Section 4.3.4Unit 4: Developments in the Global Economy
Unit 4: Developments in the Global Economy
Poverty and Inequality
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Absolute poverty means falling below the survival threshold ($2.15/day), while relative poverty means earning below 60% of the median — growth can reduce one while worsening the other.
Absolute poverty is defined as an income level below which a person cannot meet basic needs — food, clean water, shelter, and clothing. The World Bank sets this at $2.15 per day (2022 PPP). Anyone below this threshold lacks the resources for physical survival regardless of what others in their society earn.
Relative poverty is defined in relation to the living standards of the rest of society — typically below 60% of median household income. A person can be lifted from absolute poverty but still be relatively poor if the gap between them and the median widens. This distinction matters enormously for policy: economic growth reliably reduces absolute poverty but may worsen relative poverty if the gains accrue disproportionately to the rich.
The two measures can move in opposite directions. A country experiencing rapid growth may see millions escape absolute poverty while inequality simultaneously widens — meaning relative poverty rises. Policymakers must therefore track both measures to get an accurate picture of living standards.
Real Example: China lifted over 800 million people out of absolute poverty between 1978 and 2020 — the largest poverty reduction in history. However, its Gini coefficient rose from roughly 0.30 to 0.47 over the same period, meaning relative inequality worsened dramatically even as the poorest gained.
Exam Matters: Examiners frequently ask you to distinguish between absolute and relative poverty. Always define both precisely, then explain how a single policy (e.g. GDP growth) can reduce one while worsening the other — this analytical distinction earns the highest marks.
The Lorenz curve plots cumulative income share against cumulative population share, and the Gini coefficient (A divided by A+B) converts that picture into a single number between 0 and 1.
The Lorenz curve is a graphical representation of income or wealth distribution. It plots the cumulative percentage of the population (from poorest to richest) on the x-axis against the cumulative percentage of income they receive on the y-axis. A perfectly equal society produces a 45-degree line; the further the Lorenz curve bows away from this line, the more unequal the distribution.
The Gini coefficient quantifies inequality as a single number. It equals the area between the line of equality and the Lorenz curve (area A) divided by the total area under the line of equality (A + B). A Gini of 0 means perfect equality; a Gini of 1 means one person holds all income. Most countries fall between 0.25 and 0.65.
A key limitation is that two very different income distributions can produce the same Gini coefficient — a country where the middle class earns disproportionately less and one where the poorest earn disproportionately less might both have a Gini of 0.40. The Gini also ignores non-monetary factors like access to public services, which can significantly affect real living standards.
Real Example: South Africa has the world's highest Gini coefficient at approximately 0.63, reflecting extreme inequality rooted in apartheid-era land and wealth distribution. By contrast, Denmark's Gini of roughly 0.28 reflects decades of progressive taxation and universal public services compressing the income distribution.
Exam Matters: Examiners expect you to draw a Lorenz curve, label the line of equality, identify areas A and B, and state the formula Gini = A/(A+B). For evaluation, always note that the same Gini can arise from very different underlying distributions — this shows analytical depth.
Inequality stems from wage differentials driven by human capital and MRP, wealth concentration passed between generations, globalisation rewarding skilled workers, and tax policy choices.
Wage differentials are the primary driver of income inequality. Workers with higher human capital — education, skills, experience — command higher wages because their marginal revenue product (MRP) is greater. A surgeon earns more than a cleaner because the revenue generated by each additional hour of their labour differs enormously. These differentials are amplified by barriers to entry: professional qualifications restrict supply, pushing wages higher for those inside the profession.
Wealth concentration reinforces inequality across generations. The wealthy earn investment returns, inherit assets, and can fund better education for their children — creating a self-perpetuating cycle. Globalisation has widened inequality within countries: highly skilled workers who can sell services globally see their earnings soar, while low-skilled workers face wage competition from cheaper overseas labour.
Tax and transfer policy plays a crucial role. Progressive tax systems redistribute income downward, while regressive taxes (like VAT) take a larger proportion from the poor. Government choices about tax rates, loopholes, and public spending significantly shape the final income distribution after market forces have determined pre-tax incomes.
Real Example: In the United States, the CEO-to-worker pay ratio rose from approximately 20:1 in 1965 to around 350:1 in 2023. This dramatic widening reflects rising returns to human capital at the top, stock-based compensation, and tax policy changes that reduced top marginal rates from 91% to 37%.
Exam Matters: Examiners want you to analyse multiple causes, not just list them. Link each cause to a mechanism: human capital explains wage differentials via MRP, globalisation works through labour market competition, and tax policy operates through redistribution. Chains of reasoning earn higher marks than isolated points.
High inequality reduces social mobility and aggregate demand (the poor have a higher MPC), creating an equity-efficiency trade-off that redistribution policies attempt to navigate.
Inequality has significant economic consequences. Reduced social mobility means that where you are born on the income ladder increasingly determines where you end up — talent is wasted when the poor cannot access education or capital. Lower aggregate demand results because the poor have a higher marginal propensity to consume (MPC) — transferring income from rich to poor increases total spending in the economy.
Redistribution tools include progressive taxation (higher earners pay a larger share), transfer payments (benefits, pensions, tax credits), and in-kind provision (free healthcare, education). Each faces the equity-efficiency trade-off: too much redistribution may reduce incentives to work and invest, while too little allows poverty and wasted human potential.
The Laffer curve suggests that beyond a certain tax rate, revenue actually falls because high rates discourage economic activity. Poverty traps arise when the withdrawal of benefits as income rises creates effective marginal tax rates above 80%, removing the incentive to work more. Good policy design must balance adequate support with maintained work incentives.
Real Example: The Scandinavian model — particularly Sweden and Denmark — combines high redistribution through progressive taxation and generous public services with high social mobility and strong economic performance. Top marginal tax rates exceed 55%, yet these countries consistently rank among the most competitive economies, challenging the simple equity-efficiency trade-off narrative.
Exam Matters: Examiners love the equity-efficiency trade-off as an evaluation theme. Go beyond the basic trade-off: argue that some redistribution (e.g. funding education) improves both equity and efficiency by developing human capital, while other forms (e.g. poorly designed benefits) may create poverty traps — distinguish between the two for top marks.
Absolute poverty means falling below the survival threshold ($2.15/day), while relative poverty means earning below 60% of the median — growth can reduce one while worsening the other.
The Lorenz curve plots cumulative income share against cumulative population share, and the Gini coefficient (A divided by A+B) converts that picture into a single number between 0 and 1.