Economic Growth, Inequality and Poverty: Concepts and Measurement Terry McKinley Director, International Poverty Centre, Brasilia Workshop on Macroeconomics and the MDGs, Lusaka, Zambia, 29 October 2 November 2007 1
A Quick Review of Basic Concepts A Starting Point: World Development Report 2006: Equity and Development 1. Equity has intrinsic value BUT ALSO 2. Equity promotes long-term development 3. Equity means equal opportunities to pursue a life of one s own choosing 4. But the distribution of wealth and power causes an unequal distribution of opportunities 5. And such inequality has economic costs 2
Are Equity and Prosperity Complementary? Start with GDP per capita as a measure of Economic Development Assumptions: : 1) Maximize total welfare 2) total welfare is equal to total income Are we maximizing total income or equity? Maximizing Equity could imply maximizing the welfare of those with minimum income (the poor) 1. But is maximizing equity the best way to maximize total welfare (i.e., total income)? 2. Maybe not: equity and growth are different objectives 3
Are Equity and Prosperity Complementary? Equity might well enhance long-term growth or or it might not. Do we know yet? Should we justify equity on the basis of promoting growth? Probably a Bad Idea. How do we simultaneously maximize two different objectives equity equity & growth? (a combination of macroeconomic, structural and equity-enhancing enhancing policies) Could maximizing equity entail a sacrifice of growth? Hopefully not, but possibly. 4
The Debate on Pro-Poor Poor Growth What are the inter-relationships relationships among Poverty, Growth and Inequality? The Objective: Poverty Reduction The Means: Faster Growth and Greater Equity Pro-Poor Poor Growth (PPG) includes both aspects Are both absolute and relative improvements necessary? Growth in mean income per person hides various changes across the distribution The mean is biased towards higher-income income groups 5
The Debate on Pro-Poor Poor Growth Nanak Kakwani of the International Poverty Centre: Pro-Poor Poor Growth: Concepts and Measurement (2004) www.undp-povertycentre.org povertycentre.org Martin Ravallion of the World Bank: Pro-Poor Poor Growth: A Primer (2004) www.worldbank.org Two definitions of PPG: 1. PPG #1: : The incomes of the poor grow faster than those of the non-poor (i.e., a relative improvement) (identified with Kakwani s position) 2. PPG #2: : growth is poverty-reducing reducing (Ravallion s( position) In practice, the definitions of PPG by Kakwani and Ravallion are similar: We should maximize poverty reduction: often this involves a combination of both faster growth (absolute improvements) and greater equity (relative improvements) 6
The Debate on Pro-Poor Poor Growth Greater equity can be valued as an end in itself 1. Insist on relative improvements among the poor as well as absolute improvements Or greater equity can be valued instrumentally: 1. It facilitates poverty reduction 2. It promotes economic growth (a relatively new position) The three major stylized determinants of poverty reduction: 1. Faster growth 2. A reduction in inequality (ideally at the bottom of the distribution) tion) 3. Lower initial inequality Lower initial inequality and/or a reduction of inequality have: 1. A direct impact on poverty (growth more directly affects the poor) 2. An indirect impact by stimulating faster growth 7
The Debate on Pro-Poor Poor Growth The Ravallion and Chen (2003) definition of PPG: The Rate of PPG = the actual rate of growth X (a constant term X (1 an inequality index) a ) The Kakwani, Khandker,, Son 2004 definition of PPG (IPC Working Paper #1): The Poverty Equivalent Growth Rate = the actual growth rate X (the total poverty elasticity/poverty elasticity of growth Elasticity of poverty with respect to income: : percentage change in the poverty headcount over the percentage change in income per capita (growth) Elasticity of poverty with respect to inequality: : percentage change in the poverty headcount over the percentage change in the Gini Coefficient (inequality) Total poverty elasticity: the combined effect 8
The Debate on Pro-Poor Poor Growth Both definitions incorporate growth and inequality factors: Maximize the total poverty elasticity (with respect to both growth and inequality) The Complication The Complication: What is the interaction term between greater equity and faster growth? Is it positive (complementary)? Or negative (a trade-off)? Micro-economic research suggests a positive link but cross-country country regressions are inconclusive. Examine the case of growth and distribution in Thailand (Kakwani, Khandker,, Son 2004) 9
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Example: : The Poverty Equivalent Growth Rate in Thailand In the early 1990s, growth was high (8%) but inequality was rising: the Poverty Equivalent growth rate was lower than the actual growth rate In the mid 1990s, economic growth slowed (4%) while inequality dropped: The Poverty Equivalent growth rate was higher than the actual rate But was there a trade-off at work, for example in 1992-1996? 1996? Which period was better??? 11
