Rising Inequality and Polarization in Asia Trends, Causes and Potential Responses

1. Rising Inequality and Polarization in AsiaTrends, Causes and Potential Responses Wanda Tseng Deputy Director, Asia and Pacific Department International Monetary Fund September 2006

2. A. What do we know?

3. Over the last decade, income distributions across Asia have worsened significantly… • Unprecedented. Recent trend is in contrast to region’s past record of “equitable growth” • Between 1965 and 1990, East Asia grew faster than any other region • Yet maintained equitable distribution of income • Indeed, inequality fell in both NIEs and ASEAN-4 • Broad-based. Rise in inequality extends to South Asia, where inequality traditionally low • Pronounced. Today, China more unequal than US or Russia; Japan more than OECD average

4. …as reflected in a broad and pronounced rise in inequality.

5. At the same time, particular attention is being paid to polarization. • …or emergence of distinct socio-economic groups • Gap between rich and poor widens • Gap between urban-rural or coastal-inland • Although differs conceptually, polarization often moves together with inequality

6. Asia’s economies have also become more polarized, as suggested by a widening gap between rich and poor…

7. Income disparities matter because they can… • Hinder poverty reduction • Limit opportunities for social mobility, in particular when polarization is high • Lead to inferior macroeconomic outcomes • Result in resistance to reform and conflict

8. B. What explains these trends?

9. 1. Skill-biased technological change. • Shifts in production technology that favor skilled over unskilled labor (e.g., IT revolution) • Predicts an increase in relative productivity (and hence demand) of skilled labor • Which leads to rise in wage dispersion, and hence inequality

10. Indeed, wage dispersion has widened in Asia’s labor markets…

11. …as skill premia have risen, reflecting increased demand for skilled labor.

12. 2. Transition from agriculture to industry. • Find support for inverted-U relationship between inequality and income • Many economists have long believed that income disparities increase in early stages of development, and decrease subsequently • Predicted by Kuznets (1955), as people move from agriculture to modern industrial sector • inequality and polarization increase initially, but decline as majority of people find employment in high-income sector. • Results suggest turning point occurs at per capita GDP of around $4,000-$6,000

13. Encouragingly, many developing economies may be close to a turning point.

14. 4. Similarly, limited role for Asian crisis. • Economic shocks can hurt poor disproportionately • Tend to have less flexibility to protect themselves against adverse shocks • Lack of education and skills makes it less easy for them to adjust to shifting demand conditions • Illustrated by Latin American crises of the 1980s • However, little evidence that Asian crisis led to widespread increase in inequality

15. If anything, income distribution improved in some crisis economies.

16. C. What can be done?

17. Finally, some potential policy actions. • Focus should be on enhancing opportunities for moving up income ladder, rather than large-scale redistribution • Specific policies need to be tailored, but number of directions likely to help, including • Greater and/or more effective spending on education • Investing in transport and communications • Removing rigidities in labor and product markets, e.g. barriers to migration • Improving access to financing

18. Thank you