economic growth, inequality and poverty: concepts and...

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Economic Growth, Economic Growth, Inequality and Poverty:Inequality and Poverty:

Concepts Concepts and Measurementand Measurement

Terry McKinleyTerry McKinleyDirector, International Poverty Centre, BrasiliaDirector, International Poverty Centre, Brasilia

Workshop on Macroeconomics and the Workshop on Macroeconomics and the MDGsMDGs, , Lusaka, Zambia, 29 October Lusaka, Zambia, 29 October –– 2 November 20072 November 2007

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A Quick Review of Basic ConceptsA Quick Review of Basic Concepts

A Starting PointA Starting Point: : World Development Report World Development Report 2006: Equity and Development2006: Equity and Development

1.1. Equity has intrinsic value BUT ALSOEquity has intrinsic value BUT ALSO2.2. Equity promotes longEquity promotes long--term developmentterm development3.3. Equity means ‘equal opportunities to pursue a Equity means ‘equal opportunities to pursue a

life of one’s own choosing’life of one’s own choosing’4.4. But the distribution of wealth and power But the distribution of wealth and power

causes an unequal distribution of opportunities causes an unequal distribution of opportunities 5.5. And such inequality has economic costs And such inequality has economic costs

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Are Equity and Prosperity Are Equity and Prosperity Complementary? Complementary?

Start with GDP per capita as a measure of Start with GDP per capita as a measure of Economic Development Economic Development AssumptionsAssumptions: 1) Maximize total welfare 2) total : 1) Maximize total welfare 2) total welfare is equal to total incomewelfare is equal to total incomeAre we maximizing total income or equity?Are we maximizing total income or equity?Maximizing Equity could imply maximizing the welfare Maximizing Equity could imply maximizing the welfare of those with minimum income (the poor) of those with minimum income (the poor)

1.1. But is maximizing equity the best way to maximize total But is maximizing equity the best way to maximize total welfare (i.e., total income)?welfare (i.e., total income)?

2.2. Maybe not: equity and growth are different objectivesMaybe not: equity and growth are different objectives

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Are Equity and Prosperity Are Equity and Prosperity Complementary? Complementary?

Equity might well enhance longEquity might well enhance long--term growthterm growth——or or it might not. Do we know yet?it might not. Do we know yet?Should we justify equity on the basis of promoting Should we justify equity on the basis of promoting growth? Probably a Bad Idea.growth? Probably a Bad Idea.How do we simultaneously maximize two How do we simultaneously maximize two different objectivesdifferent objectives——equity & growth? (a equity & growth? (a combination of macroeconomic, structural and combination of macroeconomic, structural and equityequity--enhancing policies)enhancing policies)Could maximizing equity entail a sacrifice of Could maximizing equity entail a sacrifice of growth? Hopefully not, but possibly.growth? Hopefully not, but possibly.

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The Debate on ProThe Debate on Pro--Poor GrowthPoor Growth

What are the interWhat are the inter--relationships among Poverty, relationships among Poverty, Growth and Inequality?Growth and Inequality?The Objective: Poverty ReductionThe Objective: Poverty ReductionThe Means: Faster Growth and Greater EquityThe Means: Faster Growth and Greater EquityProPro--Poor Growth (PPG) includes both aspects Poor Growth (PPG) includes both aspects Are both absolute and relative improvements Are both absolute and relative improvements necessary?necessary?Growth in Growth in meanmean income per person hides income per person hides various changes across the distribution various changes across the distribution The The meanmean is biased towards higheris biased towards higher--income groupsincome groups

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The Debate on ProThe Debate on Pro--Poor Growth Poor Growth Nanak KakwaniNanak Kakwani of the International Poverty Centre: ‘Proof the International Poverty Centre: ‘Pro--Poor Growth: Poor Growth: Concepts and Measurement’ (2004) Concepts and Measurement’ (2004) www.undpwww.undp--povertycentre.orgpovertycentre.orgMartin Martin RavallionRavallion of the World Bank: ‘Proof the World Bank: ‘Pro--Poor Growth: A Primer’ (2004) Poor Growth: A Primer’ (2004) www.worldbank.orgwww.worldbank.org

