An analysis and briefing on the impacts governmental institutions have on poverty traps.
By Ricardo Jasson
Introduction
Roughly 689 million people around the world live in extreme poverty. Extreme poverty being defined as a someone living with less than or equal to 1.90/day. Roughly 40 percent of Sub-Saharan Africa live in extreme poverty. (Peer 2020) Why are these people still poor? There is a theory that was coined in Developmental Economic papers in the 1970s, Poverty Traps. A poverty trap is a cycle in which an individual deemed poor stays in this cycle and cannot rip through it, this theory explains that if an individual is in a poverty trap, they will stay in poverty. Poverty traps are detrimental to economic growth and development due to their nature of creating stagnation in growth of both households, firms and GDP. If individuals do not have the capital to produce output for firms and the country, the country does not develop.
A considerable detrimental influence that evokes poverty traps are governmental institutions. In most under-developed countries and developing countries, governmental institutions have structures that limit the ability of good-governance and this limitation causes a lack of support for individuals in poverty. The purpose of this article is to explore the influence that governmental institutions have on creating poverty traps and to answer the following question: How can underdeveloped countries’ governmental institutions cause poverty traps? This article will dive deep into how governmental institutions can create poverty traps through ineffective financial aid, lack of demographic assistance and lack of infrastructure.
The present example of the detrimental effects can be seen in the Middle east and North African regions where the poverty rate rose from 3.8 percent to 7.2 percent of the population. (Peer 2020) It’s no surprise that levels of poverty have a negative correlation with economic growth. Thus, the greater that percentage increases, the more countries hope for growth further diminishes.
How do Poverty traps work?
How poverty traps work can be explained using a threshold theory through an asset approach. Poverty traps are full of influential factors that cause individuals to stay in poverty. These factors are assets that hold an individual down like how a magnet holds a piece of metal to it. The threshold ideology states that if an individual can get a certain distance away from this magnetic cycle, then they can have financial success. (Market Power, 2020)
Relationship that Financial Aid and Poverty have
Under-developed and developing countries have the characteristics of producing poverty traps due to financial aid. Financial Aid is an extremely useful short term economic tool to alleviate poverty. It is not useful when the way the financial aid is distributed correctly. Unfortunately, this is not the case for most regions with high poverty. By using subsidies as an example of a financial aid distribution tool it is easily seen that incorrectly distributing financial aid can cause poverty traps. Subsidies in most cases are used as a 1:1 ration for every dollar that an individual does not make to meet the poverty line, which in this case can be used empirically as the threshold line of the poverty trap, 1 dollar is given to the individual. It is a sound strategy for an individual assumed to make 0 dollars in income. Unfortunately, that is a preposterous assumption.
With that being said there is a second issue that arises; if subsidies are the answer to allowing someone to reach the poverty line, what is the answer to them surpassing it? If the individual gains a dollar for each dollar that is not met to the poverty line, the individual will lose a dollar for every extra dollar made over the poverty line. The 1:1 ratio of a subsidy does not allow the individual to create more capital to surpass the poverty line unless the individual was already gaining that amount before. The 1:1 ratio used in most subsidies does not allow the individual to surpass the poverty line with the help of subsidies. The threshold to surpass that pull is not met. An underdeveloped government institution has ineffective distribution tools that are detrimental for individuals in poverty due to the lack of incentive to create capital to surpass the poverty line.
