THE RELATION BETWEEN ECONOMIC GROWTH AND POVERTY

INTRODUCTION:

Poverty problem in the world is persisting for a long time now and many people around the world are looking at economic growth and development as a means of poverty alleviation. There is a lack of maintaining the standards of living across different countries and it is one of the great unresolved issues in development and growth economics. This persistent poverty leads to pessimism about the development strategies in each and every country.

Developing countries all over the world are trying to reduce poverty by the ability of economic growth. There are different economists and people concerned with this issue working directly with the poor in the developing countries. People around the world have believed that poverty can be reduced by providing benefits to all citizens in a specific country through macroeconomic growth. There is a change in the distribution of income in different groups in a country. Economic growth can raise the income of everyone in the society equally.

POVERTY IN PAKISTAN:

Pakistan has a major problem regarding poverty and there is around one quarter of its population regarded as poor. It is becoming a major economic issue for Pakistan. The trend of poverty has changed drastically from 1980’s to 1990’s due to poor federal policies and corruption in the country. There were different guidelines provided by the Government of Pakistan for poverty reduction. The level of poverty has fallen by 5% since 2000 according to the statement by the World Bank.

In Pakistan and many other developing countries, poverty means difficulty in living and lack of health, education and other financial aspects. Pakistan has the major issue of lack of training to income generating activities, basic social services and infrastructure which leads to the major poverty problem.

The statistics of Pakistan show that around two thirds of its population is living in rural areas. 10% of the total population is considered very poor and 35% is about to move towards being poor according to the Government of Pakistan.

RESEARCH QUESTION AND HYPOTHESIS:

The basic research question for the study is whether economic growth reduces poverty

or not? The basic hypothesis that is being tested in this study is that the more even the distribution of income, the more favorable will be the impact of growth of output on poverty alleviation. The extent to which a given rate of growth affects poverty depends on many factors particularly on economic structure and economic policies. Literature shows that growth is more likely to lead to a reduction in poverty when the economic assets of a country are distributed relatively equal.

LITERATURE REVIEW:

Jean Dreze and Amartya Sen (1990) have argued that economic growth does not always lead to widespread improvement in standards of health and education as measured by life expectancy, child mortality, primary enrollment rates, and adult literacy. Some other researchers have also drawn attention to the way in which initial conditions were particularly favorable to the region’s growth (Rodrik, 1995; Booth, 1997; Temple, 1997). A stable macroeconomic framework is necessary for sustainable economic growth (World Bank (1989, 1990, 1992))

Investment in human capital accompanied by growth is the primary mean to reduce poverty and improve the quality of life. During 1980s growth slowed remarkably and many countries had a negative per capita growth. This was the time when majority of the countries were going through severe macroeconomic crisis (Bourguignon, Francois and Morrisson , 1991). According to a report ,poverty is defined as the inability to attain a minimal standard of living as in consumption of food, clothing, shelter, access to education, health services, clean water, and so on (World Bank, 1990).

Dollar (1992) in his study constructed a measure of openness to show the extent to which trade regime has distorted the real exchange rate and he has used this in a regression of 95 countries. He estimated that reducing the level of exchange rate distortion to that of Asia would raise GDP growth by 1.8% in Africa and 0.7% in Latin America. In developing countries recently the literature on the changing aspects of poverty has been given some importance (see Baulch and Hoddinott, 2000).

Easterly and Levine (1996) found in their study that the three variables associated with soundly managed, open economies, the exchange rate premium, the fiscal surplus as a share of GDP, and ratio of liquid financial assets to GDP, can account for a growth differential of 1.5 percentage points between African economies and East and Southeast Asian economies. Fischer (1993) looked at the effects of shorter-term, macroeconomic variables with long term growth and found that low budget deficits , low inflation and market-based official exchange rates are associated strongly and significantly with more rapid economic growth.

The difficulty of identifying the poor and the possibility of offsetting behavior on the part of the poor is largely contributed to the political instability and hence it provides an economic explanation as to why other factors required to reduce poverty have not been effected. A lot of economists have seen that poverty has fallen more rapidly in 1990’s as compared to the years before this time (Bhalla, 2000). Some others have argued that poverty rate has risen (for example, Sen, 2001).

