Inequalities and growth: A comprehensive ideology emerges in 1990-2010

Inégalités et croissance : l'émergence d'une idéologie globale entre 1990 et 2010
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How economics has addressed inequality
How economics has addressed inequality

Since the 1950s, the relationship between inequality, economic growth and poverty has fuelled intense academic debates that have shaped national policies and development organization strategies. The history of economic ideas reveals changes in the growth paradigm, with a progressively greater focus on how the most disadvantaged can accumulate productive assets. New measurement tools, social programmes and modalities for steering public policy substantiate this change in focus.

Before the World Bank integrated the concepts of inequality and equity into its strategic thinking at the beginning of the 2000s, a lively debate about poverty reduction was taking place in the academic community. It centred on the relationship between poverty, inequality and economic growth on the one hand, and the definition of poverty and in particular its multidimensional nature on the other. We will briefly review the academic history of these ideas before examining how they have permeated operations in the field.

Since poverty reduction depends in large measure on economic growth, the debate about poverty in development economics has long been – above all – a debate about growth. The 1990s saw a double turnaround: growth returned to developed economies, and growth – and therefore development – returned as a topic in economics literature. The early 1980s had seen a major macroeconomic adjustment: inflation born in the aftermath of the oil crisis led the United States to change its monetary policy, increasing scarcity in the money supply and generating higher interest rates. This caused growth to slow worldwide. As the 1990s began, the world came out of this slow-growth period, and what appeared to be sustainable growth took hold. The topic of growth reappeared in economics literature.

First came foundational articles for the “endogenous growth” theory (Romer, 1986; Lucas, 1988), followed by two ground-breaking papers by Robert J. Barro (1991) and Mankiw, Romer and Weil (1992) that tried to identify determinant factors for growth through econometric analysis of cross-country data. An entire literature then developed around this identification of growth factors. The endogenous growth theory had a considerable impact. It contrasted with the 1950s vision of economic growth (e.g. Robert Solow, 1956), which argued that growth is essentially exogenous over the very long term, determined mostly by technological progress and managerial or organizational innovations without taking into account the drivers of that progress. Robert E. Lucas and Paul Romer showed instead that long-range growth rates arise from the preferences of economic agents and from the production and organizational features of a given economy. Their contribution paved the way for subsequent research on the specific growth determinants of individual countries.

However, poverty reduction requires not only growth, but also “inclusive” growth that benefits everyone. The notion of inclusion opens an important second chapter in the poverty-reduction debate: the relationship between growth and inequality. In effect, the relationship goes in two directions, from growth to the inequality of income distribution on the one hand, and from inequality to growth on the other. On the first account, an important hypothesis by Kuznets (1955) suggests that growth can generate more or less inequality depending on the development stage of a country. The theoretical underpinning of the hypothesis had to do with what Lewis (1954) saw as the fundamental (“classical”) model of development. On the second account, some theoretical models show how inequality in wealth distribution and access to credit or education can constrain growth. This runs contrary to the positive relationship previously suggested by some economists, notably the Keynesian Nicolas Kaldor1 (1960); in fact, the recent literature has completely overturned such models. In situations of strong inequality, for instance, entrepreneurs who lack collateral (and therefore access to credit) cannot undertake privately and collectively profitable investments. By contrast, entrepreneurs with collateral or even cash to invest will pursue projects, even those that eventually provide mediocre returns. Through that mechanism, an unequal society may grow more slowly – therefore reducing poverty more slowly – since it misses profitable investment opportunities. Early papers rigorously formalizing this idea include Galor and Zeira (1993) and Banerjee and Newman (1993).

1 Kaldor argued that the wealthy saved more than the poor and consequently, even if distribution was unequal, there were more savings therefore more growth (Kaldor, 1960).

This kind of analysis provided the starting point for a voluminous literature and body of thought on the “poverty-inequality-growth” relationship. Two very frequently cited articles are those by Persson and Tabellini (1994) and Alesina and Rodrik (1994). They show what appears to be a negative correlation between economic growth rates in a sample of countries and the degree of income inequality in these countries. That was enough to convince some in the development community that maintaining inequalities counters growth and poverty reduction, and that reducing inequalities should favour development. Later, development economists and others in the field realized that the situation was far more complex, and that these first empirical constructs were, in fact, weak and little convincing. Better and more complete data showed no unambiguous empirical relationship between inequality and growth2.

