Economic Prosperity
Extreme poverty has significantly declined throughout the world, but relative poverty has proven difficult to eradicate. Can it be done?
In the first article of this three-part series, The Psychological Costs of Scarcity, I detail the cognitive and behavioral consequences of living in poverty. This article will dive into the political economics of poverty — why have sufficiently wealthy nations allowed for its existence — and the characteristics of potential solutions.
The History of Global Poverty
Extreme poverty has declined across the globe for generations, particularly fueled by the rise of the Chinese economy. The proportion of the Chinese population living on less than $1.90/day (2011 PPP) has fallen from 66.3 percent in 1990 to 0.5 percent in 2016. The total effect of this staggering achievement — beginning in 1978 — has resulted in nearly 800 million people being lifted out of poverty while averaging 10 percent growth year-over-year. Today, China is now considered an upper-middle-income country which, given its relative economic conditions, places its poverty line at $5.50, according to the World Bank. This poverty line places nearly a quarter of the Chinese population in poverty. Nonetheless, China has made great strides to eradicate poverty.
China’s meteoric rise can be seen most clearly in its domination of international trade. By the end of the 1970s, China’s nascent economic reforms were being implemented and the nation’s exports accounted for only 1 percent of global exports. By 2020, China’s share has jumped to nearly 15 percent of global exports — the largest exporter in the world since 2008. It has been about 43 years since China first announced its economic reforms, but the history of global poverty reduction begins more than a century earlier.
Although data from the early 19th century is at best a guess, it is still useful towards the development of the overall trend of global poverty. The industrial revolution set the world on course to the fastest and most sustained economic growth in human history — albeit extremely unequal as illustrated by the figure below. In 1970, there was approximately an equal number of people living in extreme poverty as there were people not living in extreme poverty. By 2015, the vast majority of people had been lifted out of extreme poverty — a significant portion of which took place in China.
Unquestionably, this is an achievement worth celebrating, as the vast majority of human history has been characterized by scarcity and negligible income growth — such figures are merely educated guesses.
Alongside the decline in global poverty has been the steady, unequal rise in GDP per capita across the globe. This is simply another lens by which to see the global elevation of living standards and poverty reduction — higher GDP per capita generally equates to lower rates of poverty. That is, however, not to say that high GDP per capita nations have solved poverty. In fact, it is an economic condition the wealthiest of nations have failed to eradicate.
The Decline of Poverty in the West
As most know, the wealthiest nations of the world lie in Western Europe and the Western Offshoots, for various reasons — ideas, luck, geography, imperialism, colonialism, etc. It is for these reasons that we see the high standard of living in the Western World. Yet, not everyone in these nations has benefited in the same fashion. In OECD countries, the average income of the top 10 percent is approximately nine times greater than the average income of the bottom 10 percent. In the United States and Mexico, this number rises to 14 times and 25 times larger, respectively. While extreme poverty in many western nations is not statistically different from zero — this is not the equivalent of zero — non-extreme poverty remains a common sight.
Official estimates of the rate of poverty in the United States stand at 10.5 percent in 2019 (pre-pandemic). This stands as the fifth consecutive annual decline of the poverty rate, which has likely risen since. Notably, the rate of poverty has steadily declined in the U.S. — occasionally deviating from this trend during periods of recession. In the U.S., the poverty threshold is approximately 36 percent of the median disposable income for a single-person household in 2019. However, Relative poverty is generally defined as between 40 and 60 percent of the median disposable income. Applying a level at 50 percent of median income across the countries of interest will present a slightly better view of poverty, albeit imperfect as economic conditions will vary between nations.
After applying this new threshold, the U.S. poverty rate stands at 18.2 percent — higher than any Western European nation — and has remained virtually unchanged for decades. As for Western Europe, poverty rates have fluctuated over the last two decades with a slight upward trend. While extreme poverty has been minimized to near zero percent of the population, relative poverty has yet to undergo the same fate.
Why did the West Progress More Quickly?
