Why Poverty Exists in a wealthy economy - U.S. as a Case study

1. What is Poverty?

The world poverty means different things to different people. Clearly poverty is a condition in which people have inadequate incomes, but it is hard to draw an exact line between the poor and the not poor. Poverty can be defined in many different ways, Some attempt to reduce it to numbers, while others argue that more ambiguous definition must be used. Economists have therefore devised certain techniques, which provide the official definition of poverty.

Poverty was officially defined in the 1960s in the United States. The federal government set the poverty line in the 1960s based on income and family size. Researchers estimated that families spent about one-third of their incomes on food, so they calculated how much families spent on food and multiplied those numbers by three to find the minimum amounts that families needed to get by. The numbers are adjusted annually for inflation, but the formula has never changed. In 2008, the poverty threshold for a family of four is $21,200. For one person, it’s $10,400. This figure represents the poverty line or demarcation between poor and no poor families. The poverty line also varies by family size.

Poverty arises from a wide variety of factors. The five key ones are:

§ Human Capital

§ Discrimination

§ Financial and physical capital

§ Entrepreneurial ability

§ Personal and family characteristics

First factor is human capital, which refers to the skills, education, health, and training of individuals. It is capital because these skills or education are an integral part of us that is long-lasting, in the way a machine, plant, or factory lasts. Prior to the nineteenth century, systematic investment in human capital was not important in any country. Expenditures on schooling, on-the-job training, and other forms of investment were quite small. This began to change radically during that century with the application of science to the development of new goods and more efficient methods of production, first in Great Britain, and then gradually spreading to other countries. During this century, education, skills, and other knowledge have become crucial determinants of a person’s and a nation’s productivity. One can even call the twentieth century the Age of Human Capital in the sense that the primary determinant of a country’s standard of living is how well it succeeds in developing and utilizing the skills, knowledge, health, and habits of its population. It has been estimated that human capital–education, on-the-job and other training, and health–comprises about 80 percent of the capital or wealth in the United States and other advanced countries. Even if such estimates are somewhat exaggerated–and if there is any exaggeration, it is not large–these estimates clearly indicate that human capital can be neglected only at a country’s peril.

Poverty can be caused by individual circumstances but certain group characteristics can also have a bearing. In particular, characteristics that cause people to be discriminated against - such as a physical disability or belonging to a particular people group - can mean they are denied opportunities. Persistent earnings differences exist between women and men and among the races. Does discrimination contribute to poverty; the economists can’t isolate and measure the effect of discrimination.

The third factor will be financial and physical capital. Financial capital means populations with more livestock were more likely to be less poor. Physical capital means populations with limited road infrastructure are more likely to be poor. The people with the highest incomes are usually those who own large amounts of financial capital and physical capital. Those people received incomes in the form of interest and dividend payment and from capital gains – increases in the stock market value.

The fourth factor is entrepreneurial ability. Some of most rich people have benefited form unusual entrepreneurial talent. Those rich people who began life with modest amounts of wealth and modest income and through a combination of hard work, good luck, and outstanding entrepreneurship have become extremely rich. But those poor people, they have put together a business plan, borrowed heavily, and through a combination of hard work, bad luck, and in some cases poor decisions have become extremely poor.

The fifth factor is personal and family characteristics. Each individual’s personal and family characteristics play a crucial role, for either good or ill, in influencing economic well-being. People who are exceptionally good looking and talented with stable and creative families enjoy huge advantages over the average person. Adverse personal circumstances, such as chromic physical or mental illness, drug abuse, or an unstable home life possible will have less change to success.

2. Are Poverty factors dependent on state of economy?

The previous factors explain why poverty exists and continues to grow in a society in general but in order to answer the question on why poverty exists in a wealthy economy, we need to understand 2 factors:

· Poverty factors which are impacted by characteristics of wealthy economies

· Socio economic factors of wealthy economy and how they interact with poverty factors

Poverty factors which are impacted by characteristics of wealthy economies: By far, the top two contributors would be a person’s human capital and family characteristics. Sure discrimination, financial and physical capital, and entrepreneurial ability still occur but these factors act independently from the economy being wealthy or not. Discrimination can exist anywhere and in wealthy and the non-wealthy economies alike. Financial and physical capital actually promotes income equality when high-income households save money and leave some for the next generation who might put that money to use during times of a bad economy. While entrepreneurial ability exists because of good ideas and good luck in many cases. People who were not necessarily wealthy have become entrepreneurs and their ideas and success do not depend on a wealthy economy. Let’s focus on a wealthy economy and how human capital and family characteristics are affected.

