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Asia's rising inequality
Wednesday, 11 July 2012 15:56

While emerging Asia continues to achieve a stunning performance in poverty reduction, the gap between rich and poor keeps widening too.  Why?  Does it matter?  And what to do?
 

Emerging Asia's average per capita GDP (in PPP terms) increased from $1,633 to $5,133 over the period 1990-2010, thanks to the region's very rapid economic growth of 7.0% over the period, according to the Asian Development Bank.  This was driven by high average growth in China (9.9%) and India (6.4%).  Thus, the proportion of Asia's population living on or below the $1.25-a-day poverty line fell from 51.8% in 1990 to 20.8% in 2008, as 714 million were lifted out of poverty.
 
This reduction in poverty has, however, been accompanied by rising inequality in many countries.  Between the 1990s and 2000s, countries accounting for about 82% of developing Asia's population experienced rising inequality of per capita expenditure or income, as measured by the Gini coefficient.  Importantly, this is a case of everyone doing better, but the rich doing much better than the poor.
 
The list of countries with rising inequality, from the top down, is China, Indonesia, Laos, Sri Lanka, Korea, Georgia, Bangladesh, Mongolia, India, Tajikistan, and Taiwan.  The following countries did not experience a widening in their inequality, but their levels of inequality remain high -- Malaysia, the Philippines and Thailand.  While the case of Japan is not included in this study, a separate report of the OECD shows that inequality is also rising in Japan, a trend which is also common among most OECD countries.

The changes in developing Asia's inequality are worse than Africa than Latin America.  Nevertheless, the level of the Gini coefficients in developing Asia are still on average lower than Africa or Latin America -- but much higher overall than OECD countries.
 
The overall trend is one of rising inequality in countries, both rich and poor, in sharp contrast to the "Kuznets model".  This model is based on a development process whereby the population moves from the rural/traditional to the urban/modern sector, and the assumption that the per capita income of the latter sector is assumed to be always higher than the former.  At the beginning of the development process, the gap between the two groups tends to widen, but then to diminish over time as the weight of the population in the urban/modern sector rises.
 
So why is inequality rising in such a broad range of countries?  In particular, for countries with abundant unskilled labor, opening the economy should raise the wages of unskilled labor and depress the wages for skilled workers and returns to capital, as the country specializes in low-skill production (known as the Stolper-Samuelson theorum).
 
China should be the classic example of this, with its vast pool of lower skilled labor and labor-intensive manufacturing.  But China is the Asian country which has experienced the greatest increase in inequality. 
 
The evidence shows that the main drivers of Asia's rapid growth -- technological change, globalization and market-oriented reform -- are also the basic forces behind rising inequality in the region.  Working together, these have significantly impacted on inequality through a number of channels, in particular:

(i) increasing skill premiums and returns to human capital.  The emergence of vast new economic opportunities, unleashed by trade and financial integration, technological progress, and market-oriented reforms, has increased returns to human capital and the skill premium, with individuals having higher education and skill attainments able to benefit more from the new opportunities.  Some 25-35% of total inequality can be explained by inter-person differences in human capital and skill endowments.

(ii) falling labor shares.  Technological progress has favored capital over labor.  The abundance of labor relative to capital, which depresses wages rates, is also a contributing factor to the declining labor share in developing Asia.  Since capital is less equally distributed, this has contributed to rising inequality.

(iii) increasing spatial inequality.  Some regions, especially urban and coastal areas, are better able to respond to the new opportunities because of their advantages in infratsructure and market access, as well as agglomeration economies from a self-perpetuating process of increasing concentration.  The process of urbanization reinforces the inequality effects of agglomeration.  About 30-50% of income inequality is accounted for by spatial inequality due to uneven growth.

But there is more to it than that.  This effect on Asian workers has been compounded by various forms of "unequal access to opportunity" -- especially to education, health and public employment services by population groups as defined by their income, gender, ethnic origin, or birth location.  The need for action is urgent because, without it, inequality of opportunity will be magnified into greater and greater inequality of opportunity, which will then continue the cycle of inequality of opportunity and outcome for the next generation.
 
Does inequality matter?  After all, the United States, the richest and most powerful country in the world, is also one of the most unequal.  Of the OECD's 34 member countries, the US has the fourth highest level of inequality, after Chile, Mexico and Turkey.
 
In fact, inequality matters very much for several reasons.  First, rising inequality holds back poverty reduction.  If inequality had not risen in association with the rapid economic growth, the ADB estimates that China's poverty headcount would have fallen to 4.9% (rather than 13.1%), Indonesia's to 6.1% (instead of 16.3%) and India's to 29.5% (not 32.7%).  For the region as a whole, one cost of inequality has been that 240 million more people, 6.4% of the region's population, are trapped in poverty.
 
Inequality can also adversely affect economic growth, as poor people invest less in human capital or small enterprises.  It can also lead to a hollowing out of the middle class, with adverse effects on social and political stability.  And inequality can lead to a political backlash against pro-growth policies.

What governments should do to address inequality?  Above all, governments should not seek to reverse the main drivers of growth -- technological change, globalization and market-oriented reform -- which have also driven inequality.

The ADB proposes three other lines of action. 

First, fiscal policy can be used for increasing spending on education and health, developing better targeted social protection programs.  Second, interventions can be made to address lagging regions through improving regional connectivity, developing new growth poles, strengthening fiscal transfers, and removing barriers to migration from poor to more prosperous areas.  Third, growth can be made more employment friendly through more balanced growth, supporting SMEs, removing policy biases that favor capital over labor, strengthening labor market institutions.
 
Is there any realistic hope of governments taking serious measure to address inequality?   
 
The quest for confronting Asia's rising inequality is a noble one, and seems like an obvious priority for governments.  And governments like China, India, Malaysia, the Philippines and Thailand have pronounced support for inclusive growth.  But the reality is that, the world over, politics is stacked up in favor of the rich and against the poor.
 
In the US for example some of the biggest political battles are taking place over tax cuts that favor the rich.  George Bush's tax cuts have been an important factor driving the US's spiralling budget deficit.  At the same time, America's public education system is in an appalling state and a large share of the American population is fighting against President Obama's initiative to provide health care to poor people.
 
In Asia's oligarchic societies, the economic system is also stacked in favor of the rich.  Witness the recent middle class protests in Indonesia when the government wanted to rationalize fuel subsidies.  Massive corruption also provides another source of inequality that ADB does not address. 

To a large extent, Asia's inequality basically occurs "by design" of the system.  But it is not clear that the beneficiaries of this system are fully conscious of the risks to social and political stability.  They should study the Arab Spring more closely.
 
Reference:
Asian Development Bank.  Asian Development Outlook 2012.  "Confronting rising uinequality in Asia".
http://www.adb.org/publications/asian-development-outlook-2012-confronting-rising-inequality-asia
 


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