There may also be price effects, as the goods produced by minimum wage work become more expensive.

How did China's accession to the WTO impact poor people? Who tended to gain from this accession and who tended to lose?

China's accession to the WTO resulted in some households gaining and others losing. Those who tended to gain were urban households. Rural households generally saw a negative impact.

List some reasons why China has seen so such progress against absolute poverty since around 1980.

China's poverty rate fallen from 84% in 1981 to 13% in 2008. In part, this is due to wide-sweeping land reforms throughout the 1940s to 1970s, which resulted in a more equal distribution of land across the country. Furthermore, the Communist regime had invested heavily in health and education, particularly in rural areas. This meant that when the economy started to develop, the gains from growth were shared by a large part of the population. Of course, these favorable initial conditions contributed to the impressive growth rates experienced by China over the last few decades (e.g. a large, literate and healthy workforce to draw from).

What are some arguments for compulsory schooling? Under what conditions may compulsory schooling actually hurt the poor?

Compulsory schooling is seen as a way to ensure that all children receive a basic education. Education is seen as a way for poor children to escape a poverty trap or increase their lifetime earnings. Goldin and Katz estimate the education is a key factor in US growth rates between 1940 and 1980. Compulsory education can also reduce inequality. However, compulsory education can impose costs on poor families in the form of foregone earnings (children may have been at work rather than school) and resources needed to attend school (e.g. uniforms, books and transportation).

What are some control variables that you should include in a growth regression? What parameter would be affected if important control variables were excluded?

Control variables are an important part of the growth regression model. In regression, it is assumed that the mean of the error term given the variables included in the regression model is zero. That is, everything that is important in explaining growth rates is included in the model. If a control variable is left out that has a strong relationship with growth rates, then it could be that the relationship between growth rates and initial mean income is overstated (beta is biased upwards).

Why might cutting aid assistance in response to weak institutions exacerbate the quality of institutions?

Cutting aid in response to bad institutions can actually worsen the quality of institutions. Loss of aid may increase instability within a country (which is likely already very unstable) and lead to rent seeking by elites. The country could then find itself stuck at the bad equilibrium.

What econometric model would you use to evaluate welfare impacts of price changes due to a trade reform? Why is it important to consider vertical and horizontal impacts?

Determining price changes due to trade reform is a difficult task. Computable general equilibrium (CGE) models can be used to simulate what happens to prices and household welfare after a trade reform. Vertical impacts are usually considered (how the difference between the rich and the poor change). Horizontal impacts are also important (how policy impacts households at the same level of income pre reform). Variation in horizontal impacts implies that some households are gaining and others are losing, which impacts overall inequality.

Both China and India have seen uneven growth rates across regions and sectors. What are these sectors? Why might this be a problem for further poverty reduction?

Different sectors of the economy were found to matter for poverty reduction between China and India. For China, the agricultural sector played a major role, while in India the modern industrial and services sectors were more important. This is likely due to the initial distribution of assets between each country. With an unequal distribution of land among rural Indians, shared growth was harder to attain. The slow growth of the agricultural sector in India is likely a reason why poverty reduction hasn't been as great as China. Since most poor people live in rural areas, a slow growing agricultural sector suggests that overall poverty reduction will be low.

How did early classical economists typically view the relationship between economic growth and poverty? How does this differ from modern day views?

Early classical economists were largely pessimistic about the possibility for economic growth to reduce poverty. Due to Ricardo's law of diminishing returns, redistribution would be the only way to redistribute poverty i.e. economic gains as a zero sum gain. Furthermore, any real gains to the poor would be squandered away, e.g. through an increase in the population. Modern economists instead argue that economic growth can be poverty reducing under the right conditions.

How did East Asia benefit from a broad-based educational system? Contrast East Asia's experiences with India's.

East Asia in particular has benefited greatly from widespread education. In one report, primary education was said to be responsible for between 58% and 87% of GDP growth. This share is larger than private investment. India has not been as successful in providing public education. States that did have broad-based education were found to have much more pro-poor growth than other states.

How is economic growth typically measured? What are some limitations in using this measure as an indicator of progress?

Economic growth refers to increases in GDP per capita. The rate of growth is the annual percentage change in GDP per capita. GDP is an aggregate of the production of all goods and services in an economy. Market prices are used to value quantities of production, then these are added up to get total GDP. Several criticisms of GDP are that it is not measured well in practice, particularly for developing countries; doesn't take into consideration environmental consequences of growth; can be a poor measure of average economic welfare of a population; doesn't explain how income is distributed.

