Comments: Nancy Birdsall
- Ke-young Chu, Sanjeev Gupta, and Vito Tanzi
- Published Date:
- May 1999
I would like to begin by congratulating the IMF for using its convocatory power to bring visibility and credibility to this critical issue of equity. Anthony Atkinson’s paper is both thoughtful and thought-provoking. Thinking of Latin America, it made me more worried than ever about the region’s inequality problem, and more convinced than ever about the necessity of aggressive compensatory policy—antidotes to the toxin Latin America’s income inequality injects into its economic, social, and political systems. Let me explain.
A Vicious Circle?
In the last four to five years of apparently increasing income inequality, the critical question for economists has been the following: Are increasingly integrated markets—for capital, as well as goods and services—exacerbating disequalizing processes? On this question, OECD countries, and especially the United States, have received considerable attention, because of the political controversy about the merits of free trade agreements. The question is important for developing countries as well.
About this question, Atkinson makes two points. First, at least for Europe, the answer is not clear. Why? Because government policy and social institutions can apparently offset any disequalizing processes, including by directly affecting wages, as decreasing wage dispersion in the 1990s in Germany and Italy shows. To quote Atkinson: “The economic constraints on national governments are exaggerated; if globalization has limited the power to redistribute, then this limit is largely political in origin.”
That seems good. But Atkinson makes a second, related point that is less heartening (perhaps referring implicitly to his own country, England): “Widening wage dispersion can result not just from shifts in the demand for skill but also from changes in social norms.” As more and more people are remunerated outside the conventional norms, the acceptable range widens. For exogenous reasons (e.g., the “political” pressures globalization brings), it becomes socially acceptable to have larger differentials within the workplace.
This raises the specter of a potential vicious circle: Are the pressures of globalization (wage dispersion, a decline in the tax burden on so-called footloose capital) shifting norms and expectations, making it more acceptable for governments to back away from their traditional redistributive (or, I would prefer to say, “compensatory”) role, even though there is no systematic evidence that governments with strong compensatory programs preside over less efficient economies?
The Case of Latin America
The possibility of endogenous social norms, and thus endogenicity of long-run government policy away from any redistributive or compensatory role, is troubling in the context of Latin America. To illustrate why, let me make four points.
- First, Latin America starts with an apparently high social tolerance for inequality (Figure 5.6). Don’t be fooled by the region’s historic bursts of populism, which have not supported any sustained redistributive policies (on the contrary). Indeed, the failure of fiscally destructive populist policies seems to have positioned even poor voters against any hint of redistributive politics in many Latin American countries.
- Second, Latin America’s inequality appears to be “destructive inequality.”
Figure 5.6.Income Inequality and Growth of GDP, 1965–92
Sources: Klaus Deininger and Lyn Squire, “A New Data Set Measuring Income Inequality,” World Bank Economic Review, Vol. 10 (September 1996), for income inequality data; Penn World Tables (various years) for growth data.
Note: Income inequality is measured as the ratio of the income share of the richest 20 percent to the share of the poorest 20 percent of the population. Observation is average of high-quality data available for 1965–92. Growth data unavailable for 1965–92 period for the following countries (years used in parentheses): Botswana (1965–89), Korea (1965–91), Nepal (1965–89), Sudan (1970–91), Taiwan (1965–91), Zambia (1965–91).
To understand this second point, it is useful to distinguish between what might be called constructive inequality and destructive inequality. Constructive inequality reflects a set of incentives that encourages innovation and hard work; it is a form of inequality that is consistent with, and supportive of, economic efficiency. Destructive inequality entails perverse incentives; the poor are excluded while the rich benefit from privileges and rents. Destructive inequality is not growth-enhancing. (The same distinction can be made when considering social mobility.)
Latin America’s inequality is destructive, in that it is associated with low aggregate growth (again Figure 5.6) and with worsening poverty (Figure 5.7). For example, if the pattern of income distribution in the 1990s had not worsened relative to the 1970s, the number of poor in the 1990s would have been reduced from about 150 million to about 120 million (the difference between the two lines in Figure 5.7).
