Is poverty really the problem and not inequality? A policy discussion

By Ayan Banerjee

Some economists hold the belief poverty, not inequality, is the problem and to alleviate poverty, the government should use income transfers rather than direct interventions in particular markets. This article will attempt to critically assess these two ideas and evaluate the overall point of view.
 
Inequality refers to the differences between income groups and poverty (absolute) concerns those who have a standard of living below a certain benchmark (Barr, 2004). Poverty is an issue that presents several multifaceted problems. Firstly, households that fall below the poverty line face serious effects on their health in several direct and indirect ways. These include the consequences of being in poorer quality housing and the health effects due to poorer nutrition which is common even in developed countries where a healthier diet is often more expensive. Poor health is a significant constraint on a society’s economic and social prosperity as there are additional care costs, opportunity costs of lost output and reduced welfare of the population due to ill health. Secondly, higher levels of poverty are related to increased crime levels. According to the Becker model, a lack of legal opportunities associated with those in poverty would encourage the rational agent to engage in criminal activity as it is more attractive. Poor households also have a lower disposable income, therefore, are unable to generate as much income through spending and consumption. Overall, poverty is a significant multi-faceted problem causing its alleviation to represent an important objective. 
 
Highlighting a value-free poverty line presents several problems (Barr, 2004). Since consumption opportunities depend on a combination of both money and non-money income, this creates issues on measuring actual consumption based solely on money income. Additionally, the definition of the unit of income and the time period of measurement of income both lead to an arbitrary definition of poverty. Since policymakers still establish a poverty line despite these issues, it is inevitable measurements either fail to capture all poverty or overestimate the number of those in poverty. Therefore, conclusions drawn from poverty data may not truly reflect actual living standards suggesting inequality and other indicators must also be considered.  

Another reason why inequality is also a problem is that some agents can have higher utility in a country with greater levels of poverty but lower levels of inequality. As shown in the above diagram, the two curves illustrate two societies, one with higher levels of poverty but also lower inequality than the other. Assuming rational utility-maximising agents, we can assess which society a representative poor person would rather be in. If their utility solely depends on their income, they will choose a society with higher inequality and lower poverty levels. Conversely, if their utility increases with their income and decreases with the income of a rich person, the rational choice may be to be in the other society. Overall, agents behind a veil of ignorance can prefer to be in a society with higher poverty levels and lower inequality demonstrating that if the aim is to maximise aggregate welfare of society, inequality is also a problem; this is shown by the existence of the income externality.
 
Income transfers are often used as a method of poverty alleviation; however, its effectiveness is contested. It is argued that income transfers are an effective way of alleviating poverty in the short run by offering cash transfers to households that satisfy certain conditions. The success of income transfers depends on its horizontal and vertical efficiency. Some applicants may face a harsh evaluation and consequently not be offered support whilst on the demand-side, eligible agents may not apply for income transfers either due to lack of knowledge, inconvenience, or stigma. Its effectiveness also depends on the vertical efficiency: that income transfers are not offered to households that no longer need them. These transfers have a strong potential of being a labour supply disincentive, increasing administrative and tax costs whilst pushing wages higher affecting firms’ profits. Therefore, the success of income transfers is highly dependent on the means testing of the eligibility for income transfers. If these programmes are both vertically and horizontally efficient, income transfers improve the standard of living to above the poverty line.
 
Alternatively, governments can choose to enact forms of market-based intervention to alleviate poverty. One example of this is housing intervention. If expenditure on housing is too high, it can force individuals into poverty, therefore, providing more affordable housing would improve living standards and increase disposable income. However, the success of this intervention is debatable. Intervention occurs through the government directly supplying houses, providing mortgage subsidies, enacting price controls or size regulation. Public sector housing suppliers lack a profit motive which can lead to the inefficient use of resources such as through over-staffing due to bureaucratic issues.  A price ceiling would also likely create a shortage of housing . This would create a loss in the welfare of society (deadweight loss). Therefore, whilst it may reduce poverty, it is likely to cause separate externalities could outweigh any benefits.

There is also a similar effect of enacting a minimum wage policy intervention in the labour market. This aims to reduce in-work poverty and offer protection against exploitation; however, it is ­­­­route at tackling poverty. There is the potential this would cause an increase in unemployment as there would likely be an excess of labour supplied, however, this was not observed in the UK after the introduction of a national minimum wage. This may lead to the firing of workers as firms would have incurred higher costs, likely affecting the lowest-paid workers most as they would be the first group impacted. Furthermore, there would likely be an increase in the price level set by firms in response to higher costs of production. This would disproportionately impact low-income workers as has a higher proportional effect on their disposable income. Overall, this policy’s effectiveness at alleviating in-work poverty is uncertain.
In conclusion, poverty alleviation represents an important economic objective for a society. However, this does not detract from the fact inequality can still be a problem and requires may intervention. Income transfers do represent a viable route at alleviating poverty in the short run, however, its effectiveness is dependent on horizontal and vertical efficiency. Alternatively, market intervention can be effective at achieving poverty alleviation, however, its success is more volatile depending on the implementation.