What is a basic income guarantee (BIG) scheme? How does it differ from perfect targeting?

Everyone receives the same transfer, regardless of his or her income. Implies that those with the lowest incomes have a minimum standard of living. This type of scheme has no targeting. Perfect targeting is where only those who are deemed poor receive the transfer. Administrative costs for BIGs are low, but certainly not zero. There is also the possibility of double dipping, whereby some people may receive the transfer twice. The scheme also has to be financed, which may also be costly.

List some reasons why external aid hasn't had more of an impact on poverty.

Firstly, aid tends to be bilateral and given strategically depending on the goals of the donor government (which is not necessarily poverty reduction). Secondly, aid is often tied to specific goods and services produced by the donor country. These projects are also not well coordinated with other donors.

What are fungibility and flypaper effects? Why is fungibility important in determining the impact of external aid?

Fungibility refers to the idea that aid can be spent on whatever the government sees fit. For example, the government receives $1 million to spend on infrastructure. If the government had already budgeting $1 million for infrastructure, then the infrastructure is built and there is $1 million left over to spend on another project. Flypaper effects are when aid sticks to a sector. For example, now $2 million is spent on infrastructure. Fungibility makes it hard to evaluate what the external aid was spent on and how much effect it had. Evaluating the infrastructure project may not properly reflect the impact of aid - it would be better to evaluate the new project.

List some macroeconomic crises that have affected developing countries in recent years. Is there evidence of lasting impacts of some crises?

High inflation rates often affect poor people disproportionately, given sticky wages and the proportion of income spent on items such as food and housing. Poor members of the population are also more vulnerable to macroeconomic shocks, either through a higher risk of job loss or inability to consumption smooth. The effects from some crises can be long lasting. For example, poor nutrition at birth and a higher infant mortality rate. It may also take some time to rebuild asset holdings or see rising wages.

Why has the urban sector typically been favored in policy making? What are the arguments for focusing instead on the rural sector?

Historically, the urban sector has had the incentive to keep rural wages low as much of the urban labor force was drawn from the rural sector. More recently, agriculture is seen to be an unproductive sector of the economy, and developing the urban sector will lead to higher wages. Labor migration from the rural sector to the urban sector (where the wages are higher) leads to a reduction in poverty. However, given that most poverty can be found in the rural sector, growth in the rural sector is likely to be more poverty reducing than growth in the urban sector. This could come through increasing the marginal productivity of rural sector workers, e.g. technology gains

Explain the cross-country regression model for testing whether trade openness benefits an economy. Has trade volume been found to be a significant predictor of growth? Why might trade volume be an endogenous variable?

Identifying the causal impact of trade openness is difficult. To find the impact, a cross-country regression can be run where the dependent variable is GDP growth and the independent variables are trade openness and relevant controls. There is some support for the view that trade openness is good for growth (significant in about two-thirds of regressions). However, trade volume is likely an endogenous variable, such that it can't be used for causal inference (the direction of causality is unclear, maybe growth leads to trade openness).

Describe the basic trade model based upon comparative advantage. What goods will a country import and export? Which factor will have the higher wages? How might trade under this model lead to a reduction in poverty and inequality? Under what circumstances might trade lead to an increase in inequality?

In the basic trade model (say two goods, two factors of production and two countries), each country specializes in producing the good it has a comparative advantage in, and trades with the other country (who is also specializing). Comparative advantage is determined by who has the lowest opportunity cost of producing a good, or in other words, who is better relatively at producing a good. If a country has an abundant factor of production (e.g. labor), then the country will be better relatively at producing the good that is labor intensive. The country will export the good it has the comparative advantage in and import the other good. The price abundant factor will increase (e.g. wages) which can lead to a decrease in poverty and inequality. However, it may also be the case that the reverse is true - if the price of some factors of production are increasing, other factors will see their price decrease (relatively) and inequality may actually increase.

In the title to the Ivanic et al. (2011) paper referred to in Box 9.5 they refer to these as "short-term" impacts. What reasons can you think of as to why the longer-term impacts could differ from those implied by the above calculations?

In the long-run, individuals can adjust their behavior substantially. For example, if the price of what has increased, consumers will switch to a cheaper staple, and/or farmers will begin growing wheat. This may imply that in the long-run, the impacts on poverty from an increase in the price of wheat may not be so severe.

Why might a public information campaign to teach people their rights under the law work better in some settings than others?

