Poverty Trap

Poverty trap definition

A poverty trap is a means by which those who are impoverished are unable to escape poverty. Poverty traps occur when the economic system demands a considerable amount of money to pull those who are impoverished out of poverty. Those without a lot of money might find it hard to get that amount of money, which creates a vicious cycle and effectively "traps" them.

Those who are above the poverty line (and especially those who are well above the poverty line) are there due to a variety of reasons. It could be that their parents were well off and so were able to provide them with decent housing, food and water that is constantly available, access to medical care, opportunities to be educated at good schools, etc. Maybe they were even left with a decent inheritance. The better opportunities than they had growing up, the more likely it is that their kids will succeed and not be at risk of falling into poverty.

Unfortunately, those who are caught in poverty traps are not able to provide all of the above-mentioned for their own children. Those things could be considered luxuries and therefore the future of those kids is also not too far removed from the situation they are already in. Meaning, that because their parents couldn't afford to send them to good schools, get them access to medical care when they need it, etc. the children don't have the opportunity to excel, get degrees, and get good jobs in the future. These kids are already starting from a very disadvantaged point compared to other kids their age.

Poverty trap diagram

Once someone is caught in a poverty trap it becomes extremely difficult to get past the poverty threshold. Unexpected expenses come up, people lose their jobs, people get sick, and all of these can create an even worse situation for those in the poverty zone. Figure 1 below will help you visualize a poverty trap.

Fig. 1 - Poverty trap. Source: Poor Economics¹

Figure 1 above shows the blue 45-degree line which represents the equality between future income and current income. The red area is the 'poverty trap zone', whilst the green area is the 'outside poverty trap zone'.

For those people who are initially in the poverty zone future income is lower than the current income.¹ This is shown by the green S-shaped curve being below the 45-degree blue line. Over time, they are trapped in poverty as they become poorer and poorer each day.

For those people who are outside the poverty trap zone, future income is higher than current income.¹ This is shown by the green S-shaped curve being above the 45-degree blue line. Over time, their income becomes higher and higher so they become better and better off.

Those who are in the green section of the diagram are considered to be in the poverty zone. Usually, some sort of outside assistance or aid is needed to get people out of the trap. However, due to things such as tax structures, those who have recently left the poverty zone tend to get sucked back in. But how?

Let's go through an example to see how this plays out:

Causes of poverty traps and poverty trap examples

Numerous situations can cause a person or a family to drop below the poverty line and stay there.

A few examples would be:

• Insufficient job opportunities
• No health insurance to cover costs of medical expenses
• Expensive goods/services
• Conflict within the country
• Being unable to afford education

The four poverty traps

There is a conflict poverty trap, a natural resource poverty trap, a landlocked with bad neighbors poverty trap, and poor governance of a small country poverty trap. Each of these traps makes it close to impossible for people to escape poverty.

Poverty Trap: Conflict

Every society faces conflicts, but persistent and recurrent conflicts can cause countries to be stuck in poverty. Underdeveloped and slow-growing countries are more likely to experience conflict, especially in the form of civil war. Once a war begins, it tends to last further into the future the poorer a country is. Wars create refugees and even more poverty than before, so the country would be stuck in a loop and effectively locked into poverty.

Poverty Trap: Natural Resource

The natural resource trap is when a country and their economy become overly dependent on the natural resources that they have and sell. They might think they have hit gold when they find they have that resource. At the beginning of selling that resource, they are profiting. However, the more they profit, the more their money is worth. This seems like a good thing but let's do an example to show why it actually is harmful to the economy in the long run.

Let's look at the diagram below for a visual representation of the above example:

Fig. 2 - Natural resource poverty trap

As you can see in Figure 2 above - as the health of the economy improves so does the domestic currency. The currency becomes stronger or appreciated. This is represented by the movement from the lower-left corner to the upper right corner in Figure 2. This positively correlates with expected profit, represented by the blue line. As the economy gets stronger and the currency appreciates, we would expect local producers' profits to increase. However, with the natural resource poverty trap, actual profit, represented by the green line, dips below the expected profit after a certain point.

And that's just the beginning. Since their money is worth more outside of their country, residents are going to buy more products from abroad rather than supporting their fellow residents by buying domestically produced goods. Those sections of the labor market that produce domestic goods then end up losing out financially, and that part of the economy is going to deteriorate. This makes the country even more dependent on natural resource. Jobs are lost, not many new jobs are created, and this continues in a downward spiral.

Poverty Trap: Landlocked with bad neighbors

A landlocked country is a country that is surrounded by land, and that does not have access to water (for trade). Countries that are landlocked have difficulty trading resources because they don't have ports, so they usually either trade resources via air or by striking a deal with a neighboring country so they can use the neighboring country's ports.

The issue comes when the neighboring countries are "bad" neighbors. This means that they will not assist the landlocked country either because they have no desire to help (due to the two countries not getting along) or are unable to help. Either way, the landlocked country cannot sell its resources and that is limiting its growth. Limited growth makes it easy to fall into poverty.

Poverty Trap: Poor governance of a small country