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Defining Welfare Measures

How to measure poverty:

Define welfare measures

Choose and estimate a poverty indicator
This site focuses mainly on the monetary dimensions of well-being, income and consumption. In particular, this section concentrates on quantitative, objective measures of poverty. Other measures exist, in particular covering non-monetary dimensions (health, education, assets, etc.), subjective measures and qualitative measures (see Types of Data).

Monetary dimensions of poverty

When estimating monetary measures of poverty, one may have a choice between using income or consumption as the indicator of well-being. Most analysts argue that provided the information on consumption obtained from a household survey is detailed enough, consumption will be a better indicator for poverty measurement than income for the following reasons:

  • Consumption is a better outcome indicator than income: Actual consumption is more closely related to a person’s well-being in the sense of having enough to meet current basic needs. Income is only one of the elements which will allow consumption of goods (others include questions of access, availability, etc.).
  • Consumption may be better measured than income: In poor agrarian economies and in urban economies with large informal sectors, income flows may be erratic and fluctuate during the year. For farmers, one added difficulty in estimating income consists in excluding the inputs purchased for agricultural production from the farmer’s revenues. Finally, large shares of income are not monetized if households consume their own production or exchange it for some other goods, and it might be difficult to price these. Estimating consumption has its own difficulties, but it may be more reliable if the consumption module in the household survey has been well designed.
  • Consumption may better reflect a household’s ability to meet basic needs: Consumption expenditures reflect not only the goods and services that a household can command based on its current income, but also whether that household can access credit markets or household savings at times when current income is low or even negative, due perhaps to seasonal variation or harvest failure. Consumption can therefore provide a better picture of actual standards of living than current income, especially when income fluctuates a lot.

One should not be dogmatic about the use of consumption data for poverty measurement, however. Using income may have its own advantages, for example, by allowing to distinguish by income sources when analyzing poverty. When this is available, income can also be compared more easily to data from other sources, such as wages, which provides a check for the quality of the data in the household survey. Finally, in some surveys, consumption or expenditure might simply not be collected.

When both income and consumption are available, the analyst might want to compute poverty measures with both indicators and compare the results. A simple way of testing the sensitivity of the results to the choice of consumption or income (or to any other choice) consists in computing a transition matrix. To construct this matrix, one divides the population into a number of groups -- for example, ten deciles, with each of them representing ten percent of the population, from the poorest ten percent to the richest ten percent. Each household belongs to only one decile for each indicator, but some households may belong to one decile for income, and another for consumption, in which case many households would not belong to the diagonal of the matrix. Since income and consumption capture different aspects of poverty, the matrix might show that household ranking is affected by the definitions, which can in turn inform on other aspects of well-being (such as the ability of households to smooth consumption, see Hentschel and Lanjouw 1996 for an illustration).

Whether one chooses income or consumption, it is typically necessary to aggregate information provided at the household or individual level for many sources of income or consumption in the survey. This aggregation is a complex process. Some adjustments might be necessary to ensure the aggregation process leads to the desired measures. However, most adjustments do require access to good information (in particular on prices), which might not be available. Complicated adjustments might also limit the understanding some users will have of the poverty analysis, and the use they will be able to make of it. Basic guidelines for aggregation are as follows (for a complete discussion of the construction of consumption aggregates, please see Deaton and Zaidi 2002 in English or in Russian).

Adjust for differences in needs between households and intra-household inequalities: Households of different size and composition have different needs, and it is not easy to reflect these differences in needs in poverty measures. Two crucial decisions need to be made. First, should adjustments be made to reflect the age of the household members—adults and children—and perhaps their gender? Second, should households of different sizes be treated differently, to reflect the fact that larger households may be able to purchase goods in bulk at cheaper rates and to economize on the purchase of some products, especially consumer durables? Using equivalence scales and adjusting for economies of scales can address this issue.

Adjust for differences in prices across regions and at different points in time: the cost of basic needs might vary between areas and over time. Nominal expenditures or incomes need to be made comparable in spatial terms, by adjusting for different price levels in different parts of the country. The more diverse and vast a country, the more important spatial adjustments will be. Adjustments are also sometimes needed over time, sometimes within a given survey, if inflation is significant during data the collection period itself.

Exclude input and investment expenditure: Care must be taken not to interpret spending that is made for inputs into household production—such as outlays for tools or other inputs such as fertilizer, water, or seed in agricultural production—as spending for consumption or as income. This would overstate the actual welfare levels achieved by households.

Impute missing price and quantity information: Not all households provide information on the various income or consumption sources available in a survey. In the case of consumption, when information is lacking regarding the amounts and prices of the goods that are known to be consumed by the household, these data may need to be estimated (imputed). One of the most common imputations is for owner-occupied housing.

Adjust for rationing: When using consumption, even if prices are available for each household in the survey, markets may be rationed. There may be restrictions on the quantities available for purchase although prices are kept at a set level—for example for public water or electricity services. In such cases, if is sometimes possible to estimate the shadow price of the goods consumed.

Check whether adjustments for under-reporting can be made: In some regions, it is a common practice to adjust income or consumption for underreporting. There is a presumption of underreporting when the mean income (or consumption) in the surveys is below what is suggested in the disposable income or private consumption information as available in the National Accounts aggregates. Underreporting tends to be more severe when poverty measures are based on income. Before adjusting household income or consumption estimates for underreporting, however, a careful examination of the reliability of the national accounts data is necessary.

Non-monetary dimensions of poverty

Poverty is associated not only to insufficient income or consumption, but also to insufficient outcomes with respect to health, nutrition and literacy, to deficient social relations, to insecurity, and to low self-confidence and powerlessness. In some cases, it is feasible to apply the tools developed for monetary poverty measurement to non-monetary indicators of well-being. The requirement for being able to apply the tools of poverty measurement to non-monetary indicators is that it must be feasible to compare the value of the non-monetary indicator for a given individual or household to a threshold or “poverty line” under which it can be said that the individual or household is not able to meet its basic needs. A few examples of dimensions of well-being for which the techniques could be used include:

Health and nutrition poverty: One could focus on the nutritional status of children as a measure of outcome, as well as on the incidence of specific diseases (diarrhea, malaria, respiratory diseases) or life expectancy for different groups within the population.

Education poverty: One could use the level of literacy as the defining characteristic, and some level judged as the threshold for illiteracy as the “poverty line”. In countries where literacy is close to universal, one might opt for specific test scores in schools or for years of education as the relevant indicators.

Composite indices of wealth: An alternative to using a single dimension of poverty could be to combine the information on different aspects of poverty. One might want to create a measure which takes income, health, assets and education into account. It is important to note that a major limitation of composite indices is that it is not possible to define a ‘poverty line’. Analysis by quintile or other percentile remains possible, though, and can provide important insights in the profile of poverty.

Subjective perceptions: Such measures of poverty are based on questions to households about 1) their perceived situation, such as ‘do you have enough?’, ‘do you consider your income to be very low, rather low, sufficient, rather high, or high?’, 2) a judgment about minimum standards and needs, such as ‘what is the minimum amount necessary for a family of two adults and three children to get by?’ or ‘what is the minimum necessary for your family?’, or 3) poverty rankings in the community, such as ‘which groups are most vulnerable in the village?’. On the basis of the answers, one can also derive poverty lines. Self-reported measures have important limitations, however. They might reproduce existing discrimination or exclusion patterns, if these patterns are perceived as 'normal' in the society. More generally, the observed perceptions of poverty need not provide a good basis to establish priority public actions. This may be the case if policy makers have a different time horizon and/or a different focus than the population.

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