Poverty from an International Economics perspective – effects and proposed solutions

oatsandsugar —  September 14, 2011 — 2 Comments

This is a paper in response to the request for reflection on the effects of poverty in the developing world, and the policy solutions proposed that are in place,  written for the UTS Economics elective  “International Economics“.  This paper discusses the effects of poverty on developing nations as well as critically analyse macroeconomic and other international policies that aim to reduce poverty.

.An unemployed fisherman at the camp

A fisherman at a IDP (internally displaced person) camp in Trincomalee, Sri Lanka

Poverty is a problem that affects much of the world directly, and the entire world indirectly.  Whilst the levels of poverty are reducing globally, much of this reduction is in China and India, where there is a growing middle class.  In much of sub-Saharan Africa, poverty is widespread, and it doesn’t look like it is decreasing.  This paper will describe the effects of poverty on the developing world (in Part 1), and describe international policy, economic and otherwise, which attempts to reduce poverty and its impacts (Part 2).

Part 1: Impact of poverty on the developing world

Poverty, where prevalent, is a troubling obstacle for governments and can hinder the growth and development of any society. In its worst form, poverty has had detrimental effects on regions such as Africa, Asia and Latin America. The World Bank (2008) found that while most of the developing world has managed to reduce poverty, the rate in sub-Saharan Africa (the world’s poorest region) has not changed in nearly 25 years. ‘In 2005, half of the population in sub-Saharan Africa was living below the poverty line (about 380 million people)’ (Wroughton 2008, para.12). Famine, high child mortality rates, vulnerability to diseases, lack of infrastructure, poor or non-existent health care and sanitation, malnutrition and corruption are just a few of the major problematic factors that developing nations have contended with due to poverty. These damaging effects have caused greater problems, affecting not just the African, Asian and South American continents, and the rest of the world.

Famine

One definition of poverty is the lack of basic essentials such as food and clean water. Many developing nations such as Ethiopia and Tonga rely on agriculture as their main source of income. However, land is scarce.[1] The statistics of poverty on developing nations are discouraging. The lack of food has meant one in three Africans do not have enough food to eat, and for the majority of these people, chronic malnutrition is a life-threatening fact of everyday life.

‘In the Sudan, 90 of every 1000 children die by the age of 5. In Ethiopia the figure is 164 per 1000, compared with a norm of 4-6 per thousand in industrialized nations. For adults, lack of food and money means lack of health care, made even more dangerous by living conditions marked by lack of clean water and adequate sanitation’ (Adkins 2008, para.2)

IMG_3569

A gardener in a town by Jaffna, Sri Lanka

AIDS/Poverty Cycle

Governments in developing nations have found it challenging to provide proper health facilities to its people. Inadequate infrastructure to support a public health system has intensified the pervasiveness of HIV/AIDS. ‘In 2002, one in four Africans was directly affected by the epidemic. It is estimated that 24.5million of the globally 34.3 million infected reside in region of Sub-Saharan Africa. Whiteside (2002) states that poverty increases the spread of HIV and AIDS which in turn further aggravates the growth in poverty – this is known as the AIDS/Poverty cycle; the increase in consumption needs due to higher medical costs depletes household assets; AIDS can push household incomes down by 80% and thus increase household poverty (pg.313).  In Botswana, a report predicted that the country’s GDP growth would fall from 3.9% a year without AIDS to between 2% and 3.1% a year with AIDS’ (Whiteside, 2002, pg.323).

High Infant Mortality Rates

In a report released by the World Health Organisation (2011), newborn deaths decreased from 4.6 million in 1990 to 3.3 million in 2009. Interestingly, developing nations were found to have a disproportionately high level of child deaths (para.1). The research found that ‘99% of all newborn deaths occurred in developing countries. Countries such as India, Nigeria, Pakistan, China and the Democratic Republic of Congo accounted for more half of them. India alone has more than 900,000 newborn deaths per year, nearly 28% of the global total’ (ABC News 2011, para.4).

Psychological Stress

It is a well-known fact that poverty impacts psychological wellbeing. The World Health Organization (2003) states that ‘no group is immune to mental disorders; however the risk is higher among the poor, homeless and unemployed and uneducated’ (Rojas 2011, pg. 208). The feeling of vulnerability and insecurity has meant that those living in developing countries are under constant psychological stress. Income poverty has exposed many to the bottom of the social ladder, which unfortunately can be detrimental to a person’s self-esteem and for most of the children in Africa: education is limited.