Effects of Human Capital: Now the one aspect that every person can directly affect is his or her human capital. Economies become wealthy when technology and skills enhance. When this happens households need to be able to keep up with the ever-changing technology in order to still be useful in an economy like that. As economies become more effluent, they transition from industrialized economies to service based economies which in turn requires enhanced skills, a crucial element of which is higher education. This is significant as in a service based economy, the job opportunities require higher educational levels which in turn requires the society to upgrade their human capital, lacking which leads to long term chronic poverty due to lesser job opportunities. An example of the extent of the effect is that among various factors inducing income inequality, education is the biggest influencer with a variation of more than $100,000 for different education attainment levels.

Effects of Family Characteristics: There are many aspects of family characteristics which are both dependent and independent of economy. While factors like marital status, age etc are independent of state of economy while factors like legal status are dependent on economy as typically wealthy economies tend to have more illegal immigration, thus impacting poverty and average household income. This is explained as follows; illegal immigrants do not have access to regular jobs or higher education, hence are unable to move out of the poverty trap. Illegal immigration also distorts the law of supply and demand as the illegal immigrants perform low skilled labor at rates which are much below the regular market rates. This in turn decreases average incomes of households. Hoping to come and prosper here in the United States illegal immigrants find it difficult to keep a regular job or higher their education. Still being included in poverty statistics, illegal immigrants account for a good percentage of the growing poverty in the states. Children of illegal immigrants may tend to stay in the psyche that living in poverty is normal, similar to children of drug abused parents, and stay in that notion of living. Without the right guidance these family characteristics would continue and grow.

3. What are the socio economic characteristics of wealthy economies, which promote poverty?

In this section we will try to correlate the findings of the above sections and apply it on some common characteristics of wealthy economies and try and analyze whether these socio-economic factors are responsible for the poverty in wealthy economies. Some of the common characteristics of wealthy economies are:

· Service based economy

· Outsourcing

· Illegal immigration

Service Based economy: With technology always improving, the service based economy replaces human capital with machinery leading to a loss of manufacturing jobs. People have trouble keeping their skills up-to-date so they lose out on jobs and increase the poverty numbers. With the never-ending trouble of getting by day-to-day it is nearly impossible to break the cycle of debt to afford to better them since school can be so expensive. This is where the poor become poorer and cannot get ahead to receive education of some sort. Along with this thought, salaries do not keep up with inflation and the ever-increasing cost of living. It can become an uphill battle to reverse this human capital problem.

Outsourcing: On top of keeping up with the economy, when outsourcing occurs times become even tougher. The large amount of jobs lost to people overseas causes the supply of entry-level jobs nearly diminishes. A service-based economy depends on high human capital to keep up with their needs.

Illegal Immigration: Lastly, like the topic mentioned earlier, illegal immigration makes a large impact on poverty increases. The children of these illegal immigrating families tend to find it difficult to break the pattern and increase their skills and knowledge. With so many entry-level jobs brought overseas for cheap labor and illegal immigrants working for close to nothing in the remaining entry-level jobs there is a lack of opportunity that remains for citizens.

Overall, human capital and family characteristics are the leading causes of poverty in a wealthy economy. Let’s take a closer look at these two causes using the United States as an example, a country that is wealthy yet poverty is constantly increasing.

In this section we will try and substantiate the analysis done in the previous sections by taking US as a case study and a representative sample of a wealthy economy.

4. Poverty Incidence in US – A Case Study

4.1. Poverty in the US – An Overview

In US, poverty is measured by the Census Bureau in terms of “Money Income”. “Money Income” is defined as a household’s wages, interest, rent and profit earned from the markets for factors of production plus cash benefits paid by the government. The poverty is measured in terms of the poverty guidelines which are revised every year. The 2009 poverty guidelines are provided below for reference:

Table 1: 2009 Poverty Guidelines

The 2009 Poverty Guidelines for the 48 Contiguous States and the District of Columbia
Persons in family	Poverty guideline
1	$10,830
2	14,570
3	18,310
4	22,050

Reference: Website of US Department of Health & Human Services

The key statistics of poverty in US are as follows:

As per the poverty guidelines, there were 37.3 million Americans living in poverty in 2007, representing 12.5% of the population Refer Figure 1
The bottom 20% of the households earn only 3.1 % of the total income & the bottom 40% earn only approximately 11% while the top 20% households earn more than 50% Refer Figure 2
The poorest 40% of the households own mere 0.2% of total wealth, while the richest 1% own 38.1%

Figure 1: Poverty Trends in US & the US Lorenz Curve

Source: US Census Department

Figure 2: Income Distribution in US

10%	20%			30%		40%	50%
3.10%	less than $20,000 -- 19.04% of all households (HH)
8.10%	$20,000 to $37,500 -- 19.45% of all HH
3.80%			$37,500 to $60,000 -- 19.44% of all HH
22.3% -- $60,000 to $95,000					20.00% of all HH
40.8% -- $95,000 to $250,000							20.15% of all HH
11.90%		$250,000 or more - 1.92% of all HH

Source: US Census Department

The statistics presented above prove the first aspect of this discussion i.e. that poverty does exist in the US which is a wealthy economy. We will now examine some key poverty trends and then try to determine the plausible factors behind those trends.

