Poverty trap

Poverty Trap – poverty trap is a scenario where people experience poverty due to circumstances beyond their control. The trap becomes cyclical and begins to reinforce itself if steps are not taken to break the cycle. Depending upon a person’s origin of birth, they may find themselves financially stable their entire lives, or at the other extreme, they may find themselves born into severe poverty that seems utterly inescapable. Many factors contribute to a poverty trap, and these factors vary from case to case. Some of the possible factors include: limited access to credit and capital markets, extreme environmental degradation (which depletes an areas agricultural production potential), corrupt governance, capital flight, poor education systems, lack of public health care, war, poor infrastructure, etcetera.

Jeffrey Sachs and "The End of Poverty"

Jeffrey Sachs, in his book The End of Poverty, discusses the poverty trap and prescribes a set of policy initiatives intended to end the trap. His policy prescriptions recommend that aid agencies behave as venture capitalists funding start-up companies. Venture capitalists, once they choose to invest in a venture, do not give only half or a third of the amount they feel the venture needs in order to become profitable; if they did, their money would be wasted. If all goes as planned, the venture will eventually become profitable and the venture capitalist will experience an adequate rate of return on investment. Likewise, Sachs proposes, developed countries cannot give only a fraction of what is needed in aid and expect to reverse the poverty trap in Africa. Just like any other start-up, developing nations absolutely must receive the amount of aid necessary (and promised at the G-8 Summit in 2005 [Collier, Paul et al. “Flight Capital as a Portfolio Choice. “ Development Research Group, World Bank.] ) for them to begin to reverse the poverty trap. The problem is that unlike start-ups, which simply go bankrupt if they fail to receive funding, in Africa people continue to die at an exponential rate due in large part to lack of sufficient aid.

Sachs points out that the extreme poor lack six major kinds of capital: human capital, business capital, infrastructure, natural capital, public institutional capital, and knowledge capital. [Sachs, Jeffrey D. The End of Poverty. Penguin Books, 2006. Pg. 244] He then details the poverty tr

The poor start with a very low level of capital per person, and then find themselves trapped in poverty because the ratio of capital per person actually falls from generation to generation. The amount of capital per person declines when the population is growing faster than capital is being accumulated….the question for growth in per capita income is whether the net capital accumulation is large enough to keep up with population growth.

Sachs argues that sufficient foreign aid can make up for the lack of capital in poor countries, maintaining that, “If the foreign assistance is substantial enough, and lasts long enough, the capital stock rises sufficiently to lift households above subsistence.”

Sachs believes the public sector should focus mainly on investments in human capital (health, education, nutrition), infrastructure (roads, power, water and sanitation, environmental conservation), natural capital (conservation of biodiversity and ecosystems), public institutional capital (a well-run public administration, judicial system, police force), and parts of knowledge capital (scientific research for health, energy, agriculture, climate, ecology). [Sachs, Jeffrey D. The End of Poverty. Penguin Books, 2006. Pg. 252] Sachs leaves business capital investments to the private sector, which would more efficiently use funding to develop the profitable enterprises necessary to sustain growth. In this sense, Sachs views public institutions as useful in providing the public goods necessary to begin the Rostovian take-off model, but maintains that private goods are more efficiently produced and distributed by private enterprise. This is a widespread view in neoclassical economics.

References

*"The Joint conference of African Ministers of Finance and Ministers of Economic Development and Planning Report." May, 1999, Addis Ababa, Ethiopia. www. uneca.org/eca_resources/Major_ECA_Website/joint/capital.htm
*Ajayi, S. Ibi $ Mahsin, S. Khan. "External Debt and Capital Flight in Sub-Saharan Africa." IMF, 2000. www.imf.or/external/pubs/nft/2000/extdebt/index.htm.
*Collier, Paul et al. "Flight Capital as a Portfolio Choice." Development Research Group, World Bank.
*Emeagwali, Philip. Interview, "How does capital flight affect the average African?" http://emeagwali.com/interviews/capital-flight/africa.html.
*Sachs, Jeffrey D. "The End of Poverty". Penguin Books, 2006.