What is Poverty Trap

The poverty trap is a mechanism, which makes it very difficult for people to escape poverty. A poverty trap is created when an economic system requires a significant amount of various forms 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.

BREAKING DOWN Poverty Trap

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.

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.

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.