Jun 26, 2000 - According to the second point of view, lump-sum redistribution is impossible in the real world, and since any redistribution necessarily goes ...
Can redistribution accelerate growth and development ?1
François Bourguignon2
First draft June 2000 1
Paper prepared for the ABCDE/Europe, Paris 26-28 June 2000. It borrows on a unpublished paper given as the Luigi Solari Lecture at the University of Geneva, November 16, 1999. 2 World Bank and Ecole des Hautes Etudes en Sciences Sociales, Paris.
2
Introduction Two points of view have dominated the economic literature on income inequality, or on distribution of resources in general. According to the first, distribution can be considered more or less independent of economic activity and efficiency. If markets function perfectly and if lump-sum redistribution - that is positive or negative transfers unrelated to economic outcomes - among agents can be carried out, then any distribution of income can be achieved as the result of pure market mechanisms. This is known as the "second theorem of welfare theory" in the Arrow-Debreu framework. According to the second point of view, lump-sum redistribution is impossible in the real world, and since any redistribution necessarily goes through an authoritarian modification of the price system, it entails a loss of efficiency for any competitive economy as a whole. It follows that there will inevitably be an inverse relation between greater equity, that is greater redistribution, and greater efficiency. The question is how to strike a balance between these two alternatives. Considerable progress has been made in detailing the conditions under which such balancing and decisions take place. However, despite considerable progress in our understanding of the phenomena involved, the debate on these questions of redistribution remains as lively and almost “doctrinal” a division as ever between adherents and opponents of extending or pulling back on redistribution. This doctrinal split is just as acute in the area of economic development. Since the ultimate purpose of development strategy is to reduce poverty, the question is whether maximum efficiency is to be encouraged, maximum growth being then the objective of policy, or whether policies should be encouraged that lead to slower overall growth rate but are more favorable to the poor. The first point of view and the 'trickle-
3 down' principle that it implies — with growth eventually having a positive effect on poverty —has been dominant at certain times during the last half-century, certainly during the 1960s and during the process of structural adjustment and return to growth that took place through the 1980s and into the early 1990s. The second point of view had an influence on the course of thinking about development in the 1970s, most notably following the famous book “Redistribution with Growth,” written under the direction of H. Chenery (1974). However, it faded in the face of the crisis that ensued and during the so-called 'lost decade of development'. It seems now to be regaining dominance as shown by the increasing priority on reducing poverty within organizations such as the World Bank and the International Monetary Fund. This emphasis on poverty reduction and possibly redistribution in development strategy may be justified in another way than by giving more weight to the poorest in a necessary tradeoff between efficiency or growth and equity. This choice may not be necessary, because the economies we live in do not satisfy the basic conditions necessary for such a tradeoff to exist. Real economies may simply be “inefficient” in which case gains in both efficiency and equity may be obtained simultaneously. More than that, a progressive redistribution of resources may prove to be a necessary condition for improving the efficiency of the economy. In that case, there would no longer be a contradiction between redistribution or equity and growth; rather, they would be complementary. Redistribution of resources would thus be a 'win/win strategy', leading simultaneously to a rise in equity and efficiency. It is easy to conjure up examples of situations where excessive inequality of resources engenders inefficient allocation of resources. The most obvious is probably the case of an imperfect credit market where an agent, due to a lack of collateral, which would allow him/her to borrow what he/she requires, is prevented from undertaking an
4 investment project whose social and private profitability is nevertheless greater than that commonly observed in the economy. There are, however, many other situations of this type, and one of the purposes of this article is to briefly review cases where excessive inequality of wealth or income leads to relative inefficiency in the economy or a growth rate slower than what it could be. This idea of a possible complementary relationship between equity and efficiency, or between equity and growth, has recently aroused considerable interest. Thanks to early positive statistical tests across countries, some have even been disposed to consider this relationship a new kind of “economic law ”. One must not go too far, however. If economic theory may identify various situations where such complementarity could be expected to exist, the opposite is also true. On the empirical side, on the other hand, available data essentially make it difficult to reach a definitive conclusion. As a matter of fact, a strong point made in this paper is that it is most likely that no uncontroversial aggregate evidence in favor or against the complementarity hypothesis between equity and growth might be drawn from existing cross-country and time series data on growth and distribution of income or resources. But of course, this is not an argument against or in favor of that hypothesis. Theory as well as micro-economic evidence matter too. Assuming that such a complementarity between efficiency and equity does exist, what are its implications for redistribution? It is one thing to infer or, less likely, to observe that excessive inequality in the ownership of productive resources can mean inefficient allocation of these resources; measuring the extent of this effect and inferring that some type of redistribution will necessarily increase the overall productivity of an economy is another matter. According to theory, it is mostly the inequality of assets rather than that of income that matters for efficiency and growth.
