Transition Events in the Dynamics of Poverty

Chapter II:
Literature Review

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Contents

  1. Theories Used to Explain Poverty
  2. Findings from the Literature
  3. Contributions to the Literature

Endnotes

A review of the poverty transitions literature finds two broad questions that have been examined: (1) What are the probabilities associated with entries into, exits from, and reentries into poverty? and (2) What are the events associated with entries into and exits from poverty? (Table 1). The first question has been addressed by numerous studies, most thoroughly in a recent study by Stevens (1999). The second question has not been fully addressed in the literature and is the focus of this study. Below we review the theories and findings from the poverty transitions literature, focusing especially on results pertaining to events associated with poverty entries and exits.(3) As the poverty literature is large, we narrowly focus on the U.S. poverty transitions literature and do not review related literatures such as those on poverty transitions in developing countries, poverty duration, or transition events in the dynamics of such programs as welfare, food stamps, and foster care.

Table 1:
Summary of Empirical Poverty Transitions Literature.
Study Data Years Primary Sample Studied Research Question(s) Addressed
Bane and Ellwood 1986 PSID 1970-1982 Persons Under Age 65 Exits, Events
Blank 1997 PSID 1979-1991 Total U.S. Events
Duncan and Rodgers 1988 PSID 1968-1982 Children Events
Eller 1996 SIPP Oct. 1991 - Apr. 1994 Total U.S. Exits, Events
Gottschalk and Danziger 1993 CPS 1968, 1986 Children Events
Iceland 1997b PSID 1970-1985 Adults Ages 18-64 in Metropolitan Areas Exits, Events
Naifeh 1998 SIPP Oct. 1992 - Dec. 1995 Total U.S. Entries, Exits
Rank and Hirschl 1999a PSID 1968-1992 Adults Ages 60-90 Entries
Rank and Hirschl 1999b PSID 1968-1992 Adults Ages 20-85 Entries
Ruggles 1990 CPS, SIPP 1984 Total U.S. Entries
Ruggles and Williams 1987 SIPP 1983-1984 Total U.S. Entries
Stevens 1994 PSID 1970-1987 Total U.S. Exits, Reentries
Stevens 1999 PSID 1967-1988 Total U.S. Exits, Reentries
Zick and Smith 1991 PSID 1970-1984 Widows and Widowers Events
Zick and Holden 2000 SIPP Feb. 1990 - Apr. 1995 Widows Ages 40+ Events

II.1. Theories Used to Explain Poverty

What theory is appropriate for analyzing poverty dynamics? Sawhill (1988) concludes in her survey of the poverty persistence literature that the literature lacks “a widely accepted theory of income distribution that might help one choose between competing model specifications and their varying results” (p. 1112). She finds that “few researchers have approached the task of analyzing the effects of different variables on the poverty rate in the context of a coherent overall model of the process by which income is generated” and that “we are swamped with facts about people’s incomes and about the number and composition of people who inhabit the lower tail, but we don’t know very much about the process that generates these results” (p. 1085).

This review of the literature indicates this is still the case. The literature provides many poverty statistics and some empirical results, but little theory to explain them.(4) Perhaps this is because a theory of poverty is complex to model. As Duncan (1984) notes, a complete explanation of why people are poor would require many interrelated theories—theories of family composition, earnings, asset accumulation, and transfer programs, to name a few.(5) Further complicating the task, a complete poverty theory would need to be based upon the family, while most theories are based upon individuals (Duncan, p. 46). If there is not a complete theory of poverty, are there theories that can be used to explain some aspects of poverty?

Most theories used to explain poverty focus on able-bodied, non-elderly adults, whose potential for escaping poverty rests on their ability to work enough hours at a sufficiently high wage rate. Many theories of poverty, as a result, become theories of labor supply and wage rates (Duncan 1984, p. 46). Human capital theory is one example. Among other strengths, human capital theory has much empirical support and so is the primary focus of this review. This review presents a brief description of human capital theory and other relevant theories, including the permanent income hypothesis, culture of poverty theory, and dual labor market theory.

Human Capital Theory

Human capital theory is a theory of earnings, one of the major determinants of poverty. First developed by Becker and Mincer, this theory explains both individuals’ decisions to invest in human capital (education and training) and the pattern of individuals' lifetime earnings. Individuals’ different levels of investment in education and training are explained in terms of their expected returns from the investment. Investments in education and training entail costs both in the form of direct expenses (e.g., tuition) and foregone earnings during the investment period, so only those individuals who will be compensated by sufficiently higher lifetime earnings will choose to invest. People who expect to work less in the labor market and have fewer labor market opportunities, such as women or minorities, are less likely to invest in human capital. As a result, these women and minorities may have lower earnings and may be more likely to be in poverty.

