$1.25 PPP per day poverty threshold - What precisely does it mean?

Question

As Wikipedia states:

In 2008, the World Bank came out with a revised figure of $1.25 at 2005 purchasing-power parity (PPP).

(Update: In 2015, this was updated to $\$1.90$ at 2015 PPP.)

Wikipedia cites Ravallion, Chen, & Sangraula. "Dollar a Day Revisited", 2009.

Of course, there will always be difficulties with measurement.

But conceptually, what precisely is this $\$1.25$ figure meant to capture?

Does it mean the equivalent of someone having to pay for absolutely everything (food, water, shelter, utilities, transport, education, etc.) with just $\$1.25$ a day, in a place where prices are similar to those of the US average in 2005? Or something else?

Answer 1

A partial answer : I m not sure what measurement the World Bank would recommend, but I suspect that in practice, the expenses that are taken into account to measure whether one is below or above the 1.25$ threshold vary from one study to another.

For instance in their famous The Economic Lives of the Poor, Banerjee and Duflo write

"From each of these surveys we identified the extremely poor as those living in households where the consumption per capita is less than \$1.08 per person per day, as well as the merely “poor” defined as those who live under \$2.16 a day using the PPP in year 1993 as benchmark.3 The use of consumption, rather than income, is motivated by the better quality of the consumption data in these surveys (Deaton, 2004)."

The use of "consumption per capita" suggest that capital income, such as the benefits one get from owning her own house, would not be taken into account. Because data quality considerations seem to enter the picture, it opens the door to much variation from one study to the other.

The above quote however suggests that at equal data quality, income data would be preferred.

Answer 2

The FAQ in the World Bank website provides detailed information about it. Some excerpts below (emphasis mine):

We start with national poverty lines, which usually reflect the line below which a person’s minimum nutritional, clothing, and shelter needs cannot be met in that country. Not surprisingly, richer countries tend to have higher poverty lines, while poorer countries have lower poverty lines.

So they usually reflect only food, clothing and housing costs. Do not include transport or education. However, it depends on how each country defines the national poverty line. Apparently the WB does not alter these lines.

When we want to identify how many people in the world live in extreme poverty, however, we cannot simply add up the national poverty rates of each country, because this would mean using a different yardstick to identify who is poor in each and every country. We therefore need a poverty line that measures poverty in all countries by the same standard.

Aggregating across these lines is not enough. You need to make them comparable. That is where the PPP comes in.

In 1990, a group of independent researchers and the World Bank proposed to measure the world’s poor using the standards of the poorest countries in the World. They examined national poverty lines from some of the poorest countries in the world, and converted the lines to a common currency by using purchasing power parity (PPP) exchange rates. The PPP exchange rates are constructed to ensure that the same quantity of goods and services are priced equivalently across countries.

So what is PPP? According to Chapter 1 in this website:

A Purchasing Power Parity is a form of exchange rate based upon a comparison of prices between countries. The Big Mac Index compiled and published by the Economist is a widely known example of a PPP based on a single consumption item. The Big Mac Index is based on the comparison of its cost between countries compared to its cost in the US. A Big Mac in the Philippines, for example, cost 68 pesos in July 2004 compared to $2.90 in the US. In the Big Mac index, the ratio of the price in pesos divided by the US price is 23.5, and this figure is a basic example of a Purchasing Power Parity between the Philippines and the US. The ratio, 23.5, implies that 23.5 pesos have the same purchasing power as one US dollar. [...] In reality, Purchase Power Parities are prepared using relative prices for a very large number of comparable goods and services because the levels of price differences vary between different items and parts of the economy.

Therefore, the PPP converts local money into US dollar equivalent, for a given year. This means that a person living in the US could get an more or less precise idea of how poor a person living under the poverty line is by comparing their own incomes and prices to those of the poverty line (adjusting the line by inflation based on current year).

You can read more about the PPP and its use for the international poverty line here.