The Monetary Approach to Poverty: Strengths and Weaknesses
By Fabian Soria*, The Hague, 5 February 2007.

“Poverty has been created by the economic and social system that we have designed for the world.
 It is the institutions that we have built, and feel so proud of, which created poverty.
It is the concepts we developed to understand the reality around us, made us
see things wrongly. […] It is our policies borne out of our reasonings and
theoretical framework, with which we explain interactions among
institutions and people, that caused this problem for so
many human beings.”

Muhammad Yunus, Nobel Peace Prize 2006

When we read about poverty in the news, most of us know more or less what it means. But what are they exactly talking about? When an academic publishes a paper on poverty reduction, what exactly is he proposing to reduce?

The monetary approach is maybe the most widely used approach to measure and understand poverty. It is the preferred method for economists, since it is highly consistent with neoclassical microeconomic theory, and it has become a widely accepted measure on which many policies and much research rely (1), (2). The main tools used in this approach are the Poverty Line and the Basic Needs methodologies. The former, by establishing a poverty line, sets a threshold below which people are classified as poor. The latter, on the other hand, constructs an index based on a series of variables that intend to show if a person has all the minimum goods and services needed to satisfy the basic needs that have been defined by the methodology. This last index is called the “Unfulfilled Basic Needs Index” or NBI in Bolivia (after “Necesidades Básicas Insatisfechas”, in Spanish). These methodologies, however, are far from being free of criticism.

The Monetary Approach proposes a method that sees income (or consumption) as equivalent (or, at least, as the best possible proxy measure) of well-being (3). To what extent can this assumption be sustained? In a complex world, where human interactions and social behavior differ greatly between countries and even within countries, an approach that tries to uniform global population and the understanding of poverty seems to be naïve. The highly debated “Less than 1 US$ a day” poverty line is maybe one of the most extreme examples of this approach and its limitations.

In the past, some of the poverty reduction policies that were applied were not correct, even in the eyes of the Monetary Approach. But the microeconomic theory underlying the Monetary Approach also poses some restrictions and limitations to the understanding of poverty. By only using an income based understanding, this view seems to be too narrow to fit reality. Social relations are left aside, and other types of welfare are not considered. These failures make the Poverty Line and other Monetary Approaches an often misleading instrument. Understanding well-being in a more realistic way seems to be the first task to correct some of these problems. However, the theory underlying this understanding of poverty seems to leave little room for this. Most of the causes of poverty are results of long processes of social, political, economic and cultural power relations. The evolution in time of such processes might be more insightful than trying to understand poverty at a single point in time through income. The Monetary Approach has led to some useless policies that tried to attack poverty by attacking effects instead of causes of poverty. Hence, these policies have had little or no effect, and today poverty and inequality seem to be defeating most of the efforts of development agencies and governments.

Though the indexes are consistent with standard economic theory, the consistency with reality seems to be questionable. The Bolivian National Statistics Institute (INE) also recognizes the limitations of these measures, stating in the NBI methodological document that “It is important to keep in sight that poverty refers to a wide and complex concept, which implies several dimensions, whether it is lack of resources, exclusion, inequality, lack of entitlements, living standards, insecurity, etc; and that NBI shows poverty only through one of the dimensions: necessity or lack.” (1)

However, the monetary approach shouldn’t be disregarded as useless. It posts some methodologies that show clear economic inequalities that can help us understand economic poverty. By considering this and by using other instruments that complement these methodologies (rather than trying to replace them), a better measurement and understanding of poverty can be reached.

Approaches such as Sen’s Capabilities Approach, Relative Poverty Lines, Participatory Methods (such as Voluntarism or Powerlessness) or Social Exclusion (among others) would lead us to different measures of poverty, and possibly to different sets of poverty reduction policies. It is important to understand what the poverty indicators really mean, because the only way of making use of this data is by a proper interpretation of it.

All the methodologies are supposed to be measuring the same: poverty. But as long as we don’t agree on and understand what poverty is, we won’t be able to attack it. Before engaging in a battle against poverty, we have to know our enemy… otherwise, the battle might turn out to be against the poor instead of against poverty.

(*) Researcher at INESAD; currently M.A. student at the Institute of Social Studies (ISS) in The Netherlands. The author happily receives comments at the following e-mail: fsoria@inesad.edu.bo.
(1) Instituto Nacional de Estadística, Cálculo del Indicador de Necesidades Básicas Insatisfechas en Bolivia 1992 y 2001, 2005, Methodological document of the National Statistics Institute. La Paz, Bolivia. Electronic version, http://www.ine.gov.bo/pdf/Metodologias2004/NBI.doc
(2) Ruggeri, Caterina, 1999, The Many Dimensions of Deprivation in Peru: theoretical debates and empirical evidence, Queen Elizabeth House Working Paper Series Nº 29, University of Oxford. Electronic version, pdf, http://www3.qeh.ox.ac.uk/RePEc/qeh/qehwps/qehwps29.pdf
(3) Ruggeri, Caterina, Saith, Ruhi, and Stewart, Frances, 2003, Does it Matter that We do not Agree on the Definition of Poverty? A Comparison of Four Approaches. Oxford Development Studies, Vol. 31(3): 243-274.

Ó Institute for Advanced Development Studies 2006. The opinions expressed in this newsletter are those of the author and do not necessarily coincide with those of the Institute.

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