Inequality: Status, Effects, Causes & Solution

This blog post is a collection of major points from the latest edition of Finance & Development magazine. It deals with inequality and its various dimension.

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Global inequality is higher than inequality within nations, argues Branko Milanovic. The richest one percent of people in the world receive nearly 14 percent of global income while the poorest 20 percent receive just over one percent of global income. He argues that “global inequality seems to have declined from its high plateau of about 70 Gini points in 1990–2005 to about 67–68 points today.This is still much higher than inequality in any single country, and much higher than global inequality was 50 or 100 years ago.”

The rising inequality in both developed and developing countries is against the prediction of Kuznets upside-down “U” shaped curve and Heckscher-Ohlin-Samuelson (HOS) theorem. Kuznets argued that when everyone is poor inequality is very low. Then as people being to move form low productive agriculture to high productive non-agriculture sector, average income rises as wages also rise. This means as economy growth, inequality rises. But, economies grow richer, urban-rural gap is reduced and social security transfers (unemployment benefit, pension) lower income gap and hence inequality. The Hecksher-Ohlin-Samuelson theorem predicts that in international trade countries specialize on production of goods in which they have comparative advantage. The poor countries specialize in production of goods that requires low skill. This means demand for low skill goods rises as they cost less. Then wages of low-skilled workers increases relative to high-skilled workers. The narrowing gap between wages of different skill levels means that inequality is declining. But, are these evidence holding up now?

Milanovic argues that Kuznets was right during the early days of the US (up until 1970s)and the UK (up until 1920s). But, inequality is rising now when average mean income is also rising. Similarly, inequality in poor countries is also rising, which is counter to HOS theorem.

[The Chinese case shows application of ‘Kuznetsian’ case, may be till the half part of the curve: Gini was 30 before 1978, i.e. when the country uniformly poor and before economic reforms. Then massive growth in coastal areas major manufacturing hubs and sectors led to increase in wages of the workers involved those sectors. Meantime, China also saw massive increase in economic growth. But, inequality is still rising and has surpassed the inequality prevalent in the US. Milanovic argues that Chinese government can help reduce inequality by extending social security to people outside the state sector or introduce unemployment benefits or, preferably, implement guaranteed rural employment scheme like NREGA in India.]

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In 2010, real per capita income in the United States was 65 percent above its 1980s level and in the United Kingdom, 77 percent higher. Over the same period, inequality in the United States increased from about 35 to 40 or more Gini points (see Chart 1), and in the United Kingdom, from 30 to about 37 Gini points. These increases reflect significant adverse movements in income distributions. Overall, between the mid-1980s and the mid-2000s, inequality rose in 16 out of 20 rich OECD countries. This coincidence of rising mean income and rising inequality in mature economies would no doubt have surprised Kuznets, as it did many economists.

Inequality also rose in China, a poor country with comparative advantage in unskilled labor–intensive products, whose trade-to-GDP ratio jumped from about 20 percent to more than 60 percent in 2008. The HOS theorem of globalization predicts that inequality would have fallen as wages of low-skilled workers relative to skilled workers rose. In fact, however, China’s Gini coefficient rose from less than 30 in 1980 to about 45 today. Once again, fact confounds theory.

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He identifies four potential causes of rise (stable in some countries) in inequality:

• technological progress (favored skilled workers, whose wages increased more)
• institutional change (higher taxes and social transfers—redistribution)
• changing social norms (society encourage high wages by skilled workers)
• globalization (specialization in high-skilled exports increases wages of the skill group)

He stresses that social transfers, unemployment benefits, guaranteed employment in rural areas like NREGA in India, social support programs such as Oportunidades in Mexico and Bolsa Familia in Brazil might help to reduce inequality. The decline in inequality in Brazil (from Gini of around 60 in 2000 to 57 today) can be attributed to social support programs, and broader access to education that increased the supply of skilled workers. Still, Brazil remains among the five most unequal countries in the world.

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Berg and Ostry explore if there is a trade-off between equality and efficiency? They say NO, especially in the long term there is no trade-off between efficiency and equality.

