Income Inequality: Challenges for Measurement and Policy

1. Public Lecture, Ungku Aziz Center for Development Studies, University of Malaya, January 29 2019 Income Inequality: Challenges for Measurement and Policy Martin Ravallion

2. Inequality is getting much attention globally Part A: How are we doing? • Received wisdom + dissenting views • Global perspective + Malaysia Part B: How can we do better? • Objectives and constraints; policy options • Recommendations for thinking about better policies.

3. Part A: How are we doing?First, the received wisdom

4. A (super) short history of global inequality • Rising global inequality from 1820 to about 1990. • Driven mainly by divergent growth processes: today’s rich world takes off from the early C19th (though some late starters). • The pattern changed dramatically toward the end of the C20th. Falling global relative inequality in the new Millennium. • Driven by convergent growth processes, esp., high growth in Asia.

5. Global relative inequality since 1990 Source: Francois Bourguignon, Globalization and Inequality. Princeton University Press, 2016

6. Rising inequality within many countries, but not all • Average inequality within countries has edged upwards since 2000. • Famous examples of US, China (though signs of stabilization) and India. Also some newcomers; e.g., Indonesia • But also falling inequality in some countries (Brazil, Malaysia). • Signs of (slow) inequality convergence: inequality tends to rise when low, fall when high. • All this assumes anonymity. Rising inequality based on cross-sectional surveys is consistent with convergent income changes in longitudinal data. Indeed, often observed.

7. Yet falling absolute poverty • The most common approach to poverty measurement sets a line with constant real value over time and space • Falling % (and number of) poor in developing world as a whole and many countries, including Malaysia. Malaysia (official poverty measures) Developing world (World Bank)

8. Globally, economic growth typically comes with lower absolute poverty rates Slope = -2.2 (s.e.=0.27) Source: Martin Ravallion, The Economics of Poverty: History, Measurement, Policy. Oxford University Press, 2016

9. Malaysia

10. Growth incidence curve for Malaysia, 1984-2016 Source: Martin Ravallion, “Ethnic Inequality and Poverty in Malaysia,” Working Paper, 2019.

11. Malaysia: poverty rates by ethnicity Source: Martin Ravallion, “Ethnic Inequality and Poverty in Malaysia,” Working Paper, 2019.

12. Malaysia: Long-run decline in inequality Source: Martin Ravallion, “Ethnic Inequality and Poverty in Malaysia,” Working Paper, 2019.

13. Ethnic convergence Source: Martin Ravallion, “Ethnic Inequality and Poverty in Malaysia,” Working Paper, 2019.

14. Falling inequality within ethnic groups Source: Martin Ravallion, “Ethnic Inequality and Poverty in Malaysia,” Working Paper, 2019.

15. Bulk of the fall in absolute poverty is due to growth, though falling inequality helped • Falling inequality has meant that economic growth has had a larger impact on absolute poverty. • Elasticity of poverty rate to mean of -3.6. This would have only need -2.2 without the fall in overall inequality. • Elasticity of poverty rate to Gini index (holding mean constant) was 9! • Decomposition of change in log poverty rate (1984-2015): 75% isdue to rising mean income.

16. The received wisdom is out-of-step with some popular thinking

17. Three things are missing from the way economists think about “inequality” • Absolute inequality matters • The poorest matter • Relative income matters

18. 1. Wake up call to economists: Many people care about absolute inequality, and they care about the extremes

19. Absolute versus relative inequality • Relative inequality is measured using the ratios of incomes relative to overall mean. • Absolute inequality is about the absolute differences—the gap between rich and poor. • Absolute inequality matters more to many people. • Which is more unequal? • State A: (1, 2, 3) • State B: (2, 4, 6) • Over half the students (n=450) say State B has higher inequality. Similarly for my Twitter survey (n=250). • Yet most (relative) inequality measures (such as Gini index) say that there is no difference.