‘On average, 62% of children in Africa do not complete primary school, and in 19 nations the figure is under 50 %. Literacy rates are low. […] As each generation grows up, the lack of education means another opportunity to break the cycle of poverty is lost. Those who do get good educations tend to leave Africa altogether, frustrated by the lack of opportunity to use their skills. Poverty means lack of the resources needed to lift oneself out of poverty’ (Adkins 2008, para.4).

Poor Public Health Infrastructure

Poverty has been a major cause for many vector borne diseases such as malaria, tuberculosis, cholera and typhoid. ‘Malaria is currently one of the most important public health problems of the developing world with around 2.5 million deaths occurring every year, mostly in children (McGuigan et al 2002, pg.12). Prepared by the World Health Organisation, the World Health Report (2008) critically assessed the methods health care was organised, delivered and financed in both the richest and poorest of countries around the world. The findings were both surprising and what was most striking were the inequalities and failures of health outcomes in the countries such as Afghanistan, Mozambique and Somalia. For example, ‘Swaziland is a country that has an average life expectancy of 39 years as opposed to Japan, of 80 years ’ (Schmidt 2010, para.3).

‘In the estimated 136 million women who gave birth in 2008, around 58 million would have received no medical assistance whatsoever during childbirth and the postpartum period. Annual government expenditure on health varied from as little as US$ 20 per person to well over US$ 6000. Globally, with the costs of health care rising and systems for financial protection in disarray, personal expenditures on health has pushed more than 100 million people below the poverty line each year’ (World Health Organisation 2008).

Food Security and Climate Change

The effects of food insecurity are well documented in the developing world. It is commonly accepted that a lack of nutrition at a very early age affects children’s height, intellectual development and hence; low productivity in adults. ‘Malnutrition also increases the susceptibility to infection and with more than 60% of households in North Ghana living below the national poverty line, households spend a much higher proportion of their income on food than households in the rest of the country’ (Cudjoe et al 2010, pg. 296). Thus, climate change will have a big impact as developing nations are more vulnerable to rising world food prices, which have particularly surged for grain products such as maize, a main food staple for countries such as North Ghana.

An older lady cleaning rice outside of her home constructed from UNHCR tarpoulins

An older lady cleaning rice outside of her home constructed from UNHCR tarpaulins

It is clear that the poor are particularly vulnerable to climate change and will suffer disproportionately from its impacts. For example, maize is a major staple crop and often forms the basis of food security in developing countries. This is clearly illustrated by the example of Mexico, where 70% of maize is grown on rain-fed land, by farmers who occupy less than 5 hectares. It is largely regarded as the “peasant crop” and has been repeatedly negatively affected by recent droughts (McGuigan et al 2002, pg.10). In many African countries, agriculture remains the principal economic activity, and agricultural products are the principal source of export trade. However, increased water stress is expected to affect from 75 million to 250 million Africans. Crop yields in some African countries are expected to drop by 50% and it is predicted that the impact on food security and malnutrition will be enormous (World Health Organisation 2008).

Thus, poverty affects the developing world dramatically: in the short term it cripples the population, and in the long term, it creates a cycle of a lack of infrastructure and education which makes it difficult to break out of.

Part 2 – Current policy initiatives to reduce world poverty

Poverty in the world today

It is important, when considering how to reduce poverty on a global scale, to note that there have been several success stories – some countries have broken out of the poverty cycle and transitioned into being “MDCs” –more developed countries.  Countries as diverse as Ireland, South Korea, Japan and Taiwan have stepped out of absolute poverty into global economic powerhouses (Kinealy, 1995, 722, MacFarquhar et al., 1991, Kleiner, 2001, Maddison, 2003). However, there is still a large proportion of the world that lives in poverty, with (at 2005) an estimated 40% of the world’s population living on less than $2 USD PPP per day, and almost 90% of the world’s population living on less than $10 per day (IMF, 2010).[2]  Further, whilst countries like China and India have burgeoning middle classes, there are still many nations in the world that are not even on a track to reducing poverty, particularly in sub-Saharan Africa. Thus, it is important in evaluating the initiatives used today to observe their success or failure, obviously accounting for the differences in the nations they are applied to.

