Of course rising income inequality is even worse for contracting economies, and empirical evidence has also shown that poverty rates can increase by up to 14% per year in countries experiencing concurrently falling income growth and rising income inequality. In a recent study published by the World Bank, “Making Transition Work for Everyone”, the results of a simulation suggest that poverty could be reduced by more than 50% in Transition Economies over a 10-year period if the region were to grow at 3.7 percent per year and if growth were shared evenly among the population. The same study suggests that poverty might actually increase among transition economies, if income inequality were to worsen by more than 20 percent and aggregate growth were much lower (World Bank [2000b]).

A simulation of the poverty impact of income inequality under constant growth rates in Latvia further corroborates these results.<sup>18</sup> Under the more unequal distribution of income of the late 1990s, the poverty elasticity with respect to the Gini coefficient is 3.65%, implying that a 1% increase in mean consumption would yield almost a 3.7% reduction in poverty. Although, higher than poverty-income elasticity observed in countries with highly unequal income distribution, this elasticity is lower than the one which would have been obtained under the hypothetical assumption of constant growth rates, with the distribution of income mirrored by that of 1997, which has a lower Gini coefficient. Under that least unequal distributional assumption, the elasticity would be about 4.25%, implying that a 1% increase in mean consumption would yield almost a 4.25% reduction in poverty, _ceteris paribus_ . This represents an income-inequality driven poverty-reduction deficit of over .6 percentage points.

# **III. Dynamics of Poverty and Correlates of Welfare in the late 1990s**

In the absence of an official poverty line, the last World Bank Poverty Assessment used a threshold of 28 LVL per person per month for welfare inference. At the time, that line represented about 50% of the officially accepted minimum crisis basket (MCB), a line then considered too high by the authorities. In fact, during that period, the notional poverty line defined in the 1995 Welfare Law and recommended by the Ministry of Welfare was 2 LVL lower (World Bank [2000a]). Since the last Poverty Assessment, a number of steps have been made toward the establishment of an institutional threshold for welfare inference. Latvian authorities increased the minimum wage to 70 LVL early in 2003 (OECD [2003], IMF [2003]).<sup>19</sup> However, these social reforms have not yet gone as far as defining an official absolute poverty line. Short of such a line, and to allow over time comparisons, we use an update of the last poverty line for welfare inference, following adjustment for inflation over time. In terms of 2000 LVL, the poverty line is established at 30 LVL per person per month, representing about 7% increase and 43% of the revised minimum wage.<sup>20</sup> For sensitivity analysis, the last Poverty Assessment used different poverty lines, depending on the scope of economies of scale parameter θ . The base line scenario assumes absence of economies of scale (θ = 1). The medium line set at 34 LVL was derived under the

> 18 The simulation draws on the methodology developed by Kakwani [1993].

> 19 More recently, in May 2003, the Government of Latvia approved a document, which envisages a gradual increase of a minimum wage from 70 to 139 LVL per month by 2010, with the latter amount set to represent about 50 percent of the average gross wage of the previous year.

> 20 Note that inflation as measured by the consumer price index was much lower in the Euro zone, Latvia’s main trading partner, in the late 1990s. Using a PPP adjusted poverty line, which accounts for the weights of traded goods in the household consumption basket would have produced an even lower poverty line.

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