Information campaigns aim to increase program participation and ensure that their rights are respected. These type of campaigns have had mixed success. In the US, anti-poverty programs have been found to work better in places with greater access to public radio. However, a study in India found less impact in the context of improving monitoring of education service providers. There are several possible explanations for this. Firstly, information may reduce participation if some people decide that they don't want to be involved in the program. Secondly, people may not be accessing services for reasons other than lack of information. Thirdly, there is also heterogeneity in the quality of information - better information may lead to higher participation.

Explain what information and incentive constraints are. Give an example of a policy with such a 100% marginal tax rate.

Information constraints arise when it is difficult to identify who poor people are. This affects how well targeted a program is. Incentive constraints occur when recipients of transfers are disincentivised from working, often because any additional income will mean loss of part or the entire transfer amount. An example of a policy with a 100% MTR is one in which for every extra dollar earned from employment, a dollar is lost from the total transfer received.

Why would self-targeting policies be more appropriate for developing countries with a large informal sector?

Information constraints mean that the government does not know who is poor, making targeting difficult. Self-targeting programs overcome information constraints as individuals self-select into the program. For example, if an individual chooses to work on a workfare program, it implies that he or she is poor.

Explain the term "initial distribution". Why might the initial distribution matter for poverty reduction?

Initial distribution refers to the distribution of incomes at the first time period considered (not necessarily the beginning of all time). It's used often in theoretical analysis when considering how a distribution changes over time. Initial distributions matter greatly to poverty reduction. For example, a country that starts with a high rate of poverty may find it hard to accumulate capital and grow. As mentioned above, countries with high levels of inequality may find growth rates affected. China provides a good example of how a country that started with relatively high levels of education and land ownership was able to grow faster than countries that might have started with a less equal initial distribution.

What is meant by "labor augmenting technical progress"? Give some examples of industries both where technical progress is typically labor augmenting and not labor-augmenting.

Labor-augmenting technical progress is a change that increases the demand for labor in production (e.g. in the production function, L increases). The technology sector could be argued to be labor augmenting e.g. through demand for programmers. The car industry is usually thought to be not labor augmenting.

Why are land-use rights (and property rights in general) important for poor people?

Land is the main non-human asset for poor people, and as a result, secure land rights are crucial to their welfare. Without secure land rights, land may be appropriated at any time, which creates both a direct loss of a valuable asset if the land if appropriated, as well as uncertainty (which affect investment decisions). Proper land titling is key in ensuring land rights, as are social institutions, which support individual ownership titles and land tenure

How does Piketty define capital? What role does it play in his argument regarding the rise in income inequality?

Piketty defines capital as all non-human wealth, which includes physical capital, financial capital and property. It excludes human capital. Note that not all the types of capital in this definition are productive, e.g. a rise in property prices will increase the value of one's capital, but will not necessarily lead to an increase in output. Inequality arises when the growth rate of GDP per capita is sufficiently low relative to the rate of return to capital. By broadening the definition of capital, Piketty argues that the rate of return to capital has been much higher than the growth rate in GDP per capita, which increases inequality.

What role do protection and promotion policies play in eliminating poverty traps? Explain the difference between the two policies with the help of a poverty trap diagram such as in Box 8.14. Why can there be poverty in society even if there is no one caught in a poverty trap?

Protection policies aim to stop people from falling into a poverty trap by keeping their incomes above a minimum level (kmin in Box 8.14). Promotion policies aim to help people escape poverty traps by getting their wealth above kmin. Poverty can still exists regardless of whether there is a poverty trap. A poverty trap implies that there is some level of wealth that will "trap" people in poverty, such that incremental gains in income will not be enough to eventually escape poverty. In a society without a poverty trap (such as in Box 8.11), incremental gains in income will lead someone to escape poverty in the long run.

Why would a protectionist trade intervention help protect against external price shocks? What are some alternative policies that could be used to protect against these shocks without causing substantial price distortions?

Protectionist trade policies can help stabilize prices. Short-term global price fluctuations can have long-term impacts on some groups. For example, a farmer that cannot sell his crop for a high price may find that he is left in debt and unable to borrow again the following season. Alternative protectionist policies could be subsidies for farmers, better credit and lending infrastructure, and risk-sharing farming practices.

What is the aim of rent controls? Why might they not work as intended?

Rent controls aim to stop rent in private sector housing from rising too quickly (i.e. above the inflation rate). It aims to ensure that there is some availability of affordable housing. However, rent controls imply that the rental price is below market price, leading to excess demand. As a result, it may be very difficult to obtain a rent controlled dwelling. Landlords also have less incentive to provide maintenance and other services. It might also be less efficient than other policies such as direct subsidies.

