In less developed countries a considerable proportion of income is spent on food. The relationship between income and work capacity is illustrated below. In this diagram it is assumed that all income consumed as food and work capacity is defined as the number of tasks that an individual can perform. At very low levels of income and consequently low levels of nutrition then work capacity is extremely low. In this case food merely sustains the body and there is little energy left to carry out useful work. After a certain point there is a rapid increase in work capacity for every marginal increase in nutrition before diminishing returns set in. Dasgupta and Ray consider a timeless economy in which land and labour power are used to produce a single good. All economic agents are assumed to act competitively. Workers in this model are heterogeneous- some own land and others are landless. A typical distribution of workers is shown below where those between -0 and n are landless and t (n) is the proportion of land that a worker owns. The reservation wage of those workers owning land is low but exceeds the amount needed to prevent death. This thus illustrates the minimum wage rate needed for different workers to be willing to work. The minimum wage rate for workers to be able to work is different. The landless will require a higher wage because this is there only source of income. The overall effect is shown whereby the wage for the landless to be able and willing to work is high. It is relatively low fro smaller landowners because they do have some non-wage income. It is high for large landowners because they have a high reservation wage.
The ‘production enterprises’ are competitive and so the wage rate must be equal to the marginal product of aggregate labour power. For those individuals whose efficiency wage exceeds the wage offered, market demand will be zero and they will not be able or willing to supply their labour. If the efficiency wage of a worker is less than the wage offered, all enterprises will want to hire him and his wage rate is bid upwards. For those workers with an efficiency wage equal to the wage offered, employers are indifferent to employing him or another such person and he is indifferent between working and not working.
If the economy is land- scarce then there is unemployment and malnutrition because there is very low demand for labour. Individuals below n1 are unemployed because their labour power is too expensive – they are incapable of supplying labour at the offered wage rate. Workers above n2 are voluntarily unemployed because their reservation wages are too high. All persons below n1 are malnourished and this includes all the landless but also some who are working. I f the economy has a moderate land endowment then all workers between n and n2 are employed. Labour demand is still low however and a fraction n1/n of the landless are involuntarily unemployed and a fraction (1 – n1/n) are employed, that is, the economy rations landless people in the labour market. The labour market does not clear. If however the economy is well endowed and there is high labour demand then there is full employment from 0 to n2 and on one is undernourished. Those above n2 are voluntarily unemployed.
In this model ‘people without assets are doubly cursed’ (Dasgupta and Ray)
This is because they do not receive any rental income but they are also at a disadvantage in the labour market because they cannot offer the labour quality that the labour market demands or can but is unlucky because the labour market is rationed and they cannot join the labour force. Thus there is a poverty trap in that the undernourished cannot accumulate and consequently can never become better nourished. This situation could also be Pareto optimum equilibrium, that is, there is no way of making people better off without making someone else worse off.
If income and assets could be redistributed and inequality of initial endowments reduced then there would be more ‘small’ landowners who have a low efficiency wage. Thus at any given offered wage there would be more people working and fewer people malnourished. If poor workers were able to borrow for consumption purposes then this would have the same effect making people better off. Unfortunately however credit markets usually require some collateral other than in the form of labour and thus do not lend to poor workers who do not have assets. If it was possible a long term contract could help to solve the problem because work capacity affects future output. These contracts are however usually not feasible. This is because unless an employer can guarantee that an employee will work for him forever there will be little incentive to take part in a long term contract. A person in good health will also be wanted by other employers thus bidding up his wage rate.
The Dasgupta- Ray model has been criticised for having little relevance in practice. In India the cost of a day’s supply of calories is approximately 2.60 rupees and the average daily wage of agricultural labourer is several times this (16.00 rupees). Thus malnutrition may not be such a huge problem. Behrman however concludes that, whilst there are limitations to most studies on the relationship between nutrition and productivity and there is also a massive range of results, there does seem to be clear, direct and indirect links especially in malnourished populations.
There is also evidence that the probability that the landless will be hired is not less than the probability for those that own land. It is also unrealistic that people’s nutritional requirements are all the same. Sukhatme has argued that ‘a person’s metabolic efficiency in the use of energy adjusts over time to his energy intake’. Thus a person’s history matters. The household decision is also very important. The larger the family then the less the worker consumes of his own income. There is also the problem of moral hazard because an employer cannot tell how much of his income a worker will spend on food.
