Economics Letters, Vol.

56 (1997): 51-57

Can high-inequality developing countries escape absolute poverty?

Martin Ravallion1
World Bank

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Abstract: At any positive rate of growth, the higher the initial inequality, the lower the rate at which
income-poverty falls. It is possible for inequality to be sufficiently high to result in rising poverty,
despite good underlying growth prospects at low inequality.
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1 Introduction

Do the poor face the same prospects of escaping poverty in high inequality developing

countries as in low inequality countries? Is it possible that inequality could sometimes be so high

as to stifle prospects of reducing absolute poverty, even when other initial conditions and policies

are favorable to growth?

1
Address for correspondence: 1818 H Street NW, Washington DC, 20433, USA. The findings,
interpretations, and conclusions of this paper are those of the author, and should not be attributed to the World
Bank, its Executive Directors, or the countries they represent.
 There are two arguments as to why initial distribution matters to subsequent rates of poverty

reduction. The first is that higher inequality may entail a lower subsequent rate of growth in average

income, and hence (it is argued) lower rate of progress in reducing absolute poverty. I shall call this

the “induced-growth argument”. There are two links in this argument, one from initial distribution

to growth, and one from growth to poverty reduction. On the first, an adverse effect of inequality

on growth has been explained in various ways, including political-economy models in which more

unequal distributions foster distortionary interventions which (it is assumed) impede growth, and

models of risk-market failure in which more unequal distribution entails a higher density of credit-

constrained people who are unable to take up productive investment options.2 This link has received

attention in recent literature and there is supportive evidence from cross-country comparisons.3

Argument and evidence on the second link -- from growth to poverty reduction -- has had a longer

history.4 A number of recent studies suggest that growth in average incomes typically reduces

absolute income poverty.5

There is a second argument linking initial distribution to the rate of poverty reduction. This

argument has received less attention. Even if initial distribution is irrelevant to the rate of growth, it

may matter greatly to how much the poor share in that growth. Assume a growth process in which

all levels of income grow at roughly the same rate. (Amongst developing countries, recent changes

in inequality have had virtually zero correlation with rates of growth, so this assumption is defensible;

2
See Persson and Tabellini (1994), Alesina and Rodrik (1994), and Bénabou (1996). For a review of
the theory and evidence as to how inequality can impede growth see Bruno et al., (1996).
3
On the effect of initial inequality on the rate of growth see Persson and Tabellini (1994), Alesina
and Rodrik (1994), Clarke (1995), and Deininger and Squire (1996).

4
For recent reviews of this literature see Lipton and Ravallion (1995) and Bruno et al., (1996).

5
On the extent to which growth reduces absolute poverty see World Bank (1990), Fields (1989),
Squire (1993), Ravallion (1995) and Ravallion and Chen (1997).

2
see Ravallion and Chen, 1997.) Higher inequality will then entail that the poor gain less in absolute

terms from growth; the poor will have a lower share of both total income and its increment through

growth; thus the rate of poverty reduction (for a wide range of measures) must be lower. At

maximum inequality—when the richest person has everything—absolute poverty will be

unresponsive to growth. By the same token, lower inequality will mean that the poor bear a larger

share of the adverse impact of aggregate economic contraction. Low inequality will then be a mixed

blessing for the poor; it helps them share in the benefits of growth, but it also exposes them to the

costs of contraction. I call this the “growth-elasticity argument”.6

This paper is mainly concerned with testing the growth-elasticity argument, though it will

throw some new light on the induced-growth argument, and it will explore implications of both. The

following section outlines the testable hypothesis implied by the “growth-elasticity argument” and

provides a test. Section 3 then brings the two arguments together to examine how initial distribution

influences progress in reducing poverty. Section 4 concludes.

2 The hypothesis and test

It is impossible to predict in the abstract how differences between countries in a measure of

overall inequality, such as the Gini index, will influence the growth elasticity of poverty reduction

for any specific measure of poverty, such as the proportion of the population living below a poverty

line. The outcome will depend on precisely how distribution varies between countries and over time,

as well as the specific properties of the poverty measure. Consideration of some special cases can

6
There is a small literature on the decomposition of changes in poverty into “growth” and
“distributional” effects (Kakwani, 1993; Datt and Ravallion, 1992). In this context one can identify and
measure a “growth elasticity” of standard poverty measures with respect to changes in the mean of the
distribution on which they are based. However, this literature has not examined the dependence of these
elasticities on initial distribution.

