Mind the Gap

Economic inequality seems to be Topic A for the global chattering classes. Even at the Davos World Economic Forum Meetings, where billionaires go to compare aircraft sizes, talk turned away from self-congratulation to sobering topics like where the next 600 million jobs will be coming from.

The big worry is that economic growth and inequality go together like doughnuts and heart attacks. And not just in rich countries, but across the developing world. That concern is surely justified: Developing economies that have outperformed the pack in recent decades have generally also experienced enormous increases in the gap between poor and rich. But this lock can be picked — and has been in a few big countries. The question is whether governments have the political will.

Step back for a moment. It’s critical to distinguish inequality between countries from inequality within countries. The explosive growth of Asia, combined with tepid growth in Europe and North America, is almost certainly narrowing the difference in average incomes between nations. But with a few significant exceptions, inequality within developing countries has risen sharply since the 1980s. By one standard measure, the Gini Index, inequality has increased by about one-fifth in India and China. And extreme wealth has become ever more extreme. In 2002, India was home to four billionaires ($US); today the number is 55. In 2002, China claimed only one billionaire. Last time Forbes added up the numbers,  China clocked in with 115 — more than Germany, France and Japan combined.Should you care? The answer isn’t as straightforward as you might expect. Rapid growth in emerging markets largely explains why at least a half-billion fewer people live in poverty today than in the 1980s. So if the leap to affluence can’t be sustained unless a disproportionate piece of the growth dividend goes to the rich — and if the rising tide still more or less carries all boats — glaring inequality is hardly the worst of possible worlds. Or to switch metaphors: Most people, one suspects, would prefer the crumbs from a very large pie to a thin slice from a small one. And that’s what they’re generally getting.

It’s one thing to say, though, that growing inequality hasn’t stopped advancement at the low end of the pecking order, and quite another to say it should be a minor concern in the context of rapid growth. Other things equal, most of us would rather live in a society that invests in upward mobility for those who are capable, and shares the bounty with those who aren’t. Besides, other things aren’t equal: In emerging market countries, even modest amounts redistributed from the haves would pay for a hefty increase in living standards for the have-nots.

It’s good news, then, that rapid growth has coexisted peacefully with declining inequality in one large, emerging market county. That country is Brazil, where in the years 2000-2008, the incomes of the bottom-fifth grew at an average annual rate of six percent, compared to two percent for the top-fifth.

How did Brazil manage to narrow the gap between rich and poor, when neither China nor India have even come close? For starters, Brazil spends a higher percentage of GDP on social programs — housing, education, pensions, medical care, unemployment compensation — than other middle-income countries. In fact, in some years it has spent a higher percentage on social programs than the United States.

Probably more important, Brazil targets the benefits well, among other things giving a fair shake to rural residents (who have less political voice than urban dwellers) and insuring a relatively large portion of the work force against joblessness.  Brazil moreover, seeks a bigger bang for its real, using cash grants as an incentive for poor families to increase their prospects for mobility. A portion of the money handed out is conditional on sending kids to school, visiting health care clinics for preventive medicine and, in the case of pregnant women, undergoing regular check-ups.

To be sure, the starting point for Brazil — in 2003, when it elected a charismatic left-center president by the name of Luiz Inácio Lula da Silva (see photo above) — was a level of inequality far worse than that of the rest of the Americas. (In fact, the only big country that had a worse gap between rich and poor was South Africa.) But the success of Brazil’s effort to lean against the winds of inequality is instructive. First, it proves that a focus on equity need not undermine growth. Indeed, allowing inequality to balloon can generate discontent that threatens political stability and thus, economic progress. In Egypt, the revolution that has been led by economically frustrated urban youth threatens to nip the country’s very real economic successes in the bud.

Second, emerging-market countries don’t have the luxury of subsidizing everybody as a politically acceptable means of subsidizing the poor. But Brazil’s tightly targeted anti-poverty program is a rarity. Contrast it, for example, to the unaffordable policy in Egypt of allowing middle-income households to garner a hefty share of the bounty from food and cooking fuel subsidies.

There’s an irony here. Brazil proves that government can be part of the solution to inequality in emerging market countries, offsetting the dynamics of capitalism by redistributing money and basic services, and providing incentives for education. But government is also part of the problem.

All the rapidly growing, emerging market countries are lands of opportunity. Returns on capital (both physical and human) are very high, and labor productivity is increasing rapidly as workers move from less productive sectors (agriculture) to more (typically manufacturing and services). But a disproportionate share of dividends to growth in the private sector ends up in the pockets of the already rich and powerful, at least in part because regulation and corruption favor incumbents over outsiders. Brazil, China and India are all very difficult places to start businesses, ranking 120^th, 151^st and 166^th respectively (out of 183 countries) on the World Bank’s index. They are also places in which who you know matters as much or more as how well you do it: All three countries rank as moderately to highly corrupt on Transparency International’s Corruption Perceptions Index. So when opportunity knocks, those with money and influence have the inside track on exploiting it. By the same token, insiders have a relatively easy time protecting lucrative niches from competition.

Thus, there are really two related issues here: income inequality and economic mobility. Governments can and should use some of the surplus from economic growth to offset the trend toward inequality. Arguably the tougher challenge, though, is to level the playing field — to increase economic mobility at the expense of incumbents.

In recent decades, the spectacular performance of the big emerging market economies has made life better for almost all residents, taking the sting out of rising inequality. But as they mature and growth slows, the ones that have failed to pay attention to the issue may well pay a price. Just ask Hosni Mubarak.