5 But transferring ownership of resources is not an easy task. It may not even be part of an economic policy agenda. Redistributing current income seems more easily feasible but it may have no direct effect on the distribution of resources and may not have the same effect on economic efficiency as a redistribution of resources. It may even have a contrary effect, if certain mechanisms advanced to explain the tradeoff between efficiency and equity are sufficiently powerful. As regards development, redistribution per se is probably not sufficient for accelerating growth, unless it is carried out in a specific manner appropriate to conditions in the economy involved. This is the issue we propose to examine in the third part of this article. Before getting into these various points, it must be stressed that the objective of this article is essentially to propose a brief synthesis of recent developments in the field of growth and inequality. It is not to contribute new theoretical ideas or empirical results. The growth/equity debate has attracted very much interest during the last decade or so and it is not yet totally clear what the actual contribution of all that literature to designing development strategy may be. Pausing a little and trying to draw the lessons of what has been learnt so far thus seems a useful exercise.
1. Equity and Growth: Complementary or Substitutes? The rich theoretical literature that developed on this subject since the return to growth in the 1990s has considerably renewed our way of thinking about the relationship between distribution and growth. This section briefly reviews in a non-technical way these developments insisting upon the various channels identified in the literature
6 through which the distribution of assets, and possibly of income, may affect the rate of growth of an economy. 3 As a starting point and for future reference, let us consider the simplest model of growth where output is proportional to a single asset, e.g. 'capital', that is being accumulated by individual agents. The rate of return of capital is thus constant over time. With perfect capital markets, sufficiently distant foresight and identical preferences of agents, the rate of accumulation is the same for all and depends essentially on the rate of return to capital and inter-temporal preferences. This common rate of accumulation determines the growth rate of the whole economy. As individual accumulation rates do not depend on initial wealth, the initial distribution of (relative) wealth remains constant over time, the same being true of the distribution of income. In this very simple, but not necessarily unrealistic representation of the world, the distribution of wealth and income thus proves to be independent of the economy’s growth rate. Growth only depends on the physical rate of return to capital and the (common) inter-temporal preferences of individual agents. The larger the rate of return to capital, or the less impatient the agents, the higher the rate of growth, independently of whether capital is more or less unequally distributed. This basic result may be easily generalized to a model with two factors. Adding labor to the picture and making the reasonable assumption that the productivity of labor is proportional to the capital/labor ratio leads exactly to the same conclusions. 4 An interesting property of the preceding model is that redistributing wealth, at any point of time, does not modify the growth rate of the economy as long of course as 3
For a recent more complete and more technical survey see Aghion, Caroli and Garci-Penalosa (1999).
7 this redistribution in not anticipated by agents. This property is strictly equivalent to the neutrality of lump-sum income transfers recalled earlier. By contrast, a non lumpsum and progressive redistribution of current income, as opposed to a redistribution of wealth, has the effect of lowering the growth rate of the economy. The mechanism is simple. Suppose to simplify that labor income is the same for all - skills or human capital being included in total capital. Then a redistribution from rich agents, i.e. with much capital, to poor, i.e. unskilled workers without wealth, may be obtained through taxing wealth, including human capital, or equivalently the return on it and subsidizing labor. Such a change in relative prices may produce a once for all increase in the supply of labor. But it will inevitably reduce the rate of return on capital, and hence both the individual rate of capital accumulation and the growth rate of the economy. This model is schematic and basic, but constitutes a fairly good point of reference. Under the various basic assumptions which it relies on, the redistribution of wealth would have no effect on the economy’s growth rate, while a permanent redistribution of current income through progressive taxation of income would reduce it. Interestingly enough, it is a model of this type that is implicitly behind the trickledown view according to which poverty will eventually disappear with growth but reducing poverty through instantaneous redistribution is likely to be harmful to growth.5 The predictions of this basic model can be modified either by changing the hypotheses that underlie it or by broadening the analytical framework. We will proceed in that order. In terms of the hypotheses, it seems logical to explore the consequences of 4
This is a succinct statement of the so-called 'aK' model in the recent endogenous growth literature. For a complete analysis of distribution and growth in that model see Bertola (1993)
8 relaxing (a) the hypothesis of constant return on capital or, more generally, on the factors that give rise to accumulation; (b) the perfect-market hypothesis. In terms of the analytical framework, we must consider those factors that are capable of changing the behavior of agents, particularly their behavior in accumulating physical or human capital. In relation with the above reasoning, one obvious question concerns the endogenous nature of the redistributive system which, we have seen, can directly affect agents’ rate of accumulation. However, one can also inquire as to the microeconomic logic of the behavior that determines this rate, and examine the consequences of certain alternative hypotheses. - Returns to scale If the productivity of the accumulated factor grows or diminishes with accumulation, or if the productivity of labor does not advance at the same pace as the accumulation of factors, then growth can distort distribution. Also, agents’ rates of accumulation may then depend on their level of wealth. The foregoing conclusions regarding the independence of growth and distribution are thus brought into question; but it would be difficult to know in which direction this goes. Besides, the assumption of a constant marginal productivity of capital and of a constant share of labor in GDP implicit in our reference model may not be bad first approximations in the long-run. Slightly more interesting conclusions are obtained when the productive sector is disaggregated into sub-sectors, some of which may benefit from economies of scale. This leads to an interesting channel through which a more egalitarian income or wealth distribution may improve efficiency and growth. If there is a good whose production yields increasing returns to scale and whose (constant) income elasticity is less than unity, then any progressive redistribution should increase demand for the 5
