On Inequality Comparisons

Is one distribution (of income, consumption, or some other economic variable) among families or individuals more or less equal in relative terms to another? Despite the seeming straightforwardness of this question, there has been and continues to be considerable debate over how to go about finding the answer. There are two points of contention. One is the issue of cardinality vs. ordinality. Practitioners of the cardinal approach compare distributions by means of summary measures such as a Gini coefficient, variance of logarithms, and the like. Accordingly, some researchers prefer an ordinal approach, adopting Lorenz domination as their criterion.

Changes over Time in Individual Countries

Of the world’s 6.7 billion people (as of 2008), 1.3 billion lived on less than $1.25 Purchasing Power Parity dollars per person per day and another 1.7 billion lived on between $1.25 and $2.50 PPP dollars. The scourge of absolute economic misery among billions of the world’s people is one of the most serious problems facing humankind today. Unemployment (defined below) befalls about 200 million of the world’s people - a sizeable number but small compared to the three billion people who are poor using the $2.50 PPP dollar poverty line. A much larger number – 900 million – are employed but earning so little that they and their families are unable to reach even $2 per person per day. They are working hard and they are the working poor. To achieve more and better employment (where “better” depends on such factors as rate of pay, job security, employment protections, and type of work), analysts and donors need to understand better how employment, growth, poverty, and other factors interact, how unemployment is caused, and how employment can be improved. At the same time, drawing on practical experience, research can identify knowledge gaps that to date pose limits to successful employment creation policy.

A Welfare Economic Analysis of Labor Market Policies in the Harris-Todaro Model

This chapter presents a welfare economic analysis of the benefits of various labor market policies in the Harris-Todaro labor market model. The policies considered are a policy of modern sector job creation, called modern sector enlargement (MSENL); a policy of rural development, called traditional sector enrichment (TSENR); and a policy of wage limitation in the urban economy, called modern sector wage restraint (MSWR). First, the inequality effects of these policies are analyzed. Then two welfare economic analyses are performed, the first based on summary measures of labor market conditions (total labor earnings, unemployment, inequality of labor incomes, and poverty rates) and the second based on dominance analysis in the labor market, in both cases assuming that the costs are borne elsewhere. The results of the welfare analyses are compared, and it is shown that TSENR unambiguously increases welfare in the labor market using both approaches, the other policies yield ambiguous results, and no policy is unambiguously welfare-decreasing.

On-the-Job Search in a Labor Market Model: Ex Ante Choices and Ex Post Outcomes

This chapter builds a multi-sector labor market model including wage dualism, open unemployment, underemployment, on-the-job search, and expected wage equalization. The innovative feature of this model is the distinction between the ex ante allocation of the labor force among search strategies and the ex post allocation of the labor force among labor market outcomes. Among the findings are: more efficient on-the-job search lowers the equilibrium unemployment rate; in a rational expectations equilibrium, the average rural and urban wages will not be equal; modern sector enlargement may leave labor market conditions in one of the sectors unchanged, even when wages and employment in that sector are fully flexible.

Directions for Future Research

Part VII concludes by laying out directions for future research, focusing on three areas. The first is the empirical analysis of the link between growth, employment, and poverty in developing countries. The second is the comparison of methodological approaches to analyze changes in income mobility. And finally, the third area is the challenge of developing better multisector labor market models of developing countries.

Income Mobility

Income mobility means different things to different people. This chapter explains the six different mobility concepts used in the literature, reviews the various indices used in the mobility literature to measure these concepts, summarizes the difference the use of different mobility concepts and measures makes in practice, presents the axiomatic approach to income mobility, and discusses a number of other issues that arise in the mobility literature.

Economic Well-Being

This chapter asks a simple question: When is one income distribution better than another? Here, the “better” society is that into which you would choose to be born, or that which you would choose if you were a social planner. It bears mention that the analytical methods introduced in this chapter apply not only to income distributions but to evaluations of economic states in general.

The Absolute Poverty Approach

“Poverty” has been defined as the inability of an individual or a family to command sufficient resources to satisfy basic needs. The workman who, in Adam Smith’s day, could not appear in public wearing a proper linen shirt, was ipso facto poor, not only to Smith but to Amartya Sen who, commenting on Smith’s observation, wrote: “On the space of the capabilities themselves – the direct constituent of the standard of living – escape from poverty has an absolute requirement, to wit, avoidance of this type of shame. Not so much having equal shame as others, but just not being ashamed, absolutely” (Sen 1984, p. 335). Over time, the poverty line needs to be adjusted for changes in the cost of acquiring the basket of basic needs. When the poverty line is adjusted for inflation and only for inflation, the line defines “absolute poverty.”

Labor Market Modeling and the Urban Informal Sector: Theory and Evidence

The purpose of this chapter is to assess the compatibility between theoretical models of the urban informal sector (UIS) and empirical evidence on the workings of that sector in the context of developing countries’ labour markets. The major point is that, although the UIS is an excellent idea which has served us well in the 1970s and 1980s, there is a need in the next round of research to refine the terminology and the models in light of empirical findings which have come to the fore in the interim. Wage employment or self-employment in small-scale units may be better than or worse than employment in the formal sector. This is not a new point: diversity of earning opportunities and other job characteristics within the informal sector has long been noted. But only recently has this view come to the fore.

Rural-Urban Migration, Urban Unemployment and Underemployment, and Job Search Activity in LDCs

This chapter analyzes unemployment and underemployment in LDCs within a quantity adjustment framework. Four extensions of the Harris-Todaro model are made, including allowances for more generalized job-search behavior, an urban traditional sector, preferential hiring by educational level, and labor turnover considerations. The result of these modifications is a much lower predicted unemployment rate, which accords more closely with actual observations. Some additional policy implications deriving from the analysis are noted.