It is no secret that the Western World has economically and socially progressed more quickly in certain areas than the rest of the world. Specifically, the West enjoys low rates of extreme poverty while the rest of the world is only now catching up or still in the process of its elimination. The West is also more accepting of the LGBTQ+ community and women have more opportunities to succeed and enjoy life — that is not to say life is perfect for either. Economically speaking, why has the West outpaced the rest of the world thus far?
This isn’t an easy question to answer and it’s not the focus of this article, so I will only discuss it briefly, but colonialism and imperialism (of which I have found little research, possibly because they are similar concepts and/or difficult to study) play a significant hand in the development of the West with heterogeneous effects. With respect to colonialism, the primary factor that determines the success — from the view of the colonizer — or failure of the colony is the institutions the colonizers bring with them and establish and the ratio of European settlers to native inhabitants. Imperialism, state policy, practice, or advocacy of extending power and dominion, especially by direct territorial acquisition or by gaining political and economic control of other areas. Such behavior by imperialists towards other nations is beneficial to the imperialist in most instances.
It’s not so simple determining why the West has progressed more quickly than the rest of the world. The West may have simply gotten a head start due to chance.
Productivity and Inequality
Labor productivity has nearly doubled since 1987, while the wage share of income has declined from more than 2 percent during the same period or greater than 4 percent since 2001. Rising labor productivity should translate to rising wages and potentially a rising wage share. However, this is clearly not the case as one will find that the relationship is not statistically significant. So, what is actually going on? What variable explains the declining wage share? A few possibilities come to mind: the decline of unions and persistent unemployment.
The decline of the ratio of unionized workers may explain the falling wage share through an accompanying decline in collective bargaining. Without collective bargaining the relative power of workers to employers falls, diminishing their capacity to negotiate higher wages. The potential consequence of this new employee-employer relationship is downward pressure on real wages and rising inequality and poverty.
Persistent unemployment is associated with lower real wages as depicted by the figure below — COVID data were excluded. While this relationship explains the U.S. data rather well at low to medium rates of unemployment, it breaks down at high unemployment. John Maynard Keynes may provide some insight into this phenomenon, which he refers to as wage-stickiness. The concept is self-explanatory, after an economic shock, wages may take time to respond to the prevailing conditions. Markets take time to adjust to new economic conditions, the labor market is no different. The Great Recession forced jobless claims to skyrocket (although it is nothing compared to the COVID recession) while real weekly wages were still on the rise and did not fall until the recession was technically over and unemployment began to fall again.
“But what does this have to do with poverty?” Productivity growth should be the great force that raises the impoverished to a greater standard of living, yet it has failed to do so in recent years. Full employment — not entirely distinct from productivity growth — is similarly another force that can reduce poverty and raise the labor share of income — this has yet to succeed as full employment remains elusive. Productivity growth has been rather sluggish for the past decade, which may partially explain rising inequality and the lack of progress towards poverty eradication. It is quite possible the mechanism at work is a combination of behavioral, social, and political factors keeping poverty alive and well.
Conflict in the Economy
Why does poverty continue to persist in an economy characterized by an abundance of wealth? The answer may be revealed through a dive into political economy and understanding relations of power in the economy. Let’s consider an economy with two classes, for simplicity: workers and capitalists.
The workers in this economy earn income strictly by selling their labor — through their wages. The capitalists earn their income strictly through profit. Again, this is done for simplicity. An individual in each class consists of a set of interests and incentives which guide the behaviors of both workers and capitalists. Workers will have a common interest in increasing their wages, which translates to a class-wide interest in increasing the labor share of income. On the other hand, capitalists have a common interest in increasing their profits, which corresponds to a class-wide interest in increasing the profit/capital share of income. Note that all workers in this economy have a higher propensity to consume than capitalists.
The interests of the workers and capitalists in this simplified economy are diametrically opposed to each other. Both classes want to lay claim to a greater share of income and improve their position relative to the other class. Say the relative position of the workers declines and the capitalist position rises, what does this mean for our economy? If the wage share is declining profits may also decline, but by a lesser magnitude as workers will continue to spend a significant portion of their income. This leaves workers at a disadvantage as many may be unemployed and forced to compete with each other in an economy characterized by profit-led growth, rather than wage-led growth.
