NS4053 Rising Inequality in Asia Winter Term, 2014

1. NS4053 Rising Inequality in Asia Winter Term, 2014

2. Overview • Asian Development Bank, “Rising Inequality in Asia and Policy Implications” February 2014 • The paper • Examines the resent trends of rising inequality in developing Asia • Asks why inequality matters in the Asian context • Examines the driving forces of rising inequality • Proposes policy options for tackling high and rising inequality • Main Findings – Increasing inequality due to • Technological change • Globalization • Market-oriented reform • Policy Suggestions

3. Introduction I • Poverty reduction in developing Asia over last two decades faster than • Any other region in the world • At any other time in history • Problem • The bulk of the region’s population lives in countries with rising inequality • New Situation in Contrast to • The “growth with equity” story that marked the transformation of the NIEs in the 1960s and 1970s and • Recent trends in some other parts of the developing world, particularly Latin America where inequality has been narrowing since the 1990s

4. Introduction II • Drivers of Asia’s rapid growth • Technological change • Globalization • Market oriented reform • Have had significant distributional consequences. • Growth drivers have favored • Owners of capital over labor • Skilled over unskilled workers and • Urban and costal areas over rural and inland regions • Unequal access to opportunity caused by • Institutional weakness and • Social exclusion • Have compounded the impacts of these forces

5. Introduction III • These factors have led to • Falling share of labor income in national income • Increasing premiums on human capital and • Growing spatial disparity • All contributing to rising inequality • Dilemma – the three drivers of inequality cannot and should not be blocked • They drive productivity and growth • A policy mix needs to be designed to reduce inequality while not suppressing increases in productivity and growth

6. Recent Trends in Inequality I • In last two decades growth and poverty reduction in Asia and Pacific have been remarkable • From 1990 to 2010: • Average annual growth in GDP for developing Asia reached 7% -- more than double for Latin America • Growth mainly driven by PRC and India with annual GDP growth rates of 9.9% and 6.4% • Per capita GDP in 2005PPP terms increased from $1,633 to $5,133 • The percentage of population living at or below the $1.25 a day poverty line fell from 53% in 1990 to 21% in 2010 • 700 million people lifted out of poverty • Seventeen countries reduced poverty by more than 15% in the period

7. GDP Growth and Poverty Reduction

8. Recent Trends in Inequality II • Growth accompanied by rising inequality • Of the 28 economies that have comparable data between the 1990s and 2000s • 12 accounting for more than 80% of developing Asia’s population in 2020 experienced rising inequality • The Gini coefficient of per capita expenditure worsened in 12 economies including the PRC, Indonesia and India • There appears to be a positive, statistically significant relationship between the increase in Gini coefficient and GDP growth • The change in the quintile ratio is more pronounced than the change in the Gini in all 12 countries – suggesting rising inequality has been driven by the rich getting richer much faster than the poor • The expenditure shares of the richest 1% and 5% of population also show rising gaps between the rich and poor

9. Annual Growth of Gini Coefficients, 1990s-2000s

10. Recent Trends in Inequality III • Another challenge facing developing Asia is inequality of opportunity which is a critical factor in widening income inequality • Great disparities exist in the means to raise one’s living standards such as • Physical assets (e.g., capital and land), • Human capital (e.g., education and health, and • Market access (e.g., labor and finance) • Inequality of opportunity derives from unequal access to public services, especially education and health • School age children from households in poorest income quintile were three to tive times as likely to be out of primary and secondary schools as their peers • Infant mortality rates among the poorest households in some countries were double or triple rates among richest households

11. Why Inequality Matters I • 1. Inequality of opportunity and income can lead to vicious circle • As unequal opportunities create income disparities • Which in turn lead to differences in future opportunities for individuals and households • 2. Rising inequality hampers poverty reduction • Simulations reveal how rising inequality holds back poverty reduction • Had inequality not increased the poverty headcount at the $1.25-a-day the poverty line would have been in: • India: 29.5% instead of the actual 32.7% in 2010 • PRC: 4.9% instead of the actual 13.1% in 2008 and • Indonesia: 6.1% instead of the actual 16.3% in 2011 • For the 12 economies the cost of rising inequality equates to 240 million more people being trapped under the poverty line -- or 6.5%of the region’s current population.

