Growth with redistribution necessary for poverty reduction

by Chakravarthi Raghavan

Geneva, 8 May 2001 - Redistribution at the margins is far more effective in poverty reduction than increases in economic growth that are distribution neutral, according to an International Labour Office study by Hulya Daddeviern, Rolph van der Hoeven and John Weeks.

The study in the ILO employment paper series challenges the orthodox mainstream neoliberal view, embedded in the Washington Consensus approach that growth itself would be a vehicle for poverty reduction, achieved through the ‘trickle-down’ mechanisms “not always clearly specified.”

The ILO study points out that there has been increasing evidence that inequality and poverty have risen in many countries in the 1980s and 1990s, including some of the OECD countries.

Apart from the ILO study itself, other recent writings in establishment journals (Foreign Affairs Jan-Feb, the London weekly Economist of 28 April), have also confirmed that contrary to the mainstream thought - that globalisation will lead to widespread improvement and prosperity, with incomes converging as poor countries grow more rapidly than the rich - average incomes are growing, but so have been the income-gap between rich and poor countries, and income inequalities within countries.

In the Economist, Prof. Robert Wade cites data and shows that the global distribution of income is becoming ever more unequal, and that there are ‘winners and losers’ in the globalisation process; that technological change and financial liberalization has resulted in a disproportionately fast increase in number of house-holds at the extreme rich end, without shrinking the distribution at the poor end; that prices of goods and services exported from the high-income countries are increasing faster than the prices of goods and services exported by the low-income countries, and must faster than the prices of goods and services produced in low-income countries that do little international trade; and thus the poorer countries and poorer two-thirds of the world population suffer a double marginalisation: once through incomes and the second time through prices.

In an editorial comment, the Economist says the ‘really new alarming finding’ of Wade is that the extent of absolute poverty in much of the world has increased, and adds” Certainly this ought to concentrate the minds of policy-makers”.

In the Foreign Affairs journal, Bruce Scott, Professor of Business Administration at the Harvard Business School writes about the ‘Great divide in the Global Village’, and notes that though international markets for goods and capital have opened up and multilateral organizations articulate rules and monitor the world economy, economic inequality among countries continue to increase, with some two billion people living now on less than $2 a day. Scott notes that since the rich nations are unlikely to lower their agricultural and immigration barriers, they must recognize that politics is the key cause of economic inequality, and recognise that the Washington consensus view that free markets will brig about economic convergence is mistaken, and that their own particular strategies are the best for all countries. “.. They should allow poorer countries considerable freedom to tailor development strategies to their own circumstances... in this the role of the state becomes pivotal.”

Free trade, Scott says, remains the right model for rich countries because it provides decentralized initiatives to search for tomorrow’s market opportunities, “but it does not necessarily promote development.” Britain, he points out, did not adopt free trade until the 1840s, “long after it had become the world’s leading industrial power... lower trade barriers may help avoid even worse strategies at hands of bad governments, but the Washington consensus model remains best suited for those who are ahead rather than behind.” The Washington consensus on the universality of the rich-country model is “both simplistic and self-serving” and the world needs “a more pragmatic, country-by-country approach, with room for neo-mercantalist regimes until such countries are firmly on the convergence track. Poor nations should be allowed to do what today’s rich countries did to get ahead, not be forced to adopt the laissez-faire approach.

The ILO study looks at the distribution issues and problems within countries.  Surveying the literature, the three authors note that of the many issues central to the development process, few have bee characterised by the shifts, reversals and reaffirmations that have plagued the analysis of interaction of growth, poverty and inequality. “The literature has not so much evolved, as fluctuated over the past 50 years;” the authors comment.

The view from the 1950s into the 1970s was of a probably trade-off between growth and income distribution, and derived in part from the Kuznets ‘inverted U-hypothesis’ that inequality would rise in the initial phase and decline after reaching some crucial level. In the 1970s, emphasis shifted to redistributive mechanisms, but this focus was short-lived, abandoned with the rise of neo-liberalism and the Washington Consensus in the 1980s, which saw growth itself would be the vehicle for poverty reduction, achieved through not-clearly-specified trickle-down mechanisms.

However, in the 1990s a number of studies have challenged this sanguine view that orthodox macro-policies were by their nature poverty reducing.. There has been accumulating empirical evidence that there is no consistent relationship among growth, inequality and poverty across countries and over time. In many African and Latin American countries, as well as countries in transition, stabilisation and adjustment policies appear to have had an adverse impact on poverty and inequality, or at best did not improve conditions of the poor.

The authors of the ILO study note that empirical evidence suggests that productivity raising redistribution ensures that distribution does not reduce poverty at the expense of growth, and produces sustainable poverty reduction.  Enhancing asset ownership for the poor is the clearest way to accomplish this.

