assumption of a constant ratio between the median monthly household per capita expenditure and the base poverty line. In this particular case, the ratio between the median per capita income and the adjusted poverty line is about 1.95, owing to rapid increase in income in the recovery phase of the transitional period.<sup>21</sup> Assuming moderate economies of scale (θ = 8. ), household per capita median expenditure is about 66.6 LVL, and the corresponding poverty line is therefore about 35 LVL. This represents about a 3 percent increase, and 50 percent of the revised minimum wage.

The use of economies of scale in poverty analysis in Latvia was first introduced by Gassmann [1998]. Using different values of θ , the author concluded that the ranking of households on the basis of their welfare was relatively stable to changing economies of scale. A variation of that approach was used to assess the potential impact of economies of scale under three scenarios: absence of economies of scale (θ = 1), moderate economies of scale (θ = 8. ), and significant economies of scale (θ = 6. ), (World Bank [2000a]). Similarly, the last Poverty Assessment concluded that allowing for economies of scale had no significant impact on the poverty mapping. Indeed, despite the urban-rural bias in the poverty gap, which is one of the characteristic features of many low-income and developing countries, the demographic structure and household size in urban and rural areas are not markedly different in Latvia.<sup>22</sup> As a result, the sensitivity analysis undertaken in the context of this study emphasizes the welfare effects of changing poverty lines. The potential effects of economies of scale are restricted to the moderate economies of scale assumption, which is tested against the base case.

Despite the surge in and persistence of income inequality, the time profile of poverty shows a slight improvement of welfare and living standards in Latvia between 1997 and 2000, owing to an exceptionally large increase in per capita income, especially urban income. The positive shift in the median of the distribution of monthly per capita household expenditure is more than mirrored by the mean per capita household expenditure (see Table 1). The latter is more sensitive to extreme values, and increased even more rapidly, from about 58 LVL to over 74 LVL, representing about a 28 percent increase. With an increase in household income of that magnitude, the incidence of poverty fell by over 27 percent at the national level, from about 19.4% to less than 14 percent (see Table 2).<sup>23</sup> The table provides estimates of the headcount, the poverty gap and severity indices over the two reference periods, and across all geographic

> 21 Between 1997 and 2000, the median household per capita expenditure increased by about 23%, from 47 to 58 LVL. 22 In fact urban areas account for about 70% of the total population. Unlike most developing countries, urban and rural household size and structure are not markedly different: between 1997 and 2000, the average household size was relatively stable, around 2.33 in urban areas and 2.50 in rural areas. In Sub-Saharan African countries, average household sizes are larger, and urban-rural differences are more important. In the Gambia for instance, the average household size was about 8.9 at the national level, 11.4 in rural areas and 7.1 in urban areas. At the same time significant differences existed across expenditure quintiles, with the lowest quintile having an average household size of 14, and the uppermost quintile having an average of 7 (World Bank [1998]).

> 23 Naturally, using a higher poverty line will lead to slower decline in poverty; for instance, assuming a 20% increase in the median income in a recent study carried out by the Central Statistics Bureau lead to a slower decline in poverty.

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