The Economics of Poverty Traps and Persistent Poverty: Policy and Empirical Implications

1. The Economics of Poverty Traps and Persistent Poverty: Policy and Empirical Implications Christopher B. Barrett and Michael R. CarterSeminar at University of California at RiversideMay 24, 2012

2. Motivation Persistent poverty is a 1st order development concern. What to do about it? - depends crucially on the causal mechanism(s): * slow, steady growth from low base? * immutable poverty (unique low eqln)? * avoidable state (low level eqln trap)? - challenge of sorting structure from stochasticity The fact that appropriate policy response to persistent poverty turns on the causal mechanism necessitates both careful theorizing and thoughtful empirics.

3. Various Mechanisms • Poverty Traps: • “any self-reinforcing mechanism which causes poverty to persist” (Azariadis and Stachurski 2004, p. 33) • A range of structural mechanisms (co-)exist • Individual/hh-level • Meso-/macro-scale • Inter- or intra-generational • Single or multiple equilibrium • Consider some simple theoretical illustrations of basic options

4. Theory Basics Well-beingt+1 W* Pov. line Well-beingt W0 Persistent poverty w/o a poverty trap Welfare Dynamics With Unconditional Convergence Welfare Dynamics With Conditional Convergence Welfare dynamics w/single non-poor dynamic equilibrium Interpretation: Slow, neoclassical growth from a low base … “convergence clubs”? Policy implications: perhaps intervene to accelerate progress, but not necessary. W*

5. Theory Basics Well-beingt+1 Well-beingt+1 W* Pov. line Pov. line Well-beingt Well-beingt W0 Poverty trap w/unique dynamic equilibrium Welfare Dynamics With Unconditional Convergence Welfare Dynamics With Conditional Convergence Welfare dynamics w/single poor dynamic equilibrium Interpretation: Can include geographic poverty traps, physical/cognitive disability traps, discrimination based traps, low-level institutional traps, etc. Policy implications: Intervene to prevent phenomena (e.g., early childhood programs, infrastructure investments in LFAs). Humanitarian social protection transfers. W* W* W* W0

6. Theory Basics Poverty trap w/multiple dynamic equilibrium Nonlinear path dynamics with multiple stable dynamic equilibria and at least one unstable dynamic equilibrium (threshold effects) Well-beingt+1 ` Chronic poverty region Transitory poverty region • Interpretations: Multiple equilibria, short-lived interventions can have permanent consequences. Many candidate mechanisms: • “Big push” coordination failures • Nutritional poverty traps • Multiple financial mkt failures • Nontradable inputs (e.g., soils) • Policy implications: High returns to properly targeted interventions, including redistributive measures. Well-beingt

7. MFMF Model • One useful fairly general poverty trap model • Multiple financial markets failures (MFMF): Where c = consumption, x = income, A = assets, α= ability, δ= discount rate, θ= asset shock, τ = depreciation rate, Fh= high technology (w/fixed cost),Fℓ= low technology (no fixed cost). MFMF assumption: no borrowing and no insurance options available.

8. MFMF Model Key implications of MFMF model:

9. MFMF Model Key direct implications of MFMF model: Endowments are expected fate. Risk matters and shocks have permanent consequences SE and ME poverty traps can co-exist Systemic change matters A burgeoning literature looks for ME poverty traps based on 1 and 2. That search is complicated by 3-4.

10. MFMF Model Key behavioral implications of MFMF model: Asset smoothing in response to shocks Highly nonlinear risk taking patterns Multplier effect of small, targeted asset transfers Crowding-in effects of risk reduction measures Some papers have been looking at these behavioral implications … that may be more fruitful than testing the direct implications of the MFMF model.

11. Empirical Testing The challenges of direct tests (the search for threshold effects in welfare dynamics): 1) Which poverty trap? Fail to find ME doesn’t mean there isn’t a SE poverty trap. 2) Disentangling true state dependence from heterogeneity is very difficult. Example: education 3) Lucas critique and underlying parameter instability 4) Econometric challenges: sparse data around thresholds; can easily appear as heteroskedasticity with positively autocorrelated errors; centering of data and estimating distant equilibria, etc. 5) Asset index construction sensitivity Etc., etc.

12. Empirical Testing An alternative: Indirect (behavioral) testing: Tests for asset smoothing: Hoddinott (2006 JDS), Barrett et al. (2006 JDS), Carter & Lybbert (JDE in press) Implications for informal credit: Santos & Barrett (JDE 2011) Implications for herder behavior (Toth AJAE r&r) Smallholder fertilizer application behavior (Marenya and Barrett 2009 Ag Econ, AJAE)

13. Summary Understanding why poverty persists for long periods of time is a key project in dev’t econ 1) Need to recognize there exist many candidate theories and major challenges in empirical testing among those theories. 2) But need to get it right in order to identify and design interventions appropriate to context. 3) Next generation of work will focus more on behavioral tests and less on direct tests for thresholds in well-being dynamics.

14. Thank you Thank you for your time, interest and comments!