The Debate on Pro-Poor Poor Growth Conclusion: Maximize the total poverty elasticity The target could be MDG #1: halving extreme income poverty by 2015 Beware of Poverty Elasticities: : they differ (based on initial conditions income income and inequality) and change over time (based on varying growth and inequality) Changing structural factors and cyclical dynamics could cause elasticities to shift (they are not constant over time) 12
Mounting 1990s Evidence of Rising Inequality Full data for the 1990s began to reveal a pattern of rising inequality Lopez (2006) finds a significant positive correlation between growth and inequality A 1% rate of growth is associated with a 0.3-0.5% 0.5% increase in the Gini coefficient (for growth spells exclusively in the 1990s) Growth has become less pro-poor poor (if not anti-poor) in the 1990s In a typical LAC country, for every 1% in growth, the poverty headcount fell 1% less in the 1990s than earlier 13
The Need for Pro-Poor Poor Growth Over the medium term, distributional changes can cause sizeable changes in poverty Especially in middle-income, income, high-inequality inequality countries (e.g., Latin America) Growth is more important for low-income, low- inequality countries Country specificity of policies matters a great deal What is the optimal mix of growth policies and inequality-reducing policies for each country? 14
Combining Growth and Inequality Reduction Middle Income Countries Low Income Countries Low Inequality High Inequality Growth and Containing Inequality Emphasize Inequality Emphasize Growth Both Growth and Inequality Reduction 15
The Interaction between Growth and Distribution Development causes structural changes in both growth and distribution (Lewis/Kuznets legacy) Development implies dramatic changes in: 1. The distribution of resources and productivities across economic sectors 2. The distribution of factor endowments and factor returns across economic agents Such structural transformations underlie both growth and distribution 1. Growth and distribution are the results of such structural changes, instead of being independent causes 2. Avoid generalizations about the relationship between growth and distribution (as though such abstractions are motive forces) 16
The Interaction between Growth and Distribution There is room for policy interventions in determining the distributional impact of growth But such public policies usually need to modify the structural features of the economy to have any definitive impact Influence technologies, relative productivities, the distribution of assets and resources (McKinley) 17
The Reverse Impact of Inequality and Poverty on Growth Bourguignon (2004), De Ferranti et al. (2004) ( Inequality in Latin America: Breaking with History ) From Vicious to Virtuous Circles: Growth and Poverty Reduction in Latin America (2006) High Inequality is due to: 1) unequal market returns based on an unequal distribution of assets (including human capital) and 2) regressive public expenditures Wealth inequality has become more important 18
The Reverse Impact of Inequality and Poverty on Growth The poor are constrained in many ways from building up assets The WB identifies Imperfect Markets as often the principal problem (Stiglitz( Stiglitz): Lack of access to credit markets, so productive investments (such as in education) are not made Lack of access to land (faulty rental markets, lack of titling, land concentration) Lack of access to insurance markets (to protect against income losses) 19
The Reverse Impact of Inequality and Poverty on Growth Pro-Growth Poverty Reduction has become as important as Pro-Poor Poor Growth This creates a virtuous circle of growth-poverty reduction-growth Otherwise there could be a vicious circle ( poverty trap ): high poverty-low growth-persistently high poverty (Sachs analysis for SSA) Poverty Traps are based on insufficient asset holdings, reinforced by lack of access to credit and insurance: Amassing human capital enables escape from the Trap (e.g., completing secondary school) Is this enough? 20
The Reverse Impact of Inequality and Poverty on Growth Estimating equations become more complicated: PR = y + g + Y -1 + G -1 + yg + (P -1 Y -1 ) PR = Poverty Reduction Y = income, y = growth G = Gini,, g = change in Gini yg = interaction term P -1 Y -1 = Poverty-income interaction (lagged) 21
The Policy Implications of the Poverty-Growth Growth-Inequality Triangle The WB view: : there is a limit to promoting asset accumulation (e.g., land, capital) Wealth inequality is pronounced even in developed social-democratic countries (e.g., Sweden) The alternative: emphasize social services and transfer systems (e.g., Conditional Cash Transfers): The European model Redistribution through taxes and transfers Complement with physical infrastructure (roads, energy) Raise more taxes (from income & property ) for expenditures 22