Two definitions of PPG:Two definitions of PPG:1.1. PPG #1PPG #1: The incomes of the poor grow faster than those of the : The incomes of the poor grow faster than those of the

nonnon--poor (i.e., a relative improvement) (identified with poor (i.e., a relative improvement) (identified with Kakwani’sKakwani’sposition)position)

2.2. PPG #2PPG #2: growth is poverty: growth is poverty--reducing (reducing (Ravallion’sRavallion’s position)position)

In practice, the definitions of PPG by Kakwani and In practice, the definitions of PPG by Kakwani and RavallionRavallionare similar:are similar:We should maximize poverty reduction: often this involves a We should maximize poverty reduction: often this involves a combination of both faster growth (absolute improvements) combination of both faster growth (absolute improvements) and greater equity (relative improvements)and greater equity (relative improvements)

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The Debate on ProThe Debate on Pro--Poor Growth Poor Growth

Greater equity can be valued as an end in itselfGreater equity can be valued as an end in itself1.1. Insist on relative improvements among the poor as well as absoluInsist on relative improvements among the poor as well as absolute te

improvementsimprovementsOr greater equity can be valued instrumentally: Or greater equity can be valued instrumentally:

1.1. It facilitates poverty reductionIt facilitates poverty reduction2.2. It promotes economic growth (a relatively new position)It promotes economic growth (a relatively new position)

The three major stylized determinants of poverty The three major stylized determinants of poverty reduction:reduction:

1.1. Faster growthFaster growth2.2. A reduction in inequality (ideally at the bottom of the distribuA reduction in inequality (ideally at the bottom of the distribution)tion)3.3. Lower initial inequalityLower initial inequality

Lower initial inequality and/or a reduction of inequality have:Lower initial inequality and/or a reduction of inequality have:1.1. A direct impact on poverty (growth more directly affects the pooA direct impact on poverty (growth more directly affects the poor)r)2.2. An indirect impact by stimulating faster growthAn indirect impact by stimulating faster growth

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The Debate on ProThe Debate on Pro--Poor Growth Poor Growth The The RavallionRavallion and Chen (2003) definition of PPG:and Chen (2003) definition of PPG:

The Rate of PPG = the actual rate of growth X (a constant term XThe Rate of PPG = the actual rate of growth X (a constant term X (1 (1 ––an inequality an inequality index)index)aa))

The Kakwani, The Kakwani, KhandkerKhandker, Son 2004 definition of PPG (IPC , Son 2004 definition of PPG (IPC Working Paper #1):Working Paper #1):

The Poverty Equivalent Growth Rate = the actual growth rate X (tThe Poverty Equivalent Growth Rate = the actual growth rate X (the he total poverty elasticity/poverty elasticity of growthtotal poverty elasticity/poverty elasticity of growth

Elasticity of poverty with respect to incomeElasticity of poverty with respect to income: percentage : percentage change in the poverty headcount over the percentage change change in the poverty headcount over the percentage change in income per capita (growth)in income per capita (growth)Elasticity of poverty with respect to inequalityElasticity of poverty with respect to inequality: percentage : percentage change in the poverty headcount over the percentage change change in the poverty headcount over the percentage change in the in the GiniGini Coefficient (inequality)Coefficient (inequality)Total poverty elasticity: the combined effectTotal poverty elasticity: the combined effect

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Both definitions incorporate growth and inequality Both definitions incorporate growth and inequality factors: Maximize the total poverty elasticity (with factors: Maximize the total poverty elasticity (with respect to both growth and inequality)respect to both growth and inequality)The ComplicationThe Complication: : What is the interaction term What is the interaction term between greater equity and faster growth? Is between greater equity and faster growth? Is it positive (complementary)? Or negative (a it positive (complementary)? Or negative (a tradetrade--off)?off)?MicroMicro--economic research suggests a economic research suggests a positive link but crosspositive link but cross--country regressions country regressions are inconclusive.are inconclusive.Examine the case of growth and distribution Examine the case of growth and distribution in Thailand (Kakwani, in Thailand (Kakwani, KhandkerKhandker, Son 2004), Son 2004)

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ExampleExample: The Poverty Equivalent : The Poverty Equivalent Growth Rate in ThailandGrowth Rate in Thailand

In the early 1990s, growth was high (8%) but In the early 1990s, growth was high (8%) but inequality was rising: the Poverty Equivalent inequality was rising: the Poverty Equivalent growth rate was lower than the actual growth growth rate was lower than the actual growth raterateIn the mid 1990s, economic growth slowed (4%) In the mid 1990s, economic growth slowed (4%) while inequality dropped: The Poverty while inequality dropped: The Poverty Equivalent growth rate was higher than the Equivalent growth rate was higher than the actual rateactual rateBut was there a tradeBut was there a trade--off at work, for example in off at work, for example in 19921992--1996? Which period was better???1996? Which period was better???