A very precise statement of such a model appears in Chenery et al. (1974, chapt. 11)
9 good whose production enjoys positive economies of scale and should increase the economy’s productivity. In other words, redistributing income means increasing mass consumption subject to increasing economies of scale. Dynamically speaking, one may think that this operation should increase the productivity of capital and also leads to more rapid growth.6 The virtue of this example is to demonstrate a simple case in which distribution has a direct impact on an economy’s overall productivity. The problem is that the direction of that impact is not clear a priori. Under the same reasoning, a more egalitarian distribution of income would involve a loss of efficiency in production if there were economies of scale for “luxury” goods, i.e., goods where the income elasticity would be greater than unity. Further, if the economy is an open one, then international trade may make it possible to take advantage of available economies of scale—assuming that they are applicable to tradable goods—thus canceling out the effects of the domestic distribution of income. - The functioning of markets In the reference model, markets are assumed to be perfect, equalizing investment and saving on the one hand, and productivity of identical factors across the economy and at every point in time, on the other hand. If one assumes that this is not the case, does the independence of efficiency and distribution still hold? A simplest example to demonstrate that it does not hold is as follows.7 Suppose the economy is made up of individual enterprises, where each entrepreneur exploits the 6
For a complete model see Murphy, Schleifer and Vishny (1989). In a sense, this is an extension of the Keynesian argument, in which redistribution appears as an expansionary factor, due to an increase in the propensity to consume for the economy as a whole. Here it is the propensity to consume a good that increases where economies of scale are involved. Note, however, that the inefficiency caused by this non-convexity could be corrected by indirect taxation rather than by redistribution. 7 See Piketty (1997)
10 capital available to him/her, say machinery, with a technology that has diminishing marginal return. With a perfect capital market, those entrepreneurs whose equipment is limited, and who are thus confronted with high marginal returns, borrow the machinery from those in the opposite situation. At the equilibrium point, the return on capital is the same in all undertakings, and total production depends strictly on the total available capital, not on how it is distributed. However, if the capital market is imperfect and if borrowing is impossible or simply limited, the return on capital is higher in some enterprises than in others. By redistributing capital toward those enterprises where profitability is higher, and therefore with the least wealth, the efficiency of the economy is improved. Wealth redistribution acts here as a substitute to borrowing on the capital market. Equity and efficiency then go together. This very simple reasoning can be extended in various directions. Perhaps more realistically, one can present it in terms of imperfections in the credit market. preventing investments to be undertaken that would yield a higher private and social return than in the economy as a whole. Because of information asymmetries and lack of collateral, individuals who would have the opportunity to invest in highly profitable projects but whose resources are limited will find themselves denied the credit they need for the project. A prospective small entrepreneur will remain a wage worker, or parents will not send a particularly gifted child to secondary school or university. Redistributing the wealth of the richest toward those who are thus prevented from investing would increase the return on capital and raise the economy’s growth rate. This argument on the imperfect nature of the credit market is no doubt the argument most frequently invoked in all of the recent literature on the inefficiency of
11 excessively inequitable distribution of wealth.8 The same type of argument, however, would apply to the insurance market. In the absence of efficient risk-sharing mechanisms, an entrepreneur or a peasant with scant resources will prefer to invest in a project or a culture where the expected yield is lower but less risky than a project where both risk and the expected yield are higher. Here too, redistribution from the wealthier to the less wealthy may increase the efficiency of the economy and the productivity of investments.9 This argument also applies to apply to imperfections of the land rental market. Output per hectare would increase if more efficient small farmers could rent land from less efficient large owners, or by moving from sharecropping to cash rent contracts. The above examples effectively demonstrate the importance of the hypothesis of satisfactory functioning of markets in order for the reference model conclusion of independence between the distribution of assets and growth to be valid. Although this should be investigated in detail for the labor market for good markets, any market imperfection seems to reestablish some role for the distribution of income and productive resources in determining the magnitude of production and growth. In all of the cases indicated, the relationship is in the direction of complementarity between the equity of the distribution of assets or wealth and economic efficiency. The reason for this is that in all cases mentioned above, the market imperfection consists in limited access to the market for those less fortunate, which can only be countered by transferring resources to them. Not much has been said in fact on the nature of the market imperfections which may be responsible for this efficiency enhancing role of asset distribution. Most of them 8
See in particular Aghion and Bolton (1997), Banerjee and Newman (1993), Galor and Zeira (1993), and the reviews of the literature of Bénabou (1996), Bourguignon (1996), Aghion et al. (1999).