4.2. Poverty Trends in US – Time series Analysis

The key trends in US Poverty are as follows:

Inequality over Time

The inequality of income over time has increased in the US. The higher incomes have increased much faster than the lower incomes and the gap between the rich and the poor has widened
The highest 20% income group saw their income increase by more than 91% between 1967 & 2006, while the lowest 20% increased by only 43% (Reference: Textbook)

Economic Mobility

While there is a high mobility (up or down) across income groups i.e. 60%, the trends in economic mobility depict a gradual slowdown in economic mobility over the past 3 decades (stagnation increased from 35% to more than 40%) (Reference: Textbook)
Almost 40% of the population stayed in the same income quintile as the past decade and 30% each moved up or down the quintiles

Poverty Duration

The incidence of consistent poverty in US (More than a year) is less than 20%. More than 50% of the poor families suffer from poverty of less than 3 months
This indicates that for majority of poor families the onset of poverty is not permanent

4.3. Socio-Economic Factors influencing poverty in US

In the sections above we studied the current state of poverty in US along with some historical trends. In this section we will look at some key socio-economic factors influencing poverty in the US currently

From a manufacturing to a service based economy

Over the past 3 decades US has transitioned from a manufacturing to a service based economy. This has implications in terms of incidence of poverty as service based economy requires more skilled labor and higher education and reduces the job opportunity for low skilled manufacturing jobs.

A leading indicator is that over the past 3 decade the share of service in US GDP has increased from 46% to more than 80% and Industry has reduced from 43% to less than 20%. A corresponding increase in educational attainment has not happened with less than 25% of US population attaining a college degree or higher. This is significant as in a service based economy, the job opportunities require higher educational levels which in turn requires the society to upgrade their human capital, lacking which leads to long term chronic poverty due to lesser job opportunities (Reference: US Census Data 2007)

Outsourcing

The US economy lost an estimated 1.9 million jobs to outsourcing in 2008 (Reference: US Bureau of Labor Statistics)
Among the jobless only 3 out of 10 were jobless for 27 weeks or more and less than 20% of the jobless were out of jobs for more than a year
This indicates that the job loss due to outsourcing primarily contributes to temporary job loss and reflects in the income mobility trends discussed earlier

Illegal Immigration

Illegal immigration is US is among the largest in the world and is a contributor to poverty. Wealthy economies like US attract large number of illegal immigrants in the hope of better jobs and a better future
Illegal immigrants do not have access to regular jobs or higher education, hence are unable to move out of the poverty trap
A leading indicator is that the Hispanic male earns the least among races (0nly 65% of white males) and have the second highest poverty rate among races in US (more than 20%). This combined with the fact that Hispanics are the largest in number of illegal immigrants’ leads to the deduction that illegal immigration promotes poverty
Illegal immigration also distorts the law of supply and demand as the illegal immigrants perform low skilled labor at rates which are much below the regular market rates. This in turn decreases average incomes of households

Cost of War

Most economic models have shown that military spending by the United States Government has diverted resources from productive uses such as consumption and investment, which has ultimately slowed growth and reduced employment
Estimates project that by 2017 the Iraq War and War in Afghanistan will have cost the U.S. budget between $1.7 trillion and $2.7 trillion. Interest on money borrowed to pay those costs could alone add a further $816 billion(Reference:http://www.sfgate.com/cgi-bin/article.cgi?file=/c/a/2005/07/17/MNG5GDPEK31.DTL)

4.4. Key Inferences from the Poverty incidence and Poverty Trends in US

Although nearly 20% of poor families suffer from consistent poverty in US, in terms of overall population less than 2.5% of population suffer from chronic poverty
Even the chronic poor with an average of 4 family members earn more than $ 22,000 and have access to basic amenities like food, shelter and basic healthcare (Refer: http://www.heritage.org/research/welfare/bg1713.cfm)
Looking at the inequality over time between rich and poor households and the gradual slowdown in economic mobility, it can be extrapolated that while the rich and middle income households are moving up the economic ladder, the poor households are either stagnating or moving down
The 60% mobility (Up or down) between income groups coupled with 50% poverty lasting less than 3 months indicate that poverty in US is mostly transitory in nature due to factors like temporary job loss. This is consistent with job loss due to Outsourcing in wealthy economies
The chronic poverty is due to more permanent factors like lack of professional education which is difficult to overcome in the short term. This in turn is related to the fact that the blue collared workers employed in Industrialized sector have lost out in the transition of US economy from manufacturing to a service based economy
Illegal immigration lowers the average household income and add to chronic poverty numbers