2 Forbes (2000) found a positive relationship between inequality and growth, whereas Banerjee and Duflo (2003) showed none of the previous relationships were robust. In the same way that the first attempts at testing Kuznets” hypothesis on a cross-section of countries initially showed an inverted-U relationship between inequality and GDP per capita (cf. Alhuwalia, 1996) – a finding that proved non-robust later on with better and more complete data.

The debate on inequality and growth is directly related to poverty reduction only inasmuch as poverty is defined in monetary terms, as for instance the threshold of 1.25 US dollars a day per person used by international organizations. Yet, such a view seems unduly restrictive. In effect, a multidimensional conception of inequalities has gradually taken hold, with the conviction that economic growth – even egalitarian growth – will not necessarily eradicate all dimensions of poverty. This evolution in thinking owes much to Amartya Sen (1985) and his “capability approach,” which postulates that what matters is not so much an individual’s level of consumption as his or her potential for generating the level to which he or she aspires. Poverty thus means the lack of education, healthcare, access to justice and other opportunities as much as it means material deprivation. Researchers quickly realized that the correlation between various aspects of poverty (thus defined) and income were far from perfect.

Together, these two currents of thought, about the relationship of inequality and growth and the multidimensional character of poverty or ability contributed to considerably expanding the development paradigm by emphasizing the fact that, in the relationship between inequality and growth, it is the inequality of opportunities – that is, unequal access to productive resources, such as education, credit, justice, and government decisions. It is the distribution of such opportunities that ultimately determines both the pace of economic growth, the distribution of income and, therefore the extent of monetary poverty. The 2006 World Bank report entitled Equity and Development exemplifies this evolution in thought: within the World Bank itself, it represented considerable conceptual progress in development policies and strategies.

Growth and inequality: what social insurance model to use?

Social insurance is an important instrument to promote the equality of opportunities and to fight poverty; corresponding policies give some indication about governments” attitudes in this area3. As a matter of fact, it can be observed that governments adopt different attitudes, often changing stances from one period to the next. In developed countries, the 1980s saw the neoliberal revolution, spearheaded by Ronald Reagan and Margaret Thatcher. It led to important reforms in both countries. In the United Kingdom, in particular, the government cut deeply into social insurance programmes, considered too generous and consequently economically inefficient.

3 For the explicit introduction of social protection policies in the inequality-growth framework alluded to earlier, see Benabou (2000).

In continental Europe, the share of social insurance in the gross domestic product (GDP) did not diminish, and even increased in several cases. The shift towards a more liberal view came later. Governments imitated the British model principally by trying to isolate the social insurance system from the functioning of the labour market to minimize its negative effect on economic efficiency. In Denmark, France, Germany and the Netherlands, social insurance systems were initially very much linked to the salaried employment status of people. Initially, only wage-based employment gave entitlement to health insurance, retirement benefits, and certain other social welfare expenditures. Gradually, governments undertook significant reforms to this model. For example, in France a minimum income known as the “active solidarity income” or revenue de solidarité active (RSA, formerly the RMI) is allocated independently of the recipient’s employment status. An increasing share of health insurance is now financed through income taxes rather than through employment taxes. In several continental European countries, governments have moved away from the Bismarckian4 model based on salaried or other work toward a Beveridgien5 model that offers safety nets to everyone, independent of employment status. Of course, this change did not occur in every country; the perception of a common model is illusory. However, the “flexicurity” model used in Denmark has gained in popularity everywhere; it frees market mechanisms while protecting individuals from the risk of entrapment in poverty.

4  Translator’s note: A social insurance system restricted to wage-earning workers in formal companies, and their direct dependents, named after the German chancellor von Bismarck.