12 may be traced back to informational asymmetries between the two sides of the market. However, they may also be due to some of the institutions in place or, more often, to the absence of particular institutions. For instance, the absence of formal property rights for some assets – housing for instance, or even land – or the absence of contract enforcement facilities in some countries are responsible for obvious market imperfections. They may also be directly responsible for both inefficiency and inequity. - Endogenous redistribution and political economy In the reference model, we have seen that distribution and growth rate were independent of each other, but that non lump-sum income redistribution had a negative effect on growth. Income taxation inevitably reduces the return on capital and hence the incentives for saving and investment. One can go further in this analysis and inquire about the validity of the independence finding, assuming that redistribution is itself endogenous, following, here, the literature on the political economy of redistribution. Interestingly enough, this again leads to the conclusion that there is a probable complementary relationship between equity and growth. There are, however, various ways of obtaining this result. The most basic way of making redistribution endogenous is to rely on existing models of public decision-making in taxation. In the simplest model a linear tax system with constant marginal rate, t, and a universal lump sum transfer direct transfer, T, is put to a majority vote. The government’s budget constraint ensures that the vote only bears on one parameter. In fact, this constraint determines the transfer, T, for a given marginal tax rate, t, or vice versa. For the problem to be non-trivial, one must also assume that a non-zero marginal tax rate involves a loss of efficiency. In other words, 9
See Bardhan, Bowles and Gintis (2000)
13 the universal transfer T is not equal to t times the average income of the population, but to a smaller amount. When the marginal efficiency cost of taxation is increasing with the marginal tax rate, t, it turns out that the preferred marginal tax rate of an individual depends on his/her income. Under these conditions, majority voting will lead to the marginal tax rate that maximizes the median voter’s net income. It is also easy to see that this rate is a rising function of the ratio of the population’s mean and the median voter’s income. This ratio, in effect, measures the benefit that the median voter derives from the transfer, proportional to the mean income, in relation to the cost he/she pays, which is proportional to his/her own income. Under these conditions, the more unequal the distribution—i.e., the higher the mean income is in relation to median income—the greater is the redistribution. Placed into our reference model, this reasoning shows that of two societies that are identical in their distribution of resources, the less equitable will grow less rapidly. It will generate stronger redistribution, and therefore a more marked reduction in the return on capital and, hence, in saving and investment rates. If redistribution is considered endogenous, then equity and growth appear again as complementary rather than independent.10 A number of hypotheses are needed in order to arrive at this conclusion, and these can be debated. In particular, not all societies work on the principle of majority vote, and even among “democracies”, the weight of citizens in public decision-making may vary as a function of their activism, the means at their disposal to impose their particular points of view, etc. Thus, Bénabou (1996) shows that the opposite of the foregoing conclusion would obtain in a society where, due to unequal political weight, 10
This result was initially proposed simultaneously by Bertola (1993), Alesina and Rodrik (1994) and Persson and Tabellini (1994) in slightly different contexts.
14 the 'pivotal' or 'decisive' voter has a income higher than the mean. Yet, in a different setting where decisions are being taken not through vote but through lobbying Esteban and Ray (1998) find another case where more inegalitarian societies tend to be less efficient. In the preceding examples, the mode of public decision making is exogenous and to each mode is associated some relationship between equity and growth. Things are more complex when the public decision making process is itself considered as endogenous. For instance Acemoglu and Robinson (1997) and Bourguignon and Verdier (1998) analyze whether the members of an oligarchy should accept democratization, even if the majority in power then decides on a certain redistribution at the expense of the oligarchy. In the first case, the benefit to the oligarchy of such a decision is to eliminate the risk of a revolution and the cost associated with putting it down. In the second case, it is assumed that democratization involves the education of a middle class or even of the population as a whole, and that the oligarchy benefits economically from the productivity gains that come from this educational progress. Decisions on education must be taken by the oligarchy, since education is assumed to be expensive and beyond the means of the masses, due to an imperfect credit market similar to the one discussed above. In such a context, it becomes evident that in an inequitable society oligarchy has much to lose and will thus slow down both democratization and growth. This seems consonant with the idea of a complementary relationship between equity and efficiency. On the other hand, redistribution will take place in initially less inequitable societies that have made the transition to democracy, which seems contradictory to the preceding conclusion, where redistribution is more likely in more inequitable societies.
15 These various developments suggest that the question of the relation between inequality and growth via the endogenous aspect of redistributive mechanisms is more complex than is suggested by the reference model, coupled with a simple representation of public decision-making on redistribution. Such a relationship may exist and be strong, but it may go in one direction or the other. Because of this, it may, in any case, be difficult to demonstrate empirically. There is another type of endogenous redistribution that one could also call “spontaneous.” This involves transfers made by the violent appropriation of the goods of others. We have already alluded to collective violence in referring, above, to the role of revolution, or the threat thereof. More generally, one could simply speak of political instability associated with excessive inequality of income distribution. However, “private” or criminal violence against property must also be considered, and here the most elementary economic model predicts that the explanation in part relates to the relative incomes of the disadvantaged in comparison to the average income in the population. In both cases, it seems clear that if inequality in a society is so severe that it creates instability or even political violence or criminal activity against property, then the cost inflicted on society by inequality is not negligible. The cost is the direct result of violence suffered by victims, material damage and the resulting losses of economic activity. But it also is the expenses incurred by the need to suppress this violence or the latent criminal activity. The cost of criminality in Latin America was recently estimated at 7.5% of GDP, and there seems to be empirical evidence that it is caused in part by the high level of inequality in a number of countries in the region.11 11
See Bourguignon (2000) and Fajnzylber, Lederman and Loayza (1998).