3
be illuminating.7 However, robust theoretical generalizations would seem well out of reach. What

I am after here is a data-consistent empirical generalization of the relationship.

The hypothesis to be tested is that, as inequality increases, the rate of poverty reduction

becomes less responsive to growth in average income, and reaches zero at sufficiently high

inequality. Assuming that the elasticity of poverty reduction to growth falls linearly as inequality

increases, and reaches zero when the richest person has all of the income, the rate of reduction in

r = β (1 - I ) g ( β > 0)
poverty can be written:

where I is a measure of initial inequality and g is the rate of growth in mean income. Thus the rate

of poverty reduction is directly proportional to the "distribution-corrected" rate of growth, (1 - I ) g .

To test the hypothesis against a more general (ad hoc) nonlinear alternative, I estimated the

r = β (1 - I ) g + γ 0 + γ 1 g + γ 2 g + γ 3 I
2

+ γ 4 I2 + γ 5 g I 2 + γ 6 g I + γ 7 g I 2 + ε
2 2

following encompassing model, including an error term:

7
For example, Kakwani (1993) derives formulae for the elasticities of various poverty measures with
respect to growth in the mean, holding the Lorenz curve constant. He also considers one special case in
which the Lorenz curves shift by a constant proportion of the difference between the line of equality and the
Lorenz curve. Suppose that distribution does not change over time, but differs between countries in the way
Kakwani assumes. Then, from Kakwani’s formulae for the “growth elasticities” it can then be shown that
the (absolute) elasticity of certain poverty measures (including, for example, the Foster-Greer-Thorbecke,
1984, index) with respect to the mean of the distribution will be decreasing in the Gini index when the
poverty line is less than the mean of the distribution.

4
where ε is an innovation error. Equation (1) implies the testable restrictions on (2) that γ i = 0 for

all i. However, (2) is flexible enough to allow a wide range of alternatives, including that initial

inequality is irrelevant, and only growth matters ( γ i = 0 for all i _ 1 and β = 0 ). It also allows

nonlinearity in the way inequality affects the growth elasticity.

To test the hypothesis in (1) I will be using data for 41 spells constructed from two household

surveys over time, for 23 developing countries.8 The two surveys use the same welfare indicator (so

one does not compare a consumption-based measure of inequality at one date with an income-based

measure at another). All distributions are based on consumption or income per person, and are

household-size weighted (so all fractiles are of persons not households). All rates of change are

compound annual rates (annualized differences in logs gave similar results.) The poverty measure

is the proportion of the population living below $1.50/day at 1993 international prices.9 All currency

conversions used the consumption PPP rate from Penn World Tables 5.6. The poverty measure is

intended to be “absolute” in that the poverty line has constant real value both across countries (based

on the PPP exchange rates) and over time (based on country-specific CPIs). (It does not reflect, for

example, any effect of rising average levels of living on the perception of what constitutes “poverty”

in a given country.) The inequality measure is the Gini index. The growth rate is the annualized rate

of change in the survey mean.10 Though care has gone into setting up this data set from the primary

8
Further details on the data can be found in Ravallion and Chen (1997), who use these data to
describe how poverty and distribution have been changing in the developing world, and what the empirical
relationship is amongst these variables (though they do not examine the issue of this paper).
9
This is equivalent to $1/day at 1985 prices; this is the average level of poverty lines found in low-
income countries; see World Bank (1990, Chapter 2) and Ravallion et al., (1991), for further discussion.

10
This is almost certainly a better measure for this purpose than (say) the private consumption
component of the national accounts; both sources entail measurement errors but for the survey mean the
attenuation bias will be offset by a bias in the opposite direction due to the use of a common survey to

5
sources, it is undeniably “noisy” data; there are underlying differences in survey methodology

between countries and over time that one cannot possibly eliminate (though by focusing on rates of

change, noncomparabilities which take the form of proportionate country-level fixed effects will be

eliminated.)

A joint F-test on the OLS estimate of (2) could not reject the null hypothesis that γ i = 0 for

all i.11 The restricted form is:12

r = 4.435 (1 - I ) g + residual
(4.695)

with an R2 of 0.355. Figure 1 plots equation (3) and the data. There is a large unexplained variance,

though at least some of this is measurement error.

