Poverty Trap: Definition, Causes, and Proposed Solutions

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 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 healthcare, 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 helps to explain why certain aid programs that 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, 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. 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 Florida in Gainesville 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.

The Public and Private Role in Addressing the Poverty Trap

In his book The End of Poverty: Economic Possibilities for Our Time, Jeffrey Sachs recommends that, as a way of combating the poverty trap, aid agencies should function as venture capitalists that fund startup companies.

Sachs proposes that, just like any other startup, developing nations should receive the full amount of aid necessary for them to begin to reverse the poverty trap. He points out that the extremely poor lack six major kinds of capital: human capital, business capital, infrastructure, natural capital, public institutional capital, and knowledge capital.

Sachs added in his book:

"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 postulates that the public sector should concentrate its efforts on investing 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
• Parts of knowledge capital—scientific research for health, energy, agriculture, climate, ecology

Business capital investments, Sachs says, should be the domain of the private sector, which he claims would more efficiently use the 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, made up of parents and two children who are below legal working age. The family has an annual income of $24,000, with the parents working 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 $27,750.

In a simple case, let us assume that the 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, 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 the home. The extra hours also mean that the parents will not have the 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 lives in one of the most dangerous neighborhoods in the city and does not have access to proper healthcare facilities. In turn, crime or susceptibility to disease could drive up their average monthly spending, making an increase in the family's income effectively useless.

Real-World Example

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 the country's government with reducing the measurement threshold in order to make Rwanda rate better on poverty statistics.