16 There are other ways by which wealth inequality could be responsible for economic inefficiency. For instance, credit market imperfections and wealth inequality create geographical segregation, which in turn prevents to exploit profitable externalities across children with different backgrounds in school. Likewise, self-fulfilling believes specific of social classes may act as disincentives for individual efforts and wealth accumulation, thus reproducing initial wealth inequalities over time.12 In these various cases, however, the relation between inequality of resources and growth or development is much less direct than in the arguments reviewed above. In sum, economic theory has very much to say about the relationship between the distribution of economic resources and growth or development. Yet, conclusions seem to go in various directions. According to elementary theory - our 'reference' model there should be some independence between the distribution of assets and the growth rate of the economy, but non lump-sum redistribution whether it bears on assets or on current income should be detrimental to growth. In opposition with this view is the idea that market imperfections of different types, but prominently on the credit market, essentially invalidate this independence between asset distribution and the growth rate of the economy. Because the poor are more often affected by these imperfections, some complementarity between the equity of the distribution of resources and growth follows. However, a key point is that these imperfections do not necessarily invalidate the view that non lump-sum redistribution may have negative effects on growth. At first sight, endogeneizing this redistribution within a perfect market and fixed institutional framework seems to reinforce the idea of some complementarity between equity and growth. Too much inequality in the distribution of resources generate too much redistribution and therefore less growth. However, 12
For a review of these various theories see Piketty (2000).
17 things become more complicated when public decision making on redistribution is made itself endogenous. In front of that diversity of opinions, two solutions are possible. The first is to resort to empirical analysis to see whether indeed available evidence suggests some one-way relationship between equity and growth. The second is to rely more on our own direct appreciation of whether the circumstances put forward by the theory for that relationship to go in one direction or the other are satisfied or not.
2. Equity and growth : the inconclusiveness of empirical evidence
The debate on development and income distribution in the 1970s and 1980s was very much influenced by the famous Kuznets curve. Simple cross-country regressions in the 1970s convinced some analysts that economic inequality was related to GDP per capita according to a curve with an inverted U-shape. Very quickly, it then became 'common wisdom' that inequality was bound to increase in the first stage of development and to decrease at later stages. However, as more and better evidence became available, initial statistical estimates of the relationship between inequality and GDP turned out to be very little robust. Nowadays very few people would base an economic argument or a development strategy on the premises of an iron cast relationship between development and distribution like the Kuznets curve.13 Very much the same thing has occurred, and as a matter of fact may still be occurring, with the growth-equity relationship. Inspired directly by the empirical literature on 13
For a presentation and critique of the Kuznets curve see Anand and Kanbur (1992).
18 growth, initiated by Barro, a plethora of regressions explained international differences in growth rates, among other factors, by income distribution inequality. Early on,14 an apparently solid negative correlation showed up between growth (conditionally on, i.e., corrected for the influence of some basic determinants) and income inequality. No more was needed for some to conclude that there was some “law” linking the two phenomena. The most obvious illustration of that law was the huge difference in growth performances since the mid 1960s between egalitarian EastAsia and inegalitarian Latin America despite comparable initial macro-economic conditions.15 With time and further work, it was found, however, that this statistical relationship was not as strong as it first appeared. The juxtaposition of all available studies in Bénabou (1996) showed some contradictory results. Fishlow (1996) found that the statistical relationship was extremely sensitive to the inclusion of a few regional dummy variables. Bourguignon (1996) suggested that the estimates obtained were incompatible with available theoretical models. The models suggested that inequality should influence growth through accumulation behavior, but overall productivity of factors seemed more sensitive to inequality. Based on what is probably the most complete data base available so far 16, Deininger and Squire (1998) also concluded that there was no significant correlation between growth and income inequality. Nevertheless, because land distribution seemed significant, they did not entirely reject the hypothesis of a relationship resulting solely from imperfections in the credit market. 14
See Alesina and Rodrik (1993) and Persson and Tabellini (1994). See Birdsall and Sabot (1995) 16 Although not without serious problems. On this see Atkinson and Brandolini (1999). 15
19 These results may seem disappointing but not really unexpected. After all, crosssection analysis is known to be a delicate exercise in which one cannot exclude the possibility that results, or the absence of results, may be due to the specific characteristics of certain countries. Measurement errors in a group of countries or the presence of common forces in a subset of countries influencing at the same time both the equity of the distribution of income and growth could be sufficient to generate a positive statistical relationship between equity and growth in some cases, and a negative or non-significant relationship in others. From that point of view, panel data analysis may be seen as much preferable to simple cross-section regressions because of its emphasis on common features across countries of time series on inequality and growth. Indeed , in that context, the question that statistical analysis seeks to answer is whether a change in the distribution of resources in a country more or less systematically involves a change in long-term growth rates, regardless of the country in question. Answering positively to that question would undoubtedly leads to more robust evidence than observing that countries which were more egalitarian in the 1960s tended on average to grow faster than others since then. A few recent studies have taken this direction by running so-called 'fixed effect' regression models on time series of 5-year average growth rates, initial inequality, and several other variables usually included in growth regressions. However, they do not seem to be much more conclusive than simple cross-country regressions. A first set of studies found a result in the opposite direction to what initial simple cross-country regressions suggested. Instead of a negative relationship between inequality and growth, panel analysis seems to point to an positive relationship between a change in inequality and a change in the growth rate of an economy 17 - a result which would be 17
