(This essay was published in Hong Kong Economic Journal on 31 May 2017.)
Poverty is a topic that occasionally makes headlines in the newspapers and attracts a variety of commentators. In a lot of these discussions reference is made to the poverty line as a measure of the extent of poverty in society. The poverty line is used in two senses to denote absolute poverty and relative poverty.
One of the Millennium Development Goals of the United Nations was to reduce the number of people in the world that are living in extreme poverty and hunger. The poverty line became an instrument for measuring goal attainment and was operationally defined as living on less than US$1 a day. The underlying conception of the poverty line used here is absolute poverty.
The measure is used in an aggregate way to estimate the proportion of individuals in a country who live in a household whose per capita income is less than the benchmark level. The policy goal here is not targeted at alleviating micro and individual cases of poverty, but at aggregate outcomes. Its purpose is to promote economic development in those countries where there are large concentrations of poor populations and lift them out of absolute poverty.
The most successful achievement of the economic globalization of the past few decades has been to pull 600 million people in the Third World out of dire poverty. Most of the gains are found in six countries: China, South Korea, India, Poland, Indonesia and Thailand, where their industries have successfully joined the global value chain of the industrial world economy. It happens these countries are mostly emerging from either Communism or post-revolutionary authoritarianism.
Over time the exact dollar amount used to define the poverty line has been revised upwards after goals were attained, to be US$1.25 then US$1.90. The absolute poverty line thus reflects a development goal to lift people’s living standards primarily through economic integration into the world economy in the past three to four decades.
The backlash against global economic integration today is because its success in pulling up the poor in the Third World has not been shared with most of the rich world.
Many countries in the rich world have embraced a different notion of poverty, that of relative poverty. The poverty line is operationally defined as a fraction (often one-half) of the median level of household income in a given society. The relative poverty concept has a long history, but its operational definition adopted by the United Nations, the Organization for Economic Cooperation and Development, and by the governments in Canada and the European Union is more recent.
In 1776, Adam Smith argued that poverty is the inability to afford “not only the commodities which are indispensably necessary for the support of life, but whatever the custom of the country renders it indecent for creditable people, even of the lowest order, to be without.”
In 1965, Rose Friedman (Milton Friedman’s other half) argued for the use of relative poverty claiming that the definition of poverty changes with general living standards. Those labeled as poor in 1995, would have had “a higher standard of living than many labeled not poor” in 1965.
In his book Capitalism and Freedom (1962), Professor Milton Friedman proposed to alleviate U.S. poverty with the ‘negative income tax’. The idea is to provide a basic level of income for every household, and those who earn less than this level will receive a commensurate subsidy to make up for the difference (hence the notion of negative income tax). His notion of poverty was clearly one of relative poverty and it entailed redistribution of income from the rich to the poor.
Friedman’s proposal was well received by the economics profession; even archrivals like Paul Samuelson of MIT and James Tobin of Yale signed up to endorse it. The proposal made its way into policy in the U.S. and many other places in the world, including Hong Kong last year with the adoption of the Low Income Working Family Allowance (LIFA).
Mark Zuckerberg’s notion of a ‘universal basic income’ advanced at the recent commencement address to Harvard University is essentially Friedman’s old idea, but in a different context and for a different purpose.
Friedman’s proposal to alleviate poverty was a countermeasure against the progressive left’s policy measures to alleviate the plight of the poor through hundreds of separate regulations and programs. These limited the freedom of markets and the liberties of individuals, which Friedman perceived as a threat to free market capitalism.
He states, “There is every reason to help the poor man who happens to be a farmer, not because he is a farmer, but because he is poor. The program, that is, should be designed to help poor people as people not as members of particular occupational groups or age groups or wage rate groups of labor organizations or industries.”
Friedman wanted to get rid of the endless profusion of programs that created a huge welfare state funded through taxation: farm programs, old age benefits, aid to dependent children, public housing, minimum wage laws, tariffs, licensing provisions of crafts and professions, and so on. These all purport to help the poor, but bring distortion to the market or impede its functioning. They are thus hugely wasteful of resources and constrain the liberties of individuals to make choices.
Friedman pointed out that in 1961 the U.S. Government was spending $33 billion on direct welfare payments and programs of all kinds to help the poor. At that time there were 57 million households. He argued it was possible to finance cash grants of nearly $6000 to each household in the lowest 10 per cent of incomes and thus raise their incomes above the household average. Alternatively, households in the lowest 20 per cent of incomes could receive nearly $3000 each and attain half the household average.