5. Insights into experiments on poverty reduction in wealthy economies

Throughout history, income inequality and poverty have been common problems for most advanced economies. Today, most governments understand that the health and well being of the whole society depends on their ability eliminate poverty and create a more equitable income distribution. Despite decades of ongoing attempts, the wealthiest of counties continue to struggle with widening income gaps and increasing numbers of people living in poverty.

Although most countries share the same poverty reduction goals, the welfare state philosophies among governments vary greatly. Canada and the European Union support a view that economic efficiency and social equity are interdependent. It is believed that “the private market is seen as inefficient in ensuring and adequate distribution of resources among citizens, and the state is understood to have an important role in pursuing a number of policies and programs with redistributive and social minimum goals.” (Ref: Poverty Reduction Policies and Programs in Canada, 2009) The United States takes a view that it is up to citizens to support themselves and those who struggle in poverty must prove that they are “poor enough” to receive support from the government. There is much political debate about whether the markets should be manipulated, at what level the government should be involved and whether income equality is even an issue of concern. The underlying philosophy has been that a strong market economy is the solution. The assumption has been that if the economy is strong enough, eventually money will trickle down to the lowest income earners. We have experienced many periods of strong economic prosperity and yet the income gap continues to widen and the number of people living in poverty has increased.

Because of societal and humanitarian concerns some countries have implemented laws and government sponsored programs to address poverty. Governments attempt to affect change through economic policy, economic development programs, legislation and public assistance programs. Economic policies that help generate employment and reduce inflation help reduce poverty. Economic development programs help those affected by discrimination earn a fair wage. Tax laws are structured to help redistribute income through progressive tax rates and negative income tax programs. Minimum wage laws attempt to improve wages for people in the lowest wage bracket. Public assistance programs help meet day-to-day needs such as food, health care and housing for the elderly, disabled or low-income individuals.

Income inequality and poverty in wealthy economies are the result of many factors. The main factors are human capital, access to affordable healthcare, discrimination, and financial & physical capital. Most countries understand that human capital is of crucial importance in reducing poverty. As countries move toward post-industrialized economies, the demand for low-skilled labor decreases and the demand for high-skilled labor increases. As a result, many countries provide education and job training programs to improve human capital. In the US there is much discussion about improving our public school system to improve the human capital of future generations. Government programs offer subsidized college loans, job skills training, and job placement services. Improvement of human capital improves marketable skills, and hopefully improves an individual’s changes of escaping poverty.

Another major factor is access to affordable healthcare. Many other advanced economy countries have government provide healthcare systems so that everyone has access to affordable healthcare. In the United States there is a large inequality in access to healthcare. The families who have healthcare insurance pay much less for their healthcare than those without healthcare insurance. Many families without healthcare insurance have ended up in poverty as a result of an accident or medical condition that resulted in large medical bills.

Discrimination is also a major factor in poverty. Despite equal opportunity laws, certain groups continue to be discriminated against making it difficult for people in low-income groups to earn a sufficient wage. Through government economic development programs, small business loans are available to minorities and women. Some government programs encourage employers to hire minorities, or do business owned by minorities and women. Differences in financial and physical capital are also factors of inequality. Individuals without financial and physical capital are disadvantaged because of their ability to earn interest and dividends. Without the capital, they may not have access to loans or pay higher interest rates because they lack collateral.

6. Conclusion

In Conclusion it can be inferred that poverty occurs in an economy due to a multitude of reasons which may be independent of the wealth of the economy, in fact the very wealth of the economy tends to promote the factors promoting inequality and poverty. A prime example in this category is the impact of “Human Capital”, dependent on the wealth of the economy where a wealthy, service based economy requires more skilled labor rather than low skilled labor, thus leading to job loss and poverty for that skill set. In this context the role of the government is for providing a social safety net and more equitable distribution of wealth, thus ensuring basic amenities. Lastly in wealthy economies while poverty does exist but the poor also have access to basic amenities, as defined in the UN Millennium Development Goals and the focus needs to turn on the poor in underdeveloped economies where the poor do not have access to basic human rights like food and shelter!!