Macro Vision Monday, April 16, 2012 The Itaú Social Well-Being Index Summary: We constructed an indicator for Brazil taking into consideration not only economic factors, but also human factors and income equality. The results show that changes in well-being sometimes decouple from changes in GDP. But, in general, we observed a notable improvement in well-being for Brazilians in the last 20 years. I Introduction 1 There are evidences that traditional measures of economic performance, such as GDP and consumption, do not necessarily indicate people s well-being. Brazil has been growing at historical high rates in recent years. But has the stronger growth been matched by a corresponding improvement in the quality of life of its citizens? In this report, we present the Itaú Social Well-Being Index, which is our first attempt to try to answer this question. We construct a quantitative indicator similar to the IDH, but one that is more complete and more fitted to Brazilian particularities than the IDH. The results show that changes in well-being sometimes do decouple from changes in GDP. But we observed a notable improvement in well-being for Brazilians in the last 20 years. II The Concept Economists, in general, use in their work a concept of well-being known as consumer utility. For the sake of simplicity, however, they normally take consumption levels as a proxy for consumer utility. In other words, measuring consumer utility means also measuring the quantity of goods and services that he or she consumes. The argument is that economic growth ends up bringing with it better income distribution, improvements in sanitation, more leisure time (due to higher incomes), lower urban criminality, etc. However, this hypothesis no longer seems to hold up. 2 There are evidences that traditional measures of economic performance, such as GDP and consumption, do not necessarily indicate people s well-being. In fact, recent scientific literature suggests that there is not a tight relationship between growth in GDP per capita and growth in happiness or well-being as measured by surveys (that ask people to grade her or his level of satisfaction). The results find strong correlation between income and happiness for individuals living in the same country. Results also point that countries with close per capita income have also similar average happiness. However, there is no consensus on whether there is a relationship between growth in income per capita over time and increase on average happiness in any one nation. In other words, within the same country, the richer, the happier; while between countries, the richer the country, the happier the population. But over time, within the same country, getting richer does not necessarily mean becoming happier. 1 We thank Samuel Pessoa, partner of Tendências Consultoria Integrada and associate researcher at IBRE-FGV, for helping construct the Index and write this report. 2 See the review article, Will GDP Growth Increase Happiness in Developing Countries?, by Andrew E. Clark and Claudia Senik, IZA Discussion Paper No. 5595, March 2011. Please refer to the last page of this report for important disclosures, analyst and additional information. Itaú Unibanco or its subsidiaries may do or seek to do business with companies covered in this research report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the single factor in making their investment decision.
Macro Vision Monday, April 16, 2012 Three explanations were suggested for the lack of a (clear) positive association between growth and happiness over time despite the very clear association in the data from the cross-section. First, the economic development process may affect other dimensions of well-being causing increases in inequality, pollution, the number of hours worked, criminality, etc. If economic growth comes along with more pollution, for instance, growth may not generate higher quality of life. Second, there is a strong signaling element: one individual s well-being only rises if his or her income rises in comparison with the average income in his or her reference group. In other words, one person s happiness depends on his or her relative income (or relative consumption) and not on his or her absolute income (or absolute consumption). The third explanation assumes that people adapt intensively to a new income level. Under this hypothesis, an individual s income gains have a strong impact on his or her well-being, but over time, this impact loses strength as the person adapts to his or her new income level. The person gets used to the higher income level and no longer feels greater well-being. The first explanation is supported by robust empirical evidence. Evidence for the other explanations has also been found, though only partially. Evidence revised by Clark and Senik (2011) shows that the relative-income effect (the second explanation) is not complete. The review also suggests that 40% of the initial income effect on well-being does not disappear in the long run. The strong and intense relationship in the cross-section data suggests that, ceteris paribus, if one country reaches a certain income level, then it should enjoy a satisfaction level that is in line with other countries at the same income level, unless we assume that people in different nations are intrinsically different. The usual hypothesis is that individuals behave in the same way when exposed to the same set of incentives. If this hypothesis is a good starting