Europe’s soaring inflation and energy prices highlight the need to measure poverty and policy responses in non-monetary ways.
Hard times continue for those on tight budgets in Europe and elsewhere. Despite the end of COVID-19 lockdowns and a return to a new normal economy, soaring prices for necessities such as food, housing, and energy are eating up the purchasing power of households’ incomes with every purchase and bill payment.
Non-monetary indicators of poverty such as the European Union’s (EU) Material and Social Deprivation (MSD) indicator are exceptionally well suited to register the pinches and punches delivered to the purchasing power of households with relatively low resources and/or high needs.
The MSD indicator measures whether households cannot afford items that are considered by most people to be necessary for an adequate living standard. Examples of items are a household’s financial ability to keep their home adequately warm, to have two pairs of properly fitting shoes for every member, and to have an internet connection. A household and its members are considered deprived when they cannot afford 5 out of 13 such items.
The EU’s official income poverty indicator cannot capture the effects of the current crisis on households’ living standards. This is because inflation and soaring energy prices decrease consumption, not income.
During the consecutive crises hitting Europe between 2007 and 2012, the MSD indicator already proved its use registering marked increases in material deprivation and, as recovery took hold, accounting for the lion’s share of the EU’s improvement towards its 2020 social inclusion target.
The MSD indicator will therefore again be the center of political attention and it will show which households are hit hardest. When households cannot influence their income enough to make up for lost purchasing power, rising costs will force them to choose between necessities, which is exactly what the MSD indicator measures.
“The EU’s Material and Social Deprivation (MSD) indicator is exceptionally well suited to register the pinches and punches delivered to the purchasing power of households.”
However, whereas measuring the effect of policies on households’ income is routine practice in governments and among researchers and interest groups, the same does not hold for assessing the effects of such policies on material deprivation.
It is a problem when potentially substantive policy effects are going unmeasured because it could lead to less support for those in need and thus less progress on the reduction of poverty and social inclusion overall. For instance, when policies appear more costly relative to their beneficial effects, decisionmakers may not find them worthwhile of pursuit. Or policies may benefit certain groups in need (e.g., those with a low income) while excluding other groups with similar or higher needs (e.g., those with a higher income and higher needs). Or policies that have a measurable effect on income poverty may appear more effective than policies that reduce the need for households to spend money out of pocket.
A reason why policy effects on material deprivation have gone unmeasured is that, despite the rising use of material deprivation indicators, there was no established methodology to measure such effects. A recently published study showcases a new methodology that estimates the effect of a small increase in income on material and social deprivation in 32 European countries.
The study quantifies the impact of a small universal income transfer and shows that the transfer’s effect is considerably higher in the most deprived countries and among the most deprived persons in a country.
Figure 1 below shows that a very modest transfer of 150 Euro per year, adjusted for differences in purchasing power across countries (PPS), would contribute to reducing MSD rates across Europe. The reductions are sizeable for countries with lower average living standards, with the largest reduction of one percentage point in Romania.
Figure 2 below furthermore shows that the same transfer has a bigger difference for those households experiencing more deprivations in each country. The average marginal effect (AME) of the transfer reduces the average number of deprivations among households experiencing one deprivation is 0.02 in the Czech Republic whereas it is 0.03 for household experiencing five deprivations. This effect is present in all countries, regardless of their living average standard.
These results demonstrate that progressiveness should not just be thought of in terms of income, while also underlining the importance of a progressive social transfer system everywhere.
The same research shows that the impact of extra income depends on the type of social transfers received. Compared to households not receiving transfers and those receiving pension transfers, those in receipt of non-pension transfers, on average, experience the largest decrease in the number of deprivations in Europe. Non-pension transfers include transfers such as child benefits, housing allowances, social assistance, and unemployment or disability benefits. In some Eastern European countries, however, those receiving pensions or both pensions and non-pension transfers also benefit more than average. Such results inform which parts of the social safety contribute to reducing material deprivation and where additional transfers are likely to make the biggest difference.
The methodology developed in this study can be applied to many microdata contexts, including microsimulation datasets. A non-linear regression technique estimates the relation between the number of deprivations and predictor variables such as income, debt burden, and other household characteristics. The methodology can be used to predict effects of potential policies, as was done in the above-mentioned study. It can also be used as part of multivariate techniques that evaluate the effects of policies implemented.
In the context of the current affordability crisis, European countries have implemented policy packages involving measures such as income support, social tariffs, in-kind support, and a cap on energy prices. As many of these measures work either through increasing income or reducing expenditures, they have a “money equivalent” value. Using that monetary value, the new methodology enables estimating the effect of such measures on social and material deprivation.
Finding out by how much such policies reduce poverty and social exclusion, who benefits (most), and by how much is an extremely relevant research effort in a policy context in which there is limited scope for expansionary fiscal policy. And now it is possible to do so.
Read the journal article in Socio-Economic Review: “Reducing poverty and social exclusion in Europe: estimating the marginal effect of income on material deprivation”