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In fact equality appears to be an important ingredient in promoting and sustaining growth. The difference between countries that can sustain rapid growth for many years or even decades and the many others that see growth spurts fade quickly may be the level of inequality. Countries may find that improving equality may also improve efficiency, understood as more sustainable long-run growth.

[…]inequality is strongly associated with less sustained growth. […]too much inequality might be destructive to growth. Beyond the risk that inequality may amplify the potential for financial crisis, it may also bring political instability, which can discourage investment. Inequality may make it harder for governments to make difficult but necessary choices in the face of shocks, such as raising taxes or cutting public spending to avoid a debt crisis. Or inequality may reflect poor people’s lack of access to financial services, which gives them fewer opportunities to invest in education and entrepreneurial activity.

[…]a 10 percentile decrease in inequality (represented by a change in the Gini coefficient from 40 to 37) increases the expected length of a growth spell by 50 percent. The effect is large, but is the sort of improvement that a number of countries have experienced during growth spells. We estimate that closing, say, half the inequality gap between Latin America and emerging Asia would more than double the expected duration of a growth spell in Latin America.

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Kumhof and Ranciere argue that higher income inequality in development countries is associated with higher domestic and foreign indebtedness.

Need for immediate relief for industrial sector in Nepal

This was published in Republica, September 12, 2011, p.6. Here is a piece on the same issue by Milan Mani Sharma of Republica.

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Relief for industrial sector

At a time when the public’s confidence on bureaucracy and political leaders is ebbing down to arguably the lowest level after skyrocketing of hope following the 2006 revolution, the newly appointed Prime Minister Dr. Baburam Bhattarai’s team has announced a slew of “relief” measures to convince Nepali people that the new government feels and fathoms the desperation for tangible change. While some of the measures are consistent with the major party’s political agenda and are outright populist, they are nevertheless required in one form or the other. Pundits and talking heads can preemptively debate on the intention and nature of the relief package, but the application of these initiatives merit some time. Their success has to be judged against the intended objective and efficacy.

Now, as much as the public needs relief package, the industrial sector also deserves immediate measures to kick-start jammed growth engine and jobs creation. It needs immediate relief for two main reasons. First, due labor related problems and policy inconsistency, the investor’s morale and market confidence are pretty low right now, leading to withholding and withdrawal of investment plans. Second, due to lack of adequate supply of infrastructure and supply-side constraints, industrial output is declining and cost of production is rising, leading to low economic activities, stagnation in employment generation, and loss of competitiveness.

Unless the industrial sector gets the badly needed relief from these constraints, the dream of attaining double-digit growth—also reiterated by Finance Minister Barsa Man Pun as soon as he assumed office and trumpeted by the UCPN (Maoist) bigwigs multiple times– won’t be realized. High growth will not be attained just by customary assistance to agriculture sector—whose output and volatility largely depends on the monsoon— by offering fertilizer subsidies, investment in irrigation and promotion of agriculture cooperatives. High and sustained growth requires structural change and more reliance on industrial activities.

Unfortunately, our industrial sector— which constitutes mining and quarrying; manufacturing; electricity, gas and water; and construction sectors—has been consistently losing ground. Currently, its contribution to GDP is approximately 14 percent only. Meanwhile, manufacturing sector is fast losing strength, bringing down its contribution to GDP to 6 percent. Note that a strong and sustained growth of manufacturing sector means more jobs, stimulation of economic activities, and a high but less volatile growth rate. We just have to look at our neighbors—China and India—for example.

It does not come as a surprise that the dismal performance of industrial sector, particularly manufacturing sector, is also reflected in the export-oriented sector, one of the most important sectors through which our economy gets foreign exchange reserves. The latest annual macroeconomic data released by the central bank shows that total exports are estimated to be just Rs 64.6 billion in 2010/11, down from Rs 76.7 billion in 2008/09 but up from Rs 60.8 billion in 2009/10. When the data was released the authorities were quick to point out that exports have increased by 6.1 percent, which is higher than 5.4 percent growth of imports. There is nothing to be exuberant about on this one as the high growth rate of exports was relative to previous year when exports plunged by Rs 7 billion. A slight improvement when the base is too low obviously gives a larger bump in growth rate! Also, the relatively low growth rate of imports has to do with decrease in imports of certain commodities, thanks to restrictive policies imposed by the government.