This section will critically analyse three areas of poverty-reduction policy: 1. Macroeconomic policies (Kemp and Kojima, 1985, Menzies, 2000, Menzies, 2008, Ben-David et al., 1999) 2.  Other economic and social policies (Counts, 2008, Escalante, 2007, Kiva, 2011) 3.  Legal policies to promote good governance (Minogue, 2008, Bardhan, 2006).  Within the limitations of this paper, it is impossible to exhaustively analyze all poverty reduction frameworks, or even to list them.  Thus, this paper will analyze several policy frames in each category through the lenses of feasibility and effectiveness.

Macroeconomic policy initiatives

Macroeconomic policy initiatives tend to look at poverty as a national or macroeconomic issue, and seek to improve national economic trends as a means to reducing poverty.

Tied aid

Tied aid is money given from a donor country to a beneficiary country under conditions, usually that the money be spent on goods from the donating country.  More than 58% of international official aid is tied (OECD, 2006, Part 1), thus, the motivations behind and the costs of tying aid must be analyzed.

Kemp and Kojima (1985, p721) enunciate the paradox succinctly:

“International transfers necessarily harm the donor and benefit the recipient [… However, where] donors require that aid be spent in a manner not close to the preferences of the recipient […] there is the possibility that aid perversely leaves the donor better off.”[3]

However, that is not to say that there are no reasons for tied aid to exist.  The motivations of tied aid are primarily self-interested: that is, the donor country receives back some of the money, and is thus less affected by the donation.  However, aid may be tied to further benefit the recipient economy whereby the recipient does not have the expertise to manage such funds.  This may actually benefit the recipient, since, in essence, the beneficiary nation is receiving both aid and economic advice.  Further, that a nation may “tie” its aid to stimulate its own exports: the USA offers many nations aid to fuel its own exports (primarily in the arms and infrastructure sectors (Hartung, 1999)).  Thus, it may be seen to be positive since it stimulates aid where there might not be any, through incentives for the donor nation.

The efficacy of tied aid, and its benefits, are severely limited. When tied aid is given, there is no benefit of purchasing power parity (heretofore “PPP”) in the developing country: since it must buy from the donor country, it must pay the prices of the donor country.   To give the example of Sri Lanka,[4] 100 million dollars of aid would be worth more than 227 million dollars of aid tied to the USA (WolframAlpha, 2011).  This is just taking into account PPP.  Further, the donor country is receiving the “multiplier effect” of the cash injection: the beneficiary country spends money in the donor country, stimulating employment and consumption in the donor country rather than the beneficiary country.  Thus, tied aid is significantly less effective to beneficiary nations and untied aid would prove more effective in reducing poverty (although it would be less politically popular).

Debt Forgiveness

The developing world currently owes more than 2.7 trillion USD in debts, this translates to $25 in debt repayment for each dollar of aid received by the developing world (Shah, 2010, WorldBank, 2008).  Further, many of these countries cannot even service the interest on the debt, thus their debt continues to grow: this is referred to as irredeemable debt.  Thus, reduction or restructuring of third world debt is paramount to reducing poverty, since highly indebted poor countries (HIPCs) spend their taxes on repayments, rather than infrastructure improvements domestically.  Since 1956, the Paris Club[5] has worked in rescheduling third world debt, but until the 1990’s, the net present value of the debt remained unaffected by these restructurings, instead of forgiving debt, the debt was just delayed (Menzies, 2000, p5).

detangling threads in the loom

Untangling third world debt

However, since 1996 the Paris Club (alongside the IMF and the World Bank) have been restructuring loans, in a manner that reduces their net present value, on a case by case basis.  For example, the Paris Club (in the 2000’s) wrote off all OECD debt to Iraq after the war and suspended Southeast Asian debt repayments after the Boxing Day Tsunami.  Perhaps the Paris Club’s most significant achievement was its 2005 agreement with Nigeria which helped the country pay off $30 billion in debt (ParisClub, 2005b).  This “ad-hoc” write-off of Nigeria’s national debt provides a clear view of the mechanics of debt forgiveness, the motivations behind it and its effects on creditor/debtor nations.