20. Debates on inequality are often debates between absolutists and relativists • Perceptions on the ground often differ to the numbers quoted by economists and statisticians! • Serge Kolm and the “May 68’ers”: Grenelle agreement gave same relative gain (13%) to all. Many felt this was inequitable. • At local level in developing world, absolutist NGO see rising inequality but relativist economist sees constant or even falling inequality. • Neither is wrong: Just different axioms of inequality measurement(scale-invariance vs translation invariance).

21. Falling relative inequality but rising absolute inequality globally Two Gini indices Source: Martin Ravallion, “Globalization and Inequality,” Journal of Economic Literature, 2018.

22. Malaysia: Falling relative inequality, but rising absolute inequality Source: Martin Ravallion, “Ethnic Inequality and Poverty in Malaysia,” Working Paper, 2019.

23. Malaysia: Ethnic convergence is relative, not absolute

24. Rising inequality in growing economies? Relative inequality (Kolm’s “rightist” Gini index) Absolute inequality (Kolm’s“leftist” Gini index) Source: Martin Ravallion, The Economics of Poverty: History, Measurement, Policy. Oxford University Press, 2016

25. The dilemma for absolutists! • The tendency for absolute inequality to rise with growth points to a trade-off between reducing absolute inequality and reducing poverty. • Those who see inequality as absolute, and give high priority to reducing it, may well find themselves living in an absolutely poorer world. • Greater clarity is needed on what trade-offs one is willing to accept between reducing absolute inequality and reducing absolute poverty.

26. Nor is the “transfer principle” universally accepted • Pigou-Dalton transfer principle: “mean-preserving transfers from rich to poor reduce inequality” • This seems very sensible. However, a sizeable minority of my students and Twitter respondents think that (2, 5, 5, 10) is more unequal than (2, 4, 6, 10). • Yet almost all think that (2, 4, 6) is more unequal than (3, 4, 5). • Why? People look at the high and low ends of the distribution. How far are the extremes from the middle?

27. 2. An important aspect of inequality: Are the poorest left behind?

28. Conflicting views • “The poorest of the world are being left behind. We need to reach out and lift them into our lifeboat.” U.N. Secretary-General Ban Ki-moon, 2011 • “Poverty is not yet defeated. Far too many are being left behind.”Guy Ryder, ILO • Yet economists appear to tell a very different story. Adages such as “a rising tide lifts all boats” or claims that “growth is good for the poor” or that there has been a “breakthrough from the bottom” How can we understand such different claims?

29. Counting poor people may miss what is happening to the poorest Rising floor Floor stays put

30. Yes, the poorest have been left behind!Fewer people living near the floor, but little change in the floor Near zero gain at bottom Source: Martin Ravallion, “Are the World’s Poorest Being Left Behind?”Journal of Economic Growth, 2016

31. ? Globally: Branko’s Elephant or Martin’s serpent? Source: Martin Ravallion, “Globalization and Inequality,” Journal of Economic Literature, 2018. (“Branko’s elephant” refers to a graph in BrankoMilanovic, Global Inequality, Harvard, 2016)

32. Malaysia’s absolute growth incidence curve

33. Much less progress in raising the consumption floor globally No sign that the new Millennium raised the floor (about $1.00 in 2011 PPP) Source: Update to Ravallion, “Are Poorest Left Behind?” J. Econ. Growth, 2016.

34. Malaysia has made somewhat more progress in raising the floor

35. 3. Relative income matters to perceptions of poverty

36. Ungku Aziz on relative poverty • Royal Professor UngkuAziz is famous for his Sarong index (# sarongs per persons over 1 year) This is presumably absolute. • But Aziz also recognized that the idea of “poverty” is relative. • Aziz’s thought experiment: Imagine people living on a remote tropical island. Adequate food and shelter. No inequality. No sense of poverty. • “The problem would begin when someone from the island visited Singapore or Sydney and then became aware of what was lacking in the level of living of the island people….The main point here is that poverty is a relative notion based on material inequality.” (Aziz, p. 1375) Ungku Aziz, 1964, “Poverty and Rural Development in Malaysia,” Kajian Ekonomi Malaysia, 1(1):75-105. Reprinted in Ungku Aziz Collected Papers, Vol. 3, Kuala Lumpur 2017.