Human capital theory also explains the pattern of individuals' lifetime earnings. In general, the pattern of individuals’ earnings are such that they start out low (when the individual is young) and increase with age (Becker 1975, p. 43), although earnings tend to fall somewhat as individuals near retirement. The human capital theory states that earnings start out low when people are young because younger people are more likely to invest in human capital and will have to forego earnings as they invest. Younger people are more likely to invest in human capital than older people because they have a longer remaining work life to benefit from their investment and their foregone wages—and so costs of investing are lower. Earnings then increase rapidly with age as new skills are acquired. Finally, as workers grow older, the pace of human capital investment and thus productivity slows, leading to slower earnings growth. At the end of a person’s working life, skills may have depreciated, as a result of lack of continuous human capital investment and the aging process. This depreciation contributes to the downturn in average earnings near retirement age (Ehrenberg and Smith 1991).

To the extent that poverty follows earnings, we might predict a similar relationship between age and poverty, with poverty more likely for the young and elderly. Consistent with this prediction, Bane and Ellwood (1986) find that a sizable portion of all poverty spells begin when a young man or woman moves out of a parent’s home—an event often associated with getting further education or training—and that these poverty spells are relatively short with an average duration of less than three years (p. 16-17). Also, our literature review indicates that persons age 65 and over are especially vulnerable to poverty because once they enter, they are less likely to exit.

While much empirical work tends to support the human capital theory,(6) it is a theory of human capital investment and labor market earnings, not poverty. As discussed below, earnings are only one of the main determinants of poverty. Non-earnings income and family composition are other important determinants that human capital theory does not shed light on. Thus human capital theory cannot be considered a complete theory of poverty. Are there other theories that shed light on these other aspects of poverty?

Permanent Income and Life-Cycle Hypotheses

The permanent income and life-cycle hypotheses—associated primarily with Nobel prize winners Modigliani and Friedman—highlight the important role of unearned income and future earned income, as well as current income (Dornbusch and Fischer 1990). An advantage of the permanent income and life-cycle hypotheses, over the human capital theory, is that they incorporate both earned and unearned income. The foundation of the theories is that people have a permanent income stream (from current and future earnings and assets), but that their income can have short-term (transitory) deviations from the permanent stream. Lillard and Willis (1978) propose the components-of-variance method as a link between poverty data and the life cycle framework of these hypotheses. Several researchers use this method to try and measure the permanent and transitory components of income and poverty (Lillard and Willis; Duncan and Rodgers 1991; Stevens 1999). However, the theory is difficult to adapt to poverty (Bane and Ellwood 1986) and results from the empirical model do not reproduce observed patterns of poverty persistence as well as other methods (Stevens 1999). In addition, the permanent income hypothesis does not allow for an individual’s income stream to change if, for example, they become disabled. This is a serious drawback for analyzing poverty transitions where one of the primary aims is to analyze the effect of events—such as a change in disability or marital status—on poverty.

Other Theories

Still other theories highlight the role that character and opportunity play in poverty. Schiller (1976) groups theories focusing on able-bodied, nonelderly adults into categories of “flawed character” and “restricted opportunity.” The flawed character theories assume that the poor have ample opportunities for improving their economic status, but lack the initiative and diligence necessary to take advantage of them (Duncan 1984). Oscar Lewis’ “culture of poverty” theory (1968) is an example of a flawed character theory. This theory maintains that a culture of poverty forms among a significant minority of the poor such that people are not psychologically geared to take advantage of opportunities that may come their way (Duncan 1984).(7) Using the PSID to examine the earnings of prime-aged white men Duncan confirms the findings of earlier studies and finds no support for the culture of poverty theory: “educational attainment is relatively powerful in distinguishing individuals with different levels of earnings, while attitudes and a simple measure of cognitive ability are not” (p. 123).