How did China and Vietnam differ in their approach to agricultural land-rights after switching from socialist agricultural systems?

Socialist agricultural systems are typically not as efficient as the family-farm model as farmers receive less than their marginal product of labor under socialist agriculture, and therefore have less incentive to produce. Both Vietnam and China shifted to the family-farm model in the 1980s and 1990s. China's land reforms involve administrative land allocation. Vietnam's land laws allowed for voluntary exchange and on the whole were found to be pro-poor, though there were some gainers and losers.

What is a structural adjustment program? Were these typically pro-poor programs?

Structural adjustment programs refer to the type of programs the Washington Consensus advocated. They were not typically pro-poor. Removing tariffs and subsidies will result in a fall in the price of domestic goods. While this is good for exporters, firms that do not export (e.g. those that provide non-traded goods) will suffer. Unemployment in these industries may result. Even with relatively cheaper prices for some goods, other goods such as food may rise in price. Wages will adjust more slowly.

Review the poverty trap model in Box 8.14. Discuss the dynamic gains from an exogenous increase in wealth to people at different levels of initial wealth. How is inequality affected? What about if income is redistributed from rich to poor?

Suppose that everyone gains an increase in w that is less than kmin. Those with initial wealth between the equilibrium points B and C will see their incomes converge to point C (no change in the equilibrium point for this group). Some people stuck in the poverty trap will escape poverty, but so long as the gain in wealth is less than the threshold, some people will still find themselves stuck in a poverty trap. There are now more people at the upper end of the distribution at point C, but there will still be some stuck at point A. Similarly, redistribution from rich to poor will also have little impact on inequality if there are still some people stuck in the poverty trap, and the amount of wealth redistributed from the rich small enough to ensure they stay at point C.

How does the Harris-Todaro model differ from the Lewis model? Why would the rural wage rate not be driven down to eliminate unemployment?

The Harris-Todaro model also tries to explain how an economy develops but through the scope of urban unemployment. A key feature is that the urban wage rate is fixed at a level above the urban wage rate. The labor surplus assumption is dropped. Rural workers are attracted to the city by higher wages, but not all find work. Equilibrium occurs when the wage rate is such that rural workers no longer want to move. Because of the higher wage rate, there is excessive migration and some urban residents find themselves without jobs. Note that the equilibrium condition is that the rural wage rate equals the expected urban wage rate, which is necessarily below the actual urban wage rate so long as the probability of getting an urban job is not 1.

What is the Kuznets Hypothesis?

The Kuznets hypothesis explains how inequality changes as an economy grows. It follows an inverted U shape: at low levels of growth, everyone is poor. As the economy grows, some people benefit while other do not. Richer countries care about inequality and redistribute income towards the poor (or the poor begin to share in the gains of growth more than the rich).

How do researchers test the Kuznets hypothesis? Does the data support the hypothesis?

The Kuznets hypothesis traces out how inequality changes with economic growth. To test the KH, a researcher can run a regression with a country's Gini index as the dependent variable then GDP per capita and GDP per capita squared (plus appropriate controls). The squared GDP term is important since the inverted U shape represents a non-linearity between income and the Gini index. If the KH is correct, both the GDP variables should be significant, with GDP per capita positive and GDP per capita squared negative. In general, there is weak evidence for the KH. Cross-sectional data (across many countries in one time period) has found some evidence, though there is much less evidence that countries evolve according to KH over time.

How does the Lewis model explain economic development? What are the main criticisms of this model?

The Lewis model explains economic development through technological change that increases the size of the modern sector. It assumes that there are two sectors, urban (modern) and rural. There is a labor surplus in the rural sector that implies that the marginal product of labor in the rural area is constant. The wage rate in the urban sector is determined by the marginal product of labor in the urban sector and is above the wage rate in the rural sector. Technological change means that more workers can be employed in the urban sector. As more workers move to the urban area, the labor surplus is absorbed. Eventually, the economy will reach the Lewis turning point and wages in the rural sector will begin to increase. The Lewis model traces out the Kuznets curve.

What is the "Washington Consensus"? List some of the major criticisms of the consensus.

The Washington Consensus refers to a set of policies advocated by International Financial Institutions (IFIs) starting from the late 1980s. Some policies include fiscal discipline, cutting subsidies, tax reforms, liberalizing trade, competitive interest rates and privatizing state-owned resources. These policies have come under criticism for being a 'one size fits all' approach that didn't take into consideration individual country needs. Rich countries that left little bargaining power for the countries in which these reforms were being implemented also imposed them.