The agreement wrote off $18 billion of Nigeria’s debt, which would have otherwise been irredeemable.  In exchange, Nigeria repaid the remaining $12 billion, and instituted some economic reform in line with the IMF’s suggestions.  This write-off was funded by two different parties: firstly, the creditor nations agreed voluntarily to write off some of the debt; secondly, the Millennium Fund,[6] and the HIPC trust fund agreed to compensate creditor nation’s write-offs, amounting to $6 billion (ParisClub, 2005a).

The creditor countries, as well as Nigeria, were pleased with this result for the following reasons.  The creditor countries were allowed an exit from a loan that would have otherwise been redeemable, extracting $18 billion (after Nigeria’s repayment and the Paris Club’s compensation) from a $30 billion loan.  Further, they were able to reform Nigeria’s economy somewhat, allowing the creditor nations greater access to Nigeria’s market. The debtor country, Nigeria, was able to offload its debt, allowing future governments greater flexibility in their budgeting and expenditure decisions.

Whilst there is the argument that writing off debts to poor countries would disincintivise loans to the third world, that the creditor nations are compensated in IMF and other funds (10 million ounces of gold[7] were to be sold to fund debt relief by the G-7 (Menzies, 2000, p5)), and that the creditors may use this as a stimulus to reform the recipient economy shows that debt forgiveness may benefit the creditor nation too.[8]  Furthermore, it may be more effective than aid, since money that would otherwise have been transferred to the creditor nations would be invested by the debtor nation, where the multiplier effect would increase the benefit to the recipient nation.  Thus, debt relief remains one of the more effective means of poverty reduction on a macroeconomic scale, and the HIPC and J2K models of debt forgiveness may, if followed through to completion, severely dent international poverty.

Tariff reduction

Where countries or economic blocs (most significantly, the European Union) protect domestic production via tariffs and subsidies and ask the IMF/World Bank to require developing nations to open up to free trade, there is a risk that trade would become unbalanced.  Developed nations would be able to export inefficient subsidized goods, and developing nations would not be able to compete with tariffs.  Winters (Ben-David et al., 1999, Part 3, p47) highlights the connection between trade policies, with unbalanced tariffs/subsidies affecting exchange rates and domestic prices in developing countries.  A reduction in developed world tariffs/subsidies would allow developing countries a new market, potentially increasing their exports and, thus, their GDP’s.

Figure 1: Tariff Reduction

However, it is a little bit more complicated when it comes to reducing the tariffs of a developing nation.  Figure 1 shows the effect of opening up a developing country to trade:[9] prices of the goods decrease (from Pe to P1), and the good becomes more affordable.  This makes the good more accessible to the populace: consumption increases from Qe to Q2 (in the case of food, it would reduce hunger within the country).

However, domestic production decreases (from Qe to Q1).  Thus, for the people manufacturing the good that is now imported (or imported more cheaply), most of whom are peasant farmers who are not able to compete with economies of scale, poverty will increase or persist because of unemployment, at least in the short term.  Further, where a country produces a good efficiently, and the bulk of the goods are exported,[10] the manufacturers of the exported good in the developing nation will receive more money in return for their goods, but domestic prices will rise, reducing consumption (this can be especially dangerous with regards to food).

Taiwan has shown the ability of a nation to benefit from trade (moving from agriculture to simply transformed manufactured goods to high value added manufactured goods whilst increasing the GDP per capita and HDI consistently), this movement to free trade must be done carefully so as not to shock the economy of the developing nation with increasing prices or decreasing incomes.  This tariff reduction unlikely to occur however, since reduction in protectionism is extremely politically unpopular, especially in Europe and the United States, where agriculture is cultural and highly subsidised.

Other economic and social policies

Apart from macroeconomic tools, countries and NGO’s are also working on reducing poverty by acting on a microeconomic level.  Some of the largest issues to developing nations are lack of infrastructure, education (the development of human capital), high transaction costs and social issues.

Whilst governments mostly fund the infrastructural work, often aid is given in the form of engineering/advisory services.  This infrastructure (in the form of roads, electricity grids, clean water, etc.) is critical to the development of a nation: the development of such infrastructure fast-tracks the nation’s economic development (Counts, 2008).