The situation has gotten so worse that we cannot even finance our petroleum imports (Rs 75.07 billion in 2010/11) by exports revenue. Diversification of exported product and destination is not happening as our export basket is squeezing and we are increasingly dependent on India for both exports and imports. Overall, exports of goods and services have declined from as high as 27 percent of GDP in 1997 to less than 15 percent today. Meanwhile, imports of goods and services have exploded to 28 percent of GDP. This has resulted in total trade deficit of around 22 percent of GDP. Similarly, an estimated Rs 2.93 billion of balance of payments surplus following two successive years of deficit has more to do with a fluke of handsome transfers and reimbursements as our economic fundamentals have not changed much. Our current account deficit is still negative despite a surge in remittances.

You might be wondering how all these dismal numbers are related to the above-mentioned call for industrial relief. Well, persistent labor dispute, which exacerbated after the UCPN (Maoist) affiliated unions formally entered the industrial sector as an organized group plus the destructive activities of Young Communist League (YCL), hit investor and market confidence pretty hard. It led to closures of multinational companies and withholding of investment spending. The unruly activities of trade unions, which are run by people who care more about themselves and party leaders rather than job security and welfare of workers they claim to represent, was continuing even when the relief package was announced. Recently, it cost us Surya Nepal Private Limited’s Biratnagar-based garment manufacturing unit. The popular Fire and Ice restaurant in Thamel is the latest victim of few unruly trade union members who are trying to dictate management level appointment, which is beyond their jurisdiction and obligation. Furthermore, the inadequate supply of infrastructure (power and roads network) and other constraints such as policy inconsistency, security, and sporadic blockade of major trade routes are also contributing to withdrawal of investment, capital flight and closure of firms. Domestic investors are moving to service sector (save hotel and restaurants) that has relatively low union pressure and less cost of doing business.

These constraints are also identified as problematic factors for doing business in Nepal by the latest Global Competitiveness Report 2011-2012, which has ranked our economy as 125^th most competitive (out of 142) in the world. We are ranked the lowest in supply of electricity and second worst in supply of infrastructure. The ranking is miserable in labor regulation, labor market efficiency, productivity, security, production sophistication, and innovation. The business sector thinks government instability is the most problematic factor for doing business, followed by inefficient government bureaucracy, policy instability, corruption, inadequate supply of infrastructure, and restrictive labor regulation.

It is leading to an erosion of our industrial capacity, without which growing at a steady 5 percent growth rate—let alone a double-digit rate—is impossible. Hence, the call and need for immediate industrial relief. A tentative relief package could be: taming labor militancy and smoothening industrial relations; policy consistency on key issues related to investment regime and sectoral support; effective end of syndicate; credit at low interest rate to key sectors where we enjoy comparative advantage consistent with our land, labor and capital resource endowment; emergency measures to supply power for at least two shifts in manufacturing plants; fast track endorsement of investment plans and lowering cost of doing business in Nepal; enactment of SEZ bill; and industrial security. These are doable and are not populist measures.

PM Dr. Bhattarai and FM Pun are well aware of these constraints and the challenges faced by the industrial sector. Now, they should at least make an effort to bring out industrial relief package to restore confidence of investors and markets. Of course, they will face resistance from their own party and other vested interest groups. But, it should be rightly confronted with as demanded by the emergency nature of our eroding strength of industrial sector.

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Middle men in agriculture market

This incident shows how middle men in agriculture distort the market. The farmers never get the true price for their agriculture products. Moreover, most of the subsidized agricultural inputs get routed by agents.

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The Sapahi farmers are also demanding that the government find market for their produces and punish people creating artificial shortage of chemical fertilizers, seeds and pesticides.

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How can you not find market for agriculture produce when in fact the market is seeing food prices? Incentives structure (price) is failing to work here.

Update on the human cost of Maoist insurgency in Nepal

• Killed: 17,828
• Disappeared: 1,452
• Disabled: 5,912
• Displaced: 89,171
• Property loss suffered: 14,348

Source: Republica, September 10, 2011, p.3 (quoted Ministry of Peace and Reconstruction)

The latest numbers are higher than the previous estimate.

