Poverty traps can be defined as a condition created by tax laws and income related societal security benefits that prevent people from getting out of welfare dependency. This means that if these people try to increase their income, they shift into an upper tax bracket and they end up paying additional taxes which results in, decreasing their disposable income.
Situations of poverty traps may also exist in cases of lack of savings. Saving may not be possible when the income is insufficient, so to avoid such a situation, it is desirable to accumulate enough wealth earlier before implementation of tax laws that lead to poverty traps (Fafchamps, 2003).
In the underdeveloped countries, poverty traps may be caused by factors such as limited, or lack of, access to credits and capital markets, corruption and bad governance, poor education systems, political insatiability and poor infrastructure.
Access to Credit
Credit facilities are provided by banks and other financial institutions in form of loans and overdrafts. Access to credit is regulated by the central bank of a country where by, it increases and decreases lending rates to fit the desired economic conditions. Credit markets are limited as a result of increased lending rates. The available lenders usually require collaterals from their borrowers.
Most people lack the collaterals and hence are unable to take these loans (Agenor, et al., 2007). This in turn results into slow establishments of businesses and low productivity of an economy leading to poverty trapping of the economy. Due to limited access to credit, investors undertake income generating activities that require low start-up costs which are usually in small scale.
Research carried out in Senegal and Ghana has pointed out that, lack of access to capital is one of the major causes of poverty. This is because poor households are less likely to receive loans than non-poor households. This situation is different in the case of countries such as Malawi, Peru and Nicaragua (Akhter, 2007).
In order to increase accessibility of credit in an economy, the government has to reduce lending rates and improve access to domestic capital markets. Like in the case of Mexico, numerous reforms have been undertaken to improve access to credit by enforcing security market laws so as to increase the number of companies listed in the stock market (OECD, 2005).
This is an economic condition where individuals have adequate skills to carry out a job but the jobs are unavailable. It is expressed as a percentage of the total available workforce. Unemployment in an economy results to low incomes to the workers since their services are readily available in the market which in turn leads to reduction in the disposable income of the workers (Mishkin, 2007).
In recent years, there has been a steady increase in the rate of unemployment due to increase in population, immigration of people to highly populated areas and slowed down economic growth which creates employment opportunities.
The best example of these cases can be given by the Latin American countries such as Brazil, Argentina, Peru, and Chile which experienced increased unemployment rates in the 1990s (Agenor, et al.,2007).
Unemployment problems can be done away with by improving the skills of the workforce so as to reduce overdependence in one sector of the economy. Once again, access to credit must be improved so as to increase investments which results to job creation.
This is an economic situation where there is a general increase in prices of goods and services usually caused by an increased supply of money which in turn results in its loss of value. Increased inflation affects the whole economy and thus usually leads to reduction of the purchasing power of the consumers.
It also results to reduced economic growth, high unemployment rate which finally leads to poverty trap in the economy (Bowles, et al., 2006). Economists and law makers have become ever more aware of the unfavorable effects of this economic condition and have tried to reduce them through enacting various measures.
In the 1970s and 1980s, policy makers and economists recognized the adverse effects of inflation which led to the need to set measures that ensure price stability. This helped in preventing overinvestment in the financial sector (Mishkin, 2007). During inflation, consumers are unwilling and lack the ability to spend.
Saving can be one of the ways an individual can use to avoid anticipated poverty traps. The savings ensure that the individual will have a better disposable income when the poverty trap has come. Avoidance of overspending is a way which can be used to ensure that an individual has some money left for saving (Agenor, et al., 2007).
The government has a very important part to play in avoiding poverty traps. It may do this by reducing tax rates and bank lending rates. The problem affecting most taxation policies in most countries is lack of equality and ensuring economic growth.
Agenor, R., Izquierdo, A. and Henning Jensen, T., 2007. Adjustment Policies, Poverty, and Unemployment: the IMMPA framework. Victoria, Australia: Blackwell Publishing Ltd.
Akhter A., Hill, V.,Lisa, C. Smith, D. et al., 2007. The World’s most Deprived: characteristics of Extreme Poverty and Hunger. Washington DC: Mondlane.
Bowles, S., Durlauf, N. and Hoff, K., 2006. Poverty Traps. New York: Princeton University Press.
Fafchamps, M., 2003. Rural poverty, risk and development. Massachusetts: Edward Elgar Publishing Inc.
Mishkin, S., 2007. Monetary Policy Strategy. Massachusetts: Massachusetts Institute of Technology Press.
OECD, 2005. Economic Surveys of Mexico. Available at: .
Causes of Poverty Traps in an Economy, its Results and Ways of Avoiding them