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Conclusion: Maximize the total poverty elasticityConclusion: Maximize the total poverty elasticityThe target could be MDG #1: halving extreme The target could be MDG #1: halving extreme income poverty by 2015income poverty by 2015Beware of Poverty Beware of Poverty ElasticitiesElasticities: they differ (based : they differ (based on initial conditionson initial conditions——income and inequality) and income and inequality) and change over time (based on varying growth and change over time (based on varying growth and inequality) inequality) Changing structural factors and cyclical Changing structural factors and cyclical dynamics could cause dynamics could cause elasticitieselasticities to shift (they to shift (they are not constant over time)are not constant over time)

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Mounting 1990s Evidence Mounting 1990s Evidence of Rising Inequalityof Rising Inequality

Full data for the 1990s began to reveal a Full data for the 1990s began to reveal a pattern of rising inequalitypattern of rising inequalityLopez (2006) finds a significant positive correlation Lopez (2006) finds a significant positive correlation between growth and inequalitybetween growth and inequalityA 1% rate of growth is associated with a 0.3A 1% rate of growth is associated with a 0.3--0.5% 0.5% increase in the increase in the GiniGini coefficient coefficient (for growth spells exclusively in the 1990s)(for growth spells exclusively in the 1990s)

Growth has become ‘less proGrowth has become ‘less pro--poor’ (if not poor’ (if not antianti--poor) in the 1990spoor) in the 1990sIn a typical LAC country, for every 1% in growth, the In a typical LAC country, for every 1% in growth, the poverty headcount fell 1% less in the 1990s than earlierpoverty headcount fell 1% less in the 1990s than earlier

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The Need for ProThe Need for Pro--Poor Growth Poor Growth

Over the medium term, distributional changes Over the medium term, distributional changes can cause sizeable changes in povertycan cause sizeable changes in povertyEspecially in middleEspecially in middle--income, highincome, high--inequality inequality countries (e.g., Latin America)countries (e.g., Latin America)Growth is more important for lowGrowth is more important for low--income, lowincome, low--inequality countriesinequality countriesCountry specificity of policies matters a great Country specificity of policies matters a great dealdealWhat is the optimal mix of growth policies and What is the optimal mix of growth policies and inequalityinequality--reducing policies for each country?reducing policies for each country?

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Combining Growth Combining Growth and Inequality Reductionand Inequality Reduction

Both Growth Both Growth and Inequality and Inequality ReductionReduction

Emphasize Emphasize InequalityInequality

High InequalityHigh Inequality

Emphasize Emphasize GrowthGrowth

Growth andGrowth andContaining Containing InequalityInequality

Low InequalityLow Inequality

Low Income Low Income CountriesCountries

Middle IncomeMiddle IncomeCountriesCountries

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The Interaction between The Interaction between Growth and DistributionGrowth and Distribution

Development causes structural changes in both Development causes structural changes in both growth and distribution (Lewis/Kuznets legacy)growth and distribution (Lewis/Kuznets legacy)Development implies dramatic changes in:Development implies dramatic changes in:

1.1. The distribution of resources and productivities across economicThe distribution of resources and productivities across economicsectorssectors

2.2. The distribution of factor endowments and factor returns across The distribution of factor endowments and factor returns across economic agentseconomic agentsSuch structural transformations underlie both Such structural transformations underlie both growth and distributiongrowth and distribution

1.1. Growth and distribution are the results of such structural changGrowth and distribution are the results of such structural changes, es, instead of being independent causesinstead of being independent causes

2.2. Avoid generalizations about the relationship between growth and Avoid generalizations about the relationship between growth and distribution distribution (as though such abstractions are motive forces)(as though such abstractions are motive forces)