point, then the first aforementioned explanation (other aspects affecting the well-being) is probably more relevant to prevent increases in happiness in line with increases in income per capita. The fact that fast growth sometimes brings about higher inequality for instance, in Brazil during the so-called economic miracle in the late 1960s and early 1970s, and in China today creates an understanding that many episodes of economic growth do not necessarily prompt increases in average happiness. No one denies the existence of effects from relative-income comparisons and the adaptation of individuals to higher income levels; we are saying only that these effects do not fully eliminate the impact of higher income on happiness. III The Itaú Social Well-Being Index Structure The process of choosing indicators to form an index is complex and requires common sense. The unavailability of data is often a restriction. The indicator must be a fair gauge of progress in the well-being of the entire population, not just of a specific social group or of people living in a given city. We have data on pollution in São Paulo, and we know there has been an improvement in the city s pollution in the last decade, followed by some deterioration in recent years. But we do not have the same information for Brazil as a whole. It would be imprecise to downgrade the well-being index for all Brazilians just because people who live in São Paulo (about 6% of the entire population) are breathing worse air nowadays (although this factor, in fact, worsens well-being). We chose to structure the indicator on three pillars (or sub-indicators): economic conditions, human conditions and social equality. Each sub-indicator is formed by characterizing variables. Let s take a look at each of them. Page 2
1992 Macro Vision Monday, April 16, 2012 Economic Conditions The economic conditions sub-indicator is divided into two blocks: consumption and employment. Well-being cannot be measured only by consumption. But higher purchasing power is undoubtedly an important piece of the quality of life in any society and particularly in Brazilian society, where the repressed consumer demand still seems quite large, notwithstanding the progress of recent years. In order to gauge consumption, we used a proxy for retail sales (inquiries to the Credit Protection System), 3 vehicle sales and consumer inflation (as a gauge of corrosion in purchasing power). Employment is also key to well-being, not only because of the income earned, but also because of the peace of mind that comes with being able to pay the bills. The level of tension in a society rises significantly as unemployment climbs, even in a rich society with high consumption levels, as has been the case in Europe recently. For labor-market indicators, we use the unemployment rate, the participation rate (the percentage of working-age people effectively employed or seeking jobs) and average real income. We collected annual data since 1992 and normalized the series to make them comparable (with values ranging from 0 to 1). Then, we inverted the series in which drops are positive developments (inflation and unemployment). 4 Finally, we Graph 1 - Sub-Indicator 1: Economic Conditions grouped simple averages in two stages: first, 0.9 within each block, and then for both blocks. So consumption and employment each have a 50% weighting in the sub-indicator. 0.7 0.5 0.3 0.1 0 The results can be viewed in Chart 1. The data show that we are clearly able to divide the past two decades into three periods. From 1992 to 1997, there was fast and substantial growth, particularly in consumption, boosted by the Real Plan. From to, there were constant crises in Brazil and in emerging countries, so the indicator shows a slight downward trend, mainly due to rising unemployment. From 2003 on, the sub-indicator rebounds less quickly than in the first period, but for a longer time. Human Conditions The human conditions sub-indicator is divided into three blocks: health and sanitation, education, and security. In Brazil, where approximately half of the population has no access to the sewage system, the health and sanitation block is probably the most important of the whole index. We use five series to characterize it: i) infant mortality; ii) life expectancy; iii) total reported tuberculosis cases as 3 The retail-sales series by the official statistics institute IBGE only starts in 2011, hurting the build-up of a longer series for The Itaú Social Well-Being Index. 4 In order to normalize the series, we used the same methodology as the HDI. For variables without trend, such as the unemployment rate or the homicide rate, each observation normalized in period t (ONt) is calculated as the original variable (Ot) less the smallest value in the series (MiV), divided by the biggest value (MaV) less the smallest value in the series. Thus, ONt=(Ot-MiV)/(MaV-MiV). For series with trend, such as vehicle sales or the real wage bill, the procedure is the same, with the series in natural logarithm. The inversion is done by 1-(Ot). Thus, a variable with a value of 0 turns into 1, turns into, and so forth. Page 3
