Growth and Development in the Presence of Absolute Poverty

Abstract

The propositions inherent in the one-sector design of the neoclassical growth model are incompatible with the realities of countries where the coexistence of poverty-free households with others who are living in absolute poverty is a persistent phenomenon. This paper introduces a novel two-sector general equilibrium model to describe growth and development in the presence of continuing differences in the conditions of production and consumption, which is a typical developing country feature. The model consists of a poverty-free neoclassical modern sector where all capital is concentrated, and of a poverty-stricken informal sector that exclusively relies on own labour and does not profit from technological progress. In this setting, net output and employment in both sectors evolve along steady-state trajectories: In the modern sector driven by modern sector job-creating net investment, and in the informal sector by the endogenous interplay of the withdrawal of workers due to modern sector job creation and of labour force growth. This interplay implies structural transformation of employment and net output that brings about a new growth-to-poverty nexus and endogenous growth or decay of total net output per average worker. Growth proves to be exclusive as it affects only those workers that – due to structural transformation – switch sectors. The paper shows that success or failure in reducing absolute poverty and in increasing the total labour productivity depends on the direction of structural transformation and on the modern sector’s relative size a country displays at the time of observation. This is why divergence rules in developing economies.

Keywords: Growth and Development, Two-sector general equilibrium model, Endogenous growth and divergence, Poverty, Persistent sectoral differences in productivity and pay, structural transformation