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The Interaction between The Interaction between Growth and Distribution Growth and Distribution

There is room for policy interventions in There is room for policy interventions in determining the distributional impact of determining the distributional impact of growthgrowthBut such public policies usually need to modify But such public policies usually need to modify the structural features of the economy to have the structural features of the economy to have any definitive impactany definitive impactInfluence technologies, relative Influence technologies, relative productivities, the distribution of assets productivities, the distribution of assets and resources (McKinley)and resources (McKinley)

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The Reverse Impact of Inequality The Reverse Impact of Inequality and Poverty on Growthand Poverty on Growth

Bourguignon (2004), De Ferranti et al. (2004) Bourguignon (2004), De Ferranti et al. (2004) (‘Inequality in Latin America: Breaking with (‘Inequality in Latin America: Breaking with History’)History’)‘From Vicious to Virtuous Circles: Growth and ‘From Vicious to Virtuous Circles: Growth and Poverty Reduction in Latin America’ (2006)Poverty Reduction in Latin America’ (2006)High Inequality is due to: High Inequality is due to: 1) unequal market returns 1) unequal market returns

based on an unequal distribution of assets (including based on an unequal distribution of assets (including human capital) and 2) regressive public expenditureshuman capital) and 2) regressive public expendituresWealth inequality has become more important Wealth inequality has become more important

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The poor are constrained in many ways The poor are constrained in many ways from building up assetsfrom building up assetsThe WB identifies Imperfect Markets as The WB identifies Imperfect Markets as often the principal problem (often the principal problem (StiglitzStiglitz):):Lack of access to credit markets, so productive Lack of access to credit markets, so productive investments (such as in education) are not madeinvestments (such as in education) are not madeLack of access to land (faulty rental markets, lack of Lack of access to land (faulty rental markets, lack of titling, land concentration)titling, land concentration)Lack of access to insurance markets (to protect against Lack of access to insurance markets (to protect against income losses)income losses)

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‘‘ProPro--Growth Poverty Reduction’ has become as Growth Poverty Reduction’ has become as important as ‘Proimportant as ‘Pro--Poor Growth’Poor Growth’This creates a virtuous circle of growthThis creates a virtuous circle of growth--poverty poverty reductionreduction--growthgrowthOtherwise there could be a vicious circle (‘poverty trap’): Otherwise there could be a vicious circle (‘poverty trap’): high povertyhigh poverty--low growthlow growth--persistently high poverty (Sachs persistently high poverty (Sachs analysis for SSA)analysis for SSA)Poverty Traps are based on insufficient asset holdings, Poverty Traps are based on insufficient asset holdings, reinforced by lack of access to credit and insurance: reinforced by lack of access to credit and insurance: Amassing human capital enables escape from the Trap Amassing human capital enables escape from the Trap (e.g., completing secondary school) Is this enough?(e.g., completing secondary school) Is this enough?

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Estimating equations become more Estimating equations become more complicated:complicated:

PR = y + g + YPR = y + g + Y--11 + G+ G--11 + + ygyg + (P+ (P--11YY--11) ) PR = Poverty ReductionPR = Poverty ReductionY = income, y = growthY = income, y = growthG = G = GiniGini, g = change in , g = change in GiniGiniygyg = interaction term= interaction termPP--11YY--11 = Poverty= Poverty--income interaction (lagged)income interaction (lagged)

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The Policy Implications of the The Policy Implications of the PovertyPoverty--GrowthGrowth--Inequality TriangleInequality Triangle

The WB viewThe WB view: there is a limit to promoting : there is a limit to promoting asset accumulation (e.g., land, capital)asset accumulation (e.g., land, capital)Wealth inequality is pronounced even in Wealth inequality is pronounced even in developed socialdeveloped social--democratic countries (e.g., democratic countries (e.g., Sweden)Sweden)The alternative: emphasize social services and The alternative: emphasize social services and transfer systems (e.g., Conditional Cash transfer systems (e.g., Conditional Cash Transfers): The European modelTransfers): The European modelRedistribution through taxes and transfersRedistribution through taxes and transfersComplement with physical infrastructure (roads, energy)Complement with physical infrastructure (roads, energy)Raise more taxes (from income & property ) for Raise more taxes (from income & property ) for expendituresexpenditures

