Optimal poverty reduction, adjustment, and growth

This article analyzes poverty reduction policies in an applied optimal growth framework. Assuming that poverty reduction is effected through redistribution, it focuses on the static and dynamic tradeoffs between equity and efficiency and on the choice between current income and future income (that is, current productive asset) transfers to the poor. By numerically estimating a stylized economy, it is shown that, given reasonable assumptions about behavioral parameters, the efficiency cost of poverty reduction in an economy on a steady growth path is relatively low. In a period of adjustment following a severe exogenous shock, however, the scope for redistribution may be extremely limited if there is a constraint on foreign borrowing. Plausible examples are given of adjustment cases in which poverty reduction becomes optimal only after partial adjustment has been achieved.