Declining Income Inequality in Latin America: A Decade of Progress

1. Declining Income Inequality in Latin America: A Decade of Progress? Nora Lustig Dept. of Economics and Stone Center for Latin American Studies Tulane University LACEA Network on Inequality and Poverty-Mexico Chapter El Colegio de M�xico November 20, 2009 1

2. Lopez-Calva, Luis F. and Nora Lustig (editors), Brookings Institution Press, forthcoming 2010 2

3. Book focuses on the causes of changes in inequality� UNDP-sponsored Project �Markets, the state and the dynamics of inequality in Latin America:� 8 Country Studies Book Contains Four Cases: Argentina (urban), Brazil, Mexico and Peru Determinants of Inequality Dynamics Data: Household Surveys Methods: Parametric and non-parametric decomposition analysis Book also has chapters on theory of markets and inequality, political economy of redistribution and inequality in advanced countries http://undp.economiccluster-lac.org/newdocument.php 3

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5. Latin America is the most unequal region in the world 19 percent more unequal than Sub-Saharan Africa 37 percent more unequal than East Asia 65 percent more unequal than developed countries 5

6. However, since around 2000� Inequality in most Latin American countries (12 out of 17) has declined (roughly 1.1% a year). Except in one case, decline is statistically significant. 6

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9. The decline in inequality has been widespread  The decline took place in: Persistently high inequality countries (Brazil) and normally low inequality countries (Argentina) Fast growing countries (Chile and Peru), slow growing countries (Brazil and Mexico) and countries recovering from crisis (Argentina and Venezuela) Countries with large share of indigenous population (Ecuador and Peru) and with low share (Argentina) Countries governed by leftist regimes (Brazil, Chile, Venezuela) and non-left regimes (Mexico and Peru) 9

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11. Main Question: Why has inequality declined in Latin America during the past decade? Additional questions: Is inequality likely to continue to fall? Are gains likely to be reversed? 11

12. Main Questions: Why has inequality declined in Latin America? Are there factors in common? In-depth analysis in four countries: Argentina (Gasparini and Cruces) (urban; 2/3 of pop) Brazil (Barros, Carvalho, Mendoca & Franco) Mexico (Esquivel, Lustig and Scott) Peru (Jaramillo & Saavedra) Representative sample of Latin American diversity: high/medium/low ineq; high/low growth; high/low share of indigenous pop; left/non-left regimes All four went through market-oriented reforms in 1990s. 12

13. Income concept Argentina: current monetary (no imputations for owner�s occupied housing); assumes it�s after taxes for wage earners & before for other (assumption); after monetary government transfers (in survey). Brazil: current monetary plus imputed value of income in kind (no imputations for owner�s occupied housing); before taxes (assumption) and after monetary government transfers (in survey and assumption). 13

14. Income concept Mexico: current monetary income (in incidence analysis total income is used: includes autoconsumption and imputations for owner�s occupied housing); after taxes (assumption) & after monetary government transfers (in survey). Peru: current total (autoconsumption, imputed value of income in kind, owner�s occupied housing and in-kind government transfers except education); after taxes and after monetary government transfers (in survey). 14

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19. Argentina: GICs 19

20. Brazil: GICs 2001-06 20

21. Mexico: GICs 2000-06 21

22. Peru: GICs 1997-2006 22

23. Significance, Dominance, Robustness Decline in inequality is statistically significant and significant in terms of order of magnitude There is Lorenz dominance for the circa 2000-circa 2006 period (unambiguous; => decline independently of choice of inequality measure) Robust to income concept (e.g., monetary vs. total) 23

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25. Non-labor income: Top incomes are grossly under-estimated well known that household surveys do not capture incomes accurately at the top. That can be due to limitations in the representativeness of the sample at the top or non-sampling errors such as under-reporting of incomes at the top, particularly non-wage income. average income of the two �richest� households for each country. In 2006, the monthly total household income in current US dollars was equal to $70,357 for Brazil, $43,148 for Mexico, $17, 563 for Peru, and $14,779 for Argentina. Do these numbers make sense? It does not seem so. Next table estimates average monthly incomes based on wealth (net worth) estimates for the region. 25