12. Actual and Simulated Poverty Rates, 1990s-2000s

13. Why Inequality Matters II • 3. Inequality can weaken basis of growth itself • Inequality of wealth and income can lead to large divergences in human capital • Those with little wealth or low income face challenges in investing in human capital or wealth and income enhancing activities and will remain poor • Imperfect financial markets may limit their ability to borrow to invest • Widening inequality – leaving more people at the top and bottom of income distribution can mean a smaller middle class • Growth driven by and benefiting a middle class is more likely to be sustained economically • Rent seeking and corruption associated with highly concentrated gains to growth are avoided • Politically to the extent that conflict and horizontal inequalities between racial and ethnic groups are easier to manage

14. Why Inequality Matters III • 4. Greater inequality may lead to a political backlash in which pressure for governments to enact populist policy measures grows. • In response to rising demands, political process may favor policies that benefit lower end of the income distribution in short run • But hold back efficient and growth in the long run • In this situation interests of political system diverge from the interests of the economy as a whole

15. Policy Responses • Asian governments are responding to rising inequality by trying to make their development plans more inclusive • Distinction between inequality of opportunity and inequality of outcome important in guiding policy • Inequality of opportunity – access to education, health care, public services of jobs often arises from differences in individual circumstances outside control of individual • Such inequality largely reflects institutional weakness and social exclusion and should be target of policy • On other hand given an individual’s circumstances, efforts in labor market or education will also affect outcomes – income, consumption etc. • Inequality of outcomes arising from differences in individual efforts reflects and reinforces the market based incentives that are needed to foster innovation and growth

16. Factors Driving Inequality in Asia I • 1. Technological Change – can influence income distribution if: • It favors skilled labor (more educated or more experienced) over unskilled labor • by increasing its relative productivity – and resulting skill premium • It is biased in favor of capital—leading to an increasing share of capital in national income • In general capital incomes are generally less equally distributed and accrue more to the rich than the poor

17. Factors Driving Inequality in Asia II • 2. Globalization can affect income distribution • Trade integration • Changes the relative demand for and hence relative wages of skilled and unskilled workers • It can affect income distribution between capital and labor because capital and skills often work together due to their complementarity • Financial integration can • Broaden access to finance by the poor, • But it can increase the risk of financial crisis and hurt the poor more than the rich • Studies by the IMF find that • Global trade integration helps reduce inequality • Global financial integration increases • But the found also found that technological progress a more important contributor to rising global inequality in last two decades

18. Factors Driving Inequality III • 3. Market oriented reform an important driver of growth, but can have significant distributional consequences • Trade policy reform often part of the driving forces of globalization • Labor market reforms can change the bargaining position of labor in relation to owners of capital Impacting on wage rates and income distribution • The three drivers of growth, technological progress, globalization and market oriented reform can be geographically uneven • New economic opportunities released by these drivers are often most easily seized by locations closer to existing trade routs • Agglomeration economies also facilitate a self-perpetuating process of increasing concentration • Considerable empirical evidence linking the three key sources to rising inequality in Asia

19. Factors Driving Inequality IV • Rising skill premiums: Share of inequality accounted for by differences in educational attainment increased in all countries • Most significant in PRC from 8.1% in 1995 to 26.5% in 7007 • India next from 20% in 1993 to 30% in 2010 • In late 2000s as much as 25-35% of total inequality can be explained by inter-person differences in human capital and skill endowments in most Asian countries • Labor’s falling share of total income. Between the mid 1990s and the mid-2000s labor income as a share of manufacturing output in formal sector fell from • 48% to 42% in the PRC • 37% to 22% in India • Because capital income more unequal than labor income, inequality increases • Increasing spatial inequality: In late 2000s about 25-50% of all inequality can be explained by spatial inequality • urban/rural, coast/hinterland, and by province.

20. Inequality from Educational Attainment of Household Head

21. Share of Labor Income in Industrial/Manufacturing Value Added

22. Contribution of Spatial Inequality to Overall Inequality

23. Responding to Inequality I • Idea is to reduce inequality without stifling factors contributing to growth • Distinction between factors outside of individual control and those that individual makes choices • Asian Development Bank recommends three sets of policy responses to rising inequality in Asia • Efficient fiscal policies to reduce inequality in human capital with view to addressing rising skill premiums relative to low wages of unskilled workers • Interventions to reduce spatial inequality • Policies to make growth more employment friendly with a view to increasing labor demand and hence labor’s share in national income • These policies cannot eliminate inequality, but will go long way to reducing it and at same time not endanger development and hurt growth

24. Responding to Inequality II • Interventions in lagging regions; • Improving transport and communications networks between more developed and poorer regions • Creating growth poles in lagging areas • Strengthening fiscal transfers for greater investment in human capital and better access to public services in lagging regions, and • Removing barriers to within country migration • Policies to make growth more employment friendly • Support development of SMEs • Remove factor market distortions that favor capital over labor • Establishing or strengthening labor market intuitions and • Introducing public employment schemes an a temporary bridge to address pockets of unemployment or underemployment

25. Responding to Inequality III • Efficient fiscal policies • Spending more on education and health, especially for poorer households • Developing and spending more on better targeted social protection schemes including conditional cash transfers that target income to poor but also incentivize buildup of human capital • Switching fiscal spending from general price subsidies (such as fuel) to targeted transfers and • Broadening the tax base and strengthening tax administration for greater and more equitable revenue mobilization • Summing up – adopt strategy of inclusive growth

26. Policy Pillars of Inclusive Growth