Explaining the fine line between absolute and relative poverty

Poverty is a topic that occasionally makes headlines in the newspapers and attracts a variety of commentators.

In a lot of these discussions reference is made to the poverty line as a measure of the extent of poverty in society. The poverty line is used in two senses: to denote absolute poverty and relative poverty.

One of the Millennium Development Goals of the United Nations was to reduce the number of people in the world that are living in extreme poverty and hunger. The underlying conception was absolute poverty, defined operationally as living on less than US$1 a day (later raised to $1.50).

The purpose of this measure is to promote economic development in countries with large concentrations of poor populations, and lift them out of absolute poverty.

The most successful achievement of economic globalisation of the past few decades has been to pull 600 million people in the Third World out of dire poverty, with the largest gains concentrated in six countries: China, South Korea, India, Poland, Indonesia and Thailand.

The backlash against global economic integration today is because this success has not been shared with most of the rich world, where many countries have embraced a different notion of poverty, that of relative poverty.

Relative poverty is operationally defined as a fraction (often one half) of the median level of household income in a given society.

The relative poverty concept has a long history, beginning with Adam Smith and including Milton Friedman. It has only subsequently been adopted by the United Nations, the Organisation for Economic Cooperation and Development, Canada and the European Union.

The problem with drawing the line of poverty like this is that it defines income as current income.

Current income is not tightly correlated with economic well-being. Incomes fluctuate over the business cycle, vary with the lifecycle, are systematically not accurately reported, and many people have no income because they are retired, unemployed or self-employed at the moment.

Research from the US has shown that 73 per cent of the population will spend a year during their lifetime in the top 20 per cent of the income distribution, and about 40 per cent will spend a year in the bottom 20 per cent. For this reason, many whose current incomes are below the poverty line are not truly poor in a lifetime sense.

Most societies have programmes that transfer cash and non-cash benefits to the poor. For example in 2015, 19.7 per cent of the population in Hong Kong was said to be below the poverty line, but after factoring cash transfers the percentage fell to 14.3 per cent, and if both cash and in-kind transfers were factored in it fell to 9.9 per cent.

I would not be surprised if a substantial proportion of the recipients of cash and in-kind transfers were not below the poverty line. For example, almost a third of the population in Hong Kong lives in public rental housing, which is the most important in-kind transfer, yet only 19.7 per cent of people live below the poverty line.

This means society either spends a lot of housing resources on helping people who are not below the poverty line or the poverty line is wrong. The same is likely to be true of many other programmes that society is now funding.

Let me make one important point here. The issue is not errors in calculation. I happen to believe government statisticians have done a careful and outstanding job analysing the data.

Rather, it is the difficulty of reducing poverty into a statistic based on current income.

A rapidly ageing society like Hong Kong will in the coming decades have a higher rate of measured relative poverty using the poverty line measure.

This is purely a statistical artifact of the rising number of retired households that have no reported income but are not necessarily without support or assets.

The poverty problem in Hong Kong is mostly one of near poverty rather than poverty. It is the problem faced by households that want to rise to a level of income security that would allow them to provide a quality education for their children, afford quality health care when it is needed, and own their home to protect the lifetime purchasing power of their hard-earned savings.

Alleviating relative poverty in rich countries has proven to be a difficult task and will not be made easier by the poverty line contraption.

The greatest concern in applying the poverty line concept in Hong Kong is not only that it exaggerates the extent of poverty, but that it detracts from the task of alleviating near poverty and recognising it as the true menace – the menace of the sinking middle class.

This is afflicting all rich societies. I hope we can gain the wisdom to stop fighting today’s challenge with yesterday’s failed policy tools.

Richard Wong is the Philip Wong Kennedy Wong Professor in Political Economy at the University of Hong Kong