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Euphoric End-of-Poverty Declarations May Be Based on Wrong Premises

February 3, 2014
by Guest author
Click to read the 2013 Development Cooperation Report - Ending Poverty

Click to read the 2013 Development Cooperation Report – Ending Poverty

Today’s post is by Helmut Reisen, former Head of Research at the OECD Development Centre and author of the Shifting Wealth blog. Erik Solheim, Chair of the OECD Development Assistance Committee will reply tomorrow.

Mostly thanks to China’s supercharged 2000s growth and the related global development impact, extreme poverty (in its 1.25$ PPP/day/person variety) has dropped as a percentage of a growing world population – from 40 to 20% over the past two decades.  Consider this back-of-the-envelope calculation: One percent of GDP growth in China has been associated with 0.34% of GDP growth in countries with an annual Gross National Income (GNI, Atlas method) below 1,035$/year per person that are classified by the World Bank as Low-Income Country (LIC); estimates of poverty elasticity for LICs to growth vary between 1.2 and 3.1 for the 2000s (they are higher than the estimates for the 1990s). Assume a poverty elasticity of 2; then, a percentage point of Chinese growth would lower the LIC poverty headcount by .68%. With roughly 1.1 billion people still in extreme poverty outside China, one percent of China´s growth has translated into 7.7 million poor people less year by year. However, note that while the bottom third of the global income distribution have also made significant income gains, real incomes of the poorest 5% of the world population have remained the same even in the past Golden Age of emerging-country growth.

Millennium Development Goal #1 – to halve extreme poverty by 2015 – was thus reached fairly easily with China as the global poverty reduction machine (and not because leaders signed the Millennium declaration!). A close corollary to developing-country growth performance has been LICs’ eligibility for and graduation from concessional finance. Several countries have graduated from IDA borrowing since 1999, including populous countries such as China, Egypt and Indonesia, with India expected to graduate soon. There are today only 36 LIC countries eligible for concessional finance – grants and soft loans – by the International Development Association (IDA) and the soft windows of the regional development banks. (The Inter-American Development Bank and its soft window, the Fund of Special Operations (FSO), considerably reduced in size). The graduation threshold itself is controversial, however: an outdated LIC/MIC threshold explains that the share of the poor (and, indeed, of the whole population) in LICs has declined over time. With China and India having crossed the threshold, the reduced demand for concessional finance (CF) may partly reflect a statistical artifact.

What arguably accounts better than income levels for CF demand is a country’s domestic capacity of resource mobilization, especially through taxation. Availability of public and private resources for development, coupled with the fall in global poverty, are said to imply that dramatically more funding is potentially available for each poor person. And domestic resources, especially tax receipts, may be mobilized better as result of high raw material income and better tax administrations.

Looking beyond 2015, the target year defined by the Millennium Goals, international organizations and their leaders have increasingly joined a chorus of euphoric We-Can-End-Poverty declarations. OECD boss Angel Gurria proclaimed when the last DAC Report Ending Poverty was presented late 2013 in London: “Ending Poverty Completely and Forever”, seconded by DAC chair Eric Solheim “Eradicating Extreme Poverty Completely – ‘Yes We Can’”.  There are today numerous websites devoted to the goal to end extreme poverty, such as www.endpoverty2015.org, www.theendofpoverty.com, www.endpoverty.org, or www.stoppoverty.com, which translates a strong belief in the feasibility of poverty eradication. While macroeconomic observers are now abuzz with secular stagnation, China´s forthcoming crash, or emerging market taperitis, this is not the stuff that most of the ODA crowd is familiar with on a professional level. So the End-of-Poverty banner waving seems quite detached now from what can be expected from future growth and seems to extrapolate a trend of global poverty reduction that may have been special to the past decade.

The End-of-Poverty banner waving seems to be based on two influential studies, from the Center for Global Development (CGD) and Overseas Development Institute (ODI), which projected total population in IDA-eligible countries to decline from 3 bn (2012) to 1 bn by 2025 and the global poverty pool to shrink dramatically by 2025 as a result of high per capita income growth. According to these studies, soft CF windows such as the African Development Fund (AfDF), the Asian Development Fund (ADF), the International Development Association (IDA) and also some International Monetary Fund (IMF) facilities would likely face a wave of country graduations by 2025. These studies also foresee a reduced number of selected low-income, post-conflict and fragile countries, mostly in Africa, re-established as the main location for CF-eligibility. A drastically altered client base will have significant implications for the strategic options as well as operational and financial models of IFIs. The strategic choices facing the IFI shareholders are at the heart of the future of the global concessional finance architecture.