Pic sourced from NepalStats

China’s economic might to surpass America’s by 2030

So argues Arvind Subramanian. Here are excerpts from The Economist which reviews Subramanian’s latest book:

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[…] Mr Subramanian combines each country’s share of world GDP, trade and foreign investment into an index of economic “dominance”. By 2030 China’s share of global economic power will match America’s in the 1970s and Britain’s a century before. Three forces will dictate China’s rise, Mr Subramanian argues: demography, convergence and “gravity”. Since China has over four times America’s population, it only has to produce a quarter of America’s output per head to exceed America’s total output. Indeed, Mr Subramanian thinks China is already the world’s biggest economy, when due account is taken of the low prices charged for many local Chinese goods and services outside its cities.

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More from The Economist:

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[…] Big though it is, China’s economy is also somewhat “backward”. That gives it plenty of scope to enjoy catch-up growth, unlike Japan’s economy, which was still far smaller than America’s when it reached the technological frontier.

[…] Buoyed by these two forces, China will account for over 23% of world GDP by 2030, measured at PPP, Mr Subramanian calculates. America will account for less than 12%. China will be equally dominant in trade, accounting for twice America’s share of imports and exports. That projection relies on the “gravity” model of trade, which assumes that commerce between countries depends on their economic weight and the distance between them. China’s trade will outpace America’s both because its own economy will expand faster and also because its neighbours will grow faster than those in America’s backyard.

[…] He is overly sanguine only on the problems posed by China’s ageing population. In the next few years, the ratio of Chinese workers to dependants will stop rising and start falling. He dismisses this demographic turnaround in a footnote, arguing that it will not weigh heavily on China’s growth until after 2030.

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Rodrik argues (Rodrik’s cautious views here and also here):

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[…] “I see lots of fragility in the Chinese system. Combine the stresses that will arise from the need to alter their economic model with the restiveness beneath the surface (the number of riots that take place in that country every single day is mind boggling) and their inability to effectively deal with political dissent, and I think you have a very explosive situation. It could well be that a balance that you can maintain at 9% growth becomes impossible at 6%.”

[…] “They have little choice but to emphasize domestic demand now. But this will create problems. Domestic consumer will demand, at the margin, more health care, housing, and entertainment — not more steel or electronics or the other stuff on which the export engine depends. The mismatch means lots of factories will have to close and lay workers off.”

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Remittance 2.0 in Nepal

Trailokya Raj Aryal digs into an old book and finds an uncanny similarity during the Rana regime and the present day. It relates to how people depend on remittances, spend an import induced consumption filled lifestyle, and stagnate the economy.

Remittance 1.0

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The signing of Versailles Treaty in 1919 officially ended the First World War, and some 200,000 Nepali soldiers who went to fight for the British Empire returned home with money and foreign ways. As Sardar Bhim Bahadur Pandey explains in the first volume of his brilliantly written book, “Tyas Bakhatko Nepa: Ranakalin Akhiri Teen Dashak” (Nepal at that time: The last 3 decades of Rana rule), suddenly impoverished villages of Nepal’s hilly region were awash with cash, almost 130 million Indian currency, equivalent to 13 billion rupees at the time of writing the book some 25 years ago, and 68. 41 billion Rs in today’s prices.

With nowhere to invest their money on, many soldiers invested on real estate, and some spent it all on merry-making. Their use of foreign products impressed the simple-minded villagers who until then had not even imagined those things existed, and their tales of faraway lands, customs and battlefields, not to mention the social prestige accorded to them made many young men dream of going abroad to work.  Similarly, the taste for foreign goods naturally resulted in an increase in imports, a trend encouraged by the Rana oligarchy as it led to an increase in customs revenue, which in turn killed the local industries as they could not compete with the cheaper and finer imports from abroad. Had the money been spent on Nepal’s industrialization and had the ways been devised to save the cottage industry, late Mr Pande argued, Nepali villages would have been no less wealthy than the Swiss villages. Alas, Nepal’s industrialization was doomed even before it started, marking the beginning of the age of Remittance 1.0 in which our able-bodied young men went abroad, sent or brought money home and then spent most of that money on sustaining the costly habit of foreign goods. The country gained nothing.