Reaction and Re-Evaluation: Inclusive Growth What Is Inclusive Growth?: More emphasis on growth per se? Less emphasis on greater equity? (Growth( with Equity of the 1970s) Equity means not leaving the poor behind : the rate of change of the income of the poor is equivalent, at least, to the rate of change of mean income per person Some analysts claim that inclusive growth is a more progressive term (??) Example: Faster Growth and more Social Inclusion? 23
Policies for Growth, Employment and Poverty Reduction 1. The Need for Three Sets of Policies for Growth, Employment and Poverty Reduction A. Macroeconomic Policies to provide the conditions for investment and growth (with macro stability as a constraint rather than the objective) B. Structural Policies to influence the pattern of growth (the elasticity of poverty with respect to income) C. Equity-Enhancing Enhancing Policies to improve the access of poor workers to expanding economic opportunities 24
Investment-Focused Macroeconomic Policies Example: IPC Policy Research Brief #4, The Macroeconomic Implications of MDG-Based Strategies in Sub-Saharan Saharan Africa 1. Fiscal Policies: : A) More Expansionary B) More focused on public investment (expanding opportunities) and C) More reliant on the mobilization of domestic revenue A stronger focus on the supply side (e.g., expanding productive capacity, mobilizing domestic resources, including revenue and savings) 2. Exchange-Rate Policies: A) A managed instead of a laissez : A) A managed instead of a laissez-faire regime B) Focus on containing external shocks (terms-of of-trade or capital outflow shocks) and C) Maintaining a competitive exchange rate (slightly( undervalued, if possible) Exchange-rate management takes precedence over monetary policies (such as setting low-inflation targets) in open low-income countries 25
Investment-Focused Macroeconomic Policies Monetary Policies: A) supportive of fiscal expansion and export promotion B) provide adequate liquidity to a growing economy C) foster low but positive real rates of interest for private (and public) investment Strict inflation targeting (especially a low inflation target, e.g., under 5%) is inconsistent with such an approach Moderate inflation (at least up to 15% per annum) is not detrimental to growth, nor to export promotion (if the exchange rate can be managed) (Managing the capital account is a corollary of this approach for capital-outflow shocks) Macroeconomics Policies are broad, blunt instruments 26
Complementary Structural Policies Policies that structure the access to economic opportunities and employment 1. Fiscal Policies: : Their impact can be differentiated by economic sector or employment category (e.g., the location of public investment in infrastructure) 2. Financial Policies: : access to financial services can be differentiated (e.g., increasing access in rural areas) 3. Industrial Policies: : resources can be channeled differentially to various economic sectors or subsectors (e.g., to tradables) 4. The Trade Regime: : Tariffs can be adjusted by sector or subsector (e.g., protecting agriculture) 5. Public-Sector Provision of Services: : Expanding access to services (e.g., water or electricity to rural areas or poor peri-urban areas) 27
Structural Policies and Limitations Structural policies can be calibrated to help foster productive employment (e.g., by supporting employment (e.g., by supporting employment- intensive sectors or increasing employment intensity within sectors) Crtiically,, such policies involve a Differential Allocation of Economic Resources However, liberalisation and privatisation remove this discretionary power of the state, leaving resource allocation to market mechanisms The limits of structural policies: Economic opportunities can be expanded without guarantees that poor workers will take advantage of them 28
Equity-Enhancing Enhancing Policies There is thus a need for Equity- Enhancing Policies: They often involve enhancing access of the working population to education, skill development, technology and, importantly, land and other productive assets and resources Households are often poor precisely because their working members lack such access Often it is a case of reshaping or refocusing the impact of structural policies, such as providing micro-finance or micro- insurance Sometimes it can involve focusing resources on certain social groupings, e.g., unemployed or underemployed workers Examples: : a) an employment guarantee programme b) a cash transfer programme 29
Inclusive versus Pro-Poor Poor Growth Spreading the benefits of growth through structural policies can make growth more inclusive, i.e., not leaving the poor behind Equity-Enhancing Enhancing policies can help make growth more pro-poor, poor, i.e., benefiting poor workers and households more than proportionately. However, this requires focusing resources on such beneficiaries It also requires a more bottom-up approach to integrate poor workers with available employment opportunities 30