Earlier poverty studies have focused on a discussion of inequality and welfare based on limited household level data [see Bigsten 1981, Hazlewood 1981, House and Killick 1981]. If the society is averse to inequality among poor then the poverty measure must give maximum weight to a transfer from the poorest and the weight should decrease with the level of income (Atkinson [1] and Sen [13]). Kravis (1960) and Lydall (1968). Persson and Tabellini (1990) have provided empirical evidence to show that equity is positively correlated not only with the level of income but with the rate of growth as well.

In the literature on poverty significant contributions have been made regarding this problem (see, for example, Rowntree [27], Weisbrod [41], Townsend [39], and Atkinson [1]). Brazil (World Bank, 1988) and Pakistan (Sohail J. Malik, 1993) are two such cases where indicators of health and educational attainment are inferior to those of countries with similar GDP per capita. Deaton (2001a) has done a detailed research on the poverty levels and has found that the rural poverty rate has fallen from 37% to 30% in 1999-2000 and urban poverty fell to 24.7 percent. Deaton has estimated that national poverty rate has fallen overall.

A study showed that poverty status is strongly associated with the level of education, household size and engagement in agricultural activity, both in rural and urban areas. In another study (Kakawani, Nanak, 1980) it was assumed that the deviation of a poor man’s income from the poverty line is proportional to the degree of misery suffered by him, then the sum total of these deviations divided by the number of poor may be considered a desirable measure of poverty.

Shorrocks (1993) also reinterpreted poverty orderings as partial orderings of unemployment that incorporate incidence, average unemployment duration, and the distribution of individual spells of unemployment .Poverty incidence is generally lower when agriculture performs better, and increases sharply with fluctuations and shocks in agriculture (Oxford Policy Management, 2003; Malik, 2005)

Over the period as a whole the other effects offset the positive income growth effect on poverty reduction (Meng, Gregory, Wang : 2005). To understand the poverty determinants and their changes over time is critical for all the analysts and also for designing effective poverty reduction strategies. (Glewwe, 1991)

METHODOLOGY:

SUB PERIODS FOR THE STUDY:

Public policy and management has affected the process of economic growth in Pakistan since 1947. Pakistan has experienced considerable political instability and social tensions since its independence. The present study would focus on economic growth in Pakistan being divided into five phases, reflecting the political regime and its approach to economic development. In each of these phases the governments played a key role.

The first stage :(1947-58)

This was a phase where Pakistan’s economy was growing annually around 3.5 percent. The first major decision not to devalue the Pakistani rupee in 1949 resulted in India’s decision to stop trading with Pakistan. The trade surplus during 1950-53 was accompanied by deterioration in the terms of trade for agriculture, resulting in the transfer of significant amount of resources from the rural to urban areas, and rapid growth of the industrial sector.

State-guided development (1959-71)

Pakistan was ruled by two army regimes during this phase, the first lasted until early 1969 and the second presided over the general election in 1970 and dismemberment of Pakistan in December 1971. The economic strategy of the first regime was due to rapid industrialization of the country. The economy experienced a growth rate of about 7 percent in the decade from 1959.The second army regime tried to continue the economic strategy of the first military regime, it spent most of its effort and resources to restore an elected government acceptable to the political parties in both East and West Pakistan.

3. Populist (“socialist”) development (1972-77)

The elected government in Pakistan reduced the land and industrial concentration, and restructured the power of the civil and military bureaucracy. The aggregate annual growth rate of about 5 percent was due mainly to the growth of the service sector, especially defense and public administration. The government undertook its most radical structural and institutional reforms. The government devalued the rupee and significantly increased the controlled prices of major crops in 1972.

Growth with a receding state (1977-88)

During this phase , economy grew annually at an average rate of nearly 7 percent, with a robust growth in agriculture and manufacturing industry.The economy was assisted greatly by the transfer of foreign exchange from Pakistani workers in the Middle East. There was reintroduction of five-year development plans, starting with the Fifth Plan (1978-83).

The IMF gave the first Extended Fund Facility (EFF) to help Pakistan establish a new exchange rate regime, rationalize prices, liberalize trade, and reform the budgetary process, financial institutions, and the public sector.The high economic growth was sustained by a rising budget deficit financed by foreign and domestic borrowing.