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Remittance 2.0

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One would expect that the economic blunder of the Rana regime to be corrected after more than 60 years since we bade adieu to the oligarchy, but no leaders, irrespective of the regime (democratic, Panchayat and the post-Panchayat) did anything about it, and call it our sheer misfortune, the leaders of New Nepal too do not seem bothered by it. Just like an upgraded computer virus, Remittance 2.0 is now affecting the country in a scale far bigger and deadlier than its predecessor.

If the figures released by the Ministry of Labor and Transport Management are to be believed, more than 42,000 of our youths went abroad to work in countries other than India, in the month of Shrawan (July17-August 17) alone. With thousands of youths going abroad for work each month, the flow of remittance has also increased and has become the mainstay of our economy with Nepal receiving with an estimated $ 3.5 billion in 2010 sent by some two million Nepali workers abroad.

However, instead of it going to productive sectors, a significant chunk of it is being spent on imports and real estate, just like in the year 1920 and as such our manufacturing capacity is going down each day. One would expect that the inflow of money would lead to industrialization which in turn would make it possible for the youths to find employment in their own country, but exactly the opposite is happening. What the economists call the Dutch disease effect, ie, reliance on one sector leading to decline in manufacture sector, is clearly visible in Nepal’s case. 

What’s more amazing is, at a time when we are witnessing a mass exodus of youths in search of employment abroad, the militant labor unions affiliated with various political parties are closing down whatever industries we have with their unreasonable demands, the recent example being the closure of Surya Garments. And at a time when other countries are negotiating trade terms and signing free trade agreements with each other, we are left requesting foreign governments to increase the quota of Nepali workers, rather than making investors, both domestic and foreign, feel secure enough to invest in Nepal.

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Check this and this (and the links within) for a detailed look at remittances. Here are two cools charts (this and this) depicting district-wise remittance distribution and the results shown by NLSS III. Here is former finance secretary Rameshore Prasad Khanal arguing how migration is leading to low fertility rate in Nepal and could stall population growth rate.

Chart source: NepalStats

Public works plus unconditional transfer program in Ethiopia: A review of PSNP

Lieuw-Kie-Song reviews Ethiopia’s Productive Safety Net Programme (PSNP)-- which includes employment through public works as well as transfer component-- and argues that the integration of the two commonly used social protection strategies creates synergies and much better outcome than implementation of the two programs independently.

For instance, it covers labor-constrained households by the safety net (transfer) program, which public works program that uses labor from each household cannot cover. But, it also employs non labor-constrained households in public works that focuses on natural resource rehabilitation and maintaining rural infrastructure, which transfer programs cannot do. Labor-constrained households (due to sickness, maternity, household size, disability, old-age, or death) can switch partially or fully to the direct unconditional transfer component of the program. This switch can be either permanent or temporary depending on the nature of the constraint faced by households.

The combination of these two components-- public works and direct transfers-- in the same program has resulted in a more “coherent framework of enhancing productivity and providing social protection”, argues Lieuw-Kie-Song . The author argues that PSNP is providing regular and predictable income and employment, fostering decent work environment; introducing a formal set of rights for participating households, including an appeals process to address grievances; allowing flexible working hours for women; and integrating a high degree of local and participative decision making.

PSNP targets chronically food insecure households in famine-prone areas in rural Ethiopia. It has around 8 million beneficiaries from around 1.5 million households. So far, the cost of the program is 1.2 percent of Ethiopia’s GDP. It provides transfers (15 kilos of cereal per household member per month for six months a year) to food insecure households. For households that are required to work, which is guaranteed, to get this transfer must work for five days to receive the transfer for one person.

The objective of the program is to provide households with enough income (cash/food) to meet their food gap and to build community assets to contribute to addressing the root causes of food insecurity. A review of the program by Anna McCord found that the program faces significant problems in identifying, designing, and implementing the scale of infrastructure projects required to absorb the levels of workers anticipated.