5 Translator’s note: A universal social insurance system named after the British economist Lord Beveridge.

In developing countries, we see great diversity in social insurance systems and entitlements. Latin American countries have adopted Bismarckian European systems in a particular way, without achieving universal coverage. In postwar Europe, social insurance tied to salaried employment expanded readily, because salaried workers progressively composed nearly 80%-90% of the labour force. That left the self-employed, professionals, small merchants and a small number of farmers who soon acquired a status similar to that of salaried workers. In Latin America, the extension of the social insurance system did not occur in the absence of sufficiently rapid growth sustained for an adequate period. A dual system resulted: formal-sector labour received social insurance while, until recently, informal-sector workers had none.

Asian countries offer little social insurance, perhaps because of their very rapid growth. In an economy that constantly creates new jobs, households can handle mishaps through increased participation in the work force; this constitutes a kind of insurance. Oddly enough, it took the 1997 Asian crisis to make South Korea recognize the need for a safety net so that individuals could avoid economic hardships. China is coming to the same conclusion for other reasons. Its government is trying to encourage households to consume more to activate its internal growth engine as a future substitute for foreign markets. Chinese households’ excessive savings stems, in part, from the fact that coverage for health problems or retirement remains uncertain or very limited.

Africa presents a special case inasmuch as a large part of its population works in the informal sector, largely escaping the formalism of social insurance; it is the extended family, above all, that covers basic risks.

From “growth at all costs” to accounting for inequalities

International financial institutions have long considered the question of inequalities and social policies of minor importance. In the 1990s, these organizations were very impressed by the Asian model, as evidenced in the publication of a World Bank report, The Asian Miracle: it presented the Asian experience as the model to follow. In countries with very rapid growth, redistribution and social insurance appear to be less acute needs than may be the case elsewhere. In its entry hall, the World Bank inscribed the slogan “Our dream is a world without poverty.” However, the Bank has conceived poverty reduction exclusively as a matter of economic growth; the Asian experience seemed to validate that approach.

By the end of the 1990s, the rather disappointing growth experience of most Latin American countries gave many observers and analysts the feeling that inequality was a powerful impediment to development. This region of the world did not experience the sustained growth seen in Asia, inequality being one of the most obvious differences between the two groups of countries. Inequality was weak in South Korea, Taiwan and Vietnam, and a little less so in China; at the same time, these countries had become the champions of growth worldwide. This fuelled the hypothesis that early inequalities could hamper growth. This comparison, together with an analysis of growth failures in some African countries under predatory political elites – the height of inequality – progressively bolstered the idea that inequalities might play a key role in the growth process.

Today it is widely recognized that poverty does not necessarily and automatically diminish with economic growth, if inequality increases as the economy grows. In Africa, some countries have recently seen rapid growth with, apparently, no poverty reduction. Very high commodity prices lay behind the rapid growth, making it possible to invest in construction and infrastructure, but the growth benefited only a small part of the population. Obviously, in economies with double-digit growth, such as China, it is hard to imagine that the growth process would exclude very much of the population. Yet, it is now well known that poverty declines less quickly with growth when inequality is high, and that at slower growth rates a moderate increase in inequality might be enough to prevent a decline in poverty (Bourguignon, 2003).

In the late 1990s, the World Bank and similar organizations began to consider inequalities an important subject. Joseph Stiglitz and Nicholas Stern, my predecessors as chief economist at the World Bank, were persuaded that inequality was a fundamental dimension of development. In 1996, James Wolfensohn, president of the Bank and friend of Amartya Sen, hired Stiglitz as chief economist. Both had a vision of development that went far beyond per capita GDP growth, but only a minority of the Bank’s staff shared their vision. When I came to the World Bank in 2003, questions of inequality were still seldom discussed, but progress was inarguable. By 2006, the Equity and Development report was a sign that the World Bank, and other international financial institutions, had finally accepted that distribution and redistribution mechanisms played a key role in fostering economic growth and in curbing poverty.

Other international organizations did not need this shift in perspective. In particular, the United Nations (UN) always had inequality at the centre of their development vision; the long-dominant discourse of the World Bank and International Monetary Fund (IMF), which extolled growth at all cost, had never been as strong in the UN. It is true, however, that these two types of institution play very different roles in developing economies. In particular, the UN can have only a limited influence on national implementation policies compared with the substantially more robust means that the international financial institutions may deploy.

