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April 15,1995

eCONOMIC
GOMMeiMTCIRY
Federal Reserve Bank of Cleveland

Growth and Poverty Revisited
by Elizabeth T. Powers

I

n the 1960s, economic growth seemed
to be the tonic for poverty. From 1960 to
1969, real gross domestic product (GDP)
grew at a 4.1 percent average annual
rate, while the percentage of all persons
in poverty declined at an annualized 5.9
percent. Had the 1960s' relationship
between real GDP growth and poverty
reduction been maintained, the share of
all Americans in poverty, or the "poverty
rate," would have been only 8.2 percent
by 1992. The actual 1992 poverty rate,
however, was nearly twice as large.1
A significantly weaker relationship
between poverty relief and aggregate
growth in the decade following the 1960s
is understandable. In contrast to the long
uninterrupted expansion of the 1960s,
economist Rebecca Blank notes that
"... the thirteen years between 1970 and
1982 contained four business cycles,...
five years of negative GNP growth, and a
rapid increase in both inflation and
unemployment. It is perhaps not surprising that poverty is less responsive to
short and sequential upturns and downturns in the economy."2
What is surprising is the apparent lack of
progress against poverty throughout the
1980s. In a decade that featured one of
the longest peacetime economic expansions in U.S. history, the share of all persons in poverty actually rose moderately.
It appears that the benefits of robust economic growth "trickled down" to the
poor in declining measure.

A more formal economic analysis seems
to confirm these simple findings. During
the 1960s, a 1 percent increase in the
annual growth of real GDP was typically
accompanied by a 0.4 percentage-point
reduction in the poverty rate (see table
1). In the 1970s, however, the effect of
GDP growth on poverty reduction was
slightly more than half that amount, and
this weaker relationship persisted
throughout the 1980s.
What caused the formerly strong correlation between output growth and poverty
reduction to break down? Economists
have offered several plausible explanations, including demographic shifts, policy changes, and increased wage and
income inequality. This Economic Commentary explores each of these notions,
then considers an alternative view: When
poverty is defined based not on annual
income but on what is actually consumed
in a year, there is no discernible break in
the "trickle-down" mechanism.

• Why a Breakdown?
Demographics
A significant demographic shift that
might have affected income poverty
rates in the 1970s and 1980s was the
surge in divorce and out-of-wedlock
births. Because female-headed households typically have the highest poverty
rates of all family types, growth in this
population translates strongly into
poverty growth. By 1989, slightly more
than half of all poor families were
headed by a single woman. The shift
toward more female-headed households

Official poverty rates remained stubbornly high throughout the 1980s
despite a prolonged expansion.
Much has been made of this apparent breakdown in the poor's share of
economic gains. But when poverty is
measured based on consumption
rather than on annual income, a different picture emerges. Comparing
growth in various macroeconomic
indicators with changes in consumption poverty rates reveals no change
in the "trickle-down" mechanism in
the 1980s.

was largely completed by the late 1970s,
however, leaving us without an explanation for the persistence of poverty rates
in the 1980s.
Single women with children may also be
less responsive to changes in overall
labor market conditions. The "feminization" of poverty would thus tend to imply
that the growth solution to poverty is becoming increasingly inappropriate. However, while the share of female-headed
households in poverty was increasing
during the 1960s and 1970s, the representation of the elderly—a group that is
even less responsive to labor-market
changes—was in dramatic decline, partially mitigating this effect. Still, the proportion of the poor accounted for by
these two groups rose from slightly more
than 30 percent to nearly 50 percent from
1959 to 1969, and has hovered around 50
percent since then.

This pattern is consistent with the decreased responsiveness of poverty to
output growth in the 1970s and 1980s.
Even within demographic groups, however, the value of growth as a tonic for
poverty has declined over time.3 This
suggests that the experience of the 1980s
really reflected a fundamental structural
change in the way aggregate growth
translates into individual well-being. It
also implies that aggregate growth
would have become a less effective
poverty-fighting strategy in the 1980s
even in the absence of significant demographic trends.4

Government Transfers
Changes in government transfer policies
(such as Aid to Families with Dependent
Children) appear to be a more promising
explanation. Reforms initiated by the
Reagan administration in 1981 made welfare participation less attractive, which
may have resulted in lower incomes for
some of the poor and near-poor. Real
transfers grew at an average annual rate
of 6 percent in both the 1960s and the
1970s, but at 2 percent in the 1980s. Such
policy changes may have offset gains to
the poor from overall economic growth,
consistent with the persistently high levels of poverty in the 1980s.
Even accounting for demographic and
policy factors, though, the qualitative differences between the 1960s, 1970s, and
1980s persist. The second column of
table 1 reports findings after correcting
for the growth in real government transfers and the population of female-headed
households. As expected, excluding
these factors caused us to somewhat
overstate the impact of aggregate growth
in the 1960s and to somewhat understate
its impact in the 1970s and 1980s. However, the effect of growth on poverty in
the 1980s continued to be small relative
to the experience of the 1960s.