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Reaction and ReReaction and Re--Evaluation: Evaluation: ‘Inclusive Growth’‘Inclusive Growth’

What Is ‘Inclusive Growth’?:What Is ‘Inclusive Growth’?:More emphasis on growth per se?More emphasis on growth per se?Less emphasis on greater equity? (Less emphasis on greater equity? (Growth Growth withwith Equity Equity of the 1970sof the 1970s))Equity means not ‘leaving the poor behind’: the rate of Equity means not ‘leaving the poor behind’: the rate of change of the income of the poor is equivalent, at least, change of the income of the poor is equivalent, at least, to the rate of change of mean income per personto the rate of change of mean income per person

Some analysts claim that inclusive growth is a more Some analysts claim that inclusive growth is a more progressive term (??)progressive term (??)Example: Faster Growth and more ‘Social Inclusion’?Example: Faster Growth and more ‘Social Inclusion’?

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Policies for Growth, Employment Policies for Growth, Employment and Poverty Reductionand Poverty Reduction

1.1. The Need for Three Sets of PoliciesThe Need for Three Sets of Policies for for Growth, Employment and Poverty Growth, Employment and Poverty ReductionReduction

A.A. Macroeconomic PoliciesMacroeconomic Policies to provide the to provide the conditions for investment and growth (with macro conditions for investment and growth (with macro stability as a constraint rather than the objective)stability as a constraint rather than the objective)

B.B. Structural PoliciesStructural Policies to influence the pattern of to influence the pattern of growth (the elasticity of poverty with respect to income)growth (the elasticity of poverty with respect to income)

C.C. EquityEquity--Enhancing PoliciesEnhancing Policies to improve the to improve the access of poor workers to expanding economic access of poor workers to expanding economic opportunitiesopportunities

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InvestmentInvestment--Focused Focused Macroeconomic PoliciesMacroeconomic Policies

Example: IPC Policy Research Brief #4Example: IPC Policy Research Brief #4, , ‘‘The Macroeconomic Implications of MDGThe Macroeconomic Implications of MDG--Based Strategies in SubBased Strategies in Sub--Saharan Africa’Saharan Africa’

1.1. Fiscal PoliciesFiscal Policies: A) More ‘Expansionary’ B) More focused on public : A) More ‘Expansionary’ B) More focused on public investment (expanding opportunities) and C) More reliant on the investment (expanding opportunities) and C) More reliant on the mobilization of domestic revenuemobilization of domestic revenueA stronger focus on the supply side (e.g., expanding productive A stronger focus on the supply side (e.g., expanding productive capacity, capacity, mobilizing domestic resources, including revenue and savings)mobilizing domestic resources, including revenue and savings)

2.2. ExchangeExchange--Rate PoliciesRate Policies: A) A managed instead of a laissez: A) A managed instead of a laissez--faire faire regime B) Focus on containing external shocks (termsregime B) Focus on containing external shocks (terms--ofof--trade or capital trade or capital outflow shocks) and C) Maintaining a competitive exchange rate (outflow shocks) and C) Maintaining a competitive exchange rate (slightly slightly undervalued, if possible)undervalued, if possible)ExchangeExchange--rate management takes precedence over monetary policies (such rate management takes precedence over monetary policies (such as setting lowas setting low--inflation targets) in open lowinflation targets) in open low--income countriesincome countries

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InvestmentInvestment--Focused Focused Macroeconomic PoliciesMacroeconomic Policies

Monetary PoliciesMonetary Policies: : A) supportive of fiscal expansion and A) supportive of fiscal expansion and export promotion B) provide adequate liquidity to a export promotion B) provide adequate liquidity to a growing economy C) foster low but positive real rates of growing economy C) foster low but positive real rates of interest for private (and public) investmentinterest for private (and public) investmentStrict inflation targeting (especially a low inflation target, Strict inflation targeting (especially a low inflation target, e.g., under 5%) is inconsistent with such an approache.g., under 5%) is inconsistent with such an approachModerate inflation (at least up to 15% per annum) is not Moderate inflation (at least up to 15% per annum) is not detrimental to growth, nor to export promotion (if the detrimental to growth, nor to export promotion (if the exchange rate can be managed) exchange rate can be managed) (Managing the capital account is a corollary of this (Managing the capital account is a corollary of this approachapproach——for capitalfor capital--outflow shocks)outflow shocks)Macroeconomics Policies are broad, blunt Macroeconomics Policies are broad, blunt instrumentsinstruments