What is the aggregate poverty gap for the developing world in 2010 (for a poverty line of $1.25/day)? How is this gap calculated? List the major reasons why the cost of eliminating poverty could be much greater than the aggregate poverty gap.

The aggregate poverty gap in 2010 was $166 billion per year. This gap is calculated by taking summing the difference between actual income and the $1.25/day poverty line for everyone below the poverty line. (See the discussion on the poverty gap index in Part 2). In other words, it is the area below the poverty line but above the curved quantile function. Incentives, targeting and leakage are some of many reasons why simply transferring $166 billion to poor people may not eliminate poverty.

Do you think it is it plausible that labor can be withdrawn from the rural economy without any loss of rural economic output, as assumed by the Lewis model (Box 8.7)? How might that happen? What does it assume about the behavior of those left behind?

The assumption of the labor surplus is one of the more criticized aspects of the model. If the assumption is true, it implies that the rural sector is producing the exact same amount of output with one less worker. This means that either the marginal product of labor is zero, or that another member(s) will increase their work to make up the difference. This seems implausible in many settings. If the labor surplus assumption is dropped, the result is an upward sloping marginal product curve and rising wages that come with increased technological progress.

What is the hukou system? How might it have mattered to poverty reduction?

The hukou system in China are restrictions on internal migration aimed to control the expansion of urban population. By stemming the inflow of people to urban areas, local governments can avoid the creation of urban slums and also control spending on health, education and housing. The end result on poverty is somewhat ambiguous. It can be argued that the hukou system benefits urban residents, as their wages remain high due to the restricted labor supply as compared to rural areas. With free mobility, it might be that wages tend to equalize, as more people choose to migrate to urban areas. However, it is likely that not all these migrants will find employment, and some may be worse off than they were in the rural area.

List some criticisms of the Harris-Todaro model. What happens when urban wages are assumed to be flexible?

The idea of a fixed urban wage rate is often criticized (e.g. why is it fixed?). It also assumes that unemployed urban workers are idle, i.e. there is no informal sector for them to work in. There is no heterogeneity in workers in both sectors, for example a type of worker may be more likely to migrate than others. There is also no unemployment in the rural sector.

What were the main findings from the Morocco trade policy simulations?

The policy simulation, which involved a hypothetical reduction on, imported cereal tariffs also found differing effects across households. In aggregate, there was only a short-term impact on the poverty rate. Urban households tended to gain from cheaper food prices, while rural households lost as their price of their produce fell. There was a small drop in vertical inequality but a larger rise in horizontal inequality.

List some reasons as to why high inequality can limit economic growth.

Typically, it is argued that growth leads to inequality. However, it is also possible that the direction of causality runs in the opposite direction, that is, inequality affects growth. Several theories could plausibly explain this interpretation. One is that poverty fosters a high rate of population growth, which leads to lower economic growth, as per standard models of economic growth (in which an increase in n leads to a lower capital-labor ratio). Another explanation (which suggests that inequality may be good for growth) is that given that the rich save a higher proportion of their incomes, a higher rate of inequality means higher aggregate savings and therefore higher growth (though, alternatively, it could be that higher inequality implies higher poverty and therefore lower savings). High inequality can also lead to long run problems in an economy, for example, lower levels of education, poorer health outcomes, and therefore less productive workers within a subset of the population. Credit constraints may also be an issue and further exacerbate growth.

What is "underemployment" as distinct from "unemployment"? Why might underemployment be a significant problem in developing countries?

Underemployment refers to those who are employed but not working as much as they would like to. In developing economies with seasonal work, many workers find themselves underemployed at certain times of the year. For example, a worker may be employed full-time during harvest season but not during other times of year.

Why hasn't urbanization in Sub-Saharan Africa been poverty reducing?

Urbanization in SSA on aggregate has not been poverty reducing. This could reflect greater regulation of urban labor markets, as well as existing agricultural policies that prevented growth in agricultural productivity. A stagnant agricultural sector may have led to excessive urban migration, excessive urban unemployment, and little poverty reduction

Consider the production function in Box 8.2. Suppose there is some (positive) kmin below which no output is possible. What implications would you expect from an increase in kmin?

With a positive minimum level of capital, the graph will shift to the right. The firm needs a minimum amount of capital before it can produce any output. A change in A will shift the curve upwards (though not the y intercept). More output can be produced for the same capital-labor ratio.