Widening Wage and
Income Inequality
Several scholars have pointed to a widening disparity in wages, including real
declines in the wages of low-skilled
workers, as the primary cause of the
weakening relationship between growth
and poverty reduction.5 According to
this theory, as the rewards to those at the

TABLE 1 EFFECT OF GDP GROWTH ON INCOME

^ | ^ g

POVERTY RATE
Percentage-point
reduction in poverty
for 1 percent increase
in GDP growth

Adjusted for
demographic and
policy trends

-0.403
-0.220
-0.228

-0.381
-0.252
-0.247

1960-1969
1970-1979
1980-1989

NOTE: Reported coefficients are statistically significant from zero. Coefficients for 1960-1969
are significantly larger than coefficients for 1970-1979 and 1980-1989.
SOURCE: Author's calculations using data from the U.S. Census Bureau and Economic Report of
the President.

FIGURE 1

ALTERNATIVE POVERTY RATES, 1959-1989

Percent of persons in poverty
23

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

SOURCES: U.S. Census Bureau; and Slesnick (footnote 6).

bottom of the earnings ladder rapidly
diminished, aggregate growth decreasingly translated into poverty reductions.
The conclusion is that beginning in the
late 1970s, a structural change in the
economy led to increasing income
inequality and to a decreasing ability to
"grow out" of poverty.

income, but also on anticipated income
in all future years, accumulated wealth
(acquired from past income), and the
degree of flexibility to reallocate these
resources by borrowing and saving. We
can infer consumption levels by making
adjustments to available data on household expenditures.

• The Mismeasurement
of Poverty

Figure 1 contrasts the official income
poverty rate from 1959 to 1989 with the
comparable Jorgenson-Slesnick (JS)
consumption poverty rate.7 The JS rate
uses a consumption poverty threshold,
computed to be logically consistent with
the official income poverty threshold.
Both the levels and trends of the two
rates are quite different. Except for a
period in the late 1960s, the official
poverty rate is higher than the JS rate.
Although both rates decline from 1961 to
the early 1970s, they paint starkly different pictures of recent poverty trends.

Recent work by economist Daniel
Slesnick suggests that flaws in poverty
measurement have led to misleading
conclusions about poverty trends.6 The
problem is that annual income is often
an imperfect indicator of economic wellbeing. For example, an elderly family
may be income poor but asset rich, and
thus able to maintain much the same
lifestyle as a well-to-do younger family
by spending their retirement savings.
This suggests that a much more accurate
indicator of the economic well-being of
families is their consumption. Consumption depends not only on current annual

TABLE 2 EFFECT OF GDP AND PCE GROWTH ON
CONSUMPTION POVERTY RATE
Percentage-point reduction
in poverty for 1 percent
increase in GDP growth

Percentage-point reduction
in poverty for 1 percent
increase in PCE growth

-0.232
-0.236
-0.190

-0.320
-0.330
-0.306

1960-1969
1970-1979
1980-1989

NOTE: Reported coefficients are statistically significant from zero. Coefficients for all periods are
not significantly different from each other.
SOURCE: Author's calculations using data from the U.S. Census Bureau and Economic Report of
the President.

While the official rates indicate a strong
resurgence of poverty in the early 1980s
and persistently high rates thereafter, the
JS rate, after a sharp increase around the
recessionary trough in 1980, declined
substantially over the 1980s.

in consumption poverty of 0.32 in the
1960s, 0.33 in the 1970s, and 0.31 in
the 1980s. Again, there is no statistical
evidence that the relationship between
growth and consumption poverty has
changed since the 1960s.8

• Aggregate Growth and
Consumption Poverty

• Interpreting the Findings

The first column of table 2 reports the
estimated effects of real GDP growth
on the consumption poverty rate. A
1 percentage-point increase in the
growth rate of real GDP is associated
with a reduction in consumption
poverty of about 0.23 percentage point
in both the 1960s and 1970s, and about
0.19 percentage point in the 1980s. The
estimated effects in each decade are so
similar that we can reject the idea of a
structural change in the trickle-down
mechanism in the 1980s.

As stated earlier, scholars have argued
that most of the stagnation in progress
against income poverty can be attributed
to structural change, not to more easily
understood causes such as a regime
change in policy or an obvious demographic trend. However, taking a fresh
look at the way we measure poverty
leads to the conclusion that the alleged
break in the trickle-down mechanism is
quite sensitive to the poverty concept
employed. Using a measure that is on a
superior conceptual footing, there seems
to be practically as much scope for
growing out of poverty as ever.