The restricted opportunity theories contend that the poor lack sufficient access to economic opportunities and cannot avoid poverty unless their economic opportunities improve (Duncan 1984). The dual labor market theory is an example. In this theory the labor market is split into two sectors with little mobility between them—the primary sector offering steady employment, higher wages, and better promotion opportunities, and the secondary sector with low wages, poor working conditions, and few promotion opportunities.(8) Using the PSID, Duncan (1984) finds little support for the dual labor market theory: “The fact that very few male workers appear to be locked into a given economic position, coupled with the movement found from ‘bad’ jobs to ‘good’ ones, contradicts rigid theories of dual labor markets” (p. 124). With these theories in mind, we now turn to findings in the poverty transitions literature.

II.2. Findings from the Literature

What do we know about the probabilities and events associated with changes in poverty over the last three decades? This section presents results from the various poverty studies discussed above. Turning back to the two questions addressed in this review of the poverty transitions literature, we present some answers to the following: (1) What are the probabilities associated with entries into, exits from, and reentries into poverty? and (2) What are the events associated with entries into and exit from poverty?

1. Probabilities Associated with Entries into, Exits from, and Reentries into Poverty

Poverty Entries

The literature examining entry rates into poverty is somewhat limited, particularly as compared to studies that examine exits from poverty. Nonetheless, several studies have examined entries into poverty. The rate of entry into poverty for the total U.S. population during the early 1990s has been estimated at roughly three percent per year. Using SIPP data, Eller’s (1996) analysis suggests that 3.0 percent of all people entered poverty in 1993 (p. 5). Naifeh (1998), also using SIPP data, finds a very similar entry rate of 3.2 percent during the 1993-94 period (p. 6).(9) Both researchers find that blacks, Hispanics, female-headed families, and children are the groups most likely to enter poverty.

Researchers also use PSID data to study poverty entry. Rank and Hirschl (1999a and 1999b) use the PSID to estimate the proportion of the population that will have experienced poverty by a particular age, rather than estimating entry rates for a particular year. Using a life table based approach, they find that 27.1 percent of adults will have experienced poverty by age 30, 41.8 percent will have experienced poverty by age 50, and 51.4 percent will have experienced poverty by age 65 (Rank and Hirschl 1999b, p. 206). Consistent with the findings of Eller (1996) and Naifeh (1998), Rank and Hirschl find that blacks are more likely to experience poverty than whites.

Poverty Exits

PSID. Some of the key papers in the literature examine exits from poverty. Bane and Ellwood (1986), Stevens (1994), and Stevens (1999) examine poverty exit rates using the PSID, while papers by Eller (1996) and Naifeh (1998) examine exit rates using the SIPP. The three PSID studies produce similar results. In general, the results suggest that the longer a person has been poor, the less likely it is that he or she will escape poverty. Using the 1970-82 waves of the PSID, Bane and Ellwood find that the probability of exiting a poverty spell starts at 0.45 for one-year spells, falls to 0.29 for two-year spells, and falls further to 0.21 for four-year spells. Using an additional six waves of the PSID, Stevens replicates Bane and Ellwood's results. Stevens also reestimates the exit probabilities on data that are not smoothed to eliminate some one-year spells, a procedure used by Bane and Ellwood,(10) and obtains slightly higher exit probabilities: 0.53 for one-year spells, 0.36 for two-year spells, and 0.23 for four-years spells.

SIPP. The SIPP data examined in the literature contain a maximum of 44 months of information, so the exit probabilities estimated by Eller (1996) and Naifeh (1998) based on SIPP data are not directly comparable to those based on PSID data. Using the 1991 and 1992 SIPP panels, Eller calculates the proportion of persons who were poor in 1992, but no longer poor in 1993. Unlike Bane and Ellwood (1986) and Stevens (1994, 1999), persons defined as poor in 1992 have various poverty spell lengths. Eller finds 21.6 percent of persons exited poverty between 1992 and 1993. This estimate is similar to that found by Naifeh, who calculates an exit rate of 23.8 during 1993-94 using the 1993 SIPP panel.

Sub-groups. Poverty exit rates have been found to be quite different across population sub-groups. Analyses carried out separately by race show that poverty exit rates are higher for whites than for blacks (Eller 1996, Naifeh 1998, Stevens 1999). Stevens (1994) examines whether the growth rate in real GDP differentially affects whites’ and blacks’ probability of exiting poverty, and finds that GDP growth has a smaller impact on the probability of escaping poverty for blacks than for whites. In other words, a strong economy reduces poverty among whites to a greater degree than it reduces poverty among blacks. Persons age 65 and over and persons living in central cities also have lower exit rates from poverty (Naifeh), while persons with greater education levels have higher exit rates (Iceland 1997b, Stevens 1999). Several studies have also examined exits from poverty by type of household head, such as female-headed or married-couple household, and in general find that households headed by females are disproportionately less likely to exit poverty (Eller, Naifeh, Stevens 1994).(11)

Over Time. Stevens (1994) also examines how exits from poverty changed over the period from 1970 to 1987. She finds that during this period, households headed by females experienced decreases in mobility from poverty, while households headed by males experienced no significant change in mobility from poverty. These differences across gender occur for households headed by both whites and blacks. Stevens investigates whether the decreased mobility for female-headed households can be explained by changes in the characteristics of these households or by differences in the events leading into our out of poverty, but finds no solid evidence of either.