However, questions arise about the way these means could be, have been or are actually deployed to serve a certain vision of development. First, it must be understood that a good part of the activity of the World Bank and other development banks is similar to commercial banking and has limited impact on development. Middle-income countries borrow from the World Bank as they would do from any big, international commercial bank, were it not for the Bank’s limited control over the nature of the projects being financed. The views that World Bank staff might hold on development mean little in such cases. In emerging and intermediate-income countries, the ties between loans and development “programmes” have increasingly loosened. The difference with the 1990s is stark. It arises from the expansion of international capital markets, the ease with which emerging countries can take on debt from international commercial operators and the weakening appeal of loans from international financial institutions. This lesser appeal also lessens the leverage that the latter can bring to bear on the development strategies of the countries that they finance.

That said, development programmes have not entirely disappeared, and the World Bank and other international development banks remain present in their implementation, but in a very different way. The banks act more as technical advisers or consultants than as project owners and financiers, as was the case in the past. In Brazil, the World Bank participated in the launch of the conditional transfer programmes to the poorest known as “Bolsa Escola”, which later became “Bolsa Familia,” but has a limited role in the programme’s financing.” Likewise, the Bank was present in the monitoring of “Progresa”6 in Mexico without being involved in its financing. The Bank can share its enormous developing-world and development experience with its partners. This may be a more valuable capital than its ability to raise money on global capital markets for lending middle-income and emerging countries.

6 Translator’s note: PROGRESA (Programa Nacional de Educacion, Salud y Alimentacion) was an anti-poverty programme begun in 1997 to provide poor mothers in rural Mexico with education grants.

The situation is different in low-income countries where the World Bank Group, through its International Development Association, constitutes a genuine development agency like France’s Agency Française de Développement (AFD) or the United Kingdom’s Department for International Development (DIFD); the only difference is that the World Bank can marshal much greater resources. In low-income countries, development projects and programmes still mean a lot, and the evolution of the World Bank’s development vision (as discussed above) takes on its full meaning.

In those countries, a large share of the work of the World Bank and that of regional development banks now centres on individual “capabilities.” This aspect of development was neglected for a long time. After the “trickle-down” or “let’s grow and poverty will automatically lessen” doctrine, which was followed by “let’s grow and redistribute”, we have entered a new stage that aims to facilitate the most-disadvantaged groups” accumulation of productive assets – both “hard” assets, such as land, equipment or housing, and “soft” ones, such as education or access to justice. Such strategies are believed to accelerate both growth and poverty reduction and, of course, to reduce inequalities. In low-income countries, conditional transfer programmes, drawing on the example of Bolsa Familia or Progresa, support the poorest households on the condition that they send their children to school up to a certain age, and that they have their children medically examined twice a year. Such redistribution programmes reduce poverty and also help the poorest accumulate immaterial assets, reducing inequality for future generations. Other types of action with the same overall objective include market-based land reform, irrigation, microcredit, free basic health care and minimum pensions.

Furthermore, while the World Bank has less and less of a role to play with its programmes and loans in emerging countries, it maintains a major role in generating ideas. It often serves as a think tank by producing high-level, original research in fields such as measuring income inequality or the inequality of opportunities. It also very much serves by evaluating specific interventions in terms of their economic efficiency and their impact on poverty. The World Bank publishes reports that discuss alternative development strategies and that recommend specific public policies in China, India and Mexico; these studies often have a major impact because the work is done professionally and supplies innovative development ideas and concepts. From this point of view, the Bank has recently played a major role in reasserting inequality’s place at the centre of governmental concerns.

 

How economics has addressed inequality

Source: compilation by the author.

  • REFERENCES
  • Acemoglu D., Johnson S. and Robinson J., 2005, Institutions as the fundamental cause of long-run growth, in Aghion et Durlauf (eds), Handbook of Economic Growth, Elsevier, 386-415
  • Aghion P. and Bolton R., 1997, "A Theory of TrickleDown Growth and Development", The Review of Economic Studies, 64(2): 151-172.
  • Alkire S. and Foster J., 2011, “Counting and Multidimensional Poverty Measurement”, Journal of Public Economics 95(7-8): 476-87
  • Bourguignon F. and Chakravarty S., 2003, The measurement of multidimensional poverty, Journal of Economic inequality, 1, pp 25-49
  • Dollar D. and Kraay A., 2002, “Growth Is Good for the Poor”, Journal of Economic Growth, Springer, vol. 7(3), pages 195-225
  • Rodrik D., Subramanian A. and Trebbi F., 2004, "Institutions Rule: The Primacy Of Institutions OverGeography And Integration In Economic Development," Journal of Economic Growth, 2004, 9(2): 131-165.
  • Sen A., 1976, Poverty: an ordinal approach to poverty measurement, Econometrica, 44(2): 219-231
     
