When growth does – and does not – reduce poverty

May 23, 2024

Poverty eradication success stories are about growth, first and foremost. But poverty is eradicated most rapidly when a range of public and private investments reinforce each other. The experiences of countries that have succeeded in translating growth into poverty reduction, and those that have failed, should guide our development policy priorities.

Investing in private businesses does not necessarily fit with most people’s ideas of what fighting poverty looks like. As a result, the role of private sector development finance institutions, such as Norfund and British International Investment, attracts controversy.

We can, of course, point to the fact that it is very rare for countries to eradicate poverty without economic growth. The historical record shows that periods of high private sector investment tend to be accompanied by more rapid poverty reduction. But those facts leave a question unanswered. Investment and growth do not always reduce poverty, so what does it take to ensure they do?

Three ingredients for inclusive growth

What we found is that economic growth has the greatest impact on poverty when three ingredients are combined. First, there is economic modernisation and urban growth. Second, there is investment in rural areas where poverty is higher – in roads, electricity, and in agriculture. Third, governments use the proceeds of growth to finance public services and social protection.

Each ingredient complements the others, through a variety of mechanisms. Urban growth pulls workers off the land and creates demand for food, raising incomes for remaining farmers. Investments in agricultural productivity reduce food prices, which helps the urban poor, and workers who have migrated to cities send remittances back to their families. The expansion of banking and other financial services helps develop the non-farm economy in rural areas. Wages rise, as firms compete to attract and retain workers.

These self-reinforcing dynamics are not guaranteed to emerge. Failure looks like the absence of growth, or a failure to ensure that growth is inclusive. When growth fails to translate into poverty reduction, that is often because it has been concentrated in sectors such as oil and gas, with fewer linkages to the rest of the economy, and when the fruits of growth are captured by elites with no effective interventions by governments to spread prosperity throughout society.

Photo credit: WeLight

Short-run and sustained poverty reduction

The short and long run drives of poverty reduction differ. When poverty is very high and most people work in agriculture, then anything that raises agricultural productivity has the greatest immediate effect on poverty. But sustained poverty reduction involves people moving out of agriculture into manufacturing and services, and small informal firms giving way to larger more productive firms.

Governments in the most successful countries made concerted efforts to attract private investment into strategically important sectors with spillovers into the rest of the economy, at the same time as they were investing to ensure rural areas benefited from growth.

As countries get richer, governments of course have more resources at their disposal, but they also tend to spend a greater share of their income on social services. Low-income countries spend on average just $15 (in international dollars) annually per person on social expenditures – an utterly inadequate sum – while in lower-middle income countries it is roughly $90 and in upper middle-income countries roughly $340. If you think that decent public services and comprehensive social protection are keys to eradicating poverty, then you should regard economic growth to reach middle-income status as absolutely essential

Prioritizing to eradicate poverty

It would be going too far to suggest that these historical experiences imply a single model for international development cooperation. But because different elements of what it takes to eradicate poverty work better together, there is a strong argument for focusing our support from the outside on strengthening these three ingredients.

Different instruments and organizations are best suited to providing support for each element. Development Finance Institutions (DFIs) like BII and Norfund can do investments that directly touch the lives of poor people, where they live today, for example through agricultural supply chains. But DFIs are especially well-suited to investments in certain types of revenue-generating infrastructure, like renewable energy, and in larger formal firms, needed to accelerate economic transformation, and they can play a key role in helping the financial sector extend access to farmers and entrepreneurs away from urban centres.

Sustained growth that translates into poverty reduction requires investments in parts of the economy that are quite distant from the lives of the poorest, but which drive urbanisation and structural change, without which sustained poverty eradication is impossible. It is quite wrong to think that for private investment to contribute to poverty eradication it must always be “targeted at poverty” in the direct sense. To believe that would be akin to believing that the tremendous urban growth and economic modernisation seen in the countries that have eradicated poverty in recent decades played no great role in that achievement.

Other institutions can help translate growth into rapid poverty eradication by supporting governments. These forms of support would call on the sovereign operations of development banks and bilateral aid programmes, that can work with partner governments and NGOs to provide support for public investment in rural areas and with the provision of social services. A balanced approach is important when the different measures are complements. Spending on education is more effective, for example, when there are jobs that can make good use of educated workers, and efforts to create jobs should be more successful when children receive a better education.

Poverty is eradicated most rapidly when a range of public and private investments reinforce each other, and several types of institution, and different forms of support have unique roles to play.

Poverty is eradicated most rapidly when a range of public and private investments reinforce each other, and several types of institution, and different forms of support have unique roles to play.

In a new report presented at the Norfund Conference on 23rd of May, we looked more closely at stories from countries that have succeeded and failed in poverty reduction, to uncover some of the mechanisms that have contributed to these outcomes.

Read the report