The public and private sectors have worked together to improve education, and increased literacy and tertiary education within a nation leads directly to increased economic growth, since the resource “labor” is improved (Escalante, 2007).  Further, education leads to increased participation amongst the women of a population (this effect is especially visible in Sri Lanka, where female participation is much higher than neighboring India, correlating with Sri Lanka’s more developed education system).

Transaction costs, lack of accessibility to credit/capital and social issues are all dealt with on a microeconomic level.  Here, microfinance providers and social businesses work with NGO’s to provide sustainable funds to poverty-stricken areas, whilst maintaining the profit motive (and the dignity of the beneficiary), increasing the effectiveness of the funds (Kiva, 2011).  Further, global and national for-profit organizations, including banks, are working to reduce transaction costs,[11] making banking, saving and loans more accessible to poor persons in developing nations (Mukherjee, 2008).

A taylor from Mannar who moved to get married in Trincomalee, now running his business out of the IDP camp in Mutthur

A tailor who purchased his industrial sewing machine with a micro-finance loan

Whilst these microeconomic/social methods of poverty reduction have huge returns, they are also extremely skill and labor intensive: requiring professionals to audit/oversee their implementation.  Potentially, however, the profit motive, especially in microfinance, may stimulate skilled labor/first-world non-humanitarian interest in these methods of poverty reduction.

Legal policies to promote good governance

Without good governance, namely in the form of positive regulatory governance and a lack of corruption, (which can only be secured by an effective political and judicial system),[12] any economic growth is stunted (Minogue, 2008, Bardhan, 2006).  In Indonesia and the Philippines alone, their leaders (in the second half of the 1900’s) embezzled more than 25 billion USD.  This does not account, at all, for the costs of corruption on a microeconomic scale.  Whilst it is outside of the scope of this paper to discuss the manner in which regime change or judicial reform may be implemented, they remain highly effective methods of reducing poverty and increasing the quality of life of the citizens of poor nations: a most effective building block to development (Grindle, 2002).

Conclusion

Poverty continues to very much affect the developing world, causing deaths in the millions from starvation and disease.  Eliminating poverty may be impossible in the short term, but its effects on the people of developing nations may be reduced, especially when a concerted threefold approach (macro – especially trade and debt relief, macro and legal) is taken to poverty reduction.  Whilst it is plain that this will aid the developing world, it may, too, economically benefit the donors, the creditors forgiving debt and those investors who are game enough to invest in developing countries.  By reducing poverty, new markets open up to first-world companies, new labor pools, new ideas and thinkers.  Whilst the short-term effects of poverty reduction may be relative harm to the donors, the long term benefits to the world at large starkly outweigh these costs.

Works cited

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[1] In Zimbabwe, only 20% of all fertile land is available to 90% of the population (Lamarca 2008, para.1).

[2] For comparison, an Australian in 2010, on average, lives on $109 USD PPP per day.

[3] Whilst this paper also posits the hypothesis that the recipient country may also be impoverished by tied aid, this hypothesis is only sound for a two economy hypothetical world.  Where there are more than two countries both countries may be enriched, although the recipient country will receive a much lesser benefit than in a non-tied system. (Kemp and Kojima, 1985, p722)

[4] Sri Lanka has a GDP of 40.56 billion USD, but a GDP of 92.17 billion USD at PPP (thus, goods are 2.27 times more affordable in Sri Lanka).

[5] The Paris Club is a group of 19 of the world’s larger economies, all larger creditors to the developing world.

[6] The Millennium Fund is a private sector charitable fund created to fund debt relief.

[7] 10,000,000 ounces of gold is worth approximately 18.83 billion USD.

[8] Further, a “Hyper-incentive contract” may remove this “moral hazard” entirely (Mezies, 2000, Menzies 2008).

[9] This acts as a metaphor for reducing domestic tariffs that would have the same effect on a smaller scale.  In this graph, the bold line represents the free trade price of the good, the point (Pe,Qe) represents the equilibrium domestic price before tariff reduction and Q1-Q2 representing imported goods.

[10] i.e where international tariffs are reduced.

[11] Transaction costs are reduced by using remote biometrics or phone/mobile banking, replacing the requirement that villagers travel to town at their own cost to transact with a bank.

[12] Preferably a democratic system, with a Executive, Legislature and Judiciary that are independent, alongside an independent media.

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LLM candidate at Cornell Tech. Consultant for King & Wood Mallesons and Project Evangelist for Legalese.

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