However, there were other null hypotheses which could not be rejected as restricted forms,

including γ i = 0 for all i _ 1 and β = 0 .13 Under this null, it is only the growth rate that matters.

estimate both the poverty measure and the growth rate; indeed, under certain conditions the two sources of bias
will be exactly offsetting (Ravallion and Chen, 1997). Using the national accounts, however, will give the
attenuation bias only, which could be large given the imperfect matching between survey dates and the
accounting periods for the national accounts.
11
The value of F(8,32)=1.467, which is significant at only the 21% level; similarly the LM tests gave
Chi-square(8)=11.003, significant at the same level.

12
The t-ratio is based on the OLS standard error. If one interprets the following equation as the first
difference of an equation for the log of the poverty measure which has a white noise error term then there will
be non-zero off diagonal elements in the error covariance matrix. If one allows for this in estimating the
standard error, the t-ratio rises slightly (to 4.76). If one also allows for any general type of heteroscedasticity,
the robust t-ratio falls to 4.26. So such corrections make little difference here.
13
The F-test was F(8,32)=1.761 and the LM test gave Chi-square (8)=12.532; both would only reject the
null at the 12% level.

6
If one lets the distribution-corrected growth rate and the ordinary growth rate fight it out in one

r = 16.096 (1 - I ) g - 6.663 g + residual

Though there is clearly a strong correlation between these two variables, this regression still suggests

that it is the distribution-corrected mean which matters more to poverty reduction than the ordinary

mean. Equation (3) is a statistically acceptable restricted form of (4).

I repeated the analysis replacing the proportion of people living below $1.50/day by a

distribution-sensitive poverty measure (for the same poverty line), namely the Foster-Greer-

Thorbecke (1984) index based on squared poverty gaps. The same qualitative results were obtained,

though the estimated value of β rose to 8.098 (with a t-ratio of 3.90514).

3 Combining the “induced-growth” and “growth-elasticity” arguments

The above results indicate that higher inequality tends to entail a lower rate of poverty

reduction at any given positive rate of growth. Equation (3) suggests that the growth elasticity

declines sharply as inequality increases. At the lowest Gini index in the sample (0.25) the growth

elasticity is 3.33, while at the highest Gini index (0.59) it is 1.82. At the mean Gini index (0.41), the

growth elasticity of the poverty reduction is 2.62.

14
In this case, the correction for heteroscedasticity and non-zero off-diagonal elements in the covariance
matrix (using the method described in footnote 12) made more difference to the standard error; the reported t-
ratio here is based on the corrected standard error; without corrections, the t-ratio was 2.45.

7
 As noted in the Introduction, there is also evidence that higher inequality results in a lower

rate of growth. To bring these two sources of evidence together, let us follow past specifications

g = g 0 + δ I + ν ( δ < 0)

used in the growth literature and write the rate of growth as:

where g 0 is the expected rate of growth at zero inequality and ν is an innovation error. The

r = β g0 + β ( δ - g0 ) I - β δ I 2

expected rate of poverty reduction (conditional on g 0 and I ) is then:

This is strictly decreasing (increasing) in I as long as the rate of growth at zero inequality is above

(below) δ ( 1 - 2 I ) . And r is strictly convex in I (for δ < 0 and β > 0 ). Figure 2 depicts the

relationship implied by (6).

If g 0 > 0 and I ≤ 0.5 then poverty will fall, and at a faster rate the lower the inequality. The

same difference in inequality will matter more to the rate of poverty reduction amongst low-

inequality countries than amongst high-inequality countries. For g 0 > 0 but I > 0.5 , it is possible

for inequality to be sufficiently high that the rate of growth becomes negative and poverty rises, as

indicated by the upper dashed line in Figure 2; this requires that δ < - g 0 (implying that the left

derivative of the RHS of (6) w.r.t. I is positive at I=1), and poverty will be rising (in expectation) for

I in the interval (- g 0 / δ , 1) . For g 0 < 0 and I ≥ 0.5 , r must be strictly increasing in I;

however, if δ < g 0 then r will be decreasing in I at sufficiently low inequality (Figure 2) .