Crises and structural adjustment programs (1988-2000)

Pakistan started to experience almost unprecedented political instability and changes in governments from August 1988, eventually ending in the imposition of military rule in October 1999. During this period, the growth of GDP fell to 4.7 percent annually, and the agricultural sector grew at just under 5 percent.

The military government since 1999 has focused its efforts on hastening the process of institutional reforms for good governance and developing coherent policies to promote growth and reduce poverty.

Using Income Distribution to Measure Poverty

The simplest form for presenting income distribution data is a frequency distribution that shows the income shares of income groups, ranked in ascending order of income. The data used for this study will be from a cumulative frequency distribution, showing the shares of the poorest 20, 40, 60, 80 and 100% of the population for the five different phases seperately. The Gini coefficient will be used as an indicator of the relative equality of income distribution in a given country. Coefficient zero indicates equality and 1 indicates inequality.

Measuring Income Distribution:

In this study the poverty line is defined as that the bottom40% of the population that lives in poverty in a particular phase. Gini coefficients are mostly stable over time so a change of more than 0.05 over a decade would be high. There is considerable scope for income distribution to worsen with growth while the welfare of the poor increases. Even in the presence of adverse changes in income distribution it is encouraging to know that the poor can benefit from growth.

Defining and Measuring Poverty

This study would contribute in defining poverty using major tools and converting national data to internationally comparable standards.The welfare approach assumes both that individuals know what is best for themselves and that monetary measures of consumption or income can serve as an indicator of well-being.

Income can be taken as a proxy for consumption where expenditure data is not available. Most of the data on poverty measures now available are based on comprehensive household surveys. If household income were the unit of analysis, then when comparing two households with equal per capita income, the larger household would wrongly appear to have higher welfare than the smaller one.

An absolute poverty line is set in terms of a particular living standard, defined in a common currency and held constant for all the countries, regions, or areas under consideration. Another approach to define poverty is at a certain dollar income per day or two dollars per day which is a common poverty line for developing countries. Each country has a different relative poverty line, expressed in dollars, and each country’s relative poverty line changes as incomes rises.

The aim of this study is to measure the growth of average income for both the poorest 20% and the poorest 40% of the population, then to compare these to the growth of GDP per capita.

Income distributions taken from the official publications are given below:

1958 1967 1970 1980 1990 1995 1999

Pakistan (Gini coefficient) 0.386 0330 0.345 0373 0.369 0348 0.410

The poverty numbers for Pakistan are not based on a consistent poverty line or series of data. They seem to reflect reasonably well the changes in rural and urban poverty. The information from publications from the IMF and World Bank, Mahbub ul Haq Center for Human Development is taken for a detailed analysis of the issues related to poverty in Pakistan and also for the data on the GDP.

TESTING OF DATA:

The study regresses the growth of income for the poorest two groups , which are poorest 20% and poorest 40% , against the growth of GDP per capita for the entire population.

For this study the regressions are expected to indicate that on average the poor would benefit from economic growth and there is a clear relationship between growth of the incomes of the bottom 20%, 40% and growth in GDP per capita. The coefficients on initial levels of GDP are expected to be small, positive, and not significant , indicating that for this sample, the starting level of GDP has no effect on income growth of the poor. This will help support the main proposition of the study that GDP growth can be and usually is a powerful force in reducing poverty.

Growth in GDP per capita = ¡€°€ €«€ ¡€±€ Income20% + ¡€°€ € Income 40% + e

The study is expected to show graphically the changes in the share of income accruing to the bottom 20% and 40%. If a 45o line from the origin will be drawn on the graph any points above that line represent improvements in the income share of the poor. So for the poorest 40%, the poor will be expected to improve their share of total income in more than half the growth. For the poorest 20% the poor would be expected to increase their average income.

Another way would be looking at Pakistan’s major economic indicators which can help reduce poverty. They are identified as real per capita GNP, real wages in manufacturing, inflation rate as percentage change over the previous year and Gini coefficient separately for Pakistan . It is expected that the higher the per capita income, the lower the poverty level, the higher the level of real wages, the lower will be the poverty levels, the lower the level of inflation, the lower will be the level of poverty. Only simple regression would be used taking the logs of independent and dependent variables where independent variables are real per capita, real wages in manufacturing, inflation rate and the dependent variable is poverty.