Figure 5.7.Latin America: The Impact of Inequality on Poverty
Source: Nancy Birdsall and Juan Luis Londoño, “Asset Inequality Matters: An Assessment of the World Bank’s Approach to Poverty Reduction,” American Economic Review, Vol. 87, No. 2 (May 1997).
- Third, during this decade, whether because of the opening of markets or skill-biased technological change, or both, the bottom line is that wage differentials between skilled and unskilled workers have increased substantially in most countries studied—with the interesting exception of Costa Rica, where education indicators are high (Figure 5.8).
- Fourth, these widening wage disparities seem to be rooted in an unhappy history of highly unequal access to effective education and limited success in reducing that inequality, at least compared to East Asia (Figure 5.9).
Figure 5.8.Real Wage Growth for Skilled and Unskilled Labor, Selected Latin American Countries
Source: E. Lora and G. Márquez, “The Employment Problem in Latin America: Perceptions and Stylized Facts?” citing S. Duryea and M. Székely, “Labor Markets in Latin America: A Supply-Side Story,” papers prepared for the seminar “Employment in Latin America: What Is the Problem and How to Address It?” at the Inter-American Development Bank Annual Meeting of the Board of Governors, Cartagena de Indias, Colombia, March 15, 1998.
Figure 5.9.Inequality of Human Capital: A Regional Comparison
Source: Nancy Birdsall and Juan Luis Londoño, “No Trade-off: Efficient Growth Via More Equal Human Capital Accumulation in Latin America,” in Beyond Trade-offs: Market Reforms and Equitable Growth in Latin America, ed. by Nancy Birdsall, Carol Graham, and Richard Sabot (Washington, D.C.: Brookings Institution and Inter-American Development Bank, 1998).
Note: East Asia includes Hong Kong, Indonesia, Republic of Korea, Malaysia, Singapore, Taiwan, and Thailand. “Human capital inequality” is measured here by the mean-adjusted standard deviation of years of education, calculated using Barro-Lee’s (1993) education attainment data. (Robert Barro and Jong-Wha Lee, “International Comparisons of Educational Attainment,” Working Paper No. 4349 (Cambridge, Massachusetts: National Bureau of Economic Research, 1993)).
This fourth point has negative implications for intergenerational mobility. There is some evidence, from a study of the link between family variables and children’s education, and how public spending on education affects that link, that in most countries of Latin America, government spending on education reinforces rather than offsets inequality (i.e., spending on education is the opposite of compensatory).1
So, in the highly unequal societies of Latin America, a history of highly unequal education has set the stage for market reforms to generate rising wage differentials. In the medium term, opening of markets and other economic reforms will clearly help the poor (certainly the defeat of inflation helps) and reduce windfall rents to the very rich. But in the short run, the tough reality is that market reforms enhance returns to existing assets, especially to education, widening wage differentials.
Atkinson implicitly suggests that short-run results may affect long-run social norms, so that equal societies (e.g., England) can become more unequal if societal standards of equity are stretched by widening wage differentials to include greater tolerance of inequality. This implies that societies that are already unequal can get stuck in an “unequal equilibrium trap.” An unequal equilibrium trap is especially worrying if, as in Latin America (more than in Europe), it is associated with what I have called destructive inequality—reflecting exclusion of those at the bottom via unequal access to the critical asset of education in a global market with a high premium on skills—in short, systematic inequality of opportunity that undermines aggregate growth as well as reduces individual and family welfare.
Atkinson’s thought-provoking insertion of endogenous social norms into the picture suggests the disturbing possibility that inequality breeds inequality. To escape that unhappy equilibrium requires particularly aggressive compensatory policy by governments—especially, but not only, in education, the key to opening up opportunities supported by much more analytic work by economists, and by more public discussion of the politics as well as the economics of inequality.