By David Dollar and Aart Kraay1
World Bank's Research GroupMarch, 2000
"While the macroeconomic indicators have often looked good, real wages in many countries have declined, and wage inequality has increased both within and between countries." Lori Wallach, leader of the anti-WTO protests in Seattle, on the impact of globalization.
"The global economy governed by international financial institutions, the World Trade Organization, and multinational corporations proposes structural adjustment for countries in the South in the name of fiscal health. The result is increasing poverty, debt, and unemployment." NGO declaration at the UN Conference on Women.
"Globalization has dramatically increased inequality between and within nations." Jay Mazur, in Foreign Affairs.
"We have to reaffirm unambiguously that open markets are the best engine we know of to lift living standards and build shared prosperity." President Bill Clinton, speaking at the World Economic Forum.
An intense debate is going on over the extent to which the poor are benefiting from the growth the world economy experienced during the 1990s. At one end of the spectrum are those—including some of the NGOs that disrupted the WTO meetings in Seattle and tried unsuccessfully to disrupt the World Bank/IMF meetings in Washington—who argue that in general the poor do not benefit from global growth and that all of the benefits accrue to the middle and upper classes. A slightly different view is that the poor may benefit somewhat in absolute terms but that they benefit proportionally less than the average household, so that inequality within countries rises. Finally, there is the view (echoed by Bill Clinton) that countries and households that participate in the global economy will share in prosperity.
In this article we investigate the link between income of the poor (defined as the bottom fifth of the income distribution) and overall income (per capita GDP). We combine data on income of the poor and mean income in 80 countries over four decades, giving us 236 episodes in which we can link growth in the two measures over a period of at least five years. We use these data to investigate some of the hypotheses about the growth-poverty nexus:
Growth Increases Income of the Poor
Our analysis indicates that income of the poor rises one-for-one with overall growth. Although there is a fair amount of variation, this general relation between income of the bottom fifth of the population and per capita GDP holds in a sample of 80 countries covering four decades.
A number of popular views about the poverty-growth relation are not true. First, a well-known idea in the development literature is the Kuznets hypothesis that inequality tends to increase during the early stages of development and decrease later on. We find no tendency for growth to be biased against poor households during the early stages of development: the effect of growth on income of the poor is no different in poor countries (or countries in the early stage of development) than in rich ones (or countries in later stages of development).
Second, we find no evidence that income of the poor falls more than proportionately during economic crises. Of course, the same proportional decline in income has a greater impact on the poor if social safety nets are weak, suggesting that crises may well be harder for the poor to bear. The greater hardship crises impose on poor people does not occur because their income falls more than that of other segments of society, however.
Third, we find no evidence that growth has become less pro-poor than it was in the past. The poverty-growth relation has not changed in recent years.
A Package of Policies Benefits the Poor
We next turn to the second set of hypotheses, concerning the role of institutions and policies in explaining deviations from this basic relation between growth and income of the poor. A core set of institutions and policies (macroeconomic stability, fiscal discipline, openness to trade, establishment of the rule of law) has been identified as pro-growth in the vast empirical literature on growth. It is possible that these policies have a systematically different impact on income of the poor. The popular idea that globalization increases inequality within countries can be tested by determining whether openness can help explain negative deviations in the relation between income of the poor and average income in individual countries. Alternatively, there may be institutions and policies that have not been established as robust determinants of growth but that are often thought to be good for the poor (notably democracy and social spending). The hypothesis that these institutions and policies are good for the poor can be tested by determining whether they explain positive deviations in the relation between income of the poor and mean income.
We find that openness to international trade raises income of the poor by raising overall income, with insignificant effects on the distribution of income. The same is true for improved rule of law and reduced government size, which raise overall per capita GDP but do not significantly influence the distribution of income. Stabilizing inflation is a super–pro-poor policy: not only does it raise overall income, it appears to have an additional positive effect on the distribution of income.
From this we conclude that the basic policy package of private property rights, fiscal discipline, macroeconomic stability, and openness to trade increases income of the poor to the same extent that it increases income of other households. This is not the result of a "trickle-down" process, in which the rich get richer first and eventually benefits trickle down to the poor. Instead, the evidence suggests that private property rights, stability, and openness directly create a good environment in which poor households can increase their production and income.
We also examine a number of institutions and policies for which the evidence of their growth impact is less robust but which may nevertheless have an impact on the well-being of the poor by improving the distribution of income. Most notable among these are government social spending, formal democratic institutions (voice and accountability), and primary school enrollment rates. Voice has a small, statistically insignificant effect on growth and offsetting distribution effects, suggesting that income of the poor is not influenced directly by formal democratic institutions. Primary education has a beneficial effect on growth but no perceptible effect on income distribution. Public social expenditure shows little effect on either growth or distribution. This reminds us that in many countries public expenditure on social services often fails to target the poor effectively.
Standard Pro-Growth Policies Are Good for the Poor
Contrary to popular myths, standard pro-growth macroeconomic policies are good for the poor, raising mean income without significantly affecting the distribution of income. In fact, macroeconomic stability (proxied in our analysis by stabilization of high inflation) tends to improve income distribution, increasing income of the poor by more than mean income. Other policies, such as establishing the rule of law and openness to trade, benefit the poor and the rest of the economy equally. We find no evidence that formal democratic institutions or heavy government spending on social services has any effect on income of the poor. The growth-poverty relation has not changed over time, does not vary during crises, and is generally the same in rich countries and poor ones.
We do not want to be misinterpreted as arguing that growth is all that is needed to improve the lives of the poor. But we do want to get the message out that growth generally benefits the poor and that anyone who cares about the poor should favor the growth-enhancing policies of good rule of law, fiscal discipline, and openness to international trade.
1David Dollar is team leader and Aart Kraay senior economist at DECRG-MG.
More Information on Inequality of Wealth and Income Distribution
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