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From issue: Impact Investing: Profit Meets Purpose (Fall 2011)

AQ Feature

The Decline in Inequality in Latin America: Policies, Politics or Luck?

Nora Lustig

While real, the recent gains in inequality remain fragile.

Latin America has been basking in good news lately. High growth, combined with an unusual resilience to the global financial crisis, has contrasted sharply with events in Europe and the United States. Even the countries hardest hit by the crisis have managed quite well.

Another piece of good news has received less attention. Income inequality in the region has declined in 13 out of 17 countries for which comparable data exist. After rising in the 1990s, inequality in Latin America declined by nearly 1 percent per year between 2000 and 2009.

More impressively, this decline has occurred even as inequality has grown in China, India, South Africa, and most advanced countries. To a large extent, inequality in Latin America has always been the result of state capture on the part of predatory elites, inequality of opportunities, lack of access to credit for the poor, and discrimination against nonwhites and women. This means the observed fall is good news both in terms of fairness and overall efficiency.

Has the decline in inequality been the result of policies, politics or luck? The answer is a bit of all three.

Shifts in Politics, Policy, Demographics, and Global Demand

Two major factors account for the decline in Latin America’s inequality: the wage gap between skilled and low-skilled workers has narrowed and governments’ social policies have become more pro poor. The decline in the wage gap occurred, in part, because of the expansion of basic education during the past two decades. Emphasis on universal coverage of basic education (both primary and the first three years of high school) and cash transfer programs targeted to the poor have been unambiguous moves toward pro-poor public spending.

In the 2000s, there was a significant rise in the importance of government transfers to the poor. This had the effect of increasing public distribution to those sectors. Large-scale conditional cash transfer (CCT) programs such as Bolsa Familia (Brazil) and Progresa/Oportunidades (Mexico) had remarkable redistributive power. These programs are a small share of total government social spending, but go a long way in terms of redistributing income to the bottom of the income scale. Bolsa Familia reaches around 11 million families and Oportunidades about 5 million. Their cost (including administrative costs), however, is below 0.5 percent of GDP.

In some countries, increases in the minimum wage and union-friendly governments have contributed as well.

What about the political dynamics behind pro-poor government spending? The first large-scale CCT program, Progresa (later called Oportunidades), began in Mexico in the late 1990s and spread to other countries later in that decade and in the 2000s. Its launch could be seen as part of a democratization process that shifted political power away from corporatist groups, like labor unions, toward rural voters.

Redistributive programs are more likely to be introduced where their poor beneficiaries have become politically vocal and organized. Bolsa Familia was instituted nationwide after Luiz Inácio Lula da Silva, leader of the Partido dos Trabalhadores (PT)—a political party whose support comes from the rural and urban poor—won the 2000 presidential election.

In Bolivia, redistribution policies took hold in 2005 when the rural party movement, Movimiento al Socialismo (MAS), led to the election of Evo Morales as president. Large-scale redistributive programs in Argentina became pervasive after the Kirchners (first Nestor and then Cristina Fernández) were elected by voters from the ranks of the unemployed, the impoverished working class and the disempowered. Although inequality declined in countries governed by both leftist and non-leftist regimes, leftist governments in general have been more redistributive than the nonleft. For this reason, politics in the region over the past decade has shifted in favor of a redistributionist agenda.

Luck, too, has been on the side of redistribution. Increasing access to education, at least at the primary and secondary levels, seems to be part of a long-term trend throughout the developing world.

In addition to the pro-poor political dynamics, the increase in coverage for basic education was possible because of a demographic transition. Fewer children are entering primary school. The demographic transition has also increased the number of working adults per child and retiree, especially among poorer households. In South America, the high growth resulting from the Asia-driven commodity boom has generated an exceptional amount of fiscal space and a good chunk of it has been used for redistribution.

Increasing access to education over a sustained period, as the supply of educated workers began to catch up with demand, made it possible to take advantage of a skills premium in wages. It also resulted in marshaling more progressive government spending, especially after 2000, to reduce longstanding inequality.

The Glass Half Empty

Nevertheless, Latin America is still the most unequal region in the world.

In spite of the undeniable progress in making public spending more pro poor, taxes and transfers in Latin America redistribute little when compared with advanced countries. In particular, the collection of taxes on personal income and wealth is very low. And relying on indirect taxes, such as the value-added tax, makes the systems less progressive than they could—and should—be. Countries in the Southern Cone, Ecuador and Mexico have made some progress, but not the rest. And there is still room for improvement. On the spending side, interventions that make the distribution of income more unequal than the market distribution continue (for example, subsidies to agricultural producers or airlines). At the same time, a substantial portion of social spending (between 30 and 65 percent, depending on the country) is not progressive enough in reaching those who really need it.

High growth and redistributive policies have not eradicated extreme rural and urban poverty. Even the largest and most successful cash transfer programs, such as Bolsa Familia and Oportunidades, exclude between 40 and 50 percent of the indigent because of flaws in design or implementation. Those in the middle classes, though larger than before, are still relatively small and vulnerable to dropping out of the middle-class ranks if faced with shocks. The result is that redistribution is unfinished business…

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