1992 1992 Macro Vision Monday, April 16, 2012 percentage of total estimated tuberculosis cases; iv) the percentage of the population with a bathroom at home; and v) the percentage of the population with access to the sewage system. The inclusion of a block for education needs no explanation. Especially in Brazil, where additional years of schooling bring substantial higher marginal income gains. In order to characterize this block, we use two complementary indicators. The first measures the population s average years in school. The second is a diffusion index, which is low when the population is concentrated around a certain quantity of years of schooling and high otherwise. For example, if the average schooling is 5 years, but almost everybody in the country has 5 years of schooling (or many have 1 year and many have 10 years), the indicator scores low. But if there are a reasonable amount of people with 1 year, 2 years, and so on, the indicator will score high. The gauge for educational inequality we used the same methodology as in the Gini index. Finally, public security is another relevant source of concern for society. We used a single variable to represent it: the annual rate of homicides in the national territory. Graph 2 - Sub-Indicator 2: Human Conditions 0.7 0.5 0.3 We proceeded with the same treatment for the historical series proceeded in the economicconditions sub-indicator. The result can be seen in Chart 2. In this case, we have two periods that are relatively well characterized. During the first period, from 1997 to 2003, the indicator rises moderately as important gains in education and sanitation are partly offset by a deterioration in security. After 2003, gains in education and sanitation continue (though at marginally lower rates), but the homicide rate starts to drop. Thus, the indicator starts to rise faster. Finally, we would emphasize the stagnation of the last two years, when security worsened again, cancelling out gains in the other two blocks. Social Inequality We opted to create a sub-indicator solely for social inequality, effectively giving more importance to this factor in our well-being gauge. Graph 3 - Sub-Indicator 3: Social Inequality 1.2 1 0 has been virtually constant, particularly after 2003. Social inequality does not necessarily directly improve individual well-being (unlike the two previous sub-indicators). Well-being comes about also indirectly through daily life in a more equal society. Nowadays, given the intense concern regarding the sustainability of growth and improvements in the quality of life, the social-inequality aspect seems particularly important. In order to measure inequality, we used two common indicators: the Gini index and the Theil index, grouping them as in the previous cases. The results are depicted in Chart 3. With the exception of 1993, when Brazil was still fighting hyperinflation, the reduction in social inequality Page 4
1992 1992 Macro Vision Monday, April 16, 2012 IV The Results 1.2 1 0 Graph 4: Itaú Social Well-Being Index The Itaú Social Well-Being Index is a geometric average of the three subindicators described above. The results can be seen in Chart 4. Monetary reform, that stabilized the economy, since not only produced a sudden reversal of the steady deterioration in well-being in Brazil that had been seen in the preceding years, but it also quickly lifted the index upward in the following years. The years and posted the greatest marginal increases in well-being in the analyzed period. A period of stagnation followed. From 1997 to 2001, a period marked by a crisis in the balance of payments in many emerging countries, including Brazil. During this period, improvements in human conditions (except for security) and inequality (at low rates) were offset by worsening economic conditions. Between 1997 and 2001, Brazilians experienced improvement in well-being solely in the year 1999, when the income distribution indicators registered an improvement. Starting in, however, well-being picked up again, with systematic advancements in the three sub-indicators. There were no big jumps, as there had been in /5, but rather a more systematic and continuous advance. From on, the growth in well-being lost some momentum. This slowdown can be tied to the global financial crisis and to an increase in the homicide rate. Progress in education and sanitation was also a bit slower between and. All in all, we observed a notable improvement in well-being for Brazilians in the last 20 years. V - Itaú Social Well-Being Index vs. GDP 1.2 1 0 Graph 5: Itaú Social Well-Being Index vs. Real GDP Itaú Social Well-Being Index outpaced gains in well-being after. GDP So how does the indicator compare with GDP performance? We executed the same normalization of the Itaú Social Well-Being Index series for the series of real GDP at market prices. The comparison between both series is presented in Chart 5. The moderate and relatively stable GDP growth between 1993 and 1997 does not communicate the loss of well-being before the Real Plan and the jump in well-being after the Real Plan. Between 1999 and 2001, GDP advanced as well, while well-being was stagnant. Starting in, both GDP and well-being expanded, but the rise in GDP somewhat Page 5