A secondary example of this is shown in the empirical study done by researchers Sixia Chen, Jianju Li, Shenfeng Lu and Bo Xiong has showed that capital injections, such as subsidies to poor communities is not effective to help break a poverty trap. Government Transfer Payments have a negative effect on alleviating poverty. True poverty alleviation has been seen through the use of public policy services in respect to healthcare, education, and many other public programs. The study pointed out evidence through an asset-based approach for Chinese communities using Government Transfer Payments such as subsidies and injections of capital versus injections of public services, schooling, community programs etc. Poverty through the use of data was found to decrease when public services were injected to a community due to a rise in human capital which can be described as working knowledge for workers. As for capital injections, poverty remained the same showing that subsidies as well as government transfer payments do not help alleviate poverty.(Chen et al. 2017)
Poverty Traps and Geography
Poverty traps can also arise in specific geographical regions due to lack of infrastructure in specific regions. Institutions, particularly in regions of chaos, can enact a sense of rejection and neglect towards specific demographic regions. This neglect can give rise to this deadly cycle of poverty that will be difficult to break. In sub-Saharan Africa, there appears to be a misallocation of resources and lack of infrastructures to create production systems. (Paris, Maison, and Weber 2007)
Furthermore, the growth out of poverty for many sub-Saharan African countries can be difficult and disheartening. Steven Durlauf, an economist, showed how traps can be developed through spatial neglect, which is when a government will neglect to provide resources to a specific region or area of the country. Regions with little to no help for schooling infrastructure, such as teachers and school buildings, creates a negative self-reinforcing narrative which can create this cycle of poverty causing a lack of growth and development. The lack of infrastructure can cause this cycle of poverty by simply continuing the same patterns from generation to generation. (Paris et al., 2007)
The lack of schooling and community projects or buildings, also known as social infrastructure, cause these poverty traps because it diminishes the knowledge needed to receive higher paying jobs. Human capital is the capital that is acquired to produce output, whether it be learning how to use factors of supply such as machinery or the knowledge of how to run proper production systems and industrial organizations. When there is an unequal distribution of human capital due to the lack of infrastructure in specific regions there can be constant impact effects that keep individuals in the slow state of poverty that they were in originally. Much of the disadvantages developed, can be resolved through the injection of human capital institutions such as schools. (Ceroni, 2001)
In recent findings by Ester Duflo, and Abhijeet Banerjee, Shawn Cole, and Leigh Linden, the effects of stronger education infrastructure can lead to greater human capital injections in the economy allowing for alleviation in poverty with specific parameters such as types of education, the delivery of education, the ratio of teacher to student as well as the geographical ratio of school to region. (Banerjee et al. 2007)
Poverty due to lack of Coordination in Market Structures
With a lack of infrastructure also comes a lack of coordination of markets and production factors which can lead to detrimental poverty cycles in underdeveloped and developing countries. It is no surprise that market structure can easily impact a countries economic growth. (Miracle, 1970) But on a deeper microeconomic level it hurts the household and the individual by creating a cycle of poverty that cannot be broken by the individual due to their limited power on market structure and legislation related to it. The role of coordination in a market is to create instances where firm’s behaviors can become synced with consumer’s choices. The incoordination will cause inequality of markets Individuals in poverty will not be able to keep up with the rising competition thus forcing a stationary agricultural result where industrialization is not an option to poor income populations. Institutions can affect this coordination by increasing levels of cooperation through public policy. (Paris et al, 2007)
When public policy does not create situations where cooperation is a stronger choice than working individually, the market shuts out individuals in poverty by having prices increase and by having disproportionate wealth distribution. Incoordination coupled with global boosting of demand levels for natural resources; underdeveloped countries have very little to go by in terms of growth. (Paris et al, 2007) By playing catch up, it causes individuals to have to produce at faster rates which also means sacrificing income for meeting a quota rather than creating an internal market structure that allows for coordination between internal and external markets, producer, and households. Sub-Saharan Africa is notorious for having an unqualified and inefficient labor supply that does not allow the countries to progress further. Catching up causes many others to be left behind, and thus creating this cycle of poverty. (Barrett & Swallow, 2006)
Where is the proof of Poverty Traps caused by such deficiencies?
All of this theoretical and applied knowledge was put to the test recently in a paper released March 24th, 2020. This paper used panel data from an asset transfer-based approach where assets with opportunities were handed on over the course of 11 years to a rural community in Bangladesh to identify the existence of poverty traps, as well as the threshold effect spoken about in the beginning of this article. The asset in the paper was a cow. In Bangladesh a cow can be seen as a factor of production that allows for a family to create income. (Balboni et al., 2020)
Though it is not a transfer payment, which stated before do not alleviate poverty the way it should nor does it break the cycle, the cows given were able to help individuals surpass the threshold effect where the opportunity of a cow allowed for growth out of poverty. With the use of the data the authors and researchers were able to find trends where institutions can play major roles in how poverty alleviation policies should be managed and the method of delivery. The paper concluded that misallocation of labor and inefficient labor can be devastating and therefore coordination policies for creating a labor supply thar works with the market is shown to alleviate this poverty cycle that develop around institutional disappointment. (Balboni et al., 2020)
Conclusion
Throughout this paper, the goal was to demonstrate and prove how institutions can cause and create poverty traps. The theory of subsidies and financial aid showed that not all financial aid is helpful. There are instances where subsidies and capital injections do not work to help an underdeveloped country’s individuals grow out of this poverty but in turn keep them at that poverty line. Rather than using capital injections, evidence and research has pointed out that public policy services can demonstrate a radical impact in poverty levels due to the greater return to scales of human capital injections and increased public services.