Both studies are penetrated by emerging market optimism that underpins their view that “we” can successfully eliminate poverty without continued access to concessional finance. However, there are important shortcomings to both studies on a closer look at technical detail:

  • Both the CGD and ODI studies cited above are start from GDP projections provided by the IMF in its World Economic Outlook (WEO). However, the accuracy of IMF-WEO forecasts is dismal as they have been overly optimistic in the past. Highly optimistic assumptions on the growth of total factor productivity in emerging countries, derived from observations of converging countries in the past decade, have been deployed for projections to 2025. Projecting growth rates over long horizons is hazardous, especially if rates are held constant and do not build in major occasional disruptions to growth, such as from natural disasters and financial crises.
  • Mind the gap: GDP is not the appropriate income concept but GNI, especially in poor countries due to inflows of remittances (that could be used to reduce poverty at home). Disruptions to remittances (e.g. when resource-rich countries send immigrant workers home, as happened recently in Saudi Arabia) can lead to important differences in the growth projections in the two national-account concepts.
  • The two studies also understate the Balassa-Samuelson effect (or Penn effect) of growth convergence in poor countries: the increase in price levels that have accompanied the last decade of high growth in emerging countries may have given rise to estimates for CF demand that are excessively low (The Economist’s brilliant post “Appreciating the BRICs”shows how actual and projected GDP is lowered by holding prices and currencies constant, by correcting for the Penn effect.). Higher prices for services (such as real estate rents, transport cost, schooling) lower the purchasing power of nominal incomes and may lock in the poor below poverty thresholds. The CGD study, e.g., holds all calculations in constant 2009 dollars with the hidden assumption that price levels stay the same. Over a decade-long projection, this leads to massive distortions.

 

Click to see the original

Click to see the original

 

  • As poor-country growth over the last decade has been based on expansive monetary policy in OECD countries and on unsustainably high growth in China, a return to normalized rates of global money supply and to sustainable growth in China must receive special attention in growth projections to 2025. (Large emerging countries with high external deficits – Brazil, India, Indonesia, South Africa and Turkey – are supposed to suffer once monetary stimulus is scaled back). Both studies were carried out at a time that many observers  consider now the peak of emerging-country euphoria. Emerging-country optimism has rapidly ebbed with two major sources – ultralight monetary policy in the US notably and unsustainable growth in China – running dry.
  • Finally, there seems to be excessive optimism around about poor countries’ capacity to mobilize their own resources rather than to depend on aid dollars, via redistribution from the “rich” to the “poor” within developing countries. Evaluating poverty levels using expenditures from the national account data helps downplay the problem of rising inequality in many middle-income countries. Whether middle-income countries will, as projected, manage to solve their enormous distributional challenges is yet to be seen.
Click to see original

Click to see original

Ravaillon shows that there is a positive correlation between domestic capacity for redistribution (as indicated by a low required marginal tax rate to close the poverty gap) and a country’s average per capita income. His measure – marginal tax rates on the “non-poor by US standards” required to cover the poverty gap – finds that for most (but not all) countries with annual consumption per capita under $2,000 the required tax burdens are prohibitive—often calling for marginal tax rates of 100 percent or more. By contrast, the required tax rates are very low (1% on average) among all countries with consumption per capita over $4,000, as well as some poorer countries. The tax ratio calculations thus demonstrate that LICs (and even UMICs) have little or no prospect for increasing domestic resources in the medium term to meet these needs.

So there a mismatch between the loudness of the End-of-Poverty chorus and the empirical solidity of the projections on which the official declarations are pegged.

A fascinating survey just released by Gallup cautions also against excessive post-2015 optimism. Gallup’s self-reported household income data across 131 countries indicate that more than one in five residents (22%) live on $1.25 per day or less.  About one in three (34%) live on no more than $2 per day. The World Bank Group recently set a new goal of reducing the worldwide rate of extreme poverty to no more than 3% by 2030, but Gallup’s data suggest meeting that goal will require substantial growth and job creation in many countries. In 86 countries, more than 3% of the population lives on $1.25 per day or less.

extreme poverty percentage population

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Even in the OECD, “Ending Poverty Completely and Forever” has not been achieved, as the Gallup global poverty map makes clear. To be sure, OECD leaders have no core competence in eliminating poverty. They would benefit from more modesty. Despite more extended tax, welfare and transfer systems and per capita income levels much higher than in developing countries, most OECD countries have witnessed a remarkable rise in poverty rates during the past fifteen years. In most OECD member countries, relative poverty – defined as the share of people living in households with less than 50% of median disposable income in their country – affected 11% of OECD population in 2010, after taxes and transfers. This was a marked increase of poverty rates compared to 1995. Source? OECD!

Useful links

Can we really end poverty?  Brian Keeley’s report from a debate in London in December 2013 to launch the Development Cooperation Report

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