Macro Vision Monday, April 16, 2012 In short, the comparison between The Itaú Social Well-Being Index and GDP shows that the wellbeing indicator supplies additional information that helps us better understand the evolution of Brazilian society. VI - Itaú Social Well-Being Index vs. HDI The Itaú Social Well-Being Index follows the pattern of the Human Development Index, or HDI, calculated by the United Nations. What improvement does the Itaú Social Well-Being Index bring in relation to the IDH? The HDI, which was created in 1990, focuses on three factors: longevity, education and income. In order to characterize each of these factors, the authors used, respectively, life expectation at birth; the literacy rate and number of years in school; and income per capita. Since 2009, the education index also incorporates average years and expected years in school. In 2011, the United Nations launched the inequality-adjusted HDI by discounting each of the three aspects according to the inequality level as measured by the Atkinson 5 index. We believe the Itaú Social Well-Being Index represents an advance relative to the HDI or the inequality-adjusted HDI. First, the economic aspects of the question are better characterized and captured in more detail, as the limitations imposed by income per capita are widely known. Second, our index incorporates other relevant factors particularly important for Brazil, such as sanitation and urban criminality. Finally, we give greater weight to social inequality, another relevant aspect for Brazil. VII The Challenge Ahead Due to the lack of available data, an important aspect of quality of life was left out of our analysis: the saturation of the physical environment. The saturation of physical space has many dimensions. It may result, for example, in heavy traffic in large cities which has real consequences for people, such as increasing the amount of time spent on the bus or in the car every day to get to work. Another facet of saturation is related to the environment. Variables such as air quality, pollution, and forest devastation may be considered. Trying to incorporate this factor into the Itaú Social Well-Being Index is a challenge for our next edition. Caio Megale Economist 5 Please visit the U.N. website: http://hdr.undp.org/en/ for further details. Page 6
Macro Vision Monday, April 16, 2012 Appendix: Description of the Series Economic Conditions: Inquiries for the System of Credit Protection (SPC). Source: ACSP Annual car sales (units). Source: ANFAVEA Annual change of the Consumer Price Index (IPCA). Source: IBGE Human Conditions: Life expectancy at birth. Source: IBGE Infant mortality (per 1,000 births). Source: IBGE Tuberculosis case detection rate (%, all forms). Source: World Bank Percentage of population that has a bathroom or toilet in the home or property. Source IBGE (PNAD). Average years of schooling. Source: Barro and Lee () Indicator of inequality of education (see description in text) Homicide rate (per 100,000). Source: Ministry of Health and Instituto Sangari Social Inequality Inequality Index - Gini. Source: Ipeadata Inequality Index - Theil. Source: Ipeadata Macro Research at Itaú Ilan Goldfajn Chief Economist Adriano Lopes Artur Passos Aurelio Bicalho Caio Megale Elson Teles Felipe Salles Gabriela Fernandes Giovanna Siniscalchi Guilherme da Nóbrega Guilherme Martins Ítalo Franca Laura Haralyi Luiz G. Cherman Luka Barbosa João Pedro Bumachar Juan Carlos Barboza Mauricio Oreng Natasha Daher Roberto Prado Tel: +5511 3708-2696 E-mail: macro@itaubba-economia.com.br Click here to visit our digital research library. Relevant information 1. This report has been produced by Banco Itaú BBA S.A ( Itaú BBA ), a subsidiary of Itaú Unibanco Holding S.A. ( Itaú Unibanco Holding ), and distributed by the companies, directly or indirectly, controlled by Itaú Unibanco Holding (altogether, Itaú Unibanco Group ). 2. This report is provided for informational purposes only and does not constitute or should not be construed as an offer to buy or sell or solicitation of an offer to buy or sell any financial instrument or to participate in any particular trading strategy in any jurisdiction. The information herein is believed to be reliable as of the date in which this report was issued and has been obtained from public sources believed to be reliable. Itaú Unibanco Group does not make any representation or warranty, express or implied, as to the completeness, reliability or accuracy of such information, nor is this report intended to be a complete statement or summary of the investment strategies, markets or developments referred to herein. Opinions, estimates, and projections expressed herein constitute the current judgment of the analyst responsible for the substance of this report as of the date on which it was issued and are therefore subject to change without notice. Prices and availability of financial instruments are indicative only and subject to change without notice. Itaú Unibanco Group has no obligation to update, modify or amend this report and inform the reader accordingly, except when terminating coverage of the issuer of the securities discussed in this report. 3. The analyst responsible for the production of this report hereby certifies that the views expressed herein accurately and exclusively reflect his or her personal views and opinions about any and all of the subject issuers or securities and were prepared independently and autonomously, including from Itaú Unibanco Group. Because personal views of analysts may differ from one another, the companies of Itaú Unibanco Group may have issued or may issue reports that are inconsistent with, and/or reach different conclusions from, the information presented herein. The analyst responsible for the preparation of this report is not registered and/or qualified as a research analyst with the NYSE or FINRA, and is not associated with Itau BBA USA Securities Inc. and, therefore, may not be subject to Rule 2711 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Page 7
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