The negative income tax proposal was welcomed by all and adopted. However, the welfare programs were never dropped. The welfare state that Friedman wanted to tame was never tamed. The government’s fiscal spending just got bigger and the budget gradually drifted into chronic deficit. And to the chagrin of all, relative poverty was not alleviated.
Indeed, as a result of the chronic persistence of poverty, there is also a substantial body of critical research purporting to show that welfare spending has actually worsened the poor by trapping them in relative poverty and that this has offset the beneficial effects of the negative income tax. Needless to say critics from the progressive left hotly contest such findings.
We have learned two things from the past half-century of policy effort to alleviate poverty. It is awfully difficult to make progress on relative poverty in the rich countries, but the record in tackling absolute poverty in the poor countries has met with considerable success, at least in some countries. Our knowledge of tackling absolute poverty appears to be far better than alleviating relative poverty.
Logically, if we define relative poverty using a poverty line that is a fraction of median income level, then relative poverty becomes difficult to alleviate because we have set a bad or misleading goal.
In drawing a poverty line, the operational definition of income is current income. Current income is not tightly correlated with economic well-being. Incomes fluctuate over the business cycle, vary with the lifecycle, are systematically not accurately reported, and many people have no income because they are retired, not employed or self-employed at the moment.
Using such a measure, research from the U.S. has shown that 73 per cent of the population will spend a year during their lifetime in the top 20 per cent of the income distribution, and about 40 per cent will spend a year in the bottom 20 per cent. For this reason, many whose current incomes are below the poverty line are not truly poor in a lifetime sense.
Most societies have many programs that transfer cash and non-cash benefits to the poor. For example in 2015, 19.7 per cent of the population in Hong Kong was said to be below the poverty line, but after factoring cash transfers the percentage fell to 14.3 per cent, and if both cash and in-kind transfers were factored in it fell to 9.9 per cent.
I would not be surprised if a substantial proportion of the recipients of cash and in-kind transfers were not below the poverty line. For example, almost a third of the population in Hong Kong lives in public rental housing, which is the most important in-kind transfer, yet only 19.7 per cent of people live below the poverty line. This means society either spends a lot of housing resources on helping people who are not below the poverty line or the poverty line fails to identify who are the poor. And the same is likely to be true of many other programs that society is now funding.
So what is wrong? Is it the poverty line as a measure of relative poverty, or the spending on other programs that have failed to identify the poor correctly?
Let me make one important point here to clear the air. I do not believe government statisticians have committed a mathematical error leading to an exaggeration of the poverty situation. I happen to think they have done a careful and outstanding job analyzing the data, and I earlier commended them for their work.
The issue is not errors of calculation, but difficulties in reducing poverty into a statistic based on current income.
A rapidly ageing society like Hong Kong will in the coming decades have a higher rate of measured relative poverty using the poverty line measure. This is purely a statistical artifact of the rising number of retired households that have no reported income but are not necessarily without support or assets. Eliminating elderly households from the calculation of the poverty line would probably give a less erroneous aggregate indicator of trends in relative poverty in Hong Kong among working age households in the future.
But a better aggregate trend indicator does not mean it is a sufficiently good indicator of the level of relative poverty at any time. And that is why there were so few takers of the LIFA after it was launched. I think poverty in Hong Kong, in the sense of low incomes as suggested by the poverty line measure, is much less serious than the numbers suggest.
The poverty problem in Hong Kong is mostly near poverty rather than poverty. It is the problem faced by households that want to rise to a level of income security that would allow them to provide a quality education for their children, afford quality health care when it is needed, and own their home to protect the lifetime purchasing power of their hard-earned savings. Alleviating relative poverty in rich countries has proven to be a difficult task and will not be made easier by the poverty line contraption.
In some countries, avoiding poverty or near poverty is also about staying away from drugs and alcohol, not becoming a criminal or victim of crime, avoiding teenage pregnancies and single parenthood, and not dropping out of school. The poverty line is of little help in alleviating such forms of poverty or near poverty. Fortunately Hong Kong is less afflicted with such ailments.
The greatest concern in applying the poverty line concept in Hong Kong is not only that it exaggerates the extent of poverty, but it detracts from the task of alleviating near poverty and recognizing it as the true menace – the menace of the sinking middle class. This is afflicting all rich societies. The poverty line is a misleading indicator for guiding poverty policy today. I hope we can gain the wisdom to stop fighting today’s challenge with yesterday’s failed policy tools.
Rose D Friedman, Poverty: Definition and Perspective. American Enterprise Institute for Public Policy Research (Report). Washington, D.C., 1965.