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Complementary Structural PoliciesComplementary Structural Policies

Policies that Policies that structurestructure the access to the access to economic opportunities and employmenteconomic opportunities and employment

1.1. Fiscal PoliciesFiscal Policies: Their impact can be differentiated by economic : Their impact can be differentiated by economic sector or employment category (e.g., the location of public sector or employment category (e.g., the location of public investment in infrastructure)investment in infrastructure)

2.2. Financial PoliciesFinancial Policies: access to financial services can be : access to financial services can be differentiated (e.g., increasing access in rural areas)differentiated (e.g., increasing access in rural areas)

3.3. Industrial PoliciesIndustrial Policies: resources can be channeled differentially to : resources can be channeled differentially to various economic sectors or various economic sectors or subsectorssubsectors (e.g., to (e.g., to tradablestradables))

4.4. The Trade RegimeThe Trade Regime: Tariffs can be adjusted by sector or : Tariffs can be adjusted by sector or subsectorsubsector(e.g., protecting agriculture)(e.g., protecting agriculture)

5.5. PublicPublic--Sector Provision of ServicesSector Provision of Services: Expanding access to : Expanding access to services (e.g., water or electricity to rural areas or poor services (e.g., water or electricity to rural areas or poor periperi--urban urban areas) areas)

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Structural Policies and LimitationsStructural Policies and Limitations

Structural policies can be calibrated to help foster Structural policies can be calibrated to help foster productive employment productive employment (e.g., by supporting employment(e.g., by supporting employment--intensive sectors or increasing employment intensity within intensive sectors or increasing employment intensity within sectors)sectors)CrtiicallyCrtiically, such policies involve a Differential , such policies involve a Differential Allocation of Economic ResourcesAllocation of Economic ResourcesHowever, However, liberalisationliberalisation and and privatisationprivatisation remove this remove this discretionary power of the state, leaving resource discretionary power of the state, leaving resource allocation to market mechanisms allocation to market mechanisms The limits of structural policies: Economic The limits of structural policies: Economic opportunities can be expanded without guarantees opportunities can be expanded without guarantees that poor workers will take advantage of themthat poor workers will take advantage of them

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EquityEquity--Enhancing PoliciesEnhancing PoliciesThere is thus a need for EquityThere is thus a need for Equity--Enhancing Policies:Enhancing Policies:They often involve enhancing access of the working population They often involve enhancing access of the working population to education, skill development, technology and, importantly, to education, skill development, technology and, importantly, land and other productive assets and resourcesland and other productive assets and resourcesHouseholds are often poor precisely because their working Households are often poor precisely because their working members lack such accessmembers lack such accessOften it is a case of reshaping or refocusing the impact of Often it is a case of reshaping or refocusing the impact of structural policies, such as providing microstructural policies, such as providing micro--finance or microfinance or micro--insuranceinsuranceSometimes it can involve focusing resources on certain social Sometimes it can involve focusing resources on certain social groupings, e.g., unemployed or underemployed workersgroupings, e.g., unemployed or underemployed workersExamplesExamples: a) an employment guarantee : a) an employment guarantee programmeprogramme b) a cash b) a cash transfer transfer programmeprogramme

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Inclusive versus Inclusive versus ProPro--Poor GrowthPoor Growth

Spreading the benefits of growth through Spreading the benefits of growth through structural policies can make growth more structural policies can make growth more ‘inclusive’, i.e., not leaving the poor ‘behind’‘inclusive’, i.e., not leaving the poor ‘behind’EquityEquity--Enhancing policies can help make growth Enhancing policies can help make growth more ‘promore ‘pro--poor’, i.e., benefiting poor workers poor’, i.e., benefiting poor workers and households more than proportionately. and households more than proportionately. However, this requires focusing resources on However, this requires focusing resources on such beneficiariessuch beneficiariesIt also requires a more ‘bottomIt also requires a more ‘bottom--up’ approach to up’ approach to ‘integrate’ poor workers with available ‘integrate’ poor workers with available employment opportunitiesemployment opportunities

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