Equity and economic growth

Just over 30 years ago Sir Arthur Lewis the Caribbean’s Nobel laureate in Economics, was moved to remark about the Less Developed Countries (LDCs) of CARICOM that: “Whoever can teach financial discipline to these states will deserve a prize.”

At that time, which was during the latter years of the colonial era, most of the LDCs were in receipt of budgetary assistance from the U.K. government. {{more}}Thankfully we have long rid ourselves of such grant-in-aid and, over the past decade or so, we in St. Vincent and the Grenadines have demonstrated elements of the financial discipline of which Sir Arthur wrote, although we are not yet prize deserving.

There is a consensus that extreme inequality of income, wealth or opportunity is unfair, and that efforts should be made to raise the incomes of the poorest members of society. Furthermore, economic policymakers have been devoting greater attention to these issues for a number of reasons: Societies view equity as a worthy goal because of its moral implications and its intimate link with fairness and social justice. There is also the conviction that equity-enhancing policies particularly investment in human capital can, in the long run boost economic growth, which in turn has been shown to alleviate poverty. Income inequality varies greatly from region to region. It is greatest in Latin America and sub-Saharan Africa and lowest in Eastern Europe while other regions fall between these two extremes. For the most commonly used measure of inequality, the numeral 1 is representative of total inequality, with zero representing perfect

equality.

In recent years income inequality has been increasing in a large number of countries following growth in their economies. This increase has been most striking in those economies which are making the transition to market-oriented systems where the average coefficient had been 0.25 until the late 1980’s. By the mid 1990s however, it had risen to more than 0.30. This represents a significant rise for a coefficient which tends to be stable in countries over long periods. In the past decade income inequality has also increased in countries such as Germany, Japan, UK and USA; and is beginning to rise in East Asian countries (China and Thailand).

Much of the debate about income distribution has centred on wage earnings, but wages tell only a part of the story. The distribution of wealth, which includes capital income, is more concentrated than labour income. Increasingly there has tended to be a shift from labour to capital income in many countries and privatisation of state assets has also hastened the trend towards non-labour income, in those countries with well-developed capital markets.

The phenomenon of globalisation has had the effect of linking the labour market, the product market and the capital market of economies around the world. Increased trade, capital and labour mobility, coupled with technological progress have led to greater specialization and to a dispersion of production processes to geographically distant locations. Software development in Bangalore India is perhaps the most celebrated example. Developing countries with an abundant supply of unskilled labour have a comparative advantage relative to developed countries in the production of unskilled labour-intensive goods and services. As a result, production of these goods in developed countries has come under increased competitive pressure and many production units have been attracted across borders to developing countries.

Economists tell us that this trend should apply a downward pressure on the relative wages of unskilled workers in the developed countries and an upward pressure on the compensation of their counterparts in developing countries.

Globalization is presumed to make it more difficult for governments to carry out equitable policies. To the extent that capital is more mobile than labour, the incidence of taxes to finance safety nets for those groups who are adversely affected by globalization, is shifted to labour. What therefore should be our policy responses?

The primary goal of policy makers has generally been the achievement of sustainable growth. Fiscal policy – taxation and spending – is a government’s most direct tool for redistributing income in both the short and long run. The expenditure side of the budget has offered better opportunities than the tax side for redistributing income. Expenditure on health and education is an avenue through which governments can influence the formation and distribution of human capital, and in the process reduce income inequality over time. As a general guide public expenditure should only displace private expenditure when it yields higher social benefits.

Equity and growth can be complementary; some policies that promote equity, particularly investment in human capital can boost growth in the long run and alleviate extreme poverty and increase social cohesion. A consensus is now forming that governments should sometimes intervene not only to ensure that the size of the national pie increases, but that everyone gets a fair share.

At independence in 1947 India took a policy decision that the new nation would focus heavily on education and training. The fruits of such investments do take time to bear results, but in the latter part of the twentieth century India began to produce outstanding mathematicians, scientists and engineers. It is no coincidence therefore that Bangalore in India has grown to be one of the premier regions for software development across the globe.

The foundations had been laid generations earlier. Ireland, another haven for software development took a shorter time to reap the benefits of its investment because of its location in Europe. It seems that St. Vincent and the Grenadines is just starting to lay its own foundations, which will of necessity take time to germinate and bear fruit.

Success will however require that all hands be on board, with contributions from both private and public sectors. And with the growth that is being anticipated for the economy in the coming decade issues relating to equity must take centre stage.