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Governments show greater sensitivity to inequalities

Governments have clearly shown a change in attitude. In the past, a country’s growth process was evaluated through its GDP growth rate; today, growth rate analysis combines with the distribution of growth’s income production through the population. This involves studying so-called “growth incidence curves,” which show how individuals starting with different income levels have seen their income grow over time. These measurements have become commonplace tools as ideas have evolved and statistics have become available, which was not the case 10-15 years ago. In fact, in parallel with the evolution of ideas stands a revolution in statistics. In an increasing number of countries, we now have the means to produce these graphs and to follow what happened to specific groups of people in the course of development; they have become indispensible tools for decision-makers who want to orient their policies and communicate on their results.

It would be an exaggeration to say that this changing of ideas is universal. But it must be noted that sensitivity to inequality issues has increased in many countries. For example, in China – the champion of growth over the last 30 years – the rise in inequalities has already preoccupied the country’s leaders for some time. The preceding Eleventh Five-Year Development Plan will come to an end this year; its title was “Toward a Harmonious Society” – harmonious in the sense of a more equal and more equitable society. The same concern hovers over several Latin American countries, beginning with the Brazil of Lula da Silva and Dilma Roussef, where great initiatives have begun. Brazil is and remains one of the world’s most unequal countries, but inequality has spectacularly diminished over the last 10-12 years. In the developed world, inequalities remain a source of constant concern for governments in several European countries, including France. Paradoxically, this is less true for the United States, even though inequality is higher there and has sharply increased.

The leading elites do not simply have moral or ethical sensitivities, but also political ones. The elites know that an increase in inequality may lead to conflicts and social tensions. Furthermore, putting social insurance systems in place meets a demand produced by the economic development process. As an economy grows, populations demand more consumer goods, and also more security. Social insurance, above all, is an instantaneous redistribution. It can also bolster an economy’s dynamism. Economic agents feel better about undertaking projects that may be riskier but also more profitable when they feel protected from sickness, old age, or an unexpected loss of income.

A particularly sensitive type of inequality concerns access to decent jobs. The Maghreb and the Arab Spring provide examples, but the situation is equally worrisome in several other Middle Eastern cities, where many young people who have completed their studies are not ready to accept jobs that do not match their expectations. This mismatch in the job market may have serious consequences. It may also exist in other regions of the world. The “decent work” recommended by the International Labour Organisation is certainly a need and perhaps a “right,” but few have access to it in the poorest Asian or African countries.

How economics has addressed inequality

Source: compilation by the author.

  • REFERENCES
  • Acemoglu D., Johnson S. and Robinson J., 2005, Institutions as the fundamental cause of long-run growth, in Aghion et Durlauf (eds), Handbook of Economic Growth, Elsevier, 386-415
  • Aghion P. and Bolton R., 1997, "A Theory of TrickleDown Growth and Development", The Review of Economic Studies, 64(2): 151-172.
  • Alkire S. and Foster J., 2011, “Counting and Multidimensional Poverty Measurement”, Journal of Public Economics 95(7-8): 476-87
  • Bourguignon F. and Chakravarty S., 2003, The measurement of multidimensional poverty, Journal of Economic inequality, 1, pp 25-49
  • Dollar D. and Kraay A., 2002, “Growth Is Good for the Poor”, Journal of Economic Growth, Springer, vol. 7(3), pages 195-225
  • Rodrik D., Subramanian A. and Trebbi F., 2004, "Institutions Rule: The Primacy Of Institutions OverGeography And Integration In Economic Development," Journal of Economic Growth, 2004, 9(2): 131-165.
  • Sen A., 1976, Poverty: an ordinal approach to poverty measurement, Econometrica, 44(2): 219-231
     
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Bibliography
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