Income Disparity vs. Growth


by Ramesh Thakur

Japan Times
November 25, 2001
UN Secretary General Kofi Annan reminded the world recently that the battle against terrorism might have displaced front-page news, but it has not solved pressing problems such as poverty and HIV/AIDS. The international community remains formally committed to the goal of reducing the level of poverty from 30 percent to 15 percent by 2015.

Of course, there is a link: Spirit-sapping poverty and income inequality make it difficult to drain the swamp of terrorism.

Policymakers remain fiercely divided over whether the goal of poverty reduction should be pursued through a single-minded focus on economic growth under the assumption that any social consequences will diminish as the prosperity of the country as a whole rises, or whether the domestic and international distributional impact of market-friendly policies, including adjustments for harsh consequences, must be factored into decisions from the start.

The number of people living in poverty (those who earn less than $1 a day) is stuck stubbornly at 1.2 billion, about one-fifth of the world's population. The number earning less than $2 per day is almost 3 billion.

No one disputes that faster growth is necessary to reduce poverty and the income gap between people. The more challenging question is whether economic growth by itself is enough to achieve the accompanying social goals.

The World Income Inequality Database compiled by the UN University's World Institute for Development Economics Research (WIDER) -- one of the most extensive databases on income inequality in the world -- shows that in most countries the inequality has increased since the early 1980s, sometimes quite sharply: from Argentina, China, Pakistan and South Africa, among the developing nations, to the industrialized ones of Australia, Finland, Japan, Britain and the United States. This is true not only with respect to income levels between regions but also between rural and urban sectors.

The traditional causes of income inequality stem principally from grossly uneven land ownership, different levels of education and urban bias. Most poor people in developing countries still live in the countryside. Skewed land ownership perpetuates rural inequality across generations. Furthermore, landlessness encourages ecological vandalism and soil erosion, thereby diminishing agricultural efficiency through lower yields per acre of farmland.

Abundance of surplus labor in the countryside depresses wages in the cities, contributing to the continuance of urban inequality. This retards productivity and economic efficiency because workers, as in the former communist countries, lack the incentive to do extra work or to labor more productively.

Traditional factors, although still relevant, have not worsened to any significant degree over the past two decades. Rather, the worsening inequality can be traced to "new" factors such as liberal economic policies, especially stabilization and adjustment measures, and the doctrinaire manner of implementing economic reforms. Privatization sometimes has led to the plunder of state assets and the flight of capital and wealth from a country.

Labor-market reforms, meanwhile, have brought not just reduced regulation and greater wage flexibility but also loss of bargaining power through a lower rate of unionization and thus lower wages.

Engagement with the international economy can raise wages in the financial sector to a level that's out of line with the prevailing levels of other sectors. Volatile currency crises resulting from international flows and events can depress income levels and exacerbate inequality in low- and middle-income developing countries, as happened in Indonesia following the Asian financial crisis of 1997.

This is significant because, according to the WIDER study, higher levels of income inequality retard efforts to reduce poverty, regardless of whether economic growth is modest or spectacular. Also, low levels of income inequality inhibit economic growth. The study identifies an "efficient inequality range" as lying somewhere between the low levels of inequality of the Northern European countries and the high levels found in China and the U.S.

The WIDER study also confirms the common-sense view that higher levels of income inequality and poverty are associated with a greater incidence of crime and political instability.

A gloom-and-doom scenario is not inevitable, though. The pressures of rapid technological change and globalization have not dented the commitment and records of some societies in maintaining high rates of economic growth while limiting the income-inequality gap. Canada and Taiwan are cited as two examples of such success.

The WIDER study concludes that the inequality multiplying effects of trade liberalization and technological innovation can be ameliorated by public investment in education (especially of girls) and in financial markets (to deny robber barons opportunities for extracting fat "rents" and to encourage entrepreneurs to invest in productive enterprises instead). Other recommended policy instruments include centralized wage fixing, minimum wages and employment protection/unemployment insurance.

The WIDER study comes down in favor of liberal economic and trade reform regimes to the extent that they are sensitive to distributional impacts on income inequality, regulatory capacity and social safety nets. Literacy, especially female literacy, is a dramatic circuit-breaker in the intergenerational cycle of poverty and income inequality.

Ramesh Thakur is vice rector of the United Nations University in Tokyo. These are his personal views. Further details on the WIDER project are available at the Web site

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