37. Poverty is absolute in the space of welfare • Poverty measures that use a constant real line do not take account of the concerns people face about relative deprivation and social exclusion. These are specific to place and time. • An overriding principle: poverty is absolute in the space of welfare: “…an absolute approach in the space of capabilities translates into a relative approach in the space of commodities”(Amartya Sen, 1983). • Clearly an absolute measure is not welfare consistent if people care about relative income (or it => capabilities). • But (as we will see) strongly relative lines are also problematic.

38. Relative income matters! Two ways relative income matters: • Relative deprivation: a person’s well-being depends on both “own-income” and income relative to social comparators. • Costs of social inclusion rise with average income. • Famously, Adam Smith pointed to the social-inclusion role of a linen shirt in eighteenth century Europe: “..a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty which, it is presumed, nobody can well fall into without extreme bad conduct.” • Anthropologists have often noted the social roles played by festivals, celebrations, communal feasts, clothing.

39. Weakly vs. strongly relative lines Poverty line Weakly relative Strongly relative Absolute (0,0) Mean income Social inclusion cost for poorest; e.g., Adam Smith’s linen shirt, which costs just as much for the poorest.

40. The key issue in measuring relative poverty: the elasticity of the poverty line • A strongly relative line has an elasticity of unity (one); if the mean increase by 10% say then the poverty line increases by 10%. • If all incomes grow at the same rate then poverty measure is unchanged. • By contrast, a weakly relative line has an elasticity less than unity. • The ratio of the poverty line to the mean falls as the mean rises. • Naturally then, relative poverty is less responsive to overall economic growth.

41. Growth is a less important proximate cause of uneven progress against relative poverty • Elasticity of absolute poverty to growth in mean = -2.2. • Elasticity of (weakly) relative poverty to mean = -0.4.

42. Is Malaysia’s official poverty line credible? • Fixed in real terms over 40 years, despite substantial progress in raising average living standards. • Frequent claims in the media that the poverty line is too low by today’s standards.

43. Malaysia’s official poverty line is lower than expected given current mean income • Malaysia’s poverty line made sense in the 1970s. • But it is well below international standards today. • Expected line of about $12 rather than $4.* OMalaysia($4, 3.33) Source: Ravallion, Martin, and Shaohua Chen, 2018, “Welfare-Consistent Global Poverty Measures,” NBER Working Paper 23739.

44. Poverty line Illustrative example for Malaysia Mean • Weakly relative line is more in line with the international experience in countries with similar average income. • Slope = 0.33; Intercept =$2.50 (“hard core poverty line”).

45. Absolute and (weakly) relative poverty in Malaysia

46. Warning against strongly relative lines Strongly relative shows falling poverty during global financial crisis 2008-9 Weakly relative: $2.50 + one third of current mean Strongly relative: 50% of current mean

47. Implications of switching to a relative poverty measure in Malaysia • Using the absolute poverty measure 25% of the reduction in poverty has been due to falling inequality. • Switching to the (weakly) relative poverty measure, 43% is attributed to the reduction in inequality. • (100% for the strongly-relative measure.)

48. Toward better public data for studying poverty and inequality in Malaysia • Over the last 25 years the govt. stats offices of most developing countries have implemented protocols for public access to complete micro data from the main national household surveys. • Malaysia is an exception. • This is constraining economic and social research on Malaysia. Many applications, including to policy, require access to the complete micro data. • This also enhances the credibility of the data. Interaction with users is an important channel for improving the surveys in the future. • Public data access should be a high priority going forward.

49. Part B: How can we do better?

50. Two challenges ahead • Motivational challenge: Should we care about inequality and relative poverty as well as absolute poverty? • The intrinsic (ethical) and instrumental arguments for why we need to also worry about inequalities. • Policy challenge: How might we have greater success against inequality? • Poor performance of current policies esp., in developing world; objectives and constraints on better policies; policy options.