What is a Poverty Trap?

A poverty trap is a mechanism that makes it very difficult for people to escape poverty. A poverty trap is created when an economic system requires a significant amount of capital in order to earn enough to escape poverty. When individuals lack this capital, they may also find it difficult to acquire it, creating a self-reinforcing cycle of poverty.

Understanding Poverty Traps

Many factors contribute to creating a poverty trap, including: limited access to credit and capital markets, extreme environmental degradation (which depletes agricultural production potential), corrupt governance, capital flight, poor education systems, disease ecology, lack of public health care, war and poor infrastructure.

In order to escape the poverty trap, it is argued that individuals in poverty must be given sufficient aid so that they can acquire the critical mass of capital necessary to raise themselves out of poverty. This theory of poverty helps to explain why certain aid programs which do not provide a high enough level of support may be ineffective at raising individuals from poverty. If those in poverty do not acquire the critical mass of capital, then they will simply remain dependent on aid indefinitely and regress if aid is ended.

Recent research has increasingly focused on the role of other factors, such as healthcare, in sustaining the poverty trap for a society. A 2013 paper by researchers at the National Bureau of Economic Research (NBER) found that countries with poorer health conditions tend to be mired in a cycle of poverty as compared to others with similar educational attainments. Researchers at the University of Gainesville in Florida collected economic and disease data from 83 of the world's least and most developed countries. They found that people living in areas with limited human, animal, and crop disease were able to lift themselves out of the poverty trap as compared to people who lived in areas with rampant disease.

In his book The End of Poverty, Jeffrey Sachs recommends that, as a way of combating the poverty trap, aid agencies should function as venture capitalists that fund start-up companies. Sachs proposes that, just like any other start-up, developing nations should receive the full amount of aid necessary for them to begin to reverse the poverty trap. 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 details that point of view:

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.

Key Takeaways

  • Poverty trap refers to an economic system in which it is difficult to escape poverty.
  • A poverty trap is not merely the absence of economic means. It is created due to a mix of factors, such as access to education and healthcare, working together to keep an individual or family in poverty.
  • Noted economist Jeffrey Sachs has made the case that public and private investments need to work in concert to eradicate the poverty trap.

The Public and Private Role in Addressing the Poverty Trap

Sachs further postulates that the public sector should concentrate their efforts on investments of 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). Business capital investments, he says, should be the domain of the private sector, which Sachs claims would more efficiently use funding to develop the profitable enterprises necessary to sustain growth enough to lift an entire population and culture out of poverty.

Example of a Poverty Trap

One of the most important considerations in studying the poverty trap is the amount of government aid necessary to lift a family out of their present conditions.

Consider the case of a family of four, parents and two kids who are below legal working age, with an annual income of $25,000. The parents work in jobs that pay $10 per hour. According to the latest federal poverty guidelines, a family of four is considered to be poor if its income is less than $25,750.

In a simple case, let us assume that government begins handing out aid amounting to $1,000 per month. This raises the family's annual income to $36,000. While it is capped at $1,000, the government aid decreases in proportion to increases in the family's income. For example, if the family's earnings increase by $500 to $2500 per month, then government aid reduces by $500. The parents would have to work an extra 50 hours in order to make up for the shortfall.

The increase in working hours comes at an opportunity and leisure cost to the parents. For example, they might end up spending less time with their children or may have to hire babysitters for the time that they are out of home. The extra hours also means that the parents will also not have leisure to upgrade their skill sets for a better paying job.

The aid amount also does not take into account living conditions for the family. Because they are poor, the family live in one of the most dangerous neighborhoods of the city and do not have access to proper healthcare facilities. In turn, crime or susceptibility to disease could drive up their average monthly spends, making an increase in their income effectively useless.

In the real world, the case of Rwanda, a country wracked by genocide and civil war until recently, is often held up as an example of a nation that tackled the poverty trap by identifying factors beyond income. The African country focused on healthcare and insurance to increase the average daily calorie intake. However, certain researchers charge its government with reducing the measurement threshold for a successful demonstration.