“Investment in infrastructure, credit targeted to the poor, land redistribution and education can all be important mechanisms to make growth ‘pro-poor’.”

In the 1990s, there was considerable stress on education, perhaps because it was seen as relatively non- controversial, but has limitations in poverty-reduction contexts, since accumulated education as such cannot be sold by the asset-holder, while land and other tangible property can. “If a worker loses his or her job during a general fall in aggregate demand, education provides no asset that can act as a safety-net when sources of livelihood are temporarily lost. People may be able to borrow on the basis of their human capital, but physical assets can serve as collateral or be sold.

The IMF and World Bank programmes of ‘social safety nets’ and ‘social funds’ in some countries, to target ‘adjustment-induced poverty’, the ILO study notes have been typically designed for a limited period. While these programmes, sometimes financed by multilateral loans, have had some positive impact on the ‘adjustment losers’, they did not necessarily reach the poor.

On the issue of land distribution and income distribution, the study notes that land re-distribution from large landowners to landless peasants involves a one-off administrative cost which once implemented could be left to generate more equal distribution and lower poverty levels. However, land redistribution unaccompanied by rural development expenditures might generate a class of poverty-stricken small-holders.

Most of the land redistribution programmes in Latin America, the study finds, proved in practice to be poverty- generating rather than poverty-reducing. Land redistribution that generates sustainable poverty reduction may require substantial current expenditures, which in the medium term could equal or exceed the cost of administering a progressive tax system and pro-poor distribution of expenditures.

Targeting of public expenditure to the poor, the study finds may involve problems in developing countries - hidden administrative costs, borderline problems (of the poor below the poverty line being raised just above). But targeting is more likely to be effective if the poor are a small proportion of the population, and poverty is not the major problem. But where poverty is widespread, the administrative cost, identification (of the poor) , monitoring and delivery of programmes may outweigh benefits.

On the ideas about credit and self-employment to escape poverty, the study says:

“The idea that most low-income wage earners could escape poverty through self-employment somewhat challenges the imagination, as well as historical trends.”

The ILO study authors say that the most important point emerging from their survey of the literature is the growing consensus that countries with an ‘initial condition’ of relatively egalitarian distribution of assets and income tend to grow faster than countries with high initial inequality. This means reducing inequality strikes a double blow against poverty.

On the one hand, a growth path characterised by greater equality at the margin directly benefits the poor in the short.-run. On the other hand, the resulting decrease in inequality creates in each period an ‘initial condition’ for the future that is growth enhancing.. “Thus any growth path that reduces inequality reduces poverty through redistribution and via trickle down.”

On the basis of simulation exercises for 50 countries - a 1% percent distribution-neutral increase in per capita incomes, a 1% increase in per capita distributed equally across income percentiles and a 1% redistribution of income from the richest 20 percent to the poorest 20 percent - the study finds that for most countries equally distributed growth proves to be more effective in reducing poverty.

For a large proportion of the countries, “equal distribution growth raises three times as many households from poverty than distribution neutral growth over any time period.”

The benefits of equal distribution growth are found to be greater the higher the country’s per capita is, and the higher its Gini coefficient (a measurement of inequality).

The study finds that the simulation results imply that “growth with redistribution would be particularly appropriate for the Latin American countries and those of North Africa and Middle East.”

But its poverty reducing advantage would be less for sub-Saharan countries, except South Africa, because of their low per capital incomes.

“However,” says the study, “no matter what a country’s per capital income or degree of inequality, redistribution with growth is more efficient that distribution neutral growth in reducing the intensity of poverty. This is because the relative benefit of equal distribution growth increases as one moves down the income distribution, independently of a country’s per capital income or degree of inequality.”

The study finds that redistribution strategies, both taxation (income and corporate) and expenditure instruments, are most appropriate for poverty reduction in middle-income countries, since their per capita incomes are high relatively to the absolute poverty line. This class of countries include the larger ones in Latin America (Argentina, Brazil, Chile, Mexico and Venezuela), several Asian countries (South Korea, Thailand and Malaysia) and virtually all former socialist countries of Central and Eastern Europe.

For a second group of countries, with low per capita incomes or relatively equal distribution or a combination of the two, redistribution with growth is an appropriate policy for effective poverty reduction.

Countries with more than 50% of their population in poverty as a result of their low per capita income, growth as such is the most effective vehicle for poverty reduction.

However, for any group of countries, growth alone is a rather blunt instrument for poverty reduction, since such growth is distribution neutral.

Thus a new agenda for poverty reduction should focus on specific policies and instruments of redistribution, with the goal of substantial reductions in urban and rural poverty in the medium-term, the study concludes. –  SUN4891

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