Real GDP is one of several alternative
macroeconomic growth indicators. In
the income poverty context, its use
amounts to examining the degree to
which the income-poor population partakes in aggregate income growth. Analogously, we can compare real personal
consumption expenditure (PCE) growth
with consumption poverty. The question
is, were the consumption gains of the
1960s, 1970s, and 1980s decreasingly
reflected in the consumption of the poor
over time?

Why do these two measures yield such
different interpretations of the past 30
years? One conjecture is that the trend
toward female-headed families drove up
income, but not consumption, poverty
rates over the 1970s, and accounted for
some of the failure of aggregate income
gains to redress income poverty.9 However, this cannot explain the different conclusions about poverty and growth employing these two measures in the 1980s.

The second column of table 2 presents
the estimated effects of real PCE growth
on the JS poverty rate. Aggregate PCE
growth of 1 percentage point was associated with percentage-point reductions

Policy changes may also have differentially affected income and consumption
poverty rates. For example, Medicaid has
come to represent an increasingly important share of welfare benefits. While the
value of Medicaid insurance and actual

benefits paid are not reflected directly in
either the standard (income) or JS (consumption) poverty rate, such transfers
may indirectly affect the consumption
poverty rate. The increasing availability
and generosity of Medicaid, particularly
in the 1980s, may have caused people to
worry less about potential medical costs
and to spend funds formerly set aside
against such contingencies. These types
of policy changes would show up in
lower consumption poverty rates
(through increased consumption), but
would have no effect on (official) income
poverty rates. Thus, it is possible that a
breakdown in the growth effect on consumption poverty was obscured by mitigating changes in policy.
Finally, recent research suggests that up
to half of the greater earnings inequality
observed from the late 1970s through the
1980s was unrelated to fundamental increases in inequality.10 Measured
annual and permanent income trends
seem to have diverged. Because theory
suggests that consumption is more closely
related to permanent income, this phenomenon could result in increased income, but not consumption, poverty
rates. This would help to explain why the
two poverty series are so divergent over
the 1980s.
A first look at the consumption poverty
data suggests at the very least that the
picture of increasing inequality and the
failure of the 1980s' "rising tide" to lift
all boats may be exaggerated. The poor
appear to benefit from a vigorously
expanding economy now as much as before. After considering this new evidence, it is not at all clear that a policy
to promote overall growth (and hence to
expand aggregate consumption opportunities) is of declining interest to Americans below the poverty line.

•

Footnotes

1. The official government poverty rate, computed for all years since 1959, is the proportion of the population with annual pre-tax,
post-transfer income below specified levels,
called "poverty thresholds" or "poverty lines."
2. See Rebecca Blank, "Why Were Poverty
Rates So High in the 1980s?" in D.B.
Papadimitriou and E. Wolff, eds., Poverty and
Prosperity in the USA in the Late Twentieth
Century, chapter 2. New York: St. Martin's
Press, 1993, p. 27.
3. Ibid.
4. Even so, promoting growth might still be a
more effective long-run poverty reliever than
other policies.
5. See, for example, Blank (footnote 2) and
David Cutler and Lawrence Katz, "Macroeconomic Performance and the Disadvantaged," Brookings Papers on Economic Activity, 1991 No. 2, pp. 1-61.
6. See Daniel Slesnick, "Gaining Ground:
Poverty in the Postwar United States," Journal of Political Economy, vol. 101, no. 1
(February 1993), pp. 1-38.

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101
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7. Daniel Slesnick developed the basis for
his poverty computations with Dale Jorgenson. For further details, see Slesnick (ibid.).
8. The careful reader might be curious about
the estimated relationship between PCE
growth and income poverty. A 1 percent
increase in real PCE growth is associated
with poverty reductions of-0.44, -0.24, and
-0.27 percentage point in the 1960s, 1970s,
and 1980s, respectively. There is no statistical difference between the 1970s and 1980s
estimates, while the latter periods are significantly different from the 1960s. These findings are strikingly similar to those obtained
using real GDP growth.

Elizabeth T. Powers is an economist at the
Federal Reserve Bank of Cleveland. The
author thanks David Altig for helpful comments and Kristin Roberts for research
assistance.
The views stated herein are those of the
author and not necessarily those of the Federal Reserve Bank of Cleveland or of the
Board of Governors of the Federal Reserve
System.

9. Female-headed households are less likely
to be classified as poor under the consumption standard, because the average age of
children is lower in female-headed households than in other households with children,
and younger children tend to consume less.
10. See Peter Gottschalk and Robert Moffitt,
"The Growth of Earnings Instability in the
U.S. Labor Market," Brookings Papers on
Economic Activity, 1994 No. 2, pp. 217-54.

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