Poverty Reentry

Once an individual exits poverty, are they likely to reenter? Stevens (1994, 1999) examines reentries into poverty and finds relatively high reentry rates. She finds that the probability of entering a poverty spell is 0.27 after being out of poverty one year, 0.16 after being out of poverty for two years, and 0.08 after being out five years. With these reentry rates, she calculates that more than one-half of those who previously escaped poverty will return to poverty within five years (Stevens 1994, p.36). For the subset of persons who were poor for at least five years before exiting, more than two-thirds will return to poverty within five years (Stevens 1994, p.37). Consistent with findings on entry and exit rates by race, Stevens (1999) finds that blacks have a higher reentry rate than whites. Households headed by females and by individuals with less than a high school education are also more likely to reenter poverty. Examining trends in reentry rates, Stevens (1994) finds that the tendency to experience repeated poverty spells has increased between 1970 and 1987 for people living in households headed by white females.

2. Events Associated with Entries into and Exits from Poverty

Poverty Entries

Descriptive analyses by Bane and Ellwood (1986), Ruggles and Williams (1987), and Blank (1997), who study all individuals, and Duncan and Rodgers (1988), who study children, find similar results concerning events associated with transitions into poverty. These analyses find that changes in labor supply and earnings are more commonly associated with poverty entries than changes in household structure and composition. Ruggles and Williams find that of the people who enter poverty, 40 percent live in a household that experienced a job loss by the head, spouse, or other household member (p. 13). Bane and Ellwood find that almost half (49.3 percent) of poverty spells begin when the household experiences a decline in earnings: 37.9 percent of poverty entries coincide with a fall in heads' earnings and 11.4 percent of entries coincide with a fall in wives’ or other family members’ earnings (pp. 14-15). Blank also finds that a large share of poverty entries (42.8 percent) occur with a fall in heads’ earnings (p. 26). Other events experienced by persons who enter poverty include transitions to female headship, young adults set up their own household, and child born into household (Bane and Ellwood and Blank). Bane and Ellwood, for example, find that the percentage of poverty spells that begin with these events are 11.1 percent, 14.7 percent, and 8.6 percent, respectively (p.13-14). Contrary to the results for all individuals, shifting to a female-headed household is more often associated with poverty entry than changes in earnings for the sub-population of female-headed households with children (Bane and Ellwood p. 13-14).

Duncan and Rodgers (1988) find that the labor supply of individuals in the household other than the mother or father is the event that coincides most with children's transitions into poverty. Fewer work hours of the male head, as well as unemployment of the male head, also coincides with poverty entries of children. Shifting into a single-parent family and having a head who becomes disabled are somewhat less important than these labor supply measures.

Poverty Exits

Similar to events associated with poverty entry, descriptive analyses using both the SIPP and PSID find that changes in labor supply and earnings are more commonly associated with poverty exits than changes in household structure and composition. Using the SIPP, Ruggles and Williams (1987) find that almost 47 percent of those leaving poverty had a family member gain a job, while the various household structure changes (including marriage) were experienced by less than one percent of those households leaving poverty. Using the PSID, Bane and Ellwood (1986) find that nearly three-quarters (73.2 percent) of poverty spells end with a rise in earnings: 50.2 percent with a rise in the head's earnings and 23.0 percent with a rise in a wife’s or other household members’ earnings. Transitions from a female-headed household to a male-headed household were experienced by 10.1 percent of individuals who exited poverty (p. 19). Examining female-headed households separately from male-headed households, Bane and Ellwood show that changes in household structure are quite important for this subset of the population, though not more important than earnings. For example, they find that 26.4 percent of female-headed households with children exit poverty when they shift to a male-headed household and 51.4 percent exit because head or others’ earnings rose (p. 19).

