ExplainSpeaking: What India must not learn from the US

However, there are some policy choices that India should not learn from the US. One of them has to do with how to stop poverty spreading from one generation to another. That’s because even though the US is the world’s biggest economy and has the highest per capita income — and should, as such, be India’s policy guide on how to become a richer country at a time when PM Modi has resolved to make India a developed country in the next 25 years — new research shows that US fairs pretty poorly on alleviating intergenerational poverty when compared to other rich countries.

Intergenerational poverty essentially refers to the likelihood of kids growing up in poverty ending up as adults living in poverty. There is overwhelming evidence to suggest that children exposed to poverty are more likely — as against kids with no exposure to poverty — to end up poor even in their adult life. But it is also true that this “persistence” of poverty from one generation to another is weaker if a country is richer.

Of course, in any country or economy that grows fast, one would expect that this likelihood would become weaker and weaker as the time goes by. In rich countries, as against poor countries, this likelihood should be lower.

However, even within the rich countries, there must be a gradation — and it would tell us much about different rich economies such as the US.

According to a new research paper, titled “The Intergenerational Persistence of Poverty in High-Income Countries” and published by IZA Institute of Labor Economics, the intergenerational persistence of poverty is notably stronger in the US relative to other high-income countries.

“Spending one’s entire childhood in poverty in the US is associated with a 43 percentage point increase in the mean poverty rate in early adulthood (ages 25 to 35),” states the study done by Zachary Parolin, Rafael Pintro Schmitt, Gøsta Esping-Andersen (all three associated with Bocconi University) and Peter Fallesen (Rockwool Foundation and Stockholm University).

The TABLE alongside captures the findings.

Column 1 of Table shows that the intergenerational persistence of poverty is 0.43 in the US. According to the authors, this indicates that if a child spent all his childhood in poverty in the US, he is more likely to also be a poor adult. To be precise, he is 43 percentage points more likely than a child with no poverty exposure.

When compared to other rich countries, this level of likelihood is quite high. “This is four times stronger than in Denmark and Germany, and more than twice as strong as in Australia and the UK,” they state.

Counter-intuitive as it may be, this finding — that a poor child in the US is far more likely to stay poor when he grows up than a poor child in other rich countries — is not where the key lesson lies for India.

What India needs to learn (or not learn) from US’s policy choices is in the second finding of the paper. The researchers also probed the question: What explains the higher persistence of intergenerational poverty in the US relative to the other rich countries?

Of course, a poor child may grow to be a poor adult for a variety of reasons.

For instance, he may not get a decent education because his parents did not have enough money to meet both everyday consumption as well as educational needs.

Similarly, it could also be that some families, even though they have the same resources or resource constraints, tend to value education more than others. Some parents may value consumption and leisure more than investments into their children.

Then the place where a kid grows up could also play a crucial role. Some neighbourhoods or areas are particularly disadvantaged and it is difficult to break free from that.

Similarly, the ability or inability of attaining an educational degree and the chances of such degrees helping one beat poverty are also crucial factors in determining which kid is able to beat the odds. These bunch of factors are called the mediation effect.

But beyond all these factors is a policy factor as well and it refers to the role of taxes and money transfers from the government. The authors state that direct income transfers from the government are considered among the most powerful interventions in addressing poverty and inequality.

When the authors broke down all these reasons, this is what they found: “The US’s comparative disadvantage is not driven by family background effects or mediation effects; instead, the US disadvantage has its roots in weaker tax/transfer insurance effects and a stronger residual poverty penalty. While Denmark and the UK use taxes/transfers to reduce their intergenerational persistence of poverty by 10 and 16 percentage points, respectively, the US reduction is merely 2 percentage points through taxes/transfers.”

This is shown in the CHART where the persistence of intergenerational poverty (black bar) is shown next to the factors that explain it. In all countries, the effect of government taxation and transfer policies (blue bar) has an effect to bring down this persistence of poverty. But this effect is weakest in the US and considerably so.

The authors conclude that the higher persistence of intergenerational poverty in the US is primarily due to the comparatively weak welfare state of the US. They argue that if the US government used its taxations and transfers in the manner that the UK uses, it would have brought down the persistence by one-third from the current levels.

Upshot?

For a very long time, the US has been held up as an example of how an economy should grow. To a great extent this has been justified by its long record of robust economic growth. But at the same time, the US has also witnessed rising inequalities. The high persistence of intergenerational poverty is just another example of what ails with US policy choices.

For India, which is already the country with the most number of people living in abject poverty as well as one of the most unequal nations on the planet, the US may be a poor role model when it comes to breaking the shackles of poverty. If India does not actively use its taxation and expenditure policies in a way that reduces the persistence of poverty, it will witness a further worsening of inequalities in the society.

Until tomorrow,

Udit