See Forbes (1998), Li and Zou (1998), Deininger and Olinto (2000)
20 in agreement with the theoretical presumption that income redistribution is not good for growth as discussed in the previous section. In another paper, and with different time lags and estimation technique, Barro (1999) finds no relationship. However, when breaking the sample into rich and poor countries, he finds a positive relationship between inequality and growth for the former and the opposite to the latter. Finally, these various results are called into question in a recent paper by Banerjee and Duflo (2000). Using non-parametric techniques, they show that apparently the sole robust statistical regularity within the comprehensive Deininger and Squire (1996) data base used in practically all these studies is simply that growth tends to decelerate when inequality changes, whatever the direction of that change. They also provide a simple political economy model rationalizing such a behavior. That these attempts at confirming or rejecting the various hypotheses born by economic theory about the relationship between equity and growth are mostly inconclusive is not really unexpected. As a matter of fact, it is the opposite that would be surprising. There are various reasons for this. The first has to do with the structure of the models that are estimated and the adequacy of available data. Most theoretical models reviewed in the previous section point to the distribution of productive assets, rather than the distribution of income, as the determinant of the rate of economic growth. They also are explicit on the fact that the channel through which the inequality of assets affects growth is accumulation behavior. In front of this, empirical models that are estimated are reduced form models where inequality generally refer to the distribution of income or consumption. Identifying in these models what may be the effect of the inequality of the distribution of assets on the accumulation of physical and human capital seems to be an impossible task. It is true that income inequality is probably strongly correlated with asset inequality, but the correlation is
21 far from perfect. On relatively short periods, moreover, changes in distribution data used in panel analysis are likely to refer more often to some redistribution of income than to a change in distribution of assets. As we have seen that both changes could have conflicting effects on the growth rate of the economy, it is indeed to be expected that econometric analysis leads to inconclusive results. 18 Assuming that it would be possible to distinguish between the changes in the distribution of assets and that of disposable income, a second reason for the inconclusiveness of an econometric analysis of the growth-equity relationship has to do with the endogeneity of these changes. The agrarian reforms in Korea and Taiwan after the war are examples where the distribution of assets has been modified exogenously, but are there many cases of this type? Human capital may be thought to the most important productive asset whose distribution may change substantially and at different speeds during the process of development. However, it would be difficult to consider that those changes are exogenous with respect to the process of development. Controlling for this endogeneity seems to be an additional argument for trying to estimate structural rather than reduced forms of the growth-equity relationship. There are other serious econometric difficulties. For instance, the number of examples of true “changes” in the distribution of resources or income in the available data base is necessarily very limited and does not necessarily correspond to the hypothetical experiments considered by theory. Not so many countries in the last 15 or 20 years have undergone a significant enough change in the distribution of resources to constitute a sort of natural experiment. On the other hand, observing an increase in the 18
Deininger and Olinto (2000) estimate a model where the explanatory variable is the inequality in the distribution of land rather than that of income. But land is only one of the various productive assets in
22 coefficient of Gini or some other aggregate measure of inequality may not be what matters from the point of view of the relationship between growth and distribution. The fact that the rich become much richer may not have much importance if the basic mechanism behind that relationship is that the poor do not have access to certain markets, or if the decisive voter has his/her income moving at the same pace as the mean income. Combining the relatively few numbers of changes in the distribution with the requirement that those changes must be of a particular nature to be relevant reduces further the number of episodes that would permit a statistical validation of the hypotheses set forth in the theory. Under these conditions, must one then conclude that no empirical verification is possible, and that the above theoretical arguments must be adhered to as acts of faith? Certainly not. First of all, there is no reason to believe that the evidence for policymaking in this area must necessarily be of a macro-economic nature. Some of the basic mechanisms invoked by theoretical arguments in favor of the growth-equity complementarity are essentially micro-economic. This is true in particular of the consequences of market imperfections. Opportunities for efficiency gains arising from a change in the distribution of assets in presence of market imperfection exist essentially at the micro-economic level, and it is not even sure they may be aggregated into any significant relationship between growth and inequality. Identifying such situations where output gains could be obtained through a different distribution of assets, or where both output and equity gains could be simultaneously increased through alleviating or correcting market imperfections may be much more effective than cross-country aggregate regressions. There are many empirical studies, in particular in the field of education, land reform and agricultural markets, which
an economy and is not the most important one in many countries.