26. The rich in Latin America: �Estimated� monthly income, circa 2007 26

27. Argentina: comparing Ginis from household survey with tax returns information on top incomes (Alvaredo & Piketty, 2009;Alvaredo, 2010) 27

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29. Analysis will focus on labor income and government transfers Given the gross underestimation of property incomes (especially at the top), it is difficult to claim that one can analyze their role in explaining changes in household inequality. Thus, analysis will focus primarily on the role played by two components: Labor incomes Government transfers (particularly, monetary transfers). 29

30. Why has inequality fallen in Latin America during the last decade? Demographic changes have been equalizing but their contribution is relatively small. Declining inequality in labor and non-labor incomes has been predominant. In the four countries: Inequality in labor incomes per adult declined. Inequality in non-labor incomes declined. 30

31. Why has inequality in workers� labor incomes declined? Two main factors: Inequality in educational attainment declined. Skilled/low-skilled wage gap fell. 31

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36. Why has the skilled/low-skilled wage gap declined? Because: the gap between returns to higher levels of education (tertiary and secondary) and lower levels of education (complete primary and below) declined. In Argentina, other factors were present too: Spectacular growth and currency devaluation after 2002 reduced unemployment and increased demand for low-skilled workers. Government increased minimum wage and mandated wage increases. Labor unions and other organizations gained more bargaining power (with support of government). 36

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41. Why did the gap between returns to higher and lower levels of education decline? Composition of the labor force changed: low-skilled workers have become relatively scarcer and thus command a relatively higher wage than before. Change in the composition of labor force is the result of a significant increase in coverage in basic education (primary and lower secondary, in particular). The increased demand for higher skills as a result of economic reforms and skill-biased technical change petered off. 41

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46. Why has inequality in labor incomes declined? Conclusion: In the race between skill-biased technological change and educational upgrading, in the last ten years the latter has taken the lead 46

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51. Brazil: 2001-2007(Barros et al., 2009) Decline in labor income inequality: About half (a third of pc household labor income ineq) accounted for by decline in educational attainment ineq. and less steep returns (wage gap by skill narrows); latter dominant, accts. for more than 1/3 (1/5). SUPPLY-SIDE EFFECT DOMINATED About 25% accounted for by decline in spatial segmentation; especially, reduction in wage differentials between metropolitan areas and medium/small municipalities. Also, decline in sectoral segmentation. INSTITUTIONS?/PATTERNS OF GROWTH? 51

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53. Mexico: 2000-2006(Esquivel, Lustig & Scott, 2009) Decline in labor income inequality: Educational attainment became more equal and returns less steep. SUPPLY-SIDE EFFECT DOMINATED The latter seems to be associated with the decline in relative supply of workers with low educational levels. Between 1989 and 2006, the share of workers with less than lower-secondary education fell from 55% to around 33%. It coincides with the period in which gov. gave a big push to basic education. Between 1992 and 2002 spending per student in tertiary education expanded in real terms by 7.5 percent while it rose by 63 percent for primary education. The relative ratio of spending per student in tertiary vs. primary education thus declined from a historical maximum of 12 in 1983-1988, to less than 6 in 1994-2000 (by comparison, the average ratio for high-income OECD countries is close to 2). 53

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55. Peru: 1997-2006(Jaramillo & Saavedra, 2009) Labor income inequality: Changes in educational structure were equalizing at the household and individual workers levels. Earnings gap by skill narrowed at the individual workers level as in the other countries. Fading out of skill-biased technical change and a more equal distribution of education/educational upgrading. SUPPLY-SIDE EFFECT DOMINANT Changes in returns to education, however, were unequalizing at the household level but not at the individual workers level. (Changes in assortative matching (positive) might have been a factor.) ASSORTATIVE MATCHING 55