So the value of δ is crucial. What is the evidence on this? There are clearly many other

factors determining the rate of growth, including the initial income level, initial human capital, and

the policies pursued. Controlling for these factors, Clarke (1995) estimates that δ = - 0.07 ( i.e., a

8
one percentage point increase in the Gini index results in about a 0.07 percentage point decrease in

the annual rate of economic growth). The growth regressions in Deininger and Squire (1996) suggest

a similar value of δ = - 0.05 , on a data set different to Clarke’s in many respects. Both estimates

are significantly different from zero at the 5% level or better.

These estimates of - δ are sufficiently high to suggest that, once the impact of inequality on

growth is factored in, even countries with relatively good growth prospects (at low inequality) will

see contraction and rising poverty at sufficiently high levels of inequality. Returning to the data used

in the previous section, and using the Deininger-Squire estimate of δ , I found that g 0 > 0 (in

expectation) for 33 of the 41 spells.15 In 24 of those 33 spells, poverty was falling (the growth rate

was positive in 26 cases); so in nine cases the data are in the region with g 0 > 0 but rising poverty.

Using the Clarke estimate of δ instead the result is unchanged;16 again g 0 > 0 in 33 cases, and

these were the same 33, so again nine had rising poverty.

However, there is (of course) statistical imprecision in the estimate of - δ and (hence) g 0 .

If instead one sets δ = - 0.03 (one standard error above the Deininger-Squire point estimate), then

the number of spells for which g 0 > 0 and yet poverty was rising drops from nine to three.

Install Equation Editor and double-

Install Equation Editor and double-

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4 Conclusion

Household survey data for developing countries suggest that initial distribution does matter

to how much the poor share in rising average incomes; higher initial inequality tends to reduce the

impact of growth on absolute poverty. By the same token, higher inequality diminishes the adverse

impact on the poor of overall contraction.

Further interpretation is possible when one combines this evidence with that from recent

investigations of the impacts of inequality on growth. One then finds that, if inequality is sufficiently

high, countries which would have very good growth prospects at low levels of inequality may well

see little or no overall growth, and little progress in reducing poverty, and even a worsening on both

counts. (And, by the same token, factoring in the growth effects magnifies the estimated handicap

that the poor face in contracting low-inequality countries.) The data used here suggest that such

cases do occur. The precision with which key parameters have been estimated makes it difficult to

say with confidence how common such cases are, although they do appear to be in the minoritty.

What would appear to be the best available estimates suggest that about one fifth of the spells

between surveys analyzed here were cases in which poverty was rising, yet positive growth in the

mean (and hence falling poverty) is predicted at zero inequality. Inequality can be sufficiently high

to result in rising poverty despite good underlying growth prospects.

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References

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Quarterly Journal of Economics 108: 465-90.

Bénabou, Roland. 1996. ‘Inequality and Growth’, NBER Working Paper 5658.

Bruno, M., M. Ravallion and L. Squire. 1995. 'Equity and Growth in Developing Countries:

Old and New Perspectives on the Policy Issues', Policy Research Working Paper 1563, World

Bank, Washington DC.

Clarke, George R.G. 1995. 'More Evidence on Income Distribution and Growth', Journal of

Development Economics 47: 403-428.

Datt, Gaurav and Martin Ravallion. 1992. 'Growth and Redistribution Components of

Changes in Poverty Measures: A Decomposition with Applications to Brazil and India in the

1980s', Journal of Development Economics 38: 275-295.

Deininger, Klaus and Lyn Squire. 1996. 'New Ways of Looking at Old Issues: Inequality and

Growth’, mimeo, Policy Research Department, World Bank.

Fields, Gary. 1989. 'Changes in Poverty and Inequality in Developing Countries', World Bank

Research Observer, 4:167-186.

Foster, James, J. Greer, and Erik Thorbecke. 1984. ‘A class of decomposable poverty measures’,

Econometrica, 52 (1984): 761-765.

Kakwani, Nanak. 1993. 'Poverty and Economic Growth with Application to Côte D'Ivoire'.

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Persson, Torsten and Guido Tabellini. 1994. 'Is Inequality Harmful for Growth?' American

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 Economic Review 84: 600-621.

Ravallion, Martin, Gaurav Datt, and Dominique van de Walle. 1991. 'Quantifying Absolute

Poverty in the Developing World', Review of Income and Wealth 37: 345-361.

Ravallion, Martin and Shaohua Chen. 1997, 'What Can New Survey Data Tell Us About

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Figure 1: Rate of poverty reduction as a function of initial inequality
Figure 2: Rate of poverty reduction (r) as a function of
initial inequality (I)