23 lead to this type of conclusion, even though their conclusions are not always formulated in terms of the growth-efficiency/equity framework. At a more aggregate level, more could probably be obtained from country case studies and structural models than from cross-country reduced forms. Models need not be fully econometric. The analysis may be partial and deal with only one part of the theoretical lines of reasoning reviewed above. We sometimes have good evidence on the basic mechanisms that may be responsible for some relationship between growth or efficiency, and equity. Evidence on some other basic mechanisms is weaker or simply non existent. For instance, it is little debatable that credit market imperfections tend to constrict profitable investments being made in less favored environments, particularly education. Likewise, there is growing evidence that a certain type of inequity generates economic inefficiency through crime and violence or protection expenditures. On the other hand, there is some ambiguity on the elasticity of an economy’s growth rate or saving or investment rates with respect to a change in the taxation of income or consumption. And so on. It is the accumulation of empirical studies in all these areas that should gradually make it possible to understand whether or not most macroeconomic scenarios that we have envisaged theoretically are plausible, and what orders of magnitude are associated with them. The methodology that is proposed thus consists of : a) relying more systematically on micro-economic evidence without trying to aggregate it into a single relationship, and b) trying to put progressively together micro- and macro-economic evidence on the various mechanisms which according to theory may behind the relationship between growth and equity. Of course, it might be found easier to rely on some simple crosscountry macro-economic aggregate relationship to recommend more equity in the distribution of assets as a means to accelerate growth than to try to make sense of all
24 these partial results or to get in more complicated national structural models. But previous empirical experience associated with theoretical reasoning suggests the first route is little promising. Moreover, as we shall now see, it is not clear that it would give very precise information on the redistribution policies that should be implemented.
3. Redistribution for Growth We now come to the question posed at the beginning of this article. Given the possibility of a complementary relationship between the equity of the distribution of resources or revenue and the growth rate, would it not be sensible for developing economies to implement a more activist policy of redistribution than they have done in the past? Answering this question requires, first of all, examining the nature of the redistribution suggested by the above theoretical lines of reasoning. Secondly, it requires taking into account the instruments of redistribution that are available. As a prelude to this discussion, it should be recalled that a progressive redistribution of income or assets may be justifiable in itself, independent of any complementarity with growth or economic efficiency. It is enough, for the purpose at hand, that the loss of efficiency that is in danger of occurring be counterbalanced by the gain in social utility anticipated by the advocates of such a policy. If one evaluates growth not in terms of per capita GDP, but in terms of mean social welfare income equivalent, redistribution would be associated with a rise in that income equivalent. Studying how to maximize this increase and possibly how to make it have an effect on GDP, as well, are not necessarily contradictory objectives.
25 In the less restrictive framework of a rise in average social welfare, it seems that a great number of combinations of redistribution instruments are available. This is not necessarily true if the objective is at the same time to ensure faster growth. In particular, income transfers, even if they were achievable with an acceptably low static distortion cost, might not be the appropriate policy because of their disincentive effect on accumulation. Moreover, according to the theoretical models briefly surveyed above, it is assets or total wealth – including the so-called human wealth that is to be redistributed. This is as true for the argument based on the imperfect nature of the credit or insurance market as for the case of endogenous redistribution. The basic difficulty is that it is practically impossible to simply redistribute wealth without a huge social and economic cost. The distribution of wealth may only be modified at the margin, essentially though favoring accumulation of human or physical capital in certain social groups or, somewhat equivalently, by partially remedying market imperfections, in particular the credit market. However, the point is that the financing of these policies which are directed toward progressively altering the distribution of assets require themselves some transfer of current income. So, the dichotomy suggested by theory between income and asset distribution may well not be practically relevant. We analyze these ideas in more detail in what follows. The feasibility of redistributing assets depends very much on the kind of asset being considered. Practically, however, most of existing redistribution instruments operate at the margin and as a substitute to a well functioning credit market. To redistribute financial wealth seems difficult, outside of a revolutionary type of process of which the social and economic cost is prohibitively high. The same could be thought of land and real estate if redistribution had to go through straight expropriation with no or purely symbolic compensation. However, a number of countries are currently engaged
26 in co-called ‘market land reform’ programs which, unlike expropriation, are essentially operations to purchase land at market price from large land owners and sell on (possibly subsidized) credit to landless peasants.19 Without credit, a peasant who knows he/she can do better than the employees who cultivate the land of a large land owner, will not be able to acquire a piece of that land, increase total output and then have access to a broader range of opportunities thanks to this new collateral. A modern land reform policy thus consists simply of guaranteeing that a certain number of transactions that would not have been possible due to lack of necessary credit, or would have come about too slowly after saving for several generations, actually take place. In other words, market land reforms operate as a substitute to a well functioning credit market. Correcting for the imperfections of the credit market may have similar effects on infrastructure expenditures, which modify the value of assets owned by less favored groups, in non-agricultural micro-enterprises or on urban housing. Urban housing is interesting because it also illustrates the potential positive impact on equity and efficiency of reforming institutions rather than coping with the adverse consequences of credit market imperfections. Many slums in the cities of the developing world built up as the result of illegal occupation of idle land. To some extent this is an example of the ‘violent’ redistribution which was alluded to above. In any case, slums have built up and it is now unlikely that the original owner of that land be able to recover his/her property. Very often moreover, the land was public. The situation thus is one of lacking property rights which are responsible for both inefficiency and inequity. Granting some property rights to established dwellers in these areas, even for a limited but sufficiently long period, is giving value to the dwellings in these slums, 19
See Deininger (1999)
27 which may modify radically the situation of the new owners, giving them access to credit in particular. In turn, this may permit them improving their dwelling and investing in infrastructure, with all the positive externalities this may involve. Comparable examples where defining appropriately property rights may bring about improvements in both equity and efficiency may also be found in transition economies. Human capital is an asset that raises particular issues. Indeed, it is physically impossible to operate any redistribution of that asset across individuals, so that redistribution goes through favoring more or less intensively accumulation in specific social groups. In education, for instance, this requires building primary and secondary schools and staffing them, which is often considered as an important progressive transfer of the public sector to households. But this is not sufficient. It is also necessary to subsidize families to compensate them for the opportunity cost of sending their children to school. In that case, favoring the accumulation of human capital in a specific social group may thus take the form of an income transfer possibly means-tested and granted conditionally on school attendance.20 Again, those transfers may be seen as substitutes to the imperfection of the credit market. More generally, however, any public expenditure that reduces the cost of schooling for parents plays partially the same role as schooling subsidies. Covering school costs born by parents or providing school lunches, is part of this strategy. However unconditional income transfers that would permit to improve the satisfaction of nutrition needs of the poorest may also be considered as contributing to a better health and a faster accumulation of human capital in that group. 20
This is exactly the spirit of programs like Progresa in Mexico or Bolsa Scolar in Brazil. Of course there is an income transfer in such a policy only insofar as the benefit exceeds the opportunity cost of schooling.
