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.
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.