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57. Why has inequality declined in Latin America during the last decade? In the four countries: Inequality in labor incomes per adult declined. Inequality in non-labor incomes declined. 57

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59. Why has inequality in non-labor incomes declined? In the four countries government transfers to the poor rose and public spending became more progressive In Brazil and Mexico, large-scale conditional cash transfers => can account for between 10 and 20 percent of reduction in overall inequality. An effective redistributive machine because they cost around .5% of GDP. In Peru, in-kind transfers for food programs and health. Also access to basic infrastructure for the poor rose. In Argentina, the safety net program Jefes y Jefas de Hogar. 59

60. Argentina: Distributional impact of social assistance cash transfers  60

61. Brazil: Decline in non-labor income inequality Contribution of changes in the distribution of income from assets (rents, interest and dividends) and private transfers was unequalizing but limited. Most of the impact of non-labor income on the reduction of overall income inequality was due to changes in the distribution of public transfers: changes in size, coverage and distribution of public transfers. 61

62. Mexico: Decline in non-labor income inequality The equalizing contribution of government transfers increased over time (both at the national level as well as for urban and, especially, rural households). By 2006 transfers became the income source with the largest equalizing effect of all the income sources considered. Remittances became more equalizing too but with a smaller effect than government transfers. Both more than offset the increasingly unequalizing impact of pensions. 62

63. Mexico: Decline in non-labor income inequality The sharp rise in the role and equalizing impact of public transfers was a consequence of a significant policy shift in 1997, when the government launched the conditional cash transfer program Progresa. During 1996-2006 the size of public transfers increased; they became more equally distributed among recipients, and the recipients of transfers increasingly belonged to relatively poorer segments of the population. 63

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65. Peru: progressivity rose in non-monetary transfers rose 65

66.  Is Inequality Likely to Continue to Decline?  Despite the observed progress, inequality continues to be very high and the bulk of government spending is not progressive. So, will inequality continue to decline? It might for a while, but: The decline in inequality resulting from educational upgrading will eventually hit the �access to tertiary education barrier� which is much more difficult to overcome because of inequality in quality (not college-ready) and �opportunity costs� are high and costly to address. (For example, the slow-down in the rate of increase of college graduates in the United States). Making public spending more pro-poor in the future is likely to face political resistance (entitlements of some powerful groups). 66

67. Is Inequality Likely to Continue to Decline?  For inequality to continue declining in the future: Reduce inequality in quality of education. Enhance redistributive capacity of state through fiscal interventions. Increase personal income and wealth taxes on top incomes (the high and ultra-high net worth individuals. 67

68.  Are Gains Likely to be Reversed because of the Global Crisis? In Brazil, Mexico and Peru the decline in inequality appears to be more resilient to the economic cycle and politics because: Changes in the labor composition are not going to reverse but if anything move in the other direction (low-skilled workers will become even scarcer) and transfers to the poor represent a small share of GDP and government spending Question: will inequality decline or increase if Brazil and Mexico grow fast? 68

69.  Are Gains Likely to be Reversed (cont.)? In Argentina the decline in inequality appears to be more dependent on unusual economic growth and populist politics so with economic downturn and change in regime there could be a reversal 69

70. Summing up: Since around 2000, income inequality in LA declined in 12 out of 17 countries. The decline in inequality in LA is significant (in order of magnitude and statistical terms) and widespread. The two leading proximate factors: i. the reduction in inequality of education and a decline in relative returns to education; ii. government transfers increased and public spending became more progressive. Market forces and state action have been at play: In the race between skill-biased technical change and educational upgrading, the latter has taken the lead. Government spending has become more pro-poor. The reduction in inequality will not continue once countries hit the access to tertiary education barrier. The declines in inequality are less likely to be reversed by current economic crisis in Brazil, Mexico and Peru than in Argentina. 70

71. THANK YOU 71