Thus inequality in the access to adequate nutrition is a cause of the persistence of poverty because of poverty traps that lock poor workers out of employment because they do not have the capacity to perform useful work. These poor workers generally do not hold any assets and thus if they cannot earn a wage income they remain poor and undernourished. Over time this problem worsens because children suffer more from malnourishment. Children experience muscle wastage, growth retardation, increased illness and vulnerability to disease and it can effect brain growth and development. Therefore the poor over time cannot break out of the poverty trap.
Inequalities in access to credit and insurance markets can also produce poverty traps which mean that poverty is persistent. For example in general only the rich can borrow and so only the rich have a chance of using their entrepreneurial abilities. Poor entrepreneurs can never break out of wage earning because they do not have access to credit for the ‘set-up’ costs and other capital costs of starting an enterprise. The poor are likely to remain poor because they are trapped as wage earners. If this is combined with missing insurance markets as well then poor people tends to invest in safe, low risk activities. As such they generally receive low returns and cannot climb out of the low asset low income trap.
Jalan and Ravallion also suggest that these widespread credit and risk market failures ‘might well be a structural cause of persistent poverty’. They argue that the path of income is nonlinear and as such there is no tendency for it to adjust back after a shock. Indeed they suggest that there are multiple equilibria points and ‘the existence of a non-convexity in the dynamics of household incomes, giving rise to a low level unstable equilibrium’. Non linear dynamics may be caused by effects of past consumption on current productivity – the Dasgupta-Ray model of efficiency wages. Non-linear dynamics results when the rate of growth depends on the initial distribution of income or asset wealth and income is a function of its own lagged value. An alternative explanation suggests that in order to participate in society, there is a minimum expenditure level for individuals. ‘Higher consumption permits social inclusion but there is diminishing returns to this effect’ (Jalan and Ravallion).
Another factor might be that a poor household faces a choice between consuming all their income or investing some in human and physical capital. Households will not invest until their income reaches a critical level. The investment yields benefits at a later point in time and thus the dynamics of income are non-linear. According to Jalan and Ravallion, the initial distribution of income has an impact on future income if the dynamics are nonlinear and in addition higher initial inequality will lead to lower future mean income. This implies that a reduction in levels of inequality will help to protect both current and future living standards of the poor.
Jalan and Ravallion test for non-linear income and expenditure dynamics in rural China and find that over 50% of the sample that suffered from a negative expenditure shock recovered within a year but 20% had not recovered within 5 years. This implies that people suffering from the same shock have different outcomes. Some only experience a temporary fall in incomes whilst others are shocked into a path possibly into chronic poverty. This could however be explained by other factors. For example those that did not recover quickly may have experienced further adverse shocks or the initial shock may not have been transient. Jalan and Ravallion go on to test the recovery speeds of the rich and the poor and conclude that the differences ‘ appear sizeable…..our results suggest that the poor eventually bounce back from short-lived shocks, (but) the adjustment process is slower than for the non-poor’.
Therefore on the microeconomic level poverty traps may be due to missing markets in credit and insurance and under nourishment. There are other characteristics of the poor that lead to poverty traps such as low physical and human capital, poor infrastructures, poor information flows and high risk that mean that it is very difficult fro them to break out of their unfortunate situations. These can all have very similar mechanisms as the models described previously. ‘Both history and economic policy matters much more in an environment with a poverty trap Purely random acts like war, disease, natural disasters or an irresponsible policy measure of short duration, may change forever the course of economic development’ (Azariadas) on a macroeconomic scale.
Government intervention may be worthwhile and indeed may have very high returns if it can protect people from such devastating transient shocks and prevent individuals from falling into the poverty trap in the first place. The policy implications from the existence of poverty traps are that whilst bad shocks can push people into destitution where they stay trapped, good shocks can push individuals onto equilibrium where there are better outcomes. Azariadis suggests that ‘public subsidies to health and education, at a rate sufficient to overcome a poverty trap, are productive at middle levels of development, but may be beyond the resource constraints of the poorest developing nations’.
In conclusion then inequality in income, assets, opportunities and access to markets among other things mean that the very poor can be pushed into a low outcome equilibrium. Once they are at this equilibrium point it is very difficult for such people to escape and thus poverty is very persistent.
