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30 Years of economics for development

Rising Income Inequality and Poverty Reduction: Are They Compatible?

Project name/title
Rising Income Inequality and Poverty Reduction: Are They Compatible?
Poverty, Inequality and Well-being
Over the last several years, the donor community has increasingly focused its efforts on poverty eradication. Meanwhile, during the same period, income inequality appears to have been rising in many developed, developing and transitional countries. Beyond the short-term fluctuations in income inequality associated with trade shocks and stabilization programmes, income concentration seems to have been growing over the long run. The increase has been particularly sharp in the former Soviet Union. However, other countries have managed to avoid this problem. Economic theory explains only poorly the rise in inequality over the last 20 years or so and the relation of this rise to poverty alleviation. While the sources of this surge in inequality vary across space and time, they seem to be frequently associated with: (I) Long-term endogenous factors, such as the labour-saving effect of technical progress (which reduces the demand for labour and increases the skewdness of the distribution of skills and wages) and the impact of trade liberalization and globalization. (ii) Policy-related factors. These include the following. High and rising inequality in the distribution of industrial and financial assets (possibly exacerbated by the recent wave of privatizations) and the persistence of a high level of inequality in the distribution of land and human capital. Unequal access to credit markets tends to compound this problem. Persistent geographical or social biases in the allocation of subsidies and public investment and in pricing policies. Long-term shifts in macroeconomic policy stances which now mainly aim at the achievement of very low inflation and very low public deficits regardless of the cost in terms of output and employment. Structural changes in key 'institutions' following the adoption of structural adjustment programmes. These new policies are gradually eroding 'labour institutions' (wage negotiations, union representation, minimum wages, and the regulation of wages in the public and monopolistic sectors), can cause greater unemployment and casual work, and tend to depress the labour share in total income. Meanwhile, the tax and transfer system (which now favours low and 'neutral' taxation and lower and targeted transfers) has seen its role in containing income inequality substantially reduced. The new trend towards rising income concentration has been greeted with little anxiety by the same institutions which promote poverty eradication. In their view, greater income concentration is a source of entrepreneurial incentives, more rapid capital formation and the spontaneous correction of past distortionary policies, or is an unavoidable but harmless Kuznetsian side-effect of development. However, poverty alleviation may not be achieved, or only in part, if income inequality is too high or if it increases sharply. First, an unequal growth pattern has a weaker poverty alleviating effect than a more broad-based one. Second, high inequality may erode the incentives to work of many, may entail mounting transaction and supervision costs in the containment of the rise in the labour shirking associated with an unequal pattern of growth, and may thus stifle growth itself. Third, it is doubtful whether a high-inequality growth pattern is politically sustainable over the long term. Rising social distance may reduce the viability of the social contract upon which growth itself is based. Thus, it is quite possible that poverty reduction - and growth itself - may be compromised if inadequate attention is paid to the policy objective of the maintenance of income inequality within an acceptable range.
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