4.3.4 - Poverty and inequality

Absolute poverty exists when income or resources are insufficient to meet essential needs such as food, safe water, shelter, sanitation, healthcare and basic education. Relative poverty exists when a household's income is far below the typical income in its own society, limiting participation in the living standards regarded as normal there.

If every household's real income doubles, fewer people may fall below an absolute poverty line. But the share below 60% of median income can remain unchanged because the relative threshold doubles too.

A poverty measure combines a poverty line with household income or consumption data, then counts or describes those below the line. The chosen line determines whether the measure is absolute or relative.

For international comparison, purchasing power parity converts incomes according to what money can buy rather than market exchange rates. Within a country, equivalised disposable household income can adjust for taxes, benefits and household size.

Poverty changes when households' earning capacity, employment, transfers, taxes or the real cost of essential goods changes. The same event can affect absolute and relative poverty differently because their reference lines differ.

Assess scale, distribution, duration and implementation. Growth that raises the median faster than the bottom can reduce absolute poverty while relative poverty stays unchanged or rises.

Income inequality is the uneven distribution of flows received over a period, such as wages, rent, interest, profit and transfers. Wealth inequality is the uneven distribution of the stock of owned assets minus liabilities at a point in time.

A retired homeowner may have low current income but high net wealth. A young professional may have high income but little or negative net wealth after student or housing debt.

A Lorenz curve plots the cumulative percentage of households or people, ordered from poorest to richest, against their cumulative share of income or wealth. The 45-degree line represents perfect equality.

The farther the Lorenz curve bows below the equality line, the more unequal the distribution. If one country's curve lies everywhere closer to equality than another's, it has the more equal distribution. Crossing curves do not provide an unambiguous ranking from the graph alone.

The Gini coefficient summarises the curve: it is the area between the equality line and the Lorenz curve divided by the entire triangular area below the equality line. It ranges from 0 for perfect equality to 1 for perfect inequality; it may also be reported from 0 to 100. A movement from 0.34 to 0.30 indicates less measured inequality.

Inequality arises because people and countries differ in productive opportunities, market rewards, asset ownership and the taxes and transfers that reshape those rewards.

Income and wealth inequality can reinforce one another: higher income makes saving and asset purchase easier, while assets generate income and can finance better education or business investment. Across countries, low income can restrict the investment needed to raise productivity.

Inequality changes incentives, access to opportunity and the way income is spent. Moderate reward differences may encourage effort and risk-taking, while severe inequality can prevent capable people from investing in themselves or enterprises.

The net effect depends on mobility, credit markets, public services, institutions and how inequality was produced. Inequality from innovation differs from inequality sustained by exclusion or inherited market power.

Economic change alters which skills, sectors, regions and assets receive the largest rewards. Development can therefore widen inequality in one phase and narrow it in another; the result is not automatic.

Track both market income and disposable income, and separate temporary transition costs from persistent exclusion. The speed of job creation, access to education and credit, regional mobility and redistributive policy determine who captures productivity gains.

A free market economy allocates resources mainly through private property, prices, profit and voluntary exchange. Because income reflects market demand, productivity, bargaining power and asset ownership, unequal outcomes are a significant feature of capitalism.

Actual capitalist economies are mixed economies. Progressive taxation, transfers, minimum wages, competition policy and universal public services can alter disposable income and opportunity without removing private ownership or market prices.