Growth, inequality and poverty
THE most commonly shared development objectives are growth and equity. Growth is usually measured in terms of either aggregate GDP or per capita income. Equity has been traditionally measured in terms of income distribution of which Gini index is a summary indicator (the index is calculated on a scale of 0 to 100; the higher the number, the greater the inequality). Over the last couple of decades, poverty alleviation has been added as an independent dimension to the concept of equity.
A large number of empirical studies, both cross-sectional and inter-temporal, have been conducted to examine the links among growth, inequality and poverty alleviation. These studies were largely inspired by the pioneering work of the well-known economist Simon Kuznets published in 1955. Based on cross-sectional evidence, this study found that as countries grow, inequality initially increases, but starts falling at higher stages of development, giving rise to the so-called "inverted-U hypothesis" characterising the relationship between growth and inequality.
I had contributed to and supervised two Escap studies on growth, inequality and poverty in the late 1990s. In one of these I wrote that the inverted U-hypothesis "at best reflects a trajectory of development followed by certain countries in the past, rather than an inherent validity of increased inequality as a precondition for, or as an inescapable consequence of growth."
I feel less sanguine about this statement now. Based on a review of recent experiences of Asian countries (Bangladesh, China, India, Indonesia, Malaysia, Pakistan, Philippines, Sri Lanka, Thailand and Vietnam), I am inclined to the view that increased inequality is an inescapable consequence of growth, if not a precondition.
What do the numbers show?
Based on data for the early 1990s and the latest available years (between 2004 and 2006), it is observed that of the ten countries mentioned above as many as seven recorded an increase in inequality, measured by Gini index. In the case of Pakistan, it remained unchanged between 1996 and 2006. But Pakistan has not been a star performer in terms of growth. It had the second lowest growth rate among the ten countries during 1990-1997 period and the fourth lowest during 2000-2005 period. In Malaysia, Gini index fell between 1989 and 2004; the country's growth rate also declined drastically to 4.8 percent during 2000-2005 from 8.7 percent during 1990-1997. And Gini index increased in 1997 before the country was hit by a negative growth of over 7 percent in 1998. In Thailand also Gini index fell between 1992 and 2004, so did its growth (7.5 percent during 1990-1997 and 5.4 percent during 2000-2005). Besides, the country had a negative growth of 10.4 percent in 1998. In contrast, countries whose growth rates increased between the two periods (Bangladesh, India, Philippines) or whose growth rates remained high (China, Vietnam) experienced heightened inequality. In Indonesia, Gini index declined between 1996 and 2002 in the backdrop of sharply negative growth in 1998; but as growth accelerated, Gini index rose again such that by 2005 the number was higher than in 1996. The above picture leads to the unsavoury conclusion that inequality is an inescapable by-product of growth. However, growth appears to be an effective antidote to poverty. During 1990-1997 period, eight of the ten countries recorded higher growth than during 1980-1990, excepting Pakistan which witnessed a substantial decline (but the rate was still reasonable at 4.3 percent) and Thailand where growth rate remained about the same -- at a high level of 7.5 percent. During 2000-2005 period, though some of them could not reach pre-1998 crisis high levels, all of them recorded substantially positive growth ranging from a minimum of 4.2 percent in Sri Lanka to 9.6 percent in China. In consequence, poverty, measured by the proportion of people below the poverty line, fell considerably in all countries. The forces underlying the above portrayal of growth inequality-poverty nexus have been extensively discussed in the literature on development economics. Some key elements are briefly noted below. Why does growth increase inequality?
-Growth leads to a shift in composition of output in favour of manufacturing and high-skill services away from agriculture in which income is usually more equitably distributed. -Within the agricultural sector, policies to enhance productivity involving input subsidies and output price support benefit the larger land-owners more than the poor with little or no land. -Growth requires higher levels of savings and investment. The policy measures to accomplish this encompass tax holidays, accelerated depreciation, rebate or exemption of income taxes on dividend, greater reliance on indirect taxes (particularly Vat), lower tax rates on interest income etc. These measures enhance returns to the owners of capital, which is almost invariably unequally distributed. -Inequality tends to increase within labour income as the demand for skilled labour and professionals required for accelerated growth outstrips the supply and, consequently, the income gap between them and unskilled labour (whose supply is more abundant) goes up. -Regional inequality increases as benefits of growth do not percolate extensively to geographically disadvantaged regions with limited access to ports, transport, energy, financial services etc. Why does growth reduce poverty despite increased inequality?