The position capitalists hold relative to the workers is one characterized by power over the latter and outsized influence over the policy direction of the State. This sort of, albeit simplified, model of class conflict may partially present a mechanism by which poverty persists, but also how it may be eliminated.
The Wage-Led Demand Regime
A clear-cut and simple means by which to reduce poverty is a wage hike. Specifically, an economy, successfully, pursuing full employment in which firms must increasingly compete with one another for a scarce resource: workers. An economy is in a state of full employment when labor resources are fully utilized in the most efficient way, which is not to say unemployment is strictly zero. Full employment need not necessitate the elimination of structural and frictional unemployment, rather it requires cyclical unemployment to be zero. How are firms to attract scarce workers? By setting wages above that of their competitor’s. A tight labor market will require firms to set wages such that their demand for labor is satisfied (see Kaleckian Labor Market).
For an economy to be running at full speed for an indefinite period of time is probably unlikely. Until economists find a cure for the business cycle, a daunting and unlikely task, supplemental income will be necessary for the jobless -- including those that cannot work. An automatic stabilizer, such as unemployment insurance, activated during an economic downturn will broaden the scope and effectiveness of the Welfare State in stabilizing the economy such that it can return to a state of full employment more quickly than without it. How does full employment relate to a wage-led demand regime?
It’s rather straightforward, a fully employed labor market places upward pressure on wages, this increases the disposable income available to workers and shifts the demand curve outward. The growing income for workers translates directly to growing profits. The question is, which one grows faster? Wages! The result is an expanding wage share relative to the position of capital. What are the implications of this economic state? The effects of a rising wage share lead to rising demand as a result of increased consumption and accelerating productivity growth through labor-saving induced technical change. These rising variables contribute to an expanding economy.
“Why is this preferred to a profit-led demand regime?” Let’s return to our simplified economy and assume that it is profit-led, what does this entail? First, let’s remember that capitalists have a propensity to consume that is strictly less than that of their laboring counterparts — for them to be capitalists this is necessary. Economic expansion led by those who spend proportionately less than laborers and who comprise an increasing share of national income logically leads to depressed growth and possibly stagnation.
Therefore, an economy in a state of wage-led demand increases the wage share of national income and those benefiting are laborers with a high propensity to consume, generating an economic expansion greater than that of a profit-led demand regime. Not only is this arrangement clearly significant for laborers, but as the tax base of any given nation increases, so does it become significant for those that cannot work, resulting in an expansion of the Welfare State and the reduction of non-workforce poverty. In other words, reversing the retreat of the State will have an expansionary effect as demand fuels the economy and the distributional position of the workers is improved.
Some of you may have noted an important caveat to this growth regime: inflation. As the labor market tightens demand rises and, according to the laws of supply and demand, so do prices. If the minimum wage rises to $15/hour will your Big Mac cost $15? What do you think? If any given wage increase was accompanied by an equal price increase real wages would have remained constant across the decades and the standard of living enjoyed by many nations today would be an impossibility, but I assume most of you don’t have terminal econ 101-ism. Is that to say real wages cannot decline? Absolutely not, inflation can and has evaded the instruments of central banks, specifically the 1970s which unraveled the post-WWII Keynesian approach to managing the economy. As long as real wage growth can be sustained, there is little need to worry.
How can we achieve this mystical wage hike? There are a few means by which to accomplish this. The first that comes to mind is a minimum wage increase. Doubling the minimum wage overnight might not be the best idea if you want to avoid the kind of inflation that plagued the 70s, but gradually increasing the minimum wage year-over-year and pegging it to the growth of some value like the median or mean wage may phase in a wage-led demand regime. Another means by which to achieve wage growth is the legislation of pro-labor union policies, such as the implementation of sectoral bargaining rights. This will give workers the power to bargain for higher wages for a broader segment of the workforce, rather than bargain with firms individually. These policies can increase the wage share, decrease inequality, reduce poverty, and foster economic prosperity.
Honestly, reducing poverty is rather simple: treat labor like an asset, not a cost to be minimized.
“The ideas which are here expressed so laboriously are extremely simple and should be obvious. The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.” ~ John Maynard Keynes