28
Overall, some redistribution of wealth thus seems possible in a time progressive manner and mostly through public intervention in credit to help the poorest. Once set in motion, this redistribution is expected to partially eliminate imperfections in the credit market and to put the economy on a faster growth track. In the short-run, however, because this redistribution of wealth takes place at the margin through additional accumulation in some part of the population, some financing is necessary which necessarily requires raising the current level of taxes. This is where the distinction between asset and income redistribution becomes somewhat artificial. If taxes are neutral, that is more or less proportional to incomes, then the additional exogenous accumulation financed by an increase in the overall tax rate will be partly compensated by a drop in the autonomous accumulation that was initially taking place in less favored social groups. Maintaining the initial marginal wealth redistribution objective may thus require some income or wealth progressivity of tax instruments. Under these conditions, the ‘asset’ redistribution strategy that is being considered in effect redistributes current income, and therefore future assets, of some part of the population toward current asset accumulation among the poorest. In terms of growth, there may be a loss coming from more taxes being levied and less assets being accumulated by some part of the population, but there is a gain coming from more assets being accumulated in less favored groups of society. The basic economic calculation behind such a redistribution is of course that the gain more than compensates the loss, so that the economy grows faster and becomes more equitable at the same time. Of course, there may be some leakage in this process, less being redistributed and actually devoted to asset accumulation among the poor than what is taken as taxes. This should not be a problem if the preceding net gain is large enough.
29 How much of the actual redistribution in developing countries actually fit the preceding definition is difficult to say as there is no well established data base to compare countries among themselves or over time. Progresses have to be made in that direction. From the discussion in the preceding section, it may be seen that this would be a highly relevant variable to consider if one were trying to estimate some structural model relating asset distribution and growth. It would indeed be more interesting to know that an increase in the relative size of that type of redistribution 21 tends to accelerate growth than to measure the relationship between the Gini coefficient of income and growth. The preceding argument implicitly sets a kind of optimal size and structure for redistribution as part of a growth strategy. This may be of little help if redistribution is endogenous, as in some of the models reviewed above. What should be done, and what should be recommended in such a situation? The answer is ambiguous a priori, as with most political economy arguments. Since government’s behavior is given, recommendations on economic policy clearly have no more raison d’être. This is true unless some external organization benefits from a certain leverage and can effectively impose conditions by providing development aid or loans, and unless it can be shown that it is in the interest of all parties to change either the rules of the political game or, in other terms, the constitution—see, above, the considerations relating to the question of democracy. 21
Of course, not any redistribution matters. In particular social security, which in many countries represent an important part of transfers may not be of relevance in the present context. Unfortunately, authors who tried to relate redistribution and growth or investment did not make the distinction. See Perotti (1996) for instance.
30
Conclusion Significant progresses have recently been made in the understanding of the relationship between asset and income distribution and growth. Market imperfections, the lack of certain institutions, the endogeneity of redistribution, and several other mechanisms provide channels through which the distribution of assets may affect growth. In particular, this analysis suggests that progressive redistribution policies financed through some (possibly progressive) tax the proceeds of which would be devoted to the accumulation of assets among the poor should contribute to an acceleration of both growth and poverty reduction. It seems illusory to look for aggregate evidence across national development experiences in favor of some strong complementarity relationship between equity and growth as the sole justification of such a strategy. There simply are too many possible definitions of equity and too many ways in which the distribution of income or assets and growth, or changes in them may interact. Yet, there is micro-economic evidence that basic market imperfections offer opportunities of improving locally both the equity and the efficiency of an economy and also that these market imperfections may be compensated by some asset redistribution. Stretching and strengthening this body of evidence and extracting from it lessons for policy making, and investigating at a national level the complex dynamic disaggregated relationship between distribution and growth should be given a high priority in our research agenda. More fundamentally, this possible complementarity between economic equity and growth implies that pure growth-oriented development strategies may not be the most efficient for poverty reduction, as with the ‘trickle-down’ view. They are likely to be dominated by some strategies that also include distribution related objectives. Unlike
31 what was thought at some stage, however, this is not because social welfare might be higher with redistribution but because a more equitable distribution of resources may enhance the dynamic production potential of an economy.
32
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