More equal than others

Most economists agree that without economic growth, we cannot end the extreme poverty that afflicts more than one billion of the world's people who live on less than $1 a day.

While some countries, including India and China, have grown and significantly reduced poverty in recent years, many others have struggled, suffered shocks and grown only marginally.

Some, especially in Africa, have not grown at all in recent years. Without growth, these countries seem unlikely to reduce by half the proportion of people living in poverty by 2015, as world leaders pledged to do in the Millennium Declaration signed in 2000.

The power of economic growth to reduce poverty is undeniable, but distribution of incomes matters too. New research based on more detailed household survey data than previously available shows that the same rate of growth reduces poverty much faster in nations where resources are more equitably distributed across the population.

This is a critical point. The goal of any society, or government, should be to reduce poverty not in some vague, distant future, but as fast as possible and certainly within the lifetime of most poor people living today.

Similarly, this new research tells us that in economies where growth is accompanied by increasing inequality, the poverty-reducing effect of economic growth can be entirely lost. Alternatively, it can be enhanced if inequality declines.

Brazil, for example, has very high inequality, with a Gini coefficient (a way of measuring inequality with zero implying perfect equality and 1 indicating perfect inequality) of around 0.6. Between 1985-96, weak growth and high inequality led to poverty reduction there of less than 10 per cent.

By contrast, the same growth rate accompanied by just a modest drop in inequality, say with the Gini coefficient falling to 0.55 -- still a very high figure -- poverty would have fallen by around 40 per cent.

In Ethiopia, growth between 1981-95 could have reduced the proportion of poor people by 30 per cent, had the pattern of income distribution remained constant. But inequality in income distribution increased as the country's economy grew, and the net result was a six-per cent increase in poverty.

What implications do this have for India? A rough estimate can be made using India's recent poverty incidence and distribution of income. Extreme poverty affects about one-quarter of India's population today.

Suppose that average real income per capita in India grows by four per cent a year and no change takes place in income distribution. Because India is a relatively egalitarian country, poverty would be cut by about 60 per cent in 10 years.

But if inequality were to increase in any substantial way, say from a Gini index of 0.33 ( the 1950-1990 average) to 0.38, still a relatively balanced distribution, the reduction in poverty would be much lower, about 40 per cent. The difference actually amounts to about 50 million people, not a small number.

Another important dimension of the relationship between inequality and growth is that improvements in income distribution today can actually pay off in higher economic growth tomorrow. This is because inequality acts as a brake on prospects for growth.

For example, the poor typically do not have access to formal credit markets, and must go to informal lenders who charge much higher interest rates.

A rich person might get a loan from a bank at 10 per cent interest, while a poor person must go to a money-lender and pay interest of 50 per cent.

This means that investment projects undertaken by the poor person must pay a return of more than 50 per cent in order to be viable. As a result, many projects that could deliver returns between 10 and 50 per cent, creating new jobs, knowledge and wealth, never take off.

Greater inequality is often linked to social tension or conflict too, which, in turn, threaten stability and discourage investors, both domestic and foreign. It also shrinks consumer demand for the goods and services on which sustained economic growth depends.

But experience has also revealed the challenges facing governments that seek to redistribute income to achieve poverty reduction, and other social goals. There is, however, new evidence that "smart transfers" in which poor families receive a monthly stipend in return for keeping their children in school, have a significant and lasting impact on poverty and potentially on growth.

Such transfers have achieved impressive results in Mexico and other Latin American countries. Through careful targeting and monitoring, they have not only increased the incomes of the poor, but also transferred wealth in the form of human capital, namely educated, healthy children, who are themselves an investment in their country's future.

Among developing countries, India's income distribution is relatively equitable, and India is a kind of global laboratory for anti-poverty programmes.

Their effectiveness record is mixed, but the 'Mid-day Meal Program' at India's schools, when combined with good quality instruction, is an effective "smart transfer" that provides a real incentive to poor families to keep their children in school, and out of poverty in the future.

India has also launched important reforms in liberalising its economy, opening itself to competition and opportunities in the global market. Indians are benefiting from these changes, and the process continues.

Even as economic growth reduces poverty, however, Indians would be wise to keep an eye on the country's inequality, to ensure that it does not grow wider.

India should protect its achievement of relatively egalitarian income distribution, and enhance it with measures that would improve opportunities for the poor.

Many of the economic reforms which would boost growth would also improve equity.For example, many of India's inefficient subsidies, which hamper infrastructure and market development, largely benefit the better-off.

Increasing economic growth rates in India's poor regions is one of the biggest development challenges facing the country today, from both the growth and equity perspective.

Powered by