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equivalence scales and the actual cost of living

July 26, 2012

Recent research published by the Institute for Social and Economic Research (ISER) at the University of Essex provides interesting new insights into changes of income needs as household composition changes. Bollinger, Nicoletti and Pudney used the British Household Panel Survey (BHPS) to analyse how different family structures relate to those families’ abilities to make ends meet. They find that whilst changing from a one-adult household to a two-adult household only marginally increases the required living costs, the addition of a first child almost doubles the required income.

These findings are not only interesting but also important as they have strong implications for how we measure poverty. The extent to which household composition changes income needs is commonly accounted for by using equivalence scales. Those scales translate additional income needs for each additional household member in a ‘weight’ given to that additional household member. Following the findings by Bollinger, Nicoletti and Pudney, an extra adult household member would receive very little weight (say 0.2) as income needs only increase slightly. The first child in that household, however, should be given a weight of a full extra person (i.e. 1) as income needs are said to double. Current equivalence scales, however, work quite the opposite. The modified OECD equivalence scale, the most commonly used scale used for poverty measurement in OECD countries, gives a weight of 0.5 to any additional adult household member. Children, however, are only given a weight of 0.3, implying that households only need 30 percent additional income to cover the costs of a child in the household.   

Implications of using different assumptions with respect to income needs for different household compositions are large. The larger weight given to additional household members, the larger the assumed incomes needs are and thus the higher poverty estimates will be. Given the large discrepancy between the assumed additional income needs for children in the household, such implications are largest in terms of child poverty. The ISER publication estimates that child poverty in the UK could be as much as 30% higher if equivalence scales were adjusted following their research. In other words, current poverty figures are likely to provide a considerable underestimate of child poverty, not only in the UK but also all other OECD countries using the same equivalence scale. Chances are slim, however, that this research will change practice with respect to the use of equivalence scales in poverty measurement. Poverty estimates are highly political and no one would like to see the percentage of people or children living in poverty in their country go up as a result of purely technical change in how these estimates are calculated. That said, research like this may give hope for practice in developing countries where monetary poverty is still largely estimated on a per capita basis. A potential move to using equivalence scales in the future should be well-informed by people’s own perception and opinions about how changes in household composition change the need for financial means.

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