Again, Duncan and Rodgers (1988) find that children's transitions out of poverty most often coincide with changes in labor supply. Moving from a one-parent to a two-parent family is also associated with transitions out of poverty, although gaining a parent is more important for transitions out of poverty for blacks than nonblacks (Duncan and Rodgers). Iceland (1997b) uses a multivariate framework to examine “the effect of four structural characteristics on individual poverty exits: (1) economic restructuring, (2) skills mismatches, (3) racial residential segregation, and (4) welfare benefit levels. Results show that these factors play a role in explaining African-Americans’ economic disadvantages, but they have a weaker and often contrary impact on whites’ poverty exit” (p. 429).

Summary of Literature Review Findings

Results from the literature can be summarized into the following key findings:

Probabilities Associated with Entries into, Exits from, and Reentries into Poverty

Events Associated with Entries into and Exits from Poverty

II.3. Contributions to the Literature

This study sheds light on three questions that remain largely unanswered in the poverty literature:

  1. What are the dynamics behind changes in the poverty rate over time?
  2. What events increase individuals' likelihood of entering and exiting poverty? Have these events changed over time? Do the events differ for short and long poverty spells?
  3. What is the likelihood of entering and exiting poverty given these different events?

These questions and our contribution to the literature are discussed below.

What are the dynamics behind changes in the poverty rate over time?

The poverty rate is a static statistic that measures the percentage of the population living below the poverty line during some fixed time interval, usually a year. While the poverty rate in a particular year provides information about the prevalence of poverty, what we learn from the poverty rate is limited. In particular, it does not provide information on the dynamics of poverty (i.e., transitions into and out of poverty). The numerous studies on poverty dynamics do not tie dynamics to changes in the overall poverty rate. Our analysis decomposes the poverty rate providing a better understanding of changes in the poverty rate over time. This analysis allows us to answer questions such as “In periods where poverty rates remained high, was it because the number of entries and exits were high or low?”

What are the events that increase individuals' likelihood of entering and exiting poverty?

While several studies examine the relationship between events and poverty transitions, most use only descriptive analyses (Bane and Ellwood 1986, Blank 1997, Duncan 1984, Duncan and Rodgers 1988, Ruggles and Williams 1987). Descriptive analyses examining this relationship are somewhat problematic because this approach does not identify the relative importance of the different events in individuals' transitions. We add to the literature by using a multivariate framework to examine how events such as changes in marital status, disability status, and employment status affect poverty entries and exits. This multivariate approach allows us to disentangle the relationship between one event and poverty transition from that of other events or demographic characteristics. We further add to the literature by examining whether the events that trigger poverty entries and exits have changed over time and whether these events differ for long versus short spells of poverty.

What is the likelihood of exiting and reentering poverty given these different events?

Our framework for examining what events increase individuals' likelihood of entering and exiting poverty (question 2) allows us to easily calculate how the probability (i.e., the likelihood) of entering and exiting poverty is affected by different events. We also examine how the probabilities have changed over time and the extent to which they differ for long and short spells of poverty.

Endnotes

3.  For a more thorough review of the poverty literature that includes a discussion of poverty measures, data, and methods, see McKernan, Ratcliffe, and Riegg (2001).

4.  Lillard and Willis (1978), Duncan (1984), and to some extent Iceland (1997b) are exceptions.

5.  Under the broad view of poverty set forth in the World Bank’s (2001) recent World Development Report “Attacking Poverty,” additional theories, such as theories of empowerment and social capital, would also be required. The World Development Report groups the causes of poverty into three main categories: (1) “lack of income and assets to attain basic necessities;” (2) “sense of voicelessness and powerlessness in the institutions of state and society;” and (3) “vulnerability to adverse shocks, linked to inability to cope with them” (p. 34), but does not provide a theory of poverty.

6.  Willis (1986), in his survey of human capital earnings functions, concludes the theory has been “repeatedly confirmed with data from around the world” (p. 598). Also, using the PSID, Duncan (1984) finds “a fair amount of evidence supporting the human capital model” (p. 124).

7.  Poverty for this significant minority will be persistent because the culture of poverty is passed from generation to generation.

8.  Doeringer and Piore 1971, as cited in Duncan 1984.

9.  Entry and exit rates were calculated only for those with no change in family status over the period. Five percent of the sample were excluded from the calculations because of changes in family status.

10.  Bane and Ellwood eliminate one-year spells in which income fell by less than one-half of the poverty threshold.

11.  While Stevens examines households, Eller and Naifeh focus on families.


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