Furthermore, a lack of infrastructure, legislation, and policy making, demonstrated a vast impact on how people can be stuck in the cycle of poverty for generations. The impact lack of geographical infrastructure, such as schools, has on the way individuals are kept and enclosed in this cycle is shown to be more harming. On the other hand, infrastructure legislation and public policy that supports education and human capital injections to the workforce can serve a country and a region in poverty greater than any financial injection can.
Lastly, this ideology of a lack of coordination in market structures, inputs, and production factors will hold a labor force in poverty due to the incoordination of both the market’s needs and the labor supply’s demand.
All of the argumentation was then shown through a study conducted in a small rural region of Bangladesh with little infrastructure where the individuals were able to surpass the threshold of the poverty trap to increase household wealth was proven to be successful through human capital infrastructure which promoted education, and asset-based transfer of cows which were used to create a stronger market for the region.
This paper clearly demonstrates that institutions have the power to create vicious poverty traps, but also have the power to help individuals to grow out of that poverty thus growing the economy as a whole out of poverty. By creating this profile of poverty traps and the discovery that theory can be used to help those in poverty we are to help the world step away from poverty, and closer to wealth equality, educational equality and equality as a whole.
References
Balboni, C., Bandiera, O., Burgess, R., Ghatak, M., Heil, A., Abed, F., Chowdhury, M., Das, N., Hossain, M., Jaim, W., Matin, I., Minj, A., Musa, M., Sulaiman, M., Rahman, A., Yasmin, R., Banerjee, A., Fafchamps, M., Hsieh, C.-T., & Kaur, S. (2020). Why Do People Stay Poor? Evidence on Poverty Traps from Rural Bangladesh. https://www.poverty-action.org/sites/default/files/presentation/13%20Burgess%20Bangladesh%20%28Paper%29.pdf
Banerjee, A, S. Cole, E. Duflo, and L. Linden. 2007. “Remedying Education: Evidence from Two Randomized Experiments in India.” The Quarterly Journal of Economics 122 (3): 1235–64. https://doi.org/10.1162/qjec.122.3.1235.
Barrett, C. B., & Swallow, B. M. (2006). Fractal poverty traps. World Development, 34(1), 1–15. https://doi.org/10.1016/j.worlddev.2005.06.008
Ceroni, C. (2001). Poverty Traps and Human Capital Accumulation. Economica, 68(270), 203-219. Retrieved May 5, 2021, from http://www.jstor.org/stable/3548834
Chen, Sixia, Jianjun Li, Shengfeng Lu, and Bo Xiong. 2017. “Escaping from Poverty Trap: A Choice between Government Transfer Payments and Public Services.” Global Health Research and Policy 2 (1). https://doi.org/10.1186/s41256-017-0035-x.
Market Power. (2020). Poverty Traps were missing...until now | Economics Research [YouTube Video]. In YouTube. https://www.youtube.com/watch?v=SxrslLv9RxQ
Miracle, M. (1970). Comparative Market Structures in Developing Countries. Nebraska Journal of Economics and Business, 9(4), 33–46. https://www.jstor.org/stable/pdf/40472371.pdf
Paris, Université, X-Nanterre Maison, and Max Weber. 2007. “Poverty Traps: A Perspective from Development Economics Document de Travail.” https://economix.fr/pdf/dt/2007/WP_EcoX_2007-26.pdf.
Peer, A. (2020, October 16). Global poverty: Facts, FAQs, and how to help | World Vision. World Vision. https://www.worldvision.org/sponsorship-news-stories/global-poverty-facts#:~:text=Recent%20estimates%20for%20global%20poverty,according%20to%20the%20World%20Bank.
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