-Growth creates more employment, also for poor, unskilled workers. Apart from direct employment, the poor benefit at least partially from the "trickle down" effect of growth. -Growth generates more resources for the government to deploy for provision of extensive public services such as preventive and primary health care, education, rural infrastructure (e.g. roads, water resources development) etc., which benefit the poor. -With greater availability of resources, governments are in a stronger position to expand the coverage of programs specifically targeted to redress the plight of the poor. Policy implications for Bangladesh
- Bangladesh needs to accelerate growth in order to alleviate poverty at a faster rate. At the present stage of development, poverty alleviation should receive the highest priority, not inequality of income distribution. -Measures aimed at accelerating growth should be complemented by further strengthening of the existing social protection measures specifically directed to the poor. Leakages should be minimised. -Though rising inequality appears to be an inescapable consequence of growth, cross-country evidence does not show any monotonic relationship between the rate of increase of inequality and the growth rate. Hence, there may exist limited policy space to mitigate increase of inequality, though not eliminate it. Efforts should be made to identify areas where policy actions can accelerate growth without seriously aggravating inequality.
Based on data for the early 1990s and the latest available years (between 2004 and 2006), it is observed that of the ten countries mentioned above as many as seven recorded an increase in inequality, measured by Gini index. In the case of Pakistan, it remained unchanged between 1996 and 2006. But Pakistan has not been a star performer in terms of growth. It had the second lowest growth rate among the ten countries during 1990-1997 period and the fourth lowest during 2000-2005 period. In Malaysia, Gini index fell between 1989 and 2004; the country's growth rate also declined drastically to 4.8 percent during 2000-2005 from 8.7 percent during 1990-1997. And Gini index increased in 1997 before the country was hit by a negative growth of over 7 percent in 1998. In Thailand also Gini index fell between 1992 and 2004, so did its growth (7.5 percent during 1990-1997 and 5.4 percent during 2000-2005). Besides, the country had a negative growth of 10.4 percent in 1998. In contrast, countries whose growth rates increased between the two periods (Bangladesh, India, Philippines) or whose growth rates remained high (China, Vietnam) experienced heightened inequality. In Indonesia, Gini index declined between 1996 and 2002 in the backdrop of sharply negative growth in 1998; but as growth accelerated, Gini index rose again such that by 2005 the number was higher than in 1996. The above picture leads to the unsavoury conclusion that inequality is an inescapable by-product of growth. However, growth appears to be an effective antidote to poverty. During 1990-1997 period, eight of the ten countries recorded higher growth than during 1980-1990, excepting Pakistan which witnessed a substantial decline (but the rate was still reasonable at 4.3 percent) and Thailand where growth rate remained about the same -- at a high level of 7.5 percent. During 2000-2005 period, though some of them could not reach pre-1998 crisis high levels, all of them recorded substantially positive growth ranging from a minimum of 4.2 percent in Sri Lanka to 9.6 percent in China. In consequence, poverty, measured by the proportion of people below the poverty line, fell considerably in all countries. The forces underlying the above portrayal of growth inequality-poverty nexus have been extensively discussed in the literature on development economics. Some key elements are briefly noted below. Why does growth increase inequality?
-Growth leads to a shift in composition of output in favour of manufacturing and high-skill services away from agriculture in which income is usually more equitably distributed. -Within the agricultural sector, policies to enhance productivity involving input subsidies and output price support benefit the larger land-owners more than the poor with little or no land. -Growth requires higher levels of savings and investment. The policy measures to accomplish this encompass tax holidays, accelerated depreciation, rebate or exemption of income taxes on dividend, greater reliance on indirect taxes (particularly Vat), lower tax rates on interest income etc. These measures enhance returns to the owners of capital, which is almost invariably unequally distributed. -Inequality tends to increase within labour income as the demand for skilled labour and professionals required for accelerated growth outstrips the supply and, consequently, the income gap between them and unskilled labour (whose supply is more abundant) goes up. -Regional inequality increases as benefits of growth do not percolate extensively to geographically disadvantaged regions with limited access to ports, transport, energy, financial services etc. Why does growth reduce poverty despite increased inequality?
-Growth creates more employment, also for poor, unskilled workers. Apart from direct employment, the poor benefit at least partially from the "trickle down" effect of growth. -Growth generates more resources for the government to deploy for provision of extensive public services such as preventive and primary health care, education, rural infrastructure (e.g. roads, water resources development) etc., which benefit the poor. -With greater availability of resources, governments are in a stronger position to expand the coverage of programs specifically targeted to redress the plight of the poor. Policy implications for Bangladesh
- Bangladesh needs to accelerate growth in order to alleviate poverty at a faster rate. At the present stage of development, poverty alleviation should receive the highest priority, not inequality of income distribution. -Measures aimed at accelerating growth should be complemented by further strengthening of the existing social protection measures specifically directed to the poor. Leakages should be minimised. -Though rising inequality appears to be an inescapable consequence of growth, cross-country evidence does not show any monotonic relationship between the rate of increase of inequality and the growth rate. Hence, there may exist limited policy space to mitigate increase of inequality, though not eliminate it. Efforts should be